FUNDING TRUSTS: ASSET PLANNING & FINANCING DISTRIBUTIONS

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1 FUNDING TRUSTS: ASSET PLANNING & FINANCING DISTRIBUTIONS First Run Broadcast: May 2, 2017 Live Replay: February 5, :00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes) Having a trust is only the first step of an effective estate plan. The practical steps of actually funding the trust is something that s often overlooked and is a more complex process than at first appears. Different asset classes financial assets, stakes in family businesses, unique objects like art, real estate, etc. are governed by different methods and rules of assignment. Some assets IRAs, 401(k) accounts, certain types of insurance can t be transferred at all, or only in narrow circumstances. Planners must also provide banks or other financial institutions detailed funding instruction letters and certify trustees. If any of these funding steps are overlooked or not carefully performed, client trusts will fail of their essential purposes. This program will provide you with a practical guide to many and complex steps of funding trusts. Planning for funding trusts and how to avoid mistakes Identifying funding sources and potential assignment and other problems with each Drafting instruction letters and trustee certifications Specific issues of working with banks on funding issues Assignment of interests business interests, real estate, financial interests, unique objects Treatment of certain assets that are non-assignable retirement benefits, insurance contracts, annuities Tax planning issues involved with funding trusts Speaker: Michael Sneeringer an attorney in the Naples, Florida office of Akerman, LLP, where he has a national practice focusing on trust and estate planning, probate administration, asset protection planning, and tax law. He has served as vice chair of the asset protection planning committee of the ABA s Real Property, Trust and Estate Section and is an official reporter of the Heckerling Institute. Mr. Sneeringer received his B.A. from Washington & Jefferson College, his J.D., cum laude, St. Thomas University School of Law, and his LL.M. from the University of Miami School of Law.

2 VT Bar Association Continuing Legal Education Registration Form Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT Fax: (802) PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name Middle Initial Last Name Firm/Organization Address City State ZIP Code Phone # Fax # Address Funding Trusts: Asset Planning & Financing Distributions Teleseminar February 5, :00PM 2:00PM 1.0 MCLE GENERAL CREDITS VBA Members $75 Non-VBA Members $115 NO REFUNDS AFTER January 29, 2018 PAYMENT METHOD: Check enclosed (made payable to Vermont Bar Association) Amount: Credit Card (American Express, Discover, Visa or Mastercard) Credit Card # Exp. Date Cardholder:

3 Vermont Bar Association CERTIFICATE OF ATTENDANCE Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: February 5, 2018 Seminar Title: Location: Credits: Program Minutes: Funding Trusts: Asset Planning & Financing Distributions Teleseminar - LIVE 1.0 MCLE General Credit 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

4 Funding Trusts: The Tips and Traps of Ensuring Client Goals Presented By: Michael A. Sneeringer, Esq. 1 Akerman LLP Naples, Florida (239) michael.sneeringer@akerman.com

5 Table of Contents I. Introduction: Planning for funding trusts and how to avoid mistakes...1 II. Identifying funding sources and potential assignment and other problems with each...3 III. Drafting instruction letters and trustee certifications...5 IV. Specific issues of working with banks on funding issues...6 V. Assignment of interests business interests, real estate, financial interests, unique objects....6 VI. Treatment of assets that are non-assignable retirement benefits, insurance contracts, annuities...7 VII. Tax planning issues...8 VIII. Conclusion...10 ii

6 I. Introduction: Planning for funding trusts and how to avoid mistakes An attorney reading this outline and listening to the accompanying presentation probably knows what a trust is and has created a trust. However, what kind of a trust did the attorney create? Is there a timeframe to put assets in this trust? Why did the attorney create this trust for the client? This outline will focus on trust funding. While the author is a licensed Florida attorney, since attorneys may be reviewing this outline from multiple jurisdictions, the author will use the Uniform Trust Code as a guide in describing and defining certain terms when applicable. A. Key Terms. Generally, a trust is created by either: (1) transferring property to another person or entity (a trustee) during the grantor s lifetime or upon his or her death; (2) declaration by the owner of property; or (3) the exercise of a power of appointment in favor of a trustee. 2 To create a trust, a grantor must have capacity to create it, the grantor must indicate an intention to create it, the trust must have a defined beneficiary (or, be a charitable trust or pet trust), the trustee must have duties to perform and the same person is not the sole trustee and beneficiary. 3 While there exists the concept of an oral trust, generally, the grantor executes (through a writing whereby a typed document is presented to the grantor and trustee to sign, sometimes in front of witnesses and a notary, and other times not) an instrument that contains the terms of the trust, including any amendments thereto (referred to as a trust instrument ). 4 Once the trust is created, often the next step is to fund it. 5 There are times when an irrevocable or revocable trust is funded immediately, or there are times when a trust is created at the death of the grantor (or funded only upon the grantor s death). Funding is a term of art used to describe the movement of title of assets from one form of title to the trust. The trustee of the trust becomes the de-facto owner of the trust assets as the trustee is the custodian of the assets for the benefit of the beneficiaries. The person who transfers assets to a trust is coined the transferor or assignor. This can be the grantor of the trust, or it can be somebody else. For example, when assets are decanted or moved from one trust to another, while the assets may come from the grantor of the first trust, the second trust may have been declared by the trustee, instead of the original grantor. B. Planning for Funding Trusts. When a client walks into an attorney s office and decides he or she wants to create a trust, once the threshold question of whether the trust will be funded during the client s lifetime or upon his or her death is answered, the major point to focus on next is what should be transferred to the trust. This is not an easy decision. 1. Inter Vivos. An inter vivos trust is created during the grantor s lifetime. An inter vivos trust funded during a client s lifetime may take several forms: revocable trust, irrevocable trust, incomplete gift and completed gift. a. Revocable Trust. A trust is revocable where the grantor retains the power to revoke or terminate the trust. Clients will fund a revocable trust during their lifetimes with two goals in mind: avoiding probate and planning for incapacity. Assets in a revocable trust avoid probate and thus negate excess fees and expenses. In avoiding probate, a client may be able to keep his or her testamentary intent a secret from the public for generally a will becomes public record upon its receipt by the probate court while a trust would only be public record if it were a party to a lawsuit or became part of a trust administration. Planning for incapacity deals with the fact that where assets have already been transferred to a revocable trust prior to a client s incapacity, upon the client s incapacity, he or she will have provided a mechanism for continuing distributions to or for the benefit of the client/grantor, 1

