Estate Planning and Life Insurance Crafting ILITs for Tax Benefits, - - PowerPoint PPT Presentation

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Estate Planning and Life Insurance

Crafting ILITs for Tax Benefits, Navigating the Transfer for Value Rule and Addressing Beneficiary Designations

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific TUES DAY, JANUARY 17, 2012

Today s faculty features:

James A. S

• ressi, Law Office of James A. Soressi, Flushing, N.Y

. Diana S .C. Zeydel, S hareholder, Greenberg Traurig, Miami, Fla. S cott K. Tippett, S pecial Counsel, Carruthers & Roth, Greensboro, N.C.

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Avoiding Pitfalls in Irrevocable Avoiding Pitfalls in Irrevocable Life Insurance Trust Planning

By

James A. Soressi, Esq., AEP, MSFS, MSD

5

James A. Soressi, Esq., AEP, MSFS Attorne at La James A. Soressi, Esq., AEP, MSFS Attorne at La Attorney at Law

Offices in Queens Westchester Manhattan

Attorney at Law

Offices in Queens Westchester Manhattan Offices in Queens, Westchester, Manhattan and Long Island Offices in Queens, Westchester, Manhattan and Long Island www.SoressiLaw.com 718 813 0360 Ji @S iL www.SoressiLaw.com 718 813 0360 Ji @S iL

6

718.813.0360 Jim@SoressiLaw.com 718.813.0360 Jim@SoressiLaw.com

This presentation is not designed or intended to provide financial, tax, legal, accounting or other professional advice. Such advice always requires consideration of individual facts and consideration of individual facts and circumstances on a case by case basis and privity of contract. If professional advice is sought, an individual should contract with a qualified professional to render such advice

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Purposes of Forming an ILIT Purposes of Forming an ILIT

D li li d t t ti

• Deliver policy proceeds to next generation

free of transfer tax Avoid gift tax on premium payments

• Avoid gift tax on premium payments
• Retain income tax free receipt of policy

proceeds proceeds

• Provide liquidity to estate

Control distribution of proceeds

• Control distribution of proceeds

8

Avoid Estate Tax Inclusion Avoid Estate Tax Inclusion

• IRC §2042—Incidents of Ownership
• Own, change beneficiary, surrender or borrow
• Avoid Grantor as Trustee (CST exception example)

IRC §2036 R t i d I t t

• IRC §2036—Retained Interests
• Right to income
• Right to change beneficial interests
• Right to change beneficial interests
• IRC §2038—Amend, Alter, Terminate, Revoke
• Careful with changes to Crummey Powers
• Careful with changes to Crummey Powers
• Trust not pay estate tax or estate debts or

satisfy legal obligations

9

satisfy legal obligations

Avoid Estate Tax Inclusion Avoid Estate Tax Inclusion

• Avoid Reversionary Interest
• Default to Heirs at Law
• Careful with Split Dollar with Majority

Sh h ld P t Shareholders or Partners

• Trust Not Pay Estate Tax Or Estate Debts Or

Satisfy Legal Obligations Satisfy Legal Obligations

10

Avoid Estate Tax Inclusion— Beware of Traps

• Single Life ILIT with Spouse as Beneficiary
• Single Life ILIT with Spouse as Beneficiary
• Do not give spouse Crummey power in excess of 5

+5% under IRC §2041 §

• Better yet, no Crummey power at all to spouse
• A Mess, Spouse as Transferor and Beneficiary
• 2nd To Die ILIT—Two Grantors
• Neither Spouse as Trustee or Beneficiary
• No right to change beneficial interests

11

Avoid Estate Tax Inclusion— Beware of Traps

• 2nd To Die ILIT

One Grantor Spouse

• 2nd To Die ILIT—One Grantor, Spouse

Beneficiary

• Neither Spouse as Trustee

Neither Spouse as Trustee

• No Crummey Power to Spouse
• Use Gift Splitting to Maximize Gifts
• How Pay Premium After Death of Grantor?
• Single Life Policy on Grantor in Trust
• Other Trust Assets Used to Pay Premium
• Other Trust Assets Used to Pay Premium
• Borrow/Split Dollar
• Avoid Reciprocal Trusts

