Tag Archives: Type of Trusts

SPATs: A Flexible Asset Protection Alternative to DAPTs

by Abigail E. O’Connor, JD, Mitchell M. Gans, JD, and Jonathan G. Blattmachr, JD, LLM

Originally published in Estate Planning magazine, February 2019

Many estate planning attorneys and their clients currently are wrestling with ways to best use the temporary increase in the federal applicable estate tax exclusion. For super high net-worth clients, a gift of $5.5 million (or $11 million for a married couple) may be nothing more than a blip off of the portfolio, and the move takes very little thought. For clients in the high net worth range ($5 million to $20 million), but not super high net worth (over $20 million), the decision typically is more difficult. Estate tax savings has to be weighed against the potential need for the assets later during lifetime. What are the options for these clients?

A similar question arises in the context of asset-protection planning: how to achieve creditor protection without fully relinquishing access to the assets. In both contexts – asset-protection and estate tax planning – self-settled trusts often are used. A self-settled trust, also called a “domestic asset protection trust” (DAPT) when created in America, is an irrevocable trust created by an individual in which that individual is designated as a beneficiary. Given the possibility that the creditor protection aspects of DAPTs may be disregarded under the laws of many states,¹ however, the question becomes whether there is another option.

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“While self-settled trusts may be excellent options for estate planning and creditor protection, the number of jurisdictions in which they can be used are limited.”

This article proposes the use of an irrevocable trust created for beneficiaries other than the grantor, in which one or more individuals (who are not the grantor and are not necessarily a beneficiary) have a lifetime special power of appointment, held in a nonfiduciary capacity, that may be used to direct assets back to or for the benefit of the grantor. The grantor would have no entitlement to benefits or even eligibility to receive benefits in the discretion of the trustee or another fiduciary; but only by the exercise of a special power of appointment held by someone in a nonfiduciary capacity-essentially a non-self-settled trust from which the grantor may benefit. In other words, the grantor would have no more right to benefit from the assets than if they were owned by someone else individually. To be sure, the concept of allowing the grantor to benefit from the trust assets through the exercise of a special power of appointment is not new. But questions about the structure of such an arrangement and its effectiveness need to be considered.

The discussion that follows begins with a brief explanation of how assets in a trust created by one person for the benefit of a beneficiary (other than the grantor) can be protected from creditors of the beneficiary. It also considers the creditor-protection issue in the context of a self-settled trust. Next it explores the use of the special power of appointment trust (SPAT). Following that, conclusions are set forth.

Spendthrift Trusts
One of the primary purposes of creating trusts is to protect property held for the beneficiaries – often spouses or descendants – from their potential creditors. This protection both assures financial stability for the beneficiaries and preserves assets that may be the legacy of a family, such as family business. Spendthrift trusts can be created for finite periods, or in some states, can continue indefinitely, or at least until the assets are depleted.

An irrevocable trust is called a “spendthrift trust” if it contains a provision (or state law essentially provides one) that says the interest of a beneficiary cannot be alienated or involuntarily transferred. In such a case, the creditor of the beneficiary typically cannot reach the assets except to the extent the assets are distributed to and are in the hands of the beneficiary. There are some exceptions to spendthrift protection in some states, such as where a beneficiary cannot or refuses to pay court-ordered child support.² But if the beneficiary finds himself or herself in some type of financial trouble, such as a loss of employment or business failure, the assets in trust are safe from that beneficiary’s creditors.³ Generally, these spendthrift trusts work well and are respected by the courts, again with few, if any, exceptions.⁴

One important qualification is that spendthrift protection is generally available only in the case of a third-party trust. A grandparent creates a trust for children and grandchildren. A husband creates a trust for a wife. A child creates a trust for a parent. All of these are universally acceptable as providing protection of the trust assets against claims against the trust beneficiaries. When a person creates an irrevocable trust and names himself or herself as a beneficiary, however, even if there are other beneficiaries, the trust becomes a self-settled trust.

Background on Sell-Settled Trusts
As mentioned above, a self-settled trust is one created for the benefit of the grantor. In some cases, it will be an irrevocable trust created by a person (the grantor), for that same person (as at least one beneficiary), with the hope and, perhaps, expectation that the assets of which generally will be protected from the grantor’s creditors. A person-the grantor-creates the trust with another individual or corporation as the trustee. The grantor also is a beneficiary, generally with other family members. For example, a parent creates an irrevocable trust in which the parent, his or her spouse, and his or her children all are beneficiaries.

Under the common law, spendthrift protection was not available with respect to the creditors of the grantor-beneficiary in the case of a self-settled trust. In 1997, Alaska enacted ground-breaking legislation that extended spendthrift protection to self-settled trusts.⁵ Today, approximately 18 states have enacted similar legislation. These states often are referred to as “DAPT states” or “DAPT jurisdictions.”

Although the requirements in each of the DAPT states differ slightly, there are some general rules of thumb:

• The grantor’s interest must be discretionary, meaning that he or she can have no right to income or principal.

• The trustee decides whether and, if so, when to distribute income and principal back to the grantor.

• The trust instrument should have the same spendthrift language discussed above.

• Almost universally, in order to be effective, the transfer to the trust cannot be a fraudulent conveyance, and the grantor cannot be insolvent when creating the trust; in addition, the transfer cannot render the grantor insolvent.⁶

• The grantor must not have a prearranged agreement with the trustee that he or she will receive distributions (no “wink-and-nod” agreement).⁷

The most obvious benefit of a self-settled trust is that the trust assets may be protected from the grantor’s creditors in the event the grantor runs into creditor issues. When structured properly, they work quite well.⁸

There are, however, some qualifications. As noted above, Bankruptcy Code section 548(e) imposes a ten-year lookback period if the trust was created to hinder, delay, or defraud a creditor. This makes it necessary to create the trust well in advance of any financial distress. In addition, as a matter of state law and bankruptcy law, fraudulent transfers to self-settled trusts generally will not be protected.⁹ Further, states cannot assert exclusive jurisdiction over fraudulent transfer actions,¹⁰ so creating a trust in one jurisdiction and funding it from assets located in another jurisdiction may expose the grantor to actions in the latter jurisdiction. Self-settled trusts can be “sticky” areas in divorce, as often both the grantor and the grantor’s spouse are beneficiaries.¹¹