7 while also choosing the proper person to continue administering the trust as trustee. There are, of course, other ways of addressing asset management in case of incapacity such as appointing a legal guardian for the client, or utilizing an attorney-in-fact under a power of attorney to manage the client s assets. However, a revocable trust gives the grantor control over the disposition of assets both during lifetime and upon incapacity since the grantor in essence will be able to pick a responsible person to serve as successor trustee. Unlike a power of attorney, the trust affords the grantor s agent more flexibility. Additionally, a guardianship proceeding to appoint a legal guardian is time-consuming and expensive. Often, a gun or firearms trust is simply a revocable trust that becomes irrevocable upon the grantor s death. This flexibility allows a gun owner to easily make changes to such trust s fiduciaries and beneficiaries (based on each s ability to possess a firearm) as well as the firearms owned by the trust. 6 b. Irrevocable Trust. At its very core, an irrevocable trust is a trust that cannot be modified, terminated or amended. As laws have evolved, what an irrevocable trust is has become murky. For example, many states have enacted decanting laws that essentially render the decanted trust useless (there is now even a Uniform Trust Decanting Act 7 ). Special needs trusts are often drafted with flexibility so that if federal laws change with regards to benefits for disabled persons, a trustee or trust protector can amend the trust solely to comply with the changed federal law (with the goal to not jeopardize a beneficiary s federal aid). Additionally, irrevocable trusts meeting a certain dollar threshold can be judicially terminated. 8 Irrevocable trusts are funded with a wide variety of assets including life insurance policies (i.e., an irrevocable life insurance trust or ILIT ), marketable securities, real property, interests in closely held businesses, automobiles, artwork, and aircraft, among other assets. Grantor retained annuity trusts ( GRATs ), qualified personal residence trusts ( QPRTs ) and charitable trusts are often irrevocable. Funding an irrevocable trust may take the form of either an incomplete gift or completed gift for federal gift tax purposes. c. Incomplete gift. Generally, transfers to trusts are structured to qualify as incomplete gifts for Federal gift tax purposes where grantors of such trusts plan to transfer assets to the trust in excess of the $5,490,000 (for 2017) lifetime gift tax exemption amount available under Section 2505 of the Code or desire to maintain a level of control over the administration of the trust. Section 2501 imposes a tax on the transfer of property by gift. The gift tax imposed under Section 2501 applies whether the transfer is in trust or otherwise, whether the transfer is direct or indirect, and regardless of the property transferred. 9 Nonetheless, the gift tax under Section 2501 is imposed only if a donor parts with such dominion and control over the property in a manner that renders the gift complete. 10 If, upon a transfer of property, the donor reserves any power over its disposition, the gift may be wholly incomplete, or it may be partially complete and partially incomplete, depending upon all the facts in the particular case. 11 Treasury Regulation (b) provides in part that if a donor transfers property to another in trust to pay the income to the donor or accumulate it in the discretion of the trustee, and the donor retains a testamentary power to appoint the remainder among his descendants, no portion of the transfer is a completed gift. While proper structuring of an incomplete gift trust is outside the scope of this outline, there are several practical approaches to funding an incomplete gift trust. Under most circumstances, a trust funded with an incomplete gift should not contain assets which are speculated to appreciate at some point in the future. This is because a more practical approach would be to fund a completed gift trust with such assets as the grantor can take advantage of 2

