Volume 18, Number 6
September 2001

ESTATE AND FINANCIAL PLANNING

Estate and Gift Tax Planning for Nontraditional Families

By Jerry Simon Chasen

W

hile the usual model for estate planning involves the traditional family situation, the reality is that a significant portion of the population does not fit this model. Unless these nontraditional families avail themselves of basic estate planning services, most states will presume that they want their property to go to their next of kin. Practitioners must appreciate the unique needs of these clients and determine how best to accomplish the goals of making estate administration efficient and minimizing tax burdens. The use of the charitable deduction may be one of the best ways available to do tax-wise planning.

Evening things out.

Harriet and Marge are in their mid-40s. Harriet purchased an apartment building that is presently worth about ten times the purchase price and yields an $80,000 annual rental income, which is more than the couple needs when their salaries are taken into account. Marge makes a decent living, but she has not accumulated much. The two are interested in evening out their assets so that the continued appreciation in the building can build in both of their estates and so Marge will be able to take advantage of her lifetime exemption amount. Harriet is willing for Marge to have a 40 percent interest in the building, which would yield an annual income of $32,000. Harriet also has a soft spot for several charitable organizations, and she is planning to retire in a few years.

Using a pro rata valuation, a 40 percent interest in the $700,000 apartment building would be worth $280,000. Because the 40 percent interest is a minority interest, it would likely be discounted for gift tax purposes, but this discount is not taken into consideration in this example. If Harriet simply gives Marge a 40 percent interest, she will use $280,000 of her lifetime exemption. The trick is to get some of this interest into Marge's column without Harriet's having to use any of her lifetime exemption.

Because the property is expected to continue to appreciate, certainty about payments seems desirable, and the AFR is currently relatively low, a charitable lead annuity trust (CLAT) seems to be an appropriate vehicle. With the current AFR, Harriet could put the interest in a CLAT at 11 percent for 13 years, with monthly payments of $2,556.67 made to charity. There would be an annual charitable payout of $30,800, which would distribute nearly all of the income earned by the trust each year. At the end of that time, Marge would own the interest outright.

However, Harriet may not be particularly happy about the term taking that long. Without the income from the gifted share, Harriet would have difficulty retiring. A solution would be to put the interest first into an LLC and then put the LLC interest into the lead trust. Harriet would make a gift to Marge of a 40 percent interest in the LLC. The value of the gifted interest would likely be discounted significantly. The terms of the CLAT would be different.

Instead of 11 percent, the annuity amount could be 19 percent. Annual distributions to charitable beneficiaries would be $31,920, nearly the exact amount of income. It would take only seven years to transfer the interest to Marge, and none of Harriet's lifetime exemption amount would be used. There would also be income tax benefits of the CLAT for Harriet, the nature of which would depend on whether Harriet has the CLAT constructed as a grantor trust. Because Harriet probably does not need a large deduction up front and probably would not want to pay tax on income she would not personally receive, she would not set this up as a grantor trust.

Protecting a domestic partner's assets.

Now suppose that Harriet is 53 and Marge is 33. Because they live in a county that has a domestic partner registry, Harriet has requested Marge's hand in domestic partnership. In addition to the apartment building, Harriet owns undeveloped beachfront property valued at $1 million. Harriet is relatively well off. She is willing to provide for Marge and to make some gifts, but she is not interested in providing for Marge if they do not stay together.

Harriet could place the beachfront property in a two-life flip charitable remainder unitrust for Harriet's life and then for Marge's life. The Taxpayer Relief Act requires that the actuarial value of the remainder that a charity will receive be at least 10 percent of the property's net fair market value as of the date of the gift. Because of the parties' relatively young ages, the only way that this planning will pass the 10 percent test is if there is a low unitrust rate. With an AFR of 6.4 percent, a unitrust rate of 5.75 percent will pass the test.

To make sure that Marge is in for the long haul, Harriet was advised to reserve a testamentary power to change the beneficiary. Therefore, Harriet would not incur any gift tax at this point. Marge, however, knows that if Harriet can change the beneficiary, Marge will always be subject to Harriet's threats. Marge's lawyer has proposed that instead of a reserved testamentary power, the trust agreement would provide that, if Marge and Harriet were no longer registered as domestic partners, Marge's interest would terminate. Lawyers may argue that Harriet could avoid Marge's interest by "deregistering" their domestic partnership. That, however, is basically the same as arguing that someone would divorce so as to affect the disposition of his or her assets. Time and again, divorce has been deemed to be an event of "independent significance."

In the majority of jurisdictions that do not have domestic partner registries, it is possible to create a domestic partnership agreement and to have the unitrust interest dependent on the partnership's continued existence and effectiveness. However, heterosexual marriage has tremendous ramifications in terms of ownership of property that are generally absent in the domestic partner situation. Accordingly, the consequences of proceeding with the right of termination without a private letter ruling could be disastrous, since the IRS may fail to recognize the trust as a CRUT. The problem, of course, is that the trust cannot qualify as a CRUT if it is a grantor trust, which it would be in the example if Harriet were deemed to have a power that was not seen as having to do with an event of independent significance.

Self-created retirement plan.

This hypothetical addresses a creative approach for partners to protect one another and benefit a charity as well. Homer and Ozzie live in a beautiful $700,000 home. Ozzie owns the home. Rather than continuing to hold the full ownership interest of the house, Homer could be provided with some additional flexibility and the asset and its continued appreciation could be removed from Ozzie's estate.

A likely vehicle would be a charitable gift annuity. In effect, Ozzie would be selling the remainder interest in the house after his and Homer's deaths in exchange for an annuity that would be paid to them together and then to the survivor. If Ozzie has designated a charitable organization as the contingent beneficiary of his retirement plan, supplementing Homer's available income may be useful. Ozzie would transfer the remainder interest in the house to his favorite large charity, reserving a life estate for Homer and Ozzie's combined life expectancy.

In exchange, the charity would agree to pay an annuity amount to Homer and Ozzie together and then to the survivor. If the primary goal is simply to remove the asset from the estate and the charity is unwilling to pay an annuity, Ozzie might simply reserve a life estate for Homer and himself and deed the remainder interest to charity.

Moreover, the amount could be made flexible by establishing a deferred gift annuity, thereby postponing the annuity starting date. With this type of annuity, Homer and Ozzie could defer the initiation of payments. The amount of their current income tax deduction would be based on the earliest time that they could elect to receive their annuity payments. Although it would not increase the amount of their tax deduction, the longer they defer the commencement of annuity payments, the greater each payment would be, thereby reducing the amounts that they would have to withdraw from the retirement accounts for living expenses.

Jerry Simon Chasen is the principal of Chasen and Associates, P.A., in Miami, Florida.

This article

is an abridged and edited version of one that originally appeared on page 6 of Probate and Property, January/February 2001 (15:1).

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