Where a self-settled trust is entitled to spendthrift protection, it offers estate-planning advantages: The trust’s assets can possibly be excluded from the grantor’s gross estate even though the grantor has retained some access to the trust’s assets. This makes a self-settled trust an attractive estate planning tool. Where, however, distributions to the grantor or other factors suggest that there was an implied understanding at the outset that the grantor would enjoy access to the trust’s assets, the trust will not achieve its estate planning objective. In the case of such an understanding, the trust assets are included in the grantor’s gross estate at the value on date of death.¹²

A gift to a self-settled trust effectively is an irrevocable gift with a built-in escape hatch. Although the grantor should not receive assets from the trust on a regular basis, the possibility of a future distribution eases the concern of “I don’t want to give it away because I may need it.” In essence, the property owner may give away the assets and thereby fix their value for estate tax purposes, but may later obtain access to them (of course, trustee discretion permitting).

While self-settled trusts may be excellent options for estate planning and creditor protection, the number of jurisdictions inwhich they can be used are limited. A person who wants to avail himself or herself of the benefits of a self-settled trust needs to create the trust in a DAPT state. Otherwise, in non-DAPT states where the common law prevails, spendthrift protection cannot be applied to a grantor’s interest in his or her own irrevocable trust; the grantor’s creditors can reach the maximum amount that can be distributed by the trustee to or for the grantor’s benefit.¹³ Some non-DAPT states simply rely on the common law; other non-DAPT states, such as New York, go further and have language expressly supporting the common law.¹⁴

Some clients have reservations about using self-settled trusts. Geography is one factor. Because most states are non-DAPT states and do not support the notion of self-settled trusts, creating one usually means that the grantor has to locate the trust in another state – a DAPT state. Each state has its own rules for determining what is a sufficient nexus to have a trust in that jurisdiction, such as designating a trustee with a place of business or residence in that state. Another factor is that some clients are concerned that, despite the existence of the self-settled trust in the DAPT state, their home states still may find a way to reach the assets.¹⁵ Lastly, these trusts may seem to some just a little too “edgy.” Although these trusts have been used as effective estate planning tools for years, they still are beyond the comfort zone for some. For all of these clients, there may be an alternative, which is the primary subject of this article.

What is a SPAT?

A SPAT is an alternative approach for clients who have reservations about using DAPTs. Under a SPAT, the grantor creates an irrevocable spendthrift trust for others and does not designate himself or herself as a beneficiary. The grantor gives one or more individuals who are not necessarily a beneficiary of the trust a special lifetime power of appointment. The power is held in a nonfiduciary capacity, and it permits the holder of the power to appoint trust assets to a class of individuals that includes the grantor (such as the descendants of grantor’s mother). This special power provides an escape hatch: The powerholder can appoint the assets back to or for the benefit of the grantor.

The SPAT is not a self-settled trust. Because the grantor is not a beneficiary, the self-settled trust rule in common law jurisdictions under which the grantor’s creditors can reach the trust’s assets-is not applicable. Accordingly, there should be no need to use a DAPT state. Nonetheless, to the extent that there is concern that creditors could argue that a SPAT should be treated as if it were a self-settled trust (see below for discussion of this point), it would make sense to locate the trust in a DAPT state.

Where a grantor resides in a common law state and creates a trust in a DAPT state, there is a risk that courts in the grantor’s home state might conclude that spendthrift protection in the case of a self-settled trust offends its strong public policy, and as a result, refuse to respect the DAPT state’s legislation.¹⁶ The likelihood that a court in a common law state would find the DAPT legislation in violation of its strong public policy could well be diminished if the grantor uses a SPAT instead of a DAPT.

Options for Structuring the Trust
The trust should be irrevocable and designed for the grantor’s tax and nontax goals, as with any trust. The usual considerations regarding selecting beneficiaries, trustees, and dispositive provisions play pretty much the same as for any irrevocable trust. With that said, there are some specific provisions to include or exclude depending on several attributes of the trust.

Should the trust be a grantor trust or a non-grantor trust? If the primary goal is estate tax minimization, then creating a grantor trust provides the opportunity for additional tax-free gifting. If grantor trust status is not optimal, such as if the grantor’s cash flow would make the payment of tax burdensome, or if the grantor lives in a high-tax state and plans to settle the trust in a jurisdiction with no or a low state income tax, then grantor trust status should be avoided.

“ If the primary goal is estate tax minimization, then creating a grantor trust provides the opportunity for additional tax-free gifting.”

If grantor trust status is not desired, then special care in the drafting is necessary to avoid inadvertently triggering the grantor trust rules.¹⁷ A power of appointment that can revest trust assets in the grantor that is exercisable by a non-adverse party, without the approval or consent of an adverse party, results in the grantor being treated as the owner of those trust assets for income tax purposes.¹⁸ In addition, the grantor is treated as the owner (for income tax purposes) of any part of the income of the trust that can be distributed back to the grantor without the approval or consent of an adverse party or accumulated for future distribution to the grantor.¹⁹ Consequently, if grantor trust status is not desired, the powerholder needs to be an adverse party, or the consent of an adverse party needs to be necessary before distributions are made to or for the grantor.²⁰

Alternatively, if there are multiple powerholders, then at least one of them, whose consent is required to exercise the power, must be an adverse party. If the grantor retained a reversionary interest in the trust, then the trust would be a grantor trust;²¹ however, a special powerholder’s ability to appoint assets to the transferor, with the consent of an adverse party, does not appear to be a reversionary interest.²²

If grantor trust status is desired, then the grantor has numerous options. He or she can appoint a non-adverse party as the special powerholder, as discussed above, who can exercise the power without the consent of an adverse party. The grantor also can retain the ability to substitute assets of equivalent value property,²³ or include a variety of provisions that are addressed in the grantor trust rules.²⁴ Creating grantor trust status is easy. Avoiding it takes much more thought, as explained above.