8 using an estate freeze like technique by locking in a low valuation on assets which the grantor does not need or will likely not use to sustain his or her lifestyle, while the assets appreciate in the trust for future beneficiaries. Where wealth preservation is important and using up a grantor s unified credit amount is not, an incomplete gift trust can be funded with assets such as a grantor s closely held business, marketable securities, or real property, among others. The key here is that the trust is properly structured to take advantage of laws applicable to domestic or foreign jurisdictions. Then, once a jurisdiction is chosen, the grantor needs to be aware of other factors which could hinder the funding of such a trust. For example, a foreign trust cannot hold S corporation stock. As such, if the closely held business is an S corporation for federal tax purposes, the grantor is limited to transferring that asset to a domestic trust. Likewise, if the assets consist of marketable securities in a Swiss brokerage account, a foreign trust could be a better vehicle to transfer such assets. d. Completed gift. A gift is complete to the whole or any part of property where a grantor has so parted with dominion and control as to leave him or her no power to change its disposition. 12 Where a gift is complete, generally a tax is imposed. 13 A completed gift trust is generally thought of to be funded with assets that will appreciate in value in the future, as opposed to more speculative investments or investments that the grantor needs to keep to support himself. For example, a client s closely held business that he expects will appreciate would be better to transfer to a completed gift irrevocable trust, as opposed to the client s brokerage account that he uses to pay bills. Clients who want to use all of their unified credit amount during their lifetime will transfer closely held business interests to a completed gift trust after the interest has been valued by a quality appraiser who then takes into account discounts in order to leverage the gift so that the client is able to transfer as much of the interest to the trust as he can, up to $5,490,000 (for 2017) Testamentary Trust. A testamentary trust is created upon a testator s death pursuant to a direction in such testator s will. The most basic example is a will that conditionally provides for continuing trusts, usually when the grantor s beneficiaries are minors, incompetent or elderly. This differs from the pour-over will/revocable trust concept described above. The testamentary trust will be funded with any assets owned by the testator in his or her individual name. If the trust was created because the beneficiary was a minor, the trust will end once the beneficiary reaches the age of majority stated in the will. If the trust was created because the beneficiary was incompetent, the trust can end once the beneficiary is adjudicated competent (or is deemed competent based on doctors evaluations, depending on the terms of the will and governing law state). The testamentary trust created for an elderly beneficiary will generally end on such beneficiary s death. The remainder beneficiaries are usually the testator s descendants. II. Identifying funding sources, potential assignments and problems with each Even before the client creates any one of the trusts described in I.B.2. above, the attorney needs to have formulated a plan of what assets are to be transferred to the trust. A couple of themes described above translate to this section as well. As noted above, a client s appreciating business is the classic example of an asset to fund a completed gift irrevocable trust. Insurance is another classic example where an irrevocable trust is created to both own and be the beneficiary of the policy. To identify funding sources, the attorney should have the client fill out an intake form. It may not be prudent to do this until an engagement letter has been sent to the client for in the author s experience, a client may be hesitant to provide this information prior to becoming a client of the attorney s firm. The client needs to be very specific on the intake form. Likewise, 3

9 the attorney needs to carefully review the form. The attorney cannot check his or her common sense at the door. For example, if the client drives exotic cars and does not report his or her car collection on the intake form, the attorney needs to be sure to make note of this and follow-up with the client on the veracity of the form. Specific assets to pay attention to are closely held business interests, insurance, retirement account assets, annuities and promissory notes. When the attorney sees these listed, it is best to ask the client for further information: a copy of an operating agreement for a closely held business interest; a confirmation of the annuity, retirement account and life insurance policy s beneficiary designation and ownership; and a copy of the promissory note. These documents are necessary to ensure whether a new trust should be created to own such asset. For example, an operating agreement which has a prohibition from the client transferring a closely held business interest to a trust may render creating such trust useless. Additionally, clients may already have their life insurance policies held by trusts, and creating a new trust may be counterintuitive. Once the potentially assignable asset is determined, the type of trust to be created can be decided. For example, life insurance is not going to be transferred to a GRAT; likewise, a trust structured as an ILIT is not going to hold firearms. Specific trusts are created with certain terminology to comply either with state law or the Internal Revenue Code (the Code ). For example, a QPRT has certain provisions drafted in it to comply with the Code; if those provisions are omitted, the purpose of the trust is rendered useless. 15 Other trusts, such as pet trusts, are state specific. 16 Avoiding assignments that trigger an adverse taxable event is encouraged. 17 There are many problems that can pop up during the funding process. While this is not an exhaustive list of trusts and their problems, some illustrations are necessary: A. ILIT. The biggest problem with an ILIT is not assigning enough cash annually to keep up the premium payment. Clients will often circumvent the formalities of the trust and pay the insurance premiums directly themselves, instead of using the trustee. If not remediated properly, this becomes a taxable gift from the grantor (instead of taking advantage of a trust s Crummey withdrawal rights). 18 Another funding problem is the beneficiary and ownership. The attorney should initially help the client with the policy application process to ensure proper titling. If it is an existing policy being transferred, the attorney should take care to avoid the inclusion of the policy in the decedent s gross estate under Code Section 2035 by properly structuring a sale to the newly created ILIT, as opposed to simply filling out a change of beneficiary designation form. Some clients may rather take the gamble and assign the policy, as opposed to paying the attorney to draft sale documents (in conjunction with using the policy s interpolated reserve value as the sales price). The attorney s job is to explain all of the risks to the client and help him or her make an informed decision. B. Retirement Accounts. Beneficiary designations are one of the biggest issues for attorneys. Clients often ask their attorney to fill out the beneficiary designation form naming a trust as the beneficiary. The complication here is that it is the author s experience that unlike insurance policy designation forms, retirement account companies have trouble accepting a client s retirement account beneficiary designation form where the attorney fills out the form with any more information than just the name of the trust. For example, the author tends to type see attached on the line corresponding to change of primary beneficiary and attach a specific statement regarding which provisions of the trust apply to the named primary beneficiary or primary beneficiaries. Some brokerages allow this; others will reject the form and direct that the 4

