In December of last year, President Obama turned the standard estate plan upside down when he signed the Tax Relief Act of 2010. In addition to a record $5 million applicable exclusion amount and continued 35% top rate, the estate tax included a brand new concept that may force your clients to re-evaluate their estate plan.

That concept is the Deceased Spouse Unused Exclusion Amount (DSUEA). Advisor’s Journal covered the DSUEA shortly after the concept was introduced [Does the New Estate Tax Make the Bypass Trust Obsolete? (CC-10-122)]. In that article, we concluded that the DSUEA not only makes bypass trusts unnecessary, but may even hurt an estate’s beneficiaries by reducing the basis of assets they receive from the bypass trust. We hinted at one solution to the bypass trust problem—disclaimers. Here we’ll discuss a particular solution to the bypass trust problem, the so-called “A-B Bypass Trust.”

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of the new estate tax in Advisor’s Journal, see IRS Finally Issues Guidance on 2010 Estate Tax (CC 11-160), Does the New Estate Tax Make the Bypass Trust Obsolete? (CC-10-122), & Obama Tax Agreement Passed by House (CC 10-117).

For in-depth analysis of the estate tax, see Advisor’s Main Library: Estate, Gift and GST Taxes

The IRS has dropped the second shoe, giving taxpayers guidance through the complex procedural machinations they must follow to avoid the 2010 estate tax.

The IRS released two pieces of guidance for estates of 2010 decedents. Advisor’s Journal covered Notice 2011-66 in a previous edition [see IRS Finally Issues Guidance on 2010 Estate Tax (CC 11-160)]. Today we discuss the second component, Revenue Procedure 2011-41, which provides a safe-harbor for executors of estates of 2010 decedents and beneficiaries of those estates. If the safe-harbor procedure is followed and the executor doesn’t take a contradictory position on a return, the IRS will not challenge the election against the estate tax or the basis allocations made by the executor.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of estates of 2010 decedents in Advisor’s Journal, see IRS Finally Issues Guidance on 2010 Estate Tax (CC 11-160), What Next? ILITs and Estates under 5MM (CC 11-114), & Does the New Estate Tax Make the Bypass Trust Obsolete? (CC-10-122).

For in-depth analysis of the estate tax, see Advisor’s Main Library: Estate, Gift and GST Taxes

When an estate is facing a liquidity crisis, why not tap the family limited partnership (FLP) for cash? After all, the decedent was a partner in the partnership and the partnership can make distributions to the estate, which is now a partner in the FLP.

No so fast. Although an FLP may look like a prime source of cash for paying an estate tax bill, the move can come back to bite the estate in a big way. Done the wrong way, it could jeopardize the valuation discounts and estate planning objectives your clients and their estate planning professionals worked so hard to secure.

The IRS is perpetually on the lookout for new weapons to use against FLPs, but Section 2036 of the Internal Revenue Code has been the IRS’s weapon of choice against FLPs over the past decade.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of family limited partnerships in Advisor’s Journal, see Use Charitable Giving to Enhance Family Business Succession Planning (CC 10-76) and
Practical Succession Planning for the Family-Owned Business (CC 08-22).

For in-depth analysis of family limited partnerships, see Advisor’s Main Library: FF—Family Limited Partnership.

Estates of decedents who died in 2010 finally have guidance from the IRS on how to opt out of estate tax treatment and allocate carryover basis to estate property. The guidance is long overdue, and leaves little time for estates to make decisions that could have a massive tax impact.

Under the guidance, Notice 2011-66, to opt out of the estate tax and apply the new carryover basis rules, an executor must file Form 8939, Allocation of Increase in Basis for Property Acquired From a Decedent. The due date for the form is November 15, 2011. But despite the November deadline, Form 8939 and its instructions will not be available until early this fall. The IRS has, however, released a draft version of the form.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of the new estate tax in Advisor’s Journal, see What Next? ILITs and Estates under 5MM (CC 11-114), Does the New Estate Tax Make the Bypass Trust Obsolete? (CC-10-122), 2010 Estates: To Elect or Not to Elect (CC 10-124) & Obama Tax Agreement Passed by House (CC 10-117).

