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September/October 2014 P L A N N I N G T H O U G H T S

Celebrity estate plans Crummey powers and the trustee’s discretionary right to distribute income and principal to the children. Upon News of the death of a celebrity is soon followed, Williams’ death, separate trusts would be created for in some cases, by news of the person’s estate plan. each child, equal in value to the trust for Zachary, with Sometimes there is commentary on the defects of the any balance divided among the three trusts equally plan. Here are two recent examples. Principal distributions are mandated at ages 21, 25 and 30, and each child has a testamentary power Robin Williams of appointment. As of this writing, the details of Robin Williams’ Usually, an insurance trust is a grantor trust. That estate are rather sketchy. Some commentators have means that the grantor will be taxed on the trust’s speculated that he may have used a revocable trust as income and gains, which effectively means that the his primary estate planning vehicle, which means that grantor is shifting wealth out of his or her estate free information may always be scarce. We do know that of transfer taxes. Williams’ 2009 insurance trust was Williams created three trusts during his lifetime. From drafted carefully so as to avoid grantor trust status, public records, two valuable pieces of real estate were insulating Williams from personal liability for the owned by the Domus Dulcis Domus Trust (Latin for trust’s tax obligations. The trustees are prohibited “home, sweet home”). from paying insurance premiums with trust income, Williams also established two irrevocable life insur- and the trust stipulates that no family member or per- ance trusts, one in 1990 and another in 2009, for the son subordinate to Williams could be a trustee. benefit of his children. Normally, the details of life insurance trusts do not become public, but Williams named individuals as trustees, rather than a corporate Philip Seymour Hoffman fiduciary. When one of the cotrustees died, court pro- Actor Philip Seymour Hoffman, who died of an ceedings were necessary to determine successor trust- apparent drug overdose in February at age 46, last eeship. That’s when the details became a matter of attended to his estate plans on October 7, 2004. The public record. estate tax laws have changed dramatically since then, The 1990 insurance trust includes Crummey pow- as did Hoffman’s personal circumstances. At that time ers of withdrawal, which lapse 30 days after notice of he had one son with his partner, Marianne O’Donnell, a contribution to the trust. The trustees are to pay to but they later had two daughters. Williams’ oldest son, Zachary, and his issue amounts Hoffman’s will left all of his property to O’Donnell. Trust Department sufficient to provide for their support, education and His estate has been estimated to be worth roughly Security Federal’s Trust Department is committed to providing our clients with services that are personalized and responsive. medical care. The trustees also have a discretionary $35 million, and the federal estate tax is imposed at If we can be of assistance to you or your clients, please call our tenured and experienced trust professionals. power to distribute income and principal to the ben- 40% of everything above a $5.34 million exemption. eficiaries. Upon reaching age 25, Zachary received all Because the couple never married, the marital deduc- JON-MYCKLE PRICE SUZANNE CHILCOTT BARBARA ROADS of the trust income. Zachary had a special testamentary tion is not available to defer estate taxes until both TrusT ADMINIsTrATOr seNIOr VIce PresIDeNT ADMINIsTrATIVe AssIsTANT power of appointment until age 30, when it converted spouses have died. Therefore, O’Donnell could be [email protected] TrusT OPerATIONs [email protected] to a special power exercisable during life. looking at a $12 million federal estate tax bill. New [email protected] The 2009 insurance trust for daughter Zelda and York State also imposes an estate tax at 16% on assets son Cody was similar, including the provision of above $1 million, but that tax payment is deductible 574-722-6261 • 314 Fourth Street, Logansport, IN 46947-0420

when calculating the federal tax. The combined death claimer by. O’Donnell, the most likely result is that taxes could come to $15 million, according to some the three children would have shared any disclaimed press reports. property equally. The will invites O’Donnell to disclaim all or part of It is possible that Hoffman made other arrange- her inheritance. To the extent that she does so, the ments in trust for the daughters, or his will might property passes to a trust for their son, who was one have been supplemented by a living trust. It’s also year old when the will was executed. That trust will pay possible that he had life insurance, retirement its principal to the son when he reaches age 25, the accounts, or other property that won’t pass through balance when he is 30. Unfortunately, the trust makes probate. These would not have to be made pub- no provision for after-born children, so the daughters lic, as a will must be. So it is entirely possible that would appear to be disinherited. Ironically, if the will Hoffman’s estate plan is not as inadequate as early had been silent on what would happen upon a dis- press reports made it out to be.

C A S E S A N D R U L I N G S

Executor held liable for unpaid estate taxes. who was not a representative of the estate. Final judg- ment was entered for the IRS.