10 beneficiary designation form solely name a trust or human being. If the brokerage will not accept the form with a see attached designation, the client can choose between moving the account or just naming the trust itself. With a specific retirement asset such as an individual retirement account ( IRA ), the client may be better off taking advantage of leaving the beneficiary as the client s spouse outright, instead of naming a trust. While a discussion of such a decision is outside the scope of this article, there are tax and non-tax reasons why an outright designation for an IRA is preferred. C. GRATs. Funding a GRAT is usually seamless. It is the annual upkeep of a GRAT that trips up clients, advisors and attorneys. In a typical GRAT, the lifetime beneficiary (the grantor) receives an annual payment in accordance with the terms of the trust (usually by a specific date, i.e. the day before the anniversary date of the GRAT). The problem is that often advisors and clients fail to coordinate the payment by the due date. Not administering the GRAT in accordance with its terms could cause tax issues and hinder its purpose. D. Revocable/Testamentary Trusts. Once a revocable trust becomes irrevocable or upon the creation of a testamentary trust, the trustee should take great care to fund it as soon as possible. Certain issues can hinder the speedy funding of a testamentary trust. For example, if the assets are transferred from the grantor s estate, certain assets may need a court order to move from one form of ownership to another (such as real property, cash or marketable securities). III. Drafting instruction letters and trustee certifications A. Instruction Letters. An instruction letter for funding a trust can take various forms. Once a client has signed a trust (revocable or irrevocable), the drafting attorney will provide the client with an instruction letter that may also be known as a funding letter or funding memorandum. This letter describes the transaction, what was signed and how to title assets in the name of the trust. This letter is generally accompanied with a sample letter to the trustee that the grantor can use to fund his or her trust. If the signed trust is irrevocable, generally its funding will be part of a transfer or planning concept (such as funding a GRAT, QPRT, etc.). In this case, where the transfer is of specific assets and for a specific purpose (usually to an irrevocable trust in the form of an incomplete or completed gift), the letter will discuss the transfer and the accompanying tax reporting necessary to properly report the transfer to the IRS. If the signed trust is revocable (or if the signed will creates a testamentary trust), funding does not take place right away. The letter will paint a broader picture of what assets can be transferred to the trust and how the trustee should go about completing such transfers. This letter will not so much discuss the tax aspects, as it will instruct the grantor and trustee on how to administer and fund in the future. This letter is written as if the attorney will not be available for questions at the time of funding. In the author s experience, this differs from an irrevocable trust because the attorney will generally be hands on in funding an irrevocable trust during a client s lifetime. B. Trustee Certification. Banks and other third parties will ask for a copy of the trust instrument prior to creating an account or completing an assignment of interest with the trust. To protect the privacy of the grantor and beneficiaries, the Uniform Trust Code outlines a procedure whereby a certification of trust may be furnished in lieu of the full trust instrument. 19 The official comments to the Uniform Trust Code indicate that a trustee certification provision was included to protect the privacy of a trust instrument by discouraging requests from persons other than beneficiaries for complete copies of the [trust] instrument in order to verify a trustee s 5

11 authority. 20 The procedure entails creating a document for signature by the trustee in the presence of a notary which contains at least the following information: 1. States that the trust exists; 2. The date the trust instrument was executed; 3. The identity of the grantor; 4. The identity and address of the current trustee; 5. The powers of the trustee; 6. The revocability or irrevocability of the trust and the identity of any person holding a power to revoke the trust; 7. The authority of cotrustees to sign or otherwise authenticate; 8. Whether all or less than all of the trustees are required in order to exercise their powers; 9. The trust s taxpayer identification number; 10. The manner of taking title to trust property. 21 IV. Specific issues of working with banks on funding issues The trustee will often want to open a bank account for the trust. In working with a bank to open an account, the trustee should be prepared to either turn over a fully executed copy of the trust or a trustee certification. Realistically, there should be no difference in service when a corporate fiduciary is trustee of the trust as opposed to an individual. However, it is the author s experience that a corporate fiduciary tends to have an easier time dealing with banks based on a corporate fiduciary s team approach, across the board experience and sheer manpower. A. Human Trustee. An individual trustee will have a larger workload and may charge greater trustee fees. This is because often, an individual will bill hourly for services as opposed to an annual fee based on the percentage of the account assets. The grantor will have to trust such trustee as he will have access to all account information. The human trustee also has to keep abreast of the various tax filing deadlines (federal and state). B. Corporate Fiduciary as Trustee. As previously described, a corporate fiduciary will charge its fees typically based on a percentage of the assets under management. If the corporate fiduciary has a banking arm, the trustee fees and bank account fees may be combined into one fee. A corporate fiduciary will have an easier time focusing on the duties of being a trustee as opposed to an individual who may or may not function as a fiduciary for a living. A corporate fiduciary has deeper pockets for purposes of liability should it be liable to the grantor or beneficiaries in a tort action. Additionally, a corporate fiduciary will most likely have a comprehensive system to remind itself when taxes and other deadlines come due. V. Assignment of interests business interests, real estate, financial interests, unique objects A. Business Interests. Business interests may come in the form of an active business, a family owned company or a speculative interest (such as an interest in venture capital). Funding a trust with an active business is the most tricky. For starters, many lawyers lack the sophistication to properly assign such an asset which may be subject to state and federal law. For example, transferring an interest in an alcohol distributor could come under scrutiny as typically states grant licenses or may have laws in place regarding who may own an interest in such a business. Closely held businesses generally are a better asset to transfer in trust, especially where the goal is to transfer a growing business asset to future generations. Where the business is speculative or the grantor is looking to receive warrants or future profits (i.e., 6