For in-depth analysis of the estate tax, see Advisor’s Main Library: Estate, Gift and GST Taxes.

Why is this Topic Important to Wealth Managers? This blogticle is a follow-up to the discussion presented yesterday on international estate planning considerations for non-resident aliens generally. We have again provided this information for wealth managers with international clients who may have estate tax issues to contend with.

How is a qualified domestic trust (“QDT” or “QDOT”) used between a citizen, resident, or nonresident alien and his/her non-citizen spouse particularly for estate tax planning purposes?

One of the major planning tools that wealth managers will often take advantage of with regards to estate tax for married couples is the use of the unlimited marital deduction. However, when planning for a client with a non-citizen spouse it is important to note that Congress has eliminated the unlimited marital deduction for assets passing to a non-citizen spouse for estate tax purposes.

Nevertheless, property passing to a citizen spouse or to a qualified domestic trust qualifies for the marital deduction. In addition, if the surviving spouse is a U.S. citizen, then the estate of the donor spouse is entitled to the marital deduction even if the donor spouse is a nonresident alien.

The use of a QDT may provide relief to those who are unable to take advantage of the unlimited marital deduction directly.

The QDT was created statutorily by Congress. Its function, like the unlimited marital deduction, is to allow a non-citizen spouse to defer estate tax on the donor spouse’s otherwise taxable assets until the death of the surviving spouse, or until otherwise the QDT loses its status as such.

First, the QDT instrument generally requires that at least one trustee of the trust be an individual citizen of the United States or a domestic corporation.

The trust instrument needs to also provide that no distribution (other than a distribution of income) may be made from the trust unless a trustee who is an individual citizen of the United States or a domestic corporation has the right to withhold from such distribution the tax imposed by this section on such distribution.

Second, if the fair market value of the assets passing, treated, or deemed to have passed to the QDOT (or in the form of a QDOT), determined without reduction for any indebtedness with respect to the assets, as finally determined for federal estate tax purposes, exceeds $2 million as of the date of the decedent’s death the trust instrument must meet the following requirements:

• The trust instrument must provide that whenever the Bank Trustee security alternative is used for the QDOT, at least one U.S. Trustee must be a bank as defined in Code section 581;
• The trust instrument must provide that whenever the bond security arrangement alternative is used for the QDOT, the U.S. Trustee must furnish a bond in favor of the Internal Revenue Service in an amount equal to 65 percent of the fair market value of the trust assets (determined without regard to any indebtedness with respect to the assets) as of the date of the decedent’s death; or
• The trust instrument must provide that whenever the letter of credit security arrangement is used for the QDOT, the U.S. Trustee must furnish an irrevocable letter of credit issued by a bank as defined in section 581, a United States branch of a foreign bank, or a foreign bank with a confirmation by a bank as defined in section 581.

The third and final requirement is that an election under the Code must be applied to such a trust by the executor. [1]

For additional information on this subject see AMAFX: Nonresident Aliens and Citizens of U.S. Possessions.

Tomorrow’s blogticle will present a special series on ETFs.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] IRC § 2056A.

Why is this Topic Important to Wealth Managers? This blogticle presents discussion on international estate planning considerations for non-resident aliens generally. We have provided this information for wealth managers with international clients who may have estate tax issues to contend with.

A now deceased individual who at the time of death was neither a resident nor citizen of the United States may nonetheless be subject to U.S. estate tax if at the time of death he or she owned property in the United States. In such a case, although the U.S. estate tax is applicable, only property located in the United States is includable in the gross estate and subject to tax.

An important distinction is made between who is subject to income tax and estate tax. For estate tax purposes, a nonresident alien is a person who is neither a domiciliary nor a citizen of the United States. Thus, an alien who dwells in the United States, but whose domicile remains elsewhere, is classed as a nonresident alien.[1]

Domicile here is used in the traditional sense. In other words, domicile generally requires presence and an intention to remain permanently.

