Creating a Dynasty Trust in WealthDocx RLT

The term “Dynasty Trust” means different things to different people.  WealthDocx uses the term Dynasty trust to describe a GST Exempt multi-generational common trust for descendants that lasts as long as the rule against perpetuities will allow.  This is one of the options for distribution of the Exempt Property when the mandatory division into GST Exempt and Non-exempt shares is selected.

 

Other individuals use the term dynasty trust to describe cascading individual trusts.  This is also available in WealthDocx by selecting the option to leave the property to a beneficiaries descendants in cascading trusts.

Submitted by Lew Dymond, JD
WealthCounsel, LLC

Modest estate in decoupled state - Which marital deduction choice?

Query: Client has $1.4MM estate in a decoupled state. Will the selection of "all going to marital share" using a QTIP trust allow the Trustee/PR to make QTIP election for state estate tax purposes?

Response: You don't want "all to marital" if you want to fund a marital and a non-marital. With Maryland's $1MM exemption and a $3.5MM federal exemption, an "all to marital" fails to use any state or federal exemption at all.

If your state allows a separate state QTIP election (that is, the state QTIP election doesn't have to be the same amount as the federal QTIP election), you can use something like the Clayton election that provides the most flexibility after the client/grantor dies. The executor/trustee makes a $400k state QTIP election (sending the remaining $1MM to the bypass trust for state estate tax purposes) and elects ALL of the estate out of QTIP treatment for federal purposes (sending all $1.4MM through the bypass for federal estate tax purposes). If your state does not allow a separate state QTIP election, then use the Clayton option, with the further option of creating two separate QTIP trusts: one funded with the amount necessary to reduce state estate tax to the lowest amount, and the other funded with the amount necessary to reduce the federal estate tax to the lowest possible amount.

Matthew T. McClintock, JD

WealthCounsel.com

$2 Million QDOT?

Query: I noticed in the WealthDocs QDOT that some of the language references a $2 Million amount. Is that tied to anything? Is it inflation adjusted or supposed to be tied to the estate tax applicable exclusion amount?

Response: The $2 Million number is specified right in the body of the Treasury Regulations. Regs. Sec. 20.2056A-2(d)(1)(i) specifically refers to additional requirements when the value of the QDOT exceeds $2 Million. Nothing in the Reg. indicates an inflation adjustment or otherwise sets the value to be equal to some other value.

Matthew T. McClintock, JD
WealthCounsel.com

Gift of REAL Property in Trust?

Query:  I’m drafting a trust where an individual wants to leave real estate to another individual in trust.  In the past, I have modified the “Monetary Gift – Trust” option to fit...but don’t see why a “Specific Property in Trust” section couldn’t easily be added.

Response: The practical concern I’ve always had about this type of provision is that it seems to me that more than the real property must be contributed to the trust. How will the financial obligations that attend managing that property be satisfied? There will be property taxes, improvements, insurance, maintenance, etc. that require money to fund. If an item of specific property (real or personal) is put in trust, how is that property maintained?

A “dry” trust owning real property (a residence) and no liquid assets or income is a real problem , one made even worse if the property is mortgaged. Principal payments on the mortgage inure to the remainder beneficiaries. If the beneficiary has to make the mortgage payments, each payment constitutes a completed gift to the remainder beneficiaries.

Trust Beneficiary occupants are theoretically the same as life tenants, except there are generally no common law rules governing trust beneficiaries equivalent to the well developed laws governing life tenants and remainder beneficiaries.

It’s best to draft to meet the specific needs and provide for payment of taxes, capital improvements, etc and be sure there is cash to support the real property.

Shared contribution by the WealthDocs Editorial Oversight Board
WealthCounsel.com

WealthDocs ILIT - What's so special about February 1st?

Query: So I'm reading my WealthDocs ILIT and I see a reference to February 1 in the trust. I think this has something to do with "hanging" Crummey powers, but I don't get it.

