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roll over individual retirement account received eral tax, and over 60 percent of Americans live in states through estate—In PLR 201901005 (Feb. 4. 2019), the that impose no estate transfer taxes. taxpayer sought IRS confirmation of a transaction involv- The preservation of a stepped-up basis at death ing her husband’s IRA. The taxpayer survived her hus- under the Tax Cuts and Jobs Act of 2017 (the Act) band, and his IRA was payable to his revocable trust. No further assures that more of the will never be contingent beneficiary was named. Within nine months subject to a levy on capital gains when realized by heirs. of his death, the trustee of the trust executed a quali- Increased estate tax exemptions, if continued over fied disclaimer. Under state law, the trustee’s disclaimer time, will ensure that the concentration of wealth caused the IRA to be payable to the estate and therefore intensifies and gives rise to a new class of wealthy young subject to the deceased spouse’s will. Furthermore, the heirs. The fact that many Baby Boomers married and spouse’s son and two grandchildren also disclaimed any had children later in life than previous generations also interest they may have had in the IRA through the estate means that individuals who in the past inherited sub- within the required time period. Under applicable state stantial wealth in their 40s and 50s may now be passing law, due to the disclaimers by the other family members, that wealth to their children who are in the 25-to-40 the taxpayer was entitled to the entire IRA as a beneficia- age range when they receive their and less ry of the deceased spouse’s estate. prepared to manage their new-found wealth. The taxpayer wished to distribute the IRA to herself, Even before they inherit from their parents or as the sole beneficiary, and roll over the distribution to grandparents, however, an increasing number of young her own IRA. people are growing up in the midst of the wealth creat- The IRS confirmed that the spouse could do so. It ed or inherited by their parents, especially in an econ- held that under the applicable rules of Internal Revenue omy in which much of the new wealth is being created Code Section 408, the taxpayer would be treated as hav- in the high tech industry spawned by relatively young ing acquired the IRA directly from her spouse, and she entrepreneurs in and other centers of was eligible to roll it over to her own IRA within 60 days technological innovation. of the distribution without including the distribution in her own gross income. The Rise of The term “affluenza” first surfaced in the 1970s to describe the negative impact of affluence on those who aren’t adequately prepared to shoulder the responsibil- ities of wealth. In recent years, the term has been more frequently associated with the debilitating effects of The Prevention and wealth on younger people and even successfully put forth as a defense against serious criminal charges.2 Cure of Affluenza One of the greatest challenges facing those who amass significant wealth after rising from humble By Robert F. Sharpe, Jr., chairman of the beginnings is the desire to give their children the bene- Sharpe Group in Memphis, Tenn. fits that can derive from that wealth without depriving them of the satisfaction of realizing their personal Much has been written about the growing concentra- potential. As Warren Buffett famously put it, “You tion of wealth in the and much of the rest should leave your children enough so they can do any- of the world. Comparisons to the pre-Depression years thing, but not enough so they can do nothing.”3 of the roaring 20s and England before World War I are But fortunately, the ill effects of affluenza can be increasingly common.1 prevented or in some cases even cured by the integra- Not only have the wealthy become wealthier in recent tion of philanthropic training with effective estate and years, but also more of the wealth in the United States will financial planning. pass over time free of tax at the federal level and under most states’ laws. With a minimal amount of planning, a Giving Heirs a Start in Life wealthy couple can now transfer $22.8 million free of fed- One of the earliest experiences in my career was the

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work I did for a wealthy individual who came from a free of capital gains tax inside the trust and reinvests the family noted for its multi-generational wealth creation proceeds in a more balanced portfolio. and the philanthropy it had made possible. This indi- The trust will make fixed payments to a 35-year-old vidual didn’t suffer from affluenza and was a pillar of his child of the donor of $125,000 per year for a period of city’s philanthropic community. 15 years. The parent in this case would be entitled to He’d inherited $1 million from his grandparents in an immediate charitable income tax deduction of $1.05 1953 and had parlayed that sum into $100 million by million. There would be a taxable gift of approximately the early 1980s. Today, that $1 million has grown to an $1.45 million, which could be offset by a portion of estimated $500 million or more. the parent’s $11.4 million lifetime gift and estate tax His estate plan was very simple. He decided to leave exemption. each of his two children $1 million, adjusted for As an added benefit, much of the income will be from 1953 to the time of his death. In 2019, that would taxed when received by the child at favorable capital amount to $9.5 million or a total of $19 million gains rates under the tier structure of income reporting to his children. The remainder of his estate was bequeathed for CRTs. to a number of philanthropic interests including a family The child is told that she’s receiving her inheritance foundation that would be administered by his children and in the form of income totaling $1.875 million payable a number of other individuals he named. over 15 years, and she’s free to spend or invest those His thinking was that he’d been given a significant, funds in any way she