For example, consider a decedent who lived in the United States six years before he died. However, he always intended to return to his native Netherlands, the location of his family and close friends, at the earliest opportunity. This man’s domicile was the Netherlands and therefore he had died a nonresident alien and was not subject to the traditional citizen or resident alien estate tax regime.[2]

The gross estate of a nonresident alien includes that part of his property which is situated in the United States at the time of his death.[3] For purposes of determining what property is situated in the United States, any property which the decedent has transferred, by trust or otherwise, which would be taxable within the provisions of Code §§2035 through 2038 (relating to termination of certain property interests within three years of death, transfers with retained life estate or to take effect at death, and revocable transfers), is deemed situated in the United States if it was so situated either at the time of the transfer or at the time of death.[4]

For a decedent who at the time of death was a nonresident alien, property is considered located in the United States if it falls into any of the categories listed below:

• Real property located in the United States.
• Tangible personal property located in the United States. This includes clothing, jewelry, automobiles, furniture or currency. Works of art imported into the United States solely for public exhibition purposes are not included.
• A debt obligation of a citizen or resident of the United States, a domestic partnership or corporation or other entity, any domestic estate or trust, the United States, a state or a political subdivision of a state or the District of Columbia.
• Shares of stock issued by domestic corporations, regardless of the physical location of stock certificates.[5]

When considering inbound international estate planning issues one question that should be addressed is if the decedent is a citizen or resident of one of the several countries with which the United States has an estate tax convention (treaty). This is because provisions of the applicable treaty may override the normally applicable Internal Revenue Code provisions. The United States is a party to estate or gift tax treaties with the following countries: Australia, Austria, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, the Netherlands, Norway, Republic of South Africa, Switzerland, and the United Kingdom.

One final but very important point to note is that proceeds of insurance on a nonresident alien’s life are not includible in his gross estate.[6]This is true even though the proceeds are paid to a resident beneficiary.

For additional information on this subject see AMAFX: U.S. Estate and Gift Tax Consequences for Non-U.S. Citizens.

Tomorrow’s blogticle will discuss the qualified domestic trust.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] Treas. Regs. §20.0-1(b).

[2] See Est. of Jan Willem Nienhuys, 17 T.C. 1149 (1952).

[3] IRC §2103.

[4] IRC §2104(b).

[5] Treas. Regs. §20.2104.

[6] IRC §2105(a).

Clients often want to use Qualified Terminal Interest Property trusts (QTIPs) to segregate certain funds to care for a surviving spouse, while retaining some measure of control over the ultimate disposition of the funds—whether they will be distributed to children or a charity. But navigating the QTIP rules as client’s circumstances change down the road can be treacherous, with the tiniest misstep eliminating any transfer tax benefit of the trust.

A recent IRS private letter ruling (PLR 201117005) provides us with a good reminder of the QTIP rules and an example of creative QTIP planning that provides the surviving spouse with adequate lifetime income while giving the grantor (and the surviving spouse) a degree of post-death control over disposition of the trust assets.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber)

For a graphic illustration of the QTIP trust, see the Concepts Illustrated practice aid at G—Credit Shelter Trust and QTIP Trust.

For coverage of QTIPs and other techniques useful in estate planning for blended families, see the Advisor’s Journal article Estate Planning for Blended Families (CC 07-16).

For in-depth analysis of marital deduction planning, see Advisor’s Main Library: G—The Marital Deduction.

Why is this Topic Important to Wealth Managers? Advanced estate planning almost always involves some attention to concept of the legal trust. It is thus essential that wealth managers understand the purposes of trusts and the ways which trusts may be incorporated into in a comprehensive financial plan. Our discussion then focuses on building a foundation to present the credit shelter trust.

“If we were asked what is the greatest and most distinctive achievement performed by Englishmen in the field of jurisprudence, I cannot think that we should have any better answer to give than this, namely, the development from century to century of the trust idea.” [1]

Generally defined, an express trust “is a fiduciary relationship with respect to property, subjecting the person by whom the title to the property is held to equitable duties to deal with the property for the benefit of another person, which arises as a result of a manifestation of an intention to create it.” [2]

The trust is unique in that there is a separation of legal and equitable title in a trustee and beneficiary, respectively. The trust may be a very effective vehicle for accomplishing the grantor’s desires. As was expressed in the beginning of this article, to appreciate the all-important role of the trust in personal and business estate planning, an understanding of the fundamentals of trust law is important.

