April 1999 - Recent Estate Planning Developments First Quarter of 1999

Administration's Budget Proposals Affecting Estate Planning
A "Bottom Line" Discussion of Alaska Trusts
Their Purposes - Who Should Use Them - How To Implement Them
David G. Shaftel 1998.
All rights reserved.
A Summary Provided by the: Law Offices of David G. Shaftel, PC


In this edition of our newsletter, we discuss the Clinton administration's February 1999 budget proposals which affect estate planning. Then we proceed to describe the three types of Alaska trusts which have been developed in the last two years: Alaska's community property trusts; Alaska's self-settled spendthrift trusts; and Alaska's perpetual trusts. There has been considerable discussion of these new trusts at national estate planning conferences, and several articles have been written and published in national estate planning journals. I am enclosing two articles which I wrote and were recently published in Estate Planning, probably the most popular professional journal in the estate planning area. The purpose of our discussion of these trusts in this newsletter is to give you some "bottom line" guidance concerning whether you should consider use of these new estate planning vehicles.


1. Elimination of Valuation Discount. In February of 1999, the Treasury Department issued its proposed legislative changes relating to estate planning. Several of the proposals are carryovers from 1998. The first is the elimination of non-business valuation discounts. The Treasury Department is concerned about the use of family limited partnerships and family limited liability companies in order to make gifts at discount. Such an approach involves the older generation contributing assets to the family limited partnership or limited liability company. Then, the older generation makes gifts of portions of their interests in the entity to their children and grandchildren. Because of the restrictions imposed by state law on family limited partnerships or family limited liability companies, the value of these gifts is substantially discounted by appraisers. As a result, the older generation may give more assets to the younger generations. Further, if the older generation dies owning limited partnership or limited liability company interests, these interests are similarly discounted in value. The IRS does not like this valuation discount, and its proposal would eliminate the discount for all the family limited partnerships and limited liability companies, unless the entity operates an active business. This proposal would be effective for transfers made after the date of enactment. FLPs and FLLCs formed and funded before enactment would not be affected by this legislation.

2. Elimination of Qualified Personal Residence Trusts. This is another carryover from 1998. Present statutory law allows a person to contribute his or her residence to a trust, and retain the use of the residence for a period of time. After the expiration of that period of time, the residence goes to the next generation or to a trust for their benefit. Use of this type of trust for gift-giving purposes produces a very substantial discount in value. Often the residence is transferred to the next generation at a quarter or a third of its full fair market value. Despite Congress's express statutory authorization of these trusts, the Treasury Department would like them eliminated. The proposal would be effective for transfers in trust made after the date of enactment. Trusts formed and funded before enactment would not be affected.

3. Elimination of the Full Basis Adjustment For Spouses Living In Community Property States. As we discuss below, Alaska has now adopted an optional community property system. One of the purposes of this enactment was to qualify Alaska couples for a full basis adjustment in their appreciated property, held as community property, at the date of death of the first spouse. The Treasury Department responded to Alaska's new statute by proposing that this full basis adjustment be eliminated for all couples living in any community property state. However, an equally compelling case can be made for extending the full basis adjustment to all spousal jointly held property.

4. Phase-Out of Unified Credit For Large Estates. At present everyone is entitled to transfer $650,000 worth of property tax free. This applicable credit will increase so that by the year 2006, everyone will be able to transfer $1,000,000 of property tax free. The phase-out which the Administration desires would gradually terminate this benefit for estates over $10,000,000.


l. Why Would You Want To Form An Alaska Community Property Trust? There are two types of benefits which an Alaska community property trust would provide. First, community property is a property ownership system which generally provides for equal ownership of property by husband and wife. Usually, there is a sharing in the appreciation and income from the property. Similarly, there is often an equal sharing in the management of the property. Many couples find this equality and sharing arrangement the preferred form of property ownership.