12

p

• Different Terms, Provisions & Dates of Creation

Avoid Gift Tax on Premium Payments Transferred to Trust

A l E l i

• Annual Exclusion
• $13k/donor/donee
• Must be present interest
• Must be present interest
• Checks vs. Transfers
• Crummey/Hanging Powers

Crummey/Hanging Powers

• My 2 Cents—No Power to Change Crummey

Beneficiaries or amounts (IRC §2038) and Avoid Naked Crummey Beneficiaries Crummey Beneficiaries

• $5 million Gift Tax Exemption 2012 Only
• Split Dollar

13

Split Dollar

• Borrowing

GSTT Allocation—Yes or No? GSTT Allocation Yes or No?

D t T t Y

• Dynasty Trust –Yes
• Non-Dynasty Trust –Maybe

P t ti l T f Di t ib ti t B fi i i t

• Potential Trap for Distributions to Beneficiaries at

ages 25, 30 & 35

• Factors to Consider—Term of Trust, Amount of

Factors to Consider Term of Trust, Amount of Estate, Amount of GSTT Exemption

• Be Aware of Automatic GSTT Allocation Rules

14

Potential Issue Potential Issue

Premiums Are Greater Than GSTT Exemption

15

Potential Solutions Potential Solutions

Split Dollar

• Split Dollar
• Spouse to Trust
• Trust to Trust
• Trust to Trust
• Use of Funding Trust and Dynasty Trust
• Use Income and Appreciation of Assets Initially
• Use Income and Appreciation of Assets Initially

Gifted

• Sales to IDGT/BDIT
• Sales to IDGT/BDIT
• Premium Financing

16

Using Two Trusts

Funding Trust Dynasty Trust Advances/Loans

S lit D ll Ad L M d t T t

• Split Dollar Advances or Loans Made to Trust
• If Both Are Grantor Trusts, No Income Tax Consequences
• Funding Trust—GPA to First Generation

17

Funding Trust GPA to First Generation

What is the Transfer for Value Rule? What is the Transfer for Value Rule?

The Transfer

• A life insurance policy is transferred
• Any life insurance policy (i.e. whole life or term).
• Any element if the policy (ownership, beneficiary

change transfer of any incident of ownership).

The Value The Value

• In return for the Transfer, the transferor

receives consideration receives consideration.

• Consideration may include cash, goods, a

business interest, transfer of another insurance

18

policy, signing of new business agreements, assuming a loan or other items of value.

Exceptions to the Transfer for Value Rule

Where the transfer is made to the:

• Insured
• Corporation which the Insured is a

Shareholder or an Officer.

• Partner of the Insured.
• Partnership in which the Insured is a Partner.

NOTE: A Grantor Trust is Treated as a NOTE: A Grantor Trust is Treated as a NOTE: A Grantor Trust is Treated as a NOTE: A Grantor Trust is Treated as a Transfer to the Insured Transfer to the Insured IF IF the Insured is the Insured is the Grantor the Grantor

19

the Grantor the Grantor

An Apparent Gift Situation, But A Trap An Apparent Gift Situation, But A Trap

• Assumptions
• $75 000 Basis

Life Insurance Policy

• $75,000 Basis
• $90,000 Loan
• $100 00 Total C V

Transferor Transferee

• $100,00 Total C.V.

(Includes loan proceeds)

• Transferee assumes the loan.
• Transferee assumes the loan.
• Trust is NOT a Grantor Trust

20

Transfer for Value Rule Violated Transfer for Value Rule Violated

• Policy transferred with an outstanding loan in excess

f b i

• f basis.
• The new owner’s acceptance of the “burden” of the

loan (which the old owner never paid back) is ( p ) consideration (value) to the transferor.

• When loan is in excess of transferor’s basis, complex

IRC rules say new owner does not get carryover IRC rules say new owner does not get carryover basis, even if otherwise a “gift”

• Result: Transfer for Value.

