Page 1



Failure to Obtain Complete Information.

A. Blunder – Failure to obtain complete information before commencing the estate planning process. B. Correction: Obtain complete financial and family information; as well as copies of the existing estate planning documents. C.

Complete Financial Information.

A good estate planning review requires that you have a complete picture of the client’s financial profile. The objective of obtaining this information is: (1) to identify the assets of the estate;, (2) to estimate the relative value of those assets; and (3) to determine the manner in which the assets are owned. Again a questionnaire like to one attached to this Unit is a good first step in gathering and organizing this information. The financial information requested should include: 1. A list of assets by property type. It is important to have a clear picture of not only the type of property owned by the client, but also the current fair market value of each asset group. One exception, life insurance, should be stated at the face value of the policy, not its cash surrender value. The aggregate value of each general asset category will suffice in most cases. For example, it is not necessary that you identify each and every stock owned. Instead, just the total stock investment can be noted. The general asset categories should include the following: Cash and Bank Accounts Notes, Accounts Receivable, Mortgages Bonds Listed Stocks Closely-Held Business Interests Real Estate Insurance Employee Benefits


Miscellaneous property (e.g., personal effects, collections, patents, trademarks, copy-rights, etc.) 2. The information gathered should include a list of the client’s liabilities, such as the following: Real Estate Mortgages Notes to financial institutions Loans on Insurance Policies Other obligations, such as charitable pledges, and tax liabilities. 3. Finally, it is also important to know how the property is titled, particularly for a married couple. Whether it is held in one party’s name alone or whether it is titled in joint names plays an important role in estate planning. D.

Complete Family Information.

1. A request for family information should be designed to identify the natural heirs of the client. It is therefore important that the client provide the identity and age of each of the members of his or her immediate family including adopted step- children and grandchildren. The client should also provide the identity of any potential non-familial heirs such as friends or charitable institutions. 2. In addition certain information may provide facts which may affect the plan of disposition. The following information may be helpful in this regard and should also be requested with the questionnaire: a. What is the client’s (and their spouse’s) current occupation? b. In the case of a married couple - whether this is first or subsequent marriage? c. Whether there is a pre-nuptial agreement which affects the disposition of assets of either spouse? d. Whether there is a property settlement agreement with a former spouse which imposes any financial obligations on either spouse? e.

Whether the children are natural or adopted?

f. Whether any of the identified heirs have special needs or have other issues which would prevent them from inheriting property outright? 2

g. citizens?

Whether the client, and the client’s spouse, – are US

h. Whether the client or the client’s spouse had residence reside in a community property state? E.

The Existing Estate Planning Documents.

Copies of the client’s current estate planning documents should also be requested. These should include the following: 1.

A copy of the client’s Last Will and Testament

2. A copy of any Trust documents executed by the client or documents in which the client is a named beneficiary. 3. A copy of any Ffinancial or Medical Powers of Attorney adopted by the client. 4. regard to plans.

A copy of the current designation of beneficiary forms in any life insurance, 401ks, IRAs, or other qualified retirement

5. If the client owns annuities the designation of beneficiary as well as the settlement option chosen. II.

Failure to Plan for the Federal Estate Tax after Estate Tax Repeal A.

Blunder – Failure to plan for the federal estate tax after the Tax.

B. Correction: Address the federal estate tax in the estate plan in one or more the following ways. C.

The State of the Estate Tax 1.

The Tax Relief Act of 2010

After a one year repeal, the Tax Relief Act of 2010 (the “Tax Relief Act of 2010” ) reinstated the federal estate tax for 2011 and 2012. During those years, the highest marginal estate tax rate was set at 35%, and the exemption amount (termed the “Basic Exclusion Amount”) was increased to $5 million per individual for 2011, to be indexed inflation thereafter. Under the Tax Relief Act of 2010, starting in 2011, the gift tax was again reunified with the estate tax. This means that the $5 million Basic Exclusion Amount was also available for gifts. Prior to 2010, a $3.5 million exemption was for available for estates, but only $1 million for gifts. Starting in 2011, the highest marginal gift tax rate was set at the same level as the top estate tax, i.e. - 35%. The Tax Relief Act of 2010 also 3

impacted the generation-skipping tax or “GST”. The GST exemption was also increased to $5 million from the $1 million it would have been without the amendments made by the Tax Relief Act of 2010. The GST tax rate for transfers made in 2011 and 2012 was, like the estate and gift tax, also set at 35%. An interesting change made by the Tax Relief Act of 2010 which will no doubt have an impact on federal estate tax planning is the concept of “portability”. Under portability, the Basic Exclusion Amount which is unused by the estate of the first of a married couple to die may now be carried over and used, with an interesting twist, by the surviving spouse’s estate. 2.

The American Taxpayer Act of 2012

On January 1, 2013, the House and Senate passed H.R. 8, 112nd Cong., 2d Sess., the American Taxpayer Relief Act of 2012 (the “Taxpayer Relief Act”). The new law makes the following changes of special interest to estate planners: •

The law permanently continues to set the exemption equivalent of the unified credit at $5 million1, indexed for inflation after 2011. This applies for both estate and gift tax purposes. •

The GST exemption will permanently be the same as the estate tax exemption. •

The top estate and gift tax rate will be 40%, for transfers over $1 million after 2013. Thus, the estate and gift taxes continue to be a single flat rate, once the donor or decedent's transfers exceed the applicable exclusion amount. •

The GST tax rate is set permanently at 40%.

Portability is made permanent.

A technical correction is made to the portability rules to clarify how the deceased spouse's unused exemption amount is calculated. This is consistent with what Treasury already included in the temporary regulations. •

The state death tax credit remains history, and the state death tax deduction is made permanent.


In Rev Proc 2013-15, 2013-5 IRB 444 (Jan. 28, 2013), the IRS announced an increase in the applicable exclusion amount to $5.25 million for gifts and deaths in 2013.


