Irrevocable Trust Planning

Individuals with substantial assets can utilize a number of techniques to minimize gift and estate taxes. These techniques include making lifetime transfers of assets using irrevocable trusts. This post will describe some of the irrevocable trust planning techniques for income-producing assets. Such trusts will name an "income beneficiary," who will be entitled to the income generated by the asset and a "remainder beneficiary," who will be entitled to the asset itself after a defined period of time.

One way to classify such trusts is by how the income of the income beneficiary is calculated: In general, income is calculated as either a fixed amount (an annuity) or as a fixed percentage of the net fair market value of the trust assets (a unitrust amount). Another way to classify these trusts is whether they involve a charitable beneficiary. Finally, with respect to charitable trusts, the charitable beneficiary can be either the income or the remainder beneficiary. These different trusts can be described using the following chart:

	Annuity Income	Unitrust Income
Charitable Lead Trusts (CLTs)	Charitable Lead Annuity Trust (CLAT)	Charitable Lead Unitrust (CLUT)
Charitable Remainder Trusts (CRTs)	Charitable Remainder Annuity Trust (CRAT)	Charitable Remainder Unitrust (CRUT)
Grantor Retained Trusts (GRTs)	Grantor Retained Annuity Trust (GRAT)	Grantor Retained Unitrust (GRUT)

In summary, a CLAT and a CLUT both provide a charity with income for a period of time, in the form of an annuity or unitrust amount respectively, with non-charitable beneficiaries receiving the remainder interest when the income period ends. A CRAT and a CRUT are similar, except that the charitable beneficiary receives the remainder interest at the end of the income period, during which either an annuity or unitrust amount is paid to non-charitable beneficiaries. Finally, a GRAT and a GRUT provide for both an income interest and a remainder interest to non-charitable beneficiaries. Future posts will discuss the situations in which each of these trusts are typically used.

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Social Security Planning

Normally, in planning when to apply for social security benefits, it makes sense (assuming you expect to live a long time) to delay applying. However, for some married couples, the "file and suspend" strategy results in greater benefits, even though it runs somewhat counter to the normal strategy. According to the Social Security Administration,

If you and your current spouse are full retirement age, one of you can apply for retirement benefits now and have the payments suspended, while the other applies only for spouse's benefits. This strategy allows both of you to delay receiving retirement benefits on your own records so you can get delayed retirement credits.

The practical effect of this technique is explained by the AARP in the following example:

John and Mary, a married couple... are 66, which is their full retirement age. Mary is retired; John plans to keep working until he is 70.

At 66, John, who had a bigger income than Mary over the course of his career, files for his full retirement benefits of $2,000 a month, but immediately suspends payment. By doing that, he will begin accruing delayed retirement credits: For each year that he keeps his payments in suspension, they'll be 8 percent higher when he does take them. The credits top out at age 70. Since John's basic retirement benefit at age 66 was $2,000, his new payment if he waits until 70 to collect will be about $2,640, plus any cost-of-living increases.

When John filed for his benefits, he automatically activated Mary's ability to apply for a spousal benefit... equal to up to one-half of the other spouse's retirement benefit. So Mary can collect $1,000 a month [without even] taking her own retirement benefit...

This means that the couple in this example receives $12,000 per year without receiving any retirement benefits on their own record, which they will start doing at a later date. This is an example of how the wrong strategy for collecting social security benefits can mean the receiving tens of thousands of dollars less than would otherwise be possible. Just as an attorney should be consulted for estate planning or other legal questions, a financial planner with social security expertise should be consulted when planning for retirement.

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Pass Wealth Tax Free by Marrying a Descendant?

As I discussed in a previous post, some states ban close relatives from marrying with gender-based consanguinity statutes on the premise that same-sex unions are unlawful. For example, Mississippi law states:

The son shall not marry his grandmother, his mother, or his stepmother; the brother his sister; the father his daughter, or his legally adopted daughter, or his grand-daughter;... and the like prohibition shall extend to females in the same degrees. All marriages prohibited by this subsection are incestuous and void. Miss. Code Ann. § 93-1-1(1).

This statute does not prohibit a son from marrying his father; but this possibility was foreclosed by Miss. Code Ann. § 93-1-1(2), which prohibited marriage between persons of the same gender. The state of Massachusetts has a similarly-worded statute, but in Goodridge v. Department of Public Health, the court legalized same-sex marriage but addressed the statutory language. The court stated in a footnote that "the statutory provisions concerning consanguinity or polygamous marriages shall be construed in a gender neutral manner."