sees fit. If she invests half the though limited, amount of capital in relation to his income, she’ll have a tidy nest egg at age 50 when the grandparents’ wealth to begin his business career. He income ends. Alternatively, she could use the funds for believed his children should start at the same place various purposes, including to help meet educational he did. What they did with their inheritance was their expenses for her teenage children, fund the start of a own choice, but they were made aware early in life that business or retire a mortgage over 15 years. regardless of the extent of his wealth, there was a limit At the termination of the trust, its remaining assets on the amount they could expect to receive. will be distributed to a donor-advised fund (DAF) cre- In past years, it might have required that $38 mil- ated by the parent with the child as the advisor. lion or more be left to his children pre-tax with the The child is told that the remainder of the parent’s remaining funds transferred to the . In estate will be left to charities of the parent’s choice, and the wake of the Act, the $19 million wouldn’t exceed she’ll receive nothing further from the estate regardless the threshold of the amount a couple can leave free of of the wealth of her parent at death. federal tax and, as a result, more would be available for The parent’s desire is that the child will use the funds philanthropy than before. received from the CRAT wisely and will appreciate the privilege to make a difference in society through grants Providing Initial Capital Flow from the DAF in her later years. In other cases, a parent, grandparent or other relative might wish to have his children or other heirs receive Giving a Child a Finish an inheritance while he’s still living—albeit a limited In other cases, a parent or grandparent may wish to amount. Further, rather than giving a lump sum to fund an heir’s education and/or invest in an initial busi- heirs, the inheritance would be staged over time. ness venture but thereafter provide no inheritance for This can be accomplished in a number of ways. One some period of time. of the most tax-effective ways is through the use of a Suppose an 80-year-old self-made multi-millionaire term-of-years charitable remainder trust (CRT). grandparent worth in excess of $50 million would like For example, a 70-year-old parent might create a to eventually leave $5 million to a grandson who’s cur- charitable remainder annuity trust (CRAT) that makes rently 25 years old. The grandparent doesn’t want the annual payments of 5 percent of the amount initial- grandson to inherit the $5 million until he’s 55 years old, ly used to fund the trust. The trust is funded with some 30 years in the future. The grandparent is aware low-yielding securities valued at $2.5 million with a cost that his life expectancy is approximately nine years. The basis of $1 million. The trustee liquidates the securities odds are that he won’t live until age 110, and he’d like to

7 / TRUSTS & ESTATES / trustsandestates.com / MARCH 2019 BRIEFING delay the grandson’s inheritance until age 55, regardless Another way for older parents of means to encourage of how long he should live. their children to work an entire career before receiving To effectuate his desires, he creates a $5 million char- an inheritance is to provide for a charitable gift annuity itable lead annuity trust (CLAT) that will make fixed (CGA) that begins making payments at around retire- payments of 5.25 percent or $262,500 each year to qual- ment age, perhaps age 65. ified charitable interests for 30 years. This would fund Take the case of this married couple: The husband charitable gifts of $7.875 million. Half of the charitable leaves $4 million in a qualified terminable interest distribution each year would go to charitable recipients property (QTIP) trust that provides for a surviving named by the grandparent, and the remainder would be spouse. At the widow’s death, the trust provides that directed to a DAF for which the grandson could advise the remainder of the trust be used to fund a CGA for distributions. each of four children that will begin to make payments The grandparent is deemed to have made a taxable gift to them at age 65 or immediately if they’re beyond the of $5 million to the grandchild in the year the trust is fund- age of 65 at their mother’s death. ed. It’s offset by a charitable gift tax deduction of $5 million While there will be no estate tax savings for this resulting in no tax, because the present value of the $7.875 couple due to increased exemptions, the funds left in million in charitable gifts offsets the gift amount. the form of the CGAs will continue to grow tax free in The grandson is informed of this plan and told the annuity reserve funds of the charity for the period that he’ll be able to make charitable gifts of up to of time between the age of the children at the mother’s $131,250 each year, but he won’t otherwise inherit death and age 65. In addition, a large portion of the anything from his grandparent until he’s age 55. In the payments are received by the children free of tax as a meantime, he’s to make the most of the education his return of the investment in the contract for the period grandparent provided him and “learn to fish before his of time equal to their life expectancy when payments pond is stocked.” begin. This same plan could be very useful for young wealth If one or more of the children predecease their creators. I’ve seen trusts such as the one described above mother, the remainder of the QTIP trust will be used to established by a 35-year-old beneficiary of a public fund larger annuities for the surviving children. offering of a high tech enterprise who created such a trust for a 10-year-old child to benefit at age 40 after Putting It All Together helping to distribute the funds originating from a lead These are just a few of the myriad of ways that phil- trust during high school, college and young adulthood anthropic planning can be combined with other estate before receiving a tax-free inheritance. and financial