The technical provisions of the Economic Growth and Taxpayer Relief Reconciliation Act of 2001 are made permanent. These include (a) liberalization of the rules on the estate tax deduction for conservation easements under Code Sec. 2031(c); (b) automatic allocation of GST exemption to transfers to GST trusts; (c) permitting certain retroactive allocations of GST exemption; (d) permitting qualified severance of trusts for GST tax purposes; (e) permitting the IRS to allow late allocations of GST exemption; (f) adopting substantial compliance rules for allocation of GST exemption; (g) slight easing of the rules on the deferred payment of estate taxes on closely held business interests under Code Sec. 6166; and (h) waiver of the statute of limitations on certain special use valuation of farm real estate under Code Sec. 2032A. •

The new law includes none of the Administration's proposed “loophole closing” changes, such as tightening the rules on grantor retained annuity trusts, family limited partnerships, and intentional grantor trusts. •

The new law raises to 39.6% the income tax rate on trust and estate income over $11,950. •

The new law extends the rule permitting a direct distribution from an IRA to a qualified charity on or after the participant has reached 70 1/2 years of age, to distributions after November 30, 2012, and before January 1, 2014; such amounts are treated as part of the required minimum distribution. The increased level of the Basic Exclusion Amount, coupled with the addition of “portability” to the planning equation both made permanent by the Taxpayer Relief Act, bring into question what whether traditional estate planning already in place should be amended in favor of simpler plans and also what form estate planning should take going forward. D.

Estate Planning After the Estate Tax Repeal

For a discussion our discussion of “Estate After Estate Tax Repeal”, see the section of the accompanying materials with that title. III.

Failure to Plan for the Disposition of Non Probate Assets.

A. Blunder – Failure to plan the disposition of non-probate property in manner consistent with the estate plan. B. Correction: Reviewing and plan the disposition of non-probate, examining the following issues:


1. Are the Designation of Beneficiaries Consistent with the Client’s Dispositional Intention? The client should be asked to produce current designation of beneficiary forms in regard to all life insurance policies, IRAs, 401ks, and other retirement accounts. In reviewing these documents, pay attention not only to who has been named as the primary beneficiary (i.e., the person first in line to receive the disposition if the owner dies) but also the manner in which the contingent beneficiary is designated. Typically a client’s Will provides that in the event that their spouse does not survive them, their estate should be divided equally among their children. The Will may provide further that if one of the children does not survive the client, the share of the deceased child is to pass in equal shares to the children of the deceased child. The Will provision would be worded as follows: “...to my wife, MOLLY, if she is then living, otherwise to my children, THOMAS, MARY, and WILLIAM, in equal shares, provided that if a child of mine does not survive me, the share that would have otherwise passed to such child shall pass to his or her then living descendants in equals shares, per stirpes.” On the other hand, the designation of beneficiary forms in regard to the life insurance of that same client for example may provide that if the spouse does not survive, then the life insurance proceeds are to pass to children individually named. The wording of the designation of beneficiary would have the following wording: “Primary Beneficiary: my wife, MOLLY. Contingent Beneficiary: my children, THOMAS, MARY, and WILLIAM” In this case if one of the children does not survive, only the surviving children will likely receive the proceeds of the insurance policy. The children of the deceased child would receive nothing. This is probably not what the client wants. At the very least, the dispositions of the estate and the non-probate asset, in our example the life insurance, are inconsistent, and should be reviewed with the client. 2. Has a trust been named as a beneficiary of an IRA, 401k, or other qualified retirement plan? Because distributions from such plans are income taxable to the recipient, making a Trust the beneficiary of an IRA, 402k, or other qualified


retirement plan is a step which should be taken only if the income tax issues, which are involved, have been closely examined first. First, a Trust is taxable at the highest marginal income tax rate of 35% at $9,500, of taxable income. Therefore, if the plan distributions are retained in the Trust, the highest level of income taxation will be incurred. This is not to say that distribution of the plan to a Trust is not appropriate in every case, often there are sound reasons for naming a trust which out-weighs the tax disadvantages. In certain cases estate tax can be saved, and in other cases control of the funds through the Trust is an overriding concern. In any event, the client should be made aware of the income tax consequence of naming a Trust as the beneficiary of such a plan. Also to be considered is the effect that naming a Trust may have in terms of the so-called “minimum distribution rules.” The minimum distribution rules require that qualified retirement plans and IRAs make distributions of minimum amounts to plan beneficiaries each year. After the death of the owner, the amount of the minimum distributions may depend upon the identity of the plan beneficiaries. As a general rule, the balance of the plan is divided by the beneficiary’s or beneficiaries’ life expectancy to determine the required minimum distribution. When the distributions are made directly to individuals, their individual life expectancy generally can be used to determine the amount of such distributions. When a Trust is named, however, certain requirements must be met in order to insure that the life expectancy of the Trust beneficiaries can be used to determine the minimum distribution. If the requirements are not met, the full balance of the plan may have to be distributed within an accelerated time period after the owner’s death. 3. Has a minor child been named as a beneficiary of an IRA, 401k, or other qualified retirement plan? As discussed previously, a minor child cannot receive property in excess of $20,000, without the necessity of having a guardian appointed on their behalf. There are certain disadvantages to a guardianship – one of which is that it terminates at age 18, at which time the funds will be distributed outright to the child. An alternative to naming the minor, is to name a Custodian under the Uniform Transfers to Minors Act to hold the distributions on behalf of the child. This will allow supervision of the funds until the recipient reaches the age of 21. IV.

Failure to Provide Flexibility in the Plan After to Death of the First Spouse.


A. Blunder - Failure to Provide Flexibility in the Plan After the Death of the First Spouse B.

Correction: 1.

Powers of Appointment.a.


A power of appointment vesting in the surviving spouse over the disposition of property in a trust; such powers are either “general of special� for estate tax purposes. If a decedent possesses a "general power of appointment" at his or her death, the property subject to that power is includible in his or her gross estate. b.

Possession of the Power at Death.

It is the possession of the general power of appointment by the decedent, not its exercise, which triggers inclusion under sec. 2041. (1) A general power, created after October 21, 1942 and held by the donee, will result in taxability of the subject property in his or her estate, if he or she merely holds the power until his or her death. (2) Also, it is not required that the decedent ever actually own the property which is the subject of the power, for inclusion to result. c.

