Here’s some good news for over 60 million Social Security and SSI beneficiaries  … you’re getting a raise!

The US government recently announced a cost of living adjustment of 3.6% for both Social Security and SSI beneficiaries. The raise benefits SSI beneficiaries starting in December 2011 and Social Security beneficiaries starting in January 2012.

This is the first “raise” beneficiaries have received in three years. Many seniors will of course welcome this news, as many have felt the effects of the economic recession, the stock market decline, and the fact that banks are paying almost zero interest on savings accounts.

The increase in Social Security income will be especially welcomed by those seniors who will be experiencing a hike in Medicare premiums in the next year. In the past, many of those seniors were shielded from such an increase due to a “hold harmless” provision that protects more than 70% of Medicare beneficiaries.

Even with the expected increase in Medicare premiums, most seniors are simply glad to see Uncle Sam acknowledging the rising cost of living. While most recipients of Social Security do have an alternate form of income (with SS benefits representing a little less than half of their earnings), many rely on their monthly check for a sizable portion of their income.

For more complete information about the coming changes in Social Security and SSI, or for help understanding how this change may affect you and your estate planning, please contact our office.

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Over 6 million children in the U.S. have “special needs” and the numbers are growing. Families of these children often pay for a range of therapies and treatments, yet many overlook the tax breaks available for such payments under the Internal Revenue Code. This article in the Wall Street Journal does a nice job of summarizing the issues.

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I am honored to have been named to the Board of Directors of the Broward Performing Arts Foundation. The Foundation is a not-for-profit charitable foundation composed of business and community leaders dedicated to supporting the Broward Center for the Performing Arts. The Broward Center is one of the gems of Broward County — a world-class facility with two theaters, over 3,000 seats, and year-round performances of music, dance and entertainment enjoyed by hundreds of thousands of South Florida schoolchildren and residents.

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Who should be trustee of your irrevocable trust? The answer may not be as simple as it seems.

This article examines who can, who should, and who should not serve as trustee; non-tax and tax factors that should be considered when selecting a trustee; who can, and should, be given the right to remove and replace a trustee; and using a team approach to segregate duties among lay and professional trustees.

Background

Irrevocable trusts are created in two ways:

1.  A revocable trust becomes irrevocable after the grantor has died.

2.  An irrevocable trust is established while the grantor is living to save estate taxes (by removing assets from the grantor’s estate) and/or for asset protection or Medicaid (Medi-Cal in California) planning.

While a grantor may technically be allowed to serve as the trustee of an irrevocable trust he creates, it is not a good idea at best. That is because if the grantor has any discretion with trust asset distributions, it could lead to inclusion of the trust assets in his estate for tax, Medicaid and other purposes, which could frustrate the trust’s objectives.

Often there is someone the grantor knows who the grantor suggests to be the trustee. Typical choices are the grantor’s spouse, sibling, child, or friend. Any of these may be an acceptable choice from a legal perspective, but may be a poor choice for other reasons. For example, some families would be torn apart if one sibling had to ask another for a distribution.

Left to their own devices, clients trustee appointments will frequently be made (out of ignorance) with little consideration of the qualifications the trustee should have. Likewise, those who agree to be trustees typically have no idea what they are getting into. Non-professional trustees often are overworked, underpaid, unappreciated, find they are dealing with unhappy and unappreciative beneficiaries, and may even wind up being sued by the beneficiaries.

With this in mind, let’s look at some factors (non-tax and tax) that should be considered when selecting a trustee.

Non-Tax Considerations for Selecting a Trustee

Here are some of the characteristics that the client should consider in choosing an individual trustee:

Judgment: Clients typically want their trustee to make the same decisions they would. Someone who shares the grantor’s values, virtues, spending habits and faith is more likely to do this. Also, consider whether the trustee candidate will be aware of his own capabilities and weaknesses. If the trustee candidate does not have accounting or investment experience, would she have the judgment to admit this and engage an appropriate qualified professional?

Availability/Location: Does this trustee candidate have the time required to be a trustee? Will he be available when needed or will work and/or family demands leave too little time for trust responsibilities? Where does the candidate live? If the trustee lives in a place different than the trust situs, different laws may apply. Is living near the beneficiary important?

Longevity: How long will the trustee be needed? Many grantors are most comfortable with friends who share their values and have gained wisdom from life experiences, but someone near the grantor’s age may not live long enough to fulfill the job. A trust established for the grantor’s child will likely need a trustee for many years to come. Thus, for trusts that may last a long time, a corporate trustee is often the preferred choice.

Impartiality: The trustee must be capable of being impartial among the beneficiaries. This is especially difficult to do if the trustee is one of several beneficiaries. Corporate trustees, because they can be impartial, are often chosen to prevent a sibling or relative from being placed in an uncomfortable (and often unfair) position.

Interpersonal Skills: The trustee needs to be able to communicate well and effectively to the beneficiaries and to professionals who may be involved with the trust. Some people may be good record keepers or investors, but lousy at diplomacy or feel intimidated or even be offended if a beneficiary gets an attorney. A good trustee will need to be able to work calmly and well with all involved.

Attention to Detail: Does the trustee understand the serious duties that come with the job and is she willing to be accountable for her actions? Fiduciaries are often thought by the beneficiaries to be guilty until proven innocent. While it may not happen, the trustee should assume he will be sued at some point and keep meticulous records as a ready defense. A trustee who expects to be sued will be much better prepared than one who doesn’t think it will happen and, as a result, does not take the record keeping requirement seriously.