Response: Believe it or not, that's a fairly technical and involved question. Recall that with "hanging powers," we want those hanging amounts to lapse to the greatest amount possible as soon as possible. For a more complete discussion on hanging Crummey powers, see the previous blog post on that topic. Here's how the hanging powers work in the context of the February 1 lapse date: 

Assume a $12,000 contribution is made to the trust in year 1. With a hanging power, the first $5,000 lapses after the initial Crummey withdrawal right term (assume the trust gives a 30 day withdrawal right). 

The remaining $7,000 (the amount of the contribution that exceeds the greater of $5,000 or 5% of the trust) "hangs around" and remains subject to a right to withdraw. On February 1 of the following year, (we have a "new year," and hence a new 5/5 that can lapse), the amount of the hanging power lapses, again to the greater of $5,000 or 5% of the trust. So on February 1, $5,000 of the hanging power lapses, leaving only $2,000 "hanging." Another contribution is made to the trust in year two, and we start the process again, gradually increasing the amount that "hangs." 

The reason WealthDocs makes the hanging power lapse as soon as possible in year two is to limit the value exposed to the beneficiary's continuing right to withdraw. We let the greatest amount of the hanging power lapse as quickly as possible in the following year. We set that date at February 1 to make sure that we have at least 30 days from year end to contemplate any gifts made to the trust on December 31 of the previous year.

Matthew T. McClintock, JD

www.WealthCounsel.com

Joint RLT - Deceased Spouse's Share

Query: I serve often a couple who has a nontaxable estate and who want a joint trust. I find that such couple own the bulk, if not all, of their assets as H and W. The individually owned assets, if any,  tend to be IRAs, annuities and insurance policies and the disposition of those assets are often controlled by carefully crafted contract beneficiaries ( the surviving spouse directly for example) as you well know. In my practice experience with the clientele that I mostly serve, the assets are simply and mostly jointly owned prior to the creation of the joint trust. They will continue to be jointly owned in the joint trust by the H and W as trustees of their joint trust. If the marital trust is funded with the dead spouse's spouse property as you teach, I am some personal difficulty grasping that concept. The other trustee or Surviving Trustmaker should have control over all the trust assets by virtue of the title ownership in the trust and his or her survivorship when the first spouse dies. I am not seeing or understanding that the dead spouse owns any property separately for purpose of funding a marital share at the death of the first spouse. I call or understand the Marital Share to be that property that the surviving spouse has complete ownership and access to as the surviving initially named trustee by virtue of  the funding work into the joint trust.

If you don’t title property in the name of the trust, you’re right – survivorship in joint tenancy will control and the surviving spouse will own the property outright. Of course, this is a function of the survivorship feature, and has nothing to do with the trust. But if H & W retitle property into the trust name, unless the property is scheduled otherwise, each spouse will be deemed to own half. When the first spouse dies, that spouse’s “deemed half” – and any separate property owned by the dead spouse – becomes the “deceased spouse’s share.” (See the introductory language in Article Five of the joint RLT.) That deceased spouse’s share is administered in Article Five, and becomes subject to the marital deduction language in Article Seven. (Note: The surviving spouse’s property – that is, the survivor’s half interest in the joint property and any separately-owned property – constitutes the “survivor’s trust.”)

Based on the language you select for Article Seven, the dead spouse’s property may be distributed into a formula that uses the marital deduction (which will cause a marital and non-marital, or “bypass-type” share), or it may all go to the “marital share.” That is, it all qualifies under the marital deduction to not use any of the dead spouse’s estate tax credit and passes everything into the surviving spouse’s taxable estate. That marital share may either be distributed into a QTIP trust (which can provide significant protection for the spouse), or it may be combined with the “survivor’s trust,” over which the surviving spouse has all rights of ownership.

Matthew T. McClintock, JD
WealthCounsel.com

"Standby" SNT vs. Conduit Trust?

Query:

Language in the "Administration of Trusts for Underage and Incapacitated Beneficiaries" Article says that the provisions of that article don't apply to conduit trusts. This means the conduit distributions are then paid out to the special needs beneficiary, disqualifying the beneficiary from benefits, correct?