Only "General Powers of Appointment" Covered.

Only powers defined as "general powers of appointment" can result in includability under sec. 2041. (1) A "general power of appointment" is one which can be exercised by the person to whom it was given in favor of himself, his or her estate, or the creditors of himself or his or her estate (2) The term includes all powers, which are substance and effect powers of appointment regardless of the nomenclature used in creating the power. The power to consume or appropriate trust principal exercisable without restriction in favor of the person holding the power is a general power of appointment.


(3) A power exercisable for the purpose of discharging a legal obligation of the decedent or for his pecuniary benefit is considered a power exercisable in favor of the decedent or his or her creditors and is therefore considered a taxable general power of appointment. d.

Contingencies Ignored.

A power shall be considered to be held on the date of death even though the exercise of the power is contingent upon giving notice or even though the exercise takes effect only after the expiration of a stated period after its exercise, whether or not on or before the date of the decedent's death notice has been given or the power has been exercised. e.

Certain Powers Not Covered.

Certain powers of appointment are considered "general powers of appointment". (1)



Powers held in Conjunction with Others.

The possession of a general power of appointment will not result in inclusion if it is only exercisable in conjunction with another person if the other person is either the creator of the power or a person who has a substantial adverse interest in the subject property. (2)

Powers limited by an Ascertainable Standard.

A taxable general power does not include a power to consume, invade or appropriate income and corpus for the donee's benefit if the power is limited by an ascertainable standard relating to the health, education, support or maintenance of the decedent. (a) In short, the holder's duty regarding use of the power must be reasonably measurable in terms of his needs for health, education, or support - or any combination of them. (b) The words "support" and "maintenance" are considered synonymous. Their meaning is not limited to the bare necessities of life. (c) A power of appointment will be regarded as limited by the necessary standard if it is


exercisable for the holder's (i) support, (ii) support in reasonable comfort, (iii) maintenance in health and reasonable comfort, (iv) support in his accustomed manner of living, (v) education, including college and professional education, (vi) health, or (vii) medical, dental, hospital and nursing expenses. (d) However, a power to use property for the "comfort, welfare, or happiness" of the holder of the power does not meet the required standard of invasion. (e) In determining the existence of an ascertainable standard, which will prevent taxation of the property subject to the power, it is immaterial that the trust agreement may or may not require the beneficiary first to exhaust his other income. f.

Exercise within Three Years of Death.

If a general power of appointment was created after 1976, its exercise or release within the three-year period ending on the date of the decedent's death will cause the value of the property to be included in the decedent's gross estate under sec. 2035. C.

Amending Trusts. 1.

Ability to Revoke.

a. Under the prior law, unless the right to revoke the trust is expressly reserved in the trust instrument, the trust will be presumed to be irrevocable. See Ingels’ Estate, 372 Pa. 171, 92 A.2d 881 (1953). b. For Trusts established after November 5, 2006, UTA Sec. 7752 provides the opposite; i.e., unless the trust instrument expressly provides otherwise the trust is revocable. c. Under prior law, the Court, upon a showing of fraud, mistake, undue influence or duress, may modify the trust terms. See Potter v. Fidelity Insurance, Trust & Safe Deposit Co., 199 Pa. 360, 49 A. 85 (1901). d. Under the UTA, a trust may be modified by substantial compliance with a method provided in the trust instrument; or if the trust instrument does not provide a method by a later writing, other than a will or codicil, signed by the settler. 10

e. Under the UTA, the following rules of modification apply to irrevocable trust documents: (1) A settlor, trustee or beneficiary may seek approval or disapproval of a proposed modification or the proposed termination of a trust, including a charitable trust. (2) The settlor and all beneficiaries of a noncharitable trust may modify or terminate the trust by agreement, whether or not in violation of a material purpose of the trust. See UTA Sec. 7740.1 (a) Spendthrift protection, if given in the trust instrument, is presumed to be a material purpose of the trust. (b) In this context, the settlor may not virtually represent any beneficiary. (3) The court may modify or terminate a noncharitable trust upon agreement of all of the trust's beneficiaries as long as no material purpose of. the trust will be frustrated. See UTA Sec. 7740.1(b) (4) The court may modify or terminate a noncharitable trust absent consent of all of the beneficiaries, if no material purpose of the trust will be frustrated and the interests of the non-consenting beneficiaries in the trust are adequately protected. See UTA Sec. 7740.1(d) (5) The court may modify or terminate administrative and dispositive provisions of a noncharitable trust, consistent with the settlor's intent and the trust's purposes. For relief from investment restrictions, see the Pennsylvania Prudent Investor Rule, Section 7202(b) of the PEF Code. (6) Absent objection from a qualified beneficiary, a trustee, who concludes that the value of the trust property does not justify the cost of administration, may terminate a noncharitable trust. (7) A court may terminate or modify a noncharitable trust, or replace the trustee, if the court finds that the value of the trust property does not justify the cost of administration. Upon termination of the trust, the trustee is


required to distribute the trust property consistent with the trust's purposes. See UTA Sec. 7740.4 (8) The doctrine of cy pres has been codified. UTA Sec. 7740.3 authorizes a trustee, with the consent of the beneficiaries and the Attorney General, to terminate a charitable trust of less than $100,000 without court approval, in which event the assets pass directly to the beneficiaries specified in the trust instrument or if there are none, then to charitable organizations the trustee selects. D.

Using Trust Protectors.

1. The concept of the so-called “trust protector” developed in the area of “off-shore” trusts, but has been more recently been grafted to more conventional domestic trust, particularly irrevocable trusts. 2. The trust protector may be an individual, a corporation, or sometimes even a committee a. A corporate protector might take the form of a small, regulated trust company. b. An alternative could be a corporate protector organized by the settlor. c. Alternatively, or in addition, a protectorship committee may be built into the structure. (1) In this case, the language of the trust instrument would call for the appointment of such a committee and empower it to hire and fire the protector (whether individual or corporate). (2) The settlor could staff the committee with a combination of advisors, both domestic and foreign, but limit the candidates who may serve as protector to nonresident aliens. 3. The “trust protector” generally serves in a non-fiduciary capacity and can be granted broad or narrow authority over the trust depending on the intent and the circumstances surrounding the trust. Examples of the type of authority granted to the protector could include the following: a.