D th P d L A t P id f th P li

• Death Proceeds Less Amount Paid for the Policy

(loan amount) plus additional premiums paid are subject to income tax

21

ILIT Funding Issues g

Crummey Powers and Transfers for Value

Diana S.C. Zeydel

AMSTERDAM • ATLANTA • BOCA RATON BOSTON • CHICAGO • DENVER FORT LAUDERDALE LOS ANGELES MIAMI

Greenberg Traurig, PA Miami, Florida

305.579.0575 • zeydeld@gtlaw.com

FORT LAUDERDALE • LOS ANGELES • MIAMI NEW JERSEY • NEW YORK • ORLANDO PHILADELPHIA • PHOENIX • TALLAHASSEE TYSONS CORNER • WASHINGTON, D.C. WEST PALM BEACH • WILMINGTON • ZURICH

Funding Using the Annual Exclusion Exclusion

• Section 2503(b)

present interest

• Section 2503(b) – present interest

requirement

Q ti i t h titl t b t

• Question is not when title vests but

when enjoyment begins – Fondren

• An income interest qualifies
• An income interest qualifies
• BUT an income interest in a trust
• wning an insurance policy does not
• wning an insurance policy does not
• 2503(c) trust works but not the best

arrangement arrangement

23

Requires a Completed Gift q p

• Must relinquish dominion and control

Must relinquish dominion and control

• Power reserved to the donor to name new

beneficiaries or to change the interests of the beneficiaries renders the gift incomplete

• Power to change timing is not enough to

Power to change timing is not enough to render gift incomplete, but may cause estate tax inclusion under section 2038 T f b h k if t b

• Transfers by check if payment can be

stopped are not complete until negotiated by the trustee y

24

Crummey Powers y

• Power of withdrawal conferred by the
• Power of withdrawal conferred by the

instrument contemporaneous with transfers to the trust transfers to the trust

• Must receive notice – cannot waive

the right to receive notice the right to receive notice

• 15 days may be sufficient --

Cristofani Cristofani

• Must have a beneficial interest in the

trust t ust

25

Crummey Powers y

• A Crummey power of withdrawal
• A Crummey power of withdrawal

right is a general power of appointment under 2514(c) appointment under 2514(c)

• Lapse of a power of withdrawal is a

release that is a taxable gift by the release that is a taxable gift by the powerholder to the trust UNLESS the lapse is within the limits of the greater of $5,000 or 5% of the value

• f the trust

26

Hanging Powers g g

• Technique to permit contributions equal to
• Technique to permit contributions equal to

the full amount of the annual exclusion

• BUT avoid taxable gifts to the ILIT

BUT avoid taxable gifts to the ILIT

• How does it work?
• Powers of withdrawal in excess of the

Powers of withdrawal in excess of the 5 & 5 limitation “hang” into subsequent taxable years until they can lapse within the limitation

• WARNING – means the beneficiary has

greater estate tax inclusion

27

Gift-Splitting p g

• Section 2513 provides that a gift made by
• Section 2513 provides that a gift made by

any person other than to his or her spouse shall, for gift tax purposes, be considered , g p p , as made one-half by each spouse

• In general, best to file two returns
• PLR 200130030 vs. PLR 200616022
• What if spouse is a discretionary beneficiary

C and trust has Crummey powers

28

Using Loans to Pay Premiums Premiums

• PLR 200603002
• PLR 200603002
• Complete restructuring of ownership of

policies due to a mistake policies due to a mistake

• Loans to ILIT to pay premiums that

were forgiven shortly afterwards were forgiven shortly afterwards

• Loans treated as gifts to the ILIT

29

Income Tax Issues

• Transfer for Value rule

Transfer for Value rule

• Section 101(a)(2)
• Exceptions

p

• Carry over basis
• Transfer to excepted transferee – insured,

partner of the insured, partnership in which the insured is a partner, corporation in which the insured is an officer or shareholder

• Rev. Rul. 85-13

R R l 2007 13

• Rev. Rul. 2007-13
• Maintaining grantor trust status

C h ld t t d

• Crummey powerholders treated as
• wners

30

Generation-Skipping Transfer Tax Issues Tax Issues

• Does giving “skip” persons Crummey
• Does giving skip persons Crummey

powers of withdrawal create a problem? problem?