12 following an investment in a technology startup), a trust would prove to be a perfect vehicle to receive the interests prior to their increase in value. B. Real Estate. The most common real estate transaction with a trust involves the creation of a QPRT for grantors to assign their interest in an appreciating property (sometimes a vacation home or second property). The attorney and client need to decide whether the trust should directly own the property or whether a disregarded entity (e.g., a single-member LLC) should initially take title to the property, followed by an assignment of the disregarded entity interest to the trust. Where there are foreign beneficiaries of a United States ( U.S. ) trust and such trust sells real estate with a U.S. situs the Foreign Investors in U.S. Real Property Tax Act ( FIRPTA ) may apply. 22 C. Financial Interests. As described throughout this outline, financial interests are typically used to fund trusts. These may include a portfolio of marketable securities, cash, bonds, and an insurance policy (i.e., through an ILIT). Additionally, trusts may be designated as the beneficiary of certain retirement accounts upon the principal s death (see discussion, below). Where the bank account is in a foreign country, certain additional filing requirements are necessary. Often the grantor will make only one gift and subsequently leave the trust assets alone to let them grow. Subject to income, gift and generation-skipping transfer taxes, this one time gift is best utilized to beneficiaries such as children and grandchildren. D. Unique Objects. Automobiles, furniture, furnishings and other non-valuable personal effects (i.e., tangible personal property) should become part of a statement of tangible personal property and disposed of pursuant to the client s will. Where such assets are more valuable, generally, they will be owned by a disregarded entity (a single-member limited liability company), and such disregarded entity will have a trust as its sole member. Such valuable assets include, but are not limited to: horses, exotic cars, art and jewelry. Additionally, clients may also have unusual collections that would similarly be an appropriate asset for a trust (e.g., a handbag collection, stamps, comic books). VI. Treatment of assets that are non-assignable retirement benefits, insurance contracts, annuities. The disposition of certain assets upon death is determined based on contractual principals as opposed to a direction in a will or trust. The assets in such category include, but are not limited to, retirement benefits, insurance contracts and annuities. A. Retirement Benefits. The words retirement benefits may include, but is not limited to, certain pension agreements, 401(k) plans or IRAs. The disposition of these assets is controlled not by the direction in a decedent s will or trust, but by the terms of the retirement plan itself. For example, many pensions expire either at the decedent or surviving spouse s death. A 401(k) plan or IRA s disposition is generally based on what the beneficiary designation form indicates. The disposition of retirement benefits that continue at death (i.e., 401(k) and IRA) is tax driven. Generally, the first beneficiary, for such retirement plan accounts should be outright to the surviving spouse. While such a tax driven discussion is outside the scope of this outline, the surviving spouse most likely enjoys income-tax advantages that are lost if a trust becomes the primary beneficiary of such accounts. On the other hand, it may be appropriate to designate trusts created for children as contingent beneficiaries in the event that the spouse does not survive the decedent. In conjunction with funding retirement benefits, it is recommended that the client consult with not only the drafting attorney, but also his or her accountant or other tax adviser before such designation is made. 7

