Types of Trusts: Revocable Trusts

A revocable living trust should be considered in the following situations:

• You have assets in more than one state;
• You wish to avoid the cost and time delays associated with probate;
• You are concerned about privacy (a will becomes a public document; and/or
• You wish to ensure ease of administering your assets if you become incapacitated.

A revocable living trust does NOT offer any asset protection with respect to the assets transferred to the trust and it does NOT reduce your estate taxes in any way that cannot be accomplished through a will.

When a revocable living trust is part of an estate plan, the dispositive provisions (i.e., the blueprint of the estate plan… the who gets what, when details) will appear in the trust agreement and not the will. However, you will still need a will to handle any assets that were not transferred to the revocable trust during your lifetime. Plus, if you have minor children, the will is needed to nominate guardians for those minor children. The will operates to pour over any assets that are outside the trust into the trust at the time of your death. Thus a will of this sort is typically called a “pour over will.”

Types of Trusts: Irrevocable Trusts

With an irrevocable trust the grantor completely relinquishes title to the property and does not retain a right to alter, amend or revoke the trust. Since the grantor gives up all control and dominion over the transferred property, the assets of an irrevocable trust are not includible in the grantor’s gross estate for federal estate tax purposes. Irrevocable Trusts are also used to shield certain assets from potential future creditors by removing them to a trust

over which neither the grantor nor the beneficiary has discretionary control.

Need Help Creating or Updating Your Estate Plan? Contact Our Firm Today.

At Adler & Adler, we are dedicated to helping our clients protect their assets and families and ensure that your wishes are heard and honored. Once you retain our services, we can advise you on all aspects of your estate planning. Contact us today: 212-843-4059 or 646-946-8327.

2 – Clayton QTIP Plan With Trusts for Descendants

3 – Two Share Plan With Trusts for Descendants

4 – Three Share Plan (Federal Bypass Trust (Family Trust); GST Exempt Reverse QTIP Marital Trust; Marital Trust)

5. Three Share Plan (Federal/State Bypass Trust (Family Trust); State Only QTIP Marital Trust; Marital Trust)

6 – Four Share Plan (Federal/State Bypass Trust (Family Trust); State Only QTIP Marital Trust; Reverse QTIP Marital Trust, Marital Trust)

Clarity begins with a conversation. Call: 212-843-4059 or 646-946-8327.

Wills and Trusts, Estate Planning: Steps, Costs and Our Process

The last deceased spouse is the most recently deceased person who was married to the surviving spouse at the time of that person’s death. The identity of the last deceased spouse is determined as of the day a taxable gift is made and is not impacted by whether the decedent’s estate elected portability or whether the last deceased spouse had any DSUE amount available. Remarriage also does not affect the designation of the last deceased spouse and does not prevent the surviving spouse from applying the DSUE amount to taxable transfers.

When a taxable gift is made, the DSUE amount received from the last deceased spouse is applied before the surviving spouse’s basic exclusion amount. A surviving spouse who has more than one predeceased spouse is not precluded from using the DSUE amount of each spouse in succession. A surviving spouse may not use the sum of DSUE amounts from multiple predeceased spouses at one time nor may the DSUE amount of a predeceased spouse be applied after the death of a subsequent spouse.

A nonresident surviving spouse who is not a citizen of the United States may not take into account the DSUE amount of a deceased spouse unless allowed by treaty.

Who Must File

A U.S. person, corporation, partnership, limited liability company, trust and estate, must file a FBAR to report a financial interest in or signature or other authority over at least one financial account located outside the United States if the aggregate value of those foreign financial accounts exceeded $10,000 at any time during the calendar year reported.

Whether the account produced taxable income has no effect on whether the account is a foreign financial account for FBAR reporting purposes.

No FBAR filing is required for foreign financial accounts that are:

• Owned by an international financial institution.
• Maintained on a U.S. military banking facility.
• Held in an individual retirement account (IRA) of which you’re an owner or beneficiary.
• Held in a retirement plan of which you’re a participant or beneficiary.
• Part of a trust of which you’re a beneficiary, if a U.S. person (trust, trustee of the trust or agent of the trust) files an FBAR reporting these accounts.
• Accounts between Correspondent banks.
• Accounts owned by a government entities.

When to File

The FBAR is an annual report, due April 15 following the calendar year reported. You’re allowed an automatic extension to October 15 if you fail to meet the FBAR annual due date of April 15.

How to File

You must file the FBAR electronically through FinCEN’s BSA E-Filing System. You don’t file the FBAR with your federal tax return.

For each account you must report on an FBAR, you should keep the following records for 5 years:

• Account title.
• Account number.
• Name and address of the foreign bank.
• Type of account.
• Maximum value during the reporting year.

Filing a FBAR late or not at all may subject you to severe civil penalties and/or criminal charges.

Key concepts to understand about income tax “Basis”:

1- What is Cost Basis?

2 – How is Cost Basis Determined?

3 – What is Carryover Basis?