• Should you allocate GST exemption

t ILIT? to an ILIT?

31

Checklist

• Make sure ILIT permits distributions

Make sure ILIT permits distributions during the life of the insured

• Do not allow grantor/insured to be

g appointed as trustee

• Settle ILIT before acquiring the policy
• Negotiate checks to pay premiums prior to

the end of the year

• Make ILIT wholly grantor as to only one
• Make ILIT wholly grantor as to only one

person

• Make sure Crummey powers are valid

Make sure Crummey powers are valid

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Checklist

• Do not permit contributors to exercise

Do not permit contributors to exercise Crummey powers

• Permit contributors to eliminate Crummey

y powerholders

• Use hanging powers
• Carefully consider advisability of allocating

GST exemption

• Consider alternatives to an ILIT
• Consider alternatives to an ILIT
• Make sure trustees have adequate

powers to administer the policy powers to administer the policy

33

Irrevocable Life Insurance Trusts Trusts Trustee Duties and Liabilities

presented by: Scott K. Tippett Scott K. Tippett Carruthers & Roth, P.A. Phone: 336-478-1130 E-mail: skt@crlaw.com

35

Trustee Duties

• Duty to Administer Trust According to its Terms

Duty to Administer Trust According to its Terms A trustee has no duty to act until he or she has y accepted the position.

Ambiguous or Uncertain terms Seek professional assistance of judicial

• Seek professional assistance of judicial

interpretation. No resignation unless permitted by terms of trust, by consent of beneficiaries, or court.

36

Trustee Duties and Liabilities

• Duty of Loyalty to Trust and Its Beneficiaries

The most fundamental duty owed by the trustee to the beneficiaries The most fundamental duty owed by the trustee to the beneficiaries. Inherent in the relationship, even if trust is silent. Settlor can waive some aspects of duty of loyalty under UTC § 105. See l UTC § 801 814( ) also UTC § 801; 814(a). Trustee must administer trust solely in the interests of the beneficiaries. Any self-dealing creates a presumption of breach of the duty of loyalty. y g p p y y y

• even if the trustee has no bad intentions.
• even if the beneficiary is not harmed.

37

Trustee Duties and Liabilities

• Duty to Administer Trust With Reasonable

Duty to Administer Trust With Reasonable Skill and Care

If the trustee has special skills and expertise, or If the trustee has special skills and expertise, or is appointed based on its representation that it possesses special skills or expertise, the trustee has a duty to use those skills. UTC § 806; Restatement of Trusts 2d § 174 (1959). St d d i l ti l d th “ bl ” Standard is relational, and the “reasonableness” will vary with the trustee’s skill and expertise.

38

Trustees Duties and Liabilities

• Duty to invest and reinvest trust assets

prudently. Includes the duty to diversify to reduce the risk of loss. Within an ILIT the duty may require the trustee to delegate management to a life i i li t insurance specialist. Delegation permitted under UTC § 807.

39

Trustee Duties and Liabilities

D t t i t/ i t d tl t’d

• Duty to invest/reinvest prudently – cont’d

Issues in the context of an ILIT.

• underperforming policies.

u de pe o g po c es

• policies insufficient for the insured’s current needs.
• newer products that may be more cost effective.

d t d id ith b tt b fit

• new products and riders with better benefits.
• policies scheduled for a big premium increase.
• maintaining existing policies without periodic

g g p p review.

• bad investment decisions with VL policies.

poor policy designs or improper policies

• poor policy designs or improper policies.
• poor selection of life insurance agent.

40

Trustee Duties and Liabilities

• Duty to Collect, Control, and Protect Trust

Property Property.

• UTC § 809 (control and protect). Follows the

common law and is an application of the duty common law and is an application of the duty to administer. Can be waived under UTC § 105 105.

• UTC § 812 (collect). Can be modified by UTC

§ 105 § 105.

41

Trustee Duties and Liabilities

• Duty to Keep Records, Give Notices, and

Duty to Keep Records, Give Notices, and Furnish Information to Beneficiaries.

