Steve Akers' Heckerling Musings (2011)

Steve Akers

Steve Akers of Bessemer Trust has published his summary of discussions and presentations at the 45th Annual Philip E. Heckerling Institute on Estate Planning held in January 2011. It is hard to imagine anyone more qualified to report on such an event than Steve. The 96-page paper goes beyond a mere summary to include general discussions of the Tax Relief, Unemployment Insurance Authorization, and Job Creation Act of 2010 and its implications on estate planning.

Steve's summary is available here and on Bessemer's website.

Among the many topics covered is the possible clawback tax on gifts made in 2011 and 2012 if the tax-free amount is reduced in later years. Steve also summarizes the planning suggestions of prominent tax practitioners as well as their predictions about what will happen in 2012.

It's time to dust off our old friend, the disclaimer trust

In moderately sized estates and happy family situations, a disclaimer trust is likely to be the right answer to the tax planning dilemma.

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 set the tax-free amount for persons dying in 2011 and 2012 at $5 million. The 2010 act also introduced "portability" -- if the proper procedures are followed, the surviving spouse may use the unused tax-free amount of the first spouse to die.  The 2010 act leaves us hanging, however, since the tax-free amount drops to $1 million and portability goes away in 2013 unless Congress extends the new law.

In this environment, what sort of estate tax planning makes sense for married couples with moderate wealth?

Problems with portability

At first glance, there seems to be no reason for most couples to do bypass trust planning because of portability.  If the surviving spouse gets to use the unused portion of the tax-free amount of the first to die, then why go to the trouble and expense of having a bypass trust?  (For an explanation of basic bypass trust planning, download this paper by Glenn Karisch from texasprobate.com.)

When looking deeper, the problems with portability become apparent:

• Most significantly, portability ends in 2013 unless Congress extends it.

• In order to use portability, the executor of the estate of the first spouse to die must file an estate tax return to establish the amount of the unused tax-free amount.  It will be expensive to prepare and file this return, and the return is unnecessary except for portability.

• Remarriage could jeopardize the use of the portability amount.  A decedent may use the unused tax-free amount of his or her most-recently-deceased spouse.  If Wife 1 dies with unused tax-free amount, then Husband marries Wife 2, who then dies, the portability amount of Wife 1 is lost.

• Portability does not shelter the appreciation of property from tax.  If property appreciates between the deaths of the spouses, that appreciation is taxed in the estate of the surviving spouse, while it could be sheltered from tax in a bypass trust. 

Problems with formula-funded bypass trusts

Using a bypass trust funded by a formula intended to maximize the property placed in the trust avoids most of the problems caused by portability, but it creates other problems:

• The formula provisions are tricky to draft when there are fundamental changes in the estate tax laws.  A poorly drafted provision may put too much or too little in the trust.  Even a well-drafted provision may have an unintended result.

• Couples with estates in the $1 million to $5 million range may face bigger problems with the capital gains tax than the estate tax.  Property placed in the bypass trust at the death of the first spouse does not get a step-up in basis when the surviving spouse dies.  If it turns out that the bypass trust wasn't needed for estate tax savings, the family will pay more capital gains tax than otherwise might have been necessary.

• Formula-funded bypass trusts must be funded.  There's no way to avoid creation of the trust if, at the time of the death of the first spouse, the trust seems unnecessary or ill-advised. 

Enter the disclaimer trust

A bypass trust funded by disclaimer may fill the bill for many married couples. Here's how disclaimer trusts work:

• Each spouse's will leaves all property to the surviving spouse.

• Each spouse's will provides that, if the surviving spouse disclaims any property, the disclaimed property will pass into a bypass trust.

A special rule that applies only to spouses permits the spouse to disclaim property into a trust of which the spouse is a beneficiary.  Internal Revenue Code Section 2518(b)(4)(A).  Therefore, the spouse may be a beneficiary of the trust.  If the trustee's power to make distributions is limited by an ascertainable standard like "health, education, maintenance and support," then the surviving spouse may be the trustee of the trust.  If the beneficiary designations on life insurance and retirement plans are coordinated properly, the surviving spouse may disclaim some or all of these assets, causing them to go into the bypass trust.

The disclaimer trust permits deferring the decision about whether or not to have a bypass trust until after the death of the first spouse to die.  With the volatility of the law and the economy, this might be the best time to decide whether or not estate tax planning is needed.  Also, a couple may appear to have no estate tax worries now, but increases in wealth may push them into needing a trust.  The disclaimer trust makes an excellent back-up estate tax plan.

Disclaimer trusts have problems, too

Disclaimer trusts have their own set of problems and are only appropriate in certain situations.  Here are some of the problems which may arise:

• A disclaimer cannot be made if the persons wishing to disclaim has accepted the interest or any of its benefits.  Internal Revenue Code Section 1518(b)(3).  If the spouse mistakenly takes control of an asset -- switches a brokerage account into his name, cashes in a life insurance policy, etc. -- that asset cannot be placed in the trust.

• The disclaimer must be made in the proper form within 9 months of the decedent's death.  Internal Revenue Code Section 2518(b)(2).  A spouse who is asleep at the switch may miss the opportunity to fund the bypass trust.  (There's a special extension of the 9-month disclaimer deadline for persons who died between January 1, 2010, and December 17, 2010.  See the 2010 tax law for details.)

• A disclaimer-funded bypass trust only works if the surviving spouse disclaims. A grieving spouse may be unwilling or unable to make a timely disclaimer.  If the remainder beneficiaries of the bypass trust are the surviving spouse's stepchildren, the surviving spouse may decide not to disclaim (and, in fact, is very, very unlikely to decide to disclaim) because he or she does not wish to be exposed to accounting demands and other actions of the stepchildren.

• In a formula-funded bypass trust, the surviving spouse may be given a special power of appointment so that he or she may control the disposition of the trust property at death.  The surviving spouse may not be given a power of appointment over a disclaimer-funded bypass trust. This means that the disposition is locked in at the time of the first spouse's death.  This creates two problems:

  • The surviving spouse cannot tweak the plan.  For example, the surviving spouse cannot direct the bypass trust property into a GST trust.

  • The surviving spouse cannot appoint the property away from an interfering remainder beneficiary.  The power of appointment can be an effective tool for dealing with uncooperative remainder beneficiaries, but it is unavailable with disclaimer trusts.

  • A disclaimer is ineffective for Medicaid planning purposes.  The surviving spouse may not exclude assets from consideration for Medicaid eligibility by disclaiming them into a bypass trust.

Keep all of your tools sharpened

In times of changing tax laws and a fluctuating economy, estate planners must be ready to use different techniques.  There are fewer "once size fits all" plans these days.  A disclaimer trust can be an effective tool for many married couples, but in most cases only if they have no children by prior marriages.