Should the gift to the trust be complete or incomplete? For the grantor who wants to fix the value of their assets for transfer tax purposes, that grantor will need to make sure that the assets conveyed to the trust will not be included in his or her gross estate-which requires a completed gift. If the purpose of the trust, on the other hand, is solely to achieve creditor protection, then the grantor may not want to complete the gift. A gift is complete when the grantor has parted with dominion and control and, therefore, has no ability to change its disposition.²⁵

Traditional irrevocable trusts created for a grantor’s descendants or spouse, with no ability to receive the assets back, either via a trustee’s discretionary distribution (such as for a DAPT) or through the exercise of a special power of appointment (such as for a SPAT), generally are completed gifts.

If the grantor wishes the transfer to be an incomplete gift, then he or she should retain a special lifetime power of appointment and/or a power to veto distributions proposed by the trustee and a testamentary power of appointment. The gift is incomplete, because the grantor retains the power to change the ultimate disposition of the assets.²⁶ If the grantor changes his or her mind after the trust is created, he or she can relinquish the power and complete the gift.²⁷

Structuring the Power of Appointment – By Whom and To Whom?
There are various ways to structure the power of appointment. The two most significant aspects of the power are the identity of the powerholder and the class of permissible appointees. Each aspect is discussed in turn.

There are two choices for the identity of the powerholder: a beneficiary or a nonbeneficiary. As explained above, if the grantor wants to avoid grantor trust status, at least one powerholder needs to be an adverse party (or must be able to exercise the power only with the consent of one), which means someone with a “significant beneficial interest” whose interest would be adversely affected by the exercise of the power. If the grantor does not care about triggering grantor trust status, or intentionally desires grantor trust status, then the powerholder need not be adverse and need not require the consent of an adverse party to exercise the power. There are some concerns about appointing a beneficiary as a powerholder (other than the grantor trust issue). An exercise of the power by the beneficiary-powerholder could be treated as a taxable gift by the powerholder, which may be viewed as an adverse consequence. In Estate of Regester,²⁸ the U.S. Tax Court held that a beneficiary with a mandatory income interest and discretionary principal interest in a trust, who also had a special lifetime power of appointment, made a gift of her income interest when she exercised her power in favor of a trust for her grandchildren. The court focused on the powerholder’s mandatory income interest, not her discretionary interest in the principal. One interpretation is that the powerholder makes a gift only if the powerholder has a mandatory right to the income or principal of the trust; a more conservative interpretation is that there definitely is a gift with a mandatory interest, but a gift still may be the result even with a discretionary interest.

“It may be wise to provide that the powerholder needs the consent of some nonadverse party such as a partner in the law firm that has represented the grantor.”

The class of permissible appointees must consist of individuals or entities in addition to the grantor. There would be nothing to stop the powerholder from exercising the power to direct the assets away from the grantor. On the other hand, the powerholder could be given the power only to appoint the property to or for the grantor, although this might be used as evidence that there was an understanding with the grantor and powerholder that the latter had agreed to benefit the former.

The appointment of multiple powerholders may solve the concerns raised above. If grantor trust status is not desired, then one should be an adverse party (a beneficiary with a “substantial beneficial interest”), and any exercise should be made either unanimously or by majority but with the adverse party’s consent. If grantor trust is desired, then the powerholders do not have to be adverse parties (as noted above, there are other ways to make a trust a grantor trust). Having the power exercised by one or more persons who are not beneficiaries, however, without the need for the beneficiary’s agreement, means that the power can be exercised without triggering a gift by the beneficiary. The “team” approach also gives the grantor a little more comfort that one rogue powerholder could not exercise the power in a manner that harms the grantor.

The class of permissible appointees can be defined in various ways. The ability to appoint to “any person or entity” generally would include the grantor. To narrow the choices and at least assure that assets remain in the family, the class can consist of the descendants of the grantor’s parents or grandparents. If, in reality, the grantor is the only descendant, then the power might be viewed more as a distribution provision than a power. There likely are numerous more ways to create the class, but the drafter must be careful to include the grantor and probably others. As the power is a special power, the drafter also must be sure to exclude the powerholder, his or her creditors or estate, and creditors of his or her estate, from the list of permissible appointees, as being able to distribute to any of those means the powerholder will have a general power of appointment for estate and gift tax and, perhaps, state creditor rights purposes.²⁹

Advantages of a SPAT
The trust, as drafted, is not a self-settled trust. The grantor is not a beneficiary, only one of, perhaps, numerous potential appointees under a power of appointment held in a nonfiduciary capacity. A beneficiary is a person for whose benefit property is held in trust.³⁰ To be a beneficiary, the grantor must manifest an intention to give the person a beneficial interest; merely benefiting incidentally from the performance of the trust does not render a person a beneficiary.³¹ The trust, therefore, is afforded the same treatment as any ordinary irrevocable trust, of which the grantor is not a beneficiary.

The trust provides asset protection both for the grantor and the beneficiaries. As long as the trust contains the spendthrift language, then the beneficiaries’ creditors cannot reach the assets as long as they remain in the trust. Neither can the grantor’s creditors reach the assets. The trust retains all of the protections of any ordinary spendthrift trust.

The transaction can be structured as a completed gift, so the grantor uses his or her applicable lifetime exclusion, or to the extent already used, pays gift tax on the value of the assets transferred. Again, from this standpoint, the trust and the transfer to the trust is no different than any other ordinary irrevocable trust. The assets should be excluded from the grantor’s gross estate at death, as the grantor presumably will have retained no rights or powers under Section 2036 or 2038.³² Of course, if the special power is exercised to distribute the assets outright to the grantor, then the assets will be included in his or her gross
estate for federal estate tax purposes.

The trust can be structured as a grantor trust or nongrantor trust. If structured as a grantor trust, and the grantor wishes to turn off grantor trust status, then he or she can relinquish whatever powers render it a grantor trust. These options give the grantor significant flexibility.

One careful consideration is ensuring there always will be someone who holds the special power that can be exercised in the grantor’s favor. Default powerholders might include siblings or cousins, for example, but allow the trustee to strip the power from any person who succeeds to the power. Also, it may be wise to provide that the powerholder needs the consent of some nonadverse party such as a partner in the law firm that has represented the grantor.