U.S. v Whisenhunt et al., USDC Texas, • • • No. 3:12-cv-00614 Dr. Jacob Lindy Kay died in August 2002. An exten- All beneficiaries liable for unpaid sion was granted for filing an estate tax return, but estate taxes. the return was not filed until July 2007, very tardy. The return was accompanied by the payment of $318,516.68 in estate taxes. The IRS accepted the U.S. v. Cheryl Cowles-Reed, et al., return as filed. However, in September 2007 the USDC Calif., No. 2:11-cv-06084 Service assessed two penalties, $85,616 for the late fil- Andrew Cowles died in April 2000. He had owned ing of the return and $95,129 for the late payment of three blocks of Proctor and Gamble stock jointly the tax. with each of his three children. Daughter Cheryl was In January 2008 the IRS examined the return and nominated in Andrew’s will to be his executor, but sent a notice to the estate that there would be no addi- apparently no probate proceedings were needed. tional estate liabilities. However, the penalties were Cheryl arranged for the filing of an estate tax return, not yet paid. In April 2008 the estate’s beneficiaries which reported the total value of the stock to be just executed an agreement. Some $95,000 was placed in over $1.7 million, generating an estate tax liability of escrow against future claims by the IRS, and the bal- $347,653. Cheryl sent somewhat more than her share, ance of the estate was distributed to the beneficiaries. $126,198, with the estate tax return. Unfortunately, Despite the IRS notices of a balance due in October 2008 and October 2009, the funds remained in escrow her brothers never sent in their portions. until the escrow agent filed an interpleader action. The IRS filed its notice of intent to levy in January The funds were transferred to the IRS in 2011 in par- 2004. All three children were targets, as transferees of tial satisfaction of the tax penalties. the estate. In July 2011 the IRS filed its action in the The IRS proceeded to file an action against the District Court to recover estate taxes, penalties and executor, Whisenhunt, and the estate’s beneficiaries interest, which by then had grown to $473,992.44. in January 2012. By that time interest on the unpaid The District Court granted summary judgment for penalties had brought the debt to $178,406. The the IRS, as there was no question that the P&G stock executor did not respond, and a default judgment was was taxable, and the tax was due. Unfortunately for entered against him. All but one of the beneficiaries Cheryl, she gets no credit from the IRS for paying her were dismissed from the action. The remaining ben- share. Her personal liability is capped only by the value eficiary, the one who had received the largest share of of the stock that she received. It may not seem fair that the estate, protested that there may have been a legiti- she has to pay the penalties and interest caused by her mate reason for the late tax filing, and that question brothers’ failures, but that is how the law is written. had never been adjudicated. Unfortunately, that argu- The Court did not entertain claims from the benefi- ment was one that the executor should have raised ciaries for administrative expenses or that the lateness years earlier. It was not available to the beneficiary, should be excused because it was for reasonable cause

© 2014 M.A. Co. All rights reserved. and not willful neglect. Those are arguments for the an irrevocable family trust. Sam had an income interest estate and its representatives to make. They are not and general power of appointment over the survivor’s available to the beneficiaries. trust, and a limited power of appointment and a “five One beneficiary, Michael Cowles, appealed, but the and five” power of withdrawal over the family trust. Seventh Circuit Court of Appeals affirmed the District After Janet died, Sam was given the wrong advice Court’s judgment in a two-paragraph decision that was by his lawyer when he was told, “The ‘survivor’s trust’ not for publication. will not be funded from the family trust; 100% of the trust assets remain as the family trust and are not split.” • • • Some years later, Sam hired a new estate planner, who spotted the bad advice. Corrective measures were Retroactive segregation of trust assets taken to segregate the assets into two trusts, including a forensic review of the financial records. All principal salvages estate exclusion. distributions made to Sam came from the survivor’s trust. None were from the family trust. Private Letter Ruling 201429009 Now Sam has died. The IRS holds that the correc- Sam and Janet had a revocable trust, in which they tive measure was successful. Except to the extent of the placed their jointly owned assets. At Janet’s death, the “five and five” power, the value of the family trust assets trust split into two trusts, a revocable survivor’s trust and will be excluded from his estate.

