I now post Part III -- the final installment -- of Paul T. Fabiano's observations from the annual Heckerling Institute held January 14-18, 2008, in Orlando, Florida. Paul works with Cornerstone Advisors in Allentown, PA.
For the first two installments of his observations from the Institute, see: PA EE&F Law Blog posting, "Developments from Heckerling Institute, Pt. I" (02/11/08), and "Developments from Heckerling Institute, Pt. II" (02/18/08).
I thank him for his contributions, which have been noted by other bloggers and appear widely read.
2008 Heckerling Highlights
Paul T. Fabiano, JD, LLB
Cornerstone AdvisorsPlanning for Retirement Plans
This presentation gave a detailed economic analysis of IRA stretching versus planning alternatives, such as withdrawing the benefits before death or rolling into a Roth IRA. The stretch IRA proved best in most scenarios along with a Roth conversion that had the highest return under Monte Carlo simulations.
There was also a scenario where paying estate tax and going down a generation, avoiding a spouse’s required minimum distributions, provided more to the heirs in the long run. The materials contain excellent forms for beneficiary designations and trust provisions.
1. Nonspouse Rollover: Although the Pension Protection Act of 2006 allows nonspouse beneficiaries to roll an inherited qualified plan into an IRA account (using the deceased’s life expectancy for required minimum distributions), the IRS is not going to require employers to accommodate this in their plans.
2. Wash Sale Rules: Revenue Ruling 2008-5 confirmed that wash sale rules, which disallow recognition of losses when taxpayers repurchase the same security, extends to repurchases made in an IRA.
3. Other Resources: If a trustee’s discretion to make distributions to a surviving spouse require trustee to consider other resources first, consider adding language directing trustee not to consider resources beyond minimum distributions from retirement plan assets.
Transfers to Parents and Siblings
This presentation discussed how wealthy family members can efficiently make gifts to, or provide for, parents and siblings. In general, the primary means to benefit these family members are annual exclusion gifts, gifts to trusts with multiple Crummey powers, payment for medical expenses (including the portion of long-term care that is medically necessary) and education expenses, and payment in the ordinary course of business.
4. Use of Property: Again, considering Dickman, the scope of gift tax law for transfers of property is broad and could extend to rent-free use of real estate. To reduce the possibility of the free use being deemed a gift, alternatives are joint ownership or trust ownership of the property.
- Co-Tenants. Generally under property law, a co-tenant does not have an obligation to pay a co-tenant rent unless he or she “ousts” the co-tenant. Possibly, under this reasoning, the beneficiary co-tenant could be a mere one percent owner.
Section 529 Plans
- Trust Ownership. A trust could also work because it cannot make a gift to a beneficiary, but there is a challenge with funding it initially with the property.
This presentation gave a unique look at considerations that planners should address in implementing and changing 529 plans. The laws governing these plans and rules by institutions offering these plans are still evolving. Be alert of potential consequences when changing ownership, naming new beneficiaries or moving the plan to another state.
5. Successor Owner: An often overlooked consideration is the successor owner of a 529 plan account. There are at least two issues to be aware of: (1) the account owner has no fiduciary duty to the account beneficiary (e.g., he or she could take the funds personally) and (2) the exemption from estate tax inclusion can be lost if the account is subject to transfer taxes or debts of the owner.
- Trust as Owner. By making a trust the account owner, the account management then falls into a fiduciary role and can survive incapacity or death; however, be aware of the potential estate inclusion and exclude the account from payment of taxes and debts.
6. 5-Year Election: It appears the five-year election for contributions to a 529 plan pro-rates the gift automatically and the annual gift over the period cannot be varied. Additionally, be careful to make the election on a timely return or the first late return. The election cannot be made once a return has been filed for the year of the contribution.
- Additionally, note that an Advance Notice indicates that trusts may no longer be permitted account owners.
7. Beneficiary Changes: There are no tax problems with changing the beneficiary of a 529 plan account as long as the change is to “a member of the family” of the prior beneficiary and in the same generation. If the new beneficiary does not meet these criteria, the old beneficiary is deemed to make a taxable gift and may have to recognize income on the account earnings. It is interesting to note, however, the old beneficiary could then file a five-year election on the resulting gift.
As introduced in Part 1 of these highlights, the Treasury released proposed regulations to IRC §2053 significantly changing the way estate tax deductions are taken into account. There are currently differences among Circuits in considering post death events and these regulations are intended to end the uncertainty.
8. Contingent Claims: Under the proposed regulations, any contingent claims or deductions cannot be reported until actually paid. Additionally, only bona fide claims can be deducted even if already paid. Accordingly, such claims must be paid and enforceable under state law.