• UTC § 810 (duty to keep adequate records).
• UTC § 813 (duty to report to benes )
• UTC § 813 (duty to report to benes.).

 Formal accounting not required.  Within 60 days of accepting trusteeship, new trustee must send all “qualified benes” notice that at least must send all qualified benes notice that at least contains the trustee’s name, address, and telephone number.  Trustee must keep “qualified beneficiaries” Trustee must keep qualified beneficiaries “reasonably informed.”

 Significant variation among states. Check your jurisdiction.

42

Trustee Duties Liabilities

• Duty to Enforce Trust Claims, Uphold and Defend Trust,

Participate In Management of Trust, and Duty Not to Delegate.

T t h d t t f d d f d l i d

• Trustee has a duty to enforce and defend claims under

UTC § 811; See also Restatement (Second) of Trusts § 177 and 178 (1959). Does not require pursuit of all claims, but does require a consideration of the likelihood and costs of does equ e a co s de at o

• t e

e

• od a d costs o
• recovery. Also includes the discretion to settle claims

against the trust.

• Duty to Participate and Duty Not To Delegate not

specifically mentioned under the UTC but are implied specifically mentioned under the UTC, but are implied under UTC § 807, which permits trustee to delegate but to do so responsibly. Some state variation on type of activities trustee permitted to delegate. p g

Irrevocable Life Insurance Trusts Trusts Drafting Considerations

presented by: Scott K. Tippett Scott K. Tippett Carruthers & Roth, P.A. Phone: 336-478-1130 E-mail: skt@crlaw.com

44

ILITs -Drafting Considerations

• Drafting Issues Regarding Crummey Rights.

A id ETIP d T bl R l

• Avoid ETIPs and Taxable Releases.

 Limit spouse’s withdrawal right to a 5x5 safe harbor harbor.  Structure right to lapse sixty days after date of contribution.  Avoid giving spouse a hanging power (not within the safe harbor rules in Treas. Reg. § 26.2632- 1(c)(2)(ii) 1(c)(2)(ii).

45

ILITs – Drafting Considerations

• Avoid Naked Crummey Powers.
• Draft to provide multiple present-interest beneficiaries; Service is

hostile to granting Crummey rights to discretionary or contingent hostile to granting Crummey rights to discretionary or contingent

• beneficiaries. See TAMs 8727003, 9045002, 962004, and
• 9731004. However, Tax Court has recognized contingent

remaindermen as valid Crummey powerholders.

• Consider giving all Crummey powerholders a specific interest,

either dollar amount or percentage in the trust, which gives them a vested interest in the trust.

• Make ILIT a GST trust so that grandchildren are

more than remote takers.

46

ILITs – Drafting Considerations

• Use Tiered Crummey Withdrawal Rights

Use Tiered Crummey Withdrawal Rights.

• Give spouse the right first, up to a 5X5 safe harbor.
• After spouse come children and grandchildren for the

balance of the gift.

• Simplifies notice and makes it easier to ascertain

consenting spouse’s interest for gift splitting. See IRC § 2513; PLR 200422051.

• If contribution is less than a 5x5 amount, consenting

spouse cannot gift split, which also prevents treating each spouse as ½ transferor for GST tax exemption.

47

ILITs – Drafting Considerations

• Make sure amounts subject to a Crummey withdrawal right are

ascertainable ascertainable.

• When dealing with multiple beneficiaries, make each beneficiary’s

right of withdrawal over the same gift pro rata. If the amount is g g p unascertainable, the gift will be an incomplete gift. Rev. Rul. 80- 261.

• Do not condition the amount subject to a Crummey withdrawal
• Do not condition the amount subject to a Crummey withdrawal

right on whether a split-gift election is made. This is a condition subsequent and makes the gift amount unascertainable. PLR 8022048.

• Make sure no power of termination, exercise of trustee or SPH

discretion, or distribution of principal will defeat an outstanding Crummey withdrawal right. PLR 8121051; 8213074.

48

ILITs – Drafting Considerations

• Crummey Mechanics in Trust Drafting
• Crummey Mechanics in Trust Drafting.
• Ensure Adequate Time for Exercise of Right.
• Rev. Rul. 81-7 (bene must have a reasonable amount of

time to exercise right before it lapses).