Potential Disadvantages of a SPAT Arrangement
The IRS could argue that there was an implied or express understanding at the time of the trust creation that the powerholder would exercise the power in favor of the grantor. This, of course, would have the negative consequence of triggering Section 2036, and therefore thwart any estate tax planning objective.³³

The grantor’s creditors might argue that the SPAT should be treated as if it were a self-settled trust. The grantor’s defense would be that there is a significant distinction between the two: Whereas the trustee in the case of a DAPT is under a fiduciary duty, the powerholder in the case of a SPAT is not. For example, in Iannotti v. Commissioner of New York State Dept. of Health,³⁴ a trust protector had the power to amend the trust and thereby make the grantor a beneficiary. Based on this power, the court ruled that the grantor’s creditors could reach the trust’s assets. Note, however, that the trust protector was subject to a fiduciary duty.

If the special powerholder does indeed appoint the assets back to the grantor, and the transfer was a completed gift, then the grantor’s exclusion would have been wasted and the assets would be back in his or her estate. In addition, if asset protection was the goal, then that purpose will have been thwarted because the assets would then be available to the grantor’s creditors. It may be anticipated that the escape hatch would be used only if the grantor actually needed the assets that is, he or she would spend the money; alternatively, someone to whom the assets are distributed would acquire assets for the use of the grantor. The SPAT trust should really be viewed as a means of last resort for the grantor as is a DAPT. If the special powerholder appoints the assets to a trust for the grantor, instead of outright, then the resulting trust might be considered a self-settled trust, which is what the grantor presumably wanted to avoid in the first place. As a matter of common law, the special powerholder is not treated as owning the trust property and is not treated as the transferor but merely as the agent of the original transferor (i.e., the grantor of the original trust).³⁵ The law seems uncertain on whether the trust created by the exercise for the benefit of the grantor of the power over the trust which the grantor created is treated as self-settled for creditor purposes.

The special powerholder needs to beware of triggering the Delaware Tax Trap. If the holder exercises the power to create another power that may postpone vesting or suspend absolute ownership for a period not ascertainable without reference to the date that the trust was created, then the assets will be subject to estate tax in the powerholder’s estate or cause the powerholder to be deemed to have made a gift.³⁶ The trust can avoid this result by limiting the exercise so that any creation of another power cannot trigger the Trap. Then again, some practitioners intentionally trigger the Trap to use the otherwise unused gift or estate exemption of the powerholder or to obtain a change in tax basis under Section 1014, in which case the trust should not include such limiting language, but the powerholder needs to be aware of the issue.³⁷

Lastly, there always is a chance that the special powerholder could exercise the power in favor of someone else in a manner not really intended by the grantor. For example, if the power permits the appointment of any descendants of the grantor’s grandparents, the powerholder may exercise the power in favor of the grantor’s sibling or cousin, much to the grantor’s dismay, although the power could be made exercisable only with the consent of a third party, such as the grantor’s legal counsel, as mentioned above.

An Analogy to ING Trusts
For years, practitioners have assisted clients in the creation of incomplete nongrantor trusts, created in asset jurisdictions such as Alaska, Delaware, and Nevada.³⁸ The purpose of these “ING” trusts generally is to attempt to avoid state income tax on assets held in trust, which otherwise would be taxed to the grantor who lives in a locale with state income tax. There are several analogies that exist between ING trusts and SPATs.

One of the key ingredients to ING trusts is the existence of a “distribution committee,” or “power of appointment committee,” which is a group consisting of at least two individuals other than the grantor to whom the committee may direct the trustee to make distributions. In these trusts, the trustee has no discretion to distribute income or principal during the grantor’s lifetime. Instead, distributions by the trustee are made only at the unanimous direction of the distribution committee or with the grantor and one other member of the distribution committee. The distribution committee can direct distributions to its own members. The members of the distribution committee act in a nonfiduciary capacity.

Although there is no “special power” or language that the distribution committee cannot appoint to themselves, the predominant theory is that the members of the distribution committee do not possess a general power of appointment, and that the decision to direct the trustee to make distributions was not a gift for federal gift tax purposes by any of them. If a person has a power of appointment that is exercisable only in conjunction with the creator of the power, then that power is not a general power of appointment.³⁹ Because there is no general power of appointment, there is no gift by a member of the distribution committee incurred by exercising the power of a committee member.

The role of the distribution committee in ING trusts is similar to the role of the special powerholder SPATs. The special powerholder holds the power in a nonfiduciary capacity. The difference is that the distribution committee members can cause distributions to themselves. In contrast, the SPAT powerholder cannot exercise the power in favor of himself or herself.

The ING trust generally is structured as an incomplete gift for federal gift tax purposes. There are two powers of an ING trust that, when combined, give comfort that the gift to the trust is incomplete:

1. The grantor retains a testamentary special power of appointment.
2. The lifetime distribution power that is held by the grantor together with a member of the distribution committee.⁴⁰

As discussed above, like an ING trust, the grantor of a SPAT can render the transfer to the trust an incomplete gift by retaining a special testamentary power of appointment. Unlike an ING, in which the grantor, by joining with a member of the distribution committee, can direct distributions, the grantor does not have any ability to affect the special power.

Each of the private letter rulings “approving” ING trusts involved trusts established in DAPT jurisdictions. The reason is that a trust is a grantor trust if the trust assets are subject to the claims of the grantor’s creditors. Although, as expressed earlier, a SPAT should not be subject to the claims of the grantor’s creditors as it is not a self-settled trust (as no trustee holds the discretionary to make distributions to or for the grantor), it makes sense to consider creating any SPAT in a DAPT jurisdiction.

Generation-Skipping Transfer Issues
Assuming the transfer to the SPAT is structured as a completed gift, generation-skipping transfer (GST) tax exemption probably should not be allocated to this type of trust. If the special power is exercised in favor of the grantor, then the GST exemption allocated to the trust is wasted.

“ Assuming the transfer to the SPAT is structured as a completed gift, generation skipping transfer (GST) tax exemption probably should not be allocated to this type of trust.”

