Domestic Trusts

0pp - Item # Individual Add-On Provisions
2503(b) Family Care Trust

The IRC 2503(b) / Family Care Trust (FCT) is a way for taxpayers to utilize the annual exclusion rules for making gifts to family members while maintaining control of the gifts to the extent desired. The FCT functions as a sub-trust of an RLT, and would have the same beneficiaries as those identified in the revocable portion of the RLT. Certain administrative rules must be followed, however, to ensure the optimal tax benefits. Utilizing the annual exclusion allowances, a taxpayer/donor can transfer up to $12,000 per year / per donee. A married couple can “split gifts” and together transfer up to $24,000 per year / per donee. This means that, under current (2007) federal tax law, a married couple with four children (for example) could transfer $96,000 each year to the FCT without incurring a gift/transfer tax liability.

If annual exclusion gifts are made to the FCT for the benefit of a minor then all income generated from the gifts must be distributed at least annually to the minor or to a Uniform Gifts to Minors Act (UGMA) account for the benefit of the minor. Unlike the rules that apply to an IRC 2503(c) Trust, the 2503(b) FCT does not have to distribute the gifted principal to the minor when the minor obtains the age of 21. In fact, the gifted assets can remain in trust for as long as the grantor directs through the terms of the trust.

If the FCT beneficiary has obtained the age of 21 and the grantor still wishes to make “annual exclusion” gifts to the trust, then the trustee of the FCT must notify the beneficiary of his/her right to withdraw the gifted amount(s). If the beneficiary allows his right to withdraw to lapse (usually after 30 days) then the gifted amount becomes a part of the FCT, and shall then be controlled and administered under the terms of the FCT. The income generated from the annual exclusion gifted amount does not have to be distributed outright to the beneficiary – assuming that the beneficiary was at least 21 years old when the gift was made – but any undistributed income would be taxed to the trust.

If the grantor(s) wants to make gifts exceeding the annual exclusion amount and/or not have the annual exclusion gifts subject to withdrawal by the beneficiary(s) of the FCT, then to the extent of the value of the gift(s) – not offset by the exclusion – a gift tax liability would occur. However, gift tax liabilities can be offset by taking a portion of the federal Gift Tax Credit (having an exemption equivalent amount of $1,000,000) against the gift tax.


QPRT

The Qualified Personal Residence Trust (QPRT) rules prescribed under IRC Section 2702(a) provide an opportunistic exception to the IRC Chapter 14 laws (1990) abolishing most “estate freeze” techniques, which were commonly used with large estates. With proper planning, taxpayers owning high value residences can significantly reduce the estate tax liability associated with the transfer of their residences (upon decease) to their children.

Estate freeze strategies (e.g., methods to mitigate the increase of the “taxable” value of an asset) usually incorporate gifting techniques, generally to younger generation beneficiaries, with a retained interest by the giftor – such as a right to

receive all income generated by the gifted property and/or the right to occupy the gifted property by virtue of a life estate interest. But, since enactment, the Chapter 14 rules generally cause the entire value of the retained-interest gift to be deemed as a part of the transferable and thus taxable estate of the giftor (at the giftor's decease) because the doctrine of retained interest holds that the gift was never completed and therefore still effectively owned by the giftor.

Congress later recognized a problem with imputing heavy taxation on family residences and so provided a corresponding exception to the disallowance of a retained interest transfer being deemed as a completed gift/transfer. Under IRC Section 2702(a)(3)(A)(ii), a taxpayer's residence or vacation home can be transferred to a QPRT with the retention of a life estate for the transferor and yet be deemed as a completed gift/transfer for tax purposes. A gift tax liability is incurred with this methodology, notwithstanding, but it would usually be considerably less than the future estate tax liability – especially if the property appreciates in value.

The grantor of a QPRT can transfer his residence (or vacation home) to the trust and name his children (or others) as the remainderman beneficiaries. Under the QPRT rules, he may retain the exclusive use of the residence for a term of years specified in the trust, which term he can choose since there is no minimum or maximum term requirement.

