Monthly Archives: May 2023

As an Estate Planning practitioner, I always considers the impact that estate, gift, generation-skipping transfer, and inheritance taxes will have on an Estate Plan. After all, clients frequently inquire about tax impact during consultation and beneficiaries usually wonder not only if taxes will result from their inheritance but also who will bear the burden of paying said taxes. Generally, the individual making the gift bears the responsibility of paying any taxes on the transfer during life or at death. The first part in this two-part series Understanding and Manipulating Estate and Gift Taxes focused on understanding the basics of the Estate and Gift Tax. This second part will explore one sanctioned way to manipulate the Estate and Gift Tax.

The Internal Revenue Code (“Code”) levies an estate tax on the value of the assets of an estate exceeding the Applicable Exclusion Amount (“AEA”) at the rate of 40%. In 2023, each U.S. citizen / resident has an AEA of $12.92 million, meaning that an individual can transfer up to $12.92 million either during life or at death without worrying about incurring a gift or estate tax on the transfer. For those whose estates exceed the AEA, Code Section 2056 offers relief in the form of an unlimited deduction for property other than terminable interest property passing to the surviving spouse. Again, the Code provides a save for even terminable interest property if it meets the requirements of Code Section 2056(b)(7) – the “Qualified Terminable Interest Property” (“QTIP”) Trust. To receive the unlimited marital deduction for property passing to a surviving spouse through a properly structured QTIP Trust, the decedent’s fiduciary needs to file Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return and elect QTIP treatment thereon. That election comes at a price though because it forces inclusion of the value of the QTIP Trust in the surviving spouse’s estate at the surviving spouse’s death, pursuant to Code Section 2044.

The surviving spouse’s estate bears the burden of paying tax on those assets, notwithstanding that the surviving spouse cannot control ultimate disposition of those assets. The decedent spouse can decide what happens to those assets upon the death of the surviving spouse. Further, the QTIP Trust need not include any distributions of principal to the surviving spouse, yet the Code includes that principal amount in the surviving spouse’s estate. Thankfully, the Code contains some balance. Code Section 2207A allows the decedent spouse’s estate the right to recover the amount by which inclusion of the QTIP Trust in the surviving spouse’s estate increased the total taxes due on the surviving spouse’s estate.

Let’s return to our example from last week. If you recall, Howard and Bernadette each had an estate of $25 million. Howard structured his plan to create a Family Trust with his remaining AEA, let’s assume that it was $12.92 million because he died in 2023 with his AEA intact. The remainder ($12.08 million) went into a Marital Trust for Bernie’s benefit. Let’s change the facts such that Bernie’s trust qualified for the QTIP election, thereby resulting in no taxes due upon Howard’s death. Now, let’s assume that Bernadette dies in 2023 without having used any of her AEA. She, too, has $12.92 million that she can shield from estate taxes. The $12.08 million remainder of her estate will be subject to tax at a rate of 40%, resulting in a tax liability of $4,832,000 ($12.08 *.40) …but wait! We forgot to include the principal of the QTIP Trust in our calculation of tax for Bernadette’s estate. Thus, Bernie’s estate would total $24.16 million ($25 million plus $12.08 million QTIP less $12.92 AEA) resulting in a total tax liability of $9,664,000 ($24.16 * .40). Not such a great result for her beneficiaries since they will not benefit from the assets in the QTIP Trust. Code Section 2207A, however, changes that result and allows Bernadette’s estate to recover the $4,832,000 amount by which the taxes increased because of inclusion of the value of the QTIP Trust in her estate. Thus, Bernie’s beneficiaries do not bear the burden of taxes on property from which they do not benefit and her estate recovers from the person or persons receiving the property that was included in Bernadette’s estate. This right to recover provides a more equitable result for Bernie’s beneficiaries who are in the same position as if Bernie never benefitted from the QTIP Trust.

Treasury Regulation Section 20.2207A-1(a)(1) explains that the recovery is from the “person receiving the property.” Thus, in our example, if Howard’s kids, Halley and Neil, received the QTIP Trust upon Bernie’s death, Bernadette’s estate could recover from the children. Let’s change the facts such that Halley and Neil were the children of both Howard and Bernadette. In that case, perhaps Bernadette’s fiduciary has no concerns about recovery because the beneficiaries are the same. Code Section 2207A(a)(2) allows a waiver of the right of recovery in either the Will or the Trust of the surviving spouse. This waiver allows the surviving spouse to determine whether their estate should recover any resulting taxes or whether the estate should forego such recovery.

If the beneficiaries of the QTIP Trust are the same as the surviving spouse’s beneficiaries, it’s more tax efficient for the surviving spouse to waive the right of recovery. If the statute of limitations for the estate to recover from the beneficiaries based upon the surviving spouse’s estate’s statutory rights under Code Section 2207A expires, then that results in a gift, likely unintended.  