4 – Basis of Property Acquired In A Tax-Free Exchange

5 – Basis Adjustments When Taxable “Boot” Received

6 – Basis of Property Transferred In Trust

7 – Stepped-Up Basis; Property Transferred Upon Death

8 – Cost Basis Consideration In Planning Family Gifts

All answered here: What is Basis?

These regulations are of importance to plan participants, designated beneficiaries, and plan administrators of these qualified retirement plans, as well as owners, beneficiaries, trustees and custodians of IRAs. The final regulations apply to distribution calendar years (defined in Treasury Regulation § 1.401(a)(9)-5, Q&A-1(b)), beginning on or after January 1, 2022. A distribution calendar year is a calendar year for which a requireded miimum distribution (RMD) is required.

See: Transitioning to the Updated Required Minimum Distribution Tables in 2022 by David M. Barral, CPA/PFS, CFP, MST.

Property can be transferred back and forth between spouses without gift tax consequences and transferred to the surviving spouse upon the death of the first spouse to die, without estate tax consequences. Only upon the death of the second spouse will the “family unit’s” wealth be taxed (except to the extent that property may have been transferred outside the family unit (i.e., other than to the surviving spouse) when the first spouse died. It should be noted that transfer by the first spouse to die, of his or her entire gross estate to the surviving spouse, although it will eliminate any estate tax when the first spouse dies, may not be desirable from a longer-range estate planning viewpoint. A will creating a credit shelter trust (sometimes referred to as a bypass trust or family trust or non-marital trust) can result in estate tax savings by taking full advantage of the unified credit in the estates of both spouses (without relying on portability) thus sheltering from estate taxation an amount equal to two times the applicable exemption amount.

Consistent with this approach, the unified transfer tax system assumes — and indeed, attempts to assure — that any of the property of the first spouse to die, which passes tax free under the marital deduction to the surviving spouse, will be includable in the gross estate of the surviving spouse when he or she dies. In this respect the unlimited marital deduction is essentially a mechanism for deferral of tax which might otherwise be payable upon the death of the first spouse to die.

In order to qualify for the marital deduction the subject property must have been included in the decedent’s gross estate and have passed from the decedent to his or her surviving spouse. For this purpose, property is deemed to qualify as passing from the decedent to the surviving spouse only under seven possible circumstances set forth in I.R.C. §2056(c):

1. by bequest or devise from decedent;
2. by inheritance from decedent;
3. through dower or curtesy rights, or their statutory equivalent, under local law;
4. by transfer from the decedent during lifetime (in a manner which caused the transferred property to be includable in the gross estate; e.g., a gift “with strings attached” under I.R.C. §2036, 2037 or 2038);
5. by accession to decedent’s share of jointly owned property, through joint tenancy with right of survivorship;
6. by exercise of a power of appointment by the decedent, or by the surviving spouse’s taking by reason of non-exercise of such a power over the property;
7. by receipt of insurance proceeds on the life of decedent.

Transfers to a surviving spouse which qualify for the marital deduction may take a variety of forms, from outright full ownership, to various trust arrangements in which the surviving spouse (or his or her estate) receives, or has the right to direct the disposition of, the benefits of ownership. In essence, the surviving spouse must have an interest sufficient to cause the trust property to be included in his or her gross estate when he or she dies.

Terminable Interests

If the interest passing to the surviving spouse is subject to possible termination (with the beneficial enjoyment passing to another party) at some future point, the spouse’s interest is not considered sufficiently vested in the spouse to give rise to the marital deduction. For example, if the surviving spouse were to receive beneficial ownership for only five years, and then the property is to pass to someone else, a marital deduction cannot be taken for the value of the property (or even for the present value of the five-year interest). This type of interest and other interests in a surviving spouse which may terminate by passage of time, the happening of a contingency, or the failure of an event or contingency to occur, are referred to as “terminable interests.” Because of the possibility that the interest of the surviving spouse may terminate before his or her death, it would be inappropriate to assume that the value of the property will eventually be included in his gross estate, and thus, it must be included in the gross estate of the first to die (i.e., no marital deduction is allowable). This general principal is sometimes referred to as the “terminable interest rule.” There are exceptions to the general rule that a terminable interest does not qualify for the marital deduction. These are spelled out in I.R.C. §2056(b)(5), dealing with situations in which the surviving spouse holds a power of appointment; §2056(b)(7), dealing with life estates which can be made “qualified terminable interests” by election; and §2056(b)(8), dealing with “qualified charitable remainder trusts.” A critical common element is that the property in question will eventually be included in the surviving spouse’s gross estate or pass to charity.

Forms of Property Transfer to Surviving Spouse

Property transfers to a surviving spouse, qualifying for the marital deduction, may be in the form of outright transfer of full ownership or a variety of trust arrangements, utilized to meet certain specific objectives, depending on factual circumstances. Again, an essential element of any such transfer in trust is that the trust be established in such a manner that the property of the first spouse to die will eventually be included in the gross estate of the surviving spouse.

Outright Transfer

This is the most straightforward accession of ownership by the surviving spouse. No trust is involved, and the survivor merely takes unrestricted outright legal title. This could occur, for example, through direct transfer from the decedent by will or survivorship with respect to joint tenancy property.