Special care should be taken not to trigger the automatic GST allocation rules under Section 2632. If the trust would qualify as a GST trust under Section 2632(c)(3)(B), then the grantor needs to opt out of automatic allocation of the GST exemption on his or her federal gift tax return, as permitted under Section 2632(6)(3). Moreover, if the Delaware Tax Trap accidentally is triggered (despite the warning above), then the powerholder becomes the new transferor for GST purposes and the grantor’s GST exemption is wasted.⁴¹

Conclusion
The SPAT essentially is a more conservative version of a self-settled trust. As such, it offers much of the benefits of self-settled trusts. The SPAT is a potential solution for grantors who want to take advantage of the temporary increase in applicable exclusion, but do not have so much wealth that they are certain they will never need the assets again. The SPAT seems to create more asset protection for the grantor than a mere a self-settled trust.

Citations

1 Note, also, that, regardless of what state law is involved, under U.S. Bankruptcy Code section 548(e), assets transferred to a self-settled trust or similar device may be avoided in a bankruptcy proceeding if the transfer was made within ten years of the filing of the bankruptcy proceeding and made with an actual intent to hinder, delay, or defraud a creditor.
2 See discussion in Roman, “Protecting Your Clients’ Assets From Their Future Ex-Sons and Daughters-in-Law: The Impact of Evolving Laws on Alimony Awards,” 39 ACTEC J. 157 (Spring/Fall 2013).
3 The U.S. has made itself a “super” creditor in some respects. See the discussion under “Stronger Asset Protection for Trust Beneficiaries” contained in Blattmachr, Chapman, Gans, and Shaftel, “New Alaska Law Will Enhance Nationwide Estate Planning-Part 1,” 40 ETPL 3 (September 2013).
4 In New York, as a general rule, 90% of a distribution from a spendthrift trust is exempt from creditors. NY CPLR section 5205. Under an exception, creditors may be permitted greater access if it is shown that the distribution is not needed for the reasonable requirements of the beneficiary and his or her dependents. Id.
5 AS 34.40.110.
6 See Shaftel, ed., Eleventh Annual ACTEC Comparison of the Domestic Asset Protection Trust Statutes Updated Through August 2017.
7 See e.g., AS 34.40.110(i) (stating that “[a]n agreement or understanding, express or implied, between the settlor and the trustee that attempts to grant or permit the retention of greater rights or authority than is stated in the trust instrument is void”).
8 But see discussion in Blattmachr and Blattmachr, “Avoiding the Adverse Effects of Huber,” 152 Trusts & Estates 7 (July 2013).
9 See generally Shaftel, supra note 6.
10 See Toni 1 Trust v. Wacker, 413 P.3d 1199 (Alaska 2018)).
11 See, e.g., Riechers v. Riechers. 267 A.D.2d 445 (N.Y 2nd Dept. 1999).
12 See. e.g., Ltr. Rul. 200944002 (not precedent under Section 6110(k)); also see Paxton. 86 TC 785; also for a full discussion, see Portfolio 810-3rd: Asset Protection Planning, Detailed Analysis, BNA Tax Management Portfolios.
13 Restatement (Third) of Trusts § 60. Comment f; Restatement {Third} of Trusts § 58. Paragraph 2; UTC § 505(2).
14 New York EPTL 7-3.1(a) (“A disposition in trust for the use of the creator is void as against the existing or subsequent creditors of the creator.”).
15 Cf. In Re Huber, 201 B.R. 685 (Bkrptcy DC WA 2013)
16 See In Re Huber, supra note 15.
17 See Akers, Blattmachr, and Boyle, “Creating Intentional Grantor Trusts,” 44 Real Property, Trust and Estate Law J. 207 (Summer 2009).
18 Reg. 1.676(a)-1.
19 Sections 677(a)(1) and (2).
20 Section 672(a). Section 672 provides a definition of adverse party.
21 Section 673.
22 See Blattmachr and Lipkind, “Fundamentals of DING Type Trusts: No Gift Not a Grantor Trust,” 26 Probate Practice Reporter 1 (April 2014).
23 Section 675(4)(C).
24 Sections 671 through 679.
25 Reg. 25.2511-2(b); see also Zeydel, “When Is a Gift to a Trust Complete: Did CCA 201208026 Get it Right?,” 117 J. Tax’n 142 (September 2012).
26 Reg. 25.2511-2(b)
27 Reg. 25.2511-2(f).
28 83 TC 1 (1984).
29 See Sections 2041 and 2514; New York EPTL 10-7.2.
30 Restatement (Third) of Trusts § 3(4).
31 Restatement (Third) of Trusts§ 48. See, e.g., Fla. Statutes§ 736.0103(4) (“An interest as a permissible appointee of a power of appointment, held by a person in a capacity other than that of a trustee, is not a beneficial inter est.... “).
32 See Rev. Rul. 2004-64, 2004-2 CB 7.
33 See Ur. Rul. 9141027 (not precedent).
34 283 A.D.2d 645, 725 N.Y.S.2d 866 (2001).
35 See discussion in Self, 135 Ct. Cl. 371, 142 F. Supp. 929 (1956), also cited in Estate of Regester, 83 TC 1 (1984)
36 Sections 2041(a)(3) and 2514(d).
37 See discussion in Blattmachr and Rivlin, “Searching for Basis in Estate Planning: Less Tax for Heirs,” 41 ETPL 3 (August 2014).
38 See Blattmachr and Lipkind, supra note 22.
39 Section 2514(c)( 3)(A); also see Blattmachr and Lipkind, supra note 22.
40 Id. (citing Estate of Sanford, 308 U.S.39 (1939)).
41 See Portfolio 825-4th Powers of Appointment-Estate, Gift, and Income Tax Considerations, BNA Tax Management Portfolios.

Private Placement Life Insurance (PPLI) :
A Strategic Tool for Estate Planning & Advanced Tax Strategies

Introduction to Private Placement Life Insurance (PPLI)

By William D. Lipkind, Matthew D. Blattmachr, and Jonathan G. Blattmachr

An Overview of PPLI
Private Placement Life Insurance (PPLI) is an advanced financial product that merges the protective features of traditional life insurance with the flexibility of private investment accounts. It’s specifically designed to meet the complex needs of high-net-worth clients, offering significant tax advantages while facilitating sophisticated estate planning and wealth management strategies.