After that title, who doesn’t want to read this post? Any practitioner in the Estate Planning world considers the impact that estate, gift, generation-skipping transfer, and inheritance taxes will have on a plan. Clients inquire about tax impact during consultation and beneficiaries wonder not only if taxes will result from their inheritance but also who will bear the burden of paying said taxes. Generally, the individual making the gift bears the responsibility of paying any taxes on the transfer during life or at death. Certain provisions of the Code may change that result. This first part in a two-part series will focus on understanding the basics of the Estate and Gift Tax.

Let’s start with the basics. The Internal Revenue Code (“Code”) levies an estate tax on the value of the assets of an estate that exceed the Applicable Exclusion Amount (“AEA”) at the rate of 40%. In 2023, each U.S. citizen / resident has an AEA of $12.92 million, meaning that an individual can transfer up to $12.92 million either during life or at death without worrying about incurring a tax on the transfer. For most of the population, that’s enough to remove the worry of estate tax from their mind. For some of the population, however, that’s not enough. Thankfully, in addition to the AEA, Section 2056 of the Code provides an unlimited deduction for property passing to the surviving spouse. Thus, married individuals may pass an unlimited amount of assets between one another during life and at death. Section 2056(b)(1) prohibits the deduction, however, for property passing to the surviving spouse that qualifies as a “terminable interest” meaning that the spouse’s interest in the property will terminate or fail on the lapse of time or occurrence of an event or contingency, or will terminate upon the failure of an event or contingency to occur, and upon such termination the interest will pass to someone other than the surviving spouse.

You may be wondering what that means. Let’s review an example. Assume that Howard and Bernadette have been married for several years but have no children together. Howard has children from a prior relationship, Halley and Neil. Over the years as an astronaut, Howard has amassed an estate of $25 million. Bernadette has her own assets of $25 million from her successful job as a microbiologist at a pharmaceutical company. Howard and Bernadette live a lavish lifestyle, flying all over the world to visit their friends, Sheldon and Amy, now living in Switzerland, along with their friend, Raj, and his wife Riva, living in India. After his death, Howard wants to make sure that Bernadette can continue this lifestyle but also wants to ensure that his children have adequate funds as well. He wants to pay as little as possible in taxes but worries that if he gives Bernadette everything outright that she will spend it all or fail to leave his children any of his wealth.

With these competing interests in mind, Howard makes an appointment to see his attorney who suggests that he structure his estate plan to create a Family Trust that will consist of his unused AEA with the remainder going into a Marital Trust for Bernadette’s benefit. The terms of the marital trust allow the Trustee of the Trust to make distributions of income or principal for Bernadette for life for her health, education, maintenance, and support. Howard does not want Bernadette to alter the plan and therefore excludes both a limited power of appointment and a general power of appointment. At Bernadette’s death, the assets in the marital trust will pass to his children, Halley and Neil. Howard likes the plan and signs it.

A few months later, Howard dies unexpectedly. Bernadette sees her attorney who advises her that Howard’s attorney structured the plan improperly. Howard’s estate cannot avail itself of the unlimited marital deduction for the assets passing to her in the marital trust. The attorney explains that Bernadette’s marital trust consists of a terminable interest, but an inappropriately structured terminable interest. He indicates that the Code allows a decedent spouse to leave assets in a trust for the benefit of a surviving spouse during that spouse’s life and obtain the benefit of the unlimited marital deduction provided that said trust has been properly structured and that Bernie’s trust was not. The lawyer goes on to advise Bernadette that two types of marital trusts will produce an unlimited marital deduction. The first is one in which the surviving spouse has a life estate coupled with a general power of appointment. While Bernie’s marital trust gave her a life estate, it did not contain a general power of appointment. The second is a trust that meets the requirements set forth in Code Section 2056(b)(7).

Code Section 2056(b)(7) requires the trustee to distribute all income from the trust to the surviving spouse. In addition, the trust gives the surviving spouse the power to make any unproductive property income-producing. Finally, no payment may be made to any other person during the surviving spouse’s lifetime. If the trust meets these requirements, it will qualify as a “Qualified Terminable Interest Property” (“QTIP”) Trust and allow the decedent spouse’s estate an unlimited marital deduction for the assets passing to the trust. The decedent spouse’s fiduciary need only file Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return and elect QTIP treatment thereon, and that forces inclusion of the value of the QTIP Trust at the surviving spouse’s death in the surviving spouse’s estate, pursuant to Code Section 2044.

The surviving spouse’s estate bears the burden of paying tax on assets that the surviving spouse cannot control. In fact, the surviving spouse may have never had the benefit of any distribution of principal, yet it’s the principal amount included in that surviving spouse’s estate. This realization undoubtedly has frustrated many a surviving spouse. Adding insult to injury, the decedent spouse controls disposition of the assets upon the death of the surviving spouse. Talk about a homerun for the decedent spouse and a recipe for a tense relationship between the surviving spouse and the stepchildren. If only there were a solution… we should be shouting “Code Section 2207A.” It provides relief to the surviving spouse’s estate.