Investment Experience: While it is helpful to have investment experience, the trustee can certainly get by without it, as long as he/she recognizes this is an area for which to secure professional help. Also, if the trustee lives in a place different than the trust situs, different investment laws may apply, making it especially prudent or even essential to seek professional assistance.

Planning Tip: CPAs can make good trustees, but often are unwilling or unable (because of insurance considerations) to serve. Sometimes, the best choice would be a corporate trustee. Seldom will the unguided grantor even think of using a team, which can include both various professionals and friends and family members.

Fees: The non-professional trustee rarely discusses fees with the beneficiaries. Often, family members and friends will not charge a fee for their services out of a sense of family duty or respect for the grantor. But trustees should be paid and, more often than not, an unpaid trustee will eventually come to that conclusion or fail to diligently carry out his duties. From the outset, a trustee should keep close track of time and expenses so that a reasonable fee can be substantiated. Generally, a reasonable fee is what a corporate trustee would charge, so thinking that a non-corporate trustee will do the same necessary work for less is false economy.

Planning Tip: Become knowledgeable about the fees charged by corporate trustees in your area as a guideline. Talk about trustee fees when establishing the trust to avoid problems and misunderstandings later.

Insurance: Anyone serving as a trustee needs to have plenty of insurance (errors and omissions or liability). Some of the laws that govern trustees are absolute standards, so a trustee needs to have adequate insurance for protection in the event of a mistake or an innocent error. The amount of insurance needed can depend on the degree to which a trustee is indemnified. However, legal defense costs in trustee litigation can be very large and are typically borne by the insurer.

Indemnification: This often comes up when family members or friends are serving as trustee. Grantors want to indemnify family members and their friends; they do not want them to be sued. It is possible to reduce or eliminate the prudent investor rule for such trustees. However, indemnification is a two-edged sword because it may result in the non-professional trustee not taking the job seriously.

Planning Tip: A good alternative is to have a family member or friend serve with a corporate fiduciary that is assigned the administrative and investment responsibility. The family member or friend trustee could make or veto discretionary distributions, but having no oversight, administration, or investment obligations would be less likely to be sued if something goes wrong.

Planning Tip: Indemnification might be appropriate in a situation with obvious bad family dynamics, where the siblings are already fighting each other yet the grantor insists on naming one sibling as trustee. In such a situation, your recommendation to name a corporate fiduciary instead should be well documented.

Planning Tip: Waiving the prudent investor rule can also be helpful in other situations, depending on the use of the trust. For example, with the sale of an appreciated asset(s) to a grantor trust, the trustee is usually buying hard-to-value assets (real estate, wholesale business interest) from the client in order to shift future appreciation to the trust and away from the grantor. Rather than starting initially with a corporate fiduciary who is not familiar with the asset or situation, it may be more effective (saving both time and money) to have the initial trustee be someone close to the family who better understands the issues, and then change later to a corporate fiduciary. Waiving the prudent investor rule and providing indemnification for the initial trustee in this situation could make sense.

Planning Tip: Being able to waive all or part of the prudent investor rule when using an irrevocable life insurance trust (ILIT) gives greater latitude and peace of mind to make some of the transactions meet the unique needs of the client. Beware, however, of the risk that the trustee, shielded from liability, may fail to do the appropriate work to make sure that the insurance held in the ILIT is appropriate as markets change.

Tax Considerations

Estate Tax

If a purpose of the trust is to remove assets from the grantor’s estate, the grantor cannot have any role in determining who gets distributions or when they occur. However, the grantor can have the power to remove and replace the trustee or to control the investments of the trust. Neither of those will cause estate tax inclusion providing the grantor cannot appoint a trustee who is related or subordinate to the grantor (as would be a brother, employee or someone else who will capitulate to the grantor’s wishes). Interestingly, there is no problem appointing, at the inception of the trust, an initial or successor trustee who is related or subordinate to the grantor.

Planning Tip: It is unclear if a grantor can have the right only to remove a trustee and allow the next named successor trustee to take over. While also unclear, it seems that a grantor can reserve the right to remove and replace someone who is not a fiduciary (for example, a trust protector).

Income Tax

A non-adverse trustee having certain powers may trigger grantor trust rules and cause the grantor to be taxed on the trust’s income. In some instances the client may not want the tax to come back to the grantor and instead want a trust that is a separate tax-paying entity for which the income that is distributed to the beneficiaries is be taxed to the beneficiaries.

Planning Tip: Because the trustee’s identity may affect state income tax as well, you may be able to shift the trust situs to a state with a lower income tax rate. Depending on the trust assets, this could be important as some investments (such as oil and gas) may be taxed significantly higher in some states than in others.

Beneficiary Removal and Replacement of Trustee

This is an area that is customizable for each trust and can help maintain some downstream flexibility. Some grantors may not want the beneficiaries to be able to remove the trustee, especially if the grantor is aware of family quarreling. But if the corporate or individual trustee knows it cannot be replaced there is little need for responsiveness or careful attention to investments. Because there does need to be a way to have the trustee removed if things should deteriorate, the document can include that the trustee can only be removed for cause as determined by the court. On the other end, spendthrifts may want to “trustee shop” until they find one that will do whatever they want, so there will need to be some restraints on when a trustee can be replaced.