The power to change trustees,


The power to change the situs of administration, 12

c. purposes,

The power to clarify or modify trust terms for

d. The power to add or eliminate beneficiaries or rearranging their rights. e. The power to approve trustee’s decisions in regard to the distribution of income or corpus. f. The power to approve trustee’s decisions in regard to the investment of trust assets. 4. The question given the broad range of powers which are sometimes vested in the trust protector is just how the courts will view the protector’s standard of conduct in relation to the trust, the grantor, and the beneficiaries. a. The issue of whether the protector stands in the role of a fiduciary is an interesting question since there is very little in the way of judicial precedent in regard to with the protector concept or other legal development of it. b. It can be assumed that a trust protector who has been granted powers normally reserved for a trustee will be treated as a trustee by the courts. 5. The trust agreement should describe the protector's powers in detail. Generally, the protector cannot take action affirmatively (other than to remove and replace the trustee, consent to alter the class of beneficiaries, and change the situs of the trust), but can block certain acts taken, or powers exercised, by the trustee. 6. provision:

The following is an example of a comprehensive protector “ARTICLE IV

THE PROTECTOR, THE PROTECTORSHIP COMMITTEE, AND THE POWERS OF THE PROTECTOR AND THE PROTECTORSHIP COMMITTEE. A. There shall be a protector of each trust created by or pursuant to this Settlement. The initial protector (herein referred to as the PROTECTOR) is *PROTECTOR*. If *PROTECTOR* fails or ceases to serve as PROTECTOR, then *SUCCESSOR PROTECTOR* shall serve as PROTECTOR in *his or her* place.


B. At any time after the execution of this Settlement, the SETTLOR shall have the power, on one occasion and one occasion only, to nominate a committee of three (3) individuals [(who may be citizens of and resident in any one or more territories of the world without restriction)] [(who may be citizens of and resident in any one or more territories of the world except the United States of America or any territory governed by the United States of America)] who shall comprise the initial members of the Protectorship Committee (the “Committee�). Such nomination shall be by a separate written instrument delivered to any person then serving as a PROTECTOR hereof, the TRUSTEE, and the persons nominated to constitute the Committee and shall be effective at the time or under the conditions specified in such instrument. C. The Committee shall have the power at any time to remove any PROTECTOR hereof by majority vote. The Committee shall also have the authority to appoint additional PROTECTORS and a successor or successors to any PROTECTOR hereof by majority vote. If, after an appointment is made, any person serving as a PROTECTOR hereof shall for any reason cease to act as a PROTECTOR hereof, then the person who has been appointed by the Committee (if such appointment has not been revoked) to then succeed such PROTECTOR shall forthwith become and be a PROTECTOR hereof. Any such removal of a PROTECTOR shall be by a written instrument, and shall be effective at the time or under the conditions specified in such instrument. Any such appointment of an additional or successor PROTECTOR by the Committee shall be by a written instrument, revocable or irrevocable, and delivered to any PROTECTOR hereof, the TRUSTEE, and to the additional or successor protector or protectors named therein, and shall be effective at the time or under the conditions specified in such instrument. D. The Committee shall always consist of three (3) members. If any Committee member (whether initially appointed or subsequently nominated in accordance with the following provisions) shall for any reason cease to act as a Committee member, a successor Committee member (or members, as the case may be, if needed to increase the number of members to three [3]) shall be appointed by majority vote of the other Committee members or by the sole remaining Committee member, as the case may be. E. Notwithstanding the other provisions of this Article IV, if at any time after the nomination of the initial Committee members in


accordance with the provisions of Article IV.B. there is no acting Committee member because all Committee members have ceased to act, by resignation or otherwise, then the Committee shall immediately be deemed to have dissolved and shall have no further or continuing power, authority, duty, or obligation with regard to this Settlement or any trust established by or pursuant to this Settlement. In addition, to the extent that any provisions in this Article IV specifically pertain to the Committee, such provisions shall be of no effect, and all other provisions of this Settlement shall be construed as if there were no Com mittee and no provision for such a Committee, and neither the SETTLOR, the TRUSTEE, the PROTECTOR, nor the Beneficiaries (or beneficiaries) shall have the power or authority to appoint new or additional Committee members. F. The Committee shall have the right to promulgate its own internal rules and procedures regarding nominations, meetings, methods of voting, and such other matters as may from time to time be applicable to exercising its powers hereunder. G. If a sole PROTECTOR resigns or otherwise ceases to act as such resulting in a vacancy in the office of PROTECTOR and the Committee fails to appoint a successor within thirty (30) days of the date such PROTECTOR resigns or otherwise ceases to act, the Committee's right to appoint a successor PROTECTOR shall lapse and the TRUSTEE shall have the power to appoint a successor PROTECTOR hereto, but may not appoint itself or any individual or entity related to or subordinate to itself [or to the SETTLOR] as PROTECTOR. H. Notwithstanding any provision of this Settlement, however, no PROTECTOR appointed hereunder shall be a resident, domiciliary, or citizen of the United States of America or any territory governed by the United States of America, and, if a PROTECTOR is a company or other entity, it shall not have an office, affiliate, or registered agent (other than a United States agent appointed in accordance with Section 6048 (b)(2)(B) of the Internal Revenue Code) in the United States of America or any territory governed by the United States of America. I. Any appointment of a successor PROTECTOR by the TRUSTEE shall be by a written instrument, revocable or irrevocable, delivered to the appointee and to the members of the Committee (if the Committee is then in existence). Such appointment shall be effective at the time or under the conditions specified in such instrument.