Power of Appointment Trust

Property is transferred to a trust which provides for income to be paid to the surviving spouse for life, with the spouse being granted a general power of appointment over the property. Although this is technically a terminable interest, it is specifically excepted from the terminable interest rule by §2056(b)(5); the exception is based upon the fact that the subject property will ultimately be includable in the gross estate of the surviving spouse by reason of the power of appointment. I.R.C. §2056(b)(5) contains specific requirements in order for such a transfer to qualify for the marital deduction. The surviving spouse must be entitled to all of the income for life, payable at least annually. He or she must have a power of appointment over the property, which may be exercisable during lifetime or by will (or either) in favor of himself or herself or his or her estate. (Although §2056(b)(5) requires that the power of appointment be exercisable in favor of the surviving spouse/power holder or his or her estate, it does not use the term “general power of appointment,” which is defined in §2041. Under that definition a power of appointment is a “general” power of appointment if it can be exercised in favor of the power holder, his/her estate or creditors of either of them. Thus, whereas a power to appoint to creditors but not to the power holder or his/her estate directly would qualify as a general power of appointment, it would not qualify the power of appointment trust for the marital deduction under §2056(b)(5).) The power of appointment must be exercisable by the surviving spouse alone and in all events. No other person may have a power to appoint to someone other than the surviving spouse. This type of trust arrangement, with the power of appointment exercisable by will only, might be desirable as an alternative to outright ownership in situations where the decedent has doubts about the surviving spouse’s ability to deal appropriately with the property during his or her lifetime.

Estate Trust

A variation on the power of appointment marital deduction trust is the so-called “estate trust.” In the case of an estate trust the income from the trust property goes ultimately for the exclusive benefit of the surviving spouse, but the trustee has discretionary authority over whether to distribute income currently or to accumulate the income, adding it to the trust corpus. In any event the trust property, including any previously undistributed income, goes to the estate of the surviving spouse on his or her death. See Regs. §2056(e)-2(b)(1).

Qualified Charitable Remainder Trust

Suppose that a decedent’s will establishes a trust which provides for annual distribution to the surviving spouse of an amount equal to 5 percent of the net market value of trust assets, and upon his or her death, the trust corpus is to be distributed to the American Red Cross. Technically, the property interest given to the surviving spouse is a terminable interest, since it will end when he or she dies. The general terminable interest rule would prevent the first decedent from claiming a marital deduction for the value of the surviving spouse’s life income interest. However, §2056(b)(8) provides an exception when the holder of the remainder interest (following the interest of the surviving spouse) is a qualified charity. This exception is based upon the fact that if the property is going to ultimately pass to a qualified charity, and therefore, would be deductible from the gross estate of the surviving spouse (and would be deductible from the first decedent’s gross estate if given outright to the charity, without the spouse’s intervening life estate), there is no reason to subject the property to tax in the estate of the first decedent, who made the split-interest transfer. The effect of §2056(b)(8) is simply to eliminate any technical impediment to the complete deductibility of a split-interest transfer, where the only recipients of interests in the property are a surviving spouse and one or more qualified charities. In order for §2056(b)(8) to apply, the remainder interest in the charitable organization must be such that it would qualify for the gross estate charitable contribution deduction of I.R.C. §2055 as an interest in either a charitable remainder annuity trust or a charitable remainder unitrust.

Qualified Terminable Interest Property (“QTIP”) Trust

As previously mentioned, one of the exceptions to the terminable interest rule is the election permitted under §2056(b)(7) with respect to “qualified terminable interest property,” often referred to as the “QTIP” election. In general, a QTIP election will allow the marital deduction to be taken with respect to property as to which the surviving spouse has been given a life income interest, but which passes to another party upon the surviving spouse’s death. Such an interest in a surviving spouse is a terminable interest within the general rule of §2056(b)(1), and absent the QTIP provision, no marital deduction would be available. This is consistent with the underlying rationale of the terminable interest rule because the terminable interest property would not be includable in the gross estate of the surviving spouse (absent a general power of appointment). The QTIP election permits the personal representative of the estate of the first spouse to die to make an election, the effect of which is to allow the marital deduction for property not otherwise deductible, in return for acceptance of the consequence that the property will later be included in the gross estate of the surviving spouse. The inclusion of QTIP property in the gross estate of the surviving spouse is mandated by I.R.C. §2044.

In order to qualify for the QTIP election, certain conditions must be met. The property must pass from the decedent, and the surviving spouse must have a qualifying income interest for life. The surviving spouse has a qualifying income interest for life if he or she is entitled to all of the income from the property, payable annually or at more frequent intervals (or has a usufruct interest (in general, the term “usufruct interest” means the right to enjoy the physical fruits of (as opposed to rental income from) real property. For example, the right to harvest crops or to exploit mineral resources for life in the property), and no person has a power to appoint any part of the property to any person other than the surviving spouse (unless exercisable only upon or after the surviving spouse’s death). The personal representative of the estate must make the election in the estate tax return, and the election is irrevocable. The election may be made as to the entire amount of the subject property (as to which the surviving spouse holds the requisite life estate), or as to any specified fractional or percentage portion. Any such partial election must be in terms of a fractional or percentage share of the property (rather than a stated dollar amount) so that the portion as to which the election is made will reflect the proportionate share of any increase or decrease in value when it is ultimately included in the surviving spouses gross estate. The fraction or percentage may be defined by means of a formula. This ability to make a QTIP election as to any proportionate share of the trust is a significant post-death planning tool.

