Presenting a live 90-minute webinar with interactive Q&A Grantor Trusts After Divorce: Tax Reform, Fiduciary Challenges, and Minimizing Tax for Trust Transfers to Former Spouse Gift Tax Exemption on Divorce Transfers, Grantor Trust Rules, Gift-Splitting and Income Tax Rules WEDNESDAY, FEBRUARY 14, 2018 1pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Audrey Young, Senior Manager, Private Client Services, RSM US, Boston Kenneth A. Goldstein, Partner, Horwood Marcus & Berk, Chicago The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 1. NOTE: If you are seeking CPE credit, you must listen via your computer phone listening is no longer permitted.
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Grantor Trusts After Divorce: Tax Reform, Fiduciary Challenges & Minimizing Tax for Trust Transfers to Former Spouse 2/14/18 Strafford Publications
Presenters Audrey Young Senior Manger, Private Client Services RSM US P: 617-241-1277 E: audrey.young@rsmus.com Kenneth A. Goldstein Partner Horwood Marcus & Berk P: 312-606-3215 E: kgoldstein@hmblaw.com 6 6
Agenda New tax law touches on many aspects of divorce Effective dates are key (Hint: not all of the changes in TCJA were effective 12/31/17) Three buckets: old rules still in effect, new rules in effect, new rules that will be in effect 12/31/18 And then there is the sunset 7
Agenda (Cont.) Grantor trust planning The continuing importance of grantor trusts How to navigate potential for divorce How to structure in the event of divorce Income tax rules on termination of grantor status New rules under TCJA alimony and alimony trusts Old rules still in effect: IRC 2516 and 1041 Basis management for divorcing spouses 8
IDGTS An Intentionally Defective Grantor Trust ( IDGT ) is an irrevocable trust that is not included in the grantor s gross estate However, the trust income is taxable to the grantor even though the grantor is not a beneficiary of the trust If the IDGT is structured so it is GST exempt, trust property also passes estate tax free from one generation to the next for the maximum period permitted under state law Assets are protected from creditors Powerful estate planning technique since the grantor s payment of the income tax on the trust income reduces the grantor s taxable estate Grantor s payment of income tax on the trust s income is not considered a gift 10
IDGTs Grantor Gifts $11.18M IDGT $11.18M Children GrandChildren The trustee can distribute income and principal to the beneficiaries based on the standard set forth in the trust agreement (i.e.. best interests or support standard) 11
IDGTS Grantor Trust vs. Non-Grantor Trust NON-GRANTOR TRUST GRANTOR TRUST Year Beginning Balance Taxable Income @ 8% Income Taxes @ 40% Ending Balance Year Beginning Balance Taxable Income @8% Income Taxes @40% Ending Balance 1 $11,180,000 $894,400 $357,760 $11,716,640 1 $11,180,000 $894,400 $0 $12,074,400 2 $11,716,640 $937,331 $374,932 $12,279,039 2 $12,074,400 $965,952 $0 $13,040,352 3 $12,279,039 $982,323 $392,929 $12,868,433 3 $13,040,352 $1,043,228 $0 $14,083,580 4 $12,868,433 $1,029,475 $411,790 $13,486,117 4 $14,083,580 $1,126,686 $0 $15,210,267 5 $13,486,117 $1,078,889 $431,556 $14,133,451 5 $15,210,267 $1,216,821 $0 $16,427,088 6 $14,133,451 $1,130,676 $452,270 $14,811,857 6 $16,427,088 $1,314,167 $0 $17,741,255 7 $14,811,857 $1,184,949 $473,979 $15,522,826 7 $17,741,255 $1,419,300 $0 $19,160,555 8 $15,522,826 $1,241,826 $496,730 $16,267,921 8 $19,160,555 $1,532,844 $0 $20,693,400 9 $16,267,921 $1,301,434 $520,573 $17,048,782 9 $20,693,400 $1,655,472 $0 $22,348,872 10 $17,048,782 $1,363,903 $545,561 $17,867,123 10 $22,348,872 $1,787,910 $0 $24,136,781 11 $17,867,123 $1,429,370 $571,748 $18,724,745 11 $24,136,781 $1,930,943 $0 $26,067,724 12 $18,724,745 $1,497,980 $599,192 $19,623,533 12 $26,067,724 $2,085,418 $0 $28,153,142 13 $19,623,533 $1,569,883 $627,953 $20,565,462 13 $28,153,142 $2,252,251 $0 $30,405,393 14 $20,565,462 $1,645,237 $658,095 $21,552,605 14 $30,405,393 $2,432,431 $0 $32,837,825 15 $21,552,605 $1,724,208 $689,683 $22,587,130 15 $32,837,825 $2,627,026 $0 $35,464,851 12
Gifts to IDGTS Removes appreciation of gifted assets from grantor s estate Technique can be further leveraged by using assets that may be discounted for valuation purposes Preserves use of sunsetting gift-tax exemption (potential clawback if die after 2025) 13
Low Interest Loans to IDGTS The grantor loans cash or other assets to the trust in exchange for a promissory note The promissory note bears interest equal to the Applicable Federal Rate (AFR) Any income and appreciation of the trust assets in excess of the AFR remains in the trust for the benefit of the beneficiaries 14
Sales to IDGTS The grantor sells assets to the trust in exchange for a promissory note Technique can be further leveraged by using assets that may be discounted for valuation purposes The promissory note bears interest equal to the Applicable Federal Rate (AFR) Any income and appreciation of the trust assets in excess of the AFR remains in the trust for the benefit of the beneficiaries 15
Spousal Lifetime Access Trust A Spousal Lifetime Access Trust ( SLAT ) is an IDGT in which the grantor s spouse is a discretionary beneficiary of the trust The purpose of this trust is to provide a source of cash flow to the grantor s spouse (or at least alleviate some of the concern that the grantor s spouse (and indirectly, the grantor) will deplete their funds during their lifetimes) If properly structured, the trust will not be included in either the Grantor or the Grantor s spouse s taxable estate Especially desirable with sun-setting of gift tax exemption after 2025 Could have each spouse create a SLAT for the other but need to structure in a manner to avoid reciprocal trust doctrine 16