J. With regard to any PROTECTOR, upon (i) certification from two licensed doctors of medicine, each doctor affirming in a written instrument signed by him or her that he or she has examined such PROTECTOR, and has concluded, based upon such examination, that such PROTECTOR is unable to discharge its duties as PROTECTOR, (ii) appointment of a guardian or other judicially appointed personal representative of such PROTECTOR, or (iii) the PROTECTOR becoming subject to any bankruptcy laws, or if the PROTECTOR is a company or other entity, (a) entering into liquidation, whether compulsory or voluntary, provided that such liquidation is not merely a voluntary liquidation for the purposes of amalgamation or reconstruction, (b) entering into receivership, (c) having an administrator of the PROTECTOR appointed, or (d) becoming subject to any bankruptcy laws (or being in any analogous state or subject to any analogous action in any jurisdiction), such PROTECTOR shall thereupon be deemed to have resigned as PROTECTOR, and the appointment of a successor PROTECTOR shall be governed by this Article IV. K. A PROTECTOR may resign at any time by delivering written notice thereof to the TRUSTEE and to the members of the Committee (if the Committee is then in existence). Any resignation of a PROTECTOR shall take effect upon the receipt of the written notice by the TRUSTEE. L. The PROTECTOR and each Committee member shall have the benefit of the same indemnities, protections, and exculpations as conferred on the TRUSTEE by the operation of law or under the terms of this Settlement. M. The PROTECTOR shall have absolutely no duty whatsoever to act or not to act with respect to any activity or action that the PROTECTOR is empowered to undertake hereunder and the PROTECTOR shall not be liable for so acting or not acting. The PROTECTOR shall also have no duty whatsoever to consent or not to consent to any activity or action that the TRUSTEE is empowered to undertake hereunder with the consent of the PROTECTOR, and the PROTECTOR shall also not be liable for so consenting or failing to consent. N. Notwithstanding the provisions of Article VII, the PROTECTOR shall have the power from time to time and at any time by deed or other written instrument delivered to the TRUSTEE:


1. to remove any TRUSTEE of any trust created by or pursuant to this Settlement; 2. to appoint an additional trustee or additional trustees, whether within or without *COUNTRY*, as TRUSTEE of any trust created by or pursuant to this Settlement; 3. to appoint a successor or successors to any TRUSTEE hereof, whether within or without *COUNTRY*, as TRUSTEE of any trust created by or pursuant to this Settlement (in the event any TRUSTEE is removed, resigns, or otherwise ceases to act); and 4. to designate the law of any jurisdiction (under which the terms of any trust created by or pursuant to this Settlement shall be capable of taking effect) to be the governing law of any trust created by or pursuant to this Settlement, and to declare that such trust shall thereafter be governed by and take effect according to the laws of the jurisdiction so designated. The PROTECTOR shall also have the power to declare that the courts of such jurisdiction may or shall become the forum for the administration of such trust. Such a designation and declaration shall be set forth in a deed or other written instrument that shall contain the powers and provisions that are necessary to enable such trust to be capable of taking effect under the laws of such jurisdiction, and that may also contain such other powers and provisions as the PROTECTOR may determine to be in the best interest of the beneficiaries, provided that such powers and provisions do not infringe upon any rule against perpetuities that is applicable to such trust. O. Upon the appointment of a successor trustee, the TRUSTEE shall immediately stand possessed of the property of such trust upon trust for the successor trustee or trustees, and shall transfer the same to the successor trustee or trustees as soon as possible, so that such property shall continue to be held upon the applicable trust or trusts hereof, but subject to and governed by the laws of the applicable jurisdiction, whether *COUNTRY* or a new jurisdiction designated by the PROTECTOR, to govern any trust established by or pursuant to this Settlement. P. Upon the declaration by the PROTECTOR that the Trust or any trust established by or pursuant to this Settlement shall be governed by the laws of a new jurisdiction, the rights of all persons, parties, and 17

entities, and the construction and effect of each and every provision of such trust shall be subject to and construed only according to the laws of the designated jurisdiction. R. Notices of all changes in the office of trustee shall be endorsed on or attached to this instrument and signed by the TRUSTEE, and every such notice shall be sufficient evidence as to the fact to which it relates. S. The PROTECTOR shall have the power, exercisable at any time, to demand an accounting by the TRUSTEE, setting forth the receipts, disbursements, and distributions of both principal and income during the period of accounting and the invested and uninvested principal and undistributed income that is in existence at the beginning and at the end of such accounting period. T. Subject to the provisions of Article XVIII, the PROTECTOR shall have the power, exercisable at any time, to require in writing that the TRUSTEE, or any person or entity to whom the TRUSTEE has delegated a power pursuant to any Article of this Settlement, be required to give a bond or other security for the faithful administration of its or their duties under this Settlement. U. The duties and powers of the PROTECTOR shall be personal and shall cease upon the death of the person holding such office (if an individual) or upon the dissolution of the entity acting as PROTECTOR (in the case of a corporation or other entity acting as PROTECTOR). The powers of the PROTECTOR shall not be capable of being delegated or of being exercised by any representative (whether a personal representative or otherwise), agent, receiver, or liquidator of the PROTECTOR. R. Any provision of this Settlement that requires the consent of the PROTECTOR shall require the PROTECTOR's written consent. Furthermore, failure by a PROTECTOR to give any such consent or make any decision or to communicate with the TRUSTEE regarding any such consent or decision shall be deemed for all purposes as a refusal to consent and shall be treated by the TRUSTEE as a refusal to consent. E.

Trustee’s Discretion. 1.

Extent of Trustee’s Discretion.

a. A discretionary power conferred upon the trustee to determine the benefits of a trust beneficiary is subject to judicial


control only to prevent misinterpretation or abuse of the discretion by the trustee. b. The benefits to which a beneficiary of a discretionary interest is entitled, and what may constitute an abuse of discretion by the trustee, depend: (1) On the terms of the discretion, including the proper construction of any accompanying standards, and (2) On the settlor's purposes in granting the discretionary power and in creating the trust. (3) On the other hand, a court will not permit abuse of discretion by the trustee. (a) What constitutes an abuse depends on the terms of the trust, as well as on basic fiduciary duties and principles. (b) Of particular importance are the purposes of the power and the standards, if any, applicable to its exercise and the extent of the discretion conferred upon the trustee. (c)

Relevant fiduciary principles include: (i) the general duty to act, reasonably informed, with impartiality among the various beneficiaries and interests, and (ii) the duty to provide the beneficiaries with information concerning the trust and its administration.