The significant difference between the QTIP trust under §2056(b)(7) and the power of appointment trust under §2056(b)(5) is that under the power of appointment trust the property will be brought into the surviving spouse’s gross estate by reason of his or her possession of a general power of appointment, whereas, with a QTIP trust, the surviving spouse need not have a power of appointment, the property being includable in his or her gross estate by reason of the QTIP election having been made. In this respect the QTIP trust is particularly useful in situations where the decedent wishes to direct the disposition of the property after the death of the surviving spouse, and does not want the surviving spouse to have the power to change it (through exercise of a power of appointment). QTIP trusts are often used where an individual’s children of a prior marriage are to be his or her ultimate beneficiaries, however, the decedent wants to take full advantage of the marital deduction.

In order to satisfy the requirement that the surviving spouse holds an income interest for life in a power of appointment trust or a QTIP trust, the trust provisions may not impose restrictions on the spouse’s degree of beneficial enjoyment of the trust property which are inconsistent with the normal rights of a life beneficiary under the general law of trusts. Thus, the requirement that the surviving spouse be entitled to all of the income will not be satisfied if the primary purpose of the trust is to safeguard property without providing the spouse with the required current beneficial enjoyment. This would apply to trusts which expressly provide for the accumulation of income and trusts which indirectly accomplish a similar purpose. For example, assume that the trust consists substantially of property which is not likely to produce income during the life of the surviving spouse. An interest passing to such a trust will not qualify for the marital deduction unless the applicable trust law and rules for trust administration require, or permit the life beneficiary to require, that the trustee make the property currently productive or convert it to alternative income-producing property. In general, the designation of the surviving spouse as sole income beneficiary for life will be sufficient to qualify the trust unless the terms of the trust and the surrounding circumstances considered as a whole evidence an intention to deprive the spouse of the requisite degree of enjoyment.

Qualified Domestic Trust

As previously mentioned, a transfer to a surviving spouse who is not a U.S. citizen will not generally qualify for the marital deduction. Since the marital deduction is merely a deferral privilege, it presumes that the property of the first spouse to die will eventually be taxed as part of the estate of the surviving spouse. However, this critical presumption may well not be applicable when the surviving spouse is not a U.S. citizen, since there is a material risk that the original decedent’s property will be removed from U.S. taxing jurisdiction before the death of the surviving spouse. See Qualified Domestic Trust.

For income tax purposes, non-grantor trusts are classified as either simple trusts or complex trusts. A simple trust is one that mandates that all income earned during the taxable year must be distributed to the trust beneficiary. A complex trust is sometimes referred to as an accumulation trust or a discretionary trust. The trustee of a complex trust has discretion over distributions as described in the trust document. If a trust mandates distributions of income and the trustee also makes a discretionary distribution of principal, the trust is considered a complex trust.

Understanding the income tax treatment of taxable trusts is important because trusts have highly compressed tax brackets. As of 2021, the top tax rate of 37% on ordinary income begins at the very low threshold of $13,051 for trusts. By comparison an individual single taxpayer only reaches the 37% marginal tax rate after reaching $523,601 of ordinary income. Married individuals filing jointly reach the the top marginal rate after reaching $628,301 of ordinary income. The top tax rate of long-term capital gains begins at a threshold of $13,250 for trusts, whereas the threshold for individual single filers is $445,850 and for married persons filing jointly $501,600 of income.

Like individuals, trusts are also be subject to an additional tax for any undistributed investment income, known as “net investment income tax.”

If a trust’s beneficiary is in a lower tax bracket than the trust and the trust’s beneficiary receives distributions from the trust, such distributions could result in a lower overall tax if the beneficiary is in a lower tax bracket.

For tax purposes, we must look at so-called trust accounting income (“TAI”). TAI is calculated in conformity with the terms of the trust agreement and state law. In simple terms, TAI includes all forms of income, except long term capital gains. But note that the trust document can redefine trust accounting income to include capital gains.

The taxable income of a trust is generally calculated the same as the taxable income of an individual, but the tax may be owed by the trust or by a combination of the trust and its beneficiaries. This is true because trusts are entitled to a deduction known as the Income Distribution Deduction, which is generally defined as the lesser of Distributable Net Income (“DNI”) or the total distributions. DNI is the construct used to allocate income between a non-grantor trust and its beneficiaries and assure that there is no double taxation.

DNI is the amount of income that will be taxed to the beneficiary. Distributions in excess of DNI are treated as tax-exempt income or as principal and are not taxable to the beneficiary. A complex trust does not have to distribute all of its income or make principal distributions. Regardless of how much is distributed, the distribution deduction is limited to DNI. The amount that is treated as DNI is taxed on the beneficiary’s income tax return since it is income earned by the trust or estate which then received an offsetting deduction on the fiduciary income tax return (Form 1041).