Team Approach

There are times when a team can do a better job than a single trustee. Having more than one trustee, even with different duties and responsibilities, can work well for many situations. The trust can benefit from assigning the trustees specific duties based on their strengths and experience. Of course, the fewer people who are involved, the less complicated the administration. Also, disagreements will have to be worked out. If there are two trustees or any even number, deadlocks are possible. With an odd number, a simple majority would be needed. If an agreement cannot be reached, the court can be allowed to intervene as a last resort.

Also, as mentioned earlier, family member trustees can work with professionals as paid advisors instead of as trustees. This would allow the advisors to provide valuable input and insight into both the grantor’s desires and the personalities of the beneficiaries, without being so exposed to possible lawsuits.

Planning Tip: Ethical issues can arise if the attorney represents more than one trustee, so she should be sure to have a waiver of conflict or other plan in place.

Planning Tip: Naming someone as trustee is a nomination. The person named is under no obligation to accept the responsibility when the time comes, and it is not unusual for someone to refuse to serve or to step aside once he understands the duties and responsibilities involved. For this reason, it is important for the trust maker to name several successor trustees and to clearly communicate with each before finalizing the choices. Most drafting attorneys will also recommend naming a corporate trustee as trustee of last resort, especially if no procedure for appointing successors is provided to the beneficiaries, short of going to court.

The Trustee’s Duties and Responsibilities

• administer the trust
• be loyal
• be impartial
• be prudent
• control and protect trust property
• collect trust property
• inform and report to beneficiaries
• diversify investments
• keep records and no commingling
• enforce and defend claims

Conclusion

A competent trustee is as important to the success of a trust as its being well-drafted. Naming a favorite family member as trustee may not be the smartest (or kindest) thing the grantor can do. As experienced professionals who have seen the consequences of unwise choices for trustee, we are in a unique position to counsel our clients with their and their beneficiaries’ best interests in mind.

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Each month, estate planners keep their eye on a few key interest rates set by the federal government. With certain planning techniques, the lower the rate, the better the result for the client.

Today the government announced a series of historically low rates. This means golden opportunities for clients engaged in wealth transfer planning. GRATs, installment sales, intra-family loans and charitable lead trusts are exceedingly attractive right now.

For example, the interest rate on an intra-family loan of 3 years or less is a mere 0.16%. For loans between 4 years and 9 years, the rate is 1.19%. And the rate on loans of 10 years or longer is only 2.95%.

To illustrate, suppose parent lends child $1,000,000. The loan fully amortizes over 9 years at a fixed annual interest rate of 1.19%. Child invests the proceeds in a business or other investment returning 8% per year. Over the life of the loan, child will have paid parent a total of about $55,000 in interest, whereas child could earn approximately $80,000 from the investment in the first year alone! Extrapolate that over 8 additional years of investing and the wealth transfer benefits are compelling.

With interest rates at historic lows, the opportunities for families engaged in wealth transfer planning are nothing short of extraordinary.

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For many of my clients, a family-owned or closely held business forms a major part of their estate. While business exit and succession planning can be challenging because of tax issues, family dynamics and emotions, it can also be exceedingly gratifying for clients and their families.

In the discussion below, I will examine a case study that uses a Limited Liability Company (LLC) in the transfer of a family business to the next generation.

[Please note: This discussion is technical in nature and therefore intended for my friends and colleagues in the legal, accounting, insurance and financial planning professions. I am not rendering legal advice. Please retain a lawyer before acting upon any of the matters discussed below.]

Case Study Facts

Frank (age 62) is married to Betty (age 58). Frank has an older son, Tom, from a previous marriage who is active in Frank’s business. Betty has a daughter, Susan, from her previous marriage. Together they have a son, Charlie, who is a minor. Betty, Susan and Charlie are not involved in Frank’s business.

Frank owns 100% of an S-corporation. It has a fair market value of $10 million and generates very good cash flow. Frank and Betty have significant other assets, including a home and investments. They own some jointly and Frank brought some into the marriage — they are held in his individual name. Their $5 million lifetime gift/estate/GSTT exemptions are fully available.

Consequences of No Planning
If Frank does nothing, according to the probate laws of the state in which they live, Betty will receive 50% of Frank’s estate including the business; his son Tom will receive 25% of Frank’s estate including the business; and Charlie will receive 25% of Frank’s estate including the business. Because Charlie is a minor, Betty will control his share until he is 18. So, in effect, Betty will control 75% of the business if Frank dies intestate. Susan, Betty’s daughter, will receive nothing.

Planning Objectives
Frank would like to ensure that ownership of the business will go to his son Tom, and Tom would like the security of knowing that one day the business will be his. Tom does not have the cash to buy the business. Frank would also like to control the timing of the transfer of the business and he would like to treat his stepdaughter and younger son fairly. He is concerned about maintaining enough cash flow to support himself and Betty now, and providing for Betty if he dies first. And he would like to minimize estate taxes.

Recommended Plan

Phase 1: Reorganize and Recapitalize the S-Corporation
In a tax-free reorganization, the S-corporation is converted to an LLC that is taxed as an S-corporation. The LLC is organized under the laws of a “charging order only” state. Frank’s ownership is changed from 100% voting shares in the corporation to 1% voting and 99% non-voting memberships in the LLC. Frank still effectively owns and controls 100% of the business, but now it is comprised of 10 LLC membership units (1%) that are voting units and 990 (99%) that are non-voting units.