"Further, the provisions of this Article shall not apply to distributions that are required to be made to a beneficiary pursuant to the provisions of [Cross reference to conduit provisions]."

Wouldn’t it be better if the conduit language did not apply to the SNT article, thus making it an accumulation trust?

Response:

That’s right. You’ll have to choose between maintaining benefits or maintaining the stretch, because the standby SNT provisions are naturally at odds with the conduit trust provisions.

The language is there to allow the RLT to qualify as a designated beneficiary. If the trust is not a “conduit” trust, then we must consider all of the trust’s beneficiaries and appointees to determine the applicable distribution period. Carving out a portion of the trust as an accumulation trust and saying that the conduit provisions don’t apply to the SNT (instead of our current approach, which provides that the SNT provisions don’t apply to a conduit trust) risks disqualifying the whole trust and jeopardizing the stretch for everyone.

Of course, the best approach would be to counsel clients often and make sure that if they have a beneficiary who develops “special needs,” the clients come in for an SNT and not rely on the “standby” provisions in their RLT. But when that doesn’t happen, or when the disabling event happens after the RLT has become irrevocable, the conduit/special needs benefits conundrum forces the drafting attorney’s hand: it’s either “preserve benefits” or “preserve the stretch.” You typically include conduit provisions when you know you have IRAs; you include the standby SNT just in case a beneficiary becomes disabled.

Matthew T. McClintock, JD
WealthCounsel.com

Which marital trust is the "gap" trust?

Query: We practice in a state that has a separate estate tax exclusion amount (we're "decoupled"). For that reason, we typically create two marital deduction trusts using WealthDocs's formula language: Marital Trust One, and Marital Trust Two. Under WealthDocs, which trust is the "gap" trust? And then how are these things administered?

Response: First of all, understand that if your state allows you to make a separate state QTIP election, then it's not necessary to create two marital trusts. You can fund the Marital Share with an amount necessary to reduce all death taxes to the lowest amount (federal and state), and then make separate QTIP elections on the estate tax returns when the client dies. On the state estate tax return you'll make a full QTIP election; on the federal estate tax return (706) you'll make a partial QTIP election (over only the amount necessary to minimize federal tax).

But if your state does not allow separate QTIP elections, WealthDocs allows you to elect to reduce all death taxes (federal and state) to the lowest possible amount, and then divide the Marital Share into two separate marital QTIP trusts: QTIP One equal to the amount necessary to reduce federal estate taxes to the lowest possible amount, and QTIP Two, a "gap" QTIP trust equal to the balance of the Marital Share. The grantor's trustee will make the QTIP election on both QTIP trusts (the federal QTIP and the "gap" QTIP) on the grantor's 706 and the state death tax return. It takes a little post-mortem finesse to maximize the tax opportunity by having the "gap" QTIP election disregarded (declared void on the 706) when the surviving spouse later dies. (Revenue Procedure 2001-38) (Note that the IRS won't allow the trustee to disregard a "partial" QTIP election. Hence the two separate QTIP trusts.)

Here's how the division is made:

First, the trust divides the estate into a marital share and a non-marital share. The marital share is created by first reducing ALL estate taxes (federal and state). The marital share is then further divided into two separate QTIP trusts.

QTIP One holds the amount necessary to minimize the federal estate tax. In computing its fractional formula, the numerator is "the minimum value...sufficient to reduce the federal estate tax to the lowest possible amount." QTIP Two thus becomes the "gap" trust; it holds the rest of the marital share.

Consider the following hypothetical:

Tom Client's gross estate = $10,000,000. His wife, Cindy, survives him, and Tom's trust contains a fractional marital "two-QTIP" formula. Tom dies while a resident of a state that has a $1,000,000 estate tax exemption.

• The marital share is first computed to hold $9,000,000. (The minimum amount necessary to reduce ALL death taxes to the lowest possible amount.)
• The nonmarital share holds the balance, or $1,000,000.