13 If certain requirements are met, the IRS allows the beneficiaries of a trust to be treated as the designated beneficiaries of the client s 401(k) plan or IRA, which will preserve the right to pay the death benefits over the lifetimes of the trust beneficiaries. A discussion on such stretchout treatment is outside the scope of this outline; however, there are certain rules that must be followed to garner such treatment. B. Insurance Contracts. As previously noted, a life insurance policy is generally owned by an ILIT, and the ILIT is the beneficiary of said policy. The ILIT structure is not for everyone due to cost and ongoing maintenance. In such case, a revocable trust that becomes irrevocable upon death or a testamentary trust is the proper vehicle to be the ultimate beneficiary of the policy. The lawyer and client need to work closely with the client s insurance advisor to make sure that the insurer receives a completed beneficiary designation form, naming the trust as the beneficiary. C. Annuities. Like retirement benefits, the initial beneficiary of tax-deferred annuities should be the surviving spouse, followed by a properly structured revocable or testamentary trust. VII. Tax planning issues When funding a trust, the attorney needs to advise the grantor on income tax, gift tax, estate tax and generation-skipping transfer tax. Once the trust is funded, depending on the type of trust, certain federal tax and informational returns may be necessary. If the trust is classified as a foreign trust or has a foreign bank account over a certain dollar threshold, the trustee will need to file additional returns. Certain tax related forms for trusts include, but are not limited to: A. Form 709. A grantor must report a transfer to his trust, domestic and foreign, on a Form 709 U.S. Gift (and Generation-Skipping Transfer) Tax Return (a Gift Tax Return ). 23 A Gift Tax Return will need to be filed whether the gift is designed as an incomplete gift (the donor of the trust property has retained such dominion and control (within the meaning of Treasury Regulations ) over the assets transferred to the trust as to render the gift incomplete for federal gift tax purposes) or completed gift (the donor has not retained dominion and control over the assets transferred to the trust). 24 B. Form 1041 and Form 1040NR for Trusts. The trust, whether domestic or foreign, should file its own Form The trustee of the trust is required to file a statement referred to as a grantor trust information letter. This statement must be attached to the Form 1041 to report the income of the trust. The form and attached statement should be filed with the appropriate IRS Service Center by the fifteenth day of the fourth month following the close of the taxable year of the trust. If the trust is a grantor trust, this will correspond to the grantor s taxable year. The person preparing this return for the trust should check the box in the upper left corner of the return to indicate that the return is for a grantor-type trust or for a complex type trust, as the case may be. No income should be reported by the trust on its Form 1041 if the trust is a wholly owned grantor trust. Instead, the return for the trust should identify its grantor as the person to whom the income, deductions, and credits of the trust are taxable. C. Form Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts is used to report the information required by Section 6048 of the Code. A U.S. person who establishes a foreign trust or transfers assets to a foreign trust must report the establishment of the trust or the transfer of assets to it on a Form The Form 3520 is also required to be filed on an annual basis by the grantor of a foreign trust. The return is required to be filed annually with the IRS Service Center even if the grantor 8

14 did not make any transfers to the trust during the applicable period. The penalty for failing to file this return is thirty-five percent (35%) of the amount transferred. 26 Furthermore, additional ten thousand dollar ($10,000) penalties may be imposed throughout each 30-day period (or fraction thereof) for persisting in failing to file such a return after notice is received from the Service. 27 The Form 3520 is due to be filed on the date that the personal income tax return is due for the grantor (typically, April 15). D. Form 3520-A. A Form 3520-A is used to report the information required by Section 6048(b) of the Code. A U.S. person who is treated as the owner of a foreign trust under the grantor trust rules is responsible for ensuring that the trustee of a foreign trust files a Form 3520-A annually. The trustee of the foreign trust is responsible for filing this return; however, the penalty for failing to file this return is enforced against the grantor of the trust. 28 The penalty for failing to file this return is 5% of the trust assets that are treated as owned by the grantor. 29 Furthermore, additional ten thousand dollar ($10,000) penalties may be imposed each 30-day period (or fraction thereof) for persisting in failing to file after receipt of notice from the IRS. 30 It is important to note that this return is due by the fifteenth day of the third month following the close of the grantor s tax year (unless the return is extended pursuant to Form 7004). In practice, many return preparers fail to recognize that the due date for this return is one month before the due date of the grantor s personal income tax return, resulting in potential penalties. E. Foreign Trust Statements. The trustee of a foreign trust that is a grantor trust is required to provide a Foreign Grantor Trust Owner Statement to the U.S. grantor when the trustee files Form 3520-A. (This form is included on page 3 of Form 3520-A.) At present, it appears that no noncompliance penalty is applicable for failure to comply with this rule. Additionally, the taxpayer is supposed to notify the IRS of any inconsistency between the taxpayer s income tax return and the information contained in the Foreign Grantor Trust Owner Statement. 31 F. Form 1040NR and 1042-S. Over the past decade, the IRS has intimated that it will one day issue a Form 1041NR for use by foreign trusts filing U.S. tax returns. At present, the IRS has not published this form. When this form is published, it may become the most appropriate form for a foreign trust to file annually. 32 It should also be noted that the instructions to Form 1040NR currently provide that it should be used to report the income of a foreign trust. The first page of Form 1040NR also provides a box for the taxpayer to check indicating whether the taxpayer is an individual or an estate or trust. A Form 1042-S is required in certain cases to report distributions of U.S. source income to a non-u.s. person. G. Authorization of Agent Agreement. For a foreign trust, an Authorization of Agent Agreement should be filed to notify the IRS regarding who is appointed to serve as the U.S. agent of the trust. The name, address, and taxpayer identification number of the U.S. agent must be included on Forms 3520 and 3520-A. H. FinCEN Form 114 (Report of Foreign Bank and Financial Accounts) and Other Filing Related to Foreign Accounts. FinCEN Form 114 must be filed by U.S. persons to report certain information regarding a financial interest in, or signature authority over, foreign financial accounts, including accounts held in a foreign trust in certain cases. With regard to trusts, a U.S. person has a financial interest in foreign financial accounts for which the owner of record (or holder of legal title) is one of the following: (1) A trust of which the United States person: (i) is the trust grantor and (ii) has an ownership interest in the trust for United States federal tax purposes. 9