From an income tax standpoint, community property is presently given a significant tax advantage. At the death of the first spouse to die, both spouses' interests in the community property receive a full basis adjustment. As a result, there will be no capital gain payable if the property is sold for its value at the date of the first spouse's death. Further, the increased basis will allow for increased depreciation deductions for business and investment depreciable property. In a separate property state, if the property was jointly owned between husband and wife, only one-half of the property would receive such an adjustment in basis.

Such a full basis adjustment is often very desirable. After one spouse dies, it may be necessary for the surviving spouse to sell certain assets. The family business may need to be sold due to the decedent's lack of participation, or pursuant to an existing buy-sell agreement. Real property may be considered burdensome to manage. Market conditions may dictate the sale of assets before an expected downturn. Assets may need to be sold to replace the decedent's earnings. If a full basis adjustment has been obtained, capital gain taxes will be eliminated or greatly reduced.

The use of an optional community property system to obtain a full basis step-up is a new development in the tax law. We are not sure if the IRS will attempt to challenge it, absent new legislation. Alaska has a strong tax law position. This is probably why the Treasury Department has proposed new legislation eliminating the full basis adjustment. However, we anticipate vigorous opposition from community property states. Also, a more persuasive position is that Congress should extend the full basis adjustment to all spousal jointly held property.

2. Who Should Consider Using A Community Property Trust? Couples who have a stable marriage and are attracted to the equality in shared ownership characteristics of community property. Further, couples who have a significant amount of appreciated property, and desire the income tax advantages discussed above.

3. How Do You Form A Community Property Trust? Many couples have already done significant estate planning. They may each have existing revocable trusts, or sophisticated wills. In this situation, a community property trust can be added to this existing estate planning. Appreciated property which is presently held in their other revocable trusts or by the spouses individually would be transferred into a new community property trust. At the death of the first spouse, when the allowable basis adjustment occurs, then the community property would be divided. One-half would be distributed to the deceased spouse's revocable trust or estate, and the other one-half would be distributed to the surviving spouse's revocable trust or outright to such spouse. If a couple had not yet accomplished estate planning, then a new joint revocable trust could be formed that would hold their community property, the husband's separate property, and the wife's separate property.

Enclosed you will find an article which I wrote along with Steve Greer in the March/April edition of Estate Planning. This article thoroughly discusses the new Alaska community property law and the use of community property trusts.

The Alaska Community Property Act allows nonresidents of Alaska to form Alaska community property trusts. However, such trusts require an Alaska qualified trustee. Such a trustee must be an individual domiciled in Alaska or an Alaska trust company or bank. Other co-trustees may be nonresidents and may include the spouses. The Alaska trustee's powers must include maintaining records for the trust on an exclusive or non-exclusive basis, and preparing and arranging for the preparation of any income tax returns that must be filed by the trust, again on an exclusive or non-exclusive basis.


1. Why Would You Want To Form An Alaska Self-Settled Spendthrift Trust? Prior to 1997, almost every state had a statutory or case law policy which provided that if a person (the settlor) created a trust, and was a discretionary beneficiary of the trust, then that settlor's creditors could reach the assets of the trust. However, in 1997, Alaska changed its law to prevent the settlor's creditors from reaching the assets of such a trust. One consequence of this new law is to allow a person to form a trust and make substantial "completed" gifts to the trust while still being a discretionary beneficiary of the trust. The settlor's applicable credit (which presently protects $650,000 from tax) would be used to offset any tax produced by those gifts. Arguably, all of the property contributed to the trust, and its appreciation, would not be subject to federal estate tax at the settlor's death. While this type of gifting is very attractive from a tax standpoint, in the past many people have hesitated to accomplish such substantial gifting because they were concerned that they might need some or all of the property in the future. That is, if their economic circumstances drastically changed, they would want to have access to such property. Under Alaska's new law, such completed gifts can be made, and if the settlor needs some of the assets in the future, the trustee can distribute them to the settlor.