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Relevance to Estate Planning and Tax Advisors
For estate planning attorneys and financial advisors, PPLI represents a powerful tool in the arsenal of advanced tax planning. Its ability to offer tax-deferred growth and shield assets from estate taxes makes it a compelling option for clients seeking to preserve and grow their wealth across generations.

Key Tax Benefits of PPLI

Tax-Deferred Growth: A Core Advantage
At the heart of PPLI’s appeal is its capacity to allow investments within the policy to grow without incurring annual taxes. This tax-deferred growth is particularly advantageous for clients looking to optimize their wealth over the long term. Compared to traditional investment vehicles, the tax efficiency of PPLI can significantly enhance the net returns on investment, making it an essential consideration in advanced tax planning.

Tax-Free Access to Cash Values
PPLI policies provide the flexibility to access the accumulated cash value through loans or withdrawals, typically without triggering immediate tax liabilities. Under Sections 7702 and 7702A of the Internal Revenue Code, these transactions can remain tax-free, provided the policy adheres to IRS guidelines. This feature is especially valuable for clients needing liquidity while minimizing taxable events, a common scenario in sophisticated estate planning.

Legal Framework Governing PPLI

IRS Code Sections 7702 & 7702A: The Foundation of PPLI
Sections 7702 and 7702A are critical to understanding how PPLI qualifies as life insurance for tax purposes. These sections establish the tests—such as the guideline premium test and the cash value accumulation test—that a policy must meet to receive favorable tax treatment. Compliance with these rules ensures that the policy’s death benefits and cash value growth remain tax-advantaged.

The Implications of Modified Endowment Contracts (MECs)
A policy classified as a Modified Endowment Contract (MEC) under Section 7702A loses some of the favorable tax treatments typically associated with life insurance. For instance, loans and withdrawals from MECs are taxed on a “last-in, first-out” (LIFO) basis, where earnings are withdrawn first and taxed accordingly. Understanding these distinctions is crucial for advisors structuring PPLI policies to maximize tax benefits and avoid unintended tax consequences for their clients. A modified endowment policy is one where the premiums are paid more rapidly than specified in the Code, such as a single premium policy.

Understanding the Investor Control Doctrine
The IRS’s Investor Control Doctrine plays a pivotal role in the taxation of PPLI policies. This doctrine posits that if a policyholder exerts excessive control over the investments within a PPLI, the IRS may deem the policyholder the owner of the underlying assets, thereby subjecting the earnings to immediate taxation.

“To prevent the adverse tax implications of the Investor Control Doctrine, estate planners and financial advisors must structure PPLI policies to limit the policyholder’s direct influence over investment decisions.”

This principle is particularly relevant in the context of private placements, where investment choices are typically broader and more complex.

Strategies to Mitigate Investor Control Risks
To prevent the adverse tax implications of the Investor Control Doctrine, estate planners and financial advisors must structure PPLI policies to limit the policyholder’s direct influence over investment decisions. Utilizing insurance-dedicated funds managed by independent third-party managers (over whom the policy owner does not exercise control) is a common strategy. This approach ensures compliance with the IRS guidelines while allowing clients to benefit from the tax-deferred growth inherent in PPLI.

Strategic Considerations for Using PPLI

Maximizing Investment Flexibility Within PPLI
PPLI policies offer unparalleled investment flexibility, enabling clients to allocate premiums to a wide range of assets, including equities, bonds, hedge funds, and private equity although Section 817 requires adequate diversification of investments (e.g., not more than 55% of the assets can be in more than one investment). This flexibility allows for the customization of portfolios to align with specific financial objectives while leveraging the tax benefits of life insurance. For advisors, understanding the intricacies of these investment options is key to structuring a PPLI policy that meets the unique needs of each client.

Asset Protection: An Added Layer of Security
In addition to tax benefits, PPLI provides substantial asset protection advantages. In many jurisdictions, the assets within a PPLI policy are shielded from creditors, offering clients a secure means of preserving wealth. This feature is particularly relevant in estate planning, where the protection of assets from potential claims can be as important as minimizing tax liabilities.

Enhancing Estate Planning Through PPLI
PPLI is a versatile tool in estate planning, offering tax-free death benefits that, together with other arrangements, can significantly reduce the burden of estate taxes. By incorporating PPLI into a broader estate plan, advisors can help clients efficiently transfer wealth to the next generation while addressing liquidity needs. For example, the death benefit from a PPLI policy can be used to cover estate taxes, preventing the forced sale of other assets.

Caveat: Proposed Changes to Tax Law
President Biden’s tax proposals for fiscal year 2025, as reflected in the Green Book issued by the Department of the Treasury on March 11, 2024, would have all distributions from most PPLI policies taxed as ordinary income, to the extent of the income of the policy, regardless of whether such distributions occurred as a loan or a death benefit.

In addition, it would eliminate the estate tax death benefit for such policies. This provision would not be applicable to existing policies that were not subsequently modified. Vice President Harris has, as part of her campaign for the Presidency, adopted, inter alia, these proposals. Considering these tax proposals, for individuals considering PPLI, it would be prudent to undertake the strategy in 2024 so as not to risk tax changes in 2025.

Conclusion

Harnessing PPLI for Advanced Tax and Estate Planning
For estate planning attorneys and financial advisors, PPLI is more than just a life insurance product—it’s a strategic solution that addresses complex tax and estate planning challenges. By combining the tax-deferral advantages of

“For estate planning attorneys and financial advisors, PPLI is more than just a life insurance product—it’s a strategic solution that addresses complex tax and estate planning challenges.”

life insurance with the flexibility of private placements, PPLI enables high-net-worth clients to optimize their wealth management strategies. While the nuances of PPLI require careful structuring and expert guidance, the benefits make it an indispensable tool in the sophisticated advisor’s toolkit.

If you have more questions about Private Placement Life Insurance, get in touch with a trust officer at Peak Trust Company today!

Charitable Remainder Trusts & IRAs

After the changes to the Internal Revenue Code made by the SECURE Act, there is a substantially reduced time that the income taxation of assets in a plan or IRA can be postponed once the plan participant or IRA owner dies. (Special rules apply to what are called Roth IRAs which are not addressed in this article).

