Eight Steps to a Proper Florida Trust and Estate

EIGHT STEPS TO A PROPER FLORIDA TRUST AND ESTATE

PLAN

Explaining Wills, Trusts, Tax, and Creditor Protection in a Logical, Easy-to-Understand Order for Estate Planning Professionals and Their Clients Alan S. Gassman, J.D., LL.M.

ISBN 13: 978-1502906854

DISCLAIMER OF WARRANTY AND LIMIT OF LIABILITY

The author and publisher make no representations or warranties with respect to the accuracy of the contents of this work and do hereby specifically and expressly disclaim all warranties, including without limitation, warranties of title, merchantability, fitness for a particular purpose and non-infringement. No warranty may be created or extended by sales or promotional material associated with this work.

i Any advice, strategies, and ideas contained herein may not be suitable for particular situations. This work is sold with the understanding that the publisher is not engaging in or rendering medical or legal advice or other professional services. If professional assistance is required, the services of a competent professional person should be sought.

Although the author and publisher have made every effort to ensure that the information in this book was correct at press time, the author and publisher do not assume and hereby disclaim any responsibility or liability whatsoever to the fullest extent allowed by law to any party for any and all direct, indirect, incidental, special, or consequential damages, or lost profits that result, either directly, or indirectly, from the use and application of any of the contents of this book. The purchaser or reader of this book alone assumes the risk for anything learned from this book.

This book is not intended as a substitute for legal advice and should not be used in such manner. Furthermore, the use of this book does not establish an attorney-client relationship.

The information provided in this book is designed for educational and informational purposes only and is not intended to serve as legal or medical advice.

References are provided for informational purposes only and do not constitute or imply endorsement, sponsorship, or recommendation of any websites or other sources. Readers should be aware that the websites listed in this book may change.

The views expressed herein are solely those of the author and do not reflect the opinions of any other person or entity.

TABLE OF CONTENTS Introduction ...... 7 How to Use This Book ...... 7 A Note on Specialist Lawyers ...... 8 Chapter 1 - Pulling Your Information Together ...... 11 Sample Planning Schematic ...... 12 Confidential Estate Planning Information Form ...... 14 Agenda for Conference with Attorney ...... 29 Follow-Up Questionnaire for Client Meetings ...... 31 Chapter 2 - Make Sure You Have Adequate Life Insurance ...... 33 Physical Examination Requirements ...... 35

ii Term Life Insurance ...... 35 Permanent Life Insurance Policies ...... 36 Using Life Insurance as an Assured Inheritance Funding Vehicle ...... 37 Annuity Contracts ...... 37 Term Life Insurance Information and Sample Rates ...... 38 Chapter 3 - Title Your Assets Properly and Do Not Forget Beneficiary Designations ...... 41 Beneficiary Designations ...... 43 Chapter 4 - Include Creditor Protection Planning ...... 47 Liability Insurance Considerations ...... 53 Understanding Your Liability Insurance Coverage Chart...... 56 Corporate Firewall Protection, Using Corporations and Other Entities to Provide Liability Protection ...... 60 The Manager or Officers May Still be Sued ...... 61 Vehicle Liability ...... 61 Using LLCs and Other Entities to Avoid Liability and for Business Structuring ...... 62 A Florida Physician’s Guide to Protection of Wages and Wage Accounts ...... 63 The 10 Most Common Mistakes Estate Planners Make with Respect to Asset Protection ...... 67 Chapter 5 - Inheritance Planning ...... 77 Should You Trust a Trust? ...... 77 Avoiding Probate by Using Revocable Living Trusts...... 78 Selecting Revocable Trust Systems for Clients ...... 80 It’s Just a JEST, The Joint Exempt Step-Up Trust ...... 88 Special Clauses for Trust Agreements ...... 102 Chapter 6 - Selecting Trustees, Guardians, Personal Representatives and Other Fiduciaries ...... 105 Trustees ...... 105 Personal Representatives ...... 105 Guardians ...... 108 Agent Under Durable Power of Attorney ...... 108

iii Surrogates or Health Care Agents Under Health Care Powers of Attorney ....109 Child Care Power of Attorney ...... 110 Division of Duties and Entities ...... 113 Trust Protectors ...... 113 Tiebreakers ...... 113 Common Examples ...... 113 Decision Chart for Client Meeting ...... 118 Chapter 7 - Federal Estate Tax Planning...... 121 General Overview ...... 121 Nuts and Bolts of the Federal Gift and Estate Taxes ...... 122 Bypass Trusts (also known as Credit Shelter Trusts and/or “B Trusts”) ...... 125 Life Insurance Trusts ...... 125 Terminology ...... 126 An Executive Summary of Defective Grantor Trusts ...... 129 Can the Grantor Be a Beneficiary of a Trust That Avoids Federal Estate Tax? ...... 134 Can a Spouse be a Beneficiary of an Irrevocable Trust? ...... 135 7 Suggestions for the Design of a SAFE Trust ...... 135 Annual Gifting ...... 138 Gifting to an Irrevocable Trust and What the Heck is a Crummey Trust? ...... 139 Discounts ...... 141 Installment Sales for Low-Interest Notes ...... 142 Self-Cancelling Installment Notes ...... 142 Defective Grantor Trusts ...... 142 Qualified Personal Residence Trusts (QPRTs) ...... 143 A Qualified Personal Residence Trust (QPRT) May Be Converted to an Annuity Trust ...... 148 GRATs are Great ...... 149 Using GRATs to Transfer Part Ownership of a Business - Is This Too Good to be True?! ...... 150 Big Picture ...... 151 “Zeroed-Out” GRATs and Formula Clauses - Unique Features That Increase the

iv Attractiveness of GRATs ...... 151 What if the GRAT Underperforms? ...... 154 How Do GRATs Work for Income Tax Purposes? Very Well! ...... 154 What Happens if the Grantor Dies Before Receiving All the Annual Payments? ...... 154 Do You Have to Have Ownership in a Closely Held Business or in Income Producing Real Estate to Use a GRAT? ...... 155 Is it Best to Use a Long-Term or Short-Term GRAT? ...... 155 What “Technical Rules” Should I Know with Respect to Establishing a GRAT? ...... 155 Do the Annual Payments Have to Be Equal Each Year?...... 156 What Happens with Respect to Income Tax Reporting and Payment if I Set Up a GRAT? ...... 157 Can Payments Received From a Grantor Retained Annuity Trust Be Creditor Proof Under the Florida Statutes? ...... 158 Charitable Planning ...... 158 Charitable Remainder Trust ...... 159 Charitable Lead Annuity Trust ...... 162 Private Foundations and Private Operating Foundations ...... 162 Don’t Overlook the Benefits - Tax and Otherwise - of Private Operating Foundations...... 163 Conclusion ...... 172 Chapter 8 - Special Considerations...... 173 I. Separate Children, Premarital Assets, and Related Considerations ...... 173 A. Special Design for Second Marriages, Possible Divorce Scenarios, and Planning for Children by Previous or Separate Marriages ...... 173 B. Special Considerations for Married Couples with Separate Children ...... 175 C. Simultaneous Death Clauses for Couples Who Have Separate Children ...... 176 D. Surprising Homestead Laws ...... 177 E. Elective Share Laws ...... 178 F. Family Allowance Law ...... 178 II. Medicaid Planning ...... 178

v III. Special Needs Trust Planning ...... 181 IV. Planning for the Addicted Beneficiary ...... 181 V. Planning for Clients or Family Members with Questionable Mental Abilities ...... 194 Conclusion ...... 195

vi INTRODUCTION

This book was written at the request of many clients and advisors who wanted an easy to follow roadmap for properly situating a person’s assets and insurances to avoid legal, creditor, tax, and expense obstacles. Many Floridians are not even aware of the multitude of rules and risks that affect them.

This book aims to provide an easily digestible, step-by-step explanation of the rules and methodology that apply to Floridians and their families when it comes to wealth preservation and inheritance. While there are hundreds of different factors and laws that estate planning professionals must consider and apply when appropriate, the vast majority of estate plans boil down to appropriate use of basic concepts, patterns and structures that Floridians and their advisors can apply to facilitate appropriate protective planning.

How to Use This Book We have distilled the vast amount of information on estate planning into eight easy to follow chapters. Clients and their advisors can utilize each of these when creating or evaluating an estate plan. The basic information provided in this book will be accessible to all readers. We will also offer more advanced material, both within the text and available for download on our website, www.gassmanlaw.com, that will be useful for planners and advisors. If you are not interested in the level of detail presented in any given chapter, or find that the information does not appear to pertain to your particular estate planning needs, feel free to skip over and around as you see fit. The book is designed to be understood without having to be read thoroughly or in the given order. Laws vary significantly from state to state, and this book is specifically designed for Floridians or people whose estate plans may be impacted by Florida law. This book discusses many of the “traps for the

7 unwary” that are unique to Florida. If you are involved with estate planning outside of Florida, this book should be helpful, but there is no substitute to using a competent lawyer who is familiar with the rules of your state. This book is not a replacement to competent legal, tax, and financial planning advisors. It is an introduction, rather than a complete how-to guide, and is not intended to provide investment advice. This book can, however, help you work with your advisors to make sure your plan is appropriate, comprehensive, and designed without the many errors we commonly see in even the most well-intentioned planning.

If you have any doubts whatsoever about your estate planning, please seek a second opinion from a qualified lawyer. Well-qualified lawyers can often take a look at another professional’s work and know within minutes whether it needs minor (or major) revisions or enhancements. On the other hand, please be careful with respect to receiving free legal advice, because it is typically worth exactly what you pay for it. Those offering “free lunches” have to earn money somehow, and usually it is from selling you a product that you might not have otherwise purchased.

“Anyone who does his own legal work has a fool for a client” - F. Lee Bailey.

We encourage you to use this book as you see fit, whether in preparation for establishing a new estate plan, to find a greater understanding of your current estate plan, or to deepen your knowledge in a new area of the law.

As legislation changes, this book will be updated, and you will be eligible for periodic updates. Send an email to us at [email protected] and ask to be added to our 8 Steps Update mailing list. We also welcome your feedback on how to improve this book for future editions. [KEEP OR DELETE THIS PARAGRAPH?]

A Note on Specialist Lawyers

If you have a complicated estate planning situation or want to be absolutely sure that your planning is done correctly, then we strongly recommend that you work with lawyers who are board certified by the Florida Bar in estate planning and trusts and/or taxation. Many of these attorneys also have advanced post-law degrees in estate planning and/or taxation, and this extra specialization can be very useful. There are, however, many advertising and specialty associations that lawyers can join which do not provide professional development or guarantee that the lawyer has an appropriate background. This is a complicated field, and often attorneys with a general background or a different subspecialty will not understand the full breadth and depth of these laws.

Martindale-Hubbell is a 140+ year-old organization that provides confidential peer review surveys by lawyers on other lawyers in their community, and it publishes an online index of attorneys and their ratings. The top 15% of peer-reviewed lawyers receive an AV rating, and lawyers in the 16% to 30% range receive a BV rating. All other lawyers receive a CV rating or request that their rating not be published.

If you are looking for a new lawyer or trying to size up your current one, check for the lawyer’s Martindale-Hubbell rating. Although we highly encourage you to use due diligence before making any decision, it is important to note that there are many excellent BV rated lawyers, and many competent lawyers who have not practiced five to seven years have not yet been rated.

9 CHAPTER 1 - STEP 1 PULLING YOUR INFORMATION TOGETHER

You cannot prepare a meal unless you have a list of the ingredients you are working with. Similarly, to design an estate plan you must know the ingredients: assets, liabilities, life insurance, and retirement benefits. Beyond that, you need a great way to organize all of this information so that all of the “flavors” of the plan work together. You need to time your preparation so that all parts of the meal are properly cooked at the right time. To this end, we have developed, and had great success with, our proprietary “Estate Planning Chart” (EPC). Our firm receives many compliments from clients, other advisors, and colleagues on the unique configuration summaries we provide for clients using our Excel software adaptations. The client provides their information and we aggregate and sort it into one visually organized document. Most clients have never seen all of their financial information together “on one page.” We include in our EPC all assets and liabilities with values, debt, titling and ownership structure, as well as beneficiary and ownership information. We format the EPC in Microsoft Excel. For 80% of our clients, this chart fits on one 11 x 17 (ledger size) summary sheet, but for clients with extensive estates it can take a scroll as long as 20 feet to display every entity and its ownership, assets, tax characteristics, indebtedness, and relationships to other people and entities on the chart! An example chart is shown on the following page.

11 Not only is the EPC invaluable for initially organizing information, it is great for illustrating suggested changes and taking notes during meetings. A client’s chart can immediately be pulled up on a computer screen, allowing everybody involved to quickly get on the same page. It is an instant snapshot of every entity, primary asset, and detail of ownership of the client’s planning. Without a system like this, important details fall by the wayside as advisors attempt to sift through and make sense of hundreds of pages of documentation that somehow fit together without having an easy to read roadmap. Can you simplify your assets, titling, liabilities, insurances, and beneficiary designation information down into one page? If not, let someone do it for you. It saves a lot of time and effort while reducing the risk of faulty planning. In order to collect the information used in the EPC, we use our color- coded “Blue Forms,” which are distributed before the initial attorney/client meeting whenever possible. We have different forms for married couples and single individuals [DELETE THIS? WE NO LONGER HAVE SEPARATE FORMS FOR MARRIED/SINGLE], and we ask a number of questions to get an introduction to clients’ assets and any current planning. We also have separate forms for physicians [DELETE THIS? WE NO LONGER HAVE SEPARATE FORMS FOR PHYSICIAN] because their planning has unique characteristics with respect to creditor protection, medical business, and investment entity arrangements. Ideally, we have a rough EPC prepared before the initial attorney/client meeting to save time and increase the effectiveness of that meeting. It is helpful for a client to be able to verify the information, and helpful for the attorney to be able to take notes and fill in details. A sample client intake form is reproduced below:

GASSMAN, CROTTY & DENICOLO, P.A. CONFIDENTIAL ESTATE PLANNING INFORMATION FORM

THIS MAY BE FAXED TO 727-443-5829

[INSERT OUR LATEST BLUE FORM INSTEAD OF THIS?] This questionnaire was developed for use by GASSMAN CROTTY & DENICOLO, P.A. in designing comprehensive estate plans for clients. The information which you supply on this form will be retained in our files and no information will be released to any person without your prior permission.

DATE: ______

Referred by: ______

1. Client Full Name ______Date of Birth ______Social Security Number ______Place of Birth ______Other Names Known By ______Citizenship ______Occupation (former if retired) ______Check one: ____ Male ____ Female Employer ______Office Telephone No. ______Fax No. (call you before faxing?) ______Cell phone: ______Pager: ______E-mail address ______Do you check this often? ____ Yes ____ No Mr. Gassman can be reached at [email protected] Driver’s License Number ______Any serious health problems? ____ Yes ____ No 13 Any details you would like us to have? ______

2. Spouse Full Name ______Date of Birth ______Social Security Number ______Place of Birth ______Other Names Known By ______Citizenship ______Occupation (former if retired) ______Check one: ____ Male ____ Female Employer ______Office Telephone No. ______Fax No. (call you before faxing?) ______Cell phone: ______Pager: ______E-mail address ______Do you check this often? ____ Yes ____ No Mr. Gassman can be reached at [email protected] Driver’s License Number ______Any serious health problems? ____ Yes ____ No Any details you would like us to have? ______

3. Residence Home Address ______Home Telephone No. ______Fax No. (call you before faxing?) ______Other Residences ______Husband Florida Resident Since ______Wife Florida Resident Since ______

4. Billing Address (if different from above) ______

______

5. Vehicle Information Year ______Make ______Model ______License Plate Number ______(please indicate Husband, Wife, or Joint) ______

6. Advisors Accountant ______Phone Number ______Trust Office ______Phone Number ______Insurance Agent ______Phone Number ______Investment Advisor ______Phone Number ______Pension Plan Advisor ______Phone Number ______May we speak with your advisors directly? ____ Yes ____ No Others we should be in touch with or know about? ______Name ______Phone Number ______Name ______Phone Number ______Name ______Phone Number ______Name ______Phone Number ______

7. Marriage A. Date of Marriage ______

15 B. Where living when married ______C. Prior Marriages: Husband: ____ Yes ____ No Wife: ____ Yes ____ No * If prior marriage ended in divorce, please provide copy of decree and settlement. D. Is there a Prenuptial Agreement or other marital contract in effect? ____ Yes ____ No If yes, please attach a copy. E. Please circle any of the following states in which you have lived or acquired property while married: Arizona Idaho Nevada Texas California Louisiana New Mexico Washington Canada None of the above

8. Names of Children of Present Marriage (If adopted, indicate (A) after name; if deceased, please indicate (D) after name) A. Name ______Date of Birth ______Social Security Number ______Check one: ____ Male ____ Female Name of Child’s Spouse (if any) ______Address ______Grandchildren ______B. Name ______Date of Birth ______Social Security Number ______Check one: ____ Male ____ Female Name of Child’s Spouse (if any) ______Address ______Grandchildren ______

C. Name ______Date of Birth ______Social Security Number ______Check one: ____ Male ____ Female Name of Child’s Spouse (if any) ______Address ______Grandchildren ______D. Name ______Date of Birth ______Social Security Number ______Check one: ____ Male ____ Female Name of Child’s Spouse (if any) ______Address ______Grandchildren ______E. Name ______Date of Birth ______Social Security Number ______Check one: ____ Male ____ Female Name of Child’s Spouse (if any) ______Address ______Grandchildren ______

9. List any children of prior marriages. (Please indicate husband’s or wife’s by (H) or (W) after name; if adopted, indicate (A) after name; if deceased, please indicate (D) after name) A. Name ______Date of Birth ______Social Security Number ______Check one: ____ Male ____ Female Name of Child’s Spouse (if any) ______

17 Address ______Grandchildren ______

B. Name ______Date of Birth ______Social Security Number ______Check one: ____ Male ____ Female Name of Child’s Spouse (if any) ______Address ______Grandchildren ______

C. Name ______Date of Birth ______Social Security Number ______Check one: ____ Male ____ Female Name of Child’s Spouse (if any) ______Address ______Grandchildren ______

D. Name ______Date of Birth ______Social Security Number ______Check one: ____ Male ____ Female Name of Child’s Spouse (if any) ______Address ______Grandchildren ______

E. Name ______Date of Birth ______Social Security Number ______

Check one: ____ Male ____ Female Name of Child’s Spouse (if any) ______Address ______Grandchildren ______

10. Are there any family members who require special schooling, special medical attention, or other special attention? ___ Yes ___ No If Yes, please give name(s) and describe nature of needs? ______

11. Do you have any other relatives now or likely in the future to be dependent upon you for support? ___ Yes ___ No If Yes, give name(s) and relationships ______

12. Do either of you have any legal obligations to a former spouse or children? __ Yes __ No / If Yes, please provide copy of relevant document(s).

13. Do either of you have a present Will? __ Yes __ No If Yes, please attach a copy.

14. Do either of you have any present Trusts? ____ Yes ____ No / If Yes, please attach a copy. 15. A. Have either of you ever received a substantial amount by inheritance? ____ Husband Approximate amount $______Date ______Wife Approximate amount $______Date ______B. Do either of you anticipate receiving an inheritance? ____ Husband Approximate amount $______Wife Approximate amount $______19 16. Do either of you hold a power of appointment under another person’s Will or Trust? __ Yes __ No / If yes, please attach a copy. 17. Have either of you given away more than $10,000 in money or property to any person in any single year after 1976? ___ Yes ___ No Have either of you ever been required to file a gift tax return? ___ Yes ___ No / If Yes, what years? ______(Please attach copies of any gift tax returns for either spouse.) 18. Do either of you work for a business which has some type of plan under which your estate or the person you specify will receive benefits on your death? ___ Yes ___ No ___ Not Sure

19. Are either of you a party to a Shareholder or Partnership Agreement (including any Buy/Sell Agreements)? ___ Yes ___ No If Yes, please attach a copy. 20. Do either of you have a safe deposit box? ___ Yes ___ No If Yes, where located? ______Name(s) box is listed under ______

21. Do either of you own any property in a foreign country? ___ Yes ___ No If Yes, give country and approximate value $______Please list any specific items or amounts that you wish to give to any individuals or organizations: Donor (Husband or Wife) Name Relationship Description of Gift

___[SHOULD MAYBE BE A TABLE TO FILL IN? WJD 5.23.19]______

______

23. All other tangible personal property (automobiles, clothing, furniture, pictures, etc.) to be distributed to (check one): ____ Spouse; if spouse predeceases, to children equally ____ Children equally ____ Other (specify) ______

24. All remaining money and other property (stocks, bonds, mutual funds, etc.) to be distributed to: ____ Spouse; if spouse predeceases, to children equally ____ Children equally ____ Other (specify) ______If you have named a beneficiary in Questions 22-24 above for whom full personal information has not already been provided (for example, a parent, aunt/uncle, niece/nephew, or friend), please provide that information here: A. Name______Date of Birth ______Address______Relationship______B. Name______Date of Birth ______Address______Relationship______C. Name______Date of Birth ______Address______

21 Relationship______

D. Name______Date of Birth ______Address ______Relationship______

26. Age(s) at which beneficiaries are to become in control of property held in trust for them or are to receive property outright. **See attached Memorandum entitled Trust Systems for Children and Subsequent Generations. (A) Traditional approach - distribute selected percentages at selected ages to the extent not otherwise spent. Example- 25% at age 25, 1/3rd of rest at age 30, half of rest at age 35, remainder at age 40. ______% at age ______% at age ______% at age ______% at age ______(B) Protective approach - child becomes Co-Trustee at what age, selects Co- Trustee at what further age, and becomes sole Trustee at what eventual age? Example- Child might become one of three Co-Trustees at age 25, may have the right to replace the Co-Trustees with a trust company at age 30, and may have the right to become sole Trustee as to one-half of trust at age 35. Child becomes Co-Trustee at age ______. Can replace acting Co-Trustee with a trust company at age _____. Sole Trustee over _____% of the trust assets at age _____.

27. With reference to surviving spouse, do you think he or she may be benefitted by serving as Co-Trustee with a protective individual or trust company of his or her choice (changeable by him or her) in order to be able to

have protection from future spouses and creditors? ______.

28. Please indicate below your choices as Personal Representative (Executor) of your estates and Successor Trustee of your Living Trusts (if applicable). Each of you will be the initial Trustee of your own Living Trust. The Successor Trustee will act if you cannot due to resignation, incapacity or death. You may select an individual or a financial institution with trust powers under Florida law to act as Personal Representative and Successor Trustee. You may also select more than one person or institution to act as Co- Personal Representatives or Co-Trustees at the same time, and you may provide that they may act with or without the joinder and consent of the other. Most clients select the same persons to act as both Personal Representative and Successor Trustee, but that’s strictly a matter of personal choice.

Who will serve as Personal Representative of your estates and Successor Trustees of your Living Trusts? Each spouse for the other? __ Yes __ No If No, whom? Husband Wife Name: ______Relationship: ______Please name alternates to serve if your first choice cannot: Husband Wife First Alternate: ______Second Alternate: ______

23 29. Your choice to act as Guardian of your minor children (if applicable): First choice Name(s) ______Relationship: ______Address ______Second choice Name(s) ______Relationship: ______

Address ______30. Are you presently involved in any litigation, or is there litigation or potential claims against you that are known? __ Yes __ No 31. Are you engaged in any high risk ventures, professions, or circumstances that would make creditor planning important? __ Yes __ No 32. Under the Florida Bar Rules, any information given to us by one spouse or relating to planning is accessible to the other spouse. Each spouse has the right to independent legal counsel with respect to planning. The transfer of assets with respect to estate planning could affect marital rights.

Do you have any questions about this? __ Yes __ No We will do your planning based upon the information described in this form. If you wish for us to verify any of this information, please let us know. We will be pleased to review any Deeds, Mortgages, account statements, or other confirmatory documentation, if requested. The specific ownership and

designation of assets, liabilities and beneficiary designations must be coordinated properly for estate planning documents to function as intended.

The undersigned has reviewed this form and the following asset summary information and believe it to be accurate.

______Husband

______Wife

25 LIST OF ASSETS FOR ______[NAME] (Attach Additional Sheets if Necessary) HUSBAND WIFE JOINT

1. Real Estate

Home $______

Mortgage $______

2. Other Real Estate (give location or briefly describe): ______3. Stocks, Bonds, Mutual Funds a. Publicly Traded Stock ______b. Closely Held Stock Name of Corporation:______Number of Shares: ______Shareholders:______c. Bonds and Mutual Funds Issuer: ______Face Value: ______Interest Rate: ______Maturity Date: ______Name of Fund: ______Fund Group: ______

HUSBAND WIFE JOINT

Number of Units:______4. Bank Accounts

Name of Institution:______Type of Account: ______Approximate Balance: $______2nd account, if applicable

Name of Institution:______Type of Account: ______Approximate Balance: $______3rd account, if applicable

Name of Institution:______Type of Account: ______Approximate Balance: $______5. IRA’s and Pension Plan Assets ______

27 ______

______

6. Mortgages, Notes or Debts (Owed to you by someone else) Debtors Name: ______Date Acquired: ______

HUSBAND WIFE JOINT

Approximate Balance Remaining $______2nd debt, if applicable

Debtors Name: ______Date Acquired: ______Approximate Balance Remaining $______3rd debt, if applicable

Debtors Name: ______Date Acquired: ______Approximate Balance Remaining $______4th debt, if applicable

7. Other Business Interests (Non Corporate)

8. Partnerships or Other Investments Not Listed Above

HUSBAND WIFE JOINT

9. Miscellaneous

Property a. Motor Vehicles (including boats, etc.) b. Jewelry c. Art d. Other Valuable Items

10. Any other items not listed above.

11. LIFE INSURANCE COMPANY DEATH CASH PERSON POLICY BENEFICIARY VALUE VALUE INSURED OWNER 29

12. LOANS AGAINST POLICIES COMPANY PERSON INSURED POLICY LOAN AMOUNT OWNER

13. LIST ANY CONTINGENT LIABILITIES, LITIGATION, ETC.

______COPIES OF STATEMENTS WITH ACCOUNT NUMBERS AND CONTACTS WOULD BE VERY HELPFUL FOR US TO HELP YOU WITH CHANGE OF BENEFICIARY AND OWNERSHIP DOCUMENTATION

SUPPLEMENT TO ESTATE PLANNING INFORMATION FORM You may or may not wish to answer the following, but it may be worthwhile to give thought thereto so that we understand your situation:

1. WHAT ARE YOUR GOALS AND ASPIRATIONS FOR THE

FUTURE AS TO:

A. The next FIVE years:

______B. The next FIFTEEN years:

______C. For your children and their descendants: ______2. WHAT DO YOU SEE AS THE BIGGEST THREE CHALLENGES OR DANGERS THAT WILL BE ENCOUNTERED BY YOU AND YOUR DESCENDANTS WITH RESPECT TO ACHIEVING THESE GOALS?

______3. IS THERE ANYTHING ELSE THAT WE MIGHT BE ABLE TO HELP YOU WITH OR SHOULD BE AWARE OF?

______

At this point you may not have the information on all of your assets, liabilities, life insurances and beneficiary designations easily accessible. Does that tell you something? It is important to provide a comprehensive summary to your attorney or CPA sometime during the planning process, with periodic

31 updates to help assure that what you have put together is still appropriate. Gathering information may be as easy as emailing a request for a summary from everyone who handles your bank accounts, brokerage accounts, IRAs, pension plans, real estate, and life insurances. The email can be simple and straightforward, like the following:

Dear ______:

I am pulling together a summary of our assets, liabilities, life insurances, beneficiary designations and other pertinent information for a planning update.

Could you please send me a one-page summary of what we have with you, showing titling, beneficiary designation information, any corporate, partnership or other entity designation information, and any liability information?

For any financial accounts, insurances, annuity contracts, IRAs or pension accounts, could you please provide a recent month end or quarter end report with account numbers, ownership, beneficiary designation and other information that may be needed?

Thank you in advance for your assistance with this.

Another advantage of our EPC is that with Microsoft Excel we are able to import data directly from information provided by other advisors. Microsoft Excel is an amazing program that goes far beyond spreadsheets and calculations. One incidental application of the EPC is that we can easily show clients how their assets are balanced between bank accounts, fixed income, equities, and real estate that may be spread out among different advisors and investments. Since we customize the EPC to each client, it takes some legwork to compile this document. Thereafter, however, the EPC is easy to maintain and has proven to be a great method for ensuring that each client’s financial information is wholly accounted for and considered when creating or modifying financial and estate plans.

Preparation for an initial or follow up planning meeting can also include consideration of the items described in the following agenda. All of these items are covered in subsequent chapters of this book. AGENDA FOR CONFERENCE WITH ATTORNEY 1. Review of family information. 2. Review of financial information. 3. Is there sufficient life insurance to support survivors? a. Proceeds multiplied by what expected rate of return can support survivors? b. Term policy expiration dates and follow-up.

4. Potential logistics for planning. 5. Trust arrangements for surviving spouse. 6. Trust arrangements for others. 7. Extended family planning: a. Inheritances expected. b. Parents or others who may need support. c. Relatives who should not inherit or have input or fiduciary roles. d. Beneficiaries if no descendants survive. 8. Financial Powers of Attorney: a. From spouses to one another. b. From any family member who may request or need assistance from clients. 9. Health Care Powers of Attorney: a. From spouses to one another. b. From any family members who may request or need assistance from clients. 10. Beneficiary designations for IRA, annuity, and pension accounts. 11. Beneficiary designations and ownership verification for life insurance. 33 12. Discuss disability insurance. 13. Discuss automobile ownership and umbrella coverage. 14. Advisor communications. 15. Business activities and ownership. 16. Discussion of spousal business/professional development. 17. Professional or business practice/company protection from potential creditors. 18. Entity tax planning.

19. Entity minutes. 20. Advisors to share information with. 21. Family members who should have access to the client files.

22. Other items?

FOLLOW-UP QUESTIONNAIRE FOR CLIENT MEETINGS Yes or Questions for Client: No? Follow-up By: Follow-up Notes IRA and Pension Follow-Up

Am I handling IRA beneficiary designations? Am I handling pension beneficiary designations? Life Insurance Follow-Up

Am I handling life insurance changes? Do they clients want me to contact their agent and run projections? Corporate Work

Do they want us to maintain their corporations? Parent Work

Did I ask if they have a Power of Attorney over their parents?

Children Work

Did I ask if any of the children will need special need provisions or other similar documents? Deed Work

35 Did I ask that they contact their insurance agency before transferring real estate to an entity? Did I ask if there was a mortgage or lien on the properties being deeded? Did I ask that they send us copies of Deeds? Who to be Involved With What From Our Office

Special Drafting of Forms

Are They Interested in Annual Gifting? Did I ask if they have done annual gifting in the past? Follow-Up

What is the deadline date for a follow-up call? What did I tell them about follow-up? Did I tell them there was going to be a call or meeting, or did I forget to do anything? Next meeting or call follow-up?

Who calls to make sure they got the package? Who do I hope they will contact?

Do we know the client’s preferred method of communication? E.g. email, call, mail. If so, did I get a signed Consent from them that allows that? List of items I need to receive from client. Who do I want made into an automatic email address? Where will the bill be sent?

Do we need to send a thank you letter? Did we promise to send the clients anything else? What other services might the client need?

37 CHAPTER 2 - STEP 2

MAKE SURE YOU HAVE ADEQUATE LIFE INSURANCE

A great many clients who come to us know what their life insurance holdings are, but do not know whether they have appropriate benefits or policy terms. Often the agent who initially sold them the policy is no longer involved with their planning or did not have a full picture of their financial situation from the outset. Once you decide on the ideal amount of life insurance and the period of time for which you expect to need coverage, the next task is to evaluate whether your current policies are sufficient or should be replaced or supplemented with new or additional policies. Note: Our firm does not sell life insurance or provide specific life insurance product recommendations or advice, nor do we receive any compensation from any life insurance or other investment carrier or agency or companies that we may suggest clients consider using. While many life insurance professionals encourage clients to purchase life insurance with a permanent investment feature for savings and retirement planning purposes, our priority as estate planning lawyers is to ensure that there is enough appropriate coverage to provide surviving family members with financial and educational security, both now and in the future. Most clients and their CPAs conclude that this is best achieved through the use of balanced term life insurance policies. Financial institutions frequently generate lengthy, complicated reports on how much life insurance you need now and in the future. While these reports can be useful, we sometimes find them overly detailed and inadvertently confusing.

One financial planning firm that we work with uses the “Rule of 6/3” to determine the appropriate amount of life insurance that a client needs. The Rule of 6/3 works as follows:

1. Estimate the continuing income needs of your family.

2. Assume that they will receive a 6% rate of return on investments at best and a 3% rate of return on investments at worst.

3. Divide the annual income needed by 3% to determine the after death investments needed. For example, if you think that your family needs $120,000 a year to live comfortably after you die, then at worst $4,000,000 would be needed after your death to provide this comfortable support. ($4,000,000 x 3% = $120,000). If you take the more optimistic estimate that your family will be able to earn 6% on investments and use the same formula, the family would have $240,000 a year. 4. Take the difference between the total amount of investments that will be needed and what you have now in order to determine how much life insurance to have. You may want to add some extra life insurance to take into account a margin of error, expenses that can be associated with losing a loved one, missed work and loss of value in investments or businesses if you are not around to handle them. Incidentally, under the “Rule of 6/3,” the family would be urged to keep their fixed expenses and commitments down so as to be able to live on 3%, while possibly using the other 3% for flexible luxury items that might be cut back if necessary, such as summer camp, private tutoring, staying at luxury hotels, or vacation rental homes and travel. Purchasing an expensive vacation home is a common financial planning mistake, especially when inexpensive time shares and rental pools are easily accessible and can be terminated if and when the family decides to no longer use a particular destination or when it cannot be afforded. The decision as to what percentage rate to use must account for inflation. Family members or appointed trustees must be sure to reinvest earnings and

39 capital gains to keep up with inflation and the ever-continuing increase in the cost of living. This is where many clients who would otherwise be inclined to keep all of their assets in bonds, CDs, and Treasury bills realize the importance of “hedging” inflation by investing in equities, stocks, and mutual funds. If you think that your family is going to invest only in CDs, bonds, and other fixed income items, then you may want to use an even more conservative 2% rule of thumb. In the example above, the family would need to have $6,000,000 after death to generate a $120,000 a year income if a 2% rate assumption applies. Obviously, the 2008 recessionary shake up and its aftershocks, along with risks for future inflation as the government continues to print money to pay debt, add a number of “wild card” factors to the determination of which rule to apply. Once you have decided how much life insurance you need now, you next need to think through how much you will need in the future. For example, a married couple with both spouses working and able to support themselves independently might not need life insurance now, but if and when they have children those needs can change dramatically. That couple would be well- advised to purchase enough life insurance now to assure that they will have coverage in case one or both of them have health issues arise before having children. If your children are approaching college age, you may need significantly less insurance in six or seven years than you do now. If you plan to have children but are not sure whether you will, then you may need a lot of insurance for the next 20 or 30 years -- just in case. There is no substitute for careful forethought with respect to present and future needs. Many clients will “ladder” term life insurance policies by buying several policies with different lengths of coverage. For example, a 35 year old client with children ages 8 and 10 may want to purchase $3,000,000 of term life insurance, based upon $1,000,000 at 10 years and $2,000,000 at 20 years. This assures that the client’s income and expected savings for the first 10 years will be covered under the $1,000,000 10 year policy, and that the client’s spouse and

children can be well provided for until they reach college age, should the client die in the first 20 years. The client may buy six separate $500,000 policies from three separate insurance carriers to take into account carrier failure risk, which has always been a minimal concern in the past. Most people do not realize that once a life insurance policy is purchased, it cannot be reduced or increased in coverage. If a client buying $2,000,000 of coverage thinks that he or she may want to reduce the coverage to $1,000,000 later, then it is advisable to purchase two separate $1,000,000 policies, or better yet, four $500,000 policies, to guarantee flexibility in the future.

Physical Examination Requirement No significant life insurance policy will be issued without the carrier sending out a nurse to verify physical condition and to properly complete a health status questionnaire. You can ask an independent agent who writes for many carriers to have you take a physical so that the agent can get quotes from several carriers. The carriers can then each give informal quotes for term coverage. This is called an “informal application” then. We recommend requesting that all results and quotes remain confidential, and not be sent to the bureau to which all carriers belong. Once a carrier either turns you down or “rates” you, all other carriers will have access to that information for the rest of your life. It is advisable to obtain a physical before shopping for coverage costs since your costs will be dependent on the results of the physical. This may also be an opportunity to investigate a disability insurance update or a core disability policy. Many clients have disability policies with their employers that will vanish, or be of no use, if and when the employer ever goes out of business or the client no longer works for the employer. If you have read our book entitled Creditor Protection for Florida Physicians, which is available on Amazon, you may already be familiar with the remainder of this chapter, in which case you may enjoy it as a refresher on these principles.

Term Life Insurance An alternative to a permanent life insurance policy is to buy much less expensive fixed annual premium term products, which are very popular. Term life insurance is available to the insured for a limited period of time to provide 41 coverage at fixed annual rates. The insured designates a beneficiary so that in the event that the insured dies during the term, the death benefit will be paid to that person. Clients often have sufficient term life insurance to provide for loved ones if they were to die in the near future, but the vast majority of term life insurance policies expire or require conversion to expensive permanent policies. Many clients should therefore consider replacing those policies with newer long-term policies. Sometimes the term life insurance policies will expire one year after the deadline for conversion to a permanent policy, so it is important to read your policy carefully and note the “convertibility option feature” dates. The cost of purchasing four $500,000 policies is not materially higher than the cost of purchasing one $2,000,000 policy, and the flexibility of being able to reduce the coverage by $500,000 at a time can be very valuable in later years. As stated previously, different policies can be purchased from different carriers, so that if one carrier goes bankrupt or becomes economically uncertain, only the policy or policies purchased from that carrier, and not all of your policies, will be in peril. The ownership of life insurance policies is a crucial consideration. If you are not concerned about federal estate tax, then it is often best to have the insured person own the policy and to make it payable to a special trust to protect the intended beneficiaries. If federal estate tax is a concern, it may be better to have the life insurance policy owned by and payable to an irrevocable life insurance trust that can facilitate allowing the policy proceeds to benefit family members without ever being subject to federal estate tax. This is further discussed in Chapter 7 (“Step 7: Federal Estate Tax Planning”).

Permanent Life Insurance Many clients are aware that permanent life insurance policies are exempt from the claims of creditors, but they do not realize that for this to work the policy needs to be owned by the person who is insured. Also, to protect the family, the beneficiary of the policy should usually be a trust that can benefit family members without becoming exposed to federal estate tax, creditors of family members, future divorce, or other threats to wealth.

Permanent life insurance, as compared to term life insurance, can be very expensive and should be looked at carefully with reputable advisors before being purchased. Clients who have permanent life insurance should periodically request carrier-printed computerized projections of each policy to see how it is performing and to make plans for future premium payments and the possibility of reducing the death benefit to decrease the cost of maintaining the policy. Some policies will grow by having the inside investment component linked to a stock market mutual fund (or funds) or index funds. These are called variable life policies. It is important to review the costs associated with maintaining a variable life policy in order to be sure that it is the best option for your particular situation. The carriers will typically provide you with illustrations which take into account “projected” mortality costs and administrative costs, but the carrier will usually not guarantee that these costs will not increase, except for certain ceilings provided in the “policy guarantees.” The carrier promises you that it will charge you based upon its standard mortality costs and administrative costs for other policy holders, but the carrier might in the future set up new kinds of policies and stop selling the category of policy you have. This is one reason that it is essential to buy permanent policies only from carriers who have good long-term track records and solid reputations that the carrier will hopefully strive to protect. We find it very useful to run spreadsheets showing both the projected and guaranteed policy results in order to help clients decide what sort of policy to buy and to understand where the policy fits in with their overall financial asset planning.

Using Life Insurance as an Assured Inheritance Funding Vehicle Many of our firm’s clients are physicians who are married to each other. In this scenario, each would be completely self-supporting if one of them were to die. We may nevertheless recommend life insurance because it can be creditor protected. Additionally, on death, the proceeds can pass to a special trust that can benefit the surviving spouse and common children without being subject to creditor claims, next-spouse divorce claims, or unwise financial

43 moves that the surviving spouse might be inclined or influenced to make during his or her lifetime. We therefore often recommend placing $1,000,000 to $2,000,000 of term life insurance on the life of each physician spouse so that on the death of one spouse the surviving spouse and children are “guaranteed” a $1,000,000 or $2,000,000 fund as and when needed.

Annuity Contracts Annuity contracts normally consist of an insurance-like contract with a carrier that agrees to take the invested funds and either pay interest or invest the funds in one or more mutual funds for the benefit of the annuity holder. For example, many life insurance companies offer fixed rate of return annuity contracts that will pay interest on the monies deposited on a tax- deferred basis. No income tax is owed on what is earned under the annuity unless or until the monies are withdrawn. Variable annuities can be purchased under which the carrier places the monies into one or more designated mutual funds. These mutual funds grow on a tax-deferred basis. Many variable annuity contracts are subject to surrender charges and significant administration fees and mutual fund expenses which help them to pay sales representatives and other expenses. However, some “no-load” mutual funds are not subject to high costs or surrender charges. Although tax-deferral is advantageous, if and when monies are withdrawn from an annuity contract, the owner will pay income tax on the monies withdrawn to the extent of profits that have built up inside the contract. If the withdrawals are made before the owner turns age 59 ½, the tax rate on the withdrawn income will be 10% above the individual rate that would otherwise apply. This is known as a “10% excise tax” and it only applies to the income that has built up under the policy. There is no tax on taking the principal out once all of the income has been withdrawn. Our firm often advises single clients to have at least 6-12 months of expenses held under low-cost variable annuity contracts with the investments held in bond funds by the insurance carrier.

The State of Florida Guaranty Fund will assure that an investor will receive his or her insurance or annuity policy investment amounts if the insurance carrier goes bankrupt. The coverage limit in Florida was previously only up to $100,000 per policy for life insurance and $300,000 per carrier for annuity contracts. This law has now changed. [NEED TO UPDATE THE LANGUAGE IN THIS PARAGRAPH. WJD 5.23.19][NEW INFORMATION AFTER THIS BRACKET. WJD 5.23.19] The Florida Guaranty Fund, as of 2019, will cover $300,000 for life insurance death benefits and $100,000 in life insurance cash surrender per insured life, rather than per policy. Additionally, the coverage for annuity contracts has remained at $300,000 per contract owner, but was reduced to $250,000 for deferred annuity contracts. [SINCE THE LAW CHANGED, THE NEXT FEW PARAGRAPHS MAY NEED CHANGING. WJD 5.23.19] One client therefore purchased twelve separate $90,000 policies from four separate insurance carriers (three policies per carrier) to protect his investment and the first $10,000 in anticipated growth in each contract. The other advantage of having multiple contracts is that at the time of a withdrawal, there will be less taxable income to come out. For example, a client who buys five annuity contracts based upon $100,000 each may have $50,000 of income inside the annuities, if they have each increased in value by $10,000. The client could withdraw $110,000 from any one of the annuities and pay income tax only on $10,000 of profit. If the same client had instead purchased only one $500,000 annuity contract and it had grown to $550,000, then the first $50,000 withdrawn from the policy would be subject to income tax. Clients or their spouses will frequently own policies on their children’s or on one another’s lives, and these policies will not be protected from the owner’s creditors where the owner is not the insured person. [MAYBE TALK ABOUT THIS EARLIER WHEN TALKING ABOUT CREDITOR PROTECTION? WJD 5.23.19] The beneficiary designations of life insurance and annuity contracts are vitally important. Typically, policy proceeds should be payable into a trust or trusts that will provide creditor, management, divorce, and estate tax protection for the individual beneficiaries.

45 Where variable annuities have increased in value, it may work best to have the spouse as the primary beneficiary and a trust system as alternate. The spouse can then decide whether to roll the annuity into an annuity of her own or disclaim (refuse to accept) the annuity so that it can pass to the protective trust system.

