The Prevention and Cure of Affluenza
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BRIEFING 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 wealth 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 inheritances 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 Silicon Valley 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 Affluenza The term “affluenza” first surfaced in the 1970s to describe the negative impact of affluence on those who PHILANTHROPY 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 United States 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 6 / TRUSTS & ESTATES / trustsandestates.com / MARCH 2019 BRIEFING 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 inflation 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 inheritance 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 philanthropies. 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.