Many of us dream about suddenly inheriting assets from a long-lost uncle. No doubt, some have experienced that new-found wealth and were overjoyed when it occurred. Sometimes, however, that wealth may not be desirable. Some clients have assets that exceed the amount they could spend in their lifetime, will have an estate tax issue, and additional assets only compound that. Others may prefer that the assets go elsewhere. This article examines the basics of disclaimers and how some situations require the more complex “double disclaimer.”

Internal Revenue Code (“Code”) Section 2518 describes the requirements necessary for a “qualified disclaimer.” If the disclaimer meets the statutory requirements, then the Code treats the disclaimant as having predeceased the decedent and imposes no gift tax on the transfer to the second beneficiary. This preserves the disclaimant’s Applicable Exclusion Amount (“AEA”) and the assets pass to the next named beneficiary or beneficiaries without additional tax liability. For the disclaimer to work; however, the disclaimant needs to follow the rules of Code Section 2518 precisely. A disclaimer needs to meet the following requirements pursuant to Code Section 2518:

1. The refusal must be in writing,
2. The refusal must be received by the transferor of the interest (or the representative or legal title holder) within 9 months of the later of the date on which the transfer creating the interest is made or the date the recipient attains age 21,
3. The disclaimant must not have accepted any of the benefits of the property, and
4. The interest must pass without direction by the disclaimant either to the decedent’s spouse or someone other than the disclaimant.

Nothing in the Code, the Treasury Regulations, nor any Internal Revenue Service guidance allows an extension on the 9-month deadline for a disclaimer. It matters not if the disclaimant were sick or had extenuating circumstances. That deadline is firm. Further, it doesn’t matter if an individual doesn’t know about their interest in the assets until well beyond the 9-month timeline. A lack of knowledge changes nothing. Let’s look at a quick example:

Granny’s Will leaves Blackare to Jose. The Will provides that if Jose predeceases Granny, Blackacre goes to Jose’s daughter, Lola. Blackacre has a value of $5 million. Jose has sufficient assets from his vast holdings and does not need  Blackacre. Jose has made several lifetime gifts and has already used his AEA. He wants Blackacre to go to Lola because she has always enjoyed vacationing there. If Jose accepts Blackacre, then gives it to Lola, that results in a taxable gift on $5 million resulting in a gift tax liability of $2 million. If Jose disclaims timely without accepting any benefits from Blackacre, then Blackacre will pass to Lola as though Jose predeceased Granny. Granny’s Will provides that Blackacre passes to Lola if Jose predeceased Granny. Allowing Blackacre to pass in this manner accomplishes Jose’s wishes and saves Jose $2 million.

While the above example is simple, that’s not always the case. If you want to consider a disclaimer, you need to map out how the property will pass after the disclaimer. The Estate Planning documents may complicate that process and the disclaimant cannot direct what happens if the Estate Plan varies from the disclaimant’s wishes. For example, above, if Jose preferred that Blackacre pass to his daughter, Gabriela, rather than to Lola, he could not disclaim and direct that the property pass to Gabriela. That would violate Code Section 2518. Instead, he would need to accept Blackacre and then gift it to Gabriela. He would incur the resulting gift tax of $2 million. In some complex situations, it may still be possible to achieve the desired result. Executing a disclaimer requires you to understand how the property will pass after the disclaimer. A double disclaimer may allow you to alter the course a bit. Let’s look at another example that highlights that principle:

Grandpa had a trust that left all his assets to his surviving spouse, Granny. Pursuant to the terms of Grandpa’s Trust, if Granny disclaimed, the property would be held in a Family or Bypass Trust for the benefit of Granny and their children, Lucia and Jose. At Granny’s death, the Trust Agreement directs distribution of the assets outright to Lucia and Jose. If Lucia or Jose predeceases Granny, the property would go to their descendants, if any, or to Grandpa’s descendants.

Granny decides she doesn’t want Blackacre and wants it to go to their children immediately without using any of her AEA. First, Granny needs to execute a qualified disclaimer of the property. That disclaimer sends Blackacre to the Bypass or Family Trust for her benefit and the benefit of Lucia and Jose. (Remember, even though Granny would benefit from the Bypass Trust, this meets the requirements of a qualified disclaimer because she is the decedent’s spouse.) Next, Granny would execute another qualified disclaimer, this time of her interest in the Bypass Trust. The second disclaimer treats Granny as having predeceased Grandpa. This allows Blackacre to pass directly to Lucia and Jose. In fact, if desired, the family could go one step further. Let’s say Granny only wanted Lucia to get Blackacre and Jose agreed to that plan. After Granny executed the first disclaimer sending Blackacre to the Bypass Trust and the second disclaimer of her interest in the Bypass Trust, Jose could disclaim his interest. Since Jose has no children, the terms of the trust would send Blackacre to Lucia. Remember, it’s imperative to chart the course of the disclaimed property to know where it will go.