15 (2) A trust in which the U.S. person has a greater than 50 percent present beneficial interest in the assets or income of the trust for the calendar year. For tax year 2016, the Report of Foreign Bank and Financial Accounts (the FBAR ) must be filed by April 15 th of the succeeding year (that is, April 15, 2017) with the Department of the Treasury, with a maximum extension for a six (6)-month period ending on October 15 th. 33 It should be noted that Section 6038D of the Code imposes similar reporting requirements. 34 The FBAR is only available electronically through the BSA E-Filing System, which allows the filer to enter the calendar year reported, including past years, on the online FinCEN Report 114. I. Form Form 8938, Statement of Specified Foreign Financial Assets, is generally required if an individual U.S. person (including residents, certain nonresident aliens, and residents of Puerto Rico or a U.S. possession) files a federal income tax or information return with the IRS and had an interest in a foreign financial account or asset that exceeded $50,000 on the last day of the tax year or seventy-five thousand dollars ($75,000) at any point during the year. 35 The reporting is done on Form 8938 and, commencing with returns filed in 2012, is attached to the annual return for tax years beginning after March 18, Id. It is proposed (but not yet required), that Form 8938 be filed by domestic corporations, partnerships, and trusts, as specified in regulations that have not yet been issued. It appears the intent is to require reporting by entities that may be used by individuals to hide assets. J. Foreign Trust Beneficiary Statement. A U.S. beneficiary of a foreign trust must provide the IRS with information regarding the proper tax treatment of any distributions from the trust. In this regard, the trustee of a foreign trust must furnish (as applicable) a Foreign Grantor Trust Beneficiary Statement (included on page 4 of Form 3520-A) or a Foreign Nongrantor Trust Beneficiary Statement to any U.S. beneficiary who receives a distribution from the trust during the year. The statements must be furnished to the U.S. beneficiary by the fifteenth (15 th ) day of the third (3 rd ) month following the close of the trust s taxable year. (In the case of a grantor trust, this will correspond to the grantor s taxable year.) A U.S. beneficiary of a foreign grantor trust with a U.S. grantor should also notify the IRS of any inconsistency between the U.S. beneficiary s income tax return and the information contained in the Foreign Grantor Trust Beneficiary Statement. K. Examples of State Filings. Generally, there are no filings for trusts at the state level in states such as Nevada, Florida, South Dakota or Delaware. However, Alaska imposes a duty to register trusts. 36 VIII. Conclusion Funding is merely part of the overall trust process. It can be the easiest or hardest part, depending on facts and circumstances. One final note, with any trust related matter there are certain steps to consider: A. Think carefully: be prepared to adroitly review a potential client s financial picture, as well as learn the client s family dynamics, in order to come up with a plan of action to discuss with the client. B. Communicate clearly: clearly communicate the plan of action to the client using concepts and terms that the client will understand. C. Be persistent: after communicating the plan, follow-up with the client in order to ascertain whether the client will go through with the plan (i.e., sign and fund the trust). D. Be patient: the client may take days, months or years before he or she decides to go through with the plan. 10

16 E. Use blue ink: the client is ready to initiate the plan; it might be easiest if the client signs off on the plan using a blue ink pen (i.e., sign the trust using a blue pen) (note: blue ink is not required; it is the author s preference). F. Process: once the documents are signed; scan and copy the signed documents, including any trusts. G. Vault: determine whether the original documents, such as any trust instruments, should remain with the attorney at his law firm s vault, or remain with the client. H. Create letter: create the funding letter to review why the trust was created and outline the next steps. I. Taxes and reporting: pay any taxes associated with the funding and report the transfer of assets as necessary. J. Follow-up annually: make sure the trust was funded or that required annual actions took place. 1 Portions of this outline are taken from: Michael Sneeringer, Trusts, Lexis Practice Advisor, Florida Business and Commercial Module (Jan. 27, 2017); Stephan R. Leimberg, et. all, The Tools & Techniques of Trust Planning (National Underwriter ed.) (2016). 2 Unif. Trust Code Id. at 402(a). 4 Id. at 103(19). 5 This outline will not address unique or complicated trust structuring. 6 See generally Michael A. Sneeringer, Gun Trusts What s All the Fuss?, 31 Prob. & Prop. 11 (Mar./Apr. 2017). 7 See Uniform Trust Decanting Act, Nat l Conf. of Commissioners on Unif. State Laws, July 2015, 8 Unif. Trust Code I.R.C. 2511(a). 10 Treas. Reg Treas. Reg (b). 12 Id. 13 I.R.C A discussion on formula gifting is outside the scope of this article. See Paige K. Ben-Yaacov, Formula Clauses: Are Two Donees Better Than One?, 29 Prob. & Prop. (Nov./Dec. 2015). 15 See e.g., Jonathan E. Gopman, et. al., In re Ferrante: Not Modifying Trust to Comply with Tax Law Creates Bankruptcy Nightmare, LISI Asset Protection Planning Newsletter #311, Nov. 10, 2015, available at leimbergservices.com. 16 Unif. Trust Code This described in more detail in Section VII, below. 18 See discussion at Jonathan E. Gopman, et. al, Mikel v. Commissioner: Another Crummey Result for the IRS, LISI Estate Planning Newsletter #2301, Apr. 14, 2015, available at leimbergservices.com. 19 See Unif. Trust Code Nat l. Conf. of Commissioners on Unif. State Laws, Uniform Trust Code 184 (2010), 21 Unif. Trust Code 1013(a). 22 See IRS, Definitions of Terms and Procedures Unique to FIRPTA, Sept. 2, 2016, (last visited Apr. 28, 2017). 23 See I.R.C See Regs (j) and Regs I.R.C. 6677(a). 27 I.R.C. 6677(a). 28 I.R.C. 6677(b)(1). 29 See I.R.C. 6677(a), (b)(2). 11