The gift tax applies to a transfer by gift regardless of whether: (1) the transfer is made outright or in trust; (2) the gift is direct or indirect; or (3) the property is real or personal, tangible or intangible.

The federal gift tax assumes that all transfers of property by gift are taxable, but there are exceptions. Nontaxable transfers that need not be reported on Form 709 (the United States Gift (and Generation-Skipping Transfer) Tax Return) include:

– Gifts of present interests (see below) within the gift tax annual exclusion amount (currently, $15,000 per donee),

– Direct payments of qualifying medical or educational expenses on behalf of an individual,

– Deductible charitable gifts,

– Gifts to one’s U.S. citizen spouse, either outright or to a trust that meets certain requirements, and

– Gifts to one’s non-citizen spouse within a special annual exclusion amount ($159,000, as indexed for inflation in 2021).

If all your gifts for the year fall into these categories, no gift tax return is required. But gifts that don’t meet these requirements are generally considered taxable and thus must be reported on Form 709 — even if they’re shielded from tax by the lifetime exemption ($11,700,000 in 2021).

Beware of common errors:

– Future interests. The $15,000 annual exclusion applies only to present interests, such as outright gifts. Gifts of future interests, such as transfers to a trust for a beneficiaries benefit, aren’t covered, so you’re required to report them on Form 709 even if they’re less than $15,000. Be aware, however, that it’s possible for gifts in trust to meet the present interest requirement by giving beneficiaries so-called Crummey withdrawal powers (the right to withdraw a contribution for a limited time after it’s made).

– Spousal gifts. As previously noted, gifts to a U.S. citizen spouse are not reported on Form 709. However, if you make a gift to a trust for your spouse’s benefit, the trust must 1) provide that your spouse is entitled to all the trust’s income for life, payable at least annually, 2) give your spouse a general power of appointment over its assets and 3) not be subject to any other person’s power of appointment. Otherwise, the gift must be reported. And, gifts to a non-citizen spouse: If they exceed the $159,000 annual exclusion, they must be reported whether they’re outright gifts or gifts in trust.

– Gift splitting. Spouses may elect to split a gift to a child or other donee, so that each spouse is deemed to have made one-half of the gift, even if one spouse wrote the check. This allows married couples to combine their annual exclusions and give up to $30,000 to each donee. To make the election, the donor spouse must file Form 709, and the other spouse must sign a consent or, in some cases, file a separate gift tax return. Keep in mind that, once you make this election, you and your spouse must split all gifts to third parties during that tax year.

– 529 plans. You can contribute up to five times the annual gift allowance of $15,000, per beneficiary in a single year without gift tax as long as no additional gifts are made to the same beneficiary during the next four years. This means that you can contribute up to $75,000 ($150,000 for married couples) for your beneficiary today and elect to treat your contribution as made over a five calendar-year period for gift tax purposes. To take advantage of this benefit, you must file an election on Form 709.

Sometimes it may be useful to file a gift tax return, even if one is not required. For example, if you make annual exclusion gifts of hard to value assets, such as interests in a closely held business, a gift tax return that meets “adequate disclosure” requirements will trigger the three-year statute of limitations period for audits. If you don’t file a gift tax return, the IRS has unlimited time to challenge the value of your gifts.

See also: Wealth Transfer Taxes (in 6 minutes)

A trust exists when one person (the trustee) holds title to property for the benefit of another person (the beneficiary).

A person called the grantor (also known as the settlor or trustor) creates the trust and transfers property in the trust. The grantor, trustee, and beneficiary can be different people. It is also possible that one single person could be the grantor, trustee and beneficiary.

What is a trustee?

The trustee is the person or entity (such as a bank or trust company) that holds legal title to the property in the trust. The trustee’s job is to manage the property in the trust for the benefit of the beneficiaries pursuant to the terms of the trust.

A trustee has all the powers set forth in the trust document (unless they conflict with New York law or unless a court order says otherwise). The trustee has a duty to collect, preserve and protect the trust assets.

Generally speaking the trustee must:

– Follow what the trust document says (as long as it is legal);

– Do only things that benefit the beneficiaries;

– Not favor one beneficiary over another (unless the trust document says otherwise);

– Avoid conflicts of interest with the beneficiaries

– Never use trust property for personal benefit (unless the trustee is also a beneficiary);

– Keep trust property separate from property owned by anyone else;

– Administer and invest the assets of the trust with reasonable care and skill, protect the trust and accomplish the purposes of the trust as set forth in the trust document;

– Keep detailed records and provide the beneficiaries with periodic reports and accountings as required by New York law.

– Make proper determinations of what is income versus principal when the trust directs that they be distributed differently.

What is a trust “beneficiary”?

A beneficiary of a trust is a person who by the terms of the trust has the current or future right to have the trustee pay out cash or other trust property to him or her. Unless the trust is revocable by someone else the beneficiary generally has the following rights, in addition to any other rights listed in the trust:

– The right to receive notice of the existence of the trust.