Phase 2: Create Dynasty Trusts
Frank next establishes three irrevocable trusts, one for each child, in a jurisdiction that permits perpetual trusts. The trusts (irrevocable grantor trusts, aka intentionally defective grantor trusts) are disregarded by the IRS for income tax purposes, but not for estate and gift tax purposes. (Alternatively, one trust with three separate shares can be established.) The trusts are also designed to own life insurance on Frank’s life.

Frank makes an initial gift of $600,000 to each trust. These are taxable gifts that must be reported on Form 709, but no gift tax will be due because it will be applied to Frank’s and Betty’s lifetime gift tax exclusions. $600,000 of their generation skipping transfer tax (GSTT) exclusions will also be allocated to each trust, giving each a zero inclusion ratio – so that it is not subject to GSTT in the future.

The trustee of Susan’s and Charlie’s trusts uses their initial gifts to purchase life insurance policies on Frank and/or Betty, providing substantial assets upon Frank’s or their deaths.

Phase 3: Tom’s Trust Buys All Non-Voting Units with an Installment Note
A business valuation is performed to determine the fair market value of Frank’s business. As part of this process a qualified valuator first values the assets the business owns (real estate, equipment, good will, inventory, etc.). The valuator then determines whether and to what extent the value of the assets should be adjusted due to lack of control, liquidity and marketability.

When these valuation adjustments are applied to non-voting interests in an LLC, the fair market value is often depressed by a significant amount when compared to the fair market value of the entire business: in this hypothetical case, 40%. In other words, the non-voting units will each have a value of $6,000, making the total value of the 990 non-voting units $5,940,000. Alternatively, voting units will have a premium value to reflect the control value. In this hypothetical case, the voting units have an appraised value of $12,000 per unit, making the total value of the 10 voting units $120,000.

Tom’s dynasty trust buys Frank’s 990 non-voting units for $5,940,000 using a 20-year installment note, payable annually. Based on the current IRS published interest rates, the trust will pay Frank $447,197 every year for 20 years. The note is adequately secured by the LLC units and the $600,000 of other assets in Tom’s trust. The cash flow from 99% of the business is more than sufficient to cover the note payments.

Planning Tip: The installment note should be handled just like an installment sale to a non-family member or a loan from a bank. A pledge or security agreement should be signed, required taxes should be paid, required filings should be made, etc. A fully documented paper trail should exist for the transaction and the payments made on the note. 

Why Reorganize the Corporation to an LLC?

Corporate stock is freely transferable, making it very easy for a judgment creditor to foreclose on corporate stock and become a shareholder. In most states, the percentage required for shareholder voting to liquidate a corporation is less than 100%, generally ranging from 51% to 80%. If a judgment creditor forecloses on enough shares of stock to allow the creditor to liquidate the corporation, the creditor would be able to seize the assets of the corporation to satisfy the claim.

Alternatively, LLC interests are usually not transferable without the consent of all members. Due to this limitation on transferability, an LLC offers much greater asset protection from creditors. Many states limit a creditor’s remedy to a “charging order” on distributions to LLC members. (Only when a distribution is made will it go to the creditor; when the claim has been repaid, the charging order is stopped.) The creditor can never become a substitute member, and will only become an assignee with no ability to vote on admission of new members or the liquidation of the LLC. In most states, it takes a 100% vote of all members to liquidate an LLC. Because a creditor can never become a member, it can never vote on liquidation of the LLC.

Outcome of the Planning

Frank owns the 10 voting units, giving him 100% control of the business and 1% of the equity. Tom’s dynasty trust owns 990 non-voting units, giving Tom no control over the business and 99% of the equity. Tom’s trust also has $600,000 in cash that Frank gifted to it as seed capital. This cash is invested, and the income tax attributes of income, gains and losses are passed through to Frank to be reported on his tax return, as is the income, gains and losses attributable to Tom’s trust’s 99% ownership in the business.

Income Tax Reporting
As long as Frank is deemed the owner of Tom’s dynasty trust for purposes of reporting trust income, the dynasty trust does not have to file a Form 1041 fiduciary income tax return. A corporate income tax return (1120S and K-1) is filed for the business and Frank reports the trust’s income on his tax return.

Income Tax Effect of Sale of Units
Because Frank is the deemed owner of the trust for income tax purposes, the sale of the LLC units to Tom’s trust is a non-recognition event; i.e., a sale by Frank to himself. No gain or loss is recognized on the sale. No interest income is recognized on the installment note payments and no interest deduction is allowed to the trust.

Planning Tip: Include a “toggle” provision to turn each dynasty trust’s grantor status off or on as needed, so that the income being taxed to Frank can be stopped if that should become undesirable later. Consider giving this power to a trust protector. 

Pass Through Dynasty Trust Income
Income from the LLC will be allocated to the unit holders based on their ownership percentages. Let’s assume the business has $500,000 in net income. Frank owns 10 voting units, equal to 1% of the equity, so he will be allocated $5,000 on the 1120S as K-1 income. Tom’s dynasty trust owns 990 non-voting units, which is equal to 99% of the equity. So Frank, on behalf of the trust, will also be allocated $495,000 on the 1120S as K-1 income.