17 30 I.R.C. 6677(a), (b)(2). 31 See I.R.C. 6048(d)(5), 6034A(c). 32 See McNamara, New Foreign Trust Tax Form Project: 1041NR, 38 The Tax Adviser 516 (Sept. 2007). 33 See H.R. 3236, Sec. 2006(b)(11). 34 See Weller & Gonzales, Final Regulations on Specified Foreign Financial Asset Reporting By Domestic Entities, Steve Leimberg s International Tax Planning Newsletter #7 (Apr. 20, 2016). 35 I.R.C. 6038D. See Internal Revenue Bulletin See Alaska Stat

18 Funding Trusts: The Tips and Traps of Ensuring Client Goals Michael A. Sneeringer, Esq. 1

19 Introduction Key Terms Planning for Funding Trusts o Inter Vivos Revocable Trust Irrevocable Trust Incomplete Gift Completed Gift o Testamentary Trust 2

20 Identifying Funding Sources and Potential Assignments Formulate a Plan Client Intake Form Specific Assets to Pay Attention to: Closely Held Business Interests Insurance Retirement Account Assets Annuities Promissory Notes 3

21 Problems with Identifying Funding Sources and Potential Assignments ILIT Retirement Accounts GRATs Revocable/Testamentary Trusts 4

22 TRANSFER IN TRUST TO: TRUSTEE, as Trustees of the GRANTOR Revocable Trust, U/A/D May 2, 2017 In accordance with Article 2 of the above designated GRANTOR Revocable Trust, created under Agreement dated May 2, 2017, whereby the Grantor reserves to himself or any other person the right to add at any time to the principal of the Trust therein created, I, GRANTOR, do hereby give, assign and transfer unto the Trustees of the GRANTOR Revocable Trust the following property: [Describe property] Drafting Instruction Letters (Sample Letter to Trustee) I DO FURTHER DECLARE that the above-described property is to be held, administered and distributed as part of the GRANTOR Revocable Trust. SIGNED this day of, 20. GRANTOR (Signature of GRANTOR) 5

23 Drafting Trustee Certifications ( Sample Certification for Real Property Purchase & Sale) STATE OF COUNTY OF CERTIFICATION OF TRUST BEFORE ME, the undersigned authority, personally appeared ("Affiant") who deposes and says: 1. This Certification pertains to the following trust (insert name of trust and reference any amendments thereto (the Trust ). 2. The Trust, executed on, currently exists and has not been revoked, modified or amended in any manner. 3. Title to the trust property described on Exhibit A attached hereto and made a part hereof (the Property ) is currently vested as follows:. 4. The conveyance or mortgage by the trustees of the Trust in favor of the following purchaser or lender is an arms-length transaction for consideration and the purchaser or lender is not a beneficiary of the Trust:. 5. Listed below are: (A) The name of each settlor of the Trust; (B) Whether the settlor is single, married or deceased; and (C) Whether the Property is the homestead of the settlor or was the homestead of the settlor at the date of death: (A) Name of Settlor: (B) Status (Single, Married or Deceased)? (C) Was the Property the Settlor s Homestead? (Yes or No) 6. If any settlor listed above is deceased and the Property was the homestead of that settlor at the date of death, I hereby represent that said settlor was not survived by a spouse or minor child. 7. Affiant, whose address is, is a currently acting trustee of the Trust. The other currently acting co-trustees and their addresses are:. (continued next slide) 6

24 Drafting Trustee Certifications ( Sample Certification for Real Property Purchase & Sale) 8. The Trust is revocable or irrevocable; If revocable, the person(s) holding a power to revoke the Trust is/are the settlor(s) unless indicated below. If person(s) other than the settlor(s) of the Trust have power of revocation, such person(s) are :. 9. The trustees of the Trust have full power and authority to mortgage and convey the Property without the consent of any beneficiary. 10. The Trust requires all or less than all of the trustees to exercise the powers of the trustees to convey or mortgage the Property. If less than all trustees are required, the following trustees can execute a deed or mortgage pertaining to the Property without the necessity of any other co-trustees signing or otherwise authenticating the instrument:. 11. An authentic copy of the Trust, pertinent excerpts from the Trust or related documents may be attached hereto as Exhibit B and, if so, shall be incorporated herein and shall be made a part hereof. (Signature of Affiant) (Print Name of Affiant) Sworn and subscribed to before me, a Notary Public, this day of, 201, by who was personally known to me or produced the following as identification:. (Signature of Notary) (Print Name of Notary) 7