• Give trustee broad discretion regarding manner of

Crummey notice. Rev. Rul. 83-108; Rev. Rul. 81-7.

• Give trustee broad discretion regarding how Crummey right

is satisfied. IRS has approved distribution of fractional interests in insurance policies. See PLRs 7935091, 8006109 8021058 8044080 8006109, 8021058, 8044080.

49

ILITs – Drafting Considerations

• Drafting to Avoid Reciprocal Trust Doctrine.

g p

• United States v. Estate of Grace, 395 U.S. 316 (1969). Factors

considered: (1) similarity of trusts’ terms; (2) similarity of trusts’ corpus; (3) the trustees; (4) the beneficiaries; (5) whether the corpus; (3) the trustees; (4) the beneficiaries; (5) whether the trusts were executed close in time; (6) whether the trusts were a prearranged plan between the grantors. To avoid RTD consider: (1) giving one spouse a broad inter vivos

• To avoid RTD consider: (1) giving one spouse a broad inter-vivos

limited power of appointment (PLR 9643013); (2) give each spouse a different type of enjoyment, i.e. HEMS distribution in

• ne trust and a discretionary power vested in an independent

trustee in the other; (3) vary length of trusts; (4) execute trusts on trustee in the other; (3) vary length of trusts; (4) execute trusts on different dates, but beware of missing the opportunity of insurability (refer one spouse to separate counsel?);

50

ILITs – Drafting Considerations

• Avoid Creating Reciprocal Crummey

Avoid Creating Reciprocal Crummey Withdrawal Rights.

• Rev. Rul. 85-24, 1985-1 C.B. 329 “where two
• r more grantors, acting mutually, each

g , g y, creates a trust for the primary benefit of a child and gives each of the other a corresponding i hd ifi d f h power to withdraw a specified amount from the trust” annual gift tax exclusion will be denied.

51

ILITs -Drafting Considerations

• Avoid Reciprocal Gifts and Reciprocal Powers of

p p Appointment.

• Reciprocal Gifts – PLR 8717003; See also Schultz v.

U it d St t 493 F 2d 1225 (4th Ci 1974) E t t f United States, 493 F.2d 1225 (4th Cir. 1974); Estate of Schuler v. Comm’r., 282 F.3d 575 (8th Cir. 2002); Sather v. Comm’r., 251 F.3d 1168 (8th Cir. 2001). If reciprocal gifts are found, Service will uncross the gifts. are found, Service will uncross the gifts.

• Reciprocal Powers of Appointment – beneficiaries of

different trusts can appoint property to one another. PLR 9235025 9451049 If i l f d S i 9235025, 9451049. If reciprocal powers are found, Service will uncross the trusts and treat each beneficiary as holding a GPA over the trust of which they are a beneficiary.

52

ILITs – Drafting Considerations

• Draft for Flexibility by:
• Permitting appointment of a special powerholder who has limited power to appoint trust

property outright or in trust. If SPH is a trustee, provide that power should be exerciseable in SPH’s non fiduciary capacity to avoid: (1) argument SPH must act in exerciseable in SPH s non-fiduciary capacity to avoid: (1) argument SPH must act in benes best interest; (2) that power held by SPH is a fiduciary power; (3) that insured- grantor has reserved a power that is considered an incident of ownership, which would cause a failure of a completed gift, estate inclusion, and exposure policy to grantor’s creditors, depending on the jurisdiction.

• Allows trust, through SPH, the flexibility to deal withy changed circumstances.
• UTC § 808(d) provides that person who has power to direct is presumptively a

fiduciary, but that can be altered under UTC § 105 to provide that SPH acts in a non- fid i it fiduciary capacity.

• Do not allow SPH’s exercise of power to defeat an unexercised or open Crummey

right.

53

ILITs – Drafting Considerations

• Draft to Permit Donor to Vary Annual Crummey Withdrawal

Ri ht Rights.

