INTRODUCTION
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.
I.
TREASURY DEPARTMENT BUDGET PROPOSALS RELATING TO ESTATE
PLANNING
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.
II.
ALASKA COMMUNITY PROPERTY TRUSTS
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.
III.
ALASKA SELF-SETTLED SPENDTHRIFT TRUSTS
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.
IV.
ALASKA PERPETUAL TRUSTS
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. |