The IRS has ruled favorably that the transfers to this type of trust will be "completed" gifts. However, the IRS has not yet ruled on whether the assets would be subject to the settlor's estate tax at death. This remains a gray area of the estate tax law.

2. Who Should Consider Using A Self-Settled Spendthrift Trust? This planning technique makes the most sense for clients who fit the following profile: (1) they have a potential estate tax problem that would be partially alleviated by making gifts that use the annual exclusion and applicable credit amount; and (2) they are also concerned that if their economic fortunes drastically change, they may need access to the funds given away. Therefore, we can exclude very wealthy clients who can afford such gift giving without any realistic concerns about needing the assets in the future.

3. How Do You Form An Alaska Self-Settled Spendthrift Trust? An Alaska self-settled spendthrift trust is an irrevocable trust. The settlor transfers assets to the trust, and reports them as completed gifts on a federal gift tax return. The dispositive plan of the trust generally gives an independent trustee the discretionary power to make distributions to a class of beneficiaries, which often include the settlor, the settlor's spouse, and the settlor's descendants. In addition, some settlors desire to use a perpetual trust plan, as described below.

The framers of the new statutory trust provisions considered that persons located outside of Alaska may well be interested in using Alaska's self-settled spendthrift trusts. In order to provide an adequate Alaska nexus for such nonresidents, the legislature required that such trust have an Alaska qualified trustee. The requirements for such a trustee are similar to those discussed above for a community property trust. In addition, with respect to this type of trust, some assets need to be located in Alaska.

Alaska self-settled spendthrift trusts are thoroughly discussed on pages 51 and 55 through 57 of an article which I wrote for the February 1999 edition of Estate Planning. A copy of that article is enclosed.


1. Why Would You Want To Form An Alaska Perpetual Trust? Under our English law heritage, most states have statutes or case law which restrict the duration of a trust. However, in 1997 Alaska joined a handful of other states in eliminating this restriction. Therefore, Alaska trusts may now be perpetual. This characteristic allows a trust to be designed so that assets may be held in trust for several generations. As a result, the trust assets are protected from your descendants' creditors. These creditors can include judgment creditors from a commercial transaction, professional negligence, a personal injury accident, or a divorce. Probate is avoided as assets are transferred from generation to generation. The perpetual trust provides an " estate plan" for your descendants which is already in place. Usually each descendant is given considerable flexibility to modify the trust's dispositive plan. Finally, and for some clients most importantly, future gift, estate, and generation-skipping transfer taxes can be avoided on $2,000,000 of assets transferred by a couple to such a perpetual trust, and the growth of such assets.

2. Who Should Consider Using A Perpetual Trust? Perpetual trusts have become quite popular. Clients who are attracted by the advantages discussed above are using these trusts.

3. How Do You Form A Perpetual Trust? Some clients create perpetual trusts during their lifetime and transfer assets to it immediately, or annually. These transfers may be annual exclusion gifts ($10,000 per year), or part or all of their applicable credit amounts (presently $650,000 per person). Other clients include provisions in their revocable trusts or wills so that the perpetual trust will be created at their death. Then assets are transferred to the perpetual trust at that time. Each client allocates part or all of his or her $1,000,000 generation-skipping tax exemption to the trust.

Nonresidents of Alaska may choose to form an Alaska perpetual trust in order to take advantage of Alaska's law. The Alaska qualified trustee provisions, discussed above with respect to the Alaska community property trusts, are designed to provide a nexus with Alaska for such nonresidents. We thoroughly discussed Alaska perpetual trusts in our August 1998 newsletter. Call us if you need a copy.

We thoroughly discussed Alaska perpetual trusts in our August 1998 newsletter. Call us if you need a copy.

We hope the above summary of the "bottom line" of these new Alaska trusts is helpful to you. The enclosed articles will provide you with substantial information about these trusts and Alaska's new laws. If you have any questions, or desire further information about these or other estate planning matters, please contact us for an appointment. We remain available to assist you and your family.