W A S H I N G T O N T A L K

Nearly everyone in Washington, D.C., agrees that Now that the $5 million federal estate tax there are major problems with the corporate income exemption (plus inflation adjustments) is perma- tax. The U.S. taxes foreign corporations more favorably nent, transfer taxes are taking a back seat in estate than it does domestic ones. Nearly alone among devel- planning. Planning for income taxes is much more oped countries, the U.S. taxes U.S.-based firms on their important to 99% of the population. Dennis Leonard global income, while most other countries have moved and Jason Schingler of the State Bar of California have to a territorial system. What’s more, the U.S now boasts asked the IRS to clarify some issues that have arisen the world’s highest corporate tax rate, even as other since the rewrite of the estate tax in 2012. countries have been cutting top marginal rates on busi- For example, Rev. Proc. 2001-38 was issued to provide nesses to boost their economies. relief when a QTIP election was made that shouldn’t The first sign of trouble was that multinationals have been made. It provides that a QTIP election will began to keep their foreign profits outside of the U.S. be ignored by the IRS if the estate tax would have been in order to avoid the tax hit that comes with repatria- zero without it. If the election is nullified, the QTIP tion. This year has seen a spate of “inversions” by large property won’t be included in the surviving spouse’s companies to work around the law. A U.S. company estate, which is what the taxpayer typically wanted when merges with a foreign company, and then it moves its the exemption was lower. But what if a spouse wants headquarters to the foreign country so as to be granted the estate inclusion in order to secure a basis step-up at the more favorable tax treatment accorded to foreign death? For many couples, the tax-free basis step-up will corporations. Such a move is perfectly legal if the stric- tures of the tax code are followed carefully. have real tax benefits, and the estate exclusion may be The most recent example is Burger King’s acquisi- pointless. Would Rev. Proc. 2001-38 undo such a plan? tion of Tim Hortons of Canada, with financing provid- Leonard and Schingler are also concerned that ed by Warren Buffett. Ironically, one side benefit of an using a bypass trust may lead to suboptimal income inversion is that it frees up more capital for investment tax results. To remedy this possibility, they propose in the U.S., which should promote economic growth. giving the surviving spouse a formula general power Although everyone agrees that there is a problem, of appointment over a portion of the bypass trust. The there are sharp differences over possible solutions. The Temporary Regulations on the portability of the estate Obama administration accused companies that have or tax exemption for married couples expire on June are considering an inversion of a lack of patriotism, and 15, 2015. The lawyers urge the IRS to clarify these two Democrats have proposed adding tax penalties to make areas when the Final Regulations are promulgated. inversions more onerous. Republicans favor tax reforms Death tax repeal efforts continue. With an exemp- to align the U.S. corporate tax system more closely with tion from the federal estate tax now at $5.34 million, those of the rest of the world. No resolution is expected and growing with inflation adjustments, this “death this year. tax” is expected to affect only about 2,000 estates each Courtesy of year. Nevertheless, the Family Business Council has tions were published on January 17, 2014. not given up on efforts to repeal it, entirely and per- 3. Revenue Procedure under § 2010(c) regarding the manently. In a July letter to Congressional leaders, the validity of a QTIP election on an estate tax return filed Council argued that: only to elect portability. • Repealing the death tax would spur job creation. • The death tax contributes a very small portion of 4. Final regulations under §§ 2010 and 2505 regarding federal revenues. portability of the deceased spousal unused exclusion. Proposed and temporary regulations were published • The death tax falls particularly hard on minorities. on June 18, 2012. • A super-majority of likely voters supports eliminat- 5. Final regulations under § 2032(a) regarding impo- ing the death tax. sition of restrictions on estate assets during the six • The death tax is unfair. month alternate valuation period. Proposed regula- The Council claims that: “Poll after poll has indicat- tions were published on November 18, 2011. ed that a super-majority of likely voters support repeal- 6. Guidance under § 2053 regarding personal guaran- ing the death tax. Typically, two thirds of likely voters tees and the application of present value concepts in support full and permanent repeal of the death tax. determining the deductible amount of expenses and People instinctively feel that the death tax is not fair.” claims against the estate. The letter, cosigned by heads of 38 different organiza- tions, concludes by encouraging support for H.R. 2429 7. Regulations under § 2642 regarding available GST to repeal the estate tax. exemption and the allocation of GST exemption to a Federal estate tax repeal could come to a vote pour-over trust at the end of an ETIP. in the House in the fall. House Ways and Means 8. Final regulations under § 2642(g) regarding exten- Committee Chair Dave Camp (R-Mich.) said that it’s sions of time to make allocations of the generation- been seven or eight years since the last vote on estate skipping transfer tax exemption. Proposed regulations tax repeal, and the House has many new members were published on April 17, 2008. now. Republicans would likely be happy to go on the record in favor of repeal before the midterm elections, 9. Regulations under § 2704 regarding restrictions on and 42 Democrats are known to favor eliminating the the liquidation of an interest in certain corporations estate tax as well. What’s more, noted one lobbyist, a and partnerships. vote for repeal by a Democrat puts daylight between 10. Guidance under § 2801 regarding the tax imposed that Representative and President Obama. on U.S. citizens and residents who receive gifts or bequests from certain expatriates. The IRS reset its priority plan on June 30, and it released the information to the public in late August. An investigation into the IRS’ targeting of conser- In the estate and gift area, the Service’s focus will vative groups was not listed among the priorities for be here: the coming year. The Wall Street Journal reports that the free meals provided to their employees by many 1. Amendment to extend the effective date of final reg- of the tech firms in Silicon Valley have hit the IRS ulations under § 67 regarding miscellaneous itemized radar. Meals furnished for the convenience of the deductions of a trust or estate. Final regulations were employer are not taxable income to the employee, but published on May 9, 2014. the Service has been requesting documentation on the 2. Final regulations under § 1014 regarding uniform costs of the free food with an eye toward applying a basis of charitable remainder trusts. Proposed regula- 30% tax on it.

Trust Department Security Federal’s Trust Department is committed to providing our clients with services that are personalized and responsive. If we can be of assistance to you or your clients, please call our tenured and experienced trust professionals. JON-MYCKLE PRICE SUZANNE CHILCOTT BARBARA ROADS TrusT ADMINIsTrATOr seNIOr VIce PresIDeNT ADMINIsTrATIVe AssIsTANT [email protected] TrusT OPerATIONs [email protected] [email protected]

574-722-6261 • 314 Fourth Street, Logansport, IN 46947-0420