The terms of the QPRT would provide for a “contingent reversionary interest” that would cause the residence to lapse back to the grantor's estate if the grantor dies before the expiration of the term-of-years period. If the grantor survives the term-of-years period, however, the transfer of his residence to the QPRT is then deemed a completed gift and thus not in his estate for tax purposes at his decease. The longer the term-of-years period the greater the value attributed to the grantor's reversionary interest in the property, which will be completely dissolved if he survives the term-of-years and thus be removed from his taxable estate at his decease.

If the grantor survives the term-of-years, the QPRT can either terminate or the residence can remain in trust, if the trust so mandates, and be required to allow the grantor a lifetime right-to-rent of the residence, for fair market value. At the grantor's decease, there will be no estate tax imputed on the transfer of the residence to the QPRT beneficiaries since the grantor was deemed to have made a completed gift of the residence before his decease.

Determining the value of the initial gift to QPRT for tax purposes is a function of (i) the grantor's age, (ii) the value of the residence at the time of transfer, and (iii) the term-of-years period selected by the grantor. The grantor's retained right to occupy the residence when in the QPRT, and the right to have it reallocated to his estate if he does not survive the term-of-years, is used to determine the value of the residence that was not part of the original gift value. Thus the initial gift amount is simply the total value of the residence minus the value of the grantor's retained interests. Again, if the grantor survives the term-of-years period, then the grantor's retained interest is automatically dissolved (by function of law) and thus not in his estate for tax purposes at his subsequent decease.

529 Educational

Legislation enacted through the Small Business Job Protection Act of 1996 created a significant opportunity for taxpayers wanting to build college-expense-relief trust funds. A combination of aggressive tax savings, control, and flexibility makes the 529 Education Savings Plan Trust a structure for serious consideration for any parent, grandparent, uncle etc. wanting to help generously meet the college expenses of a family member.

The 529 Plan developed into a dollar-funded account (from a previous “credit” plan) that gives state-appointed administrators custodial duties over the accounts regardless of where (in whichever state) the college-expense related withdrawals would eventually be used. Cash can now be contributed to designated 529 accounts, which can then compound with tax-free dollars until qualified withdrawals are made to pay for college-related expenses.

The concept of the 529 Plan is revolutionary to estate & tax planning in that it allows the account-owner nearly maximum control of an established 529 account. The control features include the account-owner's right to withdraw up to 100% of the account funds, and the ability to terminate the account (subject to a 10% penalty on non-qualified withdrawals - but only on the earnings in the account) without it being in the owner/contributor's estate for transfer tax purposes.

Because of the vested right of the account owner to transfer ownership of a 529 account (without a taxable event), a 529 account-owner may transfer his/her 529 account(s) to a special sub-trust of his/her Revocable Living Trust (RLT) wherein the RLT will maintain the qualification provisions of the 529 account inside the trust. A living trust appears to be a wise choice for holding 529 accounts seeing that essentially maximum control may be retained by the grantor. Probate and other administrative problems associated with account-transfer powers would be avoided which otherwise may occur without a RLT in place with the 529 account.

However, special provisions creating a special sub-trust must be installed in the controlling RLT to avoid disqualifying the 529 accounts being held by the RLT. RLTs provide unlimited, unrestricted, and non-penalized revocation powers to the grantor including (i) a very broad range of asset choices that can be funded to the trust, (ii) unlimited and unencumbered withdrawal rights to the grantor without penalization, (iii) aggregated accounting methods, (iv) few restrictions on investment/allocation powers and directives that can be employed by the trustee, (v) secured hypothecation or pledging of assets, (vi) no limitations to contribution amounts, (vii) that transfers are not deemed as a taxable gift, and (viii) no restrictions on the number of beneficiary designations. Conversely, a 529 owner may not retain such unrestricted control over the account. That is why special provisional features must be incorporated into the RLT draft if the RLT is to hold the 529 account(s).

The (grantor of a) RLT can meet all the requirements and enjoy all the benefits of 529 succession-ownership planning as long as the requirements described by law to qualify the 529 account(s) for the duration and life of the account(s) are upheld and maintained in the RLT. This can be accomplished with a special Educational Savings Plan “Add-on Sub-Trust” to the RLT.

$995.00