plans to preserve wealth and transfer it Some believe that philanthropy is an innate trait in to heirs in ways that encourage the development of certain individuals while others believe it’s learned and personal habits that may result in the prevention and/ can be inculcated in behavior by creating conditions or cure of affluenza. that require the activity. As the pioneering 19th centu- I’ve worked with more than one wealth creator ry American psychologist William James, the brother who had no desire to leave wealth to heirs who might of novelist Henry James, famously observed, “Do we become idle rich and make no contribution to society. run because we are afraid or are we afraid because we On the other hand, they didn’t want to completely dis- run?”4 inherit their heirs and wanted to provide inheritances One might also ask, “Do we give because we are to their families in ways that may make their lives easier philanthropic, or are we philanthropic because we give?” but not effortless. Some believe the latter and some the former. Many of Fortunately, planners have tools at their disposal to the worlds enduring fortunes from the Medicis to the creatively address the conflict wealthy individuals may Rothschilds to the Rockefellers have been based at least feel between the desire to give their heirs the oppor- to some extent on the premise that early training in phil- tunities to effect positive change with the wealth they anthropic activities are the basis of responsible manage- inherit and the desire to avoid the ill effects of affluenza. ment and stewardship of capital over generations. Helping clients discover and implement the plans that best meet their desire to combine their love for Better Late Than Never their heirs with the desire to help them be responsible

8 / TRUSTS & ESTATES / trustsandestates.com / MARCH 2019 BRIEFING while contributing to the betterment of society can be case of estates and trusts,3 starting at taxable income one of the most rewarding aspects of estate and finan- above $12,750.4 The 20 percent rate applies, in the cial planning. case of single individuals, starting at taxable income above $434,550 and, in the case of a married couple Endnotes filing jointly, starting at taxable income above $488,850 1. Andrew Keshner, “America’s 1% hasn’t had this much wealth since just before but, in the case of estates and trusts, starting at tax- the Great Depression,” MarketWatch (Feb. 13, 2019), www.marketwatch.com/ able income above $12,750.5 On top of all that is the story/its-been-almost-a-100-years-since-the-americas-1-had-so-much- 3.8 percent Medicare surtax on “net investment income,” wealth-2019-02-11. which applies, in the case of single individuals, starting 2. www.nytimes.com/2016/04/14/us/teenager-who-used-affluenza-defense- at adjusted gross income (AGI) above $200,000 and, is-sentenced-to-jail.html. in the case of a married couple, starting at AGI above 3. www.forbes.com/sites/angelauyeung/2018/06/01/warren-buffetts-advice- $250,000 but, in the case of estates and trusts, starting at on-how-to-raise-well-adjusted-heirs/#787a4838712f. taxable income above $12,750.6 State income tax, if any, 4. www.theatlantic.com/entertainment/archive/2010/08/do-we-run-from- must be considered as well. fear-or-does-running-make-us-afraid/344365/. Distribution Powers The governing instrument of a trust can confer an TIPS FROM THE PROS almost infinite variety of distribution powers on a trustee as to income and/or principal. Sometimes, trust provisions mandate distributions of income and confer Making Trust discretion on the trustee regarding distributions of principal. In some cases, the trustee has discretion as to Distributions to disposition of both income and principal. Discretionary distribution powers are sometimes limited by an ascer- Reduce Overall tainable standard relating to health, education, main- tenance and support of one or more beneficiaries. In Income Taxes other situations, discretionary distribution powers are very broad—almost open-ended—as in cases in which By Charles A. Redd, a partner at Stinson discretion is stated as “sole and absolute.” Leonard Street LLP in St. Louis and a fellow Given the current framework of income taxation of of The American College of Trust and Estate individuals and trusts, if given the authority to do so, a Counsel trustee may desire to make discretionary distributions so as to carry out as much of the trust’s distributable In the aftermath of the American Taxpayer Relief Act of net income (DNI) to trust beneficiaries as possible.7 2012 (ATRA)1 and the Tax Cuts and Jobs Act (TCJA),2 Trustees shouldn’t, however, overlook the potential the focus for many estate planners and their clients is impact of the “kiddie tax” (that is, a tax applied on more on income tax planning than transfer tax planning. a portion of a child’s unearned income), which may ATRA and TCJA have yielded, among other things, apply in the case of trust distributions to certain young historically high basic exclusion amounts (currently beneficiaries.8 When the kiddie tax would be imposed, $11.4 million), indexed for inflation, portability, a rela- shifting a trust’s taxable income to children would be no tively low estate, gift and generation-skipping transfer more beneficial, from an income tax perspective, than tax rate (40 percent), a relatively high top marginal retaining that income in the trust and subjecting such income tax rate on ordinary income (37 percent) and an income to the same compressed income tax brackets increased (from 15 percent) top tax rate on capital gains applicable to trusts that would apply to the children’s and qualified dividends (20 percent). unearned income.9 The 37 percent rate applies, in the case of single individuals, starting at taxable income above $510,300 Important Principles and, in the case of a married couple filing jointly, In considering strategies geared towards minimizing the starting at taxable income above $612,350 but, in the aggregate income taxes of a trust and its beneficiaries, a

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