Term Life Insurance Information [IS THIS A SUMMARY OF THE STUFF ABOVE? BECAUSE THIS INFORMATION IS AVAILABLE ON PAGES 40- 41. WJD 5.23.19] • You can ask an independent agent who writes for many carriers to have the client take the physical so that they can get quotes from several carriers. • You can ask that all results and quotes be confidential and not given to the bureau that all carriers belong to and share information with. Once a carrier turns the client down or “rates” the client, all other carriers know. • This is called an “informal application” and then the carriers can each give informal quotes for term coverage. If the client likes the quote, then he or she can buy it. • You might spread this among two or three carriers in case one goes under. • Sample term rates for “preferred,” “standard” and “standard smoker” individuals at ages 35, 40, 45, 50, and 55 are as follows: 35 YEAR OLD (PER $1,000,000 OF COVERAGE) STANDARD PREFERRED (35 STANDARD MALE SMOKER Year Old) (35 Year Old) (35 Year Old) 10 Year Term $375 $735 $1,685 15 Year Term $515 $915 $2,135 20 Year Term $665 $1,105 $2,885 30 Year Term $1,015 $1,735 $4,705 STANDARD PREFERRED (35 STANDARD SMOKER FEMALE Year Old) (35 Year Old) (35 Year Old)

10 Year Term $345 $565 $1,345

15 Year Term $415 $805 $1,775 20 Year Term $565 $945 $2,265 30 Year Term $825 $1,375 $3,555 40 YEAR OLD (PER $1,000,000 OF COVERAGE) STANDARD PREFERRED (40 STANDARD MALE SMOKER Year Old) (40 Year Old) (40 Year Old) 10 Year Term $505 $925 $2,405 15 Year Term $655 $1,215 $3,125 20 Year Term $865 $1,505 $4,345 30 Year Term $1,495 $2,465 $7,175 STANDARD PREFERRED (40 STANDARD SMOKER FEMALE Year Old) (40 Year Old) (40 Year Old)

10 Year Term $435 $785 $2,005 15 Year Term $575 $1,035 $2,485 20 Year Term $745 $1,255 $3,185 30 Year Term $1,135 $1,985 $5,275 45 YEAR OLD (PER $1,000,000 OF COVERAGE) MALE PREFERRED (45 STANDARD STANDARD Year Old) (45 Year Old) SMOKER (45 Year Old) 10 Year Term $805 $1,405 $4,075 15 Year Term $1,065 $1,985 $5,275 20 Year Term $1,415 $2,355 $7,195 30 Year Term $2,355 $3,845 $11,625 STANDARD PREFERRED (45 STANDARD SMOKER FEMALE Year Old) (45 Year Old) (45 Year Old)

10 Year Term $705 $1,095 $3,055 15 Year Term $875 $1,445 $3,815 20 Year Term $1,105 $1,755 $4,895 30 Year Term $1,765 $2,825 $7,555

47 50 YEAR OLD (PER $1,000,000 OF COVERAGE) MALE PREFERRED (50 STANDARD STANDARD Year Old) (50 Year Old) SMOKER (50 Year Old) 10 Year Term $1,235 $2,145 $6,435 15 Year Term $1,785 $2,805 $7,825 20 Year Term $2,225 $3,425 $10,425 30 Year Term $4,025 $6,245 $13,719 STANDARD PREFERRED (50 STANDARD SMOKER FEMALE Year Old) (50 Year Old) (50 Year Old)

10 Year Term $1,025 $1,625 $4,295 15 Year Term $1,235 $2,065 $5,725 20 Year Term $1,625 $2,715 $6,865 30 Year Term $2,645 $4,785 $10,109 55 YEAR OLD (PER $1,000,000 OF COVERAGE) MALE PREFERRED (55 STANDARD STANDARD Year Old) (55 Year Old) SMOKER (55 Year Old) 10 Year Term $2,025 $3,315 $8,935 15 Year Term $2,895 $4,655 $12,055 20 Year Term $3,505 $5,955 $14,875 30 Year Term NOT AVAILABLE NOT AVAILABLE NOT AVAILABLE STANDARD PREFERRED (55 STANDARD SMOKER FEMALE Year Old) (55 Year Old) (55 Year Old)

10 Year Term $1,495 $2,235 $5,905 15 Year Term $1,835 $2,985 $7,995 20 Year Term $2,465 $3,985 $9,985 30 Year Term NOT AVAILABLE NOT AVAILABLE NOT AVAILABLE

CHAPTER 3 - STEP 3 TITLE YOUR ASSETS PROPERLY AND

DO NOT FORGET BENEFICIARY DESIGNATIONS

Many people do not realize that the method of titling assets and deciding who owns what and how are crucial elements to avoiding disaster. This step introduces several essential concepts which are discussed in more depth later in this book. There are many different ways to own assets. The primary titling methods and the important effects of each are discussed below. Individual Ownership. An account or asset can be titled in one person’s individual name. If that person becomes incapacitated and there is an adequate durable power of attorney in place, someone else should be able to retitle or take control of the asset. On death, the asset will normally go through “probate,” which is described in Chapter 5. Probate is worth avoiding when possible. Joint Ownership. Many married couples and some unmarried people will own significant assets jointly. There are a number of different types of joint ownership which are discussed below. [PERHAPS INDENT THE NEXT FEW DEFINITIONS THAT ARE TYPES OF J.O.? WJD 5.23.19] Joint Ownership with Right of Survivorship. As the name indicates, when one joint owner dies the other joint owner becomes the sole owner, notwithstanding the dying person’s Will or intentions. Many inheritance disputes are over joint accounts that were set up for the convenience of an elderly person who may or may not have intended for all of the assets to pass to the other joint owner or owners on death.

49 Joint Ownership as Tenants by the Entireties. Florida and a handful of other states permit a husband and wife to own assets as “tenants by the entireties.” This form of ownership dates back to English common law, and it is very useful because creditors of one spouse cannot reach tenancy by the entireties assets as long as the spouses are married to each other and live in a tenancy by the entireties state. [MAYBE ADD A FEW EXAMPLES OF LARGE T BY THE E STATES? WJD 5.23.19] [12/17/19 – SHELLEY TO START HERE AND LOOK AT FORMATTING – ARE ALL PARAGRAPHS INDENTED ONE TIME? CHECK PARAGRAPH SPACING. REPLACE JEST ARTICLE.] Tenancy by the entireties is often a preferred ownership method for that reason, but if a creditor gets a judgment against both spouses, or if one spouse dies and the other spouse has creditor issues, the assets will not be protected. A major challenge for many married couples is determining whether an account is owned jointly with right of survivorship, and thus not creditor protected, or is considered to be a protected tenancy by the entireties account. The answer is not always clear, but on a bank or brokerage account, if the institution offered a box to check specified “tenancy by the entireties” and the married couple instead checked the “right of survivorship” box, tenancy by the entireties status will not exist. On the other hand, if the account agreement did not offer tenancy by the entireties as an option and the married couple checked the “right of survivorship” box, then normally tenancy by the entireties ownership would be presumed, based upon a 2001 Florida Supreme Court decision. [CITATION MAY BE NEEDED. WJD 5.23.19] Tenancy by the entireties will only exist when an asset is owned solely and jointly by a husband and wife. Placing a child as an additional right of survivorship owner on an account will disqualify it from tenancy by the entireties status.

More discussion of tenancy by the entireties appears in Chapter 4.

Joint Ownership with Right of Survivorship – Non-Marital. Many parents and some other individuals will place assets into a joint with right of survivorship

account, co-owned with a child, family member or other trusted individual. On the death of one owner the other owner owns the account. This is an adequate technique to avoid probate (discussed at Chapter 5) and to give a trusted individual access to account monies, but things to consider in deciding whether to choose this technique include the following: 1. Was a gift intended when the joint account was set up? If not, use a simple legal document verifying that the account is actually owned in full by the person who funded it, and that no gift or devise is intended unless or until the funding person dies or gives the other person permission to take the account monies. If a gift was intended or actually occurred, then a gift tax return must be filed by the due date of the donor’s income tax return for the next year. 2. If the co-owner has a lawsuit or divorce situation after receiving sole ownership by survivorship, then the account assets could be lost to the creditor or the divorcing spouse. 3. Sometimes we see joint account situations where the person who funds the account is later disappointed to find that the person whose name was added to the account takes the money out or does something that the person who funds the account does not approve of. Sometimes a child is sued and the parent who put the child on the account has to defend ownership in court, and the parent may or may not win the suit after spending legal fees that cannot be recovered. 4. There can be distortion of the estate plan when the account assets all go to the survivor and assets are not equally divided among children or other family members. As an alternative to joint with right of survivorship ownership, many banks and brokerage firms offer “pay on death” accounts. These accounts provide that on the death of the owner, the account assets pass to a particular person, trust, or other entity.

Beneficiary Designations Handling beneficiary designations and pay on death account paperwork properly is essential. Many catastrophic mistakes are made at this point in the process, so please make sure that yours are done correctly! 51 We find that many clients have named individuals as beneficiaries without thinking about whether it is best to pass assets directly to the individual or to a trust. This type of trust, which may provide for the health, education, maintenance and support of the individual, can be creditor-proof, protected from divorce, and otherwise better situated in most of our clients’ planning. Beneficiary designations under IRAs, 401(k) plans, pensions, annuities and life insurance should also be appropriately considered. Quite often, the beneficiary of an IRA, 401(k) and pension account would be the surviving spouse. In these instances, the balance of these accounts may roll over into the surviving spouse’s IRA without having to make withdrawals. The contingent or alternate beneficiary for IRA, 401(k), and pension accounts will often be the children or trusts for the children, which can “stretch” over the children’s lifetimes to permit ratable withdrawals, deferring the income tax on the eventual monies paid out. For life insurance and annuity accounts, we typically name a trust that can hold benefits for the beneficiary while offering protection from estate tax, creditor claims, and divorce claims that the beneficiary might have against him or her. Annuity contracts with built-in income that has never been distributed are often best made payable to the surviving spouse, who can continue the tax deferral on such assets. The contingent beneficiary for annuity contracts will often be the children, or trusts for the children, to obtain the safeguards described above. Make sure you thoroughly understand the reasoning and effects behind each type of ownership before making any final decisions. An example of a typical beneficiary designation instruction memo that we commonly use for married couples where each spouse has a separate revocable trust and potential estate tax or creditor protection considerations is shown below, but may not apply in your situation. Disclaimer planning is often used in sophisticated estate plans to allow a beneficiary who might otherwise receive an asset to “disclaim” it and have it

pass into a trust or to whoever would have inherited the asset if the person making the disclaimer had died. Disclaimer planning can be very complicated and should be approached carefully, but one good piece of advice is to never accept an inheritance before considering whether it would be best to disclaim it. MEMORANDUM TO: MARRIED CLIENTS FROM: ALAN S. GASSMAN RE: LIFE INSURANCE AND RETIREMENT ACCOUNT PLANNIG COORDINATION With reference to your estate planning and coordination with estate planning documents, we are available to assist you in preparing or reviewing any account agreements and ownership and beneficiary designations or documents. It is essential that this be done correctly. An error can result in the wrong person or people (or creditors) inheriting or receiving the wrong asset or benefits. It is important to point out that you may have bank accounts or financial brokerage accounts with “pay on death” beneficiary designations that would interfere with what you want to have happen in your planning. Any account owned jointly with right of survivorship could be made payable to either of your new Trusts on the death of the survivor of you if you like, but we would not recommend having any accounts pass directly to your children. An account owned jointly with right of survivorship will pass to the surviving spouse if one of you dies, and then by Will to the Trust of the surviving spouse on the subsequent death thereof. With reference to life insurance, annuity, IRA, 401(k) and associated ownership and beneficiary designations, your present estate planning documents make the following appropriate: 1. As to HUSBAND:

53 (a) Life insurance policy or policies on HUSBAND’s life can be owned by HUSBAND and made payable by beneficiary designation to HUSBAND’S LIVING TRUST dated ______[TO BE FILLED IN WHEN THE DOCUMENT HAS BEEN SIGNED], unless an Irrevocable Life Insurance Trust is being used, in which event life policies may best be owned and payable to the Trustee of such Trust.

(b) Any IRAs to be made payable to WIFE, with the contingent beneficiary to be the HUSBAND’S LIVING TRUST LIVING TRUST dated ______[TO BE FILLED IN WHEN THE DOCUMENT HAS BEEN SIGNED].

(c) Any pension account or accounts to be made payable to WIFE with the contingent beneficiary to be HUSBAND’S LIVING TRUST dated ______[TO BE FILLED IN WHEN THE DOCUMENT HAS BEEN SIGNED].

(d) Any individually owned annuity contracts not constituting “pension plan or IRA annuities” would be owned by HUSBAND and made payable by beneficiary designation to WIFE for income tax rollover purposes, with the alternate beneficiary being HUSBAND’s revocable trust.

An annuity contract that is a “pension plan or IRA annuity” would be made payable as indicated in paragraphs (b) and (c) above.

2. As to WIFE:

(a) Life insurance policy or policies on WIFE’s life can be owned by WIFE and made payable by beneficiary designation to the WIFE’S LIVING TRUST dated ______[TO BE FILLED IN WHEN THE DOCUMENT HAS BEEN SIGNED], unless an Irrevocable Life Insurance Trust is being used, in which event life policies may best be owned and payable to the Trustee of such Trust.

(b) Any IRAs to be made payable to HUSBAND, with the contingent beneficiary to be WIFE’S LIVING TRUST dated ______[TO BE FILLED IN WHEN THE DOCUMENT HAS BEEN SIGNED].

(c) Any pension account or accounts to be made payable to HUSBAND with the contingent beneficiary to be the WIFE’S LIVING TRUST dated ______[TO BE FILLED IN WHEN THE DOCUMENT HAS BEEN SIGNED].

(d) Any individually owned annuity contracts not constituting “pension plan or IRA annuities” would be owned by WIFE and made payable by beneficiary designation to HUSBAND for income tax rollover purposes, with the alternate beneficiary being WIFE’s revocable trust.

An annuity contract that is a “pension plan or IRA annuity” would be made payable as indicated in paragraphs (b) and (c) above.

3. As a reminder, any joint account should be titled as tenants by the entireties, and our planning has not contemplated that there would be any pay- on-death beneficiary designations of any joint or other accounts, except as set forth above, unless we have discussed otherwise.

IF YOU COULD PLEASE PROVIDE US WITH COPIES OF ANY AND ALL STATEMENTS AND ANY CHANGE OF BENEFICIARY FORMS THAT YOU CAN OBTAIN, THEN WE CAN WORK WITH YOU TO ASSIST IN MAKING PROPER BENEFICIARY DESIGNATIONS.

CHAPTER 4 - STEP 4

INCLUDE CREDITOR PROTECTION PLANNING We live in an age where every person with assets has to be concerned with whether his or her assets could be accessible to a creditor in a lawsuit. Therefore, creditor protection should be an objective of any estate planning arrangement. While we represent a great many physicians, real estate developers, and individuals who are at higher than normal risk for potential creditor situations, anyone who drives or owns a car, owns property, or is involved in operating a business or other activity should understand the creditor protection available in Florida to avoid losing assets to a judgment creditor. Creditors of an individual are not generally able to access properly situated homestead property, IRAs, pension plans, annuity contracts, the cash value of life insurance contracts, or 529 plans. In addition, when an individual is a member of a limited liability company (“LLC”) or a partner in a limited partnership, and there are other co- owners who do not owe monies to a particular creditor, the creditor is generally unable to penetrate the applicable entity and can only receive a “charging order.” This entitles the creditor to be paid if and when the LLC or limited partnership makes a distribution. There is nothing in the law that permits a court to require that a distribution be made.

As a result of the above, many clients keep their assets in the above designated categories, and make sure that real estate, stocks, bonds, and other investments not included in the above exempt categories are under LLCs or limited partnerships that will qualify for charging order protection. The basic categories of assets and some of the main rules that apply with respect to creditor protection planning are set forth in the following chart entitled “Creditor Protection in 2 Minutes - The Essentials.” You may also wish to watch one of our webinars on creditor protection, available on our website at www.gassmanlaw.com/webinars. Creditor Protection in 2 Minutes - The Essentials

CREDITOR ASSETS THAT ARE ASSETS EXEMPT DIFFICULT FOR A EXPOSED ASSETS CREDITOR TO OBTAIN TO CREDITORS

Homestead Limited partnership and similar Individual money and - Up to half acre if within city entity interests. brokerage accounts. limits. - May be immune from fraudulent transfer statute. IRAs Foreign trusts and companies. Joint assets where both - Includes ROTH, Rollover, and spouses owe money. Voluntary IRAs, but possibly not inherited IRAs. 401(k)s Foreign bank accounts. One-half of any joint assets - Maximize these! not owned as tenants by the entireties where one spouse owes money. Tenancy by the Entireties (joint Vocabulary: where only one spouse is EXEMPT ASSETS - An asset that a creditor cannot reach by reason obligated). of Florida law - protects Florida residents. - Must be properly and specially titled - joint with right of CHARGING ORDER PROTECTION - The creditor of a partner in a survivorship may not qualify. limited partnership, limited liability partnership, or properly drafted limited liability company can only receive distributions as 529 College Savings Plans and when they would be paid to the partner. Annuity Contracts FRAUDULENT TRANSFER - Defined as a transfer made for the purpose of avoiding a creditor. Florida has a four year look-back Wages of Head of Household

57 Wage Accounts (for six months statute on fraudulent transfers. A fraudulent transfer into a only) homestead may not be set aside unless the debtor is in bankruptcy. It takes three creditors of a debtor who has 12 or more creditors to force a bankruptcy.

Up to $4,000 of personal assets - or Upon filing a Chapter 7 bankruptcy, an individual debtor may be able to cancel all debts owed and keep exempt assets, subject to less in bankruptcy. certain exemptions.

Annuities and life insurance policies are not always good investments, and can be subject to sales charges and administrative fees.

There is a lot more to know - but this chart may be a good first step.

Waiting until the last minute to try to protect assets can be very difficult because of the fraudulent transfer rules and statutes of limitations under Florida law and bankruptcy law. Under these laws, if assets are transferred into creditor-protected modes of ownership for the purpose of avoiding an existing creditor, the creditor will be able to penetrate the structure and obtain a judgment against the person or entity who received the “fraudulent transfer,” in order to pursue it. On the other hand, transfers that are the result of business or legitimate estate planning objectives may withstand judicial scrutiny, even though the change of ownership provides creditor protection benefits. In any event, it is essential that creditor protection be considered when determining how to best own assets and facilitate structuring thereof. In addition to the above “creditor exempt asset” strategies, assets owned as tenants by the entireties by a married couple (as discussed in the previous chapter) are not subject to levy by a creditor unless the creditor has a judgment against both spouses. If the creditor has a judgment against both spouses, the assets will not be protected. For this reason, it is common for married couples in Florida to own their assets as tenants by the entireties, but there are a significant number of traps for the unwary that creditors often spring on married couples. For example, if one spouse dies, the surviving spouse will not have creditor protection with respect to former jointly owned assets. Is it better to put assets into the name of a spouse who has little creditor risk to enable him or her to fund a trust to protect the certainly higher risk spouse and their descendants? [IS THIS A QUESTION THAT IS TO BE ANSWERED BELOW OR JUST A HYPOTHETICAL? WJD 5.23.19] Sometimes one spouse will make a “fraudulent transfer” to another spouse, resulting in a creditor having a judgment against the spouse who received the fraudulent transfer. As a result, the creditor will have the ability to hold a judgment against both spouses and levy upon tenancy by the entireties assets. Many married couples wisely decide to place significant tenancy by the entireties assets into LLCs or limited partnerships that are primarily owned by them as tenants by the entireties, but are also owned in part by other trusts, persons, or entities so that they have charging order protection in addition to tenancy by the entireties protection. Say a married couple has set up a limited partnership or LLC, and the couple has gifted non-voting ownership interests to an irrevocable trust for their children for gift tax avoidance purposes. An incidental benefit of the arrangement would be charging order protection that would apply in the event that tenancy by the entireties protection is not available. Tenancy by the entireties protection will definitely not be available on the death of a spouse, charging order protection becomes very valuable. For example, a husband and wife might own 98% of a limited partnership as tenants by the entireties, with 2% owned by a trust for their children. If the husband or wife dies and the surviving spouse has a lawsuit against him or her, the creditor could at most receive a charging order against the 98% limited partnership interest, but the creditor would not be able to reach into the entity to pull out assets. In certain circumstances, wages can also be protected as an exempt asset. See Florida Statutes Section 221.11. Wages are only protected when the wage earner is the “head of household,” which generally means that he or she provides the support for himself or herself and at least one family member, or someone unrelated who resides with him or her. However, the law is at best murky in situations where the wages are paid by an entity controlled in whole or in part by the wage earner. Where the wage 59 earner is a shareholder or partner in the entity that makes the wage payments, it is best to have a written employment agreement confirming a fixed periodic wage arrangement. Even under such an arrangement the law is still unclear, so companies and partnerships are often owned jointly as tenancy by the entireties to protect dividend distributions and entity ownership from any creditor that is only owed monies by one spouse.

A FLORIDA PHYSICIAN’S GUIDE TO PROTECTION OF WAGES AND WAGE ACCOUNTS Florida law provides limitations upon the access that creditors may have to “wages” and “wage accounts” earned and funded by Florida residents. Florida Statutes Section 222.11 provides that wages earned by a head of household will generally be immune from creditors. Head of household has been defined to mean that the wage earner provides most of the support for themselves and other family members. For example, where the wage earner’s spouse earns more than the wage earner, the wage earner may not qualify as “head of household” for creditor exemption purposes unless it can be shown that the actual wages earned by such person provides more than half of the support for at least one other family member. Wages are subject to employment taxes. Wages do not include dividends that are paid attributable to ownership of a professional practice, as opposed to being labeled as wages. A family member being supported should be a relative, or maybe a non- relative, who actually resides in the household with the wage earner. Some courts have indicated that where the wage earner is a shareholder in a closely held corporation, and can thus manipulate between what would be received as wages and what would be received as dividends, then no wages may be protected. These unfortunate bankruptcy court decisions have not been appealed, and point out the importance of taking regular paychecks and having arm’s-length employment agreements in place so that wages are paid periodically in a traditional manner to enhance the probability that they will be protected. If wages are “creditor exempt,” then it is important to maintain the creditor exempt status of the wages by depositing them into an account or other investments that will also be creditor exempt. Other creditor exempt assets that wages may be “converted to” can include paying down the mortgage on a protected home, investing the paycheck directly into a properly titled annuity contract or life insurance 61 policy, funding a tenancy by the entireties account where the wage earner’s spouse would not be sued by the same creditor as the wage earner, or making deposits into a wage account. Physicians who have monies or investments that are not creditor exempt might be well advised to spend down the non-creditor exempt savings, while accumulating wages in a wage or other protected account. The Florida statutes do not explicitly impose any ownership, titling, naming or other specific requirement for an account to qualify as a wage account. A “wage account” can be owned by the physician earner, or may be held as tenancy by the entireties by the physician earner and the physician earner’s spouse. Most, if not all, married physicians whose spouses do not practice with them will be better protected by depositing their wages into a tenancy by the entireties account so that the wages may be safeguarded for two reasons: (1) the wage exemption rules as described above will apply; and (2) to “invade” a tenancy by the entireties bank account, a creditor must have a judgment against both spouses or show that the transfer into the account was a fraudulent transfer. If a wage check is a creditor exempt asset, then the deposit of the wage check directly into a protected tenancy by the entireties account should not be considered a fraudulent transfer. Many physicians and bankers waste a lot of time opening “wage accounts” where tenancy by the entireties accounts or other vehicles are just as, if not more, protective and would qualify as wage accounts anyway. The statute simply says that wages are protected for six months in the account so long as they can be traced, and, thus, are not confused with non-wage or older wage deposits that would not be protected. It makes sense to have an account funded solely by wages, and to “empty the account” into other exempt investments, at least every six months, so that there would never have to be a tracing and proof analysis as to wage money protection.

A memo to clients on making sure that bank accounts are owned as tenants by the entireties is as follows:

MEMORANDUM

TO: CLIENTS FROM: ALAN S. GASSMAN, ESQUIRE RE: MAKE SURE YOUR BANK ACCOUNTS ARE OWNED AS TENANTS BY THE ENTIRETIES ************************************************************************************* Tenants by the entireties is the legal designation that has historically applied to property that is owned by a husband and wife, where it takes both signatures or creditors owed money by both spouses to “divest” them of the asset. Under the common law, property held as “tenants by the entireties” is considered as owned 100% by both the husband and the wife, so that women would not lose their dowry rights back when women were not allowed to own property in their own names.

Another form of legal ownership is “joint tenancy with right of survivorship.” This is similar to tenancy by the entireties but does not require joint signatures nor afford creditor protection where there is a judgment against one spouse. Clients who own property jointly with their spouses should be careful to review documentation concerning ownership to be sure that items are owned as tenants by the entireties. If personal property is titled jointly with right of survivorship, this may not be considered to be owned as tenants by the entireties under Florida law, unless this designation is clearly made. Joint bank accounts and other assets are not automatically protected as “tenancy by the entireties property.”

To make things more complicated, most banks and brokerage houses do not have a “tenancy by the entireties” box to check when determining what kind of joint account to open. Fortunately, the Florida Supreme Court has indicated that a “right of survivorship” account will be considered a “tenancy by the entireties” account when a married couple in Florida opens such an account unless (1) on the face of the account agreement it is clearly designated not to be a tenancy by the entireties account; or (2) a tenancy by the entireties box was offered and for any reason the right of survivorship box was checked instead.

63 It is a good idea to confirm the intent that any financial account be a tenancy by the entireties account by actually putting the letters “TBE” after the name of the husband and wife, and by making sure that there is nothing on the account agreement that would cause the account not to be a tenancy by the entireties account.

It may not be possible to “fix” a non-tenancy by the entireties account by merely changing its title. It is safest to open a new tenancy by the entireties account and transfer the assets from any “flawed account” to the new account.

With physical objects, such as furniture, jewelry, and collectibles, Florida law is less clear as to whether these are presumed to be held as tenants by the entireties. Many clients sign joint statements with their spouses to confirm that furniture, jewelry, collectibles, and other tangible personal property is considered as owned as tenants by the entireties. It is also a good idea to list all of this property as being entireties property on the homeowner’s policy, especially where valuables are listed in special policy riders that assure protection from theft or other loss under insurance.

With automobiles and boats, we typically do not recommend tenants by the entireties ownership. Our concern is that there could be potential liability to both spouses in the event of an accident because of the Florida “Dangerous Instrumentality Doctrine.” It usually works best for only one spouse to own the automobile, and boats are commonly titled in limited liability companies or the name of one spouse or the other. Automobiles and boats can always be leased or subject to sixty-month loans, which would make them unattractive to any creditor.

Prior Florida case law has often recognized that assets held by a husband and wife will generally be considered as held by the entireties if intended between the parties.

Clients should obtain a copy of the account agreement to be sure that it is formally designated as an entireties account. If the account is not an entireties account, consider the following:

(1) Set up a new account formally designated as an entireties account and transfer the funds into the new account.

(2) Most of the time it will be sufficient that a joint account with right of survivorship have the account name clearly indicate that it is intended to be “entireties” property if the applicable bank or brokerage house does not offer an entireties account. For example, “John and Mary Smith, JTE (Joint Tenants by the Entireties).”

There are three notable exceptions to the safety of tenancy by the entireties property:

1. One applies when entireties property (other than a homestead mortgage) is subject to a mortgage or other debt for which both spouses have signed. If one of the spouses goes into bankruptcy, the Bankruptcy Court may involve the entireties property in the bankruptcy resolution because of the debt involved. To avoid this, it is suggested that spouses keep enough liquid joint entireties or exempt investments (such as annuity contracts) to allow for full payment on mortgages involving joint property before a bankruptcy is ever filed.

2. Another exception is that when one spouse dies, the surviving spouse will own all of the joint property without protection from liabilities of the surviving spouse. For this reason, some clients procure life insurance on the other spouse that would fund a creditor protected trust that in turn benefits the surviving spouse in the event of the death of the non-physician spouse.

3. The third exception is when both spouses owe an obligation to a creditor.

It is also important to understand how entireties property may be affected by changes in Florida law, divorce, or where one or both spouses move away from Florida.

Unfortunately for consumers, the Florida and federal creditor protection rules and bankruptcy laws can be extremely complicated and are not always predictable. It is important to make sure that you work with someone who stays up to date with these rules, and that any large assets or potential liabilities are reviewed by a lawyer who is well versed in this area. 65 We represent a number of lawyers who did their own creditor protection planning incorrectly and came to us seeking assistance to ameliorate the problems they caused for themselves and their families. In many situations, clients will want to have a bankruptcy/debtor-creditor lawyer team up with a business and estate/tax lawyer to make sure that all possible options are considered and that the job is done right. We also discourage anyone from obtaining creditor protection advice from advisors or other professionals who only sell one product or only have one suggestion, particularly where they will profit from the product or suggestion. As a smart consumer and saver, you have the right to know all of your options, the cost of these options, and how they will actually work, if at all. This can be distorted if you have an advisor or a salesperson who can only get paid if you do certain things. In situations like these, salespersons may make suggestions not in your best interest. Some common examples of improper advice that we have seen are as follows: 1. Someone is told to buy a big house to get creditor protection, so they buy a property within the city limits that is larger than ½ acre without realizing that only a percentage of homestead protection applies, based upon ½ acre divided by the entire parcel size, unless certain additional procedures were followed. 2. An insurance salesperson tells a customer that permanent life insurance or an annuity is better protected than tenancy by the entireties or 529 plan assets and receives a much larger commission on life insurance product sales than other investments. 3. The owner of a closely held business takes out dividends and periodic compensation that will not qualify as wages under the wage statute because of the way his or her employment compensation scheme is set up and the way that the courts interpret wage laws. 4. A couple goes to a bank or stockbroker expecting to open up a joint tenancy by the entireties account that is protected from the creditors of either spouse but end up with a traditional joint account with right of survivorship that does not offer such protection.

Also, creditor protection is not always consistent with inheritance and estate tax protection. You and your advisors may need to make judgment calls as to priorities. For example, a married couple might ideally each separately own half of the family assets as trustees of revocable trusts in order to avoid probate, and also fund a trust for the surviving spouse on the first death that would not be subject to estate tax in the estate of the surviving spouse. On the other hand, assets owned by an individual under a revocable trust that he or she sets up will be subject to creditor claims. Readers of this book may also want to review our book entitled Creditor Protection for Florida Physicians. This book is maintained as the laws change and applies to all Floridians. A list of common liabilities that cause thousands of people to go bankrupt each year are as follows: Catastrophes in the Making 1. Debt: General creditors, medical creditors, guarantees, provider agreements, etc. 2. Tort Liability (civil breaches of contract, rather than criminal): (a) auto owners and drivers (including boats and other vehicles); (b) errors and omissions - professional malpractice.

(a) Aiding and abetting others who commit wrongdoings. (b) Premises liability - building owners. Think of a child on a tricycle going up the wheelchair ramp and flipping down the stairs. Also consider the following: i. Hazardous waste.

ii. Asbestos and other harmful building materials.

iii. People injured by construction defects.

iv. People tripping and hurting themselves in the parking lot.

v. Tenants with rowdy customers who shoot people.

vi. Inappropriate acts by lease management. 67 vii. Children eating lead paint. 3. Relationship Liability: (a) Joint and several liability. (b) Partnerships. (c) Co-signors or co-guarantors on notes. (d) Joint tortfeasors (those who commit civil faults) can be jointly and severally liable for economic damages.

(e) Co-conspirators. (f) Vicarious liability: An employer is generally liable for the activities of employees in the scope of the business. What if the receptionist runs over a child while running an errand? (g) Spoiled romances and accusations by a forlorn ex-girlfriend or boyfriend, especially if you employed him or her.

4. Tax Liabilities: (a) Income taxes.

(b) Trust fund - employee withholding – money stolen that should have gone to the government - paying employees as independent contractors. (c) Penalties, interest, and criminal implications.

5. Others: (a) Divorce: Alimony and property settlement.

(b) Child support. (c) Hazardous waste liability and related issues. (d) Student loans. (e) Business participation: Sexual discrimination, etc.

(f) Involvement as trustee with relationship to pension plans. (g) Medicare and other payors. (h) Real estate liability.

(i) Lead paint.

(j) Asbestos.

(k) Tort liability.

(l) Vicarious liability for building activities.

(m) Civil rights or other violations. 6. Medicare, Medicaid, and private pay refund liabilities: Carriers have been suing doctors not following referral laws for significant refunds.

Liabilities generally not cancelable in bankruptcy include the following:

(i) Government student loans. (ii) Trust fund tax liability.

(iii) Hazardous waste liability. (iv) Breach of fiduciary duty liabilities.

(v) Child support and alimony.

Liabilities generally not covered by insurance include the following: (i) Civil rights violations committed by employees or others. (ii) Environmental liabilities, including sick building syndrome and lead paint issues.

(iii) Criminal acts.

(iv) Charitable and religious board activities.

69 (v) Jet skis normally cannot be insured for over $250,000 per occurrence. (vi) Acts of terrorism: Most casualty insurance clauses exempt acts of terrorism. The industry has been paying claims as good will up until now.

Liability Insurance Considerations All Floridians with significant incomes or assets should have sufficient liability insurance(s). Many Floridians are completely unaware of gaps in their coverages which cause significant exposure to loss of assets. Florida continues to be in a property and casualty insurance crisis, since many national carriers are afraid to “brave the storm” of insuring Florida properties for flood and hurricane damage. As a result, the state legislature established Citizens Property Insurance Corporation (“Citizens”) in 2002 as a carrier of last resort. Citizens writes thousands of policies every year and then sells the policies to small Florida carriers, who make money by receiving premiums, making payments and offering reinsurance for large catastrophes. Typically, a real estate property and casualty policy will cover both damage to the property and liability incurred by the property owner. Most liability policies for personal residences and vacation properties offer only up to $300,000 of liability coverage, and typically a separate carrier will issue an “umbrella policy” to handle any liability exceeding the $300,000 limit. For car ownership and driving, the typical car insurance limits go up to $250,000, and umbrella policies are issued to cover the excess liability. Therefore, most well-advised successful Floridians have at least three separate liability policies: one for their cars, a second for their properties, and a third that is an umbrella policy, to handle excess liability above and beyond what the car policy and the property policy will handle. Many Floridians own real estate outside of Florida. While a few national carriers will issue one umbrella policy to cover excess liability for both Florida and out of state properties or car driving, most often Florida residents need a separate umbrella policy for each state where they have a vacation residence and one or more vehicles. Many Floridians do not realize that their personal umbrella policy will not cover a car or home outside of Florida, so this should be checked periodically. To make matters even more complicated, the majority of homeowner’s policies, including Citizens, only cover liability on homes and residences for up to $100,000, and a great many policyholders have umbrellas that only cover liability exceeding $300,000. This makes for a $200,000 gap! As a result of this, many Floridians are having to buy a separate $200,000 “donut” policy from a company called RLI, which mobilized quickly when this phenomenon occurred, to fill the hole. Also, Citizens and several other insurance carriers do not provide any liability coverage whatsoever for pet liabilities, and pools do not qualify for liability coverage unless certain safety requirements are met. Fortunately, there are umbrella liability insurance carriers that will cover pet and pool accidents down to the first dollar, if properly structured under a “drop down umbrella” policy. Many clients ask us how much liability insurance they should have. This is a business decision, but we encourage clients to have as much as they can reasonably afford, regardless of whether they have proper creditor protection planning in place. Apparently many insurance agents tell clients that the liability coverage should be equal to the value of the client’s assets. We believe that a better measure is whether the liability coverage will be enough to handle claims that could cause a client’s assets to be wiped out. For example, an elderly client with $1,000,000 of unprotected assets may want to have a $5,000,000 umbrella if he or she is driving in densely populated Pinellas County and would be likely to be blamed by a jury for a serious accident. Most umbrella companies will provide up to $5,000,000 of coverage above $5,000,000 normally requires a second umbrella policy.

71 Typical umbrella insurance rates for a married couple with two cars and a home in Florida are shown on the chart on the next page with uninsured motorist coverage limits described as well, courtesy of Chuck Wasson of Wasson Bay Area Insurance in Pinellas Park, Florida.

[THE FOLLOWING CHART NEEDS TO BE FIXED!]

Two webinars on the above topics can be viewed on our law firm’s website at http:// gassmanlaw.com on the webinars page. The first is called “What Mary Poppins Didn’t Know About Umbrellas” and the second is called “What Citizens is Doing to Our Citizens.” We thank Chuck Wasson for helping us put together these informative webinars. Below is a form letter that we often encourage clients to fill out and fax or email to their insurance agencies, to help make sure that they have appropriate coverages and minimal gaps: Re: UMBRELLA LIABITY INSURANCE COVERAGE Dear ______:

As part of our planning I wanted to reiterate the importance of having an appropriately coordinated and “gap free” liability and casualty insurance program. I am enclosing a sample letter that some clients use to help assure that they have coverage for common gaps or mistakes made in structuring liability insurance. If you would like assistance in completing this type of letter, please let me know. The rest of this letter is about umbrella liability insurance coverage. We believe that it is very important to have appropriate limits of liability on automobile and homeowner insurance policies. Typically, the automobile and homeowner policies will be at $500,000 coverage, and then there will be excess coverage under what is called a “personal umbrella policy.” The personal umbrella policy is used in combination with homeowners and auto policies to cover most clients’ needs. If it is a true “umbrella” it will provide excess limits above and beyond your primary insurance coverage (such as homeowners, automobile or boat policy), and will also provide coverage for situations excluded or not addressed by underlying coverages. Each individual insurance company will have its own requirement for limits that you must have on your primary policies. You will want to be careful to assure that these policies are coordinated with your umbrella coverage.

75 Umbrella limits start at $1,000,000 and can go over $10,000,000. Pricing for these policies are based primarily on the number of houses and vehicles to be insured, with each additional $1,000,000 of coverage being less expensive than the preceding. Another coverage that is often underutilized by clients is called “uninsured motorist coverage.” If you are in an automobile accident caused by someone who does not have enough coverage to pay for your damages, you can pursue your own insurance company to the extent of your “uninsured motorist” coverage. We encourage clients to see what it costs to have $500,000 or more in uninsured motorist coverage to help compensate for catastrophic accidents that can happen. Some carriers, including Citizens and carriers who have assumed policies from Citizens do not provide liability coverage for pool and pet or animal related liabilities. In this event the umbrella liability coverage may or may not apply. This is something that should be discussed with the insurance agency or carrier that provides liability coverage. If we can provide you with any further information or with assistance concerning your insurances, please let us know.

Very truly yours,

______, 2020

Dear Liability Insurance Agency and/or Carrier:

I recently met with my estate planning lawyer and wanted to make sure of the following:

1. Please confirm that we have Personal Liability Umbrella insurance covering our automobiles, boats, recreational vehicles, and all properties owned. I would like quotes on the following coverage

limits, $1,000,000, $3,000,000 and $5,000,000, with and without Uninsured Motorist coverage.

2. Please confirm that we are covered for animal liability under our primary homeowners insurance and confirm that the Liability Umbrella would also extend to animal liability. We have been told that the primary homeowners may exclude animal liability and that some Liability Umbrella policies will not provide coverage when the primary homeowners insurance excludes same.

3. Please confirm that we are covered for pool related accidents occurring on our property and also confirm that the Personal Liability Umbrella policy will also extend coverage to pool related accidents.

4. Can you please confirm that we are covered for cars being driven by ______.

5. Can you please confirm that we are covered for the investment property that we own at ______. It is titled under the name of ______?

6. Can you please confirm that we are covered for our ______boat, which is ______foot long and is normally stored at ______. The horsepower is ______.

Are we also covered for trailering the boat with our trailer?

Also, can you please confirm that we are covered for our waverunner/jet ski which is a ______with horsepower of ______. It is stored at ______.

77 7. You do not handle the coverage for our vacation ______in ______or our vacation ______in ______. Is our potential liability relating to the use of these properties covered under our umbrella, or do we have to obtain a separate umbrella for these properties?

Our ______and ______are stored and used up in our ______.

8. ______drives the car owned by ______both for personal purposes and with respect to the ______business. We assume our coverage includes business driving both by ______and by ______who occasionally drive the car for the business.

9. Can you please confirm that we are covered for our motorcycle being driven by ______.

10. Is there anything not mentioned above that comes to mind that we should be aware of?

Please send our lawyer, Alan S. Gassman, a copy of your response to this letter, which has been generated as a part of our estate planning. Alan’s email address is [email protected] and his street address is 1245 Court Street, Clearwater, Florida 33756. His fax number is (727) 443-5829. Please send us a copy of your response as well.

If you have any further suggestions with respect to our coverages please let us know.

Thank you very much for your assistance herewith.

It is never a bad idea to get a second opinion from an independent insurance agency that can write coverage for many different carriers before coverages come up for renewal. This helps ensure that coverage costs are competitive and that there are no significant gaps in coverage or other similar issues. Clients with businesses should have separate primary and umbrella policies. These business policies should properly interact with their personal policies when it comes to car driving and other quasi-business/personal activities. Beyond insurances and keeping assets structured for creditor protection purposes, the ability to limit liability through the use of companies and similar entities is also worthy of discussion.

Corporate Firewall Protection: Using Corporations and Other Entities to Provide Liability Protection Certain endeavors that would normally result in liability may be placed under a limited liability company, a regular corporation, or certain other limited liability entities to provide “firewall” protection. The law is very clear that the shareholder or member of a company or limited liability company is not responsible for liabilities of the company itself absent guarantees, personal negligence, or certain other exceptions to what we call “firewall” liability. See Florida Statutes Section 608.4227 (discussing liability for members of an LLC).

This is why virtually all successful businesses and professional practices, as well as many real estate and other endeavors, are established under corporations, LLCs, limited liability limited partnerships (LLLPs), and similar entities.

It is important to make sure that business entities are properly managed from a legal documentation and fiscal standpoint. Individuals working on behalf of or managing a limited liability entity may become responsible for their own acts or acts of those that they are, or should be, supervising.

Even professionals with their own solo practices will typically have significant amounts furniture, equipment, and accounts receivable held under their professional practice corporations. It is often possible to structure debt,

79 ownership, and corporate arrangements to reduce exposure to creditors under professional practice circumstances. This is where firewall protection comes into place; it prevents the owner of a company or certain other entities from being responsible for liabilities of the entity. For example, rental property should almost always be owned under limited liability companies, so that if there is a catastrophic accident on the property, a tenant would not be able to sue the owners. Please note, however, that a tenant might be able to sue a manager who was shown to have negligently caused the injury to the tenant.

The Manager or Officers May Still be Sued Notwithstanding that the owner of a company will generally not be personally responsible for the liabilities thereof, the manager or president of a company may be held personally responsible for any negligent or inappropriate conduct. Why not make your nephew who has no assets the manager of your property rental company? Clients should think through who the responsible officer or manager of a company or other entity should be when potential liability is a factor. We therefore normally recommend that the doctor’s spouse has minimal involvement with any company that the doctor is involved with, at least from a management and officer standpoint. Joint ownership is discussed in Chapter 3 and may be useful for other purposes. An owner is not necessarily responsible for liabilities or obligations incurred by the entity owned. Many advisors and laymen think that LLCs or other corporations that are disregarded for income tax purposes or treated as S corporations do not shield liability like other companies do. This is incorrect. More information on LLCs and other business entities can be found in Chapter 23 of Creditor Protection for Florida Physicians, which is available for purchase on Amazon.

Vehicle Liability Under Florida Statutes Section 324.021(9)(b)(3), the owner of a car can be held vicariously liable for the negligence of any permitted driver. However, the law limits liability of an individual owner where the driver has insurance with a large amount of coverage. If a driver has at least $500,000 of liability insurance coverage, then the automobile owner is only liable for up to $100,000 per person, up to $300,000 per incident for bodily injury, and up to $50,000 per

80 incident for property damages, all of which will be satisfied by payment made by the liability insurance carrier providing the coverage described above. If the permissive user does not have sufficient liability insurance coverage, then the vehicle owner may be liable for an additional $500,000 in economic damages, but the economic damages responsibility is reduced by amounts actually recovered from the driver and from any insurance or self-insurance covering the driver. It is not clear under the statute whether joint owners will have any limitation on liability for one another’s driving negligence even when there is $500,000 worth of insurance in place. This limitation statute does not apply to situations where an automobile has been “negligently entrusted” to an inexperienced or known dangerous driver, or where the accident occurs outside of Florida. Typically, one parent will take the child to get his or her learner’s permit and sign a form called “State of Florida Department of Highway Safety and Motor Vehicles Parental Consent for a Driver Application of a Minor,” which indicates that the signor is responsible for the child’s liability incurred on Florida roadways pursuant to Florida Statutes Section 322.09. Then, when the child goes to get an actual driver’s license, the parent(s) will consent to the state granting the license by signing a form called “State of Florida Department of Highway Safety and Motor Vehicles Certification of Driving Experience of a Minor,” which removes the signor’s liability for the child’s negligence. Typically, the parents are the ones who take the child to get his or her learner’s permit and sign the document, giving them this temporary potential unlimited liability. Under the rules, the person who signs this must be the parent or legal guardian of the child, and not a stepparent or other person. In 2007, Hulk Hogan’s son was in a tragic accident approximately 100 yards from the author’s office in Mr. Hogan’s car, and the case reportedly settled in the neighborhood of $5,000,000, according to a Tampa Bay Times article. Mr. Hogan would have been well-advised to have put the title to this car in his son’s name rather than his own.

Using LLCs and Other Entities to Avoid Liability and for Business Structuring Commonly companies will establish subsidiary LLCs to own and operate vehicles, and then manage these LLCs at arm’s-length. The Florida Supreme Court made it difficult for creditors to pierce a related company that is held

81 separately in the decision of Dania Jai-Alai Palace, Inc. v. Sykes, 450 So. 2d 1114 (Fla. 1984). This decision indicated that actual fraud must be shown in order to pierce the corporate veil. As a result, related brother/sister or parent/subsidiary arrangements are often used, while being disregarded for income tax reporting purposes. In Kane Furniture Corp. v. Miranda, 506 So. 2d 1061 (Fla. 2d DCA 1987), the court determined that a carpet installer was an independent contractor for Kane when, after leaving a bar where he had been drinking for hours, he hit and killed another driver. Using the control test from agency law, the court determined he was not legally an “employee” of Kane, and therefore Kane could not be held vicariously liable.

82 THE 10 MOST COMMON MISTAKES ESTATE PLANNERS MAKE WITH RESPECT TO ASSET PROTECTION By: Alan S. Gassman Reprinted with permission from Leimberg Information Services, 02-Nov-01 Steve Leimberg’s Asset Protection Planning Email Newsletter - Archive Message #9 WHY ASSET PROTECTION PLANNING?

Asset protection planning is obviously a big part of estate planning. Planning for the protection of the client who is asking for advice on asset ownership, beneficiary designations, and financial strategies makes the estate planner responsible for providing appropriate advice on helping the clients to insulate their assets from known or potential future creditor claims. Further, clients will generally want their beneficiaries protected from creditor claims as well, and expect that the estate planner is taking these objectives into account in designing an estate plan.