Today's Supreme Court decision of Obergfell v. Hodges holds that the Constitution requires states to license a marriage between two people of the same gender. It does not mention consanguinity or contain any limiting language like Goodridge, yet it applies to all states, including Mississippi and a handful of others with gender-based consanguinity statutes.

Accordingly, in these states, there is no law preventing an individual from marrying a close relative, as long as they are the same gender. Furthermore, it is unclear what rationale a state would have in removing the right of same-sex relatives to marry. The ability for wealthy individuals to pass their estate to an heir by marrying the heir and benefiting from the unlimited marital deduction is a compelling tax planning opportunity.

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Donor-Advised Funds

For the charitably-motivated individual, the easiest way to support a nonprofit and qualify for a tax deduction is to simply make a donation to an eligible charity (the IRS maintains an on-line list of most such organizations at their EO Select Check page). However some individuals wish to retain some degree of control over exactly how their funds are utilized to support charitable endeavors. The strategies for doing this are innumerable, but one popular alternative that is almost as easy as an outright contribution is a contribution to a donor-advised fund.

A donor-advised fund is a separately-identified fund or account owned and controlled by a public charity over which a donor retains nonbinding advisory privileges. Any public charity can establish a donor-advised fund, and can even do so inadvertently if the charity operates one of its accounts "as if contributions of a donor... are separately identified" and the donor expects to have an advisory role over how the contribution is used.

Donor-advised funds have been around for decades, but were not mentioned in the Internal Revenue Code until the Pension Protection Act of 2006. Congress's objective in addressing the issue was to curtail perceived abuses whereby such funds were established "for the purpose of generating questionable charitable deductions, and providing impermissible economic benefits to donors and their families..." The response was an excise tax on any consideration paid by a donor-advised fund to a disqualified person, without regard to any consideration received in exchange, which is how standard excise taxes under Code Section 4958 function.

Fortunately, these rules are easy to follow because a public charity owns the donor-advised fund and will vet an individual's recommended distributions. The donor receives an immediate tax deduction, subject to the least restrictive AGI limitations, for contributions made to their donor-advised fund, and the donor can make additional contributions and recommendations indefinitely. Donor-advised funds are free to set up, cheap to maintain, and the fund investments are professionally managed. A donor-advised fund is a simple yet meaningful approach to charitable giving.

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Tax Refund Fraud

To continue the theme of my last post, this post discusses a specific type of identity theft: tax refund fraud. According to NBC News (and which I can verify from my own experience), all it takes to be able to electronically file a fraudulent tax return in someone else's name is a matching name, birth date, and social security number. With that information, all a thief needs to do is fabricate some wages and an employer, report a bogus tax withholding amount, and the difference between those two numbers will be refunded however the thief directs. This works because, to quote NBC:

By law, the tax-refund system as it is currently constituted amounts to a "pay first, ask questions later" system... In other words, an imaginative crook in possession of the three basic items of a person's identity could... get the money within 30 days—the amount of time the law says that the agency must refund tax filers.

Actually, by entering their own direct deposit information on the fraudulent return, the thief could get the refund in a couple days and not have to worry about trying to cash a refund check in the victim's name. Alternatively, a patient thief could paper file a fraudulent return and not even need the victim's birth date since that is not requested on the tax form itself.

The only obstacle to success in this crime is a voluntary program whereby some financial institutions can refuse to deposit a tax refund into an account on which there is a different name from the taxpayer. But not all institutions perform this cross check. Here is some Q&A from the Bureau of the Fiscal Service, a division of the Treasury that operates the federal government's deposit systems:

Can an RDFI [Receiving Depository Financial Institution] rely strictly on the account number in the ACH Entry Detail Record when posting a tax refund payment to a customer's account?

Yes, an RDFI may post IRS tax refunds received through the Automated Clearing House (ACH) network using the account number only....

Is an RDFI liable for an IRS tax refund sent to an account that does not belong to the named or intended recipient?

No. An RDFI is not liable for an IRS tax refund sent through the ACH network to an erroneous or fraudulent account since the IRS provided incorrect account information.