Because the dynasty trusts are grantor trusts for income tax purposes, Frank must pay the income tax on all their income, including the S-corporation income that is allocated to Tom’s trust. But that is what he was doing before the sale, so he is paying the same income tax before and after.

Planning Tip: Frank’s payment of income taxes in dynasty trust income is not an additional gift to the trusts, so every year he is effectively transferring additional estate assets to the trusts for the children without additional transfer tax. 

How the Dynasty Trust Makes the Required Note Payments
In this case study, we assume that the LLC will have $500,000 per year of cash flow to distribute to the unit holders. Tom’s dynasty trust will receive a cash distribution of $495,000 ($500,000 times 99% = $495,000). At the end of the first year, it will have $1,095,000 in cash ($495,000 from the LLC plus $600,000 that Frank gifted to it as seed capital). The trustee uses this money to pay the $447,197 note payment to Frank.

Planning Tip: If the business does not make enough income to pay the note, the payment can be deferred until the business recovers or the term or interest rate of the note can be adjusted. 

Results after One Year

At the end of the first year, the note has been reduced to $5,745,847 and Tom’s trust has a cash balance of $647,803. This cash can be invested and saved, distributed to Tom (gift tax-free), or used to buy and pay for a life insurance policy on Frank’s life.

Frank has received $5,000 from the LLC and $447,197 from the note payment for a total of $452,197 in income. He pays income taxes on the full $500,000 of S-corporation income. If, after all deductions, he has a 25% effective income tax rate, he would pay $125,000 in income taxes, leaving him with $327,197 in income to support his and Betty’s lifestyle.

Planning Tip: A higher income tax rate means less net income, but the client can also receive additional (reasonable) compensation as an LLC manager or as a Director. If he needs less income, his salary can be reduced, but ensure that it is not so much that he loses benefits. 

When Frank Dies

Frank and Betty also establish estate plans, so the assets in Frank’s estate will pass as planned, not according to the state’s default rules.

If Frank and Betty have consumed or gifted the net after-tax proceeds of each note payment from Tom’s dynasty trust, only the unpaid balance of the note will be included in the value of his taxable estate. Tom’s dynasty trust is GSTT exempt, so its assets will never be subject to estate, gift or GST taxes. Frank’s estate plan leaves the 10 voting units to Tom’s dynasty trust, giving Tom 100% ownership of the business. The dynasty trusts for Susan and Charlie are also GSTT exempt, and the life insurance proceeds will be exempt from probate and income, estate and GST taxes. Betty will continue to receive the remaining note payments for her support.

Estate Tax Results
Frank has removed 0.99 x $10,000,000 + 3 x $600,000 = $11,700,000 of appreciating assets from the value of his gross estate that, at his death, would have been subject to estate taxes. He and Betty have used $1,800,000 of their lifetime gift/estate/GST exemptions. (Remember, unless Congress acts before the end of 2012, the top estate tax rate in 2013 is scheduled to go back to 55% with a $1 million exemption.)

Frank has received an asset (the $5,940,000 note) that, in his estate, may have a discounted value due to lack of marketability, etc., and that will not appreciate; in fact, the note is depreciating because the principal will decrease over the 20-year term.

If Frank does not accumulate the note payments, at the end of the note term he will have completely removed the $10,600,000 and all future appreciation from his gross estate without making a taxable gift other than the initial $600,000 seed capital gifts to the dynasty trusts.

The trust assets are not subject to generation-skipping transfer tax, will be protected from creditors, and will not be included in the children’s or grandchildren’s or great-grandchildren’s gross estates at their deaths.

Objectives Met

All of Frank’s objectives have been met. His son Tom will receive the business without having to buy it, and Frank can control the timing of the business transfer. He was able to provide for his other children and his wife, and he saved substantial estate taxes.

Conclusion

While this kind of planning can be complicated, the above example demonstrates that the rewards are many. I enjoy helping my clients solve their problems, strengthen their family relationships, save money and have peace of mind. This type of planning is truly a win-win opportunity.

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The trustee of a special needs trust (SNT) has all of the duties of any trustee, plus specific added responsibilities due to the special needs of the beneficiary. All trustees are responsible for:

• Appropriate investment of trust property
• Bookkeeping and accounting of trust activities
• Communication with trust beneficiaries
• Tax reporting for the trust
• Appropriate distribution of trust property to the beneficiary or beneficiaries, taking into account both current and future needs.

On top of these responsibilities, the trustee of an SNT must also:

• Inquire into the needs and welfare of the trust beneficiary
• Make certain that the beneficiary maintains her eligibility for public benefits programs
• Report to the agency or agencies administering such programs, and
• Work with the family members, teachers, social workers or others providing support for the trust beneficiary.

Due to these demands, many families find that a professional trustee is better prepared to act as trustee or as co-trustee with a family member. Professional trustees — such as banks, trust companies, and some attorneys — are equipped to handle details like establishing accounts for the management of trust assets, handling trust recordkeeping, hiring and overseeing the activities of any service providers (such as tax reporting), making distribution decisions and investing trust assets.

With regard to taxes, the trustee is responsible for notifying the IRS that the SNT has been signed and requesting an employee identification number (EIN) that will be used on tax returns. The trustee also must prepare and file annual federal and state fiduciary income tax returns, reporting any income the trust earns, whether in the form of interest, dividends or capital gains. Since tax rules vary by state and type of SNT, it is critical for the trustee to know when potential tax reductions may warrant making distributions to or for the beneficiary.