Here are some of the most common problems we see: 1. Failure to address asset protection planning as a part of the estate and business planning process. A great many clients have told us that they expected that their revocable living trust would protect them and the assets in the trust from the claims of creditors. Other clients have told us that they expected that the plan prescribed by a prior advisor should have protected their assets from creditors when it would have been relatively easy to do so. Still other clients express surprise that significant creditor exposure that could have been avoided or at least understood were not pointed out to them in an estate planning consultation. The estate planner should have a general background on debtor/creditor law, particularly as it relates to exemption planning (what assets creditors generally cannot seize) and the overall business and personal activities of the client that can result in creditor exposure. The estate planner should help clients think through activities that they might be engaged in that can cause significant liability. The importance of having appropriate insurance coverages and understanding what insurance will and will not cover can also be discussed. At a minimum, the estate planner

83 should make clear what advice they are not giving or what areas of planning they are not able to assist with when it comes to asset protection advice. Common examples of circumstances that should be discussed are real estate that may have hazardous waste issues, rental or business activities that are done in a proprietorship or general partnership forum, situations where there could be a de facto partnership involving the activities of others, and making sure that there is plenty of liability insurance covering automobile driving and professional activities. At the same time, the estate planner should stress that there are ways to own assets or certain assets that are less creditor accessible, and that the law does allow an individual to situate their affairs so as to be insulated from creditors and also to limit the exposure of a particular activity to the assets involved with that particular activity (i.e., “firewall protection” - such as using a corporation to be involved with a high-risk activity and keeping only minimal assets within the corporation). In conjunction with asset protection planning, many clients also naturally believe that assets within a revocable trust would not be accessible to Medicaid and that the client would be able to qualify for Medicaid because of having set up a revocable trust. For the elderly client, Medicaid eligibility planning can be a very important activity, both from a fiscal and psychological standpoint. The many planning opportunities that are available in the Medicaid arena need to be discussed or the estate planner should limit their responsibility where appropriate. The estate planner should have a general background to be able to spot major issues and Medicaid eligibility candidates as to clients, their parents, and children and loved ones who may have disabilities.

2. Failure to recommend protective arrangements for beneficiaries. Any significant outright devise or gift raises the question of whether the recipient will be able to have full enjoyment after the transfer, given considerations relating to potential creditor, divorce, or child support claims against a beneficiary. Is the beneficiary well suited to handle investment and spending decisions, and will the beneficiary be subject to pressure from a spouse or other individual to place the assets into joint names, to make gifts that they might not otherwise want to make, or to make high risk investments or loans?

84 Most educated clients, when offered the choice between providing an inheritance outright or through a trust where the client has significant input as trustee or co-trustee and the trust assets gain significant protection from creditor claims, divorce claims, and also estate tax planning benefits, will generally choose such a protective trust. Clients often come to the author with estate plans that provide for distributions to pay out certain percentages at specified ages. Quite often, such clients, upon brief reflection, change the distribution provision to provide that instead the beneficiary may become co-trustee at a certain age, co-trustee with their choice of any licensed trust company or any one or more persons from a list provided in the document at a later age, and perhaps sole trustee of the whole trust or a sub-trust that would break off at a certain age or upon the happening of a certain event. Beneficiaries who are, or will in the near future be, elderly or may have mental or physical infirmities are certainly candidates for this type of protective trust mechanism. How many clients with several children and grandchildren can actually look their estate planner in the eye and say that there is no potential divorce, creditor, spendthrift, or mismanagement situation that could ever apply to any of their beneficiaries?

3. Telling the client “it’s too late to do anything.” In law school we are taught that fraud is a terrible and actionable tort, and many times a criminal act as well. We were also taught that transferring assets for the purpose of avoiding creditors can be a “fraudulent transfer.” What we are not taught is that a fraudulent transfer does not constitute a fraud, notwithstanding the nomenclature. In most states, the transfer of assets to avoid a creditor’s claim is not considered to be a tort or a crime. Under most fraudulent transfer statutes, the sole remedy of a creditor is the ability to reach to where the assets were transferred in order to have access to them to the extent permitted under state law. The fraudulent transfer statutes generally do not have any attorney’s fee provisions; thus, making a fraudulent transfer is not necessarily a high-risk endeavor.

Further, the burden of proof is generally on the creditor to prove that a fraudulent transfer was made. Creditors can have a hard time satisfying this burden where, at the time of a transfer, the debtor’s situation was such that in all probability a particular claim or risk of claim would be resolved by

85 insurance policies, other parties who are more responsible than the defendant, or by the debtor retaining sufficient assets to satisfy the reasonably expected obligations of the claim. Additionally, in many cases there are business and tax reasons for making transfers. Would you advise a client not to have proper estate tax planning because the execution of the document might be considered a fraudulent transfer that may protect their assets from a creditor situation if it ever got out of control? In many cases it will be appropriate to confer with a bankruptcy or debtor/creditor law specialist to determine whether a transfer is permissible or advisable, and to also confer with litigation counsel to determine what the reasonable probability and expected exposure of a claim or claims may be. Then a well-educated client can make a proper decision as to how to proceed. Clients do need to be informed of the state fraudulent transfer statutes, and also of the Bankruptcy Code section under which a discharge can be denied if a fraudulent transfer has taken place within one year of filing bankruptcy. Bankruptcy counsel may advise, however, that it is nearly impossible for a single creditor to force a debtor into bankruptcy within a year of receiving a judgment where the debtor has plenty of exempt assets to pay their other bills and obligations as they come due.

4. Putting all eggs in one basket.

A good many “asset protection specialists” are typically pitching one or two mechanisms, and certainly from a client satisfaction and closure standpoint, it’s easiest to make one or two mechanisms seem to be the right solution for just about every client’s problems. But there are a number of potential problems inherent with this type of strategy, which quite often involves an offshore asset protection trust, a limited partnership, or a combination of these two techniques.

Although charging order protection is apparently available in all states, and, unless there has been a fraudulent transfer to the partnership entity, creditors should not be able to seize assets directly from the partnership, clients need to understand that having a charging order against their limited partnership can effectively prohibit them from receiving any economic benefit from the partnership without sharing with the creditor. The debtor would have to rely upon a court of equity to allow them to obtain economic benefits from the partnership, such as compensation for services rendered or to use

86 partnership assets to capitalize a business that they may work in. While most creditors can probably be bought out of charging orders for pennies on the dollar, this will not always be the case and the clients need to know this.

With respect to asset protection trusts, the recent appellate decisions, which have resulted in at least two offshore trust planning debtors facing time in jail for contempt, must be reviewed with any client considering this strategy. While the Anderson and Lawrence cases each involve egregious facts, the language of the 9th Circuit of Appeals, to the effect that it will be presumed that a debtor has control over an offshore trust mechanism where the bulk of their assets have been conveyed to the mechanism, makes the “impossibility of performance” defense a challenging opposition in the offshore trust arena, particularly where clients have named themselves or close friends or relatives as the trust protectors of the trust and where the trust protectors have plenary powers over the trust arrangement.

While most plaintiffs’ lawyers will probably settle for limited liability on an available policy where the only other assets are in an offshore trust mechanism, this did not work for Mr. and Mrs. Anderson, Mr. Lawrence, or Mr. Brennan, and each of their cases would have been much stronger if they had not had all of their assets in the offshore trust mechanism.

With the availability of life insurance policies, annuity policies, pensions, IRAs, limited partnerships, limited liability companies, tenancy by the entireties, placing assets in a non-risk spouse’s name, domestic asset protection trusts which have significant utility for estate tax planning purposes, and gifting, most clients will be well advised to use a variety of planning methods and vehicles simultaneously, particularly where they have a high value, multiple asset and family member situation. We often tell clients that for every complicated situation there is a simple answer - - - and that it is the wrong answer. Complicated situations will often be resolved by complicated solutions.

Over 90 different strategies for asset protection are set forth in the author’s outline on Asset Protection in the Estate Plan which can be accessed on the Internet at gassmanlaw.com.

Many planners have made the “limited partnership” the save-all instrument of asset protection planning, without giving clients a good background on alternative exempt assets, asset protection trust planning, and

87 what a court of equity might do with a charging order situation. While it’s easy to tell a client that a creditor can do very little with a charging order, there’s no way to predict what the evolution of the law will be in this area with the proliferation of so many aggressively structured asset protection limited partnerships.

Further, a court in equity is not necessarily going to look very kindly upon a debtor who attempts to derive significant wages or other benefits from partnership property or who provides such benefits for their family members while thumbing their noses at a creditor with a charging order. Further, the Revenue Ruling which is often touted as requiring that the creditor with a charging order receive a K-1 for partnership income is not directly on point. In that Ruling, the creditor received an assignment of a partnership interest as opposed to a charging order. Many commentators have written that the same result will not necessarily apply in a charging order situation. Thus, it could be the debtor partner who has to pay income tax on income derived from an asset that he or she has no access to.

5. Failure to refer the client to appropriate counsel to help handle a known matter.

Many clients will choose to ignore a problem that should not be ignored or are not aware of legal rights that they have which may not be fully pursued by the liability company or the liability company’s legal counsel defending a claim.

For example, failure to timely report a claim to a liability insurance carrier could result in loss of coverage. Further, liability insurance carriers have an obligation to settle a matter within limits of coverage when the opportunity becomes reasonably available to them. In many situations, plaintiff’s counsel will offer to settle within the limits of liability, and the liability insurance carrier, based upon statistical experience, is willing to take the risk of not settling and going to jury trial knowing that perhaps three out of four, or four out of five times, the jury verdict will come in substantially less than defense costs plus the plaintiff’s last offered settlement amount.

The problem is, however, that one out of four, or one out of five times, a verdict may come in well above policy limits, leaving the client in the lurch unless it can be shown that the carrier failed to act reasonably in order to settle the case. Private defense counsel cannot only look over the shoulders of the

88 insurer’s defense counsel to make sure that a proper defense is provided, but might also be able to communicate with the plaintiff’s attorney to induce a settlement offer within policy limits, and then provide correspondence to the insurance carrier demanding settlement within policy limits to establish that an excess verdict is going to be the responsibility of the insurance carrier to the extent provided under state law.

Once it is established that a particular situation is covered by insurance and that the insurance carrier has had a reasonable opportunity to settle within policy limits, the chances of the client being considered as insolvent become quite remote given the insurance coverage up to policy limits and the bad faith cause of action that would exist above policy limits. At that time, it should be possible for the insured to transfer assets without such a transfer being considered as “fraudulent” with respect to the plaintiff. Of course, the documentation needs to be in place to support these items.

These are examples of why specialty counsel will often be retained by an estate planning lawyer who has an asset protection project underway.

Litigation counsel can also opine as to the potential liability of a case where there is no insurance coverage to help document that the client or other entities associated with the problem have sufficient financial wherewithal after making estate planning transfers to handle the problem.

Just as importantly, seeking assistance from an experienced bankruptcy attorney can be very useful.

6. Just because it “might not work” doesn’t mean that the strategy should not be pursued.

Oftentimes a client will come to our office several months after a claim has been filed against them, with significant assets totally exposed. When asked why the client has not transferred the assets to an exempt status, they will often indicate that they consulted with another lawyer who told them that asset protection strategies might not work. Besides confusion over the meaning and effect of fraudulent transfer statutes, such prior counsel, being the perfectionist tax lawyers that so many of us have been trained to be, may have been thinking in terms of a 5% or 10% chance that a strategy might not work, as opposed to a 90% to 95% chance that the strategy would work and that the

89 assets would be saved. If you were the client, which course of action would you embrace?

The author is reminded of the many clients who have been advised not to establish limited partnerships because the discounts “might not work” and the many lawyers who are still not using family limited partnerships, notwithstanding the case law that firmly supports their existence.

The fact is that from a negotiation standpoint, the client has a much better chance of settling the matter if they can look into the eye of the plaintiff or the plaintiff’s lawyer and indicate “go ahead and spend all your time and money pursuing me in court; I’m judgment proof anyway.” At that point most plaintiff lawyers are going to recommend to their client that they accept available insurances or a nuisance value settlement. Rarely will the plaintiff’s lawyer be so bold as to ask “when did you become insolvent and will I be able to set it aside?” The natural answer to that, however, would be “that’s for me to know and you to find out and good luck ever touching my assets.”

7. Failure to plan in time.

Notwithstanding mistake number 3 described above, clients are well advised to have their estate planning and asset protection coordination finished well before any reasonably expected circumstances arise which cause liability. For example, an estate planner doing an estate plan for a neurosurgeon should of course have the neurosurgeon completely judgment- proof as a part of the planning objective. Failure to do so will expose the estate planner to malpractice liability.

8. Failure to thoroughly understand exemption rules and exceptions thereto (as if anyone ever could!).

As with many areas of law, the rules concerning exempt and non-exempt assets, rights of lienholders, and fraudulent transfer rules can be quite challenging. Simply reading the exemption statute of a particular state or a short treatise excerpt falls short of the due diligence that needs to occur before a client is advised as to creditor exemption planning. Not only is it important to understand the case law in these areas, but quite often there are Achilles’ heels in factual scenarios which have not yet become the subject of case law.

90 A good example of this is the Florida Wage Exemption Statute. This statute provides that the wages of the primary earner in a family are protected from creditor claims as an exempt asset for up to six months if not commingled with other assets. The statute specifically provides that an independent contractor’s earnings can qualify for this exemption. But case law in Florida has held that where the debtor is a “controlling shareholder” of the company that he or she works for, the ability to “manipulate” between dividends and wages opens the statute up to too much abuse to provide any protection.

Therefore, in one published decision, a dentist who was a 50/50 shareholder in a dental practice and whose wages were based upon his personal productivity, less a fair share of the overhead, was deprived of any protection under this statute.

Notwithstanding this, an almost identically worded statute in California has been held to apply even where a well-known entertainer had a solely- owned production company and designated revenues from entertainment related endeavors to be wages. Also, some conservative bankruptcy lawyers believe that monies from a wage account transferred to another form of exempt asset within one year of bankruptcy could trigger the fraudulent transfer rule that applies under the Bankruptcy Code.

Many individuals in tenancy by the entireties states (and their lawyers) have been surprised to find that where one spouse files bankruptcy and there is joint debt, joint assets can be brought into the bankruptcy estate notwithstanding the “absolute protection” of tenancy by the entireties. Other debtors have found out that putting their mother-in-law on the joint account as an additional signer can also invalidate tenancy by the entireties.

Debtors filing with pension plans have found that the “absolute protection” provided to qualified plans under the Shumate decision will not apply if there is a technical flaw with the plan that would cause it to be disqualified for income tax purposes, or the debtor and family members are the only participants in the plan so that ERISA protection does not apply.

The treacherous nature of the exemption rules and the fast-developing exceptions thereto make it very important for the estate planner to confer periodically with well-versed and active bankruptcy counsel. Another example is the statutory protection of annuity and life insurance contracts. When these statutes were passed, there was no such thing as a variable annuity, so a Florida

91 bankruptcy court decision found that variable annuities were not really annuities as defined by the statute.

This was overturned by the Florida Supreme Court, but another way around this type of statute was found by a creditor in New York where a husband and wife each had life insurance on one another. The New York court in Jacobs apparently found that the debtor husband was not really the owner of his own policy because of the reciprocal arrangement with his wife. See Steve Leimberg’s Estate Protection Planning Newsletter of August 23, 2001 at Leimberg Information Services (www.leimbergservices.com). Once logged in, click on the Asset Protection tab and go to Commentary 8.

9. Failure to think outside of the box.

We have found that oftentimes there are creative solutions to planning challenges that are simply “not thought up” by initial advisors.

The process used in evaluating alternative strategies that may not be readily apparent initially, and the use of basic creativity, often involves brainstorming with other professionals, investigation of alternative strategies that at first may not seem useful, review of estate planning and business considerations and alternatives, and sometimes “making things complicated” so that they would not be easily understood by a plaintiff’s attorney. For example, what can be done with S corporation stock? It needs to be owned by an individual or a qualifying grantor trust to retain the S election, and a foreign grantor trust will not qualify as an S corporation shareholder. S corporation stock can also be owned by a defective grantor trust, but a gratuitous transfer of that stock may be considered to be a fraudulent transfer.

Such stock could be sold at arm’s-length in exchange for a long-term promissory note, and a creditor is going to be less than excited about receiving a long-term promissory note. A promissory note can be sold at arm’s-length at a later time, perhaps taking into account a discount. If the client has a shorter than normal life expectancy, the receipt of a private annuity as consideration under this type of arrangement can have a further positive estate tax planning result. Also, S corporation stock can be made to be voting and non-voting, and selling a 1% voting interest in S corporation stock to a trusted third party can yield positive estate tax planning results.

92 Oftentimes banks would like to have liens on assets and entities that may have creditor protection issues. For example, if a physician’s building is subject to a mortgage, upon refinancing, better terms may be obtained if the bank also receives a lien on the medical practice corporation’s assets. If the medical practice were to go bankrupt, the doctor’s spouse could buy these assets and the bank could apply the proceeds to pay down the mortgage loan. The personal injury lawyer and their client would be out of luck and unrewarded for pursuing the medical practice; they should settle for limits of coverage.

10. Failure to educate the client. It is obvious from the above that there are a great many decisions that have to be made and strategies that could be considered in asset protection planning. Obviously, many planners, given the same factual scenario, would implement significantly different plans. Whose decision should it be as to whether a client will pursue offshore asset protection, get married and put assets into tenants by the entireties, ignore a situation, or file a Chapter 7 bankruptcy before a judgment is even entered against them?

Educating the client as to the general rules of application, the different strategies available, and the risks associated with each strategy constitutes the best way to assure that the plan chosen is the best one to suit a particular client. This is also the best way to help avoid a malpractice action later on down the road when the client might question why a particular strategy was taken and another particular strategy was not pursued. The estate planner should keep in mind, however, that if the client files a Chapter 7 bankruptcy, the trustee in bankruptcy has the right to review any and all otherwise privileged attorney- client correspondence, so the “CYA letter” may provide a road map to creditors and could be detrimental to the client and the estate planner.

Nevertheless, characterizing the nature and value of assets as revealed by the client and documenting the file with respect to assets that will be retained after certain transfers may be made can help to prove expected solvency to occur after a transfer in order to help defend allegations of fraudulent transfers. Having the client obtain a second or even third and fourth opinions as to the plan to be pursued can be a good strategy as well.

When filing for bankruptcy the debtor needs to disclose on the application all lawyers consulted within one year of filing and the primary reason for the consultation. It may therefore be advantageous for the client to

93 hire bankruptcy counsel, and for the bankruptcy counsel to bring in sub- specialists through his or her office. This allows the estate planner to maintain contact and continuity of communications throughout the process.

CHAPTER 5 - STEP 5 INHERITANCE PLANNING We have now provided the preliminary considerations that apply to almost anyone who wants to plan their estate.

Now we can get to the core purpose of estate planning.

This involves determining who you want to benefit from your estate plan, and how they are best served with respect to inheriting outright, in trust, or otherwise. Before we cover creditor protection, tax planning, and related considerations in a client meeting, we encourage clients to think through the practical implications of devising assets outright or in trust for a beneficiary so that our tax, creditor, and estate planning is designed with their inheritance goals in mind.

Should You Trust a Trust? Too often people overlook the benefits of leaving assets in a trust for children instead of leaving the property to them outright. We have seen countless individuals inherit monies or receive large gifts only to have them dissipated in a few months or years. As a result, the beneficiary and his or her family become penniless or again dependent upon the parent or other family members for financial sustenance. On the other hand, leaving assets in trust can also result in trouble. A beneficiary who expects a lump sum from their wealthy parent’s estate is often unhappy to learn that instead of inheriting outright, they have become the beneficiary of a trust accumulated for the purpose of preserving assets for their

94 benefit. Consequently, the beneficiary is not permitted to spend the money immediately and live a life without having to work. In some cases, the primary fear or dissatisfaction comes from the inability to control or influence a trust company or individual trustee who may be improperly handling investments or making poor distribution decisions. To ameliorate both of the above problems, we commonly suggest and implement a Beneficiary Controlled Accountable Trusteeship (“BCAT”), where upon reaching a certain age or achieving certain goals, such as completing a college education and finding gainful employment, a beneficiary has the right to serve as co-trustee and to designate one or more individuals or a licensed trust company to serve as co-trustees in order to provide appropriate safeguards and accountability. Many clients feel much safer choosing this type of arrangement rather than appointing an unproven or inexperienced co-trustee, especially where there may be a marriage or in-law situation now or in the future that could cause an individual to lose control of assets intended for him or her. According to a recent study, over 50% of marriages end in divorce within 20 years. Although we do not have statistics for the divorce rates of marriages that have lasted longer than 20 years, we are saddened and surprised every year when we see 30 and 40 year marriages that ultimately end in divorce. When we meet with a married couple and explain that on the wife’s death the husband might marry a “Hooters girl with lovely children” and may lose most of his individual assets to this “new family,” the co-trustee conversation can have great meaning! By the same token, a husband might die leaving an inheritance to his wife, who might remarry a well-meaning man who would like to advise her on how to invest her assets, or the second husband could need loans or capital contributions for a business or real estate investment that may fail miserably. We commonly see well-meaning and semi-well-meaning advisors descend upon a recently widowed spouse who is in need of moral support and does not have the ability to determine whether financial proposals and decisions are being properly made.

95 Oftentimes, the surviving spouse is not aware that many financial advisors are paid on a commission basis and may be influenced by recommendations that primarily benefit the advisors! Having a trust arrangement in place, at least for the first few years after the death of a loved one, can be invaluable in these circumstances. Young or middle-aged clients will often assume that they can safely hold family assets as a sole trustee, but realize upon discussion that they may need co-trustees as they age. We all get older and frailer as life proceeds and risk of physical or mental incapacitation increases with age. As an individual gets older, children, spouses of children, and others may make heavy-handed attempts to receive gifts and loans or to influence investment decisions that essentially nullify the surviving spouse’s independence. This is less likely to occur when the surviving spouse serves as co-trustee with an independent trust company or trustworthy advisor who is not part of the family dynamics but is smart enough to help the surviving spouse deal with these problems. Some clients choose not to impose this requirement until the surviving spouse remarries, cohabitates with someone else, or reaches an older age where the onset of dementia becomes more likely, such as age 75. Dementia affects one in 50 people between the ages of 65 and 70, but the odds increase to one in five for people over 80 years of age!

Avoiding Probate by Using Revocable Living Trusts Probate is the process whereby a deceased person’s assets are moved out of his or her name into the name of trusts or beneficiaries as set forth under the decedent’s Last Will and Testament. Florida probate requires that the probate court judge preside over a proceeding to assure that the correct Will is given effect, that the “personal representatives” selected under the Will are bonded and understand their responsibilities, that creditors are paid, and that beneficiaries receive what they are entitled to receive, including an accounting of expenses and income generated during the probate process. Probate is often criticized because it requires hiring a lawyer and can involve a significant amount of paperwork and “red tape,” which can be expensive. Law firms and trust companies are able to charge fees based on a percentage of the assets that pass through the probate process, meaning that the family of someone who dies with a large estate may end up paying huge

96 probate costs. However, if a person has most of his or her assets under a revocable living trust that avoids probate, these companies typically charge a smaller percentage or a much smaller fixed fee. Many people use pay on death accounts, joint with right of survivorship accounts, and other techniques to avoid probate. These approaches can backfire severely. For example, some parents will place assets in joint names with a child who then gets into a divorce or a car accident, and half or more of the asset gifted can be lost. One client put his car in joint names with his son, and then his son had an accident and the client lost hundreds of thousands of dollars because the son did not have enough liability insurance. When assets are held under a revocable living trust, the successor trustees named under the trust can administer these assets privately without probate or consequent delay, expense, or public access to required information. As a result, expenses can be significantly reduced, but without court oversight there is a higher chance of theft, misadministration, or failure to follow reasonable guidelines. A revocable living trust is completely separate and different from a living will. A revocable living trust is an arrangement whereby an individual places assets under a trust that he or she can control while alive and competent. The trust can name an alternate successor trustee or co-trustees who can take over control and administration of the assets in the event of the person’s incapacity. If the person ends up in a guardianship, the trustee of the revocable trust can continue to control the assets under the living trust. On death, the assets under the trust pass without having to go through probate. The decision as to whether to use a Will or a trust system is an important one. Many Floridians are led to believe that as long as they have a trust everything will be fine, without regard to how the trust is actually used. They may also be told, or simply assume, that a revocable trust will protect their assets from creditors. This is never the case. In fact, even an irrevocable trust in Florida that can be used for the grantor will be accessible to the grantor’s creditors! Many married couples will share a joint trust or set up separate revocable trusts, depending upon their situation. We see many grave errors made by non- specialist lawyers and other advisors when it comes to trust system selection and design for married couples. For example, it may be best to allow all assets

97 to be owned by the surviving spouse if the considerations discussed earlier in the book do not apply, but many joint living trusts do not allow a high degree of control for a surviving spouse. Also, some trusts will not allow for a proper method of holding assets in trust for a surviving spouse so that the assets will be protected from the surviving spouse’s creditors and will be counted in that spouse’s estate for estate tax purposes. An article that we published in a tax advisor’s periodical on various trust systems, which is reproduced below, will be of interest to many professional advisors reading this book, as well as a good number of other readers.

SELECTING REVOCABLE TRUST SYSTEMS FOR CHILDREN By: Alan Gassman, Christopher Denicolo and Kristen Sweeney Reprinted with permission from Leimberg Information Services 02-Apr-09 Steve Leimberg’s Estate Planning Newsletter - Archive Message #1439

EXECUTIVE SUMMARY Advisors have a wide variety of revocable trusts at their disposal, and there are a number of important factors that must be carefully considered. This commentary will review:

1) Protective Beneficiary Trusts; 2) “All to Survivor” Joint Trusts; 3) “First Death Lock-Up” Trusts; 4) “Separate Trust for Each Spouse” Trusts; 5) “Joint 100% Lock-Up” Trusts; and 6) “Joint 50% Lock-Up” Trusts.

FACTS Many estate plans involve revocable trusts, and selection and implementation of an appropriate plan is more of an art than a science. Factors that should be considered when selecting a revocable trust system include:

1) Whether a surviving spouse or beneficiary should have total control or protective advantages that may be available; 2) Whether income tax savings for a surviving spouse may be desirable; and

98 3) What assets and beneficiary designation situations the client may have. NOTE Revocable trusts can be used to avoid probate and guardianship, but during the lifetime of the grantor, if the grantor establishes and owns the trust, there is no creditor protection, Medicaid protection, or income or estate tax savings. After death, such protections and savings may apply depending on the revocable trust system selected.

COMMENT CONSIDERATIONS FOR A SINGLE INDIVIDUAL Many unmarried individuals establish and maintain revocable trusts primarily to avoid probate and guardianship of their estate. Probate is the process whereby assets owned in individual names must be processed through the Probate Court System, in order to ensure that:

1) The proper Will has been identified and approved; 2) Accountings are received by beneficiaries; 3) Creditors are paid; and 4) A fiduciary is appointed as personal representative to execute and monitor all of the above.

Many clients choose to bypass the “red tape” and expenses associated with the probate system by placing their assets under a revocable trust. Immediately upon its formation, the trust is controlled and administered by a non-court appointed relative, friend, professional or trust company. Life insurance, annuities, and even pension benefits can be paid to the revocable trust upon death to facilitate the uniform distribution of assets. For pension plan purposes, it may be advantageous to instead name individuals who are able to withdraw the pension benefits out of an inherited IRA ratably over their life expectancy as beneficiaries. Such ratable withdrawals may also apply under an appropriately drafted revocable trust agreement, but special technical language and planning is required to effectuate this.

99 Some clients choose to place their homestead under a revocable trust, which does have certain advantages. For instance, in Florida, as long as the client is alive, the homestead can qualify for the Florida $50,000 homestead exemption and the 3% cap on increases in value. However, placing the homestead under a revocable trust also presents a potential danger from creditors. There is one bankruptcy court decision which has indicated that the constitutional protection of homestead from creditors will not apply when the homestead is owned under a revocable trust. While other Bankruptcy Court decisions have not found this to be the case, our office generally suggests the more conservative approach of leaving the homestead outside of the revocable trust. Clients who still wish to avoid probate of their homestead may be able to use a “Lady Bird Deed,” which maintains creditor protection while still avoiding probate.

PROTECTIVE BENEFICIARY TRUSTS A revocable trust will commonly provide that upon the death of the client the trust assets will divide into separate protective trusts for any children or other beneficiaries. Each child or other beneficiary may serve as sole or co- trustee for his or her benefit and receive amounts deemed reasonably appropriate to maintain his or her standard of living as well as to benefit his or her children.

The advantage of such a continuing trust includes protection from:

1) Estate tax at the child’s level; 2) Creditor and divorce claims that the child might have in the future; and 3) Inappropriate or risky spending and investments may be curtailed by mandating that the child serve with a co-trustee, i.e., a trusted relative, family friend, professional, or trust company.

REVOCABLE TRUST SYSTEMS FOR MARRIED COUPLES Revocable trusts for married couples incorporate the above principles, but married couples have a number of configurations to choose from:

“ALL TO SURVIVOR” JOINT TRUST

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The simple “All to Survivor” Joint Revocable Trust. A married couple who would typically own their assets jointly with right of survivorship may prefer to use a revocable trust in order to facilitate avoiding probate upon the second death, and avoiding guardianship over trust assets if a spouse is declared by a court to be incompetent. Although most couples who would use right of survivorship as their primary estate plan can simply have assets pass by Will on second death, using an All to Survivor Joint Trust assures that there would be a revocable trust in place after the first death. The All to Survivor Joint Trust eliminates the surviving spouse’s need to engage in estate planning and decision-making regarding the use of a revocable trust after the first death.

NOTE Clients should be careful to confirm that the joint revocable trust with survivorship can be considered to be a tenancy by the entireties ownership vehicle for the married couple. Under Florida law, joint assets held as tenants by the entireties between a husband and wife are not subject to the creditor claims of an individual spouse unless both spouses owe the creditor. This is a very good reason to keep assets jointly as tenants by the entireties where spouses are creditor exposed. Most joint revocable trust forms used by lawyers will not qualify the trust assets to be considered as held as tenants by the entireties, but with proper drafting this can be accomplished.

“FIRST DEATH LOCK-UP TRUSTS” There are several good reasons that a married couple might wish to have some or all of their assets “locked up” in a protective trust upon the first death, including:

1) Avoidance of federal estate tax upon the second death. 2) Creditor protection for the surviving spouse upon the first death. 3) Securing a co-trustee for the surviving spouse to help prevent loss of assets to undue influence, poor investments, or unwise distributions or loans to friends or family members. The surviving spouse can serve as

101 co-trustee with the power to select and replace the other co-trustee, and can receive benefits as needed for themselves and descendants. The “All to Survivor” Joint Trust described above will not provide these protections. Therefore, the married couple wishing to have the protections provided by a first death “Lock-Up Trust” may choose one of the following three revocable trust systems:

1) “SEPARATE TRUST FOR EACH SPOUSE” TRUST SYSTEM 2) COMPLEX JOINT TRUST: “JOINT 100% LOCK UP” TRUST SYSTEM 3) COMPLEX JOINT TRUST: “JOINT 50% LOCK-UP” TRUST SYSTEM These three trust systems are described in more detail below.

“SEPARATE TRUST FOR EACH SPOUSE” TRUST SYSTEM Each spouse will have a separate revocable trust that “locks up” upon the first death to benefit the surviving spouse with those assets held by such trust and those assets made payable to the trust by beneficiary designation. The “Separate Trust for Each Spouse” trust system is the most popular, and traditionally has been the only revocable trust system used by most estate planning lawyers. In this system, a “bypass trust” or “family trust” can be established upon the first death to be held for the surviving spouse without the assets under such trust being subject to federal estate tax, creditor claims of the surviving spouse, or claims of future spouses and the descendants of future spouses. Most of the married couple trust work that our office performs uses the Separate Trust for Each Spouse trust system with separate revocable trusts for each spouse, but there are other alternatives.

“COMPLEX JOINT LOCK-UP” ALL ASSETS TRUST SYSTEM

Clients who may instead be better suited for a “Complex Joint Trust” would typically have one or more of the following characteristics: 1) Clients who prefer a simpler plan with assets under one trust as opposed to two. 2) Clients who wish to “lock up” more than the assets of the first dying spouse upon the first death (which is the case under the Separate Trust for Each Spouse trust system). The surviving spouse would become co-trustee

102 of the trust holding these assets. Similar to the Separate Trust for Each Spouse trust system, these assets are held without being subject to federal estate tax, creditor claims of the surviving spouse, or claims of future spouses and the descendants of future spouses. 3) Clients who have had an All to Survivor Joint Trust in the past and do not wish to retitle assets to separate revocable trusts when updating their planning. As stated above, clients who elect to have a Complex Joint Trust may choose between a “Joint 100% Lock-Up” trust system and a “Joint 50% Lock- Up” trust system. Most wealthy clients who use a revocable trust system choose a “Joint 100% Lock-Up” trust system in order to achieve the following: 1. The ability to claim a “stepped-up” basis for income tax purposes on all assets held under the joint revocable trust. For example, a stock is purchased for $200 that is worth $1,100 with capital gains tax only owed on $100 worth. With a typical joint revocable (ATS) trust there is only a “step-up” for half of the value upon death, so the capital gains tax would be based upon the excess of $1,100 over $100, plus $500. 2. The ability to “lock up” as much in assets as possible to avoid estate tax upon the second death. For example, a married couple with good earnings may have $13,000,000 worth of assets and may wish to lock up a full $11,400,000 worth of assets in a bypass trust upon the first death, with the expectation that the surviving spouse will have future earnings and the possibility that the estate tax exemption will be reduced in the future. The Joint 100% Lock-Up Trust has special design features that allow the trust assets to be considered, for federal income and estate tax purposes, to have passed from the first dying spouse into the surviving spouse’s trust upon the first death. This is done by giving each spouse the right to execute a separate document directing how the trust assets would pass if that spouse were to die first. To ensure that the first dying spouse does not appoint assets to somebody other than the surviving spouse or the Joint 100% Lock-Up Trust, the tax law permits the appointment of “trust protectors,” who have the power to

103 disapprove any exercise of such “power of appointment” by the first dying spouse. For example, a husband and wife could appoint one or two close family friends or advisors as trust protectors under the trust. Their sole function would be to have the power to disapprove either spouse’s decision to direct assets anywhere besides the Joint 100% Lock-Up Trust or the surviving spouse, unless the surviving spouse also approves of such direction of assets. The tax law does permit the entire Joint 100% Lock-Up Trust to be held upon the first death for the surviving spouse, without being subject to federal estate tax upon the surviving spouse’s death. The tax law is not clear on whether all of the assets of the trust receive a “stepped-up” basis upon the first death. Many tax commentators, the author included, believe that all assets inside a revocable trust should receive the “stepped-up” basis. However, the IRS has disagreed.

“JOINT 50% LOCK-UP” TRUST SYSTEM The other Complex Joint Trust that can be used for estate tax and/or protective trust planning would be the “Joint 50% Lock-Up Trust”. This is a simpler document than the Joint 100% Lock-Up Trust, but only allows the couple to lock up to 50% of their assets upon the first death. The Joint 50% Lock-Up Trust does provide a “stepped-up” income tax basis for the 50% of the assets that are locked up, but there is no stepped-up basis for the other 50% of the assets. Under the Joint 50% Lock-Up Trust, the spouse who dies first cannot override the mutually agreed upon trust document, as he or she could under the Joint 100% Lock-Up Trust system, and therefore the language used in the trust document is not as complicated.

BE SURE TO CONSIDER MEDICAID ISSUES Medicaid planning for a married couple adds one more twist to revocable trust structuring. Unfortunately, the Medicaid regulations provide that assets passing by revocable trust into a protective trust for a surviving spouse can qualify, unless such assets have passed through the probate estate of the first dying spouse.

104 We may therefore suggest that clients who wish to help ensure that their spouse will qualify for Medicaid without using trust assets place the assets in their personal names, to pass into a revocable trust system by a “Pour Over Will” upon the first death.

PLANNING TIPS

Obviously, revocable trust planning is varied and complex. We hope that this commentary will open up planning opportunities, as well as common configurations, to clients and advisors. As with most estate planning techniques, “one size does not fit all.” It is best to structure a joint trust (or any trust for that matter) that is appropriate for the client’s needs and circumstances. Our office has developed a special kind of joint revocable trust that may facilitate allowing all assets in the trust to receive a higher income tax basis based upon the fair market value of the assets on the date that the first spouse dies. Our article entitled “It’s Just a JEST, the Joint Exempt Step-Up Trust” is as follows and may be of interest to professional advisors and some sophisticated individuals. The JEST trust is certainly not for everyone, but it will be a powerful planning tool for a few Floridians.

IT’S JUST A JEST, THE JOINT EXEMPT STEP-UP TRUST By: Alan Gassman, Thomas Ellwanger & Kacie Hohnadell Reprinted with permission from Leimberg Information Services 03-Apr-13 Steve Leimberg’s Estate Planning Email Newsletter - Archive Message #2086 There are two primary concerns that arise when dealing with joint trusts in non-community property states: 1) whether, upon the first dying spouse’s death, all joint trust assets (including those contributed by the surviving spouse) can be used to a fund a credit shelter trust for the benefit of the surviving spouse without later being included in the surviving spouse’s estate, and 2) whether, upon the first dying spouse’s death, it is possible to obtain a step-up in basis for all trust assets, no matter which spouse contributed them to the trust.

105 After extensively researching these issues and reviewing alternative structures, we have designed a joint trust planning technique, entitled the ‘Joint Exempt Step-Up Trust (JEST).’ The JEST should allow a married couple in a common law state to make maximum use of the first dying spouse’s unused estate tax exemption by fully funding a credit shelter trust upon the first dying spouse’s death, even if this requires using assets contributed by the surviving spouse. We also believe that with proper structuring the joint trust can provide a full step-up in basis for all of the trust assets. Although not without risk or some uncertainties clients who want a stepped up basis for all “joint” assets, and to maximize use of credit shelter trust funding on the first death should be offered this strategy. While the risks herein described do exist, there is also the risk that the family will ask the planner why these techniques were not used to avoid capital gains taxes and facilitate making full use of the first dying spouse’s estate tax exemption amount. Practitioners will have to invest significant time to understand issues, to develop trust documents that take the above and many other considerations into account, and make sure that clients understand the risks and possible advantages of the system.” EXECUTIVE SUMMARY: Many legal scholars and practitioners have considered whether a married couple living in a non-community property state can contribute assets to a joint trust, which upon the first spouse’s death would be used to fund credit a shelter trust and to facilitate a full step-up in basis. LISI commentators Alan Gassman, Tom Ellwanger, and Kacie Hohnadell analyze the many issues that arise with respect to joint trusts and present an innovative joint trust design strategy that can be used to avoid or reduce the issues at hand. In addition to letting members in on this new innovative technique, this letter describes a number of interesting concepts that relate to joint trust planning and also concepts that relate to joint trust planning and its impact upon estate tax, gift tax, and creditor protection objectives. FACTS: There are two primary concerns that arise when dealing with joint trusts in non-community property states: 1) whether, upon the first dying spouse’s death, all joint trust assets (including those contributed by the surviving spouse) can be used to a fund a credit shelter trust for the benefit of the

106 surviving spouse without later being included in the surviving spouse’s estate, and 2) whether, upon the first dying spouse’s death, it is possible to obtain a step-up in basis for all trust assets, no matter which spouse contributed them to the trust. After extensively researching these issues and reviewing alternative structures, we have designed a joint trust planning technique, entitled the “Joint Exempt Step-Up Trust (JEST).” The JEST should allow a married couple in a common law state to make maximum use of the first dying spouse’s unused estate tax exemption by fully funding a credit shelter trust upon the first dying spouse’s death, even if this requires using assets contributed by the surviving spouse. We also believe that with proper structuring the joint trust can provide a full step-up in basis for all of the trust assets. The basic structure of the JEST is as follows: a married couple funds a jointly-established revocable trust, with each spouse owning a separate equal share in the trust. Either spouse may terminate the trust while both are living, in which case the trustee distributes 50% of the assets back to each spouse. If there is no termination, the joint trust becomes irrevocable when the first spouse dies. Upon that first death, the assets of the first dying spouse’s share will be applied this way:

 First, assets equal in value to the first dying spouse’s unused estate tax exemption will be used to fund Credit Shelter Trust A for the benefit of the surviving spouse and descendants. These assets will receive a stepped-up basis and will escape estate tax liability upon the surviving spouse’s death.

 Second, if the first dying spouse’s share exceeds his or her unused exemption, then the excess amount of that share will be used to fund Q-TIP Trust A for the benefit of the surviving spouse and descendants. The assets will avoid estate tax because of the marital deduction. They will receive a stepped-up basis on the first dying spouse’s death and again on the surviving spouse’s death, at which time they will be potentially subjected to estate tax.