The marital share ($9,000,000) is then further divided:

• QTIP One is computed to hold $8,000,000. (The minimum amount necessary to reduce FEDERAL death taxes to the lowest possible amount.)
• QTIP Two is computed to hold $1,000,000. (The balance of the marital share, or the state "gap" trust.)

If Tom's state allows separate QTIP elections, Tom's trustee elects QTIP treatment on QTIP One only for the 706, because that's all that is needed to minimize federal estate taxes. Tom's trustee elects QTIP treatment on both QTIP One and QTIP Two on the state estate tax return, because both are needed to minimize the state death tax.

If Tom's state does NOT allow separate QTIP elections (like New York or Minnesota), then Tom's trustee must take the QTIP election on both QTIP trusts One and Two. But when Cindy later dies, Cindy's trustee relies on Rev. Proc. 2001-38 to disregard the QTIP election on QTIP Two, because it was not needed for federal estate tax purposes.

Matthew T. McClintock, JD
WealthCounsel.com

Separate SNT, or "Subtrust" SNT?

Query: How do I decide whether to create a "standalone" SNT, or whether to create an SNT subtrust within a client's RLT? 

Response: I think a "standalone" special needs trust (a separate trust agreement exclusively created for a "special needs" beneficiary) is appropriate when the beneficiary is already qualified for needs-based assistance due to the beneficiary’s disability. Those benefits are often provided through government agencies but may also come from private sources, like charitable organizations.

If the beneficiary already has an SNT in place and the grantor likes the terms of that SNT, then the grantor may choose distribute a portion of the grantor’s RLT to the beneficiary by adding the property from the grantor’s RLT to the beneficiary’s separate SNT.

If the beneficiary does not already have an SNT in place, the grantor may either:

1) Create a separate “standalone” SNT and add property to it for the beneficiary, or

2) Create an SNT “subtrust” within the grantor’s RLT. This doesn’t result in a new trust document, it just carves a portion (subtrust) to be administered as an SNT for the beneficiary. The RLT gives life to the SNT if you will; the SNT created as a subtrust doesn’t have its own separate governing document.

The option the grantor chooses is typically based on whether or not the beneficiary has already qualified for needs-based benefits due to the beneficiary’s disability, and when the grantor actually wants to fund the trust. Generally speaking, consider the following matrix:

           

Separate “Standalone” SNT	SNT as subtrust of RLT
· Beneficiary has already qualified for   needs-based benefits due to disability	· Beneficiary has NOT already qualified for   benefits
· Grantor wants to fund the SNT immediately   (while the grantor is alive)	· Grantor wants to fund the SNT only after death

And don’t think of these as mutually-exclusive solutions. A client may want to do both, depending on the level of funding involved and the unique situations facing the client and the intended beneficiary. It may be appropriate to create and partially fund a standalone SNT for a disabled beneficiary now, and then add more property to it later when the grantor dies. In fact, this is very common.

Matthew T. McClintock, JD
WealthCounsel.com

RLT - statement that property held in fiduciary capacity

Query: In Section 1.01 of the RLT, the last sentence states that "any description referring to our trust shall be effective if it reasonably identifies our trust and indicates that the trust property is held in a fiduciary capacity."

We were wondering why the clause at the end was necessary. If the designation refers to a trust of some sort, doesn't that automatically imply a fiduciary capacity, because a trust must have a trustee?

Response:  Clearly, the very fact that property is held in the name of a trustee implies a fiduciary relationship, but WealthDocs is are explicit about it to eliminate any doubt. We consider this to be one of those “android” provisions in trusts, like the assertion that the RLT is a grantor trust and the grantor can thus use his or her SSN for the trust’s tax ID number. Saying it doesn’t make it so; the facts make it so.

But often, clients have to deal with androids. These creatures look and talk and smell like humans, but they are devoid of original thought and logic – they’re androids. In case the android is standing between the client and proper trust funding, WealthDocs errs on the side of caution and includes the statement.

Matthew T. McClintock, JD
WealthCounsel.com