After the SECURE Act, long-term income tax deferral remains unchanged for select beneficiaries such as a surviving spouse, a minor child of the participant or owner, a disabled person, a person who is chronically ill, or someone who is not more than ten years younger than the participant or owner. All others, however, must take out the entire amount in the plan or IRA within ten years (or, in some cases, five years).

The options can be complicated when deciding the best way to continue to postpone taxation of interests in plans or IRAs; however, one strategy is to make use of a charitable remainder trust.

An Answer for Some: A Charitable Remainder Trust

A charitable remainder trust (CRT) is a trust where one or more individuals receive benefits for life or a fixed term (of not more than 20 years) and then the remaining property in the trust passes to charity. Both the Internal Revenue Code and regulations have detailed rules about CRTs. Generally, these trusts have been used to postpone taxation. For example, if a taxpayer decides to sell appreciated stock, the shares instead can be contributed to a CRT and the trust can then sell them without any tax because the trust is exempt from income tax.

Distributions from the trust are included in the recipient’s income under somewhat complex rules. Because a CRT is income tax-exempt, proceeds from a qualified plan or IRA can be paid to the trust when the participant or owner dies and no income tax will then be payable. However, as the plan or IRA proceeds are distributed out of the CRT, they will be taxed to the recipient.

A Special Kind of CRT: The NIMCRUT

The rules related to CRTs are complicated. One of the complications is choosing what kind of CRT to use. There are three types of CRT. One type, called a charitable remainder annuity trust (CRAT), pays a fixed amount (an annuity) each year to the beneficiary or beneficiaries. Actuarial rules limit how much of an annuity and for how long the CRAT can pay.

The second type, called a charitable remainder unitrust (CRUT), pays an annual amount equal to a fixed percentage of the annual value of the trust. If the trust grows in value, the beneficiaries receive more. If the trust declines in value, they will receive less. Actuarial rules also limit how much of a unitrust amount can be paid and for how long, but there is greater flexibility with a unitrust than with an annuity trust.

The third type is the most complicated but may offer the best results. It pays the lesser of either the unitrust amount or the “fiduciary accounting income” (“FAI” or simply “Trust Income”). This type of CRT is sometimes called a “Net Income” CRT. Trust Income is itself a complicated topic. Generally, it means income (as opposed to principal or corpus) under state law rules relating to trusts. Trust Income usually consists of dividends and interest and normally not capital gains, however, there are exceptions that a taxpayer may use to produce a better result.

With this third type, the law allows for amounts to be “made up” or paid in future years. For example, if Trust In- come is lower than the unitrust payment, the annual payment can be postponed until a year when Trust Income is greater than the unitrust amount. This type of CRT is sometimes called a “Net Income with Make-up Charitable Remainder Unitrust” or “NIMCRUT".

Why a NIMCRUT May Help with Plan and IRA Proceeds

Making plan or IRA proceeds payable at death to a CRT means they must be paid out within five years of the death of the participant or owner, however, there is no adverse income tax due to the CRT’s tax exemption. The CRT would invest the proceeds and, even if a NIMCRUT is used, Trust Income (such as a dividend or interest) would be earned and would have to be distributed to and taxed to the trust beneficiary, however, by “sandwiching” an entity, such as a limited liability company or LLC, between the CRT and the assets it invests in, Trust Income can be kept at zero. If and when it is desirable to generate Trust Income, the entity (that is, the LLC) can voluntarily make a distribution to the NIMCRUT which will then make distributions to the beneficiary for the unitrust amount for that year and for shortfalls in prior years.

As long as no Trust Income is generated (because the LLC makes no distributions), the value of the trust can grow entirely free of income tax. In fact, a NIMCRUT can provide for a yearly unitrust payment of 11% for 20 years. It will be noted that if the LLC (and thereby the trust) grows over time, the 11% will apply to ever-increasing amounts meaning more will be accruing for the beneficiary. If the LLC makes no distributions until the 20th year, no income tax will be due regardless of how much the LLC earns. If the beneficiary is under the age of 30, the payments can be made for the life of the beneficiary, but payments will usually be under 11% a year.

A limitation to keep in mind is that to have a valid CRT, the value of the remainder in the trust for charity must be at least 10% of the value of the assets when they are first transferred to the trust. That does not mean that the charity must receive 10% of what is in the trust when it ends. In fact, with the current low interest rates the IRS uses, the amount a charity receives at the end may be a very small percentage of what is in the trust when it ends.

Key Considerations for Drafting a CRT

The IRS has issued sample forms for CRTs which, if used, practically guarantees a valid CRT; however, these IRS forms can be modified to ensure a better result. It will almost always be best to have the value of the remainder when the CRT is created to be the minimum required, which is 10%. As indicated, the best benefit of a CRT is its exemption from income taxation. That exemption is available whether the remainder is 10% or greater. Since the family member of the participant or owner benefits from this exemption and loses the benefit to the extent the trust goes to charity, it usually is best to keep the charitable remainder value at 10% and not more. Those drafting a CRT may consider the included sample provisions to obtain this result.

Sample Language

Unitrust Amount. The Unitrust Amount shall be the lesser of: (i) the trust income for the taxable year (Trust Income), as defined in Internal Revenue Code Sec. 643(b) and the Regulations thereunder, and (ii) the “Unitrust Percentage Amount,” which shall be equal to the largest percentage, paid with the frequency provided below and using the highest rate published by the Internal Revenue Service pursuant to Internal Revenue Code Sec. 7520 that may be used to determine the value of the remainder of this trust under Internal Revenue Code Sec. 664(d)(2)(D), which percentage is not less than five percent (5%) and not greater than fifty percent (50%) of the net fair market value of the assets of the trust valued as of the first business day of each taxable year (the “valuation date”) rounded to the nearest one one-thousandths of one percent, paid for the term and at the manner specified above, such that the value of the remainder within the meaning of Internal Revenue Code Sec. 664(d)(2)(D) of this charitable remainder trust as of the date this trust commences shall be ten percent (10%) or, if it is not mathematically possible for the remainder to equal ten percent (10%), as mathematically close to but greater than ten percent (10%) as possible.