- Family Presumption. Family claims carry a rebuttable presumption that they are not legitimate and bona fide.
9. Estimated Amounts: An exception to the actually paid rule applies for claims that are “ascertainable with reasonable certainty, and will be paid.” Under the proposed regulations, this exception could apply to executor’s or attorney’s fees if reasonable and within accepted amounts in the jurisdiction. If later not paid, the executor must notify the Commissioner and pay the resulting tax with interest.
- Recurring Noncontigent Payment. For recurring payments due in the future, which are not contingent (e.g., installment payments under a buy-sell agreement), the estate may deduct an amount equal to the present value of the future payments.
Defined Value Transfers
With the new penalties for undervaluation of gifts, it is a good idea to use a defined value gift to reduce any risk.
10. Formula Gifts: Although the Service dislikes all types of formula gifts, a defined value gift has a base of authority and is superior to a gift adjustment clause.
- Adjustment. An adjustment clause, which the 4th Circuit held to be void as against public policy, is where the amount of the gift is retroactively adjusted if the value is later found to be different than assumed.
- Defined Value. The defined value clause, which is sanctioned by tax law in other contexts (such as GRATs, allocation of GST exemption and marital deduction formulas), instead, defines the amount transferred with reference to the final valuation. Such a clause was upheld for a gift in the 5th Circuit.
- Pour-Over. A variation of the defined value clause, is to have the excess value, as finally determined, flow into another place such as to a charity. This removes the incentive for the Service to challenge the gift value and involves an interested third party to substantiate the value used.
11. GRAT with Trust: While the ability to adjust the annuity in a GRAT eliminates the gift tax risk of gifting hard to value assets (e.g., business interests), the return of a higher annuity through principal distributions may frustrate the client’s intent. If the client established another trust and gifts cash to it, the trust could loan the cash to the GRAT to make the annuity payments to client with no valuation risk. At the GRAT term end, the GRAT could repay the loan with its principal.
- Incomplete Gift. The defined value and pour-over could be taken a step further by having a trust purchase an asset from the client then divide into a sale share and an uncompleted gift share. The uncompleted gift share of the trust, as defined by formula based on the asset’s finally determined value, would grant back to the client a power of appointment.
States statutes are beginning to allow the decanting of trust assets into another trust. This can provide a great deal of flexibility to address many issues, such as solving trust liquidity needs, reducing administration costs, modifying administrative provisions, changing state law or correcting drafting errors. These powers are different from modification statutes because the trustee is acting without the consent of beneficiaries.
- Common Law: If not specifically authorized by client’s state statute, it is possible to apply ordinary common law principals to establish a new trust when the trustee has the discretion to apply principal “for the benefit of” the beneficiary.
- GST Impact. Be careful to consider any impact on GST exemption. The regulations provide guidance on the extension of an otherwise GST exempt trust.
- Income Tax Effect. Another tax consideration is triggering a gain if the beneficial interests of the new trust differ from the old trust. There may be more leeway on this issue under a decanting statute then if done by modification.
Trust Distributive Provisions
- Beneficial Interests. There are varying state provisions in the decanting statutes requiring similar beneficial interests or standards of distribution. Also, consider whether a taxable gift can occur if a beneficiary who is giving up some portion of interest does not object to a decanting.
This presentation provided good insight into the selection of trustees, the terms of trust distribution and tax implications of different arrangements.
- Incentive Trusts. In particular, there is great coverage and language addressing incentive trusts, such as for education or employment incentives.
- Mission Statement. Although most planners do not spend a great deal of time on the standards of distribution, there is a very broad range of interpretations and applications in such language. Consider spending more time on what the standards mean to the client and possibly develop a mission statement for them to that effect.
 Notice 2007-94.
 Dickman v. Comm., 465 U.S. 330 (1984).
 IRC §529(c)(4)(A) .
 Advance Notice of Proposed Rulemaking, released on January 17, 2008.
 Prop Reg. §20.2053-1.
 Prop Reg. §20.2053-4.
 Prop Reg. §20.2053-3.
 Comm. v. Procter, 142 F.2d 824 (4th Cir. 1944).
 McCord v. Comm., 120 T.C. No. 13, 120 T.C. 358, 2003 WL 21089049 (2003).
 New York, Alaska, Delaware, Tennessee, Florida, and South Dakota.
 See, PLR 200530012, Phipps v. Palm Beach Trust Co., 196 So. 299 (Fla. 1940); but see Third Restatement on Property (which seems to disallow this by providing a distribution power is not the same as a power of appointment).
 Reg. §26.2601-1(4)(i)(A).