107 If the first dying spouse’s share is less than his or her exemption amount, then the surviving spouse’s share will be used to fund Credit Shelter Trust B with assets equal to the excess exemption amount. We believe that the assets of Credit Shelter Trust B should avoid estate taxation at the surviving spouse’s death although the surviving spouse originally contributed these assets to the JEST. We also believe that the assets of Credit Shelter Trust B should receive a full stepped-up basis at the first death. IRS opposition on this issue can be expected, at least for the time being, but how this trust is structured may help obtain a favorable result. Finally, the remainder of the surviving spouse’s share (if any) will be used to fund Q-TIP Trust B, under which the surviving spouse will be at least an income beneficiary. We believe that there is a good chance that these assets will also get a basis step-up if the surviving spouse retains only the right to receive income; again, we think more rights for the surviving spouse will somewhat lessen the chance of that result. The tax and other issues raised by this technique are further discussed below. COMMENT: Over the last 20 years, the IRS has issued four significant rulings touching on joint trust arrangements, three private letter rulings and a TAM.i The first was TAM 9308002, which was issued in 1992. The facts indicated that both spouses funded a joint revocable trust, which granted each spouse a general power of appointment over the entire trust in the form of a right to direct payment of his or her debts and taxes from any of the trust assets. The IRS determined that all trust assets were included in the first dying spouse’s estate under IRC Section 2041. However, the IRS ruled that assets contributed by the surviving spouse were in effect gifted to the first dying spouse upon that spouse’s death; since those assets passed back to the surviving spouse within one year, those assets could not receive a basis step-up because of IRC Section 1014(e). PLRs 200101021 and 200210051 addressed the same issues. In both PLRs, married couples formed joint revocable trusts. In one ruling, each spouse had a lifetime power to withdraw the income and principal; in the other, the first to

108 die spouse was given a testamentary general power of appointment over the entire trust. In both rulings, upon the first spouse’s death, the assets of the joint trust were used first to fund a credit shelter trust (in the amount of the first dying spouse’s unused exemption) for the surviving spouse’s benefit. Both PLRs made the following determinations: 1) All of the joint trust assets were included in the first dying spouse’s estate. The assets contributed by the first dying spouse were included under IRC Section 2038; the assets contributed by the surviving spouse were included under IRC Section 2041. 2) Upon the death of the first dying spouse, the surviving spouse made a completed gift to the first dying spouse of the assets contributed by the surviving spouse. The gift qualified for the gift tax marital deduction. 3) Because of Section 1014(e), only the assets contributed by the first dying spouse could receive a step-up in basis. PLR 200403094 addressed similar issues in a slightly different context. Rather than a joint trust, the ruling dealt with a revocable trust to be created and funded by a husband. If the wife died first, the trust agreement provided her with a testamentary general power of appointment over trust assets equal in value to her remaining exemption, less her own assets. In that case, the wife’s will exercise the power by appointing assets to set up a credit shelter trust for the husband’s benefit. The IRS ruled as follows: 1) The husband’s creation of the power of appointment would constitute a gift to the wife which would be considered completed at her death if she died before him. The gift from him would qualify for the gift tax marital deduction. 2) If the wife died first, assets contributed by the husband to the trust but appointed by the wife to a credit shelter trust for the husband would not be included in the husband’s estate for estate tax purposes at his later death. No basis issue was discussed. These rulings sparked renewed interest in using joint trusts as a way to make sure that both estate tax exemptions of a married couple would be fully

109 used, without having to split up assets and set up a living trust for each spouse. Although no ruling allowed a total basis step-up for the marital property at the first death, there was speculation about weaknesses in the IRS arguments on that point and potential ways to rebut those arguments. However, some commentators have expressed concern about the favorable results of the rulings, none of which has any value as precedent. The estate tax laws at the time of the rulings did not give a surviving spouse the benefit of any exemption not used by the first spouse to die—i.e., there was no portability. Thus, the commentators pointed out, the IRS was being lenient in these rulings so as to permit a simpler way to achieve basic estate tax savings. But, the IRS was not giving the comfort of a Revenue Ruling which practitioners could rely upon, meaning that it could change its position on some or all of the favorable decisions in the rulings. After extensively reviewing these issues, we believe that our JEST technique can be used to maximize the use of both spouses’ estate tax exemptions, as well as setting up a situation to provide the best possible arguments in favor of getting a total basis step-up on all assets at the first death. Nevertheless, because it is an area without binding precedent, any practitioner should carefully consider the concerns that commentators have raised. Where practitioners (or clients) are particularly risk-averse, thought might be given to getting an IRS ruling. Using a joint trust arrangement can complicate creditor protection aspects of trusts. Throughout this article we touch on that issue. Below, we provide an in depth explanation of the “mechanics” of the JEST and discuss the various issues surrounding this technique. JEST Creation In implementing the JEST, the married couple first establishes a joint revocable trust. Each spouse will have a separate share consisting of any assets contributed to the trust by that spouse. To avoid having to retitle assets, preexisting revocable trusts can become separate shares of the joint revocable trust by amendment and restatement. The trust agreement will give each spouse an equal share of the trust assets. While both spouses are living, either spouse can revoke the agreement

110 and terminate the trust, in which case the trustee will transfer the trust assets back to the spouses in equal shares. Unequal funding of the trust raises the possibility of a gift on funding. A spouse who contributes more than 50% of the assets but only has the power to get back 50% in a unilateral termination has presumably made a completed gift of the difference. Transferring property held in a tenancy by the entireties would result in such a gift if, as is generally the case, the tenancy can only be severed by joint action of the parties. The severance occurring when entireties property is added to the trust would be a gift by the younger spouse, who has a greater actuarial interest in the property.ii Estate planning attorney Michael Mulligan has suggested that any gift on funding is incomplete until the first death, whether or not a spouse can terminate the trust and take back assets. He states that “[u]nder the laws of most states, the retained right to distributions of income and principal would cause any contribution by a beneficiary to the trust to remain subject to claims of the beneficiary’s creditors. If applicable state law permits a settlor’s creditors to reach property conveyed to a trust, such conveyance does not constitute a gift for Federal gift tax purposes.”iii If a gift on funding does occur, so long as both spouses are U.S. citizens, one might assume that the gift tax marital deduction should eliminate tax concerns (unless a spouse is a non-citizen, where the marital deduction does not apply). This is the position the IRS has taken in the rulings. However, as discussed below, questions have been raised by commentators as to whether the IRS is correct in applying the marital deduction in this situation. Mr. Mulligan’s comment as to funding touches on another issue. Holding properties in tenancy by the entireties usually provides creditor protection because the properties can only be reached by creditors with a claim against both spouses. Tenancy by the entireties property transferred into a joint trust will lose the entireties status and this creditor protection unless (1) the joint trust satisfies all unities required by tenancy by the entireties law (which will not be the case with a JEST), or (2) the governing law explicitly provides that trust assets can be designated by a married couple to be treated as tenancy by the entireties property, even if the unities are not satisfied. Delaware, Virginia, Hawaii and Illinois are examples of jurisdictions having such statutes. When the First Death Occurs

111 Upon the first dying spouse’s death, the joint trust becomes irrevocable. The trust assets are still in two equal shares—one attributable to the first dying spouse, and one attributable to the surviving spouse. We will assume that the first dying spouse has not exercised his or her general power of appointment. Assets of the first dying spouse’s share equal in value to the first dying spouse’s unused estate tax exemption will be used to fund Credit Shelter Trust A for the benefit of the surviving spouse and descendants (or surviving spouse, then descendants). If the first dying spouse’s share exceeds his or her unused exemption, then the excess amount can be used to fund Q-TIP Trust A for the lifetime benefit of the surviving spouse, and later for the couple’s descendants. All of these assets receive a stepped-up basis at the first death, unless they were gifted to the first dying spouse by the surviving spouse within a year before the first dying spouse’s death, when IRC Section 1014(e) denies the step- up. Turning to the surviving spouse’s share, if the first dying spouse’s share is less than the first dying spouse’s exemption amount, then the surviving spouse’s share is used in Credit Shelter Trust B. Like Credit Shelter Trust A, this can be for the benefit of the surviving spouse and descendants (or the surviving spouse, then descendants), although including the spouse as a beneficiary may imperil getting a basis step-up for these assets at the first death. If there are assets remaining in the surviving spouse’s share after fully funding Credit Shelter Trust B, the remainder of the surviving spouse’s assets will be used to fund Q-TIP Trust B, with the surviving spouse as lifetime beneficiary and the descendants as remainder beneficiaries. Again, the extent of the surviving spouse’s interest may affect the basis argument. The results of this technique are as follows: Credit Shelter Trust A. The assets of Credit Shelter Trust A will be treated as coming from the first dying spouse. They will be included in the first dying spouse’s gross estate for estate tax purposes pursuant to IRC Section 2038 because of the first dying spouse’s lifetime right to revoke the trust and receive back these assets. These assets are sheltered from estate tax liability at the first death by the first dying spouse’s estate tax exemption. Unless the Section 1014(e) one year rule applies,

112 the inclusion of these assets in the first dying spouse’s gross estate will provide a stepped-up basis.iv A spendthrift provision in Credit Shelter Trust A will provide creditor protection to the surviving spouse because the first dying spouse (rather than the surviving spouse) will be deemed the grantor/transferor of the trust. Increased creditor protection could be provided by limiting the surviving spouse to distributions in the discretion of the trustee according to an “ascertainable standard,” such as distributions for health, support, maintenance, and education. In most jurisdictions, limiting discretionary distributions to the surviving spouse by such a standard prevents creditors of the surviving spouse from being able to reach the trust assets or demand trust distributions. Q-TIP Trust A. Similarly, the assets of Q-TIP Trust A will also be included in the first dying spouse’s estate under IRC Section 2038. They will avoid estate tax at that time because of the estate tax marital deduction. These assets will receive a stepped-up basis on the first dying spouse’s death unless Section 1014(e) applies. Since the assets remaining at the surviving spouse’s death will be includable in the surviving spouse’s estate under Section 2044, those assets will receive another basis step-up then. Even with a spendthrift provision, Q-TIP Trust A cannot provide total creditor protection for the surviving spouse because qualifying for the marital deduction requires that all trust income be paid to that spouse. Creditors will be able to reach the income distributions after they are received by the spouse. However, the principal can be further protected by making principal distributions discretionary and limited by an ascertainable standard. The trustee can potentially minimize or eliminate the surviving spouse’s income exposure by investing in low or zero dividend stocks or other cash neutral investments. Of course, this will require implicit consent of the surviving spouse because of the surviving spouse’s right to have marital trust assets be productive.v

113 Credit Shelter Trust B and Q-TIP Trust B. Let’s look at how the first death affects the surviving spouse’s share of the JEST. Issue 1: Estate Tax on Credit Shelter Trust B Credit Shelter Trust B is designed to use up the first dying spouse’s estate tax exemption if the first dying spouse’s share of the trust is smaller than that exemption amount. This requires having assets from the surviving spouse’s share go into Credit Shelter Trust B after having been includible in the estate of the first dying spouse for estate tax purposes, even though these assets are from the surviving spouse's share of the JEST. By providing the first dying spouse with a testamentary general power of appointment over all of the trust assets, we make the assets of Credit Shelter Trust B includible in the first dying spouse’s estate under IRC Section 2041, as was the case in most of the rulings.vi The rulings to date made clear the IRS’s view that with proper drafting, Credit Shelter Trust B would not be considered as funded by the first dying spouse and would not be includible in the gross estate of the surviving spouse, even if the surviving spouse is a beneficiary of that trust. Risks: Taxable Gift Treatment on Funding of Credit Shelter Trust B and Inclusion in Surviving Spouse’s Estate The IRS rulings are promising, but they are not binding on the Service and cannot be cited as precedent. It is certainly possible for the IRS to come to different conclusions in the future. One concern expressed by Mr. Mulligan is that Section 2041 may not apply to the joint trust assets because the first dying spouse’s power of appointment is effectively contingent upon the surviving spouse’s failure to withdraw his or her share of the trust assets before the first death. His fear is that the contingency may turn the testamentary power of appointment into a power only exercisable in conjunction with the creator of the power— something which is not considered a general power of appointment under IRC Section 2041(b)(1)(C)(i).vii That would mean that assets of the surviving spouse’s share could not be applied to use up the first dying spouse’s exemption if the first dying spouse’s

114 share is insufficient. It opens the door to an argument that the assets in Credit Shelter Trust B are includible in the gross estate of the surviving spouse under IRC Sections 2036 and 2038. According to Mr. Mulligan, the Service could reach the same result by a “conduit” or “step transaction” argument by looking at the entire transaction as one in which surviving spouse is viewed as the actual contributor of the assets of Credit Shelter Trust B, again triggering Sections 2036 and 2038 rather than Section 2041. He cites several cases in which, for example, one party who transferred assets to a second party is deemed to be the actual grantor of a trust created by the second party with those assets.viii In the end, however, Mr.Mulligan points out that the lifetime Q-TIP rules justify ignoring these arguments where spouses are involved. Spouse A can set up a lifetime Q-TIP for Spouse B with Spouse A’s assets; the trust can benefit Spouse A after the death of Spouse B; but Sections 2036 and 2038 do not bring the assets back into Spouse A’s estate. Apparently inclusion in the estate of Spouse B under Section 2044 “cleanses” the trust assets, so that Spouse B is considered to be the source of them. Mr. Mulligan sees no reason why the same concept should not apply in the joint trust arena. In their 2008 article, Mitchell Gans, Jonathan Blattmachr and Austin Bramwell share Mr. Mulligan’s concern about the step transaction doctrine. They fear that the IRS could determine that the surviving spouse is the transferor of the Credit Shelter Trust B assets, causing inclusion under Sections 2036 (if the surviving spouse had the right to receive income from Credit Shelter Trust B) or 2038 (if the surviving spouse has a special power of appointment over the trust). They note that even if the surviving spouse has neither an income interest nor a power of appointment over the trust assets, being merely a discretionary beneficiary, Section 2036 could apply for one of two reasons: (i) the Service could find an “implied understanding” that the surviving spouse would receive distributions from the trust or (ii) the Service could decide that the ability of creditors of the surviving spouse, under state law, to reach assets of the trust because it is considered to be self-settled. ix Some planning may be possible to minimize the risk of estate tax inclusion. Perhaps careful drafting can negate an “implied understanding.” Drafting to avoid creditors (such as by setting up Credit Shelter Trust B in a jurisdiction which protects self-settled trusts) can be helpful both for tax and non-tax reasons (the non-tax reasons being discussed below).

115 One could always try to structure the funding of the joint trust to minimize the need for a Credit Shelter Trust B created with assets from the surviving spouse. Of course, this eliminates one advantage of joint trust planning, the ability to ensure full use of both spouse’s exemptions without having to split assets up or move them around. In the end, the PLRs and TAM are a weak bulwark against a later IRS attack on these issues unless there are strong reasons for the IRS to continue to support the same reasoning. Messrs Gans, Blattmacher, and Bramwell fear that the reasoning in the rulings could invite abuse by taxpayers seeking to overcome the step transaction doctrine in other contexts. Mr. Mulligan seems to feel that the Q-TIP analogy will continue to support the rulings. Planners forced to confront this issue and seeking certainty may consider getting rulings of their own. Two alternative questions can be asked: 1) Does inclusion of Credit Shelter Trust B in the surviving spouse’s estate cause a significant problem? If the alternative to a joint trust arrangement would not result in full use of both exemptions anyway, then what is the harm if that aspect of the joint trust arrangement doesn’t work? 2) Is there a way to minimize the harm caused by inclusion? On the second point, consider the result if Credit Shelter Trust B is structured as a defective grantor trust with the surviving spouse as grantor. This might be done by giving the surviving spouse the power to replace Credit Shelter Trust B assets with assets of equal value. The surviving spouse would owe income taxes for trust income left in the trust or distributed to other beneficiaries, and the tax payments would reduce her taxable estate without being considered gifts. For example, if Credit Shelter Trust B is funded with $2 million worth of assets and the surviving spouse has a $5.25 million estate tax exemption, it would seem that, at worst, the surviving spouse would have been deemed to have made a $2 million gift to the trust. If the trust is moved to an asset protection jurisdiction and the spouse does not have a power of appointment over trust assets, all growth in the trust that occurs during the surviving

116 spouse’s remaining lifetime can escape federal estate tax, notwithstanding that the trustee may have discretion to make distributions to the surviving spouse. Issue 2: Creditor Protection Risk: No Creditor Protection from the Surviving Spouse’s Creditors Where an individual transfers assets to a trust for his or her own benefit, the British common law (and most states which follow it) allows the individual’s creditors to reach those assets. Just as there is a risk that the surviving spouse may be considered to have transferred assets to the trust for estate tax purposes, there is a risk that the surviving spouse could be considered the transferor of the assets for creditor purposes. This could allow creditors of the surviving spouse to reach the assets of Creditor Shelter Trust B if the surviving spouse is the beneficiary. Note that the two issues would arise in different contexts, probably in different legal jurisdictions, and the decisions might not be consistent. Depending on the outcome, the estate tax could take part of Credit Shelter Trust B on the surviving spouse's death, but even worse, creditors could take all of the assets. The best way to minimize the risk of actual creditors would be to situate the Credit Shelter Trust B in an “asset protection trust” jurisdiction such as Nevada, Alaska, Delaware, or Nevis, where creditor protection is available for self-settled trusts. An alternative that could help for creditor protection purposes, but not federal estate tax purposes, would be to have the trustee invest in a family LLC or Limited Partnership to obtain charging order protection so that creditors of the surviving spouse would have a more difficult time obtaining assets from Credit Shelter Trust B. But, just as an IRS determination does not apply to creditors, taking actions which as a practical matter deter creditors by using LLC and limited partnership structures does not prevent the IRS from concluding that creditors of the surviving spouse can reach into Credit Shelter Trust B, and thereby cause its assets to be considered as owned by the surviving spouse for estate tax purposes. Issue 3: Marital Deduction Risk: The Gift May Not Qualify for the Marital Deduction

117 Under our proposed JEST, gift tax consequences may arise at two points in the life of the trust. First, because each spouse will have individual right, while both spouses are alive, to terminate the trust and receive back half of the assets, a gift would occur upon funding the trust if the spouses do not contribute equal amounts or, in most cases, if the spouses contribute property held as tenants by the entireties. Unless the recipient spouse is not a citizen, the gift tax marital deduction should eliminate any gift tax consequences. Second, in the rulings, the IRS concluded that upon the first spouse’s death, the surviving spouse would make a completed gift to the deceased spouse of the assets that the surviving spouse contributed to the joint trust.x This is because as of the first death the surviving spouse relinquishes dominion and control over those assets, either by losing the power to revoke those assets or because the assets are subject to the first dying spouse’s testamentary general power of appointment (or, under our suggested arrangement, for both reasons). The rulings go on to conclude that this completed gift by the surviving spouse would qualify for the estate tax marital deduction (assuming the first deceased spouse was a citizen). Common sense suggests that the IRS is correct on the marital deduction issue. Of course, common sense is not always a reliable guide to the workings of the tax laws. While the IRS rulings don’t go into detail on the marital deduction question, the Service must have reached two conclusions: 1) That the gift occurred at a time when the spouses were married, and 2) That the gift did not involve a non-deductible terminable interest. Reminding us again that this determination has been made in non- binding rulings, the commentators have suggested that these are conclusions the IRS may later abandon.xi They point out that whether the gift was made when the spouses were married turns on exactly when it was made. If it was considered made after the moment of death, the parties were not then married, and the marital deduction would not apply. If it was considered made before or at the moment of death, then the first requirement of the deduction is met.

118 Messrs Blattmachr, Gans, and Bramwell take comfort from the authorities dealing with the death of spouses in common disasters.xii There it has been held that a gift occurs at the moment of death, rather than after death. These commentators opine that “no policy justification exists for refusing to extend this rationale to the [joint trust] strategy.”xiii Messrs. Blattmachr, Gans, and Bramwell also bring up the Ninth Circuit Court of Appeal’s 1935 decision in Johnstone v. Commissioner,xiv in which the court suggested that a transfer occurs the moment before death rather than after death. However, their discussion reveals that later cases have cited Johnstone, with the result not always being consistent. On the other hand, Johnstone did not involve spouses, while the simultaneous death authorities do. We believe that practitioners can be fairly confident that the gift at death will be deemed to be made during the marriage. The terminable interest issue is more problematic. The facts in the rulings show no outright gifts or Q-TIP election. The question is whether the surviving spouse receives enough rights in the gifted property to satisfy IRC Section 2523(e): a right to receive lifetime income and a general power of appointment over the applicable interest. In PLR 200210051, each spouse had the right to demand distributions of income and principal while both were living, effectively having lifetime general power of appointment. In the others, the first spouse to die received only a testamentary general power of appointment with no particular income rights. Under the rulings, the IRS allows a marital deduction, but there is no discussion of the terminable interest issue. To Messrs. Blattmachr, Gans, and Bramwell, getting the marital deduction would seem to require relying on case law allowing a marital deduction where a spouse may elect whether to accept a gift and does accept it.xv Finding acceptance here would seem to require that the surviving spouse exercise the testamentary power of appointment. One ruling did involve the exercise of the power; the rest did not. And, these commentators feel that even exercise may not be enough, since the relevant cases all involve spouses who personally accept outright gifts, not just spouses who receive a power of appointment. Clearly we hope that the IRS will not change its position on the marital deduction issue and will eventually issue a definitive ruling. In the meantime,

119 short of requesting a ruling for each joint trust we prepare, how can we increase our chances of avoiding a marital deduction problem on Q-TIP B? Certainly there is no harm in using language so closely identified with the marital deduction that the Service may grant the deduction without giving the subject much thought. As an example, one of the rulings made the first deceased spouse’s testamentary general power of appointment “exercisable alone and in all events.” This language added nothing, but it does scream out, “marital deduction!” More substantively useful may be the inclusion of a joint trust provision allowing both spouses to withdraw principal from the trust while both are living, as found in PLR 200210051, could help bring the gift within the statutory requirements of Section 2523(e).xvi Having Credit Shelter Trust B set up and funded by exercise of the testamentary power of appointment should improve the odds of coming within the case law on gifts made by election. If all else fails, a savings clause in the trust agreement could provide that should the gift tax marital deduction not apply, Credit Shelter Trust B would be funded only to the extent of the surviving spouse’s estate tax exemption (or to an amount slightly less than the surviving spouse's exemption to permit future gifting and a cushion for valuation issues that could apply in later years). That way the surviving spouse could avoid a gift tax on assets going into that trust at the first death. So long as the terms of Credit Shelter Trust B don’t subject the remaining assets to estate tax at the second death, the parties should be no worse off than if they had not tried to use a joint trust to protect both exemptions. Of course, description of the contingency could alert the Service to the marital deduction issue if it is not otherwise aware of it. Stepped-Up Basis In its rulings, the IRS has denied that the assets of the surviving spouse’s share of the joint trust will get an IRC Section 1014(a) basis step-up in non- community property jurisdictions at the first death even though the assets are includible in the gross estate of the first dying spouse. We believe the IRS is wrong. We believe that a basis step-up should be available. The risk to practitioners would seem minimal, since it is confined to not getting a step-up which would not have been otherwise available for clients not living in community property states. Although we expect the Service to

120 continue to contest the issue, we also think there are ways to significantly increase the chances of a successful outcome. In the rulings, the IRS denied a step-up to assets which, prior to the first death, were in the surviving spouse’s share of trust. The IRS asserted that the step-up was prohibited by IRC Section 1014(e). Section 1014 generally provides that the basis of property in the hands of a person acquiring the property from a decedent, or to whom the property passed from a decedent, is the fair market value of the property at the date of the decedent’s death. However, Section 1014(e) provides the following exception to this rule: if appreciated property was acquired by the decedent by gift during the one-year period ending on the date of the decedent’s death, and the property is acquired from the decedent by, or passes from the decedent to, the donor of such property, the basis of such property in the hands of the donor is the adjusted basis of the property in the hands of the decedent immediately before the death of the decedent.xvii [Emphasis added]. For Section 1014(e) to apply, the property must be “acquired by” or “pass to” to the original contributor of such property—in this case, the surviving spouse. How does this language apply when the property does not pass directly to the surviving spouse, but instead passes to a trust for the benefit of the surviving spouse? The Service thinks it does, but does not have an explanation. We share the belief of many others that the Service has stretched the literal language of the law in so concluding. To us, “acquired by” or “pass to” should apply only if full ownership is transferred back to the surviving spouse. Assets originating with the surviving spouse will wind up in Credit Shelter Trust B or Q-TIP Trust B. The less interest the surviving spouse has in these trusts, the easier it is to argue that Section 1014(e) should not bar a step- up. For example, we think it is clear that a step-up should be allowed if the surviving spouse is not a beneficiary of the Credit Shelter Trust B. Of course, economic considerations may require that the surviving spouse be a beneficiary. Some planners have asserted that Section 1014(e) should not apply

121 if the surviving spouse) is only a discretionary beneficiary.xviii There have not been any rulings or cases that explicitly confirm this conclusion, but it’s difficult to say that property “passed to” or was “acquired by” a discretionary beneficiary, who by definition has no certain rights to the property. The requirements of the estate tax marital deduction require that the surviving spouse be an income beneficiary of Q-TIP Trust B. Again, we and others feel that should not bar a step-up; nor should the right to receive principal in the discretion of the trustee, or a special power of appointment. But, the fewer rights the surviving spouse has, the better the argument for a step-up may be. CONCLUSION: The JEST technique eliminates many of the concerns that have prevented estate planners in non-community property estates from using joint trusts in the manner approved by the IRS in PLR’s 200101021 and 200210051. Although not without risk or some uncertainties clients who want a stepped up basis for all “joint” assets, and to maximize use of credit shelter trust funding on the first death should be offered this strategy. While the risks herein described do exist, there is also the risk that the family will ask the planner why these techniques were not used to avoid capital gains taxes and facilitate making full use of the first dying spouse’s estate tax exemption amount. Practitioners will have to invest significant time to understand issues, to develop trust documents that take the above and many other considerations into account, and make sure that clients understand the risks and possible advantages of the system. We hope that every law firm reading this article implements at least 23.8 JESTs this year, and we are not jesting!

HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!

A more complicated concept relating to joint trusts involves the consideration of whether the married couple would like to attempt to obtain a new fair market value income tax basis for all joint assets, and the ability to have joint assets benefit the surviving spouse without being subject to federal estate tax on the surviving spouse’s death.

122 Unfortunately, the laws are not very clear on this, but professional advisors may be interested in the following article, which describes a type of joint trust that the author has been involved with designing. A letter to a client on this subject is as follows:

Dear Client: [NEW AMOUNT INPUT..RECALCULATE??] I wanted to provide you with an example of how a (Joint Exemption Step-Up Trust) JEST trust works. Let’s say that a husband dies in 2018 leaving everything to his wife, and the wife has the ability to disclaim some portion of what the husband leaves her into a trust that can benefit her for her lifetime without being subject to federal estate tax. In addition, let’s assume that the couple has $25,000,000 worth of assets. If the wife accepts all of the assets, and does not disclaim any of them, then they will be subject to federal estate tax on her death. She will also owe estate tax upon her death on any assets exceeding $22,800,000, assuming she dies at a time when the exemption amount is still $11,400,000, indexed for inflation. Her estate tax exemption on her death will be based upon her $11,400,000 present exemption, [mdp: minus what she has used during her lifetime of her gift tax exemption?] increased annually by the Consumer Price Index, plus the husband’s unused $11,400,000 portability allowance, which gets “locked in” upon making the election at his death and does not grow with inflation. As an aside, let’s say she receives the portability allowance from husband #1 and subsequently remarries husband #2. If husband #2 predeceases her, then the portability allowance left by husband #1 completely disappears, and she only receives whatever portability allowance husband #2 has remaining.

Now let’s assume that same client, having not remarried, disclaims $3,000,000 worth of assets that will be held for her benefit without being subject to federal estate tax at her death. Let’s assume further that the $3,000,000 worth of assets grows to $7,000,000 in value before she dies.

123 That whole $7,000,000 in value passes without being subject to federal estate tax, and she still has $8,180,000 remaining from her husband’s portability allowance. Assuming that she does not remarry, upon her death, the amount that passes estate tax free will be the $7,000,000 in the trust, plus $8,180,000 of the husband’s remaining allowance, plus whatever the allowance is when the wife passes. (The current $11,400,000 estate tax allowance is scheduled to revert to $5,000,000 indexed for inflation in 2026.) Now, let’s say that the wife decides that she will rely upon portability completely and would like to maximize the amount that will be held in a protective trust for her daughter for life, so as to never be subject to estate tax at the daughter’s level. Upon the husband’s death in 2018, she can disclaim up to $11,400,000 worth of the assets that would have been inherited from the husband, thereby directing them into a special trust. The trustees of the special trust can make a “Clayton Q-TIP election” so that those assets will be subject to federal estate tax as if they belong to the wife when she dies, reducing her allowance to $0. Still, the wife will have the entire $11,400,000 in portability allowance from the husband. More aptly put, the Clayton Q-TIP election uses the deceased spouse’s generation skipping transfer tax exemption and the surviving spouse’s estate tax exemption. The advantage here is that the husband has a $11,400,000 generation skipping tax exemption that enables that amount in assets to be placed into the Clayton Q TIP trust on the husband’s death (after the disclaimer and the Clayton Q TIP trust election have been made). If that $11,400,000 grows to $16,000,000 before the wife dies, all $16,000,000 will nevertheless be able to pass to a trust that can benefit the wife’s daughter without being subject to federal estate tax at the daughter’s level or any other future generations. So in a situation like yours, if one of you dies, the spouse has the disclaimer option, the use of portability option, and the Clayton Q-TIP option. We have added these provisions to your husband’s Will as you can see by the attached comparison pages. All of these decisions have to be made within nine months of the first dying spouse’s date of death. I hope that this is useful, but please let me know if you need further explanation.

124 Best personal regards, ATTORNEY

In drafting trust agreements, it is important to consider the circumstances under which the trustee may make distributions to the beneficiaries. To help clients decide the best approach for their particular situation, we have prepared the following list of considerations for clients and advisors to take into account when drafting trust documents:

125 SPECIAL CLAUSES FOR TRUST AGREEMENTS By: Alan S. Gassman and Christopher J. Denicolo [email protected] and [email protected] Not all trusts are created equal. While the trust agreements that we typically prepare for clients have a number of clauses that give instructions to trustees on how and when to determine what income, support, and principal payments should be made to beneficiaries, different clients have different views and preferences. Here is a list of questions and approaches that can be considered in trust design and implementation: 1. Whether to let the beneficiary of a particular trust have a voice as co- trustee or the ability to replace any acting trustee with a licensed trust company or other trustworthy trustee or advisor. 2. Whether to require that the beneficiary have a prenuptial agreement or a postnuptial agreement before being able to inherit from a trust, to receive any significant benefits, or to have control. 3. Whether there should be a monthly or annual distribution amount guideline that would be presumed to be the maximum that a person should receive, the minimum that a person should receive, or a provision that gives a minimum and a maximum that can be changed with the Consumer Price Index. 4. Whether young beneficiaries should be required to finish a four year degree, a post-undergraduate degree, work full time, have a profession, or be a full-time homemaker with children before being able to receive any significant benefits. 5. Whether a beneficiary should have an “incentive clause” where the trust would pay minimal benefits, except to match W-2 or other professional or entrepreneurial earnings, or pay an hourly rate based upon actual hours worked by the beneficiary in any notable endeavor. 6. Whether individuals who may have tendencies towards alcoholism, drug abuse, gambling problems, or other addictions should have separate guidelines and standards.

126 7. Whether any spouse or a long-time spouse should have the ability to be (a) added as a beneficiary after a certain number of years of consecutive marriage; or (b) to serve as a trustee for the benefit of descendants if that spouse will not be a beneficiary (or if he or she will). 8. Whether the beneficiary should have the power to appoint some portion of the assets upon death to a class of persons, or entities, which can include descendants or certain qualified charitable organizations. 9. Whether the beneficiary should have a power to appoint some portion of the assets upon death to a trust that could benefit the long-term spouse and would then eventually be devised to the descendants upon his or her death, or upon his or her re-marriage. 10. Whether a beneficiary will be able to receive a percentage or other specified portion of the trust assets for use in business or entrepreneurial endeavors if the Trustee deems appropriate. 11. Whether a Trust Protector Committee should be appointed, with the power to change the trust language or to direct the trustees as to certain matters or parameters. This is also known as a “King Solomon Clause.”

127 CHAPTER 6 - STEP 6

SELECTING TRUSTEES, GUARDIANS,

PERSONAL REPRESENTATIVES AND OTHER FIDUCIARIES Even what seems like a perfect estate or personal protection plan can go completely awry if the wrong people or institutions are selected to act on your behalf or carry out your estate and financial plan. There are a number of different roles that need to be filled in a properly designed estate plan, which normally include the following:

Trustees Trustees administer assets to be held for the long-term benefit of selected beneficiaries, and also administer any trust arrangement that calls for asset management, liquidation, or distribution. Florida law allows any individual, company or licensed trust company to serve as Trustee of a revocable or irrevocable trust, which is one reason that many people prefer trusts over wills.

Personal Representatives A personal representative appointed to administer a person’s estate must be a Florida resident or be related to the deceased person or the deceased’s spouse. Assets held under the personal name of a deceased person constitute his or her “probate estate.” If the estate exceeds a certain size or has other characteristics, the probate court judge will appoint one or more personal representatives who have the legal obligation to administer the estate properly under probate court supervision. Any person who is competent and a resident of Florida is qualified to serve as a personal representative. Exceptions to this include minors, people convicted of a felony, or people who are mentally or physically incapacitated. Relatives are eligible to be personal representatives. The term “relative” includes siblings, ancestors (parents and grandparents), descendants, nephews

and nieces, and a spouse’s siblings, ancestors, descendants, nephews and nieces. Trust companies licensed to have offices in Florida are also able to serve as personal representatives and typically do a very good job, but can be expensive. Under Florida Statutes Section 733.617, personal representatives are permitted to charge a percentage of the value of the probate estate, and trustees are permitted to charge a percentage of the value of the trust assets under Florida Statutes Section 736.1007. Trust companies will almost always charge on a percentage basis. Professionals may charge on an hourly basis or on a percentage basis. Oftentimes, a trust company named under a Will or trust to serve as trustee or personal representative will hire the law firm that wrote the document in which they were appointed, to provide legal representation. This allows them [mdp: the trust company or the firm?] to be paid from the assets of the estate or trust on a percentage basis. If there are two personal representatives or two trustees, they may be compensated on a percentage basis which could cost the estate or trust twice as much depending upon the circumstances. Alternatively, family members will often not charge, or will charge a lesser amount or an hourly amount, compared to many professionals. We will often draft documents to provide for a “lead individual” family member or friend to serve as co-trustee, with his or her choice of one or more other individuals or any licensed trust company that may be chosen, in order to have appropriate checks and balances while not tying the family or individual co-personal representative or co-trustee to a particular trust company. Almost all trust companies do a very good job and have conscientious people who sincerely care about preserving assets and taking proper steps that are in the best interests of beneficiaries. A large number of trust companies, however, are very conservative by nature and not always best suited to run businesses, sell unusual assets, or decide whether to hold investments or to allow family members to run businesses or to administer investments.

129 For example, clients who have built a significant part of their wealth with rental properties do not realize that a trust company will typically sell the real estate assets to invest solely in stocks and bonds. A great many individuals mistakenly appoint a trusted family member or friend of the family who seems caring and trustworthy, without taking into consideration that many people simply are not willing or able to handle a lot of detail or the time it can take to properly make decisions with impartiality and good business sense. One of the reasons that we commonly recommend a co-trusteeship is so that if one appointed individual does not do the right job or has trouble making decisions, one or more of the other appointed co-fiduciaries will do the right thing. When one spouse dies and significant assets are held under a trust that has become irrevocable for the other spouse, we commonly recommend that the surviving spouse be required to have a co-trustee serve with him or her. Often clients will give us a list of trusted individuals, and the spouse can choose between one or more of those individuals, a trust company, or a professional (like a lawyer or a CPA) meeting certain qualifications to serve as co-trustee.

A typical clause for this is as follows:

130 Death. Upon my death, the following shall apply:

(a) My spouse, ______, shall serve as successor CoTrustee with said spouse’s choice of any one or more of ______, ______, or any licensed trust company that is managing at least $500,000,000 worth of assets. My spouse, ______, shall have the power to remove and replace any currently serving Co-Trustee with any individual listed above or any licensed trust company of said spouse’s choice.

(b) If my spouse,______, is unwilling or unable to serve as CoTrustee, then ______shall serve as Co-Trustee with his or her choice of one or more of ______, ______or a licensed trust company and shall have the power to replace the acting Co-Trustee with one or more of ______, ______or a licensed trust company, and if ______is unable or unwilling to serve then ______shall serve as Co-Trustee with his/her choice of ______or a licensed trust company and shall have the power to replace the acting Co-Trustee with ______or a licensed trust company.

Notwithstanding any provision above, after my incapacity or death any individual serving as Trustee, including my spouse, shall be required never to serve as sole Trustee, but to at all times serve as a Co-Trustee with one or more of the individuals named above or a licensed trust company and shall have the power to appoint such Co-Trustee and to at any time replace the individual or the licensed trust company then serving with an alternate individual named above or a licensed trust company at any time and/or for any reason, the purpose of this co-trusteeship requirement being to provide checks and balances and to provide for shared responsibilities with respect to individuals appointed to serve as Trustee after my death.

Notwithstanding the above, after my incapacity or death, any individual including my spouse, who is serving as Trustee who has reached the age of eighty (80) shall be required to not serve as sole Trustee, but to at all times serve as Co-Trustee with a licensed trust company, and such individual shall have the power to replace the licensed trust company with an alternate licensed trust company at any time and for any reason.

We strongly believe that the lead individual co-trustee should be able to replace any acting co-trustees from among other individuals, professionals, or trust companies in order to help ensure that the other co-trustees are responsive. We are often surprised to see documents written to facilitate handling significant wealth without naming backup trustees or a procedure for replacing a trustee who may not be doing a good job.

131 We sometimes have to go to court to have irrevocable trusts reformed, with the consent of all beneficiaries, to provide greater detail and checks and balances for trusteeship.

Guardians When a minor (someone who has not reached age 18) does not have a parent who can act as his or her legal decision maker, the courts will appoint a guardian for the child. The court will most often choose the person or persons selected under the Will of the child’s parent, who may or may not be the people that will actually physically raise the child as surrogate parents until he or she reaches age 18.

Oftentimes clients will appoint a married couple for this role, but when we ask them about what would happen if that couple divorces, they usually prefer one spouse over the other or provide another alternative altogether. Divorce rates will continue to be high and the pressure of raising someone else’s children can potentially contribute to divorce, so we prefer to name only one person, as well as an appropriate backup. When an individual becomes incapacitated and is therefore unable to make his or her own personal decisions, the courts will appoint a guardian of their person and a guardian of their property. These can be two separate individuals or institutions, and all Floridians should have up-to-date Pre-Need Guardianship Designation documents in place so that the court will know who or what trust company to appoint as the guardian of their person and guardian of their property in the event of incapacity. Typically, effective financial powers of attorney and health care surrogate designations avoid the need for this, but pursuant to Florida Statutes Section 709.2109(3), if and when a petition for guardianship is filed by anyone, all financial powers of attorney automatically lose their legal force unless the guardianship court determines that the agent can retain certain powers or permits the agent to act in lieu of a guardian. Durable power of attorney language can specifically address whether the person giving the power of attorney would want a professional guardian to be appointed in the event of permanent incapacity.

132 Agents Under Durable Power of Attorney The agent under a durable power of attorney is normally able to take any action that a person would be able to take for himself or herself. In order to be effective under Florida’s new stringent power of attorney laws, it is vitally important that the power of attorney document be properly drafted, initialed, and signed in the presence of two witnesses and a notary. Florida law requires that every power granted to the Agent must be specifically enumerated in the document and that certain statutory powers listed in the document must be initialed in order to be effective. As a result, powers of attorney that do not provide sufficient specific authority to effectuate certain tasks, or are not properly initialed as required by the statute, will not give the agent the ability to act as needed in Florida. Therefore, many Floridians will require court appointed guardianships because they and/or their lawyers were not aware of these exacting laws. Florida law essentially “grandfathers” in valid powers of attorney that were signed, witnessed, and notarized before October 1, 2011, except that “springing” powers of attorney, which only take effect in the event of the incapacity of the person who gives it, will be more difficult to activate. (See Florida Statutes Section 709.2402). For valid springing powers of attorney executed prior to October 1, 2011, a primary care doctor must specifically sign off to confirm the incapacity of the principal. Springing powers are specifically not permitted for post-September 30, 2011 powers of attorney, although something called an “escrowed” power of attorney can be used. A “general power of attorney” typically allows an appointed agent to exercise any power and sign any document that the principal would be able to sign or effectuate. However, under these laws, each and every action the agent is permitted to take must be specifically enumerated in the document for it to be effective. A general power of attorney, or any other power of attorney for that matter, expires and has no force or effect if the principal becomes incapacitated. The theory of the law is that the principal would not want the agent to act without supervision if the principal were to become incapacitated. In contrast, a durable power of attorney allows the agent to continue to act as authorized in the document upon the incapacity of the principal, except

133 when the individual is formally declared incapacitated by the court, in which case the power of attorney will automatically expire. Our book, The Florida Power of Attorney & Incapacity Planning Guide, provides many forms as well as an in-depth explanation of how financial and health care powers of attorney work. This book is intended to be used by lawyers or under the review or supervision of qualified lawyers, and it can be found at Amazon.com.

Surrogates or Health Care Agents Under Health Care Powers of Attorney Health care powers of attorney are frequently referred to as health care surrogate appointments, because these documents allow individuals to appoint someone (a surrogate) to make medical decisions for them in the event they lose capacity. Most often clients appoint their spouses or adult children to serve in this capacity. We typically encourage clients to appoint someone who will “lobby for them” and be available to go to the hospital or other facilities and speak with physicians and other caregivers to ensure that the proper things are being done for the incapacitated individual. Sometimes the client will appoint a trusted lawyer, CPA, or other professional, with the understanding that decisions will be made based upon the advice of medical professionals. One elderly physician and his wife appointed the author to serve as their health care decision maker, and they told me to do everything possible to keep them alive and comfortable for as long as possible. When I got a call at two o’clock in the morning from an emergency room physician, telling me that this was probably the last day that the wife would live, I told the physician that we wanted an immediate second opinion and named a physician who had privileges at that hospital and was a known non-conformist. The physician was fortunately available and came up with a new treatment strategy that the emergency room physician and the client’s other physicians had not thought of. She lived another four years and enjoyed her time at a well-suited facility where she had friends and companionship until age 91. In considering who to appoint as a surrogate, consider this example and appoint a trusted individual willing to take the necessary measures to help

134 ensure that you will have a good advocate during any time that you cannot make your own health care decisions.

Child Care Power of Attorney Medical, dental and similar professionals and facilities will normally not provide non-emergency services to children under the age of 18 unless a parent specifically consents or has delegated consent rights using a Child Health Care Power of Attorney.

Our form for this is as follows:

135 CHILD HEALTH CARE POWER OF ATTORNEY AND AUTHORIZATION The undersigned, being the parents and legal guardians of the following minor child/children: [CHILD/CHILDREN NAME] THE UNDERSIGNED, being the parents and legal guardians of the following minor child/children:

[CHILD’S/CHILDREN’S NAME(S)]

in order to provide for the possibility that authorization or supervision may be needed for medical care of the above-named and any future children we may have, and pursuant to Florida Statute Section 765.2035, hereby name and appoint ______, ______and ______, and such individuals who are named in Exhibit A attached hereto, as health care agents and surrogates for such child or children, as our attorneys-in-fact and Agents, and we hereby authorize such appointed persons to secure any form of medical treatment which is either necessary or appropriate, provided that it is administered by a licensed physician except when emergency circumstances do not permit securing a physician. We agree to be liable for all reasonable medical fees, costs and charges, dental fees, costs and charges, diagnostic testing, treatments, and hospital costs associated with any diagnosis or treatment. Such individuals are covered as dependents under a medical insurance plan. A copy of the coverage card may be attached to this document. We request that any and all powers that may be bestowed upon a health care surrogate for a minor shall apply, and authorize and request that all physicians, hospitals and other providers of medical services follow the instructions of such appointed Agent or Agents at any time and under any circumstances whatsoever with regard to medical treatment and surgical and diagnostic procedures and any and all other care, treatment or advice as may be requested or deemed appropriate. We fully understand that this designation will permit our designee to make health care decisions for a minor and to provide, withhold, or withdraw consent on our behalf, to apply for public benefits to defray the cost of health care, and to authorize the admission or transfer of a minor to or from a health care facility.

136

WITNESS:

______Witness PARENT 1

______Witness

______Witness PARENT 2

______Witness

STATE OF FLORIDA ) COUNTY OF ______)

ON THIS ____ day of ______, 2020, before me ______(name of notary) the undersigned notary, personally appeared PARENT 1 and PARENT 2, known to me, or who produced ______as identification, and who did take an oath, to be the persons whose names are subscribed to the above instrument, and being informed of the contents of said instrument, acknowledged that they voluntarily executed the same for the uses and purposes herein contained.

IN WITNESS WHEREOF, I have hereunto set my hand and official seal.

______Notary Public My Commission Expires:

EXHIBIT A TO

137 HEALTH CARE POWER OF ATTORNEY AND AUTHORIZATION 1. ______2. ______3. ______4. ______5. ______6. ______7. ______

Division of Duties and Entities Sometimes a client will ask me or another professional to serve as trustee of a trust for family members in a situation where there are real estate or other business concerns, which I or the other professionals do not want to have direct responsibility for. In such circumstances, a limited liability company or other entity could be set up and owned under the trust but managed by the client or a family member as manager. This keeps the assets out of the client’s estate and provides safeguards to assure that profit distributions are properly administered, while allowing the appointed fiduciary to serve without requiring the fiduciary to be involved in running the business or other activities.

Trust Protectors In addition to the appointed trustees, sometimes a client will appoint trust protectors, who have the authority to replace one or more trustees or even make changes to an irrevocable trust arrangement. For example, a client might trust his or her nephew or niece to serve as trustee for a person with special needs, but at the same time appoint an older brother, a trusted professional and a longtime family friend as trust protectors; they could then appoint an alternate trustee or change the terms of the trust if and when circumstances change.

138 Obviously, a great amount of confidence needs to exist before a person would be named as a trust protector.

Tiebreakers When there will be two (or another even number) of co-trustees or other categories of fiduciaries serving and neither has the right to replace the other, we will often recommend the appointment of a tiebreaker who can make final decisions to avoid deadlock and adversary situations. The tiebreaker could be the first available from a list of trusted friends and/or advisors.

Common examples The Surviving Spouse - When one spouse dies the surviving spouse receives $2,000,000 of life insurance premiums in trust to support themselves and the children. Instead of serving as sole trustee, the surviving spouse can serve as co-trustee with their choice of any trust company or any one of certain persons named in the document. The spouse can negotiate fees before making a decision and terminate the acting professional co-trustee and replace them with an alternate trust company or listed individual at any time and for any reason. The spouse is much less likely to be “bossed around” or inappropriately influenced by a new spouse or by the children in later years where a professional co-trustee is serving. The Elderly Client - When an elderly client loses their spouse they are often quite shaken up both emotionally and sometimes from a health standpoint. By designating a co-trustee, these clients have an added security and independence from well-meaning loved ones and caretakers who might exert undue influence or make mistakes from an investment or fiscal responsibility standpoint. A Child - Monies left to an adult child who is responsible but has marital problems, is an emotional spender, or has other issues such that it is best that the assets be managed and paid out in a professional manner with the child perhaps having the power to replace the trustee or trustees with alternate independent trustees. A Gambler - Monies left to people who have gambling tendencies, including entrepreneurs who tend to do deals and risk losing assets are much more secure held with a co-trustee.

139 The Addict - Monies left to individuals who have alcohol, drug or similar addictions will typically be lost and make the person even worse than they were. This is further discussed in Chapter 8.

Memoranda that we have written on the subject are as follows:

MEMORANDUM

TO: CLIENTS FROM: ALAN S. GASSMAN, ESQ. RE: WHY HAVE A CORPORATE OR PROFESSIONAL CO-TRUSTEE? *************************************************************************************** While family members may seem like the best choice for trusteeship of long- term trusts to benefit spouses and children, we often recommend consideration of having the family member serve as co-trustee with their choice of a licensed trust company and/or professional individual or individuals to act as co-trustee in order to avoid major pitfalls that often occur. Examples are as follows:

1. Loss of assets often occurs by reason of: a. Loans authorized by the fiduciary are not repaid. b. High-risk investments that did not seem high-risk to the non- professional trustee at the time they were made.

c. Liberal distribution and beneficiary/loan decisions made where a feeling of generosity was allowed to influence what should have been an attitude of conservatism for long-term benefit.

2. Tax and funding mistakes are often made by well-meaning individuals who do not hire and closely follow the advice of appropriately specialized advisors. Non-specialized advisors may mean well, but sometimes give mistaken advice, and a non-professional fiduciary would never know the difference. 3. Family squabbles that can often occur when one family member has decision-making authority over other family members with no one to “blame decisions on.”

140 The professional trustee will commonly be a bank or brokerage firm affiliate, an experienced CPA, a lawyer who works extensively in the trust administrative area, or in some cases, an offshore trust company. We always recommend that selected family members or advisors have the ability to replace an acting trustee from a list of alternate trustees or categories thereof to help assure responsiveness, competitiveness and reasonableness as to fees charged, and to exert a reasonable degree of influence over trustee decisions.

MEMORANDUM TO: ESTATE PLANNING CLIENTS FROM: ALAN S. GASSMAN, ESQ. RE: TRUST SYSTEMS FOR CHILDREN & SUBSEQUENT GENERATIONS ********************************************************************************************************** I. THE TRADITIONAL APPROACH:

A. On the death of the surviving spouse there is a separate share for each child. B. Each child receives what the trustees deem appropriate and receives percentages of principal upon attaining certain ages, such as:

Age Percentage of Remaining Assets 25 33 1/3% 30 50%

35 100%

C. Release as needed, plus at specified ages. D. The child may become co-trustee at a certain age, such as 30, and sole trustee at age 35.

141 II. A MORE PROTECTIVE APPROACH FROM A POSSIBLE DIVORCE AND CREDITOR PROTECTION STANDPOINT FOR THE CHILD:

Child becomes a trustee but has trust protection for life. A. Assets are held in a protective trust that is as immune as possible from creditor claims and divorce claims. B. The child is to receive amounts as reasonably needed for the health, education, maintenance and support of themselves and their descendants. C. The child may serve as co-trustee upon reaching a certain age, such as 25, co-trustee with their choice from a list of selected people or a licensed trust company at a later age, such as 30, and sole trustee at age 35. D. The child can designate how the assets would pass on the child’s death, which may be restricted to lineal descendants or perhaps up to 1/3rd to a spouse or charity.