(d) This combination of duties entitles the beneficiaries (and also the court) not only to accounting information, but also to relevant, general information concerning the bases upon which the trustee's discretionary judgments have been or will be made. 2.

Limitations in re: Trustees/Beneficiaries

a. ยง 7504 provides that the following powers conferred by a governing instrument upon a trustee, in his or her capacity as a trustee, shall not be exercised by that trustee; the power to make discretionary distributions of either principal or income to or for the 19

benefit of the trustee, the trustee's estate or the creditors of either unless the power is either: (1) limited by an ascertainable standard relating to the trustee's health, education, support or maintenance within the meaning of 26 U.S.C. §§ 2041 (relating to powers of appointment) and 2514 (relating to powers of appointment); or (2) exercisable by the trustee only in conjunction with another person having a substantial interest in the property subject to the power which is adverse to the interest of the trustee within the meaning of 26 U.S.C. § 2041(b)(1)(C)(ii). b. The power to make discretionary distributions of either principal or income to satisfy any of the trustee's personal legal obligations for support or other purposes. c. The power to make discretionary allocations in the trustee's personal favor of receipts or expenses as between income and principal unless the trustee has no power to enlarge or shift any beneficial interest except as an incidental consequence of the discharge of the trustee's fiduciary duties. d. The power to exercise any of the powers proscribed in this subsection with regard to an individual other than the trustee to the extent that the individual could exercise a similar prohibited power in connection with a trust that benefits the trustee. e. Limited Exercise of Prohibited Power. (1) If a trustee is prohibited by subsection (a) from exercising a power conferred upon the trustee, the trustee nevertheless may exercise that power, but shall be limited to distributions for the trustee's health, education, support or maintenance to the extent otherwise permitted by the terms of the trust. (2) Unless otherwise prohibited by the provisions of this section, a trustee may exercise a power described herein in favor of someone other than the trustee, the trustee's estate or the creditors of either. 3.

Extended Discretion

a. Although the discretionary character of a power of distribution does not ordinarily authorize the trustee to act 20

beyond the bounds of reasonable judgment, a settlor may manifest an intention to grant the trustee greater than ordinary latitude in exercising discretionary judgment. b. The UTA Sec. 7780.4 provides the discretionary powers be exercised in good faith in accordance with the provisions and purposes of the trust, notwithstanding the breadth of discretion granted in the trust instrument. c. How does such an intention affect the duty of the trustee and the role of the court? (1) It is contrary to sound policy, and a contradiction in terms, to permit the settlor to relieve a "trustee" of all accountability. (2) Once it is determined that the authority over trust distributions is held in the role of trustee, words such as "absolute" or "unlimited" or "sole and uncontrolled" are not interpreted literally. (3) Even under the broadest grant of fiduciary discretion, a trustee must act honestly and in a state of mind contemplated by the settlor. (4) Thus, the court will not permit the trustee to act in bad faith or for some purpose or motive other than to accomplish the purposes of the discretionary power. (5) Except as the power is for the trustee's personal benefit, the court will also prevent the trustee from failing to act, either arbitrarily or from a misunderstanding of the trustee's duty or authority. d. Within these limits, it is a matter of interpretation to ascertain the degree to which the settlor's use of language of extended (e.g., "absolute") discretion manifests an intention to relieve the trustee of normal judicial supervision and control in the exercise of a discretionary power over trust distributions. e.


“A trustee's discretion shall be absolutely conclusive regarding any and all distributions or lack of them and shall not be subject to judicial review under any circumstances. In addition, trustee is under no obligation to distribute any amounts to or for settlor's child if such child has available 21

other funds or assets, or if such child shall have distributed or disposed of any assets without receiving adequate or acceptable consideration for them.” "Such additional amounts from the principal of the trust as the Trustee, in its sole and uncontrolled discretion, believes appropriate for W's comfortable support and care," 4.

Discretionary subject to an ascertainable standard a.

The meaning of “support” and “maintenance”

(1) The terms "support" and "maintenance" are normally construed as synonyms, even when this treats the terms as redundant. (2) Probably the most common guides used in grants of discretion, these terms are sometimes accompanied by a reference to the beneficiary's accustomed standard of living or station in life. (3) That level of intended support is normally implied from "support" or "maintenance" even without an express reference to the beneficiary's customary lifestyle. (4) Whether this accustomed style is expressed or implied, a lower level of distributions may be justifiable if the trust estate is modest relative to the probable future needs of the beneficiary. (5) The accustomed manner of living for these purposes is ordinarily that enjoyed by the beneficiary at the time of the settlor's death or at the time an irrevocable trust is created. (a) The distributions appropriate to that lifestyle not only increase to compensate for inflation, but also may increase to meet subsequent increases in the beneficiary's needs resulting, for example, from deteriorating health or from added burdens appropriately assumed for the needs of another. (b) Also, if a beneficiary becomes accustomed over time to a higher standard of living, that standard may become the appropriate standard of support if consistent with the trust's level of productivity and not


inconsistent with an apparent priority beneficiaries or other purpose of the settlor.


(c) Furthermore, distributions allowing the beneficiary an increased standard of living may be appropriate if, in light of the productivity of the trust estate, the eventual result would otherwise favor the remainder beneficiaries over the present beneficiary to a degree unlikely to have been intended by the settlor. (d) "Productivity" for these purposes refers not only to trust income, but also to a pattern of appreciation beyond maintenance of purchasing power, such as might result from a growth-oriented investment program. b.