The trustee also has sole responsibility for distribution decisions. To avoid compromising public benefits eligibility, distributions generally should be made directly to providers of goods or services, rather than to the beneficiary. When the beneficiary receives an amount above the allowable monthly limit, it is considered unearned income and SSI benefits are reduced on a dollar-for-dollar basis. Similarly, distributions made for items covered by SSI (i.e., food and shelter) are considered “in-kind” income and reduce monthly SSI benefits. The trustee must fully understand and follow SSI’s distribution guidelines, which vary by state. He or she also must adhere to any distribution guidelines the Grantor outlined in the trust.

One of the most significant abilities of a trustee is often the necessity of saying “no” to a request for trust funds. While trusts may look like they hold a lot of money, often when distributed over the lifetime of the beneficiary it’s not as much as is needed. Even with as much as $1 million invested, it may well be necessary to scrimp and to use the trust funds quite sparingly. It can often be easier for an independent, professional trustee to say “no” than for a family member to do so.

Finally, the trustee has fiduciary responsibility for the management of trust assets, even if he or she chooses to hire professional investment managers to make day-to-day investment decisions. While the appropriate investment strategy depends, in part, on the beneficiary’s age and needs and the amount of assets that can be invested, the trustee generally must comply with the “Prudent Investor Act,” which requires that investment decisions be made responsibly and impartially. When the trust outlines specific investment guidelines, however, those take precedence over Prudent Investor Rules.

Selecting a trustee of a special needs trust is a challenging yet pivotal decision. Please let us help guide you in that process. Contact me at kurt@zimmermanlaw.com or 954-202-7440.

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One of the most important decisions parents must make when preparing their estate plan is the choice of a guardian for their child should they be the ones to die first. The choice of guardian can be especially difficult for the parents of a child or children with special needs. Unfortunately, many people don’t put nearly enough thought into their selection, choosing a close relative or friend regardless of that person’s background in dealing with children with special needs. Academy of Special Needs Planners co-founder Diedre Wachbrit Braverman has prepared a checklist of important questions any parent should ask when choosing a guardian for their child. It is a great starting point for parents preparing their estate plan and can help focus the search for the ideal guardian.

• Does the prospective guardian have the necessary maturity, experience, temperament, patience, and stamina to undertake the responsibilities as guardian of the particular child or children?
• Does the individual selected have a genuine interest in the minor’s welfare, either through family relationship or personal friendship, and have the confidence of the minor and parent?
• Does the prospective guardian have some understanding of the emotional needs of children or the willingness and ability to obtain skilled guidance on this subject?
• Is the prospective guardian a person of integrity and stability?
• Is the individual physically able to undertake the care of an additional child or children, and have the time necessary to devote to this task?
• Are the prospective guardian’s personal situation, religion, age, marital status, other children, personality traits, and similar factors acceptable to the parent?
• Will sufficient funds be available to cover the costs of caring for the child throughout the period of guardianship and, if the child is to live with the guardian, to enable the guardian and family to meet the increased strain on their resources?
• Does the prospective guardian have any conflicts of interest with the minor?
• Is the prospective guardian willing to serve?
• Is the prospective guardian willing and able to give the children an upbringing similar to that which the parent would have provided financially, socially, morally, and in other ways important to the parent?
• Does the parent want the guardian to adopt the children and, if so, is the nominee willing to do so?
• Does age of the prospective guardian pose any problems?

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On December 17, 2010 President Obama signed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “Act”). The Act significantly changes federal estate and gift tax laws — both of which impact estate planning for many of our clients — and, in the process, presents significant planning opportunities. This memorandum summarizes the Act’s key changes and provides you with our observations about the Act’s impact from an estate planning perspective. Please note that there are several important changes made by the Act that this memorandum does not summarize.

SUMMARY OF KEY ESTATE AND GIFT TAX PROVISIONS OF THE ACT

Estate Tax

Before the Act, the federal estate tax was gradually reduced over several years and then eliminated for decedents dying in 2010. Prior law provided that the estate tax, with a maximum tax rate of 55 percent and a $1 million applicable exclusion amount, would be reinstated after 2010. Additional changes scheduled for years after 2010 affected the gift and generation- skipping transfer (“GST”) taxes.

The Act reinstates the estate tax for decedents dying during 2010, but at a significantly higher applicable exclusion amount of $5 million, and a lower maximum tax rate of 35 percent, than under prior law. This estate tax regime continues for decedents dying in 2011 and 2012. Unfortunately, this new regime is itself temporary and will sunset on December 31, 2012 and the prior estate tax regime, with a 55 percent maximum estate tax rate and a $1 million applicable exclusion amount, is reinstated at that time.

The Act also eliminates the modified carryover basis rules for 2010 and replaces them with the stepped-up basis rules that had applied before 2010. Property with a stepped-up basis generally receives a basis equal to the property’s fair market value on the date of the decedent’s death. Under the modified carryover basis rules that applied during 2010 before the Act, executors could increase the basis of estate property only by a total of $1.3 million (plus an additional $3 million for assets passing to a surviving spouse, for a total increase of $4.3 million), with other estate property taking a carryover basis equal to the lesser of the decedent’s basis or the property’s fair market value on the decedent’s death.