In other words, the IRS is required by law to authorize a refund before verifying if it is legitimate, and the Bureau of the Fiscal Service will authorize the deposit into any account reported to them by the IRS. The bank has no obligation to verify that the name on the refund destination account matches the name of the taxpayer. The real taxpayer will be left to clean up the mess when they discover they can't file their own return. Of course, the thieves will likely be caught after the fact, but the moral of the story is to avoid the mess by protecting your personal identification information and filing your tax return early.

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What to do About Identity Theft

Identity thieves can wreak havoc on your credit report and your life, and the Federal Trade Commission has a very useful informational packet designed to help victims get their lives back in order. Some highlights from that packet describing what victims of identity theft should do immediately after realizing they've been victimized are as follows:

1. Have a credit reporting company place an Initial Fraud Alert on your report. This is easy to do, it lasts for 30 days, and it will make it harder for an identity thief to open accounts in your name. This can be initiated online at each of the credit reporting companies websites, Equifax, Experian, and TransUnion.

2. Although not emphasized in the FTC's packet, identity theft victims should immediately change PIN numbers and online passwords to all financial accounts. The password to the email addresses used to reset online financial account passwords should itself be updated.

3. Order copies of your credit reports, review the reports for unauthorized charges or accounts, and contact any businesses related to the problem accounts. Placing the Initial Fraud Alert entitles you to a free credit report immediately. The FTC packet has sample letters that can be sent to businesses alerting them of the identity theft.

4. Contact appropriate government agencies. Income tax fraud is popular at this time of year; the IRS's Form 14039 can used to report identity theft to the IRS. The U.S. Postal Inspection Service, the "leading federal law enforcement agency in the investigation of identity takeovers," has a complaint form located here. Contact your state's attorney general office as well.

5. Create an Identity Theft Report. This consists of two separate documents; first is an Identity Theft Affidavit that can be generated online with the FTC's Complaint Assistant. The Identity Theft Affidavit should be taken to your local police station, along with documentation of the theft, photo ID, and proof of address. Use this information to file a police report; the police report and the FTC Identity Theft Affidavit together constitute an Identity Theft Report. Keep track of your police report number and Identity Theft Affidavit number.

After these steps have been taken, next comes the long process of clearing up your credit report, closing fraudulent accounts, ensuring that businesses remove fraudulent charges, and taking legal action where necessary. The FTC is a good resource for these steps as well.

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Utah DAPT Update

Two recent developments in Utah Domestic Asset Protection Trust law are worth mentioning. First, the Utah Supreme Court issued a ruling in the case of Dahl v. Dahl, dealing with a DAPT in the context of a divorce. Ms. Dahl appealed a lower court's decision, arguing that it erred in holding that she had no enforceable interest in the assets of a DAPT established by Mr. Dahl, and the Utah Supreme Court agreed.

Although the trust agreement specified Nevada law as the law governing the trust, the Utah Supreme Court applied Utah law for public policy reasons. Whereas under Nevada law the trust would have been irrevocable, under Utah law the Court found that the trust was revocable. Even though the trust agreement stated that it was irrevocable, another provision said that Mr. Dahl could amend the trust with the consent of the beneficiaries, and the trust did not include any express restrictions on this power.

This case is not a "traditional asset protection planning case," according to Jay Atkisson writing for Forbes. However, it reminds planners and clients alike that in order for a DAPT to be effective, it should, at a minimum, be formed pursuant to the law in which the settlor is domiciled and not be used to try and "cheat another spouse."

In another development, a bill has been proposed in the Utah legislature, H.B. 318 - Domestic Asset Protection Trust Amendments, which would repeal and replace Section 25-6-14, the current Utah asset protection trust statute. The "new type of asset protection trust" the bill creates would, among other things, require asset protection trusts to be registered with the Utah Division of Corporations and reduce the value of a settlor's assets that would be protected from creditors. Specifically, a DAPT could assert only the following exemptions:

The Median Exemption is an amount equal to the sum of the median value of a Utah owner occupied housing unit and the median Utah household income as determined in the most recent American Community Survey conducted by the United States Census Bureau.

The 50% Exemption is determined on a claim by claim basis and is an amount equal to the sum of [certain amounts] reduced by the Median Exemption...

For 2013, the Median Exemption would appear to only be $211,400 for median owner-occupied unit value plus $59,770 for median household income. This would represent a significant creditor-friendly change to Utah's DAPT law.

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