• Donor cannot change the benes of an ILIT, but donor can vary,

from year to year, which benes can exercise Crummey rights, the from year to year, which benes can exercise Crummey rights, the amount of withdrawal permitted, and the period of exercise. See PLRs 8003033, 8103069, 8103074, 8901004, 9030005, and 9834004.

• Donor is exercising control over the property to be gifted before

relinquishing dominion and control so there is no retained interest issue.

• Flexibility permits donor to take into account changed

circumstances/future creditor issues with respect to the benes and limit or suspend Crummey right when necessary.

54

ILITs – Drafting Considerations

• Draft to Permit Trustee to Terminate ILIT.
• Preserves flexibility for change in exemption amount or repeal of estate tax.
• Preserves flexibility if non-estate tax reasons for ILIT no longer justify keeping ILIT.
• Make sure trustee cannot terminate while a Crummey withdrawal right is pending (if

Crummey power can be unilaterally terminated by trustee while pending, power may be deemed to be illusory).

• Vest power to terminate in an independent trustee to avoid power being one to
• Vest power to terminate in an independent trustee to avoid power being one to

determine beneficial enjoyment (if exercised by a bene-trustee in his sole discretion or with a co-trustee who does not have a substantial adverse interest).

• To avoid common law prohibition against the termination of spendthrift trusts, may need

to modify any spendthrift provisions in the ILIT to modify any spendthrift provisions in the ILIT.

• Likewise, if ILIT contains marital deduction trust or charitable trust, must prohibit trustee

from exercising power of termination in a manner that would adversely affect the marital deduction or charitable deduction.

55

ILITs – Drafting Considerations

• Permit Trustee to Change Situs of Trust and Trust’s Assets.

e us ee o C a ge S us o us a d us s sse s

• Provides flexibility for a mobile society.
• Permits trustee to take advantage of changes in laws of

various jurisdictions (absence of a state income tax, changes in or repeal of RAP, avoidance of UTC or Restatement (Third) of Trusts) Restatement (Third) of Trusts).

• Note: Some states do not recognize a change for income

tax purposes. Changing the situs may affect vesting and p p g g y g accumulations, which in turn could cause a loss of a trust’s GST tax exemption.

56

ILITs – Drafting Considerations

• Provide post-mortem flexibility upon

beneficiary’s death by giving beneficiaries a beneficiary’s death by giving beneficiaries a testamentary limited power of appointment.

• Note: May cause a Delaware tax trap issue

depending on the governing law depending on the governing law.

57

ILITs – Drafting Considerations

• Grant Insured, Spouse, and Beneficiaries Power to Remove and Replace

Trustee.

• Grantor cannot remove trustee and replace with a person related or subordinate to the

grantor within the meaning of IRC § 672(c) Rev Rul 95-58 as clarified by PLR grantor within the meaning of IRC § 672(c). Rev. Rul. 95-58, as clarified by PLR 9832039.

• Insured’s power to remove a trustee for cause and replace with someone other than

insured is not an incident of ownership.

• Benes can remove and replace and existing trustee as long as replacement is not a

person related to or subordinate to the beneficiaries within meaning of IRC § 672(c).

• Rev. Rul. 95-58, as amplified by PLR 9607008.
• Gives the insured and beneficiaries the ability to get out of a bad relationship. Make

sure trust prohibits the person holding the power to appoint: (1) herself; (2) an insured;

• r (3) the grantor as trustee.

58

ILITs – Drafting Considerations

• Create Spousal Access Rights and Permit Trustee to Make

p g Discretionary Distributions to Give Insured Indirect Access to ILIT Assets.

• Permit trustee to borrow, withdraw or surrender policy’s cash value and

, p y distribute to grantor’s spouse. Could include right to permit trustee to distribute the policy to the grantor’s spouse, who could then transfer ILIT to a new ILIT with more appropriate terms.

• If the insured’s spouse is a trustee, give the spouse-trustee the right to

invade trust principal for a HEMS standard, which because it is an ascertainable standard, does not create a GPA in the spouse-trustee. T id t i d i t t i if th t t t t k

• To avoid a retained interest issue, specify that trustee cannot make

distributions for the purpose of the insured’s legal support obligation to the insured’s spouse.