As was presented in the general definition, an express trust is created only if the grantor manifests an intention to create it. Such manifestation may be evidenced by conduct or words. Generally the creation of an express trust is through a trust document. A great majority of U.S. jurisdictions today require the creation of an express trust to be in writing, with the exception of trusts in some states dealing with personal property.

The trust is a device or instrument for the administration and disposition of property. No other device for this purpose possesses comparable flexibility. This factor of flexibility makes the trust unique; and this extreme flexibility makes the trust a valuable instrument for the framing and execution of estate plans.

The purposes for which trusts may be created are almost unlimited. However, a trust which has as its purpose the accomplishment of illegal objectives or which is against public policy would, of course, not have a valid purpose. Thus, a person may create a trust for any lawful purpose that he or she deems wise and expedient.[3]

One of the basic purposes of most trusts is protection. It may be the protection of a spouse, child, parent, dependent (or even a tax credit) that is desired. It may be the protection of a beneficiary against his or her own possible errors of judgment in the management of the trust property. There may be a desire to protect someone else later, by giving the income to certain persons for their lifetimes, and the principal to others at death. The intention of the grantor, as discussed above, will dictate the terms of the trust arrangement.

See a detailed analysis of trust law in the Main Library Section 21. Trusts, Guardianships And Minors B—The Law Of Trusts.

Tomorrow’s blogticle will discuss the credit shelter trust in general terms.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] F. W. Maitland, Selected Essays. 129. (1936).

[2] Restatement (Second) of Trusts § 2. (1959).

[3] 90 C.J.S. Trusts § 17 (2011).

Why is this Topic Important to Wealth Managers? This blogticle concludes our weeklong series on the unified estate and gift tax as well as the portability of the spousal credit. This week we discussed the estate and gift tax in detail so that wealth managers are well prepared to address client planning needs.

How the DSUEA will be treated after 2012 is uncertain, but wealth managers should consider the possible ramifications of the returning sunset and how it may affect your clients’ estate planning. As we have seen Congress may extend the sunset date, revert the rules to a prior act in time, or treat the DSUEA as if it never existed.  Not surprisingly because there are currently no provisions to address the consequences if the law is not renewed in 2013, long term planning uncertainty still exists in the gift and estate tax area.

On the one hand, if Congress extends the DSUEA, then bypass trusts will likely remain unnecessary for estate tax purposes. Spouses will have the continued opportunity to utilize the DSUEA and take advantage of its many benefits, such as making gift transfers to heirs or establishing trusts that take full advantage of the increased exemptions.

On the other hand, if Congress does not take action by 2013, the Bush tax cuts – and the modifications made by the Tax Relief Act of 2010 – will be treated as if they had never been enacted. Under the latter scenario, the estate tax would revert back to the 2001 level which amounts up to a $1 million exemption, with a maximum rate of 55%. Additionally, if no further action is taken before the end of 2013, the portability feature would no longer be available at that time. Thus, if the DSUEA ceases to exist after December 31, 2012, the bypass trust will likely once again become an integral part of the estate planning process.  In light of the new DSUEA concept, existing bypass trusts should be examined to determine whether the benefits of a bypass trust outweigh the loss of step-up basis that results from their use.

Series Summary

The increased estate and gift tax exemptions along with unification of the gift and estate tax created changes to the treatment of estate and gift taxes generally. The new law reinstated the estate tax but provides for an exemption of $5 million with a top tax rate of 35%. Moreover, the new DSUEA created an even higher combined exemption amount for some spouses. Thus, the provisions in the TRA of 2010 provide one planning route that may be examined as the optimal path for some married couples. As always with tax law, what is appropriate for each client should be determined on a case-by-case basis.

For more information on the implications of the new estate and gift tax in particular client situations please feel free to contact our panel of experts.

