The National Underwriter Company Presents:

Advanced Markets Case Study

Beginning next month The National Underwriter Company will begin its case series for wealth managers. The case studies will be in addition to our daily articles. Check back in September to see the new content.

The case studies have expert commentary and analysis to help wealth managers with common planning issues.

Here’s a sneak peak of what is to come…

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.

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? This blogticle presents an overview of the credit shelter trust. Given the $5 million estate and gift tax exemption, along with the portability of the spousal credit, and wealth managers and clients alike are asking how this will affect estate plans. We thus review the credit shelter trust so as to provide information for decision making regarding client estate plans given the new estate and gift tax legislation.

The unlimited marital deduction is “superficially” attractive. The wealthier spouse doesn’t have to worry about estate tax erosion of assets transferred to a surviving, less wealthy spouse. But what about the second death? The unified credit and portability may be sufficient in some cases to shelter the estate, but not always. Therefore, some affluent families benefit from the split-estate (A-B Trust) concept in marital deduction planning. The benefits arising from the use of such instrument are nevertheless being questioned by wealth mangers given the new estate and gift tax exemption amounts.

While the marital deduction provides a tremendous tax benefit at the first death, it largely postpones the estate tax on the qualified property until the second spouse dies. Since most clients are anxious to conserve as much of the estate as possible for succeeding generations, proper estate planning considers the effects of the combined estate tax on both spouses’ estates and takes steps to keep death taxes at a minimum in the survivor’s estate as well as at the first death.

For many years the testamentary credit shelter trust has been a standard element in estate planning for married persons. These trusts, created upon death and funded to the extent of the decedent’s applicable exemption amount, still represent a vast potential market for the sale of life insurance. Life insurance on the life of the surviving spouse can be a highly suitable asset for credit shelter trusts. This discussion focuses on the advantages of life insurance as an asset of a credit shelter trust notwithstanding the increased gift and estate tax exemption amount and spousal portability.

Significant advantages can be achieved by widows and widowers and their heirs who are beneficiaries of credit shelter trusts (established upon the deaths of their respective spouses), through the purchase by the credit shelter trust of insurance on the life of the surviving spouse.

One of the appealing aspects of investing credit shelter trust assets in life insurance is that when the trust is ultimately distributed to children (or other heirs) after the death of the surviving spouse, the property will have achieved, in effect, two successive step-ups in basis subsequent to the death of the first spouse.

In summary, it works as follows: Consider a spouse with appreciated assets who dies. The appreciated assets are transferred by the decedent’s will to a credit shelter trust, taking a stepped-up basis equal to the market value at which they were included in the gross estate. Assume that before the assets appreciate further in value some portion is sold by the trustee at no taxable gain. The proceeds of the sale are used to purchase an insurance policy on the life of the surviving spouse. When the surviving spouse dies, the death benefit will be received by the trust income tax free under I.R.C. §101. Thus, in effect, the property that was received by the trust with a stepped up basis upon the death of the first spouse will have grown to an amount equal to the insurance death benefit by the time the second spouse dies. This second increase in value (occurring between the death of the first spouse and the death of the second spouse) is not subject to income tax, because of Code §101, and thus, there has effectively been a second step-up in basis for the increased asset amount eventually received by the couple’s heirs.

Next week’s blogticles will present discussion related to estate planning generally.

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.

[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).

Why is this Topic Important to Wealth Managers? This blogticle represents part three 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.

The Marital Deduction

A 100-percent marital deduction generally is permitted for estate and gift tax purposes for the value of property transferred between spouses.[1] Transfers of ‘‘qualified terminable interest property’’ are eligible for the marital deduction. ‘‘Qualified terminable interest property’’ is property: (1) that passes from the decedent; (2) in which the surviving spouse has a ‘‘qualifying income interest for life’’[2]; and (3) to which an election applies. [3]

In other words, the marital deduction allows spouses to deduct unlimited amounts for property that passes from a decedent to his or her surviving spouse. [4]

Portability of the DSUEA

Fittingly, as Benjamin Franklin notes there are two certainties in life; death and taxes.[5] Eventually the surviving spouse too will die and a tax on the combined estate will be imposed. Nevertheless, the Tax Relief Act of 2010 introduces a new estate tax concept for 2011 and 2012—the deceased spouse unused exclusion amount (DSUEA). Essentially, the DSUEA allows a surviving spouse to utilize the unused exclusion amount of the first spouse to die.

Under the provision, any applicable exclusion amount that remains unused as of the death of a spouse who dies after December 31, 2010 (the ‘‘deceased spousal unused exclusion amount’’), generally is available for use by the surviving spouse, as an addition to such surviving spouse’s applicable exclusion amount.[6]

If a surviving spouse is predeceased by more than one spouse, the amount of unused exclusion that is available for use by such surviving spouse is limited to the lesser of $5 million or the unused exclusion of the last such deceased spouse. A surviving spouse may use the predeceased spousal carryover amount in addition to such surviving spouse’s own $5 million exclusion for taxable transfers made during life or at death.

A deceased spousal unused exclusion amount is available to a surviving spouse only if an election is made on a timely filed estate tax return (including extensions) of the predeceased spouse on which such amount is computed, regardless of whether the estate of the predeceased spouse otherwise is required to file an estate tax return.

The applicable exclusion amount is the sum of two components: the basic exclusion amount and the DSUEA. The basic exclusion amount for estates of decedents dying in 2011 and 2012 is $5 million. The second part of the equation, the DSUEA, is the amount of the first-to-die spouse’s exclusion amount that is not used by that spouse’s estate. Note that a surviving spouse’s DSUEA is equal to the unused exclusion amount of the surviving spouse’s last deceased spouse.