The Act gives estates of decedents dying during 2010 the option to apply (1) the estate tax based on the new 35 percent top rate and $5 million applicable exclusion amount, with stepped-up basis, or (2) no estate tax and modified carryover basis rules under prior law.

The Act also provides for “portability” between spouses of the estate tax applicable exclusion amount for estates of decedents dying in 2011 and 2012 if both spouses die before 2013. Generally, portability allows surviving spouses to elect to take advantage of the unused portion of the estate tax applicable exclusion amount (but not any unused GST tax exemption) of their predeceased spouses, thereby providing surviving spouses with a larger exclusion amount.  Special limits apply to decedents with multiple predeceased spouses.

To preserve the first deceased spouse’s unused applicable exclusion amount, the executor for such spouse must file an estate tax return and make an election on such return, even if such an estate tax return would otherwise not be required.

Gift Taxes

For gifts made in 2010, the maximum gift tax rate is 35 percent and the applicable exclusion amount is $1 million. For gifts made in 2011 and 2012, the Act limits the maximum gift tax rate to 35 percent and increases the applicable exclusion amount to $5 million.   As discussed below, this change provides an opportunity to move significant amounts of wealth free of estate and gift taxes.

Donors continue to be able to use the annual gift tax exclusion before having to use any part of their applicable exclusion amount. For 2010 and 2011, the annual exclusion amount is $13,000 per donee (married couples may continue to “split” their gift and may make combined gifts of $26,000 to each donee).

Generation Skipping Transfer (“GST”) Tax

The Act provides a $5 million GST exemption amount for 2010 (equal to the applicable exclusion amount for estate tax purposes) with a GST tax rate of zero percent for 2010. For transfers made after 2010, the GST tax rate would be equal to the highest estate and gift tax rate in effect for the year (35 percent for 2011 and 2012). The Act also extends certain technical provisions under prior law affecting the GST tax.

OBSERVATIONS REGARDING THE ACT

Generally

Generally, the estate and gift tax provisions of the Act are very favorable to taxpayers because of the substantial increase in the applicable exclusion amount, to $5 million, and the lower maximum estate and gift tax rate of 35 percent. The Act also addresses several technical estate, gift and GST tax issues in a manner that is favorable to taxpayers (e.g., the impact of the lapse of the estate tax, including the application of basis rules, on decedents passing away during 2010).

Temporary Fix

The Act is a temporary fix, which sunsets on December 31, 2012, immediately after the next election cycle.  It is impossible to predict whether it will be extended in either its current or some modified form, especially given the fact that it is a hot button issue with both major political parties.  If Congress fails to act, the Act will lapse and the estate tax will revert to what it would have been under prior law (i.e., $1 million applicable exclusion amount and 55 percent maximum estate and gift tax rate).

Increased Gift Tax Applicable Exclusion Amount

From 2001-2010, the applicable exclusion amount for gift tax purposes has been $1 million.  The Act increases this to $5 million, or $10 million per married couple.  This change provides an unprecedented opportunity to move substantial amounts of wealth out of individuals’ estates.  There are several techniques that individuals can use to leverage this $5 million applicable exclusion amount, to move substantially more wealth out of their estates.

To illustrate, individuals can now make gifts of $5 million to trusts governed by the laws of certain states, such Delaware and Alaska, move all growth in such wealth out of their estates, provide a significant amount of asset protection for such assets, and the transferor may continue to be a discretionary beneficiary of such trusts, without any gift tax cost.

In addition, the increased gift tax applicable exclusion amount increases the amount of assets that individuals can transfer via an installment sale to a dynasty/grantor trust.  Under this estate planning technique, individuals can now make an initial gift of as much as $5 million ($10 million per married couple) to a dynasty trust, and then transfer as much as $45 million ($90 million for a married couple) to such dynasty trust in exchange for an installment note.  This technique works especially well for family businesses that are expected to grow significantly in value over time.

Given the fact that the Act will sunset without further Congressional action in 2012, we are advising clients that it would be prudent to implement estate planning techniques utilizing lifetime gifts before the December 31, 2012 sunset date.

State Estate Taxes

Many states have separate estate tax regimes with lower applicable exclusion amounts than the federal applicable exclusion amount. These include the District of Columbia, Maryland, New Jersey, and New York, among others.  It is critical that the estate plans of individuals living in or owning property located in such states address such estate tax exposure.

Portability

One of the more notable provisions contained within the Act is the “portability” provision, which provides in general terms that if one spouse does not fully utilize his/her entire $5 million applicable exclusion amount, the unused portion can be used by the surviving spouse’s estate.  This provision is intended to avoid the need for credit shelter trusts in estate planning documents. Unfortunately, both spouses must die before 2013 in order to benefit from the portability provision.

In addition, credit shelter trusts continue to provide significant additional benefits beyond just the use of each spouse’s applicable exclusion amounts. These include the following:

• Ensuring that assets contained in the credit shelter trust pass to children of the couple and not to any new spouse of the surviving spouse.
• Ensuring that appreciation on the assets contained within the credit shelter trust, which may exceed the applicable exclusion amount at the surviving spouse’s death, are not subject to estate tax at that time.
• Protection of assets in the credit shelter trust from creditors of the surviving spouse, including any marital claims of future spouses.

Given the fact that the portability provision will sunset in 2012, as well as for the reasons stated above, we are advising clients to continue to use estate plans that incorporate credit shelter trusts.