– The right to receive a copy of the trust.

– The right to receive trust information about the beneficiary’s interests in the trust.

– The right to enforce the terms of the trust and to hold the trustee accountable for any wrongful acts or omissions that affect that beneficiary’s interests.

See also:

What is a Trust?

Revocable Trusts

All property that is included in the gross estate and passes to a surviving spouse is eligible for the marital deduction. The property must pass “outright.” In some cases, certain life estates and certain marital trusts (for example, a so-called QTIP trust) also qualify for the marital deduction.

Once you have accounted for the Gross Estate, certain deductions (and in certain circumstances, reductions to value) are allowed in arriving at your “Taxable Estate.” These deductions may include mortgages and other debts, estate administration expenses, property that passes to surviving spouses and qualified charities. The value of some operating business interests or farms may be reduced for estates that qualify.

After the net amount is computed, the value of lifetime taxable gifts (beginning with gifts made in 1977) is added to this number and the tax is computed. The tax is then reduced by the available unified credit.

Most estates do not need to file an estate tax return. A filing is required for estates with combined gross assets and prior taxable gifts exceeding $11,180,000 in 2018, $11,400,000 in 2019, $11,580,000 in 2020, and $11,700,000 in 2021. In 2026, the exemption amount is scheduled to revert to its pre-2018 level of $5 million, as adjusted for inflation.

Treasury regulations state that taxpayers taking advantage of the increased exemption amounts by making gifts during the period 2018 to 2025 will not be adversely effected after 2025 when this amount reverts to its pre-2018 level of $5 million. Thus, taxpayers planning to make large gifts between 2018 and 2025 can do so without being concerned that they will lose the tax benefit of the higher exemption level once it decreases.

Since January 1, 2011, estates of decedents survived by a spouse may elect to pass any of the decedent’s unused exemption to the surviving spouse. This election is made on a timely filed estate tax return for the decedent with a surviving spouse and is known as the portability election.

See: Wealth Transfer Taxes (in 6 minutes)

Section 1014(a)(1) of the Code states that the basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent shall, if not sold, exchanged, or otherwise disposed of before the decedent’s death by such person, be the fair market value of the property at the date of the decedent’s death.

Section 1014(b)(1) of the Code provides that property acquired by bequest, devise, or inheritance, or by the decedent’s estate from the decedent shall be considered to have been acquired from or to have passed from the decedent for purposes of section 1014(a).

Section 1014(b)(9)(C) of the Code further provides that section 1014(b)(9) shall not apply to property described in other paragraphs of section 1014(b).

Section 1014(b)(9) of the Code provides that, in the case of a decedent dying after December 31, 1953, property acquired from a decedent by reason of death, form of ownership, or other conditions (including property acquired through the exercise or non-exercise of a power of appointment), if by reason thereof the property is required to be included in determining the value of a decedent’s gross estate shall be considered to have been acquired from or to have passed from the decedent for purposes of section 1014(a).

Section 1.1014-2(b)(2) of the Income Tax Regulations provides that section 1014(b)(9) property does not include property that is not includible in the value of a decedent’s gross estate, such as property not situated in the United States acquired from a nonresident who is not a citizen of the United States.

Estates

When a will makes a bequest to charity, the estate must register with the Attorney General.

Are any charitable estates exempt from registration?

Registration is not required if all bequests to charity are specific dollar amounts left to named charities. However, if the bequests cannot be paid in full for any reason (for example, the estate has insufficient assets, a named charity no longer exists, etc.), then the estate must register as soon as possible but no later than six months after these facts become known.

How does an estate register?

A registration file is opened automatically, and a registration number is assigned, when the Attorney General’s office receives a copy of the Notice of Probate, a court document that is prepared by the executor or the estate’s attorney. The executor or attorney will receive a letter from the Attorney General’s office confirming that the estate is registered, and requesting a copy of the will if has not already been provided.

Must a charitable estate file financial reports with the Attorney General?

The only required financial report is the executor’s final accounting, which is filed when the estate is ready to be closed. The accounting may be formal (filed in court) or informal.

The applicable fee is payable at the time of the final accounting. The fee amount is based on the amount that is paid to charity.

Trusts

Which trusts must register?

Any trust that has a current charitable interest must register with the Attorney General. This includes charitable lead trusts, charitable remainder trusts (when the charitable remainder interest becomes current), and trusts with wholly charitable purposes, including private foundations and public charities organized in trust form.

In general, a trust is required to register no later than six months after the charitable interest becomes current.

When divorce occurs, there are important tax law and estate planning issues that need to be addressed. — especially by high net worth families. Unfortunately, these issues are often ignored or misunderstood. Divorcing spouses often wrongly assume that their divorce attorney understands the gift tax, estate tax and generation skipping transfer tax implications of the divorce settlement (some do.. many don’t). The best practice is to have a competent tax and estate planning lawyer involved in the divorce settlement negotiations… this is especially necessary where the divorce attorney’s engagement agreement specifically disclaims responsibility for any tax or estate planning issues.

Also, all existing estate planning documents (including beneficiary designations) should be reviewed and redrafted by an estate planning attorney.