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.

[2] A ‘qualifying income interest for life’’ exists if: (1) the surviving spouse is entitled to all the income from the property (payable annually or at more frequent intervals) or has the right to use the property during the spouse’s life; and (2) no person has the power to appoint any part of the property to any person other than the surviving spouse.

[3] See generally IRC Secs. 2056 & 2523.

[4] IRC Secs. 2056 & 2523.; AMAFX-AUS Main Library. The Federal Estate Tax.

[5] Benjamin Franklin. Letter to Jean Baptiste La Roy 1789. “But in this world nothing can said to be certain except death and taxes.’

[6] See generally IRC Sec 2010(c)(4).

Why is this Topic Important to Wealth Managers?  Discusses the Estate and Generation Skipping Transfer Tax with regards to the new Obama Tax Cuts.

The recent Obama Tax Cuts reinstated the estate and generation skipping transfer taxes effective for decedents dying and transfers made after December 31, 2009.  As was discussed earlier this week, the estate tax applicable exclusion amount is $5 million for decedents dying in calendar years after 2011, and the maximum estate tax rate is 35 percent. Furthermore, the generation skipping transfer tax exemption for decedents dying or gifts made after December 31, 2009, is equal to the applicable exclusion amount for estate tax purposes ($5 million for 2010).

For a general background on the Generation Skipping Transfer Tax, see our November 1^st Blogticle entitled: Life Insurance and the Generation—Skipping Transfer Tax

Although technically the generation skipping transfer tax is applicable for 2010, the generation skipping transfer tax rate for transfers made during 2010 is zero percent. After this year, the generation skipping transfer tax rate equals the highest estate and gift tax rate in effect for such year (35 percent in 2011 and 2012), notwithstanding the exclusion amounts.

Moreover, under the new law, a recipient of property acquired from a decedent who dies after December 31, 2009, generally will receive fair market value basis (i.e., “step up” in basis). [1]

Election for decedents who die during 2010

In the case of a decedent who dies during 2010, the new law generally allows the executor of such decedent’s estate to make an election whereby the estate would not be subject to estate tax, and the basis of assets acquired from the decedent would be determined under the modified carryover basis rules. [2]

Portability of unused exemption between spouses

Under the new law, any applicable exclusion amount that remains unused (including those used in the calculation of the generation skipping transfer tax), from the death of a deceased spouse, beginning next year, is available for use by the surviving spouse, in addition to such surviving spouse’s applicable exclusion amount.  A surviving spouse may use the unused amount in addition to such surviving spouse’s own $5 million exclusion for taxable transfers made during life or at death for a total of $10 million.

Extension of certain filing deadlines

The new law also provides for the extension of filing deadlines for certain transfer tax returns. Specifically, in the case of a decedent dying after December 31, 2009, and before the date of enactment, the due date shall not be earlier than the date which is nine months after the date of enactment to file and pay the estate tax

Sunset provision

Under the bill, the sunset of the new law of applies to estates of decedents dying, gifts made, or generation skipping transfers made after December 31, 2012.

Tomorrow’s blog will continue to discuss pertinent provisions of the new Tax Cuts and how they relate to wealth managers.

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

[2] For determination of modified basis carryover, see 26 U.S.C. § 1022.

President Obama’s tax compromise introduces a new estate tax concept for 2011 and 2012, the deceased spouse unused exclusion amount (DSUEA).  Essentially, the DSUEA allows a surviving spouse to utilize the unused exclusion amount of the first spouse to die.  The new law raises an important planning question: Is the bypass (credit shelter) trust obsolete as an estate planning device? Also: Do existing bypass trusts need to be amended in light of the new law?

In general, under the new estate tax, an estate’s exclusion amount, referred to as its applicable exclusion amount, is the sum of two components: the basic exclusion amount and the DSUEA. The basic exclusion amount for estates of decedents dying in 2011 and 2012 is $5 million. The second part of the equation, the DSUEA, is the amount of the first-to-die spouse’s exclusion amount that is not used by the that spouse’s estate. Note that a surviving spouse’s DSUEA is equal to the unused exclusion amount of the surviving spouse’s last deceased spouse.  Read this complete article 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 Obama’s tax agreement, including its estate tax provisions, in Advisor’s Journal, see Obama Tax Agreement Faces Stiff Resistance in Congress (CC 10-112) and 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 estate tax is scheduled to explode in 2011. Analysts have assumed for years that Congress would act to fix the estate tax before it expired in 2010 and reverted to its pre-2001 levels in 2011, but it is looking more and more likely that the current Congress will hand the problem off to the next Congress on January 11, 2011. With the election coming on November 2, 2010, time is short for the 111th Congress to act. Although movement during the lame duck session is possible, it is not likely to generate any positive action on the estate tax.

Whether Congress acts on the estate tax or not, 2011 will likely bring drastic changes to the estate tax, requiring your clients to do significant tinkering on their estate plans. In the interim, estate planning professionals will continue to use disclaimer planning as a stop gap measure to deal with 2010′ s estate tax uncertainty. For instance, rather than split an estate’s assets between credit shelter and marital deduction trusts—which is unnecessary when there is no estate tax—all of the assets are devised to the spouse or the marital deduction trust.  The surviving spouse can then disclaim up to the tax-free amount— … Read this complete article 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 estate tax conundrum in Advisor�s Journal, see Estate Tax Chaos (CC 10-02).

For in-depth analysis of the federal estate tax, see Advisor�s Main Library: Section 2 A—Overview Of The Federal Estate Tax And Its Calculation.

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