59

ILITs – Drafting Considerations

• Saved The Best for Last

Saved The Best for Last

• Rev. Rul. 2011-28 provides that grantor's retention of

power, exercisable in non-fiduciary capacity, to acquire insurance policy held in trust by substituting other p y y g assets of equivalent value will not, by itself, cause value of insurance policy to be includible in grantor's gross estate under Code Sec. 2042; , provided trustee has fiduciary obligation (under local law or trust trustee has fiduciary obligation (under local law or trust instrument) to ensure grantor's compliance with terms

• f this power by satisfying itself that properties

acquired and substituted by grantor are of equivalent acquired and substituted by grantor are of equivalent value, and further provided that substitution power cannot be exercised in manner that can shift benefits among trust beneficiaries. g

Irrevocable Life Insurance Trusts Trusts Beneficiary Designations

presented by: Scott K. Tippett Scott K. Tippett Carruthers & Roth, P.A. Phone: 336-478-1130 E-mail: skt@crlaw.com

61

ILITs – Beneficiary Designation

• Cardinal Rule: Do Not Name an Estate as a

Beneficiary Beneficiary.

• Estate Inclusion for federal and state estate

tax purposes at present and potentially at tax purposes at present and potentially at successive generations.

• May Subject Proceeds to Claims of
• May Subject Proceeds to Claims of

Decedent’s Creditors.

• Loss of Opportunity to Leverage GST
• Loss of Opportunity to Leverage GST

Exemption

62

ILITs – Beneficiary Designation

• Consider Naming a Trust Instead of

Individual as Beneficiary Individual as Beneficiary.

• Protects proceeds from claims of intended

p beneficiary’s creditors if trust is structured properly. P id f f i l t f

• Provides for professional management of

policy proceeds.

• Provides planning flexibility if designed

Provides planning flexibility if designed properly.

63

ILITs – Beneficiary Designations

A id N i G t B fi i f th T t

• Avoid Naming Grantor as a Beneficiary of the Trust.
• Estate Inclusion as an Incomplete Gift or under Creditors’ Rights Doctrine. If grantor’s

interest in trust can be enforce by grantor or grantor’s creditors, then grantor will not be considered to have parted with dominion and control See Treas. Reg. § 25.2511-2(b); considered to have parted with dominion and control See Treas. Reg. § 25.2511 2(b); PLR 8040039 (where grantor was income beneficiary of trust, under applicable state law grantor’s creditors could reach the trust assets, therefore gift was not complete); but see PLR 9332006 (transfer to trust was a complete gift where grantor’s creditors could not reach property transferred to trust notwithstanding grantor’s discretionary interest).

• What about an ascertainable standard? Depends whether under state law a grantor or

the grantor’s creditors could compel a distribution.

• Under comment (f) to the Restatement (Third) of Trusts § 60 (2003) creditors “can

Under comment (f) to the Restatement (Third) of Trusts § 60 (2003), creditors can reach the maximum amount the trustee, in the proper exercise of fiduciary discretion, could pay to or apply for the benefit of the settlor.”

64

ILITs –Beneficiary Designations

• If the Insured Has an Interest in the Trust, Is That an Incident of

Ownership? Ownership?

• Treas. Reg. § 20.2042-1(c)(2) provides that the right of the insured or

the insured’s estate to the economic benefits of the policy is an “incident of ownership ” “incident of ownership.”

• Unclear if insured’s right to interest (but not principal) or whether an

interest subject to a trustee’s discretion is an incident of ownership. See E t t f S l i k C ’ 15 T C 716 (1950) ff’d 195 F 2d 735 Estate of Selznick v. Comm’r., 15 T.C. 716 (1950), aff’d, 195 F.2d 735 (9th Cir. 1952)( where insured had interest in trust as well as right to cancel policy’s with consent of trustee or third party, insured had incidents of ownership); but see Estate of Jordahl v. Comm’r., 65 T.C. 92 (1975) acq 1977 2 C B 1 (no incident of ownership where insured 92 (1975), acq., 1977-2 C.B. 1 (no incident of ownership where insured merely entitled to receive income of trust in excess of amount required to pay premiums on policies held by trust).