The meaning of “education”: (1) Supplementary terminology may affect the degree of generosity appropriate to a beneficiary's support, or it may suggest a special emphasis. (2) For example, the term "education," without elaboration, is ordinarily construed as extending to payment of living expenses as well as fees and other costs of attending an institution of higher education, or the beneficiary's pursuit of a program of trade or technical training, and the like, as may be reasonably suitable to the individual and to the trust funds available for the purpose. (3)

Sample Provisions.

“In addition, the trustee shall, from time to time, pay to or for the benefit of such child as much of the principal of such share as the (corporate or disinterested) trustee, in its discretion, may consider desirable, after considering all resources available to such child, for such child's education at a public or private grammar or high school, college, university or vocational or technical institution, to pay associated expenses including, but not limited to, tuition, laboratory fees, books and supplies, travel, room and board.”


“In addition, trustee shall from time to time pay to such child (or such child's issue) as much of the principal of such share as (disinterested or corporate) trustee, in its absolute discretion, may consider desirable for the health, maintenance, support and education, including college, graduate level or professional education of such child, after considering all resources available to such child.” c.

The meaning of “health”: (1) Similarly, without more elaboration, references to "health," "medical care," and the like in the terms of a discretionary power may be useful to inform beneficiary expectations or guide an inexperienced trustee, but presumptively they provide merely for health and medical benefits like those normally implied by a support standard. (2) Thus, if the intention is to assure the beneficiary some special form of education further elaboration would be helpful. (3) Adding a grant of extended discretion will not address the problem since it would be difficult for a beneficiary to compel a trustee to follow a particular course of action, if the trustee does not act generously. (4)

Sample Provision

“Trustee is authorized and shall pay over to, or apply for the benefit of, or loan to, settlor's child, at any time and from time to time, so much of the principal, as trustee, in the exercise of trustee's sole and absolute discretion, shall deem needful, proper, or necessary to provide adequately for such child's maintenance and health if income from other sources and the income from this trust share are insufficient for such purpose. Whenever possible, all payments are to be made directly to the providers of medical services or equipment after insurance coverage benefits.” 5. Mandatory Distributions. “One-half of the principal in the trust shall be paid to the child at age 24

__, and the balance at age __.” 6.

Right to Withdrawal

“Trustee shall pay and distribute the net income of each share of a living child to or for the benefit of that child for life, subject, however, to the right of such child to withdraw from the principal of such share up to but not exceeding _________________ after having attained age _________________, valued as of the date on which the first withdrawal is made, and the entire balance after having attained age _________________.” 7.


“A. In each taxable year of the trust, trustee shall pay to or for the benefit of settlor an amount (hereinafter the ''unitrust amount'') equal to ten (10%) percent of the net fair market value of the trust principal, determined as of the first day of each taxable year of the trust (hereinafter the ''valuation date'').” IV.

Owning Life Insurance. A. Blunder: Owning life insurance- A fundamental concept of sound federal estate tax planning is that the client should not own any life insurance in their own name alone. B.

Correction: An Irrevocable Life Insurance Trust

1. The irrevocable insurance trust or “ILIT” can prove a valuable estate planning tool. If properly structured, the ILIT can effectively remove life insurance form an insured’s taxable estate with very little or no gift tax consequence. 2. If an individual dies owning the incidents of ownership on a life insurance policy, the face value of the policy is fully includable in their federal gross estate. a. As an alternative to naming one or more individuals or the insured's estate as the beneficiary of the life insurance policy, consideration should be given to having the policy owned by an irrevocable life insurance trust. b. An individual who already owns a life insurance policy may transfer that policy to an inter vivos trust or, if an individual has not already acquired a policy, he or she could create a trust and have the trustee acquire one or more policies on his or her life.


c. Under either scenario, the life insurance policy will be the property of the trust. (1) The trust will be both the owner of the life insurance policy and the beneficiary of the proceeds, and therefore it will not be taxed as part of the insured person’s estate. In the case of an existing policy, this does require that the transferor survives for three years after the transfer. (2) From a gift tax point of view, the transfer of the policy is generally a taxable gift, but its value is based on the cash surrender value of the policy and not is face value. d. The trust instrument then designates the intended beneficiaries of the policy and the nature and extent of their interests in the proceeds. This allows the insured to control the use and enjoyment of the funds through the trust. V.

No Cash to pay the Estate Tax – What do you do? A.

Blunder – Inadequate cash to pay the federal estate tax.

B. Solution – Consider possible qualification or deferral under IRC Sec. 6166, or 6161. C.

Section 6166.

1. Section 6166 provides for an extension of time for the payment of estate tax where an estate consists of a specified percentage of one or more interests in a closely held business. 2. The payment of estate tax can be deferred for as long as 14 years from the date the estate tax return is due to be filed if the benefits of Section 6166 are elected in a timely manner by the taxpayer and the IRS approves the election. B.

Requirements of Section 6166.

1. If the gross estate of a U.S. citizen or resident includes an interest in a closely held business valued at more than 35% of the adjusted gross estate, the executor may elect to pay part or all of the estate tax in two or more (but not more than 10) equal installments. 26 U.S.C. §6166(a)(1). a. The "adjusted gross estate" is the value of the decedent's gross estate reduced by deductions allowable under §2053 and §2054 of the Internal Revenue Code.


b. Interests in two or more "closely held business" may be combined and treated as a single business interest for the purposes of the 35% test if at least 20% of the total value of each business is included in the decedent's gross estate. Section 6166(c). 2. In general, such an estate may defer that portion of the estate tax, as reduced by the credits against the estate tax, in proportion that the amount of the interest in the closely held business bears to the adjusted gross estate. 26 U.S.C. §6166(a)(2). a. The first installment payment of estate tax may be made on or before a date selected by the executor; however, the date selected cannot be more than 5 years after the due date for the payment of estate tax. b. Each succeeding installment payment must be made on or before the next anniversary of the initial payment date selected by the executor. 26 U.S.C. §6166(a)(3). c. The deferred estate tax can always be prepaid without penalty at any time before it is due. d. However, if an election is made for a period that is less than the maximum allowable deferral period, a longer period cannot be elected after the election has passed. e. The estate's payment of the first required installment five years after the decedent's death is allocated proportionately in the following order: (1)

first to the required installments of deferred tax;


next to the interest on the deferred tax; and


finally to any unpaid balance of deferred tax.

f. An election under Section 6166 must be made no later than the date prescribed by 26 U.S.C. §6075(a) for filing the estate tax return, including extensions. C.