Spousal Lifetime Access Trusts Grantor Gifts $11.18M IDGT $11.18M Spouse Children GrandChildren The trustee can distribute income and principal to the beneficiaries based on the standard set forth in the trust agreement (i.e.. best interests or support standard). However, if spouse will be acting as sole trustee, distributions must be based on a support standard. Grantor maintains indirect access to the trust assets. 18
Spousal Lifetime Access Trust After Divorce Trust Contains Provision that Provides that Spouse is Deemed to be Deceased Upon Divorce (Kick Out Provision) Should be possible to turn off grantor trust status Trust Does Not Contain Any Provision that Provides that Spouse is Deemed to be Deceased Upon Divorce (No Kick Out Provision) Current IRC Code 672 (As Amended by the Technical Corrections Act of 1988) provides: (e) Grantor treated as holding any power or interest of grantor s spouse (1) In general. For purposes of this subpart, a grantor shall be treated as holding any power or interest held by» (A) any individual who was the spouse of the grantor at the time of the creation of such power or interest, or» (B) any individual who became the spouse of the grantor after the creation of such power or interest, but only with respect to periods after such individual became the spouse of the grantor (2) Marital status For purposes of paragraph (1)(A), an individual legally separated from his spouse under a decree of divorce or of separate maintenance shall not be considered as married Original IRC Code 672 (Tax Reform Act of 1986) provided: "(e) For purposes of this subpart, if a grantor's spouse is living with the grantor at the time of the creation of any power or interest held by such spouse, the grantor shall be treated as holding such power or interest" 19
Spousal Lifetime Access Trust After Divorce Majority position seems to be that spousal attribution continues after divorce If Grantor and spouse were married at the time of creation of any power or interest or were living together at the time of such creation, divorce does not cut off spouse attribution under Section 672(e) If spouse remains a beneficiary of the trust, this means that it is not possible to turn off grantor trust status after divorce until death of spouse or death of grantor unless distributions can only be made to the grantor s spouse with the consent of an adverse party Not aware of any case or ruling that has definitively addressed this issue 20
Spousal Lifetime Access Trust After Divorce Minority Position is that Spousal Attribution ceases upon divorce Was the intent of 672(e) to provide that spousal attribution continues after divorce? Reg. 1.677(a)-1(b)(2) provides: With respect to the treatment of a grantor as the owner of a portion of a trust solely because its income is, or may be, distributed or held or accumulated for future distribution to a beneficiary who is his spouse or applied to the payment of premiums for insurance on the spouse's life, section 677(a) applies to the income of a trust solely during the period of the marriage of the grantor to a beneficiary Reg. 1.1361-1(k)(1) Ex. 10 also provides that spousal attribution is cut off on divorce: Example 10. (i) Transfers to QTIP trust. On June 1, 1996, A transferred S corporation stock to a trust for the benefit of A's spouse B, the terms of which satisfy the requirements of section 2523(f)(2) as qualified terminable interest property. Under the terms of the trust, B is the sole income beneficiary for life. In addition, corpus may be distributed to B, at the trustee's discretion, during B's lifetime. [portion omitted] (ii) Transfers to QTIP trust where husband and wife divorce. Assume the same facts as in paragraph (i) of this Example 10, except that A and B divorce on May 2, 1997. Under section 682, A ceases to be treated as the owner of the trust under section 677(a) because A and B are no longer husband and wife. Under section 682, after the divorce, B is the income beneficiary of the trust and corpus of the trust may only be distributed to B. Accordingly, assuming the trust otherwise meets the requirements of section 1361(d)(3), B must make the QSST election within 2 months and 15 days after the date of the divorce 21
Spousal Lifetime Access Trust After Divorce Planning Ideas if Majority Position is Correct: Have adverse party serve as trustee or require consent of an adverse party for any distributions to the grantor s spouse Provide for lump sum payment to grantor to reimburse grantor for anticipated grantor trust taxes Include reimbursement provisions in Marital Settlement Agreement to the extent trust does not reimburse grantor for income taxes of grantor trust Have spouse create trust for the benefit of grantor to be used to reimburse grantor for each year for income taxes of grantor trust Have spouse agree to exercise LPOA to appoint assets, in whole or in part, to new trust which does not include spouse as a beneficiary and trustee (or take other steps permitted by trust agreement to eliminate spouse as a beneficiary and trustee of the trust) Same as item 3 but trust allows a spouse friendly person to appoint trust property to spouse Have grantor friendly trustee to try to minimize income tax consequences (or split roles so person who makes distribution decisions is a person who is spouse friendly and person who makes investment decisions is a person who is grantor friendly 22