See: Planning for Divorce from the Perspective of a Tax and Estate Planner by Attorney John J. Scroggin, AEP, J.D., LL.M.

(1) possession or enjoyment of the property by the transferee can be obtained only at or after the transferor’s death, or

(2) the decedent retained a possibility (referred to as a “reversionary interest”) that the property, other than the income alone, would return to the decedent or his estate or would be subject to a power of disposition by him, and such reversionary interest had a value, immediately prior to decedent’s death, in excess of 5 percent of the total value of the property.

The value of a reversionary interest is determined in accordance with recognized valuation principles for determining future or conditional interests in property as set forth in Treasury regulations.

The underlying rationale of §2037 is similar to that of §2036: although the decedent may have given the property away during his lifetime, he actually retained for himself the beneficial enjoyment of the property (or, in the case of a reversionary interest, he retained a meaningful prospect of receiving the property back again).

Notwithstanding the foregoing, an interest in transferred property is not includable in a decedent’s gross estate under section 2037 if possession or enjoyment of the property could have been obtained by any beneficiary during the decedent’s life through the exercise of a general power of appointment (as defined in section 2041) which in fact was exercisable immediately before the decedent’s death. The application of section 2037 with respect to a reversionary interest held by the decedent is illustrated by the following example:

Example: The decedent transferred property in trust with the income payable to his wife for life and with the remainder payable to the decedent or, if he is not living at his wife’s death, to his daughter or her estate. The daughter cannot obtain possession or enjoyment of the property without surviving the decedent. Therefore, if the decedent’s reversionary interest immediately before his death exceeded 5 percent of the value of the property, the value of the property, less the value of the wife’s outstanding life estate, is includable in the decedent’s gross estate.

In addition to the property owned outright at the date of death the gross estate for federal estate tax purposes includes certain other property with which the decedent was connected, as discussed in the following blog posts:

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Property Transferred With Retained Life Estate – I.R.C. §2036

Transfers Taking Effect at Death – I.R.C. §2037

Revocable Transfers – I.R.C. §2038

Annuities – I.R.C. §2039

Jointly Owned Property – I.R.C. §2040

Property Subject to General Power of Appointment – I.R.C. §2041

Proceeds of Life Insurance – I.R.C. §2042

Gifts Made Within Three Years of Death – I.R.C. §2035

D dies and his will provides that certain rental property which he owned be placed in a trust, from which all future income is to be paid to his daughter for life, with the principal going to a charity upon the daughter’s death. However, D also grants to his surviving wife, W, the right to require at any time that the trustee transfer outright ownership of the trust’s property to her or to anyone else she might designate. Thus, W holds a power of appointment over the subject property. Although W does not own the subject property, the power of appointment represents a valuable interest in the property, practically equivalent to ownership, because it is a right to obtain ownership on demand.

Power of Appointment for Future Flexibility

A power of appointment is created by the original owner of the subject property, as donor, and the person granted the power is referred to as the “power holder.” Powers of appointment are a valuable tool in estate plans, because they allow for future flexibility in the ultimate disposition of the donor’s property which is placed in a trust. Thus, at the time the trust is created the intention to provide income to a spouse or other beneficiary may be the donor’s primary objective. Although a designation of the remainder beneficiary(ies) is necessary, this may be of secondary importance to the donor, and if the remainder interest is unlikely to be received until some distant future time, the person(s) whom the family would chose to receive the interest at that point in time may be different than the choice made when the trust is established. Factors such as changes in financial circumstances, divorce, family estrangement and others may well affect future choices of beneficiaries.

For example, in a family with two adult children, an estate plan might provide that the surviving spouse is to receive trust income for life, with the remainder to be divided 50-50 between the two children. However, what if the early adult lives of the two children indicate that one of them is likely to be financially secure on his own, while the other may not be, by reason of a high risk or low-potential career path? Or perhaps one of the children presents a risk that an inheritance would be rapidly dissipated through substance abuse or other anti-social activity. The family can essentially take a wait-and-see approach to the disposition of the trust property after the death of the surviving spouse, by granting the surviving spouse a power of appointment to designate the ultimate property distribution between the children. The power of appointment could be made exercisable only upon the surviving spouse’s death (a “testamentary” power of appointment), or it could be made exercisable during the spouse’s lifetime (an “inter vivos” or “lifetime” power of appointment).

What happens if the power of appointment is never exercised? When the power of appointment is created, the trust instrument must spell out the disposition of the property in the event that the power of appointment is not exercised. This might be referred as the “default” result, or the disposition of the trust property “in default of appointment.”