III. AN EVEN MORE PROTECTIVE APPROACH:

Independent trusteeship for entire life of child. A. The same as II above, except the child must serve as trustee for life with their choice of any licensed trust company. IV. WITH EACH OF THE SYSTEMS DESCRIBED ABOVE THERE CAN BE SPECIAL STIPULATIONS, SUCH AS NOTHING BUT EDUCATIONAL EXPENSES AND SUPPORT UNTIL A FOUR-YEAR DEGREE OR A CERTAIN AGE HAS BEEN ATTAINED, A RESTRICTION ON THE CHILD SERVING AS A CO-TRUSTEE OR TRUSTEE DURING THE PENDENCY OF A DIVORCE, CREDITOR PROBLEM, REACHING A CERTAIN ADVANCED AGE, AND EVEN REQUIREMENTS THAT THE CHILD’S DISTRIBUTION WOULD BE LIMITED TO A PERCENTAGE OF W-2 INCOME OR TIMES WHEN THE CHILD IS A FULL-TIME HOMEMAKER WITH YOUNG CHILDREN AT HOME.

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CHAPTER 7 - STEP 7 FEDERAL ESTATE TAX PLANNING

This will be the most important chapter of this book for a great many readers, because federal estate tax planning requires careful structuring that will significantly affect the form and content of a person’s estate and creditor protection planning. Fortunately, many well- organized and dedicated Florida lawyers who specialize in estate tax planning have the tools to provide a family with a well-prepared estate plan that takes creditor protection and other complicated legal variables into consideration. Please do not expect someone who is not a well- qualified tax lawyer to be able to do this without help or oversight from a qualified tax lawyer. Very few advisors other than tax lawyers have a sufficient understanding to be sure that a plan is properly designed, drafted and implemented. Many new clients come to us with the understanding that their current estate tax plan is well-prepared and complete, but we often find significant planning opportunities that were overlooked or not properly implemented. If you have any doubt whatsoever as to whether your estate planning documents, asset, insurance and other dynamics are complete, or whether your retirement and life insurance beneficiary designations are correct, or other concerns, please meet with a qualified Florida tax lawyer! It is essential to use a qualified estate tax planning specialist lawyer if you think that estate tax will be a significant concern in preparing your estate plan.

General Overview Since 2001, the estate planning community and its clients have survived quite a roller coaster. From January 1, 2001 through 2017, estate tax exemption amounts went anywhere from $675,000 to infinite (no estate tax for people dying in 2010), and everywhere in between. Effective January 1, 2019, the estate, gift, and generation skipping transfer (“GST”) tax exemption all more than doubled, from $5,490,000 in 2017 to $11,400,000 in 2019. As a result, many families will no longer have tax

avoidance as a large priority in their estate planning. Also, the annual gift and GST tax exclusions are $15,000, set to increase by $1,000 increments in accordance with the inflation index. Absent additional legislation, all three lifetime exemption amounts are set to revert back to the 2017 amount indexed for inflation in 2026. Since 2001, estate tax rates have fluctuated between 35% and 55%. That said, the estate tax rate has remained steady at 40% since 2013. Some 2016 presidential candidates supported abolishing the estate tax altogether, while others supported raising the top bracket to 65%. Nonetheless, it remains at 40% under the 2018 Tax Cuts and Jobs Act. From 2002 to 2017, a taxpayer’s lifetime gift tax exemption fluctuated anywhere between $1,000,000 and $11,180,000. Under current law, a taxpayer can gift up $11,400,000 in addition to the annual exclusion amount before incurring the 40% gift tax. Any gift exceeding the $15,000 annual exclusion amount causes the use of both the $11,400,000 gift and the estate tax allowance. For example, someone who has never gifted before can transfer $5,000,000 to a child in 2019 in addition to the annual exclusion amount, and later die with up to $6,400,000 of remaining gift tax and estate tax allowance ($11,400,000 minus $5,000,000 in both cases). Federal law also provides for an unlimited marital deduction, so that assets can pass to a spouse or to a marital deduction trust, defined in the previous chapter, without being subject to federal estate tax on the first dying spouse’s death. Those assets will still be held by the surviving spouse or in a marital deduction trust for the spouse and are considered to be owned by that spouse for his or her own estate tax measurement on subsequent death. University of Florida estate tax law professor Douglas C. Miller often refers to the estate tax as a “voluntary tax” because there are so many different avoidance techniques that go unused. Anyone who thinks otherwise should be sure to see a competent estate tax planning lawyer periodically to implement an ongoing program of estate tax avoidance and to take full advantage of the ability to chip away at tax exposure using a variety of techniques. A number of factors affect the implementation of techniques, including circumstances of the assets held, age, health, and new developments in the field, which are often changing.

146 We further describe the federal estate and gift tax and a number of strategies below. Nuts and Bolts of the Federal Gift and Estate Taxes When a person dies, the federal estate and gift tax systems add up the value of the person’s assets, allowing deductions for assets that pass to charity, to a spouse, or to special trusts for charities and spouses. The amount that can pass estate tax free is called the estate tax exemption. Each person is entitled to his or her own estate tax exemption. If the value of an estate, minus allowable deductions, is less than the estate tax exemption, no estate tax is due. The law provides an unlimited marital deduction so that spouses can transfer assets to each other, either directly or under a marital deduction trust, without incurring estate or gift tax. Therefore, if the first spouse to die gives all of his or her assets to the surviving spouse, or to a marital deduction trust, his or her estate will not pay any estate or gift tax. For example, if the amount that passes estate tax free is $5,600,000 (the 2018 exemption), and a married person who has never made gifts before dies with $12,000,000 in assets, he or she could pass $5,600,000 to a family/bypass trust that could benefit his or her spouse without ever being subject to federal estate tax, with the remaining $6,600,000 passing directly to the surviving spouse and/or to a marital deduction trust. When the surviving spouse dies, no part of the family/bypass trust that was funded with $5,600,000 in assets will be subject to federal estate tax if the trust was properly drafted and administered, and whatever remains of the $6,600,000 that was passed to the surviving spouse or to the marital deduction trust will be included in the surviving spouse’s taxable estate when he or she dies, where the surviving spouse can use his or her estate tax allowance. In 2019, gifts can be made annually to one or more individuals up to the amount of $15,000 per year without being counted for gift tax purposes. A married couple can give $30,000 together to each gift recipient. We call these “excluded” gifts. Gifts to or for any one person that exceed this amount, or for any reason do not qualify for the gift tax annual exclusion, must be reported

147 on a gift tax return, and the current (2019) $11,400,000 lifetime gift and estate tax exclusions are reduced by the amount of such reportable gifts. Gifts that exceed the amount of the annual exclusion allowance are “reportable gifts,” also known as “taxable gifts,” but do not cause incurrence of a federal gift tax until the person has used all of his or her lifetime gifting exemption. If a person makes cumulative taxable reportable gifts in excess of the lifetime gifting exclusion, a federal gift tax will be imposed at the 40% bracket. If the person who died lives in one of the six states with an inheritance tax, Nebraska, New Jersey, Kentucky, Pennsylvania, Iowa, and Maryland, then additional logistics are called for to help assure that additional tax will not be incurred and that the federal estate tax system planning is properly coordinated. Fortunately, Florida does not have inheritance or estate tax at this time. There is no income tax deduction for giving a gift and no income tax payable by the recipient of a gift. When gifts are given outright to a person, the donee’s tax basis for capital gains tax purposes is the same as what the donor’s basis was. When gifts are made to a “defective grantor trust,” as described below, the trust has the same basis in the assets as the donor had. It is quite likely that when the donor dies, the trust gets a date of death fair market value basis, which can save significant amounts of income taxes for the trust beneficiaries. Here is an example of how the gift tax system works: If a father gave his daughter gifts based upon the amount that can be gifted each year without being counted (“the annual exclusion amount,” presently $15,000 per person) plus an additional $1,000,000 total up through 2019, then the father will have used $1,000,000 of his gift and estate tax exemption. If the father died in 2019 when the gift and estate tax exemptions were $11,400,000 collectively, then his estate could have transferred another $10,400,000 without payment of gift or estate tax. This example assumes that the father was not married or left no assets to his wife.

148

Bypass Trusts (also known as Credit Shelter Trusts and/or “B Trusts”) For married clients who have estate tax concerns, the first step is to be sure that on the death of one spouse, a certain amount of assets that

149 can benefit the surviving spouse without being subject to federal estate tax are placed into what we call a “family trust” or “bypass trust.” By placing this requisite amount of assets into this type of trust, a surviving spouse may benefit without being subject to federal estate tax on the second death. If a husband and wife own all of their assets jointly with right of survivorship and/or as tenants by the entireties, then all of the assets are automatically owned by the surviving spouse and will be subject to federal estate tax on the second death, unless the surviving spouse is able to elect not to have the joint assets pass by right of survivorship by “disclaiming” the half ownership of the first dying spouse, which can be permitted under Florida and the federal estate tax law if certain requirements are met. Typically, a special arrangement will have been thought through in advance. If the first dying spouse has placed the assets into joint names, then the surviving spouse may be able to disclaim all of such assets into a bypass trust if the proper documentation is in place. Because of the above, qualified advisors will typically help to situate appropriate assets, life insurances or other benefits in a way that can facilitate funding a bypass trust on the first death from assets owned by the first dying spouse. However, it is important to understand that this strategy is not always ideal where the spouse who might die first has possible creditor situations that could cause loss of assets held under that spouse’s individual name or revocable living trust during his or her lifetime. This is where an experienced and conscientious Florida-based estate planner, with both tax and creditor protection expertise, becomes necessary to create an appropriate plan. A professional with these qualifications can best determine how to implement a number of hybrid techniques, several of which are discussed in detail below. In addition to attempting to fund a bypass trust when the first spouse dies, we urge clients who may have estate and gift tax concerns to make lifetime gifts using their yearly $15,000 per person/donee gifting ability, and to make use of their lifetime gifting exemption. Generation skipping tax is described below, but at this point, it is useful to know that for the most part, assets passing from a “bypass trust”

150 on the surviving spouse’s death can be used to fund separate trusts for the children that can benefit each child for his or her lifetime and not be subject to federal estate tax at his or her level as well. Typically, assets passing via a marital deduction trust can be held in trust for the children or after the surviving spouse’s death, but will need to be considered as owned by the children for estate tax purposes as they later die.

Life Insurance Trusts Life insurance is typically subject to federal estate tax unless the insured person has no ownership, control or influence over the life insurance policy. It is therefore common to have life insurance policies owned by an irrevocable life insurance trust, which may be funded using the $15,000 per year per beneficiary allowance. There are a good many complexities associated with irrevocable life insurance trust planning, but these are often very worthwhile to consider, particularly where the life insurance is on the life of one spouse who wishes to assure that there will be creditor-proof and estate tax free benefits for the surviving spouse and descendants. Some clients also purchase “second-to-die” life insurance that has low premiums because the death benefit is only payable on the death of the surviving spouse, which is when federal estate tax will become due. Second-to-die policies are typically owned by irrevocable “dynasty” life insurance trusts in order to generate benefits that can benefit one or more generations without being subject to estate or generation taxes at the levels of the clients, their children, grandchildren, and even further descendants for up to 360 years from formation of the trust.

Terminology At this point it is useful to review concepts we have already covered, and to familiarize yourself with new information we will begin to cover, by reading over the following definitions: Beneficiary – A party who receives benefits from a trust.

Bypass Trust – A trust that is funded to maximize the estate tax exclusion amount. It is also referred to as a family trust or credit shelter trust.

151 Marital Deduction Trust – A trust that is funded to maximize the unlimited marital deduction. It is also referred to as a Q-TIP trust. A Q- TIP trust can qualify for the estate tax marital deduction by paying all income to the surviving spouse, plus amounts as needed for her health, education, maintenance and support, with the surviving spouse being the sole beneficiary of the trust during his or her lifetime. Sometimes wealthy individuals will fund a lifetime Q-TIP for a spouse as a gift to assure that if such spouse dies first, then the assets can be used to fund a bypass trust for the wealthy donor. Gift Tax Annual Exclusion – The annual amount an individual is permitted to give to another person without incurring gift tax. For 2019, it is currently set at $15,000 per year/per donee. Gift Tax Exemption Amount – The amount of taxable gifts an individual may make during his or her lifetime without having to pay federal gift tax. As of 2019, it is currently set at $11,400,000, indexed annually for inflation, and is scheduled to revert to $5,000,000, indexed for inflation, in 2026. Taxable Gift – A gift that does not qualify for any of the gift tax exclusions and is therefore “reportable” and either (1) reduces the donor’s gift tax exemption amount; or (2) causes the donor to pay federal gift tax if the donor has made cumulative taxable gifts which have utilized all of the donor’s gift tax exemption amount. Defective Trust / Defective Grantor Trust / Intentionally Defective Grantor Trust – A trust that has assets treated as owned by the grantor for income tax purposes, which allows for additional planning opportunities without incurring income tax.

Donor – The party who gives or appoints something to another party.

Donee – The party who receives something from another party. Dynasty Trust – A trust that is designed to be held for the benefit of multiple generations of descendants. Estate Tax Exemption Amount – The amount permitted to pass free of federal estate tax. Recent changes in the law have made the exemption from 2011 permanent.

152 Generation Skipping Trust – A trust that is established to avoid estate tax on transfers to descendants who are more than one generation level from the grantor; i.e. a grandchild. Generation Skipping Tax - A tax imposed when assets pass through a generation in excess of the transferor’s federal generation skipping tax exemption. Generation Skipping Tax Exemption - The amount that an individual can pass directly to grandchildren or other “skip generations” without incurring federal generation skipping tax.

Grantor/Settlor – The party who funds the trust. Irrevocable Life Insurance Trust (ILIT) – A trust specially designed to receive premium dollars as gifts and to hold life insurance to avoid federal estate tax on life insurance proceeds.

Power of Appointment – The power to designate who will receive property held under a trust. General Power of Appointment – A power given to an individual to appoint property under a trust in a way that causes the trust assets to be considered as owned by the power holder for estate tax purposes when he or she dies. Special/Limited Power of Appointment – The power to designate beneficiaries under a trust that does not cause the trust assets to be considered as owned by the power holder, because of special drafting. Often such a power is limited to being exercisable only for the benefit of lineal descendants of the grantor of the trust. Trust Protector – The party appointed in a trust who has the power to change how the trust assets will pass when the surviving spouse dies.

Trustee – The individual or entity that oversees and manages the trust assets. A “Dynasty Trust” is a name used to describe a number of different types of trusts that are intended to benefit multiple generations over time. These trusts are also often called “Generation skipping Trusts” because they can provide health, education, maintenance and support payments,

153 as well as loans and certain other benefits, to one or more generations without being subject to estate tax when members of a particular generation die. Typically, these trusts provide health, education, maintenance and support for beneficiaries who can also control trusteeship and designate how the trust assets pass if they wish to redirect them upon death. Florida has a 360-year term to which such trusts can extend. In February of 2012, the Obama administration proposed limiting “generation skipping trusts” to 90 years, but nothing came of this proposal. For example, if a grandparent transfers assets to his children, who then transfer the assets to their children, there would be two taxable transfers, one at the level of the grandparents when they leave the assets to the children, and then another at the level of the children when they leave the assets to the grandchildren. Congress wanted to curb the use of trusts that benefit the next generation without being taxed at its level, so it implemented the generation skipping transfer tax (“GST tax”). The 40% GST tax is imposed in addition to the estate and gift tax when more than a certain amount “skips” a generation without being taxed. Currently, each person has an $11,400,000 generation skipping tax exclusion that allows cumulative lifetime gifting and dispositions on death to go directly to grandchildren, or to benefit children and then pass for the benefit of grandchildren, without the donor being subject to the federal general skipping tax. In addition, $15,000 per year in properly structured gifts to or for grandchildren do not have to be counted. As an example of the above, assume that a grandfather has $20,000,000 in assets, no spouse, two children, and six grandchildren. He would like to maximize what could benefit the grandchildren without being subject to either federal estate tax or federal generation skipping tax. He would also like to now make a $4,000,000 gift to his grandchildren and has never given large gifts before. He can put $4,000,000 into a dynasty trust to benefit his children and grandchildren now, and then when he dies he will have $7,180,000 left of his GST allowance that could go to another trust or the same gifting trust described above to benefit his children and then his grandchildren. For any part of the original $4,000,000 gift or subsequent $7,180,000

154 disposition to go directly to or for the benefit of one or more grandchildren, that arrangement will be sufficient. To avoid federal estate tax, the grandfather could leave the remaining assets with a value over his $11,400,000 estate tax exemption in the trust. This would put a total of $8,820,000 in the dynasty trust ($4,000,000 plus 4,820,000). The remaining amounts in the grandfather’s estate could pass estate tax free to the children, and whatever is remaining at the time of a child’s death would be considered as owned by that child for determining whether there is an estate tax on the child’s death. Obviously, it can be catastrophic to leave more than the generation skipping tax exemption amount to or for a grandchild unless special planning is effectuated. A trust that allows the grantor to pay tax on its income is called a defective trust or a defective grantor trust. Many clients therefore have “defective generation skipping dynasty trusts.” These types of trusts can also provide indirect financial benefits for the grantor, such as by loaning him or her money at reasonable interest rates, hiring him or her, or buying assets in exchange for monies, long-term notes, or other assets. Such trusts can also be owners of limited liability company and limited partnership interests. The grantor may co-own as well. Additionally, the grantor can maintain managerial control of the entity while the portion of the entity owned by the trust will not be subject to federal estate tax, creditor claims, or unwise spending by the beneficiaries. Often limited partnerships will be set up and owned 99% by the defective grantor trust as non-voting limited partner and 1% by the grantor as controlling general partner.

155 AN EXECUTIVE SUMMARY OF DEFECTIVE GRANTOR TRUSTS An Irrevocable Gifting Trust that is treated as owned by the Grantor for Income Tax purposes provides a number of outstanding planning opportunities. 1. A properly designed irrevocable trust can receive gifts from a client which can be administered and can pass without being subject to estate tax in the client’s estate. The trust can be totally tax neutral and treated as owned by the grantor for income tax purposes. It need not apply for a tax identification number if properly established. This combination of being immune from estate taxes but considered as part of the grantor for income taxes provides important advantages, including the following: A. The Trust does not necessarily need to apply for a tax identification number or file an income tax return.

B. The grantor’s payment of income tax on behalf of the trust does not constitute a gift to the Trust subject to the $15,000 donor/donee limitation. C. Such a trust can buy or sell assets from and to the grantor thus providing significant flexibility, particularly if the grantor receives back a long-term low interest rate note.

D. Such a trust could own S corporation stock - if properly structured. See below. E. Instead of gifting partnership interests to children or grandchildren, gift to a trust where a trustee (replaceable by the grantor with an independent party) can control what happens to distributions. F. Consider an installment sale of a discounted limited partnership or LLC interest to a defective grantor trust.

156 G. Consider a sale of a limited partnership or LLC interest to a defective grantor trust in exchange for a private annuity payment right. H. A husband and wife wishing to establish some “absolutely safe assets” might decide to have one spouse fund a “lifetime benefit trust” for the other spouse and children. The donor spouse cannot be a beneficiary of the trust, but if the trust is established under circumstances where there are no creditor issues, the trust may be held in a creditor-proof and estate tax-proof manner for the spouse, children, and future generations, while being taxed as part of the couple’s joint form 1040 for the sake of simplicity and tax planning. 2. Gifts to irrevocable trusts can be made by using the credit exemption amount of the grantor, to keep the cows in the barn for when the estate tax is later increased. In the past, the IRS published Private Letter Rulings to the effect that a trust funded using annual exclusion (“Crummey power”) contributions can also qualify as a defective grantor trust as to the donor/grantor. The law in this area, however, may be somewhat uncertain. A donee possessing a Crummey withdrawal power may be treated as the owner of a portion of the Trust attributable to the contribution over which the power was exercisable. 3. Clients most often wish that the trust will be held for their children and/or grandchildren during their lifetime, with distributions, or separate shares, established after death. This way, clients can dole out property as needed to the children from their own assets while alive.

4. Under Revenue Ruling 95-58, the client can retain the right to replace the trustee, so long as the replacement is not a subordinate or related party. A trustee can be given a good deal of discretion as to how to manage the trust for the beneficiaries. Even more flexibility can be given to the Trust by the use of a trust protector or a trust protector committee. This would be one or more persons or institutions who would have the power to make amendments to the trust for the benefit of the beneficiaries if deemed appropriate after the Trust has been established. 5. For income tax purposes, irrevocable trusts are often considered a separate taxable entity. If all income is paid out annually, then the concept of

157 distributable net income results in the beneficiaries paying the applicable income taxes. Many advisors are unaware of the “defective grantor trust” rules. These were passed many years ago when individual tax rates were higher than trust tax rates. Congress determined it appropriate to require that individuals be responsible for the payment of income tax attributable to income on trusts that they held certain powers over. The most popular of such powers is the power to replace trust assets with assets of equal value under Internal Revenue Code Section 675(4)(c). Other circumstances that can result in grantor trust status, under appropriate circumstances, include having a spouse of the grantor as a beneficiary, establishing a foreign trust with one or more U.S. beneficiaries, allowing a person or persons unrelated to any beneficiary to add discretionary income beneficiaries to a trust, and authorizing the trust to hold life insurance on the life of the grantor under Section 677(a)(3) (which may only apply when significant life insurance is actually purchased). None of the aforementioned powers should result in the trust being subject to estate tax, but nevertheless the client can pay the income tax attributable to trust income. This way the trust grows “tax free,” and the payment of tax on the trust income is not considered a taxable gift by the Grantor. 6. The family limited partnership makes an irrevocable gifting trust even more attractive to a client, since the client can retain a 1% general partnership interest to control the partnership and transfer limited partnership interests to the gifting trust by gift or sale. The trustee of the trust simply receives a certificate of ownership for a limited partnership interest in the limited partnership. The arrangement allows substantial discounts to be used so that the overall value of what is given may be considered as worth more than $15,000 per donor/donee in the eyes of the client. 7. For income tax purposes, the defective grantor trust and the grantor are considered to be one person. Therefore, assets can be swapped tax free. Before death, assets can be traded between the grantor and the trust so that the grantor dies owning assets most in need of a stepped-up basis. Further, the grantor can sell assets to the trust and be paid over time at a reasonable interest rate, which as of June of 2019 is only 2.76% for notes over nine years, 2.38% for notes over three years and up to nine years, and 2.37% for notes of three years or less. If the assets will grow at a rate that is higher than the interest rate on an installment sale, then this would be advantageous. The

158 IRS’s position is that if the grantor dies while owed money on an installment sale, then there may be capital gain tax to be recognized after death, but the law appears to be that there will not be any income tax payable, even if the note is satisfied after the death of the grantor. 8. Such a trust can also be used to maximize generation skipping planning. For example, clients normally want to primarily benefit children, but withdrawal powers can be given to grandchildren. Clients commonly like to fund a grandchild trust, but the trust will have a provision whereby on the death of the grantor a separate share will be established for each child and will be held for the health, education, maintenance and support of that child, passing to the grandchildren only after the death of the respective children. This makes use of the exemptions attributable to grandchildren while primarily benefitting the children. The children should not always be given withdrawal powers exceeding the greater of 5% of the value of all trust assets or $5,000 per year, if estate tax is to be avoided at the child’s level on the death of the child. See 2036(a) and 2041. It is important to allocate the generation skipping tax exemption on a timely basis by filing a Form 709 on April 1st of the calendar year following the year of transfers to the trust under many circumstances. This applies even if the transfer to the trust qualifies as an exempt gift under the $15,000 per year exclusion.

9. Asset protection trusts are a popular variety of defective grantor trusts. An asset protection trust can be formed under the jurisdiction of a foreign country that has advantageous creditor protection laws. Under Internal Revenue Code Section 679, if any possible beneficiary of such a Trust is a U.S. citizen, then if the Trust is established by a U.S. citizen, it will be considered as owned by that citizen as a grantor trust notwithstanding irrevocability. Such a Trust can be drafted to avoid any gift tax being implemented on the trust by the client settlor retaining a testamentary power of appointment over the trust assets. Thus, the trust could function as if owned totally by the client for tax purposes, but would be creditor proof to a great extent for financial planning purposes. If the client owns a 1% general partner interest in a limited partnership and conveys a 99% limited partner interest to the offshore trust, then the client would have practical control of the assets with asset protection advantages. Offshore asset protection trusts cannot own S

159 corporation stock, but Alaska, Nevada, Delaware or Rhode Island asset protection trusts can. 10. 2004 Clarification from the Internal Revenue Service. On July 6, 2004, the IRS published Revenue Ruling 2004-64. The Ruling discusses three ways to structure such trusts from an income tax payment standpoint: Situation 1. Where the trust does not authorize payment to the Grantor for the income tax the grantor pays. Under this scenario, the ruling confirms that the grantor’s payment of income tax attributable to income earned or K-1’d to the trust will not be considered a gift by the grantor. Situation 2. Where the trust requires reimbursement to the grantor for income tax paid. The Ruling provides that for trusts duly formed and funded on or before October 3, 2004, the defective grantor trust will not be included in the estate of the grantor under Internal Revenue Code Section 2036(a)(1). For trusts formed after October 3, 2004, the Service will take the position that a mandatory tax payment clause is the equivalent of the retention of the right to income from the trust. While it would seem that the maximum payment from the trust would be the income thereof multiplied by the grantor’s tax bracket, it could be argued that the tax on capital gains could exceed the fiduciary accounting income of such a trust, so the IRS has some support for its position. CAUTION: What about trusts that were formed before October 3, 2004 that require tax reimbursement, and may be added to by the grantor? Would these trusts be grandfathered under Revenue Ruling 2004-64? The language of the Revenue Ruling states “the Internal Revenue Service will not apply the estate tax holding in Situation 2 of the Revenue Ruling adversely to a grantor’s estate with respect to any trust created before October 4, 2004.” There may be some concern, however, that a preexisting trust that requires payment of the grantor’s taxes might not be grandfathered if there is a substantial addition of assets by gift to such trust. The Revenue Ruling, however, does not mention any limitation to the above quoted language. Situation 3. The trust instrument provides the trustee with the discretion to make payments to the grantor to pay the grantor’s income taxes. Under the third scenario, the grantor funds an irrevocable trust under which the trustee has discretion to make payments to the grantor to pay the grantor’s income taxes. Under the Revenue Ruling, such discretion, existing without any sort

160 of other understanding or agreement to pay the grantor’s income taxes, will not cause the defective grantor trust to be subject to income tax in the grantor’s estate. There are three CAVEATS, however, to this conclusion: (a) The Revenue Ruling implies that the IRS can review the facts and circumstances of any situation to see if there was an “unwritten understanding” that the grantor’s taxes would be paid. Any letters, explanations, or correspondence prepared which would show a general understanding that the grantor’s taxes will be paid from the defective grantor trust should be worded cautiously and kept under the attorney/CPA/client privilege. (b) Where a trustee has discretion to make payments to a grantor, state law creditors of the grantor may be able to reach into the trust. If creditors of the grantor can reach into a trust, then the grantor may be subject to estate tax on trust assets under Internal Revenue Code Section 2036(a)(1), because the grantor receives a benefit if the grantor’s creditors are satisfied from trust assets. (c) Notwithstanding the above issues, the Ruling does not grandfather defective grantor trusts which provide a trustee with discretion to pay the grantor’s income taxes, even if created before October 4, 2004. The grandfathering language only applies for Situation 2. With respect to trusts established and funded after October 3, 2004, if there is to be a discretionary power in the trustee to pay the grantor’s income taxes attributable to the trust, then the drafter and client may consider establishing the trust in a “creditor protection jurisdiction,” which will usually entail having a co-trustee in a jurisdiction that provides trust law under which creditors cannot reach into a trust. Most well-recognized offshore jurisdictions have a two-year waiting period before creditor protection becomes effective as to “fraudulent transfers.” Belize, on the other hand, has only a one day waiting period and many trust companies which offer extremely competitive trusteeship rates and services. The U.S. jurisdictions have longer waiting periods and more exceptions for items such as alimony, child support, and IRS liens. The Ruling also addresses the ability of the grantor to replace the trustee, and to thus manipulate results. The Ruling gives examples where a grantor

161 can replace a trustee holding tax payment discretion with an individual who is an employed or subordinate party. 11. Situations where a client may not want to use a “Defective Grantor Trust,” and may prefer an irrevocable trust taxed at its own brackets:

A. Non-Grantor trusts pay tax at the 10% bracket on the first $2,600 of income, and then at the 24% bracket on income over $2,600 and up to $9,300. The 23.5% bracket applies between $9,300 and $12,750, and the 39.6% bracket (plus the 3.8% Medicare tax) applies for income over $12,750 in 2019. These thresholds will increase annually with the Consumer Price Index.

B. The grantor may not want to pay the tax on behalf of the trust.

C. Increasing the grantor’s income by the income of the trust can result in Alternative Minimum Tax, and reduce itemized deductions based upon the phase-out for adjusted gross income rules. Other income tax deduction phase-outs that occur based upon adjusted gross income may also be affected. D. The 3.8% Medicare tax has to be planned for. Non-grantor trusts are subject to this tax beginning at $12,750 for 2019, but distributions made by such trusts to individual beneficiaries may avoid the tax where the beneficiaries receiving the distributions are below the $200,000 Medicare tax income threshold for single individuals or $250,000 for married couples who file jointly. The threshold is $125,000 for married couples who file separately.

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Can the Grantor Be a Beneficiary of a Trust that Avoids Federal Estate Tax? If the dynasty trust is formed in a creditor protection trust jurisdiction, like Nevada, Alaska, or Nevis, then it may also be possible for the grantor to be a discretionary beneficiary of the trust, while the trust assets remain outside of the grantor’s estate for federal estate tax purposes. If the trust is formed in Florida and the grantor is a possible beneficiary under the estate tax law then existing, the trust assets will be considered as owned by the grantor for federal estate tax purposes. This is because under Florida law, creditors of a grantor who contributed assets to a trust and is a possible beneficiary can reach into the trust to satisfy debts. In other words, if a Trustee has the discretionary ability to make distributions for the grantor, the creditors of the grantor can obtain any trust assets that the trustee would be able to distribute. The IRS has successfully won court cases imposing estate tax on assets under these trusts based upon the rationale that the grantor could indirectly reach in anytime he or she wants to by running up bills and not paying them, because they would be paid by the trustee. Because of this phenomenon, a number of states, including Delaware, Nevada and Alaska, have passed asset protection trust legislation which allows a person to establish a trust in their jurisdiction that can permit discretionary distributions to the grantor while not permitting creditors to reach into the trust. As a result the grantor can be a potential beneficiary, but should also be able to have the trust assets excluded from his or her estate for estate tax purposes if the documentation and activities under the trust are properly structured. While the creditor protection strength of these types of trusts has not been tested in court, the IRS did issue a ruling to one taxpayer in 2009 indicating that a trust set up in Alaska could include provisions that allow the trust to benefit the grantor without having the trust assets be considered as owned by the grantor for estate tax purposes. Any such trust should be designed and drafted very carefully by a lawyer who is well-versed in these areas.

163 Can a Spouse be a Beneficiary of an Irrevocable Trust? In addition, many taxpayers and advisors are not aware that the grantor’s spouse can be a beneficiary of a properly prepared and funded dynasty trust. Monies that would be needed to support the grantor’s spouse can be distributed from the trust if and when financial circumstances would be appropriate for this to occur. We have called these types of trusts “SAFE Trusts” because they are safe from creditors of the grantor and the grantor’s spouse in most situations and can pass free of estate tax while giving the spouse benefits as needed for health, education, maintenance and support. “SAFE” stands for Spousal and Family Exempt Trust.

7 Suggestions for the Design of a SAFE Trust A description of the SAFE Trust from our book entitled Estate Tax Planning in 2011 and 2012 from Bloomberg BNA Tax & Accounting, and the 2012 Supplement thereto, which was authored by Alan S. Gassman, Esq., Erica G. Pless, Esq., Kenneth J. Crotty, Esq. and Christopher J. Denicolo, Esq., is as follows:

1. The grantor’s spouse may be a trustee of the trust. The trustee of a trust is the person who manages and oversees the administration of the trust. The trustee is responsible for making distributions and owes a fiduciary duty to the beneficiaries of the trust. It is important to select a trustee who you completely trust, and who is competent to handle the fiduciary responsibilities. The obvious choice for most married couples is to have their spouse be the trustee, but this may not be the best option for all married clients. As with all irrevocable trusts, administration should be well documented and according to the trust document. 2. The grantor’s spouse can have the right to receive amounts as reasonably needed for health, education, maintenance, and support. It is best to provide that any such distributions for the spouse will be made only after taking into account the spouse’s other assets and resources.

164 Otherwise, the spouse might be considered to be gifting to the trust if he or she had the right to receive distributions and did not take them. Alternatively, distributions to the spouse can be restricted by requiring an independent fiduciary to approve them. The author therefore discourages provisions that provide for the payment of income or distributions of up to 5% of trust principal each year. It may be beneficial to require that an adverse party approve any distribution for the spouse. Additionally, a provision may be included that prevents the spouse from receiving any benefits from any portion of a trust attributable to a direct or indirect contribution by the spouse. The trust should also prevent distributions that would satisfy any obligation of support or other legal obligation of a beneficiary or trustee.

3. The grantor’s spouse may be the beneficiary of an outright disposition or a general power of appointment marital trust provision to be funded if total contributions to the trust would otherwise cause gift tax responsibility. A Q-TIP trust is not recommended here because a marital deduction election has to be filed for a lifetime Q-TIP trust gift no later than October 15 of the calendar year after funding. 4. Typically the trust will be disregarded for income tax purposes so that the grantor can pay the income tax attributable to the trust’s income. Income tax rules and estate tax rules treat trusts in different manners. For income tax purposes, a grantor can be treated as the owner of the trust assets and therefore will be responsible for paying the income taxes associated with the trust income, but for estate tax purposes may not be treated as the owner of the trust assets, and therefore the assets are not included in the grantor’s estate. These types of trusts are referred to as grantor trusts.

In some cases, advisors may intentionally draft a trust so that the grantor is treated as the owner for income tax purposes. These trusts are referred to as Intentionally Defective grantor trusts (IDGT). This type of trust offers several benefits for the grantor and potential beneficiaries. If structured properly, an IDGT can reduce the grantor’s estate for estate tax purposes and the grantor’s income tax payments on the trust income will not trigger gift tax. If the grantor wants to “toggle off” defective grantor trust status (such as by reserving the right to replace trust assets with assets of equal value, and then releasing that right), then an adverse party (another substantive beneficiary

165 under the trust) must have the right to approve any distributions to the spouse. Otherwise, the trust will be a defective grantor trust under Internal Revenue Code Section 677, and the grantor will not be able to toggle that off (except by getting divorced). 5. The grantor’s spouse may choose to “split the gift” on a gift tax return, which is permitted notwithstanding that the spouse is a beneficiary, so long as it is very unlikely that the spouse will need to receive benefits for health, education, maintenance and support when taking into account the spouse’s other assets and resources.

Either spouse may own the assets being transferred to make use of the $11,400,000 lifetime gifting exclusion, and the desired use of exclusions is not required to match the ownership of assets being transferred. Married couples are permitted to “split gifts” so that exclusion amounts can be best utilized. For example, Husband has a $22,800,000 asset and Husband and Wife wish to use each of their $11,400,000 gifting exclusion. Is it best for Husband to transfer $11,400,000 worth of the asset to Wife, who can in turn gift this portion of the asset, or is it preferable for Husband to make the entire gift and for Wife to sign a split gift return in order to consider the gift to have been made half by Wife?

The split gift return technique works even if Wife is a beneficiary of a trust that receives the gifts from Husband, unless (1) the trustee’s power to distribute property for the benefit of Wife is not limited by an ascertainable standard; and (2) Wife does not have sufficient financial assets outside of the trust, and therefore it is likely that the trustee will distribute assets from the Trust for the benefit of Wife.

166 For an excellent discussion of this topic, see Qualifying Trust Transfers for Split- Gift Treatment by William R. Swindle, July/August 2007, Vol. 81, No. 7, FL Bar Journal. However, if Husband transfers half the assets outright to Wife, and Wife then transfers these assets to a trust that benefits Husband, the step transaction doctrine may apply. 6. What if the assets used to fund the trust had recently been owned jointly by the grantor and the spouse, or were owned by the spouse and transferred to the grantor, who then transferred them to the trust?

The step transaction doctrine is a judicially created law imposed by the courts to prevent taxpayers from structuring transactions in separate steps to avoid taxes. In simple terms, the courts will collapse separate transactions into one, viewing them as an integrated plan to avoid tax. The IRS is more likely to argue that the step transaction doctrine should apply when transfers occur within a short period of time and between related parties. Therefore, it is important to carefully structure transfers to avoid the step transaction doctrine. Under the “step transaction doctrine,” the assets and the economic risk associated therewith should be owned and held exclusively by the grantor for a reasonable period of time. In case the IRS argues that the contribution to the trust was really made by the grantor’s spouse (in which event the grantor’s spouse may be subject to federal estate tax under Internal Revenue Code Section 2036(a)(1) - retained life interests), it may be important to have the trust language provide that any trust assets considered as transferred to the trust by the spouse beneficiary will be held in a separate sub-trust where the spouse is not a beneficiary. The author recommends including a provision in the trust documents to avoid having the grantor’s spouse be considered the owner of any trust assets for purposes of Internal Revenue Code Section 2036(a)(1) and (2) or any Treasury Regulations set forth therein. Consistent therewith, the grantor’s spouse should not be the Trustee of any such separate trust and any acting co-trustee should have the power to act without the joinder or consent of the grantor’s spouse as to any such trust.

Some courts have noted that the step transaction doctrine should only apply if tax savings is the sole motivation behind the taxpayer’s actions. If the

167 transaction has an “independent purpose or effect” in addition to the goal of tax savings, then such purpose or effect may be sufficient to avoid the application of the step transaction doctrine.

Planners will therefore need to consider whether the step transaction doctrine will apply, how to avoid the step transaction doctrine, and whether to use split gift returns if one spouse makes a gift that they wish to consider having been made half by the other spouse. Clients who have been involved with installment sales shortly after the funding of the entity to which the interests were sold may wish to unwind those sales or have the note paid off as part of their 2020 estate tax law planning, in order to reduce the likelihood that the IRS would attempt to apply the step transaction doctrine to the transaction that occurred.

7. Should the surviving spouse be given a limited power of appointment to direct how trust assets will pass? In some cases, it is beneficial to provide a surviving spouse with the ability to direct who can receive the trust assets. This is referred to as a power of appointment. A general power of appointment permits the surviving spouse to appoint anyone as the recipient of the assets, including the surviving spouse, the surviving spouse’s estate, creditors of the surviving spouse, or creditors of the surviving spouse’s estate. A general power of appointment is typically not recommended for creditor protection reasons, as a creditor may be able to access the trust assets if a general power of appointment is included in the trust document. On the other hand, a limited power of appointment restricts the surviving spouse’s ability to appoint trust property.

At what point should the power of appointment exist and/or be terminated? Immediately upon inception of the trust until the death of the surviving spouse, only after the death of the grantor until the death of the surviving spouse, or only unless or until the parties are divorced or either party has a child who is not a beneficiary under the trust? Each of the above options should be discussed with your legal representative as they each have implications for the grantor, the grantor’s spouse and beneficiaries.

168 Annual Gifting The $15,000 annual exclusion amount (which was raised from $14,000 by reason of inflation in 2018 and continues through 2019) should not be wasted! Many clients gift directly to children and grandchildren or fund uniform gift to minors act accounts, or 529 college savings plans, but it is more effective to gift part ownership interests in limited liability companies, limited partnerships, or certain other entities that can enable the parent or grandparent to retain control of the entity, and also permit valuation discounting techniques as described below. Uniform gifts to minor’s accounts have to be paid to the child at age 21, are subject to the child’s creditor claims at all ages, and can only be spent on the child, not siblings or others who may be more deserving. 529 Plans have to be spent on college or graduate school education or living expenses to avoid being subject to a tax on income that can reach 37% under the income tax rules.

Gifting to an Irrevocable Trust and What the Heck is a Crummey Power? Many clients are reluctant to gift cash to family members, or do not use their entire allowance, for fear that family members will (1) spend unwisely; (2) possibly lose the assets to a creditor; or (3) simply fail to make proper decisions with the money. Also, clients may have multiple children and grandchildren and may not be sure how to allocate their gifting allowances to benefit them. We therefore often establish “gifting trusts” that can receive gifts on behalf of individual beneficiaries, making use of the $15,000 per donee allowance while permitting the grantor to replace the trustees who operate the trust and control the investments if and when there would be distributions. These trusts can protect descendants from creditors, divorce claims, inappropriate decisions, and other common mishaps. The $15,000 per donee gift tax exemption was designed to apply only to gifts made directly to individuals, but a federal court in the 1968 case Crummey v. Commissioner held that a taxpayer was able to use the annual gift exclusion for gifts to a trust, where the beneficiaries of the trust had a few days after a contribution was made to decide whether to withdraw the contribution or to allow it to remain in the trust. The

169 Crummey case now stands for the principle that a beneficiary’s right to withdraw assets gifted to a trust for a limited period of time creates a present interest in such assets that allows the gift to qualify for the gift tax annual exclusion. “Crummey powers” have since been popular as a way to use the $15,000 per year allowance while keeping control and protection of the assets gifted under the trust. For example, Grandma and Grandpa have two sons and eight grandchildren. One of their sons has six children and the other has two, so they have always had mixed feelings about gifting the same amount each year to every grandchild, because it doesn’t seem fair between the children. With two children and eight grandchildren, they can gift $300,000 a year to an irrevocable trust that can be used to pay expenses for children and grandchildren, if and when deemed appropriate by the trustee. If the two children are in good marriages, they could also make their two daughters-in law discretionary beneficiaries. If they want to include their daughters-in-law as permissible beneficiaries, they could gift another $60,000 a year to the trust, even though a daughter-in-law might never receive any distributions and would no longer be a beneficiary if she ever divorced their son. To qualify the contributions for the $15,000 per year gift allowance, the trust agreement often states that when a gift is made to the trust, each beneficiary has 60 days to withdraw what is put there, and that the withdrawal power is limited to each beneficiary’s pro rata share of contributions made at that time only, not past contributions. Once the 60 days has passed, the assets can remain in the trust, and the trust can provide that after the death of the surviving grandparent there will be a 50% share for the first son and his wife and descendants and a 50% share for the second son and his wife and descendants. This way the first son shares equally in benefitting from the gifting allowance provided to his brother’s children. Discounts

170 To make this even better, if Grandma and Grandpa have a limited partnership or a LLC with either investments or a business held in it, they can gift part ownership of the limited partnership or LLC as opposed to cash. For example, if Grandma and Grandpa own an investment LLC having $1,000,000 of assets, you would logically think that they could gift a 30% ownership interest in the LLC to make a $300,000 gift. Fortunately, based upon the concept that a gift is valued based on what a willing buyer would pay a willing seller for a given ownership interest, Grandma and Grandpa would be able to gift more than a 30% ownership interest in the LLC, using their $15,000 per person each allowances. Many advisors would suggest that they use a 30% discount, so they could gift a 42.8% LLC interest and consider this to be a $300,000 gift, while it will effectively move $428,571.43 of value out of their taxable estate, if the discount is accepted or not contested by the IRS, not to mention the future growth in value that will also escape estate taxation ($300,000 divided by 0.7 is $428,571.43). The following chart shows that based upon 6% growth, a gift of $330,000 in year 1 followed by a gift of $30,000 per year (by one parent for two children, or by two parents to one child, for example) through year 10 places $935,719.22 outside of the estate and gift tax system over a period of ten years. After ten years, Column D shows that assuming a 30% valuation discount and the same 6% growth in assets, the amount placed outside of the estate and gift tax system grows to $ 1,336,741.74, a $401,022.52 increase! The chart also shows that after 20 years the increase would be $718,170.26!