Of course, if Granny wants to get the property just to Lucia, she’d have to rely on the expectation that Jose will disclaim after Granny does. Jose would be under no legal obligation to do so.

Disclaimers represent yet another way to achieve client goals. Sometimes they can be quite tricky and require thought to achieve the desired outcome. Sometimes more than one disclaimer might be necessary to accomplish the preferred result. Remember to chart the post-disclaimer course of the asset prior to disclaiming. Once you are confident that the disclaimed property will pass as intended, it’s imperative to follow Code Section 2518 exactly. Even a small misstep will invalidate the disclaimer and make the transfer a gift.

Revocable Trusts lay the foundation for many an Estate Plan. They serve various functions, like avoiding probate, planning for incapacity, protecting beneficiaries, and providing continuity after death. Revocable Trusts provide the grantor with flexibility by giving the grantor the right to change the trust during their lifetime. Well-written trusts contain explicit instructions regarding the steps that the grantor needs to follow to amend, revoke, or change the trust. If a Revocable Trust lacks those specific instructions that can lead to questions regarding the grantor’s intent and ultimately, litigation, which benefits no one. Let’s look at a recent Michigan case, In re Gregory Hall Trust, No. 361528 (Mich. Ct. App. Mar. 16, 2023), that underscores the importance of clear instructions in the trust agreement.

Gregory Hall created a Revocable Trust that he subsequently amended and restated. The amendment and restatement indicated that his three children, Kenneth, Cheryl, and Michael, would split the residue of the trust after Gregory’s death. The amendment and restatement indicated that Gregory could amend the trust “by an instrument in writing delivered to the Trustee.” The trust provided no instruction regarding whether Gregory needed to sign the instrument or whether any other formalities typically required for trust amendment were necessary. A few years later, Gregory prepared a spreadsheet, the contents of which remain unknown. Several years after the amendment and restatement, but just weeks after preparing the spreadsheet, Gregory conveyed his home worth $500,000 to Kenneth. A few years later, Gregory created another spreadsheet reflecting the value of his overall estate, approximately $6 million, and reflecting conveyance of the home to Kenneth. After Gregory died, Kenneth argued that the house was a gift to him and that entitled him to 1/3 of the residue of the trust. Kenneth’s siblings indicated that the home was an advancement and argued for reduction of Kenneth’s 1/3 share of the residue by the value of the home.

After Gregory’s death, all three children became co-Trustees of the Trust. Cheryl and Michael petitioned the court for limited supervision of the Trust to resolve the advancement issue. Kenneth failed to cooperate during discovery and violated several of the court’s orders relating to discovery during the proceeding. Ultimately, the lower court found in favor of Cheryl and Michael and entered a default judgment against Kenneth as a discovery sanction. Kenneth appealed and the higher court affirmed the lower court’s decision. Kenneth’s egregious behavior concerning the documents and related electronically-stored information requested during discovery despite numerous reprimands from the lower court convinced the higher court of the correctness of the lower court’s decision. For those interested, here’s a link to the case detailing Kenneth’s bad acts: In re Gregory Hall Trust.

For purposes of this article, though, the discovery issue isn’t the most compelling part of this case. It’s that the lower court found that the second spreadsheet created by Gregory met the statutory definition of a contemporaneous writing as applied to trusts. The statute provides that an advancement includes property given by the testator during life if “the testator declared in a contemporaneous writing that the gift is in satisfaction of the devise or that its value is to be deducted from the value of the devise.” Based upon this statute, the court considered the transfer of the home an advancement rather than an intervivos gift. While the court never made an express finding that the spreadsheet was a declaration, their decision permits us to infer that the spreadsheet was a declaration for purposes of application of the statute. The court remained silent regarding the length of time between the amendment and restatement and creation of the second spreadsheet, but perhaps the first spreadsheet prepared just weeks before the transfer convinced the court that the second spreadsheet merely confirmed the contents of the first.

The court never disclosed whether Gregory’s Will or Revocable Trust contained language regarding an advancement but maybe it didn’t matter. Perhaps this case demonstrates the willingness of a court to apply statutes broadly to achieve the desired result in a matter. If nothing else, In re Gregory Hall Trust provides valuable lessons on the importance of clear instructions in the trust agreement regarding what constitutes an amendment, as well as how to effectuate such an amendment. Further, the trust agreement should have clear instructions regarding what constitutes an advancement. As In re Gregory Hall Trust demonstrates, these things are too important to leave to chance.