Next week’s blogticles will again address issues surrounding wealth management practice.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

Why is this Topic Important to Wealth Managers? This blogticle represents part four of five in a series on the unified estate and gift tax as well as the portability of the spousal credit. Most wealth managers are aware of the new changes to the federal estate and gift tax structure with the unification and increased exemption amount of five million dollars. This week we discuss the estate and gift tax in detail so that wealth managers are well prepared to address client planning needs.

Generally the purpose of a bypass trust is to fully utilize a deceased spouse’s exclusion amount which is now also accomplished by the statutory DSUEA. Thus, there is no need to preserve the first spouse’s exclusion amount since the surviving spouse’s estate will be able to utilize the first spouse’s exclusion amount without use of a trust. In short, the bypass trust is no longer usually necessary for estate tax purposes.

Both the DSUEA and bypass trust will fully utilize the first-spouse-to-die’s exclusion amount, so why not use an A-B trust arrangement? After all, Congress could eliminate the DSUEA in 2012 as easily as it introduced it in 2010. The A-B trusts are the marital deduction trust (A), and the credit shelter trust (B).

Yet there is a very good reason to think twice before using a bypass trust in 2011 and 2012 (and in later years if the DSUEA concept sticks around). Assets of the first spouse to die that are placed in a bypass trust do not receive a step-up in basis at the death of the second spouse; however, assets that pass untaxed in the second spouse’s estate due to the first spouse’s DSUEA will receive a step-up in basis, which can result in a very significant income tax savings when beneficiaries of the surviving spouse’s estate sell property received from that estate.

Although use of a bypass trust in 2011 and 2012 is unnecessary—and even counterproductive— for estate tax purposes, existing bypass trusts do not necessarily need to be eliminated from the estate plan. Estate tax “certainty” extends only through 2012, and the DSUEA may disappear when the next Congress takes its turn with the estate tax. If the DSUEA is eliminated, the bypass trust will again become an important tool for estate planning.

Rather than remove the bypass trust from the will, the trust can be dealt with if the testator dies in 2011 or 2012 through the use of disclaimers. If the standard A-B trust arrangement is kept in place while the DSUEA is in effect, and the surviving spouse is named as residual beneficiary of the trust, the gift to the bypass trust can be disclaimed and the surviving spouse will take the property. Then, at the surviving spouse’s death, the DSUEA component of the last-to-die spouse’s exclusion amount will capture the first-to-die spouse’s unused exclusion amount.

Importantly, beneficiaries will receive property covered by the DSUEA with a stepped-up basis, unlike property received from a bypass trust. [1]

Under the new estate tax regime, the estate’s applicable exclusion amount is equal to the basic exclusion amount plus the DSUEA.[2] More specifically, the Tax Relief Act of 2010 sets the DSUEA for a surviving spouse of a deceased spouse dying after December 31, 2010, as the lesser of: (A) the basic exclusion amount, or (B) the excess of – (i) the basic exclusion amount of the last such deceased spouse of such surviving spouse, over (ii) the amount with respect to which the tentative tax is determined under IRC Section 2001(b)(1) on the estate such deceased spouse.[3]

In sum, the DSUEA is “portable” in nature, meaning that it allows a surviving spouse to utilize his or her deceased spouse’s applicable unused exclusion amount.[4] It is also important to note that the portability feature does is not apply to the unused GST tax exemptions of a pre-deceased spouse.[5]

Tomorrow’s blogticle will continue our weeklong series on the gift and estate tax.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] Robert Bloink, Esq., LLM & Professor William H. Byrnes, Esq., LL.M., CWM, Selected Provisions and Analysis of the Tax Relief Act of 2010, 8, The National Underwriter Company (2011).

[2] IRC Sec. 2010(c).

[3] TRA of 2010 § 303(a)(4). See also IRC Sec. 2010(c)(4).

[4] TRA 2011 §303(a).

[5] U.S. Congress. Joint Committee on Taxation. General Explanation of Tax Legislation Enacted in the 111th Congress, 554 (JCS-2-11). Text from: Committee Reports. Available at: http://www.jct.gov/publications.html?func=showdown&id=3777 (last accessed April 6, 2011).