IRC. Sec. 6161.

1. The IRS can exercise discretion in permitting the deferral of estate tax liabilities in circumstances that do not qualify for postponement under the elective provisions described above. a. The IRS can extend the time for paying the tax for a “reasonable period” not to exceed 12 months. 27

b. The effect of a 12-month extension is to make the tax due 21 months after death. c. Upon the expiration of the extension period, the estate may apply for another extension. d. The IRS can grant an extension of the time to pay estate taxes for up to 10 years if “reasonable cause� exists. 2. Reasonable cause might exist, for example, because estate assets cannot produce sufficient present cash to pay estate tax liabilities and a significant economic loss would be inflicted on the estate if these assets were required to be sold at distress prices. 2397 a. The assets might be located in several different jurisdictions and not be otherwise immediately subject to the control of the executor. b. Alternatively, a claim to substantial assets might not be collectible without litigation, thereby postponing liquidity in the estate and the availability of cash for estate tax payments. c. The Service will want to examine all the relevant facts and circumstances to verify that reasonable cause does exist for a payment extension. VI.

No Buy or Out Dated Buy Sell Agreement.

A. Blunder: No buy sell agreement in place or the buy sell agreement is outdated or is not effective is achieving its objectives, such as fixing the value for estate tax purposes. B.

Solution: 1.


A buy-sell agreement is a contractual agreement among the owners of a business (the shareholders of a corporation, the partners of a partnership, or the members of an limited liability company) which restricts the right to transfer the ownership interests and establishes certain purchase and sale rights and obligations upon the occurrence of certain events. 2.

Uses of the Buy Sell Agreement.

a. A buy-sell agreement may serve achieve one or more of the following objectives:


(1) Restriction of Transfer -By restricting the transfer of an ownership interest outside the ownership group, a buy-sell agreement can help the owners control and restrict who is part of the ownership group. (2) Provides Liquidity - If the agreement provides a purchase obligation in the event of death of an owner and that obligation is funded with life insurance the agreement can be used to convert the deceased owner’s equity interests into cash. (3) Fixeds Value - By fixing the price which applies in the event of a purchase under the terms of the agreement, the estate tax value of the equity can be fixed in the estate of a deceased owner. b. In order to be effective the agreement must of course be in place and effectively bind the owners of the business. One common problem with buy sell agreement is that the purchase price is based upon an agreed upon value, and that price is not adjusted periodically. A solution might be to provide that the stated price will be reviewed and agreed to on at least an annual basis by the parties. Further if the price has not been updated with the stated time frame the price will be determined by an alternative measure such as appraisal. VII.

S Corporation Stock.

A. Blunder: Having stock in an S Corporation pass into an ineligible trust. Only certain trusts, specifically “qualified sub-chapter S trusts” (a “QSST”) and “Electing Small Business Trusts (an “ESBT”), qualify as S Corporation shareholders. If stock passes into a trust which does not qualify as a QSST or an ESBT the S Election will be lost. B. Correction: The following provision could be added to the estate planning documents: “THIRTEENTH:

Special Provisions for S Stock.

(a) My Trustee may at any time hold stock of an S Corporation as defined in the Internal Revenue Code (hereinafter "S Stock"), make an election to have any corporation treated as an S Corporation, enter into agreements with other shareholders relating to transfers of S Stock or the management of the S Corporation, and allocate amounts received and the tax on


undistributed income between income and principal. My Trustee may allocate the tax deductions and credits arising from ownership of S Stock between income and principal. In making any such allocations, my Trustee shall consider that the income beneficiary is to have enjoyment of the property at least equal to that ordinarily associated with an income interest and in all events shall provide the required beneficial enjoyment to the income beneficiary. (b) Notwithstanding anything herein to the contrary, my Trustee may at any time divide any trust hereunder which has a single income beneficiary into two separate trusts, one trust consisting of all S Stock and the other trust consisting of the remaining assets. Each such trust shall be held under the terms hereunder applicable to the trust so divided, except that (i) there shall be no power in the trust consisting of S Stock to make payments of principal during the lifetime of the income beneficiary to any person other than the person then entitled to receive the income, (ii) all income of the trust consisting of S Stock shall be paid to the income beneficiary at least annually and (iii) all income of such trust accrued or undistributed at the death of the income beneficiary shall be payable to his or her estate. The trust consisting of S Stock shall at all times have only one current beneficiary and shall not be recombined with the other trust upon the exchange of any S Stock for other assets, but shall at all times after its creation permit payments of principal only to the thencurrent income beneficiary. (c) Any provision of this Agreement which may appear to conflict with my intention that any trust containing S Stock qualify as a Qualified Subchapter S Trust as defined in Section 1361(d) of the Internal Revenue Code shall be construed so as to accomplish that intention. If my Trustee, in my Trustee's sole discretion, determines that such intention might not be accomplished, my Trustee shall have the power to amend the trust to accomplish said intention, subject to the following conditions and limitations: 1. No such amendment shall be made except to accomplish the intentions set forth in this subparagraph (c). 2. All such amendments shall be in the form of a decree of the court having jurisdiction over the trust, upon petition by my Trustee and after such notice to the parties in interest as such court may direct. 30

3. My Trustee shall have the power to request that any such amendment take effect as of the effective date of this trust, or any subsequent date, in my Trustee's sole discretion.


Profile for Gibson & Perkins, PC

Common Errors in Federal Estate Tax Planning  

Prepared by Gibson & Perkins, PC attorney Edward L. Perkins Media, PA www.gibperk.com 484-326-8285

Common Errors in Federal Estate Tax Planning  

Prepared by Gibson & Perkins, PC attorney Edward L. Perkins Media, PA www.gibperk.com 484-326-8285

Profile for gibperkpc