10 YEAR GIFTING PERIOD – ALLOWING GROWTH THEREAFTER $330,000 FIRST YEAR GIFT FOLLOWED BY 9 YEARS OF $30,000 GIFT | 30% VALUATION DISCOUNT MOVING MORE VALUE OUT OF TAXABLE ESTATES BY USING DISCOUNTED LIMITED PARTNERSHIP OR LLC ANNUAL GIFTING

171 A. B. C. D. E. F.

Gross Gift Discounte Cumulative Cumulative Value Potential Amount d Gift Gross Gift Discounted Added by Estate Tax Amount Value with Gift 30% Savings Year (30% 6% Growth Amount Discount (40% of Discount) (30% Phenomeno Value Discount) n With 6% Added) With 6% Growth Growth $ $ $ $ 1 $ 330,000.00 $ 59,965.71 471,428.57 349,800.00 499,714.29 149,914.29 $ $ $ $ 2 $ 30,000.00 $ 68,706.51 42,857.14 400,788.00 572,554.29 171,766.29 $ $ $ $ 3 $ 30,000.00 $ 77,971.76 42,857.14 454,835.28 649,764.69 194,929.41 $ $ $ $ 4 $ 30,000.00 $ 87,792.93 42,857.14 512,125.40 731,607.71 219,482.31 $ $ $ $ 5 $ 30,000.00 $ 98,203.36 42,857.14 572,852.92 818,361.32 245,508.39 $ $ $ $ 6 $ 30,000.00 $ 109,238.42 42,857.14 637,224.10 910,320.14 273,096.04 $ $ $ $ 7 $ 30,000.00 $ 120,935.58 42,857.14 705,457.54 1,007,796.49 302,338.95 $ $ $ $ 8 $ 30,000.00 $ 133,334.57 42,857.14 777,784.99 1,111,121.42 333,336.43 $ $ $ $ 9 $ 30,000.00 $ 146,477.50 42,857.14 854,452.09 1,220,645.85 366,193.75 $ $ $ $ 10 $ 30,000.00 $ 160,409.01 42,857.14 935,719.22 1,336,741.74 401,022.52 $ $ $ 12 $ - $ - $ 180,235.56 1,051,374.11 1,501,963.02 450,588.91 $ $ $ 14 $ - $ - $ 202,512.68 1,181,323.96 1,687,605.65 506,281.70 $ $ $ 16 $ - $ - $ 227,543.25 1,327,335.60 1,896,193.71 568,858.11 $ $ $ 18 $ - $ - $ 255,667.59 1,491,394.28 2,130,563.25 639,168.98 $ $ $ 20 $ - $ - $ 287,268.10 1,675,730.61 2,393,900.87 718,170.26 $ $ $ 22 $ - $ - $ 322,774.44 1,882,850.91 2,689,787.02 806,936.11 $ $ $ 24 $ - $ - $ 362,669.36 2,115,571.28 3,022,244.69 906,673.41 $ $ $ 26 $ - $ - $ 407,495.30 2,377,055.90 3,395,794.14 1,018,738.24 $ $ $ 28 $ - $ - $ 457,861.71 2,670,860.00 3,815,514.29 1,144,654.29 $ $ $ 30 $ - $ - $ 514,453.42 3,000,978.30 4,287,111.86 1,286,133.56

172

Installment Sales for Low-Interest Notes As of June 2019, the federally determined “applicable federal rates” that apply for notes between related parties that are up to three years (“short-term”), over three years and up to nine years (“mid- term”), or longer (“long-term”) are as follows: Short-Term AFRs Mid-Term AFRs Long-Term AFRs Annual 2.37% Annual 2.38% Annual 2.76% Semi- 2.36% Semi- 2.37% Semi- 2.74% June Annual Annual Annual 2019 Quarterly 2.35% Quarterly 2.36% Quarterly 2.73% Monthly 2.35% Monthly 2.36% Monthly 2.72%

As an example of the above, assume that Grandma and Grandpa gift 42.8% of the LLC in the example above to the gifting trust in year one, and in year two retain 1% voting control but sell the remaining 57.2% non-voting ownership interest to the trust in exchange for a $435,202, 0.87% (eighty-seven hundredths of one percent) 9-year promissory note that has no penalty for prepayment. The annual payments on the note would therefore be $3,786 a year. If the LLC makes distributions of $10,000 a year, Grandma and Grandpa would receive $38,100 a year directly from the LLC, and the trust would receive $6,210 a year that it could use to make the $3,786 a year payment to Grandma and Grandpa.

Self-Cancelling Installment Notes If Grandma or Grandpa are in reasonable health and the note meets a certain minimum interest rate rule, then it can “cancel on death” and not be subject to federal estate tax. This is called a “Self-Canceling Installment Note” (SCIN), and these are very popular for people who are not in good health. The tax law allows a SCIN to be used as long as (a) the person has at least a 50% chance of living at least one year at the time the Note is entered into; or (b) the person actually lives at least 18 months from the date the Note is put into place. These are often used for clients who have short life expectancies, but are expected to live at least one year.

173 In the example above, if Grandma and Grandpa are age 64, then a note that would cancel on the death of the survivor of them that is entered into in January of 2013, could bear interest at 3.573%.

Defective Grantor Trusts As discussed above, one fantastic loophole in the present estate and gift tax world is that a properly drafted irrevocable trust can be completely effective for estate and gift tax purposes, but “disregarded” for income tax purposes. As the result of this, the sale of stock by Grandma and Grandpa to the trust described above does not trigger any tax, and their receipt of interest from the trust is also not subject to income tax. For all purposes, Grandma and Grandpa are considered the owner of the LLC for income tax purposes, because the gifting trust is “disregarded.” As the result of this, Grandma and Grandpa can pay all of the income taxes attributable to the income resulting from ownership of the LLC, and this is not considered to be a gift to the gifting trust, although it subsidizes it substantially. If this trust is properly drafted, then in future years Grandma and Grandpa would be able to take steps to cause the trust to be subject to federal income tax at its own brackets if and when they want to. This is known as “toggling off” defective grantor trust status.” Qualified Personal Residence Trusts (QPRTs) For most purposes, the federal estate tax law prevents a person from making a gift of an asset, that he or she then makes use of, without paying fair market value rent or other usage charges. For example, someone who gifts a tree, and retains the right to eat the fruit, will be subject to estate tax as if they still own the entire tree. In fact, a farmer who gifts an entire farm, but retains the right to let one cow stay there, will have the entire farm included in his estate. One notable exception to this applies for individuals who gift their primary residence and/or a vacation residence to a special type of trust called a Qualified Personal Residence Trust (“QPRT”). Under a QPRT, the person gifting the residence can retain the right to live there rent-free for a specified number of years, and the value of the

174 reportable gift is reduced to take into account only the value of the remainder interest based on the IRS actuarial tables. Once the selected term of years has run, the donor can continue to live in the home by paying the trust rent based on fair market value, which further reduces the donor’s estate, and is not considered to be a taxable gift. These trusts can be structured so that the income tax and state law advantages of home ownership can continue to apply for most jurisdictions. For example, John Smith has a $1,000,000 home and is age 57. He expects the home to be worth at least $2,000,000 in ten years. He gave the home to a qualified 10-year retained use Qualified Personal Residence Trust in November of 2018 and the value of the gift is determined to be only $800,450 because of the actuarial assumptions that applied. He can thereafter use the home without paying rent and after the 10 years pass, he can continue to use the home as long as he pays fair market value rent to the trust, and this rent will not be considered an additional gift for gift tax purposes. Upon funding the trust with the home, he files a gift tax return and then dies in year 11, after paying fair market value rent from the 10th anniversary until the date of his death. At that time the home is worth $2,000,000 and the entire $2,000,000 is excluded from his estate, notwithstanding that he had full use of the home during the 10-year term and only used $800,450 of his gifting allowance. An example of a QPRT arrangement for a married couple is described by the following letter and chart, which demonstrates that each spouse could gift one-half of their home or vacation property to a qualified personal residence trust and calculate the gift tax return reporting based upon an additional discount to reflect what a willing buyer will pay a willing seller for only half of the home since each of them are giving only one-half away. The following is an excerpt from The Thursday Report, a bi-weekly newsletter providing information on various current legal topics. To be

175 added to the mailing list to receive future Thursday Reports please email [email protected]: Many taxpayers establish Qualified Personal Residence Trusts (QPRTs) to make effective use of what remains of their $11,400,000 gift tax exemptions this year. With real estate values solidifying, and the excess supply of vacant homes and condominiums decreasing, many affluent clients conclude that establishing a QPRT is an excellent opportunity to substantially reduce potential estate tax liability and utilize their remaining gift tax exemption. A QPRT is an irrevocable trust established by the owner of a residence by transferring title to his or her primary or secondary residence to the trust. The trust terms provide that the previous owner of the residence (the “grantor”) will continue to have the right to use and occupy the residence for a term of years to be specified by the grantor. Once the given term has passed, the trust provides that ownership of the personal residence will pass to remainder beneficiaries. If the grantor wishes to continue living in the home after the initial term specified in the trust agreement, the grantor must pay a fair market rent to the remainder beneficiaries.

The Tricks Using present low values and the supportive evidence of low tax assessed values, along with the reduction of gift value by the actuarial tables that give credit for the retained use term, QPRTs are a real bargain for many clients. If each spouse transfers one-half of a residence into a separate QPRT, an additional discount can be taken, and one spouse can have free lifetime use of one-half of the home. [NEED TO RECALCULATE WITH THE NEW AMOUNT??]The following example demonstrates the tax benefits of a QPRT for a married couple. Spouses who are 55 years old with a house worth $5,400,000 could each transfer 50% of the residence to separate QPRTs. Assuming a 15% reduction in fair market value due to co-ownership, a one-half interest in the home would be valued at $4,751,500. If the clients retain the right to live in the residence for twelve years, then each

176 client would be making a taxable gift of $4,751,500 when the QPRT is funded. With a ___% [TO BE COMPLETED] estate tax rate and a 7% growth rate on the residence, the QPRT would generate an estate tax savings of $986,625 after the 12-year term, so long as one spouse survived. Based on these assumptions, the estate tax savings would be approximately $1,977,339 after 20 years. A letter that we use to explain QPRTs to married couples is as follows:

Dear ______: Please find enclosed draft Qualified Personal Residence Trusts (QPRT) for your review. Both you and your spouse will transfer one-half of the house into a separate trust. Therefore, each of the trusts will own one-half of the house, and each of you will be given the right under the trust you establish to have use of the house. We have made these for ____ year terms. If one of you dies during the term and the other survives, then the surviving spouse could continue to use the home, but would pay one-half of the fair rental value into the first dying spouse’s Trust, which would be held for the surviving spouse or for your children. The advantage of paying rent is that this is not considered a taxable gift, and therefore helps to reduce the surviving spouse’s taxable estate. With reference to the trust provisions, Article One provides for setting up the Trust, Article Two of the Agreement provides general definitions, and Article Three specifies that the Trust is absolutely irrevocable, which means that the Trust cannot be terminated or modified after it is established, except as specifically provided in the Trust Agreement. Article Four provides that you will have exclusive possession of the residence for the term specified. The longer the Trust term, the lower the gift tax exemption usage, but you need to live for the full term of the Trust in order to have the estate tax savings for your respective half, so ____ years seems like an appropriate period of time. At the end of the specified term, the residence will be held in trust until the death of the survivor of you, and then it, or the proceeds of its sale and reinvestments of those proceeds, will be distributed to trusts that are established for your children under Article Five.

177 Once the specified term has expired, fair market value rent will need to be paid to the trust for your continued use of the residence. If you die prior to the end of the specified term, the residence will be held in trust for your spouse unless you provide otherwise in a provision in your Will. If you do die before the end of the specified term, then your interest in the residence will be taxed in your estate, but the unified credit exemption equivalent used when you contributed the residence to the trust will be restored.

178 Article Five provides that after the end of the retained possession term, the trust assets will be divided into separate trusts for your children, and your children will receive distributions as needed for their health, education, maintenance and support for their lifetimes, and will have the power to appoint the assets held in their respective separate trusts among your descendants. Article Six provides for the Trustee and Successor Trustee. Each of you are the initial Trustees of your respective Trusts, with the other of you as Successor Trustee, if the initial Trustee becomes unable to serve. Upon expiration of the specified term, you will not be able to serve as Trustees of these Trusts any longer. We have drafted the Trusts so that each of your children who are able and willing to serve would serve as Co-Trustees. In the event that only one of your children is able and willing to serve, he or she would be required to serve as Co-Trustee with a licensed trust company. Article Seven provides standard Trustee powers and Article Eight provides prohibitions on Trustee powers to prevent the Trust from being taxed in your or the Trustee’s estates. Article Nine provides that third parties, such as banks and stock brokerage firms, are authorized to deal with the Trustee and any Successor Trustee for Trust purposes. Article Ten contains phraseology intended to facilitate having the Trust operate properly under state and tax law. Also enclosed please find draft deeds of your respective one-half interest in your residence to the Trust. No title insurance will be written for the Trusts. We strongly encourage that you receive appraisals on the one-half interests being transferred. In receiving those appraisals, you can ask the real estate appraisers to take into consideration that this is a one-half interest being transferred, so the overall value transferred by each of you should be less than one-half of the value. For example, a typical willing buyer would not pay a typical willing seller 50% of the value of a property for a one-half undivided interest, because of the inconvenience and uncertainty of having a co-owner. Typically, there would be a 15%-25% discount to take that into consideration. In other words, if a house is worth $850,000, a one-half undivided interest being transferred to a qualified personal residence trust might be worth between 75% to 85% of $425,000. It will be important to have written appraisal reports to attach to a gift tax return that should be filed with the Internal Revenue Service to disclose these transfers. The gift tax return is required. If the returns are accompanied by what appear to be

179 reputable appraisals, I do not think there is much likelihood that the Internal Revenue Service would try to change the assumptions being posited.

If you have any questions or changes concerning this please do not hesitate to contact me.

Best personal regards, ATTORNEY

A spreadsheet that can also be reviewed is as follows: QPRT DISCOUNTED VALUE CHART Initial Value of Home $3,500,000 Fractional Discount Assumed 15.00% Discounted Value of 1/2 of Home $1,487,500

180 Gift Component VALUE OF ESTATE ESTATE TAX ESTATE 1/2 OF TAX ON SAVINGS ON TAX SAVINGS RESIDENCE VALUE 1/2 OF AFTER 20 AT AT END RESIDENCE YEARS END OF OF TERM AT ASSUMING 7% TERM ASSUMING END OF QPRT GROWTH ASSUMING 35% ON 1/2 7% ESTATE OF RESIDENCE GROWTH TAX RATE

GIFT % 88.625% 6 YEAR VALUE OF $2,626,278 $919,197 $457,793 $1,908,778 QPRT $1,318,297 GIFT GIFT % $84.419% 8 YEAR VALUE OF $3,006,826 $1,052,389 $612,883 $1,930,675 QPRT $1,255,733 GIFT

10 GIFT % 80.045% YEAR VALUE OF $3,442,515 $1,204,880 $788,146 $1,953,447 $1,190,669 QPRT GIFT

12 GIFT % 75.456% YEAR VALUE OF $3,941,335 $1,379,467 $986,625 $1,977,338 $1,122,408 QPRT GIFT

14 GIFT % 70.607% YEAR VALUE OF $4,512,435 $1,579,352 $1,211,754 $2,002,584 $1,050,279 QPRT GIFT

16 GIFT % 65.474% YEAR VALUE OF $5,166,287 $1,808,200 $1,467,326 $2,029,308 $973,926 QPRT GIFT

20 GIFT % 54.191% YEAR VALUE OF $806,091 $6,771,948 $2,370,182 $2,088,050 $2,088,050 QPRT GIFT Probability of Death Before Certain Age | Current Age: 57 6 years (63) - 5.92% 8 years (65) - 8.59% 10 years (67) - 11.58% 12 years (69) - 14.97% 14 years (71) - 18.84%

181 16 years (73) - 23.23% 20 years (77) - 33.88%

The following example demonstrates the tax benefits of a QPRT for a married couple. Spouses who are 55 years old with a house worth $3,500,000 could each transfer 50% of the residence to separate QPRTs. Assuming a 15% reduction in fair market value due to co-ownership, a one-half interest in the home would be valued at $1,487,500. If the clients retain the right to live in the residence for twelve years, then each client would be making a taxable gift of $1,222,408 when the QPRT is funded. Assuming a 35% estate tax rate and a 7% growth rate on the residence, the QPRT would generate an estate tax savings of $986,625 after the twelve-year term, as long as one spouse survived. Based on these assumptions, the estate tax savings would be approximately $1,977,339 after 20 years.

A Qualified Personal Residence Trust (QPRT) May Be Converted to an Annuity Trust Under Treasury Regulation Section 25.2702-5(c)(8)(i), if the home is sold while in the QPRT, the trust ceases to be a QPRT and the trustee must either 1) distribute the proceeds outright to the grantor; or 2) the interest of the grantor should be converted into an annuity interest. Although the regulation permits the proceeds to be distributed to the grantor or for the grantor’s interest to be converted to an annuity, it is strongly recommended that all trust documents are drafted to require conversion to an annuity interest. Under this option, the trust will make an annual annuity payment to the grantor, which, if properly drafted, should qualify as an exempt asset under Florida Statutes Section 222.14. Sample language that the author has used in a QPRT to facilitate this process is as follows: If the Trust ceases to be a Qualified Personal Residence Trust with respect to certain property, such property shall, within thirty days, be held in a separate share and the interest of the Grantor shall be converted into a qualified annuity interest (as defined by Treas. Reg. § 25.2702-3 and the requirements

182 for such interest shall be deemed incorporated into this Article) with the smallest fixed annuity payments permitted by Treas. Reg. § 25.2702-5(c)(8)(ii)(C) to be made to the Grantor each calendar month for the balance of the Retained Possession Term, provided that the Trustee is authorized to make the conversion at an earlier time. The commencement date of the qualified annuity interest shall be determined in accordance with Treas. Reg. § 25.2702-5(c)(8)(ii)(B), and the Trustee may defer and determine the payment of any annuity amount as provided in that Regulation. If the Trust ceases to be a Qualified Personal Residence Trust with respect to certain property, the intent of the Grantor is to provide for issuance of an annuity contract to the Grantor based on the terms of this Agreement.

Treasury Regulation Section 25.2702-5(c)(8)(i) reads as follows: (8) Disposition of trust assets on cessation as personal residence trust--(i) In general. The governing instrument must provide that, within 30 days after the date on which the trust has ceased to be a qualified personal residence trust with respect to certain assets, either-- (A) The assets be distributed outright to the term holder; (B) The assets be converted to and held for the balance of the term holder’s term in a separate share of the trust meeting the requirements of a qualified annuity interest; or (C) In the trustee’s sole discretion, the trustee may elect to comply with either paragraph (c)(8)(i)(A) or (B) of this section pursuant to their terms.

GRATs are GREAT Another very effective estate tax planning trust is the Grantor Retained Annuity Trust (“GRAT”), which is specifically permitted under the Internal Revenue Code. Under a GRAT, an individual can transfer assets to a trust and will receive back a set payment amount for a period of years. Anything remaining in the trust after that period of years will pass estate tax free.

183 The value of the gift made when the trust is funded will be based upon the value of the assets transferred in, minus the present value of the payments to be made. A safety clause can be included to provide that the payments made back will be in proportion to the contribution made, so that if there are valuation issues, gift tax exposure is minimized. For example, assume that John Smith is 62 years old and owns stocks worth $1,000,000 which he believes will be worth much more than that in three years. He transfers the $1,000,000 worth of stocks to a GRAT in January of 2013 that will pay him $350,000 per year for three years. Using the IRS tables, the value of the gift is considered to be only $0, so no gift tax return will have to be filed, although it may be advisable to file a gift tax return disclosing the gift or to make the payments slightly lower to have a very small gift to be reported so that the IRS’s ability to challenge the arrangement will expire three years after the gift tax return is filed. After the third year, the trust has $260,000 worth of assets that can benefit family members and pass estate tax free along with the appreciation in value that occurs during John’s remaining life, notwithstanding that $350,000 a year of stocks and/or cash were transferred to him in each of the three payment years. [CONFUSED AS TO WHERE $260,000 AND $340,000 CAME FROM. WJD 6.10.19] After the third year, the trust can be held for the health, education, maintenance and support of his wife and children, and he can control who the trustee is and change the identity of the trustee at any time and for any reason so long as whoever he chooses is not related to or employed by him.

Using GRATs to Transfer Part Ownership of a Business – Is This Too Good to Be True?! Oftentimes wealthy individuals will transfer the stock of a closely held business to a GRAT and receive a payment back that can be made from dividends yielded by the investment interest. Sometimes very little estate tax exclusion will have to be used, notwithstanding that significant

184 ownership of the subject company will be held by the GRAT at the end of the payment term. Experienced estate tax lawyers are often able to provide specific examples of how GRATs can apply in given situations. The following professional literature with respect to GRATs should be of interest with respect to advisors and individuals with financial backgrounds: [IS SOMETHING MISSING, OR IS WHAT’S BELOW THE “PROFESSIONAL LITERATURE”? :saw 9/24/19]

Big Picture Congress’s primary goal in enacting GRAT legislation in 1990 was to permit a Grantor to place assets into a trust and receive back a specified amount in value over a term of years. The assets held under the GRAT could grow in value and/or generate income that would remain under the GRAT, to be held on an estate tax free basis after the GRAT term. Actuarially, the GRAT mechanism allows growth and income above an interest rate that is prescribed by the IRS (which is tied to the Treasury Bond Index level) to pass estate tax free.

Example 1 Assume that a grantor placed $1,000,000 of cash or investments into a GRAT that would be held for the grantor’s spouse and children. The GRAT would be required to pay the grantor $200,000 per year in cash or other assets for five years. Anything left in the GRAT after the fifth annual payment could be held for the lifetime benefit of the grantor’s spouse or descendants without being subject to federal estate tax at the level of the grantor or his or her spouse. If $1,000,000 in equity stocks were placed in the GRAT, and the stocks grow at 7% per year, then after the fifth year of paying the grantor $200,000 per year, there would be $252,404 worth of stock in the GRAT that would never be subject to estate tax upon the death of the grantor, or upon the death of the grantor’s spouse.

185 “Zeroed-Out” GRATs and Formula Clauses – Unique Features That Increase the Attractiveness of GRATs When a GRAT is funded, a statistical calculation is conducted by a software program which determines how much of a gift (if any) is considered to have been made upon funding of the GRAT. In Example 1 above, based upon the applicable federal rate in effect for October 2018 (3.4%), [DO YOU WANT TO USE THE OLDER PERCENTAGE FOR THE SAKE OF THIS EXAMPLE OR UPDATE WITH THE CURRENT 3.4%?] the gift element of a $1,000,000 transfer to a GRAT, with a $200,000 per year repayment for five years is only $______. If we use the 2019 [UPDATE TO 2017 – 2018?] lifetime gifting exclusion level of $11,400,000 per person, this leaves $4,942,700 [IS THIS NUMBER CORRECT?] remaining that the grantor is able to gift over his or her lifetime estate tax free. [NEED TO DO THE CALCULATION STILL. WJD 6.10.19] If the payments for the GRAT discussed in Example 1 above were $212,156.57 per year for the five years, then the gift element would be considered to be $0, and no gift tax return would have to be filed when the GRAT is established. This is called a “zeroed-out GRAT.” When GRAT legislation first appeared in 1990, many academics believed that it was not safe to attempt a zeroed-out GRAT. Based, however, upon case law and analysis that has occurred since then, most published authorities agree that zeroed-out GRATs are considered to be safe from a tax compliant standpoint. Another excellent feature of a GRAT relates to the ability to use a “formula valuation clause” in the GRAT document. In the example above, the GRAT document would not necessarily provide that the grantor would receive exactly $200,000 in cash or other assets per year for five years. Instead, the GRAT document would provide that the grantor would receive 20% of the initial contribution value of the GRAT per year, in five annual installments. This feature allows the GRAT to be especially favorable with assets that are “hard to value” or if the values are unclear. The reason for this is that it absolutely prevents the IRS from imposing a gift tax in a situation where assets placed in the GRAT may be considered to be worth much less than what the IRS eventually determines as an appropriate value.

186 For example, assume that someone wants to put one-third ownership of a closely-held company into a GRAT, and values the stock at $1,000,000. If the IRS later determines that the stock was worth $2,000,000, then no gift tax will be due. Instead, by the terms of the GRAT document and applicable legislation, the annual payments will be re- determined to have been $400,000 per year (20% per year of the value of the assets at contribution for five years), and the grantor will receive more cash and other assets from the GRAT, but the IRS will not be owed any gift tax. This significantly reduces the motivation of a gift tax auditor to challenge the values of assets that are contributed to a GRAT. The combination of the above techniques and valuation discounts makes the GRAT a very exceptional and often successful wealth transfer vehicle for closely-held businesses and/or investment income arrangements.

Example 2 Assume that a business owned by a family LLC generates $1,000,000 a year of income and is considered to be worth $5,000,000. Thirty percent of the stock of the company would be worth $1,500,000 before discounts, but might be valued at $1,050,000, assuming a 30% valuation discount applicable to a minority interest in the company. For a five-year GRAT established in November 2018, 30% of the stock of the company would be transferred into the GRAT in exchange for the right to receive annual payments of $222,765 per year for five years. Each payment represents 21.22% of the initial contribution amount of $1,050,000. ($222,765 ÷ $1,050,000 = 21.22%). Assuming that the company pays dividends of $1,000,000 per year, the GRAT would receive $300,000 per year and would pay the grantor $222,765 per year as the annual GRAT payment. The GRAT would be able to invest $77,235 per year in an investment account or however else it determines appropriate. ($300,000 - $222,765 = $77,235.)

187 After the fifth year, the GRAT would have accumulated $386,175 ($77,235 x 5), plus whatever earnings it might receive under the investment account, and would continue to own 30% of the stock of the company, at a zero gift tax cost!

Example 3 To use another example, assume that an LLC owns rental property worth $10,000,000, and has net positive cash flow of $800,000 per year. A 10% ownership interest in the LLC may be worth $700,000, after applying a 30% valuation discount ($10,000,000 x 10% = $1,000,000; $1,000,000 x 70% = $700,000), and would be expected to receive $80,000 a year of rent income. If a five-year GRAT were used, then 21.22% of $700,000 is $148,510, so the rental income on the 10% interest is not sufficient to make the GRAT payments alone. The client might instead choose to use a 10-year GRAT. A 10-year zeroed-out GRAT would require payments of approximately 11.13% per year, which would result in an annual payment back to the grantor of $77,929. In this example, the GRAT would receive $80,000 a year in distributions from the LLC and make $77,929 per year in annual payments to the grantor, which leaves $2,071 per year of excess rental income in the GRAT. If the GRAT does not have sufficient cash flow to make the annual required payments, then the GRAT payments can be made in cash or “in kind” by having the GRAT distribute property outright to the grantor. Therefore, part ownership of an LLC or other investment can be transferred back to the grantor to satisfy a GRAT payment.

Example 4 Assume in the case of the operating company described in Example 2 above that the company chose to reinvest its earnings in the fourth and fifth years instead of paying dividends, and that the stock of the company owned by the GRAT was worth $2,250,000 during the fourth and fifth years.

188 The $222,765 annual GRAT payment divided by $2,250,000 is 9.9%. Because the GRAT owned 30% of the company, it would simply transfer 9.9% ownership of the company back to the grantor in year four and 9.9% ownership of the company in year five. As a result, the GRAT would still own 10.2% of the company after the fifth year, plus whatever it had saved from positive cash flow and the earnings and appreciation thereon. Hopefully the company would have an increased value in the future based upon its reinvested earnings.

What if the GRAT Underperforms? What happens if the GRAT underperforms expectations, and asset values and/or income is not sufficient to allow all of the GRAT payments to be made? As discussed above, the GRAT is able to use its assets to make the required annual GRAT payments, and the GRAT may use all of its assets to make the payments, if necessary. Once the GRAT runs out of assets, there is nothing further that needs to be done. If the initial gift element of the GRAT is considered to be very small, then there is “nothing lost” by having tried to use the GRAT structure. For example, assume that under the real estate structure described above in Example 3, the tenant of the real estate properties goes out of business and the company cannot find another tenant. As a result, the company does not have the rental income that was previously anticipated. Ownership interests in the company could be transferred back to the grantor each year to satisfy the annual GRAT payments. If the company has gone down in value, then the grantor may receive all ownership and monies back from the GRAT, but nothing has been lost in the process.

How Do GRATS Work for Income Tax Purposes? Very Well! Although the GRAT is completely separate and apart for estate and gift tax purposes, for income tax purposes the GRAT can be

189 “disregarded,” and all of the income that the GRAT earns can be recorded and paid for under the grantor’s Form 1040 income tax return. This allows the GRAT to grow income tax free, and to be indirectly subsidized by the grantor. The taxes that are to be paid by the grantor can be taken into account in determining what percentage of a given entity or what amount of various investments will be transferred to the GRAT by the grantor. For example, a grantor may initially think that it is best to transfer a 20% interest in a company to the GRAT but might decide that 15% interest in the company is best, after taking into account that the grantor will pay the income tax on the GRAT’s income. Once the payments to the GRAT have expired (five years in Example 2 above, and 10 years in Example 3 above), the GRAT can pay its own taxes, or may be designed to permit the grantor to pay its taxes until the grantor decides otherwise!

What Happens if the Grantor Dies Before Receiving All the Annual Payments? If the grantor dies before receiving all GRAT payments, then all of the GRAT assets will be considered to be owned by the grantor, and therefore, will be includable in the grantor’s estate for federal estate tax purposes. However, by drafting appropriate provisions into the GRAT and into the grantor’s Will, any GRAT assets that are included in the grantor’s estate for federal estate tax purposes can be passed to the surviving spouse, or into trust for the surviving spouse, to qualify for the estate tax marital deduction. The result of such action is that no estate tax will be incurred with respect to the inclusion of the GRAT’s assets in the grantor’s estate for federal estate tax purposes.

Do You Have to Have Ownership in a Closely Held Business or in Income-Producing Real Estate to Use a GRAT? Many GRATs are used by clients who simply have equity portfolios, vacant real estate, or other passive investments.

190 A common example would be a two-year, zeroed-out GRAT (the shortest GRAT term available) funded with the stock of a company or a mutual fund. A client places $1,000,000 worth of stock into the GRAT and will receive $515,040 on the first anniversary of the GRAT and $515,040 on the second anniversary of the GRAT. If the stock is worth $1,200,000 at the end of the first year, then the GRAT still has $684,960 remaining after the first annual payment. If the stock is worth $750,000 at the end of the second year, then the grantor receives $515,040 worth of stock or funds, and the GRAT thereafter holds $234,960 of assets that will pass estate tax free.

Is it Best to Use a Long-Term or Short-Term GRAT? The conventional wisdom has been to use as short of a GRAT term as can work well under a given scenario, for two primary reasons: 1. If the grantor dies during the GRAT term, the assets held in the GRAT are going to be subject to federal estate tax. A short-term GRAT lessens the possibility of death during the term. However, as addressed above, it is possible to pass the assets to the surviving spouse in such a way to avoid incurring federal estate tax. 2. If the assets under the GRAT go up in value, and later go down in value, then the family would have been better off if the GRAT had ended before the value decline.

What “Technical Rules” Should I Know With Respect to Establishing a GRAT? As with all irrevocable trusts, a GRAT should be drafted and implemented with the assistance of a competent tax and estate planning lawyer. Most lawyers who work extensively with GRATs have post-law graduate degrees in taxation or estate planning (an LL.M. degree), or board certification as a tax or trusts and estates lawyer. Other lawyers who are not as well-versed in tax law or estate planning will sometimes obtain assistance from a tax lawyer. It is not safe to just “use a form from last year” or to use one GRAT form for all situations.

191 The GRAT needs to be irrevocable and needs to be funded upon the day that it becomes irrevocable. The law does not permit additional contributions to be made to a GRAT after it is executed. Some lawyers implement special clauses that permit the GRAT to remain revocable until it has become fully funded. Documents can also provide that inadvertent later transfers to the GRAT, as well as forgotten payments, can be considered as set aside under a separate non-GRAT sub-trust so that the GRAT continues to comply with the tax law requirements. The GRAT document can provide that the trustee make the scheduled payments for the benefit of the grantor, which may be appropriate if the grantor has creditor issues or competency issues in the years after the GRAT is established. Some GRATs are established in offshore jurisdictions in order to help assure that future creditors of the grantor would not be able to access GRAT payments. Some states, such as Florida and Texas, have statutes which protect annuity contract rights from creditors. It is widely believed that GRAT payments can qualify as a creditor-protected annuity asset when properly drafted. Many sophisticated lawyers draft a “two-trust GRAT system,” consisting of the GRAT trust as described above and a separate “GRAT Remainder Trust” which is funded with all remaining assets that stay in the GRAT after the last scheduled GRAT payment. Having the “remainder interest” held by a separate trust makes it possible for the family to purchase the remainder interest if and when the circumstances would make this favorable from an estate tax avoidance standpoint. Of course, a proper formula clause is also essential. As discussed above, GRATs should provide that annual payments are based upon a percentage of the initial contribution value rather than upon specified dollar amounts. The GRAT document will also determine whether the GRAT or the GRAT remainder trust will be taxed as a separate entity for income tax purposes after the GRAT payment term, as opposed to being considered as owned by the grantor and thus “disregarded” for income tax purposes,

192 as described above under the heading entitled “How Do GRATS Work for Income Tax Purposes? Very Well!”

Do the Annual Payments Have to be Equal Each Year? It would make sense to delay payments as long as possible so that the GRAT can grow more assets than it would have if it had to make required payments. The increased value of assets held under the GRAT could lead to greater appreciation and income earned by the GRAT with respect to such assets. The law does permit the payments to start smaller, but does not allow payments to increase by more than 20% per year. Based upon a $1,000,000 contribution, and a five-year, zeroed-out GRAT with payments that increase by 20% per year, the annual payments could be as follows:

Year 1: $143,568 14.3568% Year 2: $172,283 17.2283% Year 3: $206,739 20.6739% Year 4: $248,087 24.8087% Year 5: $297,704 29.7704%

As you can see from the above, the GRAT payment for each of years two through year five are 20% greater than the payment made in the previous year. On a 10-year, zeroed-out GRAT that is based on the same assumptions as the previous example, the numbers would be as follows: Year 1: $44,124 4.4124% Year 2: $52,949 5.2949% Year 3: $63,539 6.3539% Year 4: $76,247 7.6247% Year 5: $91,496 9.1496% Year 6: $109,795 10.9795% Year 7: $131,754 13.1754% Year 8: $158,105 15.8105% Year 9: $189,726 18.9726%

193 Year 10: $227,671 22.7671%

The applicable tax law regarding GRAT payments permit a GRAT payment to be delayed for up to 105 days after the anniversary date of the funding of the GRAT. For example, if a GRAT was established and funded on July 1, 2019, the first annual payment can be made at any time before October 14, 2019. Likewise, the second annual payment can be made at any time before October 14, 2020. Once the grantor receives payments back, the assets that the grantor has received are “unfrozen” and therefore would be included in the grantor’s gross estate for federal estate tax purposes upon the grantor’s death, even if the grantor survives the GRAT term. However, the GRAT payments that are received by the grantor can be used for the payment of living expenses for the grantor and his or her spouse, which would reduce the grantor’s taxable estate.

What Happens With Respect to Income Tax Reporting and Payment if I Set Up a GRAT? One very nice feature of a GRAT is that it can be “disregarded” for income tax purposes, and therefore does not need to file a full income tax return or pay its own income taxes. Under the income tax rules, all of the income and deductions of the GRAT can simply go on the grantor’s personal individual or joint tax return. If the GRAT has income then the grantor, in effect, subsidizes it by paying the income tax attributable to what it earns. The grantor’s payment of the GRAT’s income taxes is not considered to be a gift under federal tax law. The annual (or more frequent) payment from the GRAT to the grantor is also disregarded for income tax purposes, so there is no extra tax or any sort of deduction generated as a result of the GRAT payment mechanism. After the GRAT stops making annual (or more frequent) payments to the grantor, then it may be taxed as a separate entity and be responsible for paying its own income taxes. Alternatively, the GRAT may be structured strategically as “disregarded” for income tax purposes, so that

194 the grantor can continue to subsidize the GRAT by paying the income taxes on the GRAT’s earnings. It is also possible to draft a GRAT such that the grantor or appointed advisors can determine whether the GRAT would pay its own taxes or be disregarded for income tax purposes after the GRAT payment term has ended. For example, the grantor would pay income tax on the income earned by the GRAT during the annual or quarterly payment period and may decide that it is best to continue to subsidize the GRAT by having it be “disregarded” for income tax purposes for a few years after the last GRAT payment. If the grantor, however, has an economic reversal and decides that he or she would like for the GRAT to pay its own income taxes, it can only occur if the GRAT has been designed to “toggle off” its income tax “disregarded entity” status. In that event, the GRAT would be subject to income tax in its own separate brackets, except that income tax liability will generally be carried out with monies that are distributed to GRAT beneficiaries under the “complex trust” income tax rules, and the beneficiaries would essentially pay the tax associated with the GRAT’s income.

Can Payments Received from a GRAT be Creditor-Proof Under the Florida Statutes? A 2009 Florida Bar Journal article entitled “Unraveling the Mysteries of the Florida Exemption for Life Insurance and Annuity Contracts, Part Two” concluded that a private annuity arrangement will not be protected from creditors and that the creditors of the grantor of a GRAT would be able to reach into the trust to the extent of payment owed to the grantor. The author, and many others, disagree with these conclusions, as explained in “Creditor’s Rights Under Private Annuities and Grantor-retained Annuity Trusts in Florida” 83 Fla. B.J. 49 (July/August 2009) by Alan S. Gassman, David L. Koche, and Michael C. Markham.

195 Charitable Planning Many wealthy clients seek to support their favorite charities, especially if doing so provides income tax deductions and facilitates estate tax avoidance. The first thing that we tell clients asking about charitable arrangements is that in almost every situation, the family will receive less because the tax savings will not match the value of the assets going to charity. Regardless, clients who have the intent of providing for charities should take full advantage of the several tax structures that favor charitable giving. These are described below.

Charitable Remainder Trusts Monies or other assets can be contributed to a trust that makes an annual payment to the grantor or someone else, and then passes to charity after a term of years or upon the death of a designated person. The actuarially calculated value of the charitable remainder interest is permitted as an income tax deduction, and there is no gift or estate tax on assets passing into the Charitable Remainder Trust or eventually to charity. This deduction can range from 10% to 90%, or more, of the value of the trust assets depending upon the size of the payments and the number of years they are to be made. Once the trust is funded, the assets must be invested carefully under a fiduciary standard, but the grantor can be the trustee and can also change the charity that will receive the remainder interest if the trust is drafted to allow this. The payments can come out as a fixed dollar amount if the trust is what is known as a Charitable Remainder Annuity Trust (“CRAT”), or based upon a percentage of the value of the assets each year, if the trust is what is known as a Charitable Remainder Unitrust (“CRUT”). Since the principal of the trust will never be accessible beyond the payment rights, clients who think that they might need these assets to support themselves or others during their lifetime should be very careful when thinking about creating a Charitable Remainder Annuity Trust.

196 The following is a technical discussion on Charitable Remainder Trusts from our book entitled The Essential Planning Guide to the 2013 Income & Estate Tax Increases. This is intended primarily for financial advisors but should be understandable to individuals with even a slight financial background. Charitable Remainder Trusts A charitable remainder trust (“CRT”) is a planning technique that taxpayers should consider to help reduce the amount of his or her income tax liability, especially if the taxpayer is charitably inclined. A CRT is an irrevocable trust created by a grantor when the grantor transfers certain assets to the trust. Pursuant to the terms of the CRT, the CRT will pay an annuity percentage to the grantor for a set number of years, or for the life of the grantor. On the grantor’s death, or at the expiration of the annuity term, the assets in the CRT will then pass to charity.

A taxpayer creating a CRT will obtain numerous income tax advantages. The taxpayer will receive a charitable deduction equal to the value of the charity’s remainder interest in the trust when the CRT is funded. Interestingly, the taxpayer is allowed the deduction in the year the trust is created, even though the charity will not receive the property until a later date.

Trusts that qualify as CRTs will not be subject to the 3.8% Medicare Contribution Tax. Also, in many states, the annuity interest received by the grantor should be protected from the creditors of the grantor.

In addition, CRTs generally do not pay income taxes. Therefore, if a taxpayer contributes a highly appreciated asset to a CRT, then the CRT could sell the asset and not recognize any gain on the sale. This allows the additional value that would otherwise have to be used to pay income taxes to be reinvested in the trust, possibly increasing the payments back to the grantor, depending on the terms of the trust. This should also result in the charity receiving more assets at the end of the CRT, although this will not have any impact on the charitable deduction allowed to the taxpayer.

Because the rules related to the formation and operation of CRTs are very complex, a taxpayer interested in possibly establishing a CRT is strongly encouraged to consult with a qualified tax professional.

197 Example: With respect to the Medicare contribution tax, John is a 60-year-old single, wealthy man and would like to put $2,000,000 of assets having a tax basis of $500,000 into a CRT that will sell these assets in 2018. Assuming that John has held the assets for more than one year, the capital gains and Medicare contribution tax on this in 2018 would be $349,400, calculated as follows: [UPDATE THIS FOR 2019?]

Capital gains tax calculation:

$2,000,000 – $500,000 = $1,500,000

(capital gain) $1,500,000 x (long-term capital gain rate) 20%

= $300,000

Medicare contribution tax calculation:

Lesser of net investment income or excess of modified adjusted gross income above $200,000 for individuals.

$1,500,000; or

$1,500,000 – $200,000 (threshold for single filer) = $1,300,000.

$1,300,000 x 3.8% = $49,400 Total: $300,000 + $49,400 = $349,400 in taxes

John can receive a large income tax deduction and immunity from the 3.8% Medicare contribution tax by contributing these assets to a CRT that is actuarially designed to provide 90% of its overall value to John in the form of annual payments.

Assuming a Section 7520 discount rate of 2.8% in June 2019, and John retaining an annuity interest of $100,000 per year for 20 years, the contribution of the assets to the CRT is considered to be a $266,090 gift for gift tax purposes, although gift tax will not be payable because the

198 ultimate beneficiary is a charitable organization. [MDP: AUGUST 2019 RATE IS 2.2%, NOT SURE HOW TO DO THIS CALCULATION]

If the charitable remainder beneficiary is a public charity or a private operating foundation, then John would be entitled to an income tax charitable deduction equal to the fair market value of the remainder interest in the trust that passes to charity. If the amount of the income tax charitable deduction exceeds 30% of John’s adjusted gross income, then he can carry forward any unused charitable deduction to apply toward any income that he earns in the next five years.

Therefore, John will get an income tax charitable deduction on funding of the trust equal to the $266,090 fair market value of the remainder interest in the CRT that passes to charity.

John would have to pay income tax and the 3.8% Medicare tax (if it applies to him) on the annuity distributions that he receives from the trust to the extent that the trust has taxable income.

Accordingly, with respect to the appreciation in the assets contributed to the trust, John would reduce his taxable income by a total of $266,190 in capital gains income offset by the income tax deduction. [NEED TO DO CALCULATION. WJD 6.10.19] [MDP: WHY IS THIS NUMBER $100 HIGHER THAN REST?]

Over the 20-year term, he has received $2,000,000 in payments and paid significantly less in taxes than he would have paid if he did not set up the CRT. On his death, the remaining assets pass to charity instead of to his family, but the charity could be a private operating foundation that his children could run and from which they can receive reasonable compensation.

Additional advantages of the CRT include: asset protection from creditors, recognition in the community or by an established charity or educational institution, and avoidance of capital gains tax.

Charitable Lead Annuity Trust As discussed previously, under a Charitable Lead Annuity Trust (“CLAT”), monies or other assets are transferred to a trust which makes

199 a series of annual payments to charity and can then pass to or for the benefit of family members. One fantastic opportunity is to fund a “zeroed-out CLAT.” Under a zeroed-out CLAT, there is no gift tax or gift considered to have been made upon funding, even though all assets can pass to or for the benefit of family members after the payments to charity have been made. [REDUNDANT? ZEROED-OUT CLATS ARE TALKED ABOUT ON 199-200. WJD 6.10.19] An example would be that a client could fund a CLAT with $1,000,000 worth of assets, and the trust could pay $105,000 a year for 10 years to the grantor’s church, local hospital, or other charitable organization. The grantor gets an income tax deduction for funding the trust based on the entire initial contribution, but will have to pay income tax on the trust’s income during the 10-year term, even though all of the monies get paid to charity. There is no additional charitable donation deduction after the 10th year when the assets pass to or for the benefit of the grantor’s children, but no estate or gift tax transfer is considered to have been made at that time. Many wealthy individuals, including Jacqueline Kennedy Onassis, have left significant assets to CLATs on death. Any family who makes large annual charitable contributions should consider setting up a CLAT that would make those payments and then be held for family members. Doing so is explicitly permitted under the Internal Revenue Code and IRS Regulations, and provides numerous advantages. A husband or wife could set up a CLAT that would benefit charity and then pass into a trust that would benefit his or her spouse and then descendants without being subject to federal estate or gift tax. It might even be possible to allow the grantor to become a beneficiary of the trust after the final charitable payment if it is established in an asset protection jurisdiction.

200 Private Foundations and Private Operating Foundations Private Operating Foundations are charities organized and controlled by the individuals or families who primarily fund them. Private Foundations, on the other hand, are usually designed for the purpose of supporting a public charity, rather than directly operating the charitable purpose. Clients who want to take an income tax deduction now for donations that will become payable to public charities or for charitable purposes in later years are well-suited to establish these types of organizations. While there are a number of organizational and tax compliance rules that have to be followed, many advisors are not aware that Private Operating Foundations can be funded to receive charitable income tax deductions with assets that have appreciated in value without having to recognize capital gains. An article that the author has published on the use of Private Operating Foundations and Charitable Trusts is set forth below:

Don’t Overlook the Benefits - Tax and Otherwise - of Private Operating Foundations by Thomas J. Ellwanger, Esq. and Alan S. Gassman, Esq. Should your affluent, charitably-inclined client have one? Clients willing to run their own charities can qualify for the tax breaks that are otherwise limited to public charities. Affluent and charitably-inclined clients wanting to use an entity to carry out their private philanthropic plans have traditionally relied on private foundations. Since the foundation rules were tightened up in 1969, most clients have opted for foundations which are “non- operating;” that is, foundations which do not carry out charitable work directly, but which rely instead on making grants to other charities which actually conduct charitable operations. For clients frustrated with existing charities, however — a client who wishes to deal directly with their pet, social, educational, scientific,

201 religious or other charitable causes —a private operating foundation can give them the means to carry out their cause in their own way. Moreover, such clients can derive tax benefits not available with a conventional non-operating foundation because contributions to private operating foundations qualify for the more generous charitable contribution rules ordinarily applicable only to gifts to public charities. In this article, we will summarize how the private operating foundation fits into the panoply of charitable entities, describe its tax benefits, and set out the requirements for qualifying as a private operating foundation. Throughout this article we will refer to a private operating foundation as a “POF”. Note that the term “charitable” used here should be read broadly to mean any type of purpose for which a tax exemption may be granted under § 501(c)(3) of the Internal Revenue Code. Also, the terms “charitable purposes” and “exempt purposes” are synonymous; each refers to the purposes permitted by § 501(c)(3) for which a particular organization has been established. Finally, a word of caution. The tax laws governing charitable contributions and entities present a morass of rules, exceptions to the rules, exceptions to the exceptions, and exceptions to those exceptions. We have not tried to fully explain every applicable concept. Any planning in this area should be undertaken only after your own study of the actual laws and rules. [MDP: ADD “OR AFTER CONSULTATION WITH A BOARD CERTIFIED WILLS, TRUSTS & ESTATES OR TAX LAWYER.”?]