IRC Section 2516 Certain transfers between former spouses are deemed to be for full and adequate consideration Timing considerations Actual payments must be traceable to written agreement Has less significance given current lifetime exemption but consider snap back 23
Don t forget gift-splitting rules To be eligible for gift split, couple must be married at the time of the gift (and neither may remarry during the calendar year) How to handle required consent Liability is joint and several Applies to all gifts made in a calendar year and eligible for gift splitting. Application to spousal trusts 24
IRC Section 1041 Prevents recognition of income, gain or loss on transfers of property between spouses incident to divorce Rules on timing Don t lose sight of tax on the ultimate disposition of assets by the spouse that receives the asset pursuant to the divorce decree Can couples work together to lower overall future tax impact and plan for each other s tax attributes and effective rates 25
Dividing closely-held business or investment interests Ben and Jen are divorcing. Jen owns a 50% interest in Intellijen LLC, which is taxed as a partnership. Her tax basis is $200,000 and her interest has an FMV of $400,000. She plans to give Ben $120,000 under the divorce decree If Intellijen redeemed a portion of Jen s interest so that she had sufficient funds to pay Ben $120,000 under section 1041, she would not be taxed though she would lose most of her basis in Intellijen If she transferred an interest worth $120,000 to Ben and then he redeemed that interest, the redemption would not be protected under section 1041 so he would recognize capital gain income What if Ben did not redeem? What does the silent partner think of these events? What does the partnership agreement say? 26
Alimony Repeal of deduction for alimony payments for divorce or separation agreements entered into after December 31, 2018 Also applies to modifications to divorce or separation agreements entered into before December 31, 2018 if the modification expressly provides that the TCJA is to apply Does the TCJA provide an opportunity for both parties to agree to change taxation of pre 2019 orders? How will judges react to a unilateral request to change the taxation of pre 2019 orders? prenuptial agreements that address alimony should be reviewed TCJA change affects alimony negotiations Will states that have set alimony formulas revise their laws? Treatment of child support payments is unchanged 27
Section 682 is repealed Section 682 overrides grantor trust rules but is repealed by TCJA The repeal of the provision relating to alimony and Section 682 trusts apply to any divorce or separation instrument (as defined by Section 71(b)(2) prior to its repeal), executed after Dec. 31, 2018 Divorce and separation agreements executed on or before the law s Dec. 31, 2018 effective date will be grandfathered. Grandfathered agreements modified after the Dec. 31, 2018 effective date will also be grandfathered unless the modification expressly provides that the modified agreement be governed by the new law. 28
New rule no personal exemptions and SALT limitation Many separation agreements allocate the personal exemptions for children Example of rule that sunsets on 12/31/25 SALT deduction capped at $10,000 example of marriage penalty after divorce, each spouse would get $10,000 how will divorcing couples account for this 29
Section 121 unchanged but still complicated For many couples, residence is one of most significant joint assets Section 121 permits homeowners to avoid tax on gain of up to $250,000 (or $500,000 if married filing a joint return) Helpful ownership definitions for divorcing spouses How do modern day nesting arrangements work with Section 121 Consider taxes on future disposition of house 30
Questions? Audrey Young Senior Manger, Private Client Services RSM US P: 617-241-1277 E: audrey.young@rsmus.com Kenneth A. Goldstein Partner Horwood Marcus & Berk P: 312-606-3215 E: kgoldstein@hmblaw.com Note that these materials are intended for general informational purposes only and should be used only as a starting point for addressing the issues raised herein. This document does not constitute audit, tax, consulting, business, financial, investment, legal or other professional advice, and you should consult a qualified professional advisor before taking any action based on the information herein. Horwood, Marcus & Berk and RSM US LLP (and its affiliates and related entities) are not responsible for any loss resulting from or relating to reliance on this document by any person. Internal Revenue Service rules require us to inform you that this communication may be deemed a solicitation to provide tax services. This communication is being sent to individuals who have subscribed to receive it or who we believe would have an interest in the topics discussed. Also note that any U.S. federal tax advice contained in these materials are not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. RSM US LLP is a limited liability partnership and the U.S. member firm of RSM International, a global network of independent audit, tax and consulting firms. The member firms of RSM International collaborate to provide services to global clients, but are separate and distinct legal entities that cannot obligate each other. Each member firm is responsible only for its own acts and omissions, and not those of any other party. Visit rsmus.com/about us for more information regarding RSM US LLP and RSM International. 31