General and Limited Powers of Appointment

There are two types of powers of appointment for tax purposes: a general power of appointed and a limited (or special) power of appointment. Under a limited power of appointment, the power holder is limited by the terms of the power, in the selection of persons in favor of whom the power may be exercised (“appointees”). The class of potential appointees may be narrowly limited (e.g., only the donor’s children), or may be virtually unlimited, the only limitation being that the power may not be exercised in favor of the power holder himself, the power holder’s estate, or the creditors of either. Any power of appointment that can be exercised in favor of the power holder, his creditors, or his estate or the creditors of the estate, is a general power of appointment. (It should be noted that section 20.2041-1(c) of the treasury regulations provides that a power of appointment exercisable for the purpose of discharging a legal obligation of the power holder is considered a power of appointment exercisable in favor of the power holder or the power holder’s creditors. This would include the legal obligation for support of the power holder’s minor children. )

Because the holder of a general power of appointment can appoint the property to himself or his estate or creditors, the possession of such a power represents a degree of beneficial ownership in the property only slightly removed from outright ownership. For estate tax purposes, the holder of a general power of appointment is deemed to have rights so close to outright ownership that if he or she were to die while holding the power (whether or not exercised at death), the property subject to the power must be included in the gross estate.

On the other hand, property subject to a limited power of appointment is not includable in the gross estate of the power holder (i.e., will not subject to estate tax). Accordingly, when powers of appointment are used in estate plans for trusts other than the marital deduction trust, it is important that they be structured as only limited powers; otherwise, the property subject to the power will be pulled into the gross estate of the power holder, with potentially disastrous tax consequences. With respect to marital deduction trusts, a general power of appointment is sometimes used, giving the surviving spouse absolute power over the trust property, since the property must be included in the surviving spouse’s gross estate as a condition to qualification for the marital deduction at the time of the first spouse’s death.

See also:

Wealth Transfer Taxes (in 6 minutes)

Estate Planning in Times of Unstable Estate Tax Law and Policy

Buy Sell Agreements (Cross Purchase and Stock Redemption)

The underlying rationale for inclusion of the transferred property in the gross estate is based upon the fact that the decedent actually retained control over the ultimate beneficial enjoyment of the property transferred. A transfer of property which is subject to revocation and reclaiming by the transferor is not considered a completed transfer. Note that the transferor need not actually exercise his power to alter, amend, revoke or terminate; he need only possess any such power in order for the property to be includable in his gross estate.

A prominent example of this type of transfer is the revocable inter-vivos trust (popularly referred to as “living trust”). Such trusts are often used for the transfer of title of property in order to remove such property from eventual probate proceedings. However, a “living trust” will not remove the trust property from the gross estate for federal estate tax purposes as long as the grantor retains the right to revoke it.

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In addition to the property owned outright at the date of death the gross estate for federal estate tax purposes includes certain other property with which the decedent was connected, as discussed in the following blog posts:

Property Transferred With Retained Life Estate – I.R.C. §2036

Transfers Taking Effect at Death – I.R.C. §2037

Revocable Transfers – I.R.C. §2038

Annuities – I.R.C. §2039

Jointly Owned Property – I.R.C. §2040

Property Subject to General Power of Appointment – I.R.C. §2041

Proceeds of Life Insurance – I.R.C. §2042

Gifts Made Within Three Years of Death – I.R.C. §2035

Example: Ben is the beneficiary of a trust under which he is to receive all the income during his lifetime and he has an unrestricted power to cause corpus to be distributed to himself or any other party. Ben died in 2020 Ben had a general power of appointment over the corpus of the trust and therefore, the entire corpus at the date of his death is included in his gross estate.

In the foregoing example there was no limitation imposed upon the range of parties in

favor of whom the power could be exercised. Ben could exercise the power in favor of

any person, group of persons, any entity (such as a charity), etc. In fact, Ben could even appoint the property to himself. Powers of appointment are often created with a delimited group of potential appointees among which the power holder may select. For example, the power may be limited to appointment to such one or more of a decedent’s children as the surviving spouse may designate.

A power of appointment under which the power holder may appoint in favor of himself, his estate, his creditors or creditors of his estate is referred to as a general power of appointment. A power of appointment which does not permit appointment in favor of himself, his estate, his creditors or creditors of his estate is referred to as a “special” or “limited” power of appointment.

In the case of a general power of appointment, because the holder of the power can

appoint the property to himself or his creditors or to his estate or estate creditors, the possession of the power of appointment represents a degree of beneficial interest in the property only slightly removed from outright beneficial ownership. Thus, under I.R.C. §2041, in effect, the holder of a general power of appointment is deemed to have rights so close to outright ownership that if he were to die while holding the general power, the property subject to the power will be subject to estate tax. On the other hand property subject to a special (limited) power of appointment held by a decedent when he dies is not includable in his gross estate. A special or limited power of appointment allows the power-holder to dispose of property in favor of anyone other than himself, his estate, his creditors, or the creditors of his estate.

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In addition to the property owned outright at the date of death the gross estate for federal estate tax purposes includes certain other property with which the decedent was connected, as discussed in the following blog posts:

Property Transferred With Retained Life Estate – I.R.C. §2036

Transfers Taking Effect at Death – I.R.C. §2037

Revocable Transfers – I.R.C. §2038

Annuities – I.R.C. §2039

Jointly Owned Property – I.R.C. §2040

Property Subject to General Power of Appointment – I.R.C. §2041

Proceeds of Life Insurance – I.R.C. §2042

Gifts Made Within Three Years of Death – I.R.C. §2035