202 Background Charitable entities set up and operated for certain purposes can qualify as tax-exempt organizations under § 501(c)(3) of the Code. Qualifying under § 501(c)(3) provides two significant benefits: the organization is exempt from most federal income taxation, and those contributing to the organization may generally deduct some or all of their contributions for federal income tax purposes. Since 1969, organizations qualifying as tax-exempt under § 501(c)(3) have fallen into one of two categories: either they are considered “public charities,” or they are considered “private foundations.” In general, public charities are either (i) organizations which enjoy widespread public support; or (ii) “supporting organizations” which have been established to assist one or more public charities and which are controlled by or in conjunction with those charities. Virtually every other § 501(c)(3) tax-exempt organization is a private foundation.

Tax Advantages of Public Charities It’s good to have a public charity. Public charities provide significant tax advantages over most private foundations. For one thing, contributors to public charities can generally derive more charitable contribution benefits.

For example, § 170 of the Internal Revenue Code limits the amount of charitable contributions which an individual may deduct in any given year. If contributions are made to public charities, the limit equals 50% of the taxpayer’s adjusted gross income (30% for gifts of appreciated property). Conversely, the limit for contributions to most private foundations equals 30% of the taxpayer’s adjusted gross income (20% for gifts of appreciated property). Although contributions in excess of the above-referenced percentage limits may be carried forward and deducted for up to five years later, the lower limits applicable to most private foundations can lead to these disadvantages: 1) They increase the chance that the five years will run before a large contribution can be fully deducted; and

2) The economic benefit of the tax deduction to the contributor may well be delayed.

203 Further, contributors of appreciated property to a public charity can usually take a charitable deduction equal to the property’s full value, although for tangible personal property the contributed items would need to be used for the purposes of the charitable organization. Contributors of appreciated property to a non-operating private foundation may only deduct an amount equal to the property’s basis, unless the appreciated property consists of publicly traded stock.

204 There are other disadvantages. Most private foundations are subject to a special 2% annual excise tax on net investment income. [SHOULD I ADD LANGUAGE ABOUT REDUCING THE 2% TAX TO 1%? WJD 6.11.19] Public charities are not subject to this tax. Finally, private foundations are also subject to certain “anti-abuse” rules which penalize certain conduct by imposing stiff excise taxes that do not apply to public charities. These taxes have the effect of discouraging conflict of interest transactions, discouraging risky investments, discouraging the foundation from owning more than a minimal interest in any business in which individuals involved in the foundation or other related parties have any significant interest, and requiring most private foundations to distribute a certain amount each year; usually roughly equal to 5% of the value of the foundation’s investments (with that figure reduced by any tax paid on investment income).

Difficulty of Having a Public Charity While it’s good to have a public charity, most clients will not be able to have one. Rarely is an individual or family able to meet the public support test required of a public charity. The alternative of having a supporting organization used to be popular, but perceived abuses caused Congress to tighten up those rules with the Pension Protection Act of 2006. Having a supporting organization now requires submission to much more control on the part of the supported charity or charities than it did before, and, typically, more submission than many clients would be comfortable with. This leaves most clients with two alternatives if they want to obtain the tax benefits associated with a public charity. First, rather than establishing their own charitable organizations, clients can make gifts to a “donor-advised fund” established by a public charity. Second, clients can derive most of those benefits by establishing private foundations which qualify as POFs.

Using a Donor-Advised Fund In the donor-advised fund approach, the clients make contributions to an individual segregated fund held by a sponsoring public charity. The sponsor then allows the donor or donors to “advise” by designating other public charities to receive gifts from the fund. Typically the sponsor will comply with those designations. Since the clients are considered to be making their

205 contributions to the sponsoring public charity, the more favorable public charity tax rules apply. Donor-advised funds have traditionally been sponsored by community foundations. More recently, some financial institutions have set up public charity affiliates to offer these programs. Besides providing the tax benefits of a public charity, a donor-advised fund can also provide an alternative to the significant administrative and financial responsibilities associated with maintaining a private foundation. Nevertheless, many clients still avoid donor-advised funds for reasons such as these:

206 1) Firm control over recipients. Clients making charitable gifts at this level tend to want to retain as much control as possible. While donors to donor- advised funds may designate recipients of gifts, these designations are actually mere recommendations. The final selection is made by the sponsor of the fund. By using a private foundation, clients clearly retain more direct control. 2) Greater recognition. Clients making charitable gifts at this level frequently enjoy the recognition which philanthropic efforts can bring. They frequently believe that the name of a family foundation on a contribution check will bring more recognition and carry more clout than the same check coming from a “donor-advised fund.” 3) Immortality. In the same vein, clients making charitable gifts at this level often want to keep the family name and philanthropic reputation alive for as long as possible. Generally, the sponsor of a donor-advised fund will agree to keep it in place for the current generation and possibly the next one. After that, the remaining assets are simply folded into general assets of the sponsor. Conversely, a sufficiently-funded private foundation can continue in existence indefinitely, for generation after generation. 4) Ability to contribute a wider range of assets. Sponsors of donor-advised funds typically limit contributions to cash and listed securities. This handicaps clients who want to donate appreciated real estate or closely-held business interests. 5) Ability to employ family members and others. The tax laws allow private foundations to employ individuals to perform services for reasonable compensation. Donor-advised funds don’t do this. Frequently clients who establish private foundations are interested in having family members or others involved to derive a sense of self-worth, and the clients often appreciate the notion that compensation for doing so can be a form of inheritance or even a safety net against future financial reverses. 6) Control of actual charitable functions. Some clients may eschew the use of donor-advised funds because they have goals which cannot be achieved by simply making contributions to existing public charities. It is for these clients that the POF can be a godsend.

The POF Solution

207 As opposed to a donor-advised fund, a POF can provide all of the control, recognition, lengthy existence, and other advantages associated with any private foundation, while still giving contributors the favorable treatment accorded contributions to public charities. In addition, the private foundation excise tax requiring certain distributions each year does not apply to a POF, although other requirements of POF status can lead to a similar required level of distributions or expenditures. (It should be noted that the investment income tax continues to apply, along with the other excise taxes.)

Because the public charity rules apply, clients can gift all types of appreciated assets to a POF and be entitled to deduct the fair market value, not simply the basis. The annual contribution limit for contributions to a POF is 50% of the contributor’s adjusted gross income (30% for gifts of appreciated property), just as with public charities and as opposed to the lower limits otherwise applicable to gifts to private foundations.

208 These tax benefits come with one seemingly simple requirement: a POF must directly carry out its own charitable purposes. While other private foundations may simply make grants to other charities, a POF must conduct its own charitable operations. Typical examples of POFs would include scholarship programs aimed at a particular group, school enrichment programs promoting subjects dear to the donor’s heart, and museums established to hold and display a family’s art collection. The possibilities, however, are as broad as the terms of § 501(c)(3). A donor with a special love for a particular type of animal might set up a foundation devoted to its scientific study. A donor with a particular interest in a subject might set up a library devoted to materials on that subject. We tend to think of the “charitable operations” requirement as a severe restriction in setting up this type of organization. In fact, however, the real benefit of a POF may come not from the tax laws, but from the psychic pleasure of a wealthy individual or family which sees a social, educational, health-related, religious, or other charitable need and sets out to address it directly. Since conducting charitable operations is the key requirement of a POF, a client whose sole interest is giving money away will not want one. On the other hand, there is no requirement that the creators of a POF individually conduct its operations. The foundation may have employees hired to conduct the operations and even managers hired to supervise the operations, so long as there are operations to be conducted and supervised.

Technical Requirements of a POF

The overall requirement of a POF — that it function directly in carrying out its charitable purposes is simple. Unfortunately, qualifying as a POF for federal tax purposes involves satisfying the Internal Revenue Service, which is not quite so simple. Section 4942(j)(3) of the Code imposes technical requirements which must be met for a foundation to qualify as a POF. Regulations promulgated by the Treasury flesh out the statutory bones. There are two main requirements to be met before an organization can qualify as a POF:

1) First, the organization must meet the so-called income test.

209 2)Second, the organization also must meet one of the following three tests:

a) An assets test; b) An endowment test; or c) A support test.

Each of these tests requires considerable explanation.

210 The Income Test The income test is designed to make sure that the organization is actually conducting charitable operations. The test requires that the organization apply a certain minimum amount of funding each year to directly carrying out its charitable purposes. Mechanically, the income test looks at two factors. The first is the computation of that minimum amount, which must at least equal “substantially all” of the lesser of the following:

(i) The organization’s “adjusted net income”; or

(ii) The organization’s “minimum investment return.”

The regulations provide further guidance:

1) “Substantially all,” in the eyes of the IRS, means at least 85%. 2) The “adjusted net income” of the organization is its gross income for the year, reduced by deductions which would be allowable to a corporation, subject then to certain complex adjustments. 3) The “minimum investment return” equals 5% of the value of assets of the organization not used directly in carrying out the organization’s charitable purposes — in other words, what would typically be the organization’s investment assets. Certain types of assets are excluded from this computation, such as an interest in an estate which has not been distributed. So, the minimum amount which the organization must apply each year equals the lower of these amounts: a) 85% of its gross income (including not just investment income, but also contributions, dues, program income, etc.), reduced by its expenses and other deductions; or

b) 4.25% (being 85%of 5%) of the value of its investments and other non- operational assets. The second factor specifies how the minimum amount so determined must be applied. It must be applied to qualified distributions which operate directly. Again, the regulations explain:

211 1) A “qualifying distribution” is an expenditure by the organization which goes towards the “active conduct of the activities constituting [the organization’s] ... exempt purposes.”

2) “Directly” means that grants to other organizations do not count as qualifying distributions. Expenditures of the organization which do count as qualifying distributions include these:

a) Amounts paid for the direct conduct of such activities; b) Amounts paid for assets used in conducting such activities, such as monies used to buy a building where the activity will be conducted; c) A reasonable amount of administrative expenses that are necessary to conduct such activities; and d) Amounts set aside for later use in carrying out such activities (but in this last case, only with the consent of the IRS).

212 The Second Test Meeting the income test alone is not sufficient for an organization to be considered a POF. The organization must also meet any one of three additional tests:

1) The first possible test is the asset test. To meet the asset test, “substantially more than half” of the organization’s assets (as determined by asset values) must be held for use in carrying out the organization’s exempt purposes. According to the regulations, “substantially more than half” means at least 65%. So, if the investments, etc. constitute more than 35% of the total assets, then the organization will have to pass one of the other tests. This test seems designed to discourage the holding of what the IRS would deem to be an excessive amount of investments or other assets which are not actively utilized in the charitable endeavor. 2) The second possible test is the endowment test. This generally requires that at least 33 1/3% of the value of all investments and other non-operating foundation assets be spent on qualifying activities and reasonable expenses associated with such activities. The goal here seems to be to make sure that investment income is not simply accumulated. Specifically, an organization seeking to meet the endowment test must make qualifying direct distributions each year equal to at least 2/3 of its minimum investment return (with those terms having the meanings given them under the income test). Since the minimum investment return generally equals 5% of the value of the investment and other non-operating assets, multiplying the 5% figure by 2/3 results in the requirement that the foundation make qualifying direct distributions of at least 33 1/3% of the value of those assets.

This test is frequently the easiest to pass.

213 3) The third possible test is the support test. “Support” in this instance generally breaks down into two parts: non-investment support of the organization (such as amounts received from contributions, grants, membership fees, and income earned while carrying out the organization’s exempt purposes) and support provided by investment income. The test requires that the organization demonstrate a broad base of support. It imposes three requirements, all of which must be met: a) At least 85% of the organization’s total non-investment support must come from the general public and five or more other exempt organizations. For purposes of this requirement:

(i) Support from a governmental unit is considered to come from the general public. (ii) Support is not considered to come from the general public to the extent that it comes from one party contributing, or from a group of related parties contributing in the aggregate, more than 1% of the total non-investment support. In other words, the organization fails this requirement if more than 15% of the total non-investment support comes from any combination of four or fewer other exempt organizations and of other parties disregarded because of the 1% test. b) Not more than 25% of the organization’s total non-investment support may come from any one other exempt organization. c) Gross investment income shall not make up more than 50% of the organization’s total support (including both non-investment support and investment income). If the income test is designed to make sure that a POF does in fact “operate,” these tests seem aimed at ensuring that a POF is not in reality a passive investment company (asset test); or that, even if the POF does have a lot of investment assets, at least the investment income is not simply accumulated (endowment test); or that even if there are substantial investments and substantial accumulated income, the POF at least has a broad base of contributors who might demand an appropriate level of charitable activity (support test).

214 Period for Which Tests Are Applied Whether an organization is a private operating foundation is determined for each tax year. It is clearly sufficient if the organization meets the income test and one of the three other tests during each tax year, but the organization has two other routes possible to qualification. Both of the other routes look to the current year and the three years immediately prior to it. First, the organization can qualify as a POF by meeting the income test and one of the other tests for any three years out of such four-year period. Second, the organization can qualify as a POF if it meets the income test and one of the other tests when it aggregates the relevant amounts of income or assets held, received, or distributed during the four-year period. Consistency is required; the organization cannot look at the income test on the “three out of four” basis and the other test on the “four-year aggregation” basis.

215 Flexibility for New POFs With Respect to Meeting the Above Rules

New organizations are given a certain amount of latitude in establishing POF status. For one thing, a new organization can be considered a POF for its entire first year of existence if, by the end of the year, it has satisfied the income test and one of the other tests for its first year of existence. The organization will continue to retain its POF status for its second and third years only if it meets the tests after looking at the aggregate results for its entire existence. (Of course, meeting the tests each year will automatically pass this aggregation requirement.) After the organization’s third year, the regular rules apply. In addition, a new organization can be considered a POF for its first taxable year by making a good faith determination that it will pass the income test and one of the other tests for that year and by supplying the IRS with an affidavit or opinion of counsel to that effect, setting out enough facts to permit the IRS to agree with the determination.

If the new organization then fails to meet the tests for the first year, it is still treated as a POF for that first year. It may continue to qualify by actually meeting the tests or by providing evidence of a good faith determination that it will pass the tests on the basis of its second, third, and fourth years; but, in the latter case, should it flunk in any year, its POF status terminates for that year and remains terminated until it can again qualify. Contributors to a new organization who assume that they will get the more liberal charitable deductions afforded gifts to a POF could be detrimentally affected if the organization does not, in fact, qualify. The regulations protect good faith contributors in that situation by allowing them to rely on the alleged POF status. The regulations do not protect contributors after the IRS has announced in the Internal Revenue Bulletin that the organization’s status is being changed or if the contributor was responsible for the organization not qualifying, was aware of the organization not qualifying, or was aware that the IRS would be making the status change. Conclusion The requirement that a POF actually conduct its own charitable activities has traditionally caused many planners to rule out this device. For the average

216 client, a POF would require much more time and attention than a conventional private foundation, which simply makes grants to other charities. However, some clients will be instantly attracted by the concept — clients with charitable goals which they feel are not being met by existing organizations, or clients who believe that their charitable goals can best be met by doing things their way. For these clients, a POF may bring lasting satisfaction over and above any tax benefits. From a tax standpoint, the 2006 restrictions on the use of supporting organizations have spurred interest in POFs. Tax planners want to provide clients with the option of a charitable entity over which the clients can retain significant control, but which can qualify for the charitable deduction attributes of a public charity without having to meet the usual public charity tests. The tax advantages alone are unlikely to attract clients who are indifferent to running their own charities, but the tax advantages might be sufficient to convince a client who is otherwise tempted by the idea of a POF, .all of which suggests that tax planners should not automatically rule out the POF option for their wealthy and charitably inclined clients.

“There are some people that if they don’t know, you can’t tell them.” - Louis Armstrong

217

PUBLIC CHARITY DONOR OTHER PRIVATE OPERATING (including supporting ADVISED PRIVATE FOUNDATION organization) FUND FOUNDATION Can deduct up to 50% of adjusted gross income each YES YES YES NO year (30% for appreciated assets) Can donate appreciated assets other than marketable YES YES YES NO securities and deduct fair market value Can pay YES, but reasonable compensation compensation to more family members NO NO YES limited than with a and others POF because duties are likely to be fewer Virtually full control over ultimate charitable NO NO YES No use of contributions Possible perpetual control by creator No No YES YES and family

Conclusion This chapter has only scratched the surface by providing a general overview of how federal generation skipping tax works and can be avoided. The planning must go hand in hand with creditor protection and overall inheritance planning. Please do not forget that this is a voluntary tax for the vast majority of individuals whose family ends up paying it. Do everything you can within reason to avoid federal estate tax. The cost is usually minimal compared to savings for the family.

218 CHAPTER 8 - STEP 8 SPECIAL CONSIDERATIONS Almost every family has special considerations that involve legal or practical issues that do not apply to all families. We have therefore written Step 8 as a “pick and choose” chapter, so that you can look at the beginning of a section to see whether it may apply to you, or whether to skip to the next section.

I. Separate Children, Premarital Assets and Related Considerations A. Special Design for Second Marriages, Possible Divorce Scenarios, and Planning for Children by Previous or Separate Marriages. Divorce rates, differing interests in estate planning results, and family members from previous marriages with differing objectives can cause significant complexity and sometimes unfortunate results. Clients and their estate planners can avoid unwanted results by properly understanding the challenges and opportunities that exist in situations that involve second marriages or separate children. “Yours, mine, and ours” can have differing meanings, especially when it comes to assets and children. As mentioned in Step 5, the high divorce rate is a harsh reality, and certain assets are protected from being shared with an ex-spouse or a soon to be ex-spouse under Florida law. A prenuptial agreement can prevent the situations described below, and we recommend such agreements for clients who begin a marriage with one or both spouses holding significant assets. Generally, unless there is a premarital agreement in place, assets that are saved during a marriage as the result of the earnings of one or both spouses will be considered “marital property” and will normally be shared equally between the spouses in the event of a divorce. On the other hand, premarital assets and gifts received from third parties during the marriage will not typically have to be shared in the event of a divorce, unless ownership is commingled. However, growth

219 in value or interest, dividends and other income on such assets resulting from significant “marital efforts” of either spouse can cause increased value and earnings to be considered “marital assets,” which must be divided equally upon divorce. In addition, when a divorce occurs, one spouse may have to pay alimony to the other, depending upon relative needs, earning ability, and sacrifices made during the marriage. Florida is not a community property state, and has an equitable distribution statute, Section 61.075, that applies when people get divorced. Florida also has an alimony statute, Section 61.08, effective July 1, 2011, and a prenuptial agreement statute, Section 61.079, effective January 1, 2002. Example: Ken and Barbie get married in the year 2014, and at that time Ken owns a rental house that he keeps in his personal name. After the marriage, Barbie’s parents give her a $200,000 brokerage account. Ken’s hobby is restoring buildings, and he works a few hours every month to improve the rental house. He also manages the house and receives rental income that he deposits into an account in his name. Barbie lets her parent’s stockbroker manage her individual brokerage account, and it grows significantly. When Ken and Barbie divorce in the year 2020, Barbie will get one- half of the rental income account, and Ken will have to pay Barbie one- half of the increase in the value of the rental house that occurred between 2014 and 2020. Ken gets no part of Barbie’s brokerage account. If Ken earns significantly more than Barbie, then he may have to pay alimony to Barbie for a few years, but this will be reduced to some extent to take into account that Barbie’s financial needs are reduced by the brokerage account and other monies that she has received from the rental house appreciation and the rental account. If Ken and Barbie had signed a valid prenuptial agreement before they were married, then the results above would generally follow the premarital agreement instead of Florida law.

220 This example illustrates why we commonly counsel individuals who are getting married to either enter into a premarital agreement or segregate their premarital assets. It is imperative that the prenuptial agreement properly address “active appreciation” of non-marital assets in order to avoid sharing such appreciation with an ex-spouse. Unfortunately, this clause is left out of many prenuptial agreements, thus subjecting the appreciation of non-marital assets to equitable distribution. We also encourage individuals with premarital assets or assets received by gift to not add to or make use of those assets, so that an expensive and sometimes controversial forensic accounting procedure would not have to be used in the event of a divorce. To return to our previous example, assume that when Ken and Barbie got married, Ken also had an IRA. Ken would be well-advised to not add to his premarital IRA, but to instead start a new post-marital IRA, so that in the event of a divorce it would be easy to determine what the post-marital IRA contributions resulted in without having to spend thousands of dollars on accounting analysis and theoretical arguments in an attempt to determine what post-marital growth comes from premarital and post-marital contributions. Oftentimes, when we explain that assets held by one spouse would be subject to creditor claims, whereas they could be protected if owned jointly as tenants by the entireties (as explained in Chapters 3 and 4), the spouse with separate individual assets will consider placing these into tenancy by the entireties with the other spouse. However, the protection of these assets is sacrificed in the event of a divorce, unless the couple enters into a proper marital agreement. Sometimes we advise married clients who have separate assets to consider each placing an equal amount of separate assets into a joint account or investment vehicle. This gives them the protection of tenancy by the entireties and the knowledge that if they are divorced, they will equally share the joint investments, and not be disadvantaged by having combined their assets.

Other rules that apply in the marital law arena include the homestead inheritance rules, the elective share rules, and the family

221 allowance. When a married person dies he or she is not required to leave assets to a spouse, but Florida law has built in spousal protection in the form of homestead laws, elective share laws, and family allowance statutes. These are described below.

Each of these three spousal laws can be waived by an appropriate legal document or in a pre- or postnuptial agreement.

B. Special Considerations for Married Couples with Separate Children.

One of our most challenging situations is putting together estate plans when clients have remarried and have children by prior marriages. The Brady Bunch had a great life, but were their estate planning documents set up to protect the surviving spouse as well as the children of the first dying spouse? No matter how good your relations may be with the children of your spouse’s prior marriage, there is going to be a strong tendency for the surviving spouse to favor his or her own descendants. This creates a need for a balance between benefitting the surviving spouse and holding assets as a practical matter on the one hand, and not allowing the surviving spouse to “give away the farm” and disinherit the children of whoever dies first on the other. It is relatively easy to set up a trust agreement which indicates that on the death of one spouse the surviving spouse will have the lifetime use of assets, with the remainder then passing to the children of the first dying spouse. If all assets are owned jointly with right of survivorship or in large part by the surviving spouse outright, the trust agreement described above will be of little use. Sometimes clients will enter into post-marital agreements to provide that assets otherwise owned outright by the surviving spouse will nevertheless be contributed to a trust arrangement or otherwise held to facilitate protection of the children of the first dying spouse. Enforcement and administration of such trust or contractual arrangement, however, is far from simple or foolproof.

222 Marital agreements can also provide for a good deal of creditor protection for the surviving spouse, if there is a requirement that he or she place significant investment assets into an irrevocable trust formed in a creditor protection trust jurisdiction, assuming that there is no active creditor situation at the time that the first dying spouse passes away. Creditor protection trusts are discussed briefly in Chapter 5. When clients are relatively young, they can simply purchase a large amount of term life insurance that can be used to benefit the children of the first dying spouse. Another consideration is whether the children of the first dying spouse should have to wait until the death of the surviving spouse in order to receive an inheritance. Sometimes the surviving spouse outlives one or more of the children of the first dying spouse, and even one or more of their own children. In addition, with large estates it is often necessary to leave assets to a marital deduction trust that can only benefit the surviving spouse for his or her lifetime in order to avoid estate tax on the first death. For example, given that the amount that passes estate tax free on the first death is $11,400,000 and the first dying spouse has a $15,000,000 estate, $11,400,000 can go to the children of the first dying spouse and/or a trust that benefits both the children and the surviving spouse without being taxed in the surviving spouse’s estate. However, the remaining assets will have to pass outright to the surviving spouse or into a trust that can benefit the surviving spouse without being subject to federal estate tax. This is often called a “Q-TIP Trust”, which stands for Qualified Terminable Interest Property Trust. No distribution from a Q- TIP Trust can be made to anyone but a surviving spouse during his or her lifetime, and the surviving spouse has to receive all income from such trust. Clients who have separate children by prior marriages are strongly encouraged to recheck their estate planning documents, assets, and life insurance and beneficiary designation placement every two or three years, along with their decisions with respect to how to treat children and one another, to help assure an appropriate result. Sometimes the right decision for middle aged couples is to buy much more term life insurance than the surviving spouse will need, and to place it under a specially designed irrevocable life insurance trust to

223 enable estate tax free funding of trusts for the children of the first dying spouse, if there is an early death, and children who will need or are considered to deserve directly accessible financial benefits.

C. Simultaneous Death Clauses for Couples Who Have Separate Children. If John’s Will provides for his assets to go to his children and Mary’s Will directs her assets to her children, what happens to their joint with right of survivorship assets if they die in a common accident or within a few days of one another? In Florida, if Mary survives John by one minute, all of the joint assets will pass to her children. In jurisdictions that have adopted the Uniform Simultaneous Death Act, spouses (or beneficiaries) that have died within 120 hours of each other are deemed to have suffered a simultaneous death.

There are Florida appellate cases where the survivors of married couples have litigated over the question of who died second for inheritance purposes. In one case, a married couple was killed by a train that hit the driver’s side. After litigation and trial the court concluded that the wife must have died after the husband because she was sitting on the passenger side. This is why one of the author’s favorite law professors used to suggest having the wealthier spouse sit in the row in front of the less wealthy spouse on international flights. If you’re looking for a good reason not to sit with your spouse on the airplane, there’s one!

All jokes aside, it is essential to have Wills and trusts provide that jointly owned property that is inherited shortly before death will pass equally between the descendants of the two spouses to avoid this potential disaster.

D. Surprising Homestead Laws. Under the homestead law, an individual who is married and owns his or her homestead individually is not permitted to transfer or mortgage the property without permission of his or her spouse. This is why the non-owner spouse will have to sign on a mortgage if the homeowner spouse wants to borrow money, even though the non-owner spouse is not actually a borrower and is not guaranteeing the loan.

224 Consistent with the above, if the homeowner is married with no children, then on death of the homeowner, the surviving spouse will inherit the homestead as a matter of Florida law, unless this right has been waived. This applies even if the first dying spouse’s Will states that the house would pass otherwise. Please note that these rules do not apply if the house is being treated as owned jointly with right of survivorship or as tenants by the entireties between a husband and wife. In that event, the home will be completely owned by the surviving spouse, notwithstanding what a Will or trust says. This will apply whether or not they have children. If the homeowner is married and has one or more children, then upon the homeowner’s death, the home in his or her sole name will become owned as a “life estate” held by the surviving spouse and a “remainder interest” held by the child or children of the deceased homeowner. The surviving spouse can then choose to keep the life estate or to convert this to a 50% ownership, whereby the other 50% will be owned by the deceased homeowner’s descendants. Under the life estate/remainder interest laws, if the surviving spouse had a life estate, the children (or grandchildren), as “remaindermen,” would have no right to occupy the property during the time that the owner of the life estate was still alive. Under a life estate, the “remaindermen” have the right to exclusive ownership and use of the property when the life estate owner dies. Under the joint ownership laws, every joint owner of a tenancy in common property has a right to occupy the property. Therefore, the spouse may have to share possession of the home with the decedent’s children or grandchildren if these individuals also want to live in the home. As a result of the above laws, there are many properties owned in Florida as life estates held by a surviving spouse and remainder interests held by the children of a prior marriage who must wait patiently for the surviving spouse to die or negotiate a settlement whereby the house can be sold and the parties can split the proceeds as they agree. Without agreement, it is not possible for any party to require a sale of the home.

225 The life estate spouse’s right to receive one-half ownership instead of a life estate only became effective in 2010, and only applies to homestead rights that are inherited in this way after October 1, 2010.

E. Elective Share Laws. Under Florida’s elective share laws, a spouse is entitled to receive an amount equal to 30% of the “elective share estate” of his or her deceased spouse, unless there is a valid prenuptial or postnuptial agreement that waives this right.

The “elective share estate” generally includes any and all assets held directly or indirectly by a person, with very few exceptions. One exception is the death benefit of a life insurance policy, and another exception is for assets held under an irrevocable trust where the deceased spouse is not a beneficiary, to the extent funded at least one year before death. There is an alternative means of satisfying the elective share that many clients use. In lieu of leaving 30% of the elective share estate outright to the surviving spouse, it is possible to establish an irrevocable trust upon death that can be funded with 37.5% of the elective share estate. The trust must pay all of its income to the surviving spouse, plus amounts as reasonably needed for his or her health, education, maintenance and support. The trust can provide that the trustee must take other sources of monies into account in determining whether to make distributions of principal to the spouse. Therefore, a client dying with a $1,000,000 estate could leave $300,000 outright to his or her spouse, or $375,000 into a trust like the one described in the paragraph above to satisfy the elective share.

F. Family Allowance Law. In addition to the protections described above, there is a “family allowance,” whereby a surviving spouse can receive up to $18,000 from the estate of his or her spouse for support purposes. The amount awarded to the surviving spouse must be “reasonable,” and the court will look at factors such as the previous standard of living, needs of the spouse and children, age and health of the spouse, and other resources available to

226 the spouse. The right to receive a family allowance can be waived by a spouse in a prenuptial agreement or other properly signed document.

II. Medicaid Planning We thank Clearwater elder lawyer, Charlie Robinson, Esq., for his contribution and for providing us with this excellent section on Medicaid Planning. Charlie’s email address is [email protected]. We unfortunately live in a time where the comprehensive medical benefits of Medicare, for individuals over age 65 or who are disabled, do not extend to nursing home or home health care beyond 100 days after discharge from a hospital after a minimum three-day admission. The 100- day coverage only applies while the patient needs skilled or rehabilitative coverage. As soon as the physical therapist determines that no progress is being made, the patient will get a notice that she or he is moving to “custodial care,” meaning that payment sources will be long-term care insurance, private pay from the patient, or Medicaid. As a result, thousands of senior citizens lose most or all of their assets every year to pay for their own nursing home or home health care. Most people cannot afford long-term care insurance nor have policies that pay an adequate percentage of the cost for home health care. Having around the clock, trustworthy, non-medical personnel at home for someone who is not able to use the bathroom or otherwise take care of themselves can easily cost $15,000 to $18,000 a month when coordinated by a competitive, trustworthy home health agency. The cost of special nursing visits to administer medication, shots, or similar needed services will run the cost even higher. Florida nursing homes that are Medicare qualified to be reimbursed for the first 100 days after a hospitalization will typically charge approximately $245 a day for continuing services in a shared room, or substantially more for an individual room, according to the AHCA survey. This is where Medicaid comes in. When a person has run out of “countable resources” and qualifies for Medicare by reason of being age 65, or is disabled and has been accepted for Social Security disability, he or she will qualify for unlimited nursing home benefits, but will have to assign his or her Social Security check and possibly other benefits to the

227 nursing home, retaining a $ 35 per month allowance for extra spending money. Nursing homes that accept Medicare are required to allow admitted patients to stay on and accept what Medicaid pays once Medicare and countable assets run out. Medicaid negotiates a daily reimbursement rate with each individual nursing home for a shared room. Medicaid does not cover single rooms. However, the family may choose to pay a differential for a private room for a Medicaid patient. An immediate question is what assets are “countable” and what assets can a person keep before they have the benefit of Medicaid? How can you and your parents set assets aside that could be used to pay for non-necessities, such as extra nursing care, clothing, food, and otherwise, if and when nursing home care is needed? While there are some planning opportunities, extreme caution is the order of the day for anyone who may need Medicaid services and is thinking about transferring assets. There is a five year look-back rule which could cause individuals who transfer assets or make gifts to be denied any Medicaid benefits whatsoever for a period of five years after the gift is made. This could be a very serious problem! There are some exceptions that you can understand in thinking about possible Medicaid planning for yourself and others, but because of the complexity of these rules, please consult with a specialist lawyer before doing anything in this area, especially if the person in question might need to go on Medicaid within five years of making any large gift transfer. A person’s homestead is an exempt asset for eligibility purposes (up to $585,000 in value as of January of 2019) according to Florida Administrative Code § 59H-1.0035. They must live in the home for at least one year before it can be considered exempt. Even if the person is ill, and must leave the home and move to a long-term care facility, the home will be an exempt asset as long as they intend to return to the home. The intent to return can exist even if the person in question has dementia or Alzheimer’s. The homestead will not be subject to Medicaid claims after the death of the person receiving care if there is a surviving spouse or heir. If

228 there is no beneficiary who qualifies as an heir surviving the Medicaid recipient, homestead may be subject to Medicaid claims after the person’s death. This is referred to as estate recovery, and the Medicaid program is required by federal law to pursue the person’s estate for any unpaid debts. In Florida, the person’s estate is limited to the probate estate only. Medicaid recipients without constitutional heirs whose homestead is subject to Medicaid estate recovery can protect their home with the use of a “Lady Bird Deed,” also known as an enhanced life estate deed. A Lady Bird deed gives the decedent a life estate in the property until death, and at death, the property passes according to the deed outside of probate. Lady Bird deeds executed within the 60-month lookback period do not disqualify a person applying for Medicaid, and because the property passes outside of probate, the property passes outside the reach of a Medicaid lien, even when the homestead is transferred to a non- relative transferee. Also, one automobile with an unlimited value can be owned and used by family members to assist the person on Medicaid. Single persons are allowed to exempt $2,500 in a burial account, irrevocable burial contracts (services and plot), and life insurance up to $2,500. Individuals with income over Medicaid’s Institutional Care Program (“ICP”) limits ($2,313 per month) may qualify by establishing a Qualifying Income Trust where they can deposit any extra income. If admitted, the individual will be required to use this trust income to pay for medical care as part of their patient responsibility. Different rules apply to married couples where only one spouse needs institutionalized care. To qualify, both spouses’ assets are counted together and a community spouse resource allowance of $126,420 (in 2019) is deducted. The spouse needing nursing home care must not have resources exceeding $2,000 after the deduction. The community spouse also has income protection as a diversion from the institutional spouse’s income, with the maximum amount retained being $3,160.50 per month (varying by case) in 2019. An applicant can transfer their assets, including homestead, to their spouse at any time before applying for services without a penalty.

229 Some clients have had to get their parents to divorce so that the spouse not needing nursing home care can keep more than the above allowances. This is sad, but so is losing almost all of a family’s assets to nursing home care. Some very good websites that offer more information on Medicaid planning can be found at myflorida.com/accessflorida and dcf.state.fl.us/programs/access/docs/ssifactsheet.pdf and Charlie Robinson, Esq.’s website at www.specialneedslawyers.com.

III. Special Needs Trust Planning Many times, parents want to leave a special trust for a child or grandchild who may receive financial assistance from the government, Social Security, or estate or a charitable agency. Typically, the eligibility requirements for government provided housing or a special benefit program will include lack of financial resources, so leaving an inheritance directly to a child or grandchild, or even into an irrevocable trust for the child or grandchild, could result in disqualification for benefits. Qualified lawyers therefore use special language and provisions for “special needs trusts,” which are typically funded at death by a parent or a grandparent. The special needs trust provisions will typically include giving the trustees authority to use the monies held in trust for the benefit of other family members who do not have special needs, and to even exclude the beneficiary with special needs from being eligible to receive any benefits from the trust if it is deemed to be in his or her best interest. Oftentimes the language of the trust will further provide that the trustee is not to allow the intended beneficiary to receive any benefits that would otherwise be provided by governmental agencies or other institutions so as not to disqualify him or her from being able to receive such benefits. This type of “special needs trust” is much simpler and less involved than what is needed for more specialized situations, such as where an individual with special needs receives monies in a lawsuit or has outright ownership of monies or other assets that need to be protected. In those

230 situations, an elder law specialist with an extensive background in these areas should be retained and will typically be well paid and earn their fees in following the labyrinth of state and federal laws that can apply in these situations.

IV. Planning for the Addicted Beneficiary

A good many people have loved ones with addiction problems that are not properly addressed in planning. What follows is an article published in Estate Planning Magazine that was co-written by the author, Robin Piper, LMHC, MCAP, NCC, CCTP, the current CEO and Clinical Director of Turning Point of Tampa, Natalie Fala, PsyD formerly of the PTSD & Substance Use Department at the U.S. Department of Veterans Affairs, (currently a staff psychologist in the trauma recovery program at the U.S. Department of Veteran’s Affairs). The depth of this article can give the layman reader an appreciation of what sort of language and considerations can apply in structuring trust arrangements. This is only the tip of the iceberg that we work in.

231 PLANNING FOR THE ADDICTED BENEFICIARY By: Alan S. Gassman, J.D., LL.M., Robin Piper and Natalie Fala Many successful families have one or more members who at some point deal with addictions to drugs, alcohol, or gambling. Illicit drug use continues to rise in the United States, and millions of Americans meet the criteria for either dependence or abuse of alcohol or other substances (Substance Abuse and Mental Health Services Administration, 2011). Gambling addiction is thought to occur in a small percentage of the American population, yet these individuals are believed to account for a large percentage of the revenue acquired in parts of the gambling business (Dizikes, 2012). This information indicates that those with gambling addictions are spending significant monies to support their addictions. Along with the emotional distress that addiction creates in families, there are also important issues concerning finances and inheritance. The natural desire of parents to treat their children equally with respect to their inheritance and the management of their inheritance, however, is often outweighed by the problems associated with providing outright gifts to an “addicted beneficiary.” The issue of gifting to the addicted beneficiary is the primary focus of this article, but many of the issues and concepts are equally applicable to passing wealth to beneficiaries who function at a high level but who display emotional and other psychological challenges, such as impulsivity, anger and bipolar issues. Wealthy families often provide living accommodations, a stream of income, and gifts to an addicted individual, which tends to result in the individual receiving such benefits without work experience and may lead to diminished motivation or desire to work. The process of “enabling” the addicted family member often exacerbates the dependency problem because the well- meaning support of family for the addicted loved one inhibits development of a sense of self-esteem and pursuit of personal or professional goals. They do not dedicate the necessary time to ensure successful employment or develop meaningful relationships that are commonly helpful to working professionals, business owners and gainfully employed individuals. Although in most circumstances the road to recovery will need to include firm boundaries and a discontinuation of the enabling process, many times parents are not willing to leave their children on their own, regardless of their age. Ultimately, the best case scenario for the addicted personality is treatment and continuing care that potentially involves such things as abstinence

232 monitoring and community support (McKay et al., 2009). Research on individuals who remained abstinent over a period of three years were shown to have self-esteem levels comparable to college students, indicating that a sober life may increase goal-directed behavior (Christo & Sutton, 1994). Several treatment options are available, especially to those with available funds, but relapse is likely when treatment plans are not followed (National Institute on Drug Abuse, 2012). If the addicted family member is not willing to commit to follow the medically prescribed road to recovery, the best case scenario is to have the estate plan control the flow of money to the addicted person. Families and estate planners should bear in mind that money is often recognized as a trigger for relapse, and that many addicted individuals have not developed the life skills sufficient to handle money in a responsible manner. Although families may desire their loved one to continue the status quo financially, addicted individuals should also receive counseling and advice regarding how to manage money while in recovery. Commonly the family head wishes to continue the status quo of “enabling,” but must address the addicted family member specifically in their estate plan. The estate planner may

233 therefore occupy a pivotal role in helping the family determine how to handle not only the inheritance of the addicted individual and his or her family, but also with respect to how to handle the addicted individual’s support and applicable issues while the family matriarch and/or patriarch is still alive and well. The estate planner will often find that a significant degree of denial exists between one or both of the clients concerning the severity of the problem. They will deny their role in what has caused or is causing the problem, and what type of approach is best taken to help both the addicted person and the immediate family members realize the best outcome for the situation. In most cases the addiction has already created a significant amount of family strain, so some family members will have very strong ideas and opinions about the estate plan. In most family systems there are enablers and members who are more willing to discontinue support, both emotional and financial. The problem with waiting to address the problem is the often unforeseen danger that as the family head ages, he or she becomes more exposed to pressure, both mentally and physically, from the addicted individual for money, attention and inheritance rights. This can exacerbate conflicts already present, including relationships with siblings and other family members who are commonly resented and made fearful by the addicted individual. The welfare of the addicted child’s spouse and/or significant other is also a common concern, which is made even more difficult as they will often have the same or a similar addiction, co-dependence and a substantial investment in denial of the problem, as well as the children and/or stepchildren of the impaired individual and other family members, all of whom are gravely affected by the decisions ultimately made on how the inheritance will be handled. Recovery of the addicted individual is the paramount objective. Unfortunately, however, family dynamics and the potential for a large inheritance create a significant stressor for the addicted beneficiary and those around them. Financial support has the possibility of promoting their recovery process or destroying it. This article will provide some suggested structures and forms to address the inheritance of the impaired beneficiary with their best interests and the interests of their family in mind, and will also offer suggestions on how an estate planner may best interact with the family and allied health care professionals in the process. 1. Minimal Support Guidelines.

234 The author has found that a great many clients, perhaps understandably, simply refuse to “cut off” an addicted individual during their lifetime, or to even disinherit someone after their death or incapacity for fear of reprisal by the beneficiary. They may lament that the addicted individual will become a “street person” and do further harm to himself or herself. A common plan is to divide that individual’s inheritance share on the death of the client into separate shares whereby a certain portion is held for the primary benefit of the addicted beneficiary, and the remaining portions are held for the primary benefit of each of the children of the addicted individual. The “divided share plan” allows the children of the addicted individual to receive their inheritance without waiting for the death of the addicted beneficiary. With respect to the benefits provided for the addicted individual and his or her household, the following “minimal support language” may be useful. We have used the term “addicted

235 beneficiary” here but the individual’s name or another similar term may be substituted: MINIMAL BENEFITS MODE. Upon funding of this Trust and thereafter for the lifetime of the Addicted Beneficiary, unless otherwise herein set forth, the Trustee shall provide minimal direct benefits to the Addicted Beneficiary for food, clothing, and shelter in order to assure that he has modest means to have a clean place to live, heated running water, air conditioning, heating, basic food, needed medical and dental attention, counseling, career development, transportation, and clothing to facilitate participation in legitimate charitable activities, and access to public and/or private transportation , it being the intention of the Grantors that the Addicted Beneficiary shall have the benefit of such item or items as the Trustee deems appropriate in the discretion of the Trustee on a modest basis. Housing arrangements may be in shared facilities, food arrangements may include actual delivery of food to the Addicted Beneficiary, and transportation may consist of purchasing public transportation passes for the Addicted Beneficiary. During such times as the Addicted Beneficiary is not in compliance with Suggested Lifestyle Guidelines described in Section 5.02 below, the Trustee may nevertheless provide the Addicted Beneficiary with a standard of living equivalent to the standard of living that he has been enjoying as of the time of execution of this Trust Agreement if the Addicted Beneficiary’s lifestyle and responsibility level appear to be of a reasonable and non-destructive manner. Notwithstanding the above, the Addicted Beneficiary shall not be eligible to receive benefits under this Minimal Benefits Mode if his conduct, or lack thereof, is considered to be hostile, uncooperative, unsocial, impolite, or otherwise not befitting of a polite, well- mannered, and cooperative individual. The Diagnostic and Statistical Manual of Mental Disorders, Fifth Edition (DSM-5) uses “Substance Use Disorder” as the umbrella term for the various types of drug addictions. The DSM-5 classifies a Substance Use Disorder as mild, moderate, or severe, which is determined by the number of diagnostic criteria (out of eleven factors) met by an individual. Notable criteria factors include “a persistent desire or unsuccessful effort to cut down on use” and

236 “recurrent use of the substance resulting in a failure to fulfill major obligations at work, school, or home.” Similarly, the DSM-5 defines a “Gambling Disorder” as a persistent and recurrent problematic gambling behavior leading to clinically significant impairment or distress, as indicated by the individual exhibiting at least four out of nine criteria factors met by the individual. Notable Gambling Disorder criteria factors include “making repeated unsuccessful attempts to stop gambling” and “jeopardizing a significant relationship, job, career, or educational opportunity because of gambling.” Based on these definitions, the “Addicted Beneficiary” described in this article can be defined as one who compulsively engages in drugs, alcohol, or gambling, despite the negative and harmful consequences it causes in their life.