Things Not In the Act

There are two key provisions that many commentators feared would be in the Act, but which were not included in it.  Specifically, there have been several proposals to place limits on Grantor Retained Annuity Trusts (“GRATs”), which allow individuals to transfer wealth out of their estates with as little as a zero estate or gift tax cost that would have made GRATs less valuable from an estate planning perspective.  There have also been several proposals to limit valuation discounts in connection with certain estate planning techniques such as family limited partnerships. There were no such provisions included in the Act.  Therefore, these techniques continue to be available to move wealth to lower generations.

Temporary Relief Does Not Extend to Non-US Citizens Who Are Not Resident for Estate Tax Purposes

The Act reinstates federal estate taxes on United States-situs property of non-US citizens who are not residents.  The increased applicable exclusion amount to $5 million per person does not apply to non-US citizens who are not residents. US situs property exceeding $60,000 in value is again currently subject to US estate taxes beginning at graduated marginal rates beginning at 18 percent.  Accordingly, particular vigilance needs to be exercised in structuring the acquisition of US assets such as real property, so as to avoid imposition of US estate taxes at pre-2010 levels.

SUMMARY

To summarize, the Act makes significant estate and gift tax changes.  The key points discussed above include the following:

• The estate tax exclusion amount increases to $5 million per person for 2010 through 2012.
• The maximum estate and gift tax rate is reduced from the 55 percent maximum rate under prior law to a maximum estate and gift tax rate of 35 percent for 2011 and 2012.
• A “portability” provision is included, which allows surviving spouses to use any applicable exclusion amount that is not used by the first spouse to pass away.
• The GST exemption amount is increased to $5 million for 2010 through 2012.
• The Act sunsets at the end of 2012, thus making the foregoing changes temporary in nature.

As always, we recommend that clients review their estate plans periodically and/or whenever a significant life event occurs (e.g., birth of a child, death of a spouse, purchase of new home, etc.).

For clients with substantial amounts of wealth and with closely held businesses, we highly recommend that such clients consider using lifetime gifts to take advantage of the current $5 million lifetime gift tax applicable exclusion amount, which will expire absent further Congressional action at the end of 2012.

Please do not hesitate to contact us with any questions that you might have or if you would like to discuss your estate plan in light of the Act.

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Private retirement savings plans, like IRAs and 401(k)s, have become the main way for American families to save for retirement. But parents of children with special needs need to be vigilant when signing up for a retirement plan or company life insurance program.

Most retirement accounts allow the owner to choose a designated beneficiary to receive the funds in the account if the owner dies. This beneficiary designation is especially useful because it allows the funds in the retirement account to pass to the owner’s heirs without the cost and hassle of probate. In general, an owner names a so-called “primary” beneficiary who is first in line to receive the benefits, as well as a “secondary” or “contingent” beneficiary who would get the funds if the primary beneficiary has died or refused to accept the account. Account owners can usually name multiple people as beneficiaries, and they can often name a class of people, like “my surviving children” or “my nieces and nephews,” instead of designating people by name.

This ability to name a class of beneficiaries often leads to trouble when a member of the particular class has special needs. Problems also arise when parents name account beneficiaries when they first join a company, often before having a child with special needs. The retirement account grows over time, but the owner never revisits the beneficiary designation she created when she was just starting out. Many years later, when the account owner dies, the old beneficiary designation springs up and creates havoc for the child with special needs. For instance, if an employee fills out her IRA beneficiary designation form to give her $200,000 IRA to “her children” on her death, and she dies with four surviving children, each child will receive a $50,000 retirement account. If one of these children has special needs and is receiving needs-based government benefits, like Supplemental Security Income, Medicaid or Affordable Housing, her receipt of her share of her mother’s IRA could compromise her access to benefits. This is not just a problem for large retirement accounts; given the strict income and asset limits for many government programs, even an inheritance of a few thousand dollars can lead to the loss of health insurance worth a great deal more.

There are several ways to deal with this problem. The easiest way is to avoid class designations by specifically naming the beneficiaries of the retirement account and not including a relative with special needs as a beneficiary. The obvious drawback of this strategy, especially when the retirement account makes up the majority of a family’s net worth, is that the child with special needs loses his inheritance. A better option for families who want to leave a share of a retirement account to a person with special needs is to create a special needs trust and name it as a designated beneficiary. If properly drafted, the special needs trust can receive the retirement funds without negative income tax implications, and the funds will assist the person with special needs without compromising his benefits. If the family has other assets outside of the retirement plan, it may make sense to fund the special needs trust with those assets while leaving the retirement plan to other beneficiaries.

Employer-sponsored life insurance can be essential, especially for younger families. In many cases, companies will provide small policies that pay a death benefit equal to a year or two of salary. Employees usually have the option to purchase additional insurance, often at a discount, through their employer’s benefit program. The same concerns regarding retirement account beneficiaries apply when naming beneficiaries of life insurance policies. However, life insurance can often be a great option for funding a special needs trust, because it provides a relatively low-cost way to provide a much larger benefit to the person with special needs. In some cases, employees who have children with special needs may consider naming a special needs trust as the primary beneficiary of their company life insurance policy, and they will often purchase additional insurance to guarantee that funds will be available for their child with special needs if they were to pass away.

If you’re saving for retirement or if you have life insurance, come see us to make sure you’re maximizing the value of these assets for your family and not inadvertently interfering with public benefits for your child with special needs.

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