Intervention After Death or Incapacity of Benefactor. Some clients know that an addicted individual would be well served by going to a live-in rehabilitation facility, but have not drawn that line during their lifetime. Once an individual completes treatment and engages in continuing care, substance abuse experts agree such things as monitoring their sobriety through testing and also providing incentives for abstinent behavior is helpful to the recovery process (McKay et al., 2009). The following provision provides for significant benefits to be paid immediately after an addicted individual successfully completes a 90 day rehabilitation program, and conditions a large monthly payment upon having the addicted person stay off of drugs and/or alcohol for a period of approximately two years (100 consecutive calendar weeks) thereafter. The language provides for a total of $20,000 to be paid in 100 equal monthly installments beginning in the month where the individual successfully completes a 90 day rehabilitation program:

237 Suggested Lifestyle Guidelines. It is the hope of the Grantors that the Addicted Beneficiary will recognize and appropriately take the steps that are suggested by conventional counseling and rehabilitation programs to facilitate having good mental and physical health, including the ingestion of only healthy substances, without abuse of alcohol or drugs, and will refrain from participation in activities such as gambling that can be harmful to him. The Trustee is therefore authorized and encouraged to pay for transportation to and from counseling, counseling or recovery- related meetings, and for participation in full-time, live-in drug addiction treatment programs for such periods of times as may be recommended by such program or counselor selected in the discretion of the Trustee, and may provide the Addicted Beneficiary with specific financial, standard of living, or related benefits that can be earned upon completion of recommended programs. Further, upon completion of a 90 day full-time, live-in drug addiction treatment program in a manner deemed satisfactory by the treatment center, the Addicted Beneficiary shall be entitled to receive the amount of $20,000 if this is completed before ______, 20__, with such amount to be paid over equal weekly installments of $200 per week for each week that the addiction counselor and/or treatment center verifies that the Addicted Beneficiary has successfully completed the activities and has demonstrated that he is following the parameters set forth by them each week. In order to continue receiving benefits under this provision, the Addicted Beneficiary shall be required to fully cooperate by attending meetings and programs recommended by an addiction counselor or counselors, or an addiction treatment center selected by the Trustee. After receiving the amount of $20,000 in full during the 100 week period which begins with the successful completion of a 90 day addiction program, the Addicted Beneficiary shall be entitled to receive $1,000 per week for each week thereafter that he or she maintains such desired conduct. If the Addicted Beneficiary does not maintain such desired conduct for two consecutive weeks, or for any three weeks during any ten week period, then he or she shall be required to restart the Minimal Benefits Mode described in

238 Section ___ hereof, with the requirements imposed for him to regain status under the Suggested Lifestyle Guidelines mode to be as determined by the Trustee. Equivalent Language for Gambling. The following provides language equivalent to the drug 90 day rehabilitation program and monthly payment for 90 days described above, except the language is adapted for a beneficiary who is addicted to gambling. Although money is recognized in the addiction industry as a trigger for anyone struggling with an addiction, it is more so a trigger for people with a gambling addiction. All parties should bear in mind that fact when determining the amount of money allotted for successful completion of treatment. As well as successful completion of treatment and ongoing counseling, gambling addicted individuals may need to show trustees financial records and budgets for a period of time to ensure there is no gambling happening. Notwithstanding any provision under this Trust Agreement to the contrary, as to the assets held in trust for the primary benefit of the Addicted Beneficiary, and his descendants, if the Addicted Beneficiary survives me, an amount equal in value of one-third of the amounts passing to the Trusts under this Agreement which are held for the primary benefit of the Addicted Beneficiary after the

239 death of the survivor of myself and my spouse shall be set aside to be transferred outright to the Addicted Beneficiary. I recognize that these assets will be first from any non-generation skipping trust share set aside for the Addicted Beneficiary, and secondly from any generation skipping trust share set aside for the Addicted Beneficiary, provided that such devise to the Addicted Beneficiary shall not be made unless or until the Addicted Beneficiary has, after the death of myself, started and completed a full-time, live-in gambling addiction treatment program for 90 consecutive days, at a facility and with an organization designated by the Trustee, and then only after the Trustee has verification that the Addicted Beneficiary has not gambled from the date that he enters into such program until 30 days after completing such program, as verified to the best of the knowledge of a reputable addiction counselor selected by the Trustee. The Addicted Beneficiary shall not be eligible to receive such amounts unless he or she fully cooperates by attending a treatment program and meetings as recommended by a reputable addiction counselor or counselors. After successfully completing at least 60 days in a treatment program and not gambling for 30 days thereafter, the Addicted Beneficiary will receive $300,000 from the one-third share set aside for him, and thereafter he will receive $100,000 from such share at the end of each subsequent month completed unless or until he has been found to gamble. If and when the Addicted Beneficiary gambles, if such gambling occurs after entering into a gambling treatment program, then all distributions otherwise applicable as to this one-third share being set aside shall not occur whatsoever, and instead such assets shall be returned to the applicable generation skipping and/or non- generation skipping trusts from which they were withdrawn and/or earmarked to be held for the future benefit of the Addicted Beneficiary and his or her descendants. 2. Rewarding Five Years of Clean Behavior. Research indicates five years of sobriety for alcoholics significantly lessens the likelihood that they will relapse (Vaillant, 1996). Many addiction counselors report that an addicted individual who remains clean for five years has a good chance of not relapsing. In order to encourage five years of success, the following language may be used:

240 TRUST MANAGEMENT UPON PROOF OF 60 MONTHS OF MAINTAINING SUGGESTED LIFESTYLE GUIDELINES.

If and when the Addicted Beneficiary has achieved 60 months of continued adherence to the Suggested Lifestyle Guidelines by completing the 90 day program described in Section ___ above and four years and nine months of conduct as described in Section ____ above, then in addition to the minimal benefits set forth under Section ____ hereof, the Addicted Beneficiary shall receive a lifetime cash allowance of at least $1,000 per week during any time that he or she is not entitled to receive the Suggested Lifestyle Guidelines benefits set forth in Section ____ above. 3. Discouraging Inappropriate or Counterproductive Behavior. The following clause allows a reduction dollar-for-dollar of payments otherwise made for the benefit of the Addicted Beneficiary for expenses incurred as a result of inappropriate or nonproductive conduct:

241 EXPENSES TO REDUCE BENEFITS. If at any time the Trustee of this Trust incurs a liability or obligation as a result of conduct of the Addicted Beneficiary or any agent, contractor, or representative of the Addicted Beneficiary, for reasons including but not limited to the Addicted Beneficiary making multiple requests for information, challenging the Trust arrangement or the Trust Agreement, or in any other way, individually or by reason of the activities of an agent or affiliate of the addicted individual causing expenses to be incurred by the Trustee, then any and all expenses associated therewith shall be paid from this Trust, and may cause a reduction in amounts that would otherwise be payable to or for the benefit of the addicted individual under Article Five. Any and all third parties providing services for the Trustee, including but not limited to Trust Protectors, addiction counselors, lawyers, treatment centers, and other advisors, shall be indemnified and held harmless for any liabilities and obligations incurred by them as a result of their actions or inactions, except to the extent that any such actions or inactions are the result of clearly intentional and wanton or willful misconduct. Further, if the Addicted Beneficiary causes any expenses or liabilities to be incurred by any members of the ______family for any reason whatsoever, the Trustee may reimburse such family members and provide such family members with legal representation and such other benefits as are reasonable and appropriate to compensate for such conduct, with all such expenses being paid from this Trust. In the discretion of the Trustee, the expenses paid may result in a reduction of payments or benefits otherwise payable to the Addicted Beneficiary. 4. Conditional Powers of Appointment. Oftentimes an Addicted Beneficiary has descendants and the ability to change the inheritance of those descendants after the Addicted Beneficiary’s death may be desirable. The following clause allows such alteration, provided that the Addicted Beneficiary has remained addiction free for 60 months, or that the power is exercised with the consent of other individuals who may be named in the document. Addicted Beneficiary’s Conditional Power of Appointment. Notwithstanding Section 5.05 above, if and when the Addicted Beneficiary has obtained the 60 month status as described in

242 Section 5.03 of this Trust Agreement, or with the written approval of any two of ______, ______, or ______as to the content thereof, then the Addicted Beneficiary shall have a testamentary power of appointment, exercisable upon his or her death, to appoint how the assets held under this Trust shall be devised in the event of his or her death, provided that he or she maintains such Suggested Lifestyle Guidelines status up through and including the date of his or her death, and further provided that such power of appointment must be exercised solely in favor of descendants of the Addicted Beneficiary or any spouse of the Addicted Beneficiary that has been married to him or her for ______consecutive years. Notwithstanding the above, if the Addicted Beneficiary clearly lapses back into addiction after having achieved 60 months of Suggested Lifestyle Guidelines, then for the purposes of this provision it shall be considered that the Addicted Beneficiary has not completed 60 months of Suggested Lifestyle Guidelines unless or until completing a new 60 month period after the time of the lapse. 5. Making the Trustee Replaceable. Who should be the trustee of a trust established for an addicted individual? Typically, the parents will suggest a sibling or siblings, or a close family friend. The author recommends an independent professional or a trust company so

243 that family relationships can be kept intact to the extent possible and to minimize any sibling resentment. However, there may come a point in time when the addicted individual has earned the right to serve as a Trustee. Because of the nature of addiction, the addicted individual should never serve as sole Trustee; however, the family may want to leave open the possibility for the addicted individual to serve as co-trustee. The trustee power should be operable in conjunction with a co-trustee that is a licensed trust company. The following clause allows the addicted individual the opportunity to become a co-trustee while still maintaining a balance in that power. Addicted Beneficiary as Co-Trustee. If and when the Addicted Beneficiary reaches the status described in Section 5.03 hereof, then he shall be entitled to serve as Co-Trustee of this Trust with a licensed trust company managing at least $1,000,000 in assets. The Addicted Beneficiary shall have the power to replace the Co- Trustee with an alternate licensed trust company managing at least $1,000,000 worth of assets, but may not exercise that power more than once in a 36 month calendar period. This status could, ultimately, still be changed by the Trust Protectors of the Trust. Restrictive language to prevent an addicted individual from serving as Trustee is as follows: Substance Dependency Restriction Upon Trusteeship. No individual who is otherwise permitted to serve as a Trustee under this Trust Agreement and who has a “Substance Dependence Disorder” or is subject to “Substance Abuse” (as such terms are defined below) at any time after my death or incapacity may serve as a Trustee under this Trust, or any trust established hereunder, participate in the selection or initiate or cause the replacement of any Trustee, or otherwise have fiduciary rights or powers under this Agreement. An individual who has recovered from a Substance Dependence Disorder as exhibited by no longer using such substance and continuously participating in whatever activities have been recommended by appropriate addiction counselors shall not be considered to have a Substance Dependence Disorder so long as such individual has not committed Substance Abuse from the date of my incapacity or death, whichever occurs first. Any question or issue associated

244 with the possible existence of such circumstances shall be resolved by licensed and reputable addiction counselor hired by the licensed trust company then serving, which opinion shall be binding unless clearly erroneous, and is subject to challenge only by private arbitration pursuant to the terms of Section 8.08 hereof, with such private arbitration occurring only after such descendant has prepaid the estimated arbitration costs incurred in the filing of such arbitration. Any beneficiary who does not willingly and cooperatively submit to such physical and mental testing and addiction and suggested associated counseling as may be recommended or requested by any acting Trustee or Trustees under this Trust or any trust herein established shall no longer serve as a Trustee of any Trust established under this Agreement. Any child of mine shall have the power to request confirmation of there not being a Substance Dependence Disorder or the existence of Substance Abuse.

245 A Primary Beneficiary who is unable to serve as a Trustee by reason of the two paragraphs set forth above shall also not have the right to replace any licensed trust company unless or until such Primary Beneficiary becomes eligible to serve as a Co-Trustee, and during the time that an individual Primary Beneficiary is not able to serve as a Trustee if no licensed trust company is then serving, then the terms of this Trust Agreement shall apply as to the appointment of an alternate successor licensed trust company, provided that an individual who is not able to serve as a Trustee by reason of the two paragraphs above shall not be qualified to act to choose the alternate licensed trust company. This instrument adopts the current definition of “substance use disorder” as indicated by the DSM-5. In 2013, the American Psychiatric Association (APA) replaced the categories of substance abuse and substance dependence with a single category: substance use disorder. The symptoms associated with a substance use disorder fall into four major groupings: impaired control, social impairment, risky use, and pharmacological criteria (i.e., tolerance and withdrawal). The DSM-5 defines a substance use disorder as a problematic pattern of use of an intoxicating substance leading to clinically significant impairment or distress, as manifested by at least two of the following, occurring within a 12 month period: (1) The substance is often taken in larger amounts or over a longer period than was intended; (2) There is a persistent desire or unsuccessful effort to cut down or control use of the substance; (3) A great deal of time is spent in activities necessary to obtain the substance, use the substance, or recover from its effects; (4) Craving, or a strong desire or urge to use the substance; (5) Recurrent use of the substance resulting in a failure to fulfill major role obligations at work, school, or home; (6) Continued use of the substance despite having persistent or recurrent social or interpersonal problems caused or exacerbated by the effects of its use; (7) Important social, occupational, or recreational activities are given up or reduced because of use of the substance; (8) Recurrent use of the substance in situations in which it is physically hazardous;

246 (9) Use of the substance is continued despite knowledge of having a persistent or recurrent physical or psychological problem that is likely to have been caused or exacerbated by the substance; (10) Tolerance, as defined by either of the following: (a) A need for markedly increased amounts of the substance to achieve intoxication or desired effect; or (b) A markedly diminished effect with continued use of the same amount of the substance; and (11) Withdrawal, as manifested by either of the following: (a) The characteristic withdrawal syndrome for that substance (as specified in the DSM- 5 for each substance); or (b) The substance (or a closely related substance) is taken to relieve or avoid withdrawal symptoms.

The National Institute on Drug Abuse (NIDA) defines “drug addiction” as a chronic, relapsing disorder characterized by compulsive drug seeking and use despite adverse consequences. Accordingly, for the purposes of this instrument, “substance abuse” refers to compulsive drug-seeking and use, despite adverse consequences, which may or may not manifest as a chronic or relapsing disorder.

This instrument adopts the current definition of “gambling disorder” as indicated by the DSM-5. The DSM-5 defines gambling disorder as persistent and recurrent problematic gambling behavior leading to clinically significant impairment or distress, as indicated by the individual exhibiting at least four of the following in a 12 month period: a. Needs to gamble with increasing amounts of money in order to achieve the desired excitement. b. Is restless or irritable when attempting to cut down or stop gambling. c. Has made repeated unsuccessful efforts to control, cut back, or stop gambling. d. Is often preoccupied with gambling (e.g., having persistent thoughts of reliving past gambling experiences, handicapping or planning the next venture, thinking of ways to get money with which to gamble). e. Often gambles when feeling distressed (e.g., helpless, guilty, anxious,

247 depressed). f. After losing money gambling, often returns another day to get even (“chasing” one’s losses). g. Lies to conceal the extent of involvement with gambling. h. Has jeopardized or lost a significant relationship, job, or educational or career opportunity because of gambling. i. Relies on others to provide money to relieve desperate financial situations caused by gambling.

6. Naming a Designated Representative. In most states a beneficiary has the right to receive information on a trust established for him or her, including a copy of the trust and annual accountings. Under the Uniform Trust Code and the laws of many states, a designated representative may be appointed and given the power to receive or waive the right to receive such information on behalf of the beneficiary. The author recommends that designated representatives be appointed for this purpose when there is or may be an addicted individual as a beneficiary. There is typically nothing under state law that will prevent the grantor or any other individual from serving as designated representative. In some cases it may be appropriate to appoint an offshore trust company or lawyer who is beyond the jurisdiction of local courts, if there is any concern that the addicted individual might assert a cause of action against the designated representative. A designated representative clause used by the author is as follows: 6.05 Designated Representatives. It is recognized that Florida Statutes Section 736.0306, effective July 1, 2007, permits the appointment and service of a “Designated Representative” who can receive information and accountings that might otherwise be required to be delivered to Trust beneficiaries. Unless otherwise set forth under this paragraph, the Trustee or Trustees serving from time to time may select and alter the identification of one or more Designated Representatives to receive information and otherwise serve on behalf of one or more beneficiaries of this Trust or any trust established hereunder, provided that if names of specific individuals are enumerated below in this Section, then

248 except to the extent required by statute, the first person named below shall be the Designated Representative, the second person named below shall be the alternate Designated Representative, and the third person named below shall be the second alternate Designated Representative. It is acknowledged that, pursuant to Florida Statutes Section 736.0306, any Designated Representative chosen by a Trustee of the Trust and not specifically named below must be a relative who is a grandparent or a descendant of a grandparent of the beneficiary, or must be the beneficiary’s spouse, or the grandparent or a descendant of a grandparent of the beneficiary’s spouse. The first Designated Representative, if chosen, is ______, the alternate Designated Representative, if chosen, is ______, and the second alternate Designated Representative, if chosen, is ______. Any Designated Representative will be held harmless and indemnified from any and all trusts herein established for any liability or obligation incurred in serving as a Designated Representative, except in the case of conduct that is clearly malicious and willful except to the extent required under applicable law. A Designated Representative or an alternate Designated Representative shall not be considered a fiduciary unless circumstances otherwise dictate. It is the Grantors’ intent to reduce expenses and responsibilities with reference to Trust reporting and accounting to beneficiaries, and the Grantors therefore request that this Trust shall be construed and administered accordingly. Any Designated Representative then serving may resign by giving written notice to the persons then having the authority to appoint Successor Designated Representatives and to the Trustee. Notwithstanding the above, the Grantors, by mutual consent, or one Grantor if the other Grantor is unable to participate in such decision, may replace a Designated Representative or change the successorship rules relating to Designated Representatives. In the event that this Trust Agreement does not otherwise provide for the replacement of the retiring Designated Representative, and the Trustee requests that a Designated Representative be selected, then the following persons, in the order listed, shall have the ability, by written instrument delivered to the Trustee, to appoint

249 a Successor Designated Representative or Designated Representatives subject to any guidelines herein imposed: (a) The retiring Designated Representative, if such Designated Representative was appointed under Section 6.05 herein; and (b) The party or parties named in Section 6.06 below who would be empowered to appoint a Successor Trustee if this Article otherwise fails to provide for a Successor Trustee. 7. Trust Advisory Committee. Oftentimes a trust advisory committee should be named to assist in making “the hard decisions” with respect to benefits and other treatment of the addicted individual. The following clause allows trust protectors held under an irrevocable support trust to appoint a trust advisory committee. 6.17 Trust Advisory Committee. The Trust Protectors may appoint a Trust Advisory Committee to provide advice and ground rules to be followed with reference to addiction and related issues concerning the Addicted Beneficiary and any other

250 beneficiary under this Trust. Any such Trust Advisory Committee appointed from time to time shall be compensated. At all times, there shall be three members, and if one individual cannot serve, then the remaining individuals shall appoint an alternate so as to maintain three members. Each member of the Trust Advisory Committee may be compensated based upon time reasonably spent, reasonable hourly rates, and reimbursement of reasonable expenses, and shall be indemnified and held harmless for any liability, obligation, or reasonable expense incurred as a result of serving under this Agreement or providing any services to or for the benefit of the Addicted Beneficiary. It is requested that the members of the Trust Advisory Committee accept any communications from family members or other sources which would indicate that a beneficiary has a drug or alcohol addiction problem, and upon receiving such information that the Trust Advisory Committee or any member thereof may cause an investigation of the situation, which shall be paid for by the applicable trust that benefits such beneficiary. Any Trustee serving under such a trust may cooperate with the Trust Advisory Committee and shall be indemnified and held harmless for following the advice of the Trust Advisory Committee. 8. Trust Protectors. Oftentimes the author uses a trust protector provision whereby independent parties may change the provisions of an irrevocable trust or completely delete a beneficiary from being eligible to receive any benefits from a trust. A trust protector provision used by the author is as follows: 6.16 Trust Protector Provision. (a) The Grantors appoint ______and ______as Trust Protectors hereunder, provided that if one of them is unable or unwilling to serve, then ______shall serve. If no two of them can serve as Trust Protector, then the remaining Trust Protector shall select one or more of a licensed addiction counselor with at least a Masters Degree in Psychology or Counseling who is engaged in the full-time practice of addiction counseling or working as an addiction counselor and/or manager in an addiction treatment facility and/or a board certified estate and probate attorney who has an “AV” rating in the Martindale-Hubbell law directory and licensed to practice in the State of Florida to serve in such Trust Protector’s stead. If

251 there are only two or fewer Trust Protectors serving, then the remaining Trust Protector or Trust Protectors may choose a new additional Trust Protector meeting the above requirements. No trust created under this instrument is required to have a Trust Protector acting with respect to that trust. Notwithstanding any provision under this Section to the contrary, a Trust Protector who is not a U.S. citizen or permanent “green card” resident may not serve so long as the United States tax rules would cause this Trust to be treated as a “foreign trust” by reason of having one or more foreign Trust Protectors and any power otherwise vested in such an individual shall be null and void from inception. Any deadlock between the Trust Protectors shall be resolved by an individual appointed by ______. (b) The Trust Protectors may, by majority vote, and for the sole benefit of the beneficiaries named or designated in this Agreement, as deemed appropriate by them in their absolute discretion, and with respect to any trust as to which the Trust Protector is acting, modify or amend:

252 (1) The trust administrative provisions relating to the identity, qualifications, succession, removal and appointment of the Trustee; (2) The financial powers of the Trustee; (3) The provisions relating to the identity of the contingent beneficiary of trust property; (4) The withdrawal rights granted under this instrument (except a withdrawal right that has already matured at the time the Trust Protector seeks to exercise the power conferred under this subparagraph); and (5) The terms of any trust created under this instrument with respect to: (i) the purposes for which the Trustee may distribute trust income and principal, and the circumstances and factors the Trustee may take into account in making distributions; (ii) the termination date of the trust, either by extending or shortening the termination date (but not beyond any applicable perpetuities period); (iii) the identity of the permissible appointees under the testamentary power of appointment granted to the beneficiary for whom the trust is named; (iv) with the consent of all Trust Protectors, and when deemed reasonably necessary by the acting Co- Trustees to avoid having Trust assets made available to creditors, divorcing spouses, or other non-beneficiaries, institutions, or to avoid causing a beneficiary to be eligible for governmental or institutional support, or to prevent monies from being spent unwisely, or to divert assets from one trust or beneficiary herein designated to another trust or beneficiary herein designated; and (v) benefits payable or to be paid to any descendant of the Grantor, establishing separate shares or trusts with trust assets for one or more specified descendants of the Grantor, and providing for assets which are held under any trust herein established to be transferred to another trust established under this Agreement for the benefit of one or more descendants of the Grantor, which may include provisions which permit one or more descendants, or descendants meeting certain qualifications, to receive amounts as deemed appropriate for health, education, maintenance and support. (c) The Trust Protectors acting from time to time, if any, may appoint any one or more individuals as successor Trust Protectors, but only by unanimous written approval of all of the originally named Trust Protectors. Further, by majority vote, the Trust Protectors acting at any time may appoint successor Trust Protectors who meet the requirements

253 set forth under subsection (a) above. It shall always require at least two Trust Protectors to take any action. Any appointment of a successor Trust Protector hereunder shall be in writing, may be made to become effective at any time or upon any event, and may be single or successive, all as specified in the instrument of appointment. The Trust Protectors may revoke any such appointment before it is accepted by the appointee, and may specify in the instrument of appointment whether it may be revoked by subsequent Trust Protectors. In the event that two or more instruments of appointment or revocation by the same Trust Protectors exist and are inconsistent, the latest by date shall control. (d) Any Trust Protector may resign by giving prior written notice to the Trustee. All trusts created under this instrument need not have or continue to have the same Trust Protector. The provisions of this instrument that relate to the Trust Protector shall be separately applicable to each trust held hereunder.

254 (e) Notwithstanding any other provision of this instrument, the Trust Protector shall not participate in the exercise of a power or discretion conferred under this instrument for the direct or indirect benefit of the Trust Protector, the Trust Protector’s estate, or the creditors or either, or that would cause the Trust Protector to possess a general power of appointment with the meaning of Sections 2041 and 2514 of the Internal Revenue Code. (f) A Trust Protector acting from time to time, if any, on his or her own behalf and on behalf of all successor Trust Protectors, may at any time irrevocably release, renounce, suspend, cut down, or modify to a lesser extent any or all powers and discretions conferred under this instrument by a written instrument delivered to the Trustee. (g) A Trust Protector shall have no duty to monitor any trust created hereunder in order to determine whether any of the powers and discretions conferred under this instrument should be exercised. Further, the Trust Protector shall have no duty to keep informed as to the acts or omissions of others or to take any action to prevent or minimize loss. Any exercise or non-exercise of the powers and discretions granted to the Trust Protectors shall be in the sole and absolute discretion of the Trust Protector, and shall be binding and conclusive on all persons. A Trust Protector shall not be required to exercise any power or discretion granted under this instrument. Absent bad faith on the part of the Trust Protector, the Trust Protector is exonerated from any and all liability for the acts or omissions of any other fiduciary or any beneficiary hereunder or arising from any exercise or non-exercise of the powers and discretions conferred under this instrument. (h) Subject to (a) above, if more than one Trust Protector is serving under this Trust, then the exercise of any power authorized under this Section shall require the consent of a majority of the Trust Protectors then acting, unless otherwise provided. If there is a sole Trust Protector serving under this Trust, then such Trust Protector shall have the ability to exercise any power authorized under this Section only after appointing another Trust Protector as set forth in Subsection (a) above. (i) Notwithstanding any provision herein to the contrary, unless or until such time as the Trust is taxed as a foreign trust under the Internal Revenue Code and applicable regulations, a person who is not a

255 permanent resident or citizen of the United States, and no entity that is not a United States entity shall have the power to act as Trust Protector without unanimous consent of an acting U.S. Trust Protector or Trust Protectors, and the Trustee or Co-Trustees. 9. Closing Withdrawal Power Rights. Many times an irrevocable trust is funded by use of “Crummey withdrawal powers” which allow one or more beneficiaries to withdraw contributions made to the trust by exercising the power of withdrawal within a certain specified period of time (typically 60 days or slightly longer than 60 days from the time a contribution was made). Typical provisions that allow flexibility in order to prevent a certain beneficiary from having a withdrawal power as to future contributions, and otherwise, is as follows: It is recognized, however, that occupying a trusteeship or a paymaster role can be very challenging, depending upon how the addicted beneficiary responds to the applicable program. The author therefore recommends that there be a replacement committee or individual appointed who has the power to replace the acting trustee. A clause that can be used for this is as follows:

Gifting to the Addicted Beneficiary. It has been the author’s experience that the parents of an impaired adult will commonly cut the impaired adult off immediately or use all of their $15,000 per year per person exclusion to provide support for the Addicted Beneficiary and his or her family. If a client is not making use of the $15,000 per year annual exclusion, then they may consider using irrevocable trusts with Crummey withdrawal powers. However, they should be fairly confident that the addicted beneficiary will not exercise the withdrawal powers because the individual has forgotten about them or is willing to “tow the line” with respect thereto. If the withdrawal powers are provided under an irrevocable trust that allows withdrawal powers to be exercised by other family members, then alternatively, a check could be given to the beneficiary, and the beneficiary could endorse the check or immediately in turn make a check payable to the beneficiary’s landlord, credit card lender, or a 529 plan for the beneficiary.

256 V. Planning for Clients or Family Members with Questionable Mental Abilities Trust planning is essential to preserving the assets of a client or a family member with an unstable mental situation. We have had many clients amend their revocable trusts to install a “safety latch” provision which requires confirmation from doctors and/or trusted individuals before the trust can be amended or before any large withdrawals can be taken. A sample provision for this is available upon request. Those who would like to have background in Alzheimer’s, dementia, and similar issues may be interested in the following discussion: In the estate planning world, the focus is usually on the interaction between assets, liabilities, inheritance goals, and state and federal taxes. It can be very easy for estate planners to become lost in the numbers and not take into account the client’s mental and physical health, two dynamics of the estate planning equation that can be absolutely critical, particularly for elderly clients. Understanding the futures of clients with potentially debilitating mental diseases is necessary to help them plan properly. To that end, we offer a quick overview on a medical condition that may be affecting your elderly clients, known as “cognitive disorders.” Our brains age constantly, resulting in what has been termed “cognitive aging.” Individuals most often begin to see the effects of cognitive aging in their 40’s, when little things like losing keys, slower reaction times, or difficulty remembering a name from the past begin to happen. For some, cognitive aging will result in disorders that affect the ability to make sound estate planning and personal decisions. Because cognitive disorders go hand-in-hand with aging and people are living so much longer, we are seeing larger numbers of people develop cognitive disorders. For instance, the percentage of men with some form of cognitive disorder in the age range of 70-74 is 11%. That number skyrockets to 34% for men 85 and older.

257 It had long been thought that cognitive disorders, such as Alzheimer’s, were unavoidable. But recent research has shown that some degree of cognitive aging is avoidable. Staying healthy by avoiding severe or long-term diseases will lower an individual’s risk of a cognitive disorder.

Cognitive disorders come in one of four forms: (1) “Age-Associated Memory Impairment” – basically, a more severe form of memory loss than average age-associated memory loss; (2) “Age-Associated Cognitive Decline” – when “Age-Associated Memory Impairment” combines with severe losses to other cognitive abilities, such as language or depth perception; (3) “Mild Cognitive Impairment” – the state in between (1) or (2) and (4); and (4) “Dementia.” Dementia is a catch-all term for severe impairment to two or more cognitive abilities, including “memory, language, visuospatial ability and executive functions (e.g., planning, cognitive flexibility, executing specific tasks).” Teresa Andreoli, Cognitive Disorders Among the Elderly. Dementia includes a number of different types of mental diseases, including Alzheimer’s Disease (the most common form of dementia), Pick’s Disease, Parkinson’s Disease, and Huntington’s Disease. Even more promising, and a factor that is within every individual’s control, is that at least some degree of cognitive aging appears to be due to lack of use of the individual’s brain. Simply putting your brain to work will help stave off cognitive aging. Maybe it’s time you advise your elderly clients to turn off The Price is Right and pick up a crossword puzzle. For those who are already suffering a cognitive disorder, beginning a “cognitive training program” may result in some degree of reversal to a cognitive disorder. The Seattle Longitudinal Study of Adult Intelligence found that 66.66% of individuals suffering from cognitive disorders showed significant improvement by participating in training programs, and that 40% even returned to pre-decline levels of cognitive functioning. Just as importantly, these gains remained for over seven years. Estate planners, attorneys, and other fiduciaries must be aware of their client’s mental health, not just to plan the client’s financial future effectively, but also to protect the client.

258 Clients with cognitive disorders are more susceptible to influence by family or friends with poor intentions and should be on guard for requested changes not in the client’s best interest. Estate planners should also make sure to help, or make sure that their clients get help, in planning for their future health care, such as by setting up a durable power of attorney or a health care surrogate. Finally, estate planners should also monitor the progression of a client’s cognitive disorder. It may be up to you to finally determine that a client has become incapacitated, particularly when the client lives a solitary lifestyle or is not receiving regular medical treatment. CONCLUSION Estate planning is a lot more than just signing a Will just before going on vacation!

This book has addressed important considerations and factors that must be looked at and followed in order to successfully navigate the various rules and obstacles that can cause failure of even the best- intentioned planning. It is essential to have a qualified lawyer who is well-versed in the areas of concern, and to make sure that appropriate titling, beneficiary designation work, and other associated follow up occurs. The estate plan should be revisited every two to three years, or more often, if and when circumstances or laws change. Finally, the financial and business well-being of the person putting the estate plan together needs to be considered and properly situated. It is good to know that your assets will pass as intended on death, but will they be protected for you during your lifetime, and for your loved ones during their lifetimes following yours? We welcome any and all questions, comments or suggestions for future editions of this book. We hope that these materials have been helpful and effective for your own planning or for the planning of others.

259 INDEX

260 401(k) 43, 45, 48 Contingent Beneficiary 44-46, 192 529 Plan Assets 50 Corporate 28, 31, 60, 62, 114 CPA 28, 33, 107, 110, 115, 133 A Creditor Exempt Assets 48, 63 Creditor 7, 21, 30, 36, 38, 41, 42, 45, 47-51, Addicted 182-189 60, Addicted Beneficiary 181-188, 190, 191, 193, 62-71, 74, 75, 77, 79-84, 92, 94, 96, 97, 194 116, 125, 130, 133-135, 138, 139, 156, After Death Investments 33 158, 160, 161, 176, 192, 193 Alternate Beneficiary 43, 45, 46 Creditor Accessible 67 Annual Gifting 32, 123,138, 141 Creditor Claims 37, 43, 51, 67, 68, 73, 82-84, Annual Income 33 94, 116, 129, 138, 175 Annuity Contracts 28, 37, 38, 44-48, 66, 158 Creditor Exemption Planning 73 Asset Ownership 67 Creditor Exposure 67 Asset Planning 37 Creditor Issues 41, 130, 156 Asset Protection Planning 67, 68, 70, 74 Creditor Planning 21 Assured Inheritance Funding 37 Creditor Proof 43, 126, 130, 132, 158 Attorney 8, 13, 28, 29, 31, 41, 69, 71, 72, 74, Creditor Protection 13, 44, 47-51, 54, 58, 60, 75, 64, 74, 77, 80, 81, 83, 88, 91-94, 97, 116, 87, 92, 108-112, 118, 133, 146, 191, 195 121, 125, 131, 133, 134, 138, 172, 176 Creditor Protection Jurisdiction 133 B Creditor Protection Rules 50 Creditor Risk 49 Bankruptcy 48, 50, 53, 63, 66, 69, 72, 73, 75, Crummey Power 130, 139 81 Crummey Trust 139 Beneficiary Allowance 125 Beneficiary Controlled Accountable D Trusteeship (BCAT) 77 Beneficiary Designation 13, 22, 28, 29, 31, 38, Death Benefit 35, 36, 126, 178 41, 43-46, 67, 80, 83, 121, 176, 196 Debtor/Creditor Law 67, 69 Bypass Trust 83, 84, 125, 126 Defective Grantor Trust 74, 97, 123, 126, 128- 133, 136, 142, 143 C Disability Insurance 29, 35 Disability Policies 35 CDs 34 Discretionary Beneficiary 96, 101, 134 Capital Gains Tax 84, 88, 101, 123, 160, 161 Divorce 16, 36-38, 42, 43, 52, 66, 68, 78, 79, Charitable Lead Annuity Trust 162 82, Charitable Planning 158 108, 116, 136, 138, 139, 173-175, 180 Charitable Remainder Trust 159-161 Dynasty Trust 127, 128, 134, 135 College Age 34, 35 E Complex Joint Trust 83-85

261 Elder Law 178, 181 100, 127, 136, 138, 193 Elective Share 175, 178 General Power of Attorney 109 Entity Tax Planning 30 Gift Tax 19, 42, 49, 88, 90-92, 98, 100, 121, Estate Planning 7, 8, 11, 14, 22, 27, 33, 45, 47, 123, 125, 126, 128, 132, 136, 139, 140, 142- 48, 58, 59, 67, 71, 72, 74, 77, 80, 82, 83, 146, 149-154, 161, 162 86, 88, 92, 115, 121, 155, 173, 175, 176, Gift Tax Avoidance 49 181, 194, 195 Gift Tax Return 19, 42, 122, 136, 144, 146, Estate Tax 36, 38, 43, 44, 50, 51, 68-70, 74, 149, 80, 151 82-89, 91, 93, 94, 96-98, 100, 101, 117, Grantor 74, 79, 80, 93, 95, 97, 123, 126-139, 121-123, 125-138, 140-145, 147-151, 142-144, 148-160, 162, 184, 185, 189- 154- 192 159, 172, 176 GRAT 149-158 Estate/Tax Lawyer 50 Guardian 21, 61, 105, 108, 111 Estate Tax Marital Deduction 94, 98, 101, 126, Guardianship 79-82, 108, 109 155 Excise Tax 37, 165, 166 H Exempt Assets 48, 63, 69, 70, 73 Exempt Investments 64, 66 High Risk Investments 68, 114 Homestead 47, 48, 50, 66, 81, 175, 177, 180 F I Family Allowance Law 178 Family Assets 51, 78 Income 28, 33-35, 37, 38, 42-46, 52, 53, 61, Family Member Creditors 36 62, Federal Estate Tax 36, 83-87, 97, 121-123, 71, 73, 79, 80, 84, 85, 86, 89-94, 96, 97, 125129, 134,137, 142, 143, 151, 154, 99-102, 116, 123, 126-134, 136, 138, 155, 157, 142, 172, 176 143, 150, 151, 152, 153, 154, 156-174, Federal Gift and Estate Tax 122 176, 178, 180, 182, 192 Federal Gift Tax 92, 123, 126 Income and Principal 90, 92, 99, 192 Federal Income Tax 143, 164 Income Beneficiary 89, 101 Financial Planning 8, 33, 34, 132 Income Exposure 94 Fixed Income 28, 34 Income Rights 99 Fixed Rate of Return 37 Income Tax 37, 38, 42, 43, 45, 46, 52, 61, 62, 71, G 73, 80, 84-86, 93, 97, 123, 126, 128-134, 136, 138, 142, 143, 154, 156-164, 166 General Creditors 51 Income Tax Deduction 158, 163, 123, 134, General Power of Appointment 90, 93-95, 98- 159, 161-163 Income Payments 100

262 Income Protection 180 121, 125, 126, 127, 131, 158, 176, 178, Individual Ownership 41 180 Inflation 34, 86, 121, 123, 126, 128 Life Insurance Trust 36, 125-127, 176 Inheritance 7 18, 29, 37, 41, 44, 50, 68, 77, 78, Lifetime Beneficiary 93 123, 166, 172, 175, 176, 181, 182, 183, Lifetime Income 99 187, 194 Installment Sale 129, 131, 138, 142 M Intended Beneficiary 181 Investment 8, 13, 15, 33, 36, 38, 59, 68, 78, Married Couple 34, 42, 45, 49, 51, 55, 65, 78, 114, 123, 140, 150, 152, 153, 165, 166, 168- 82-86, 88, 89, 91, 92, 108, 144, 148, 176 170, 175, 176, 183 Medical 12, 13, 18, 51, 74, 109, 110, 111, 178, Investment Advisor 15 179, 180, 184, 194, 195 Investment Carrier 33 Medical Creditors 51 Investment Interest 150 Medicare 52, 53, 133, 134, 160, 161, 178, 179 Investment LLC 140 Medicaid 53, 68, 80, 85, 178-180 IRA 12, 29, 31, 43, 45, 46, 48, 81, 174 N Irrevocable 36, 49, 79, 89, 93, 105, 106, 108, 113, 125-127, 129, 130-133, 135, 139, Non Creditor Exempt 63 Non- 142, Marital 42, 174 144, 145, 155, 156, 159, 176, 178, 180, 181, 190, 191, 193, 194 O

J Outright Ownership 181 Ownership 11, 13, 22, 27-30, 36, 41, 42, 44, Joint Assets 12, 48, 73, 82, 86, 88, 101, 125, 45, 176 48-50, 54, 61, 63-65, 67, 82, 101, 125, Jointly Owned Assets 49 131, Joint Ownership 41, 61, 177 136, 138, 140, 142, 143, 144, 148, 150, Joint with Right of Survivorship 41, 42, 48, 79, 152-155, 173, 177, 181 176 P L Partnership 12, 19, 28, 47-49, 58, 67, 69-71, Ladder 35 97, 129-132, 140-141 Lawsuit 42, 47, 49, 181 Partnership Income 71 Liabilities 11, 13, 22, 26, 28, 50-54, 56, 58, 60, Pension 12, 15, 24, 28, 29, 31, 43, 45-47, 52, 61, 66, 187, 194 73, Life Insurance 11, 12, 26, 29, 31, 33, 34, 36- 81 38, Permanent Life Insurance 35, 36, 50 43, 45-48, 50, 63, 66, 70, 73, 74, 81, 113, Personal Assets 48 Personal Representative 21, 79, 81, 105, 106,

263 119 Stock 12, 23, 36, 74, 84, 95, 129, 132, 142, Physician 28, 37, 63, 66, 110, 111 146, Potential Creditors 30 150-153, 155, 164 Power of Attorney 31, 41, 108-112, 118, 195 Substantive Beneficiary 136 Private Foundation 164-166, 171-172 Private Operating Foundation 161, 163, 170, T 172 Probate 41, 42, 51, 78, 79, 80, 81, 82, 85, 105, Tax 7, 8, 11, 12, 19, 30, 36, 37, 38, 42-46, 49, 106, 180, 191 50, Protective Beneficiary Trust 80, 82 51, 52, 53, 61, 62, 68-74, 77, 80, 82-98, 100, 101, 115, 121-123, 125-176, 191 Q Tax Characteristics 11 Tax Court 95 QPRT 143-149 Tax Deferral 37, 44 Qualified Income Trust 180 Tax Deferred Annuity 12 R Tax Deferred Basis 37 Tax Liabilities 52 Real Estate Investment 78 Tax Planning 30, 36, 68-70, 74, 77, 121, 122, Reinvestment 145 130, 135, 149 Rental Income 154, 154, 174 Tax Rate 37, 123, 144, 147, 148 Retirement 11, 33, 45, 121 Taxable Income 38, 161 Revocable Trust 44-46, 51, 68, 79-86, 90-92, Tenancy by the Entireties Assets 41, 49 117 Term Life Insurance 33, 35-37, 176 Right of Survivorship 41, 42, 48, 50, 65, 66, Tiebreaker 113 79, Titling 11, 13, 28, 41, 63, 196 82, 125, 175-177 Trust 12, 15, 19, 20, 21, 29, 36, 37, 38, 42-46, 49, 51-53, 66-70 ,74, 77, 78-103, 105- 108, S 113-117, 122, 123, 125, 126-139, 142- 146, SAFE Trust 135 148-151, 155, 156, 158-162, 175-178, Savings 33, 35, 48, 63, 80, 91, 100, 137, 138, 180- 141, 145, 147, 148, 158, 172 181, 184-194 SCIN 142 Trust Assets 20, 68, 82-85, 88-90, 92-97, 103, Second Marriage 173 106, 127, 128, 130-134, 136-138, 146, Self-Cancelling Installment Note 142 149, Simultaneous Death 99, 176 159, 192 Sole Beneficiary 126 Trust Fund Tax Liability 53 Special Needs Trust 181 Trust Income 94, 97, 131, 136, 158, 180, 192 Spouse Beneficiary 137 Trust Investment 150

264 Trust Protector 70, 85, 103, 113, 127, 130, 187, 188, 190-193

Unprotected Assets 55

Variable Annuity 37, 73

W-2 Income 116

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i See PLRs 200101021, 200210051, 200403094, and 51 T.C. 696 (1969); Sinclaire Estate v. TAM 9308002. Commissioner, 13 T.C. 742 (1949); and ii See IRS Reg. Section 25.2511-2(c). In PLR Schwartz Estate v. Commissioner, 9 T.C. 229 200101021, the IRS held that the contribution of (1947). In each of these cases, the IRS tenants by the entireties assets to a joint trust did not successfully showed that trust assets were constitute a gift by either spouse under this included in the beneficiary’s estate, even regulation, because each spouse retained the right, though the beneficiary did not directly acting unilaterally, to revoke his or her transfer and contribute the assets to the trust. revest title in himself or herself, rendering the gift incomplete. Much as we like the result, we think it ignores the actuarial difference between the In Mahoney, a father created a trust for his interests of the spouses. son’s benefit and funded it with stock. The son then executed a promissory note to his father in an amount equal to the stock’s iii Michael D. Mulligan, Is It Safe to Use a Power of value. The son died and the IRS concluded Appointment in Predeceasing Spouse to Avoid Wasting that the trust assets were included in the Applicable Exclusion Amount? 23 Tax Mgmt. Fin. Plan. son’s estate because he was the party who J (Sept. 18, 2007). in substance transferred assets to the trust iv PLRs 20010102 & 200210051; see also Mulligan, by paying consideration to his father at supra n. iii (stating that “[p]roperty which is contributed by the predeceasing spouse and included in such time the stock was transferred to the trust. spouse's estate under §§ 2036 and 2038 rather than § Citing to Marshall, Sinclaire, and Schwartz, 2041 is unaffected by § 1014(e), and acquires a new the court concluded “that although [the income tax basis under § 1014(a)”). Of course, Section father] nominally created the Trust, the 1014(e) could apply if the first dying spouse receives decedent must be considered the effective the property from the surviving spouse and dies within a grantor of the Trust to the extent of his year after contributing it to the trust. contribution.” a trust created by the second party with those assets. v Treas. Reg. 20.2056(b)-5(f)(5). vi The same conclusion was reached in PLR 200210051, where each spouse had the power, to withdraw all of the trust assets In Sinclaire, the decedent transferred assets while both were living. We do not to her father, and her father funded a trust recommend that approach because it for the decedent using those assets before would most likely subject all of the trust her death. The Tax Court found that the assets to creditor claims against either trust assets were included in the decedent’s spouse prior to the first death. Otherwise, estate, noting that “in substance and reality claims against one spouse should only decedent was the settlor of the trust and imperil that spouse’s share of the trust. that her father acted only as her agent in its creation.”

vii Mulligan, supra n. 3. ix Mitchell M. Gans, Jonathan G. Blattmachr & Austin Bramwell, Estate Tax Exemption Portability: What viii Footnote 14 of Mr. Mulligan’s Should the IRS Do?And What Should Planners Do in article supports this concept by citing the the Interim?42 Real Prop. Prob. & Tr. J. 413 (2007– cases of Mahoney v. U.S., 831 F. 2d 641 (6th 2008). Cir. 1987); Marshall Estate v. Commissioner, x See PLRs 200101021, 200210051 & 200403094.

266 See Treas. Reg. Section 25.2523(e)-1(f)(6). Whether xi each spouse is comfortable with the other spouse having Mulligan at 9 et seq.; Mitchell M. Gans, Jonathan G. such a power is another question.) Blattmachr & Austin Bramwell, Estate Tax Exemption xvii PLR 200101021 (p. 4), PLR 200210051 (p. 4). Portability: What Should the IRS Do?And What Should xviii See Brian E. Barreira, Proper Medicaid Planning Planners Do in the Interim?42 Real Prop. Prob. & Tr. J. May Permit Keeping the Home in the Family (May 12, 413, 422 et seq. (2007–2008). 2011) (stating that “[t]he discretionary nature of the xii Id. at 422–430. xiii trust should allow a complete step-up in basis as of the Id. at 424. deceased spouse’s date of death for capital gains tax xiv 76 F.2d 55 (9th Cir. 1935). xv purposes”). Gans, Blattmacher and Bramwell at 429. xvi Each spouse would seem to have a lifetime general power of appointment, which eliminates the need for income payments to qualify for the marital deduction.

267