The LLC and Trust Income

In order to provide the greatest flexibility to produce as much or as little Trust Income as possible, the NIMCRUT should be funded with an LLC or similar entity. However, none of the trustees, the grantor of the trust, or any beneficiary of the trust can determine when distributions from the LLC may be made to the trust. However, some independent person, such as legal counsel to the grantor, can be given the power to control distributions from the LLC, by naming that person as a “non-member manager” of the LLC. That means that the person will have no ownership interest in the LLC and the LLC can be a “disregarded entity” for income tax purposes so its income will be attributed to the NIMCRUT, which being tax-exempt will owe no income tax on the income earned by the LLC. The included provision may be considered to obtain this result.

Sample Language

Limitation on Determination of Income.The determination of what is and is not Trust Income of this trust shall be made under Alaska law. In addition, the following rules shall apply: (1) proceeds from the sale or exchange of any assets contributed to the Charitable Remainder Trust herein created must be allocated to the principal and not to Trust Income, at least to the extent of the fair market value of those assets on the date of contribution, (2) proceeds of any sale or exchange of any asset purchased by the Charitable Remainder Trust herein created must be allocated to the principal and not to Trust Income, at least to the extent of the Trust’s purchase price of those assets, and (3) Trust Income may not be determined by reference to a fixed percentage of the annual fair market value of the trust property, notwithstanding any contrary provision and applicable state law.

Notwithstanding the foregoing, the following rules shall apply except to the extent but only to the extent that they depart fundamentally from traditional principles of income and principal within the meaning of Treas. Reg. 1.643(b)-1. The trust will not be deemed to have any Trust Income merely by the imputation of tax income to the trust from an entity, such as a limited liability company or a partnership, whether it is owed in whole or in part by the trust or of which the trust is a partner or member. Any cash distribution from such an entity shall be considered Trust Income except to the extent the entity advises the trust it constitutes a liquidating distribution.

It likely will be best if the NIMCRUT is created and funded with an entity, such as an LLC, prior to the death of the plan participant or IRA owner. The LLC (or other entity) may be named as the beneficiary of the plan or IRA. This way, the proceeds can be paid from the plan or IRA to the entity soon after the death of the participant or owner. The entire plan or IRA must be paid within five years of the death of the owner or participant.

Although the entity will be deemed to receive taxable income from the distributions, this income will be imputed to the NIMCRUT which is income tax exempt. In many cases, this may prove ultimately beneficial. For example, all distributions from a plan or IRA are taxed as ordinary income, but distributions from a CRT follow a more favorable tax regime. If capital gain income is earned in the plan or IRA after the death of the participant or owner, it will be treated and taxed as ordinary income. But, if the entity (LLC) receives qualified dividends, long-term capital gain or other income which is more favorably taxed than ordinary income, this better character or flavor of the income will be retained when and if paid out to the NIMCRUT beneficiary.

What Is a Life Insurance Trust?

By Amber Gunn, CTFA and Mariam Hall

As the name suggests, a life insurance trust is a trust designed to own life insurance. This type of trust will most often be irrevocable. An irrevocable life insurance trust, or “ILIT” is a trust created to own and control a life insurance policy while the insured is alive, and then to manage and distribute the proceeds paid out after the insured’s passing according to the terms of the trust and the grantor’s intent. If a couple sets up a life insurance trust jointly, the insurance policy purchased inside the trust is often a “survivorship” or “second to die” policy, which pays the death benefit on the passing of the last surviving spouse.

Funded vs Unfunded Life Insurance Trusts

Life insurance trusts can be either “funded,” where the trust owns both a policy and income earning assets that provide for the payment of insurance premiums, or “unfunded,” where the trust owns the policy and the grantor makes an annual contribution to the trust that is used to pay the insurance premiums.

Funded and unfunded life insurance trusts are effective tools. However, keep in mind that with a funded life insurance trust, the transfers to fund the trust may be subject to the gift tax (when transferring income-producing assets to the trust) and income tax for a grantor trust. Unfunded insurance trusts make use of the grantor’s annual gift tax allowance to maximize tax savings and pay the annual insurance premiums.

Insurance Premium Tax

When establishing a life insurance trust, one of the several factors in deciding where the trust will be domiciled is the insurance premium tax rate in the state where the trust will be located. All states charge some form of tax on insurance premiums, including life insurance premiums. While this tax is rarely noticeable on most insurance products, for large life insurance policies with high annual premium amounts, it can make a big difference. This consideration becomes particularly relevant for annual premium amounts in excess of $100,000 a year, which is usually the case with private placement life insurance.

Insurance premium tax rates vary significantly among states. Alaska and Delaware are two states with particularly competitive insurance premium tax rates for large premium amounts. Alaska’s insurance premium tax rate is 2.7% on the first $100,000 of the premium, and then 0.08% on premium amounts in excess of $100,000. Delaware’s insurance premium tax rate is 2.0% on the first $100,000 of the premium, and premium amounts in excess of $100,000 are tax free. In contrast, most other states average between 1.75% to 2.5% on the entire premium amount, for example, California 2.35%, Nevada 3.5%, Florida 1.75%, New Jersey 2.0%, and New York 2.0%.

Nevada Incomplete Gift Non-Grantor Trusts (NINGs)

What Exactly is a NING Trust?

A NING is a Nevada Trust where gifts are considered “incomplete" for gift and estate tax purposes. Incomplete gifts are so named because the grantor may retain control over or access to the contributed asset. NING trusts are non-grantor trusts, which means that the trust is the taxpayer for income tax purposes. This allows the income from trust assets to be taxed based on the residence of the trustee rather than that of the grantor. For grantors living in a high-income state, like California, this can offer significant tax savings. If, for example, the sale of a highly appreciated asset is anticipated, doing so through a NING could limit the capital gains tax which might be higher if done under the laws of the grantor’s state of residence.

How do NINGs Work?

A NING works exceptionally well if a client lives in a high-income tax jurisdiction and is either looking to eliminate state income taxes or is selling an asset with a significant capital gain.

Here’s how a Nevada Incomplete Gift Non-Grantor Trust strategy works:
1. The grantor transfers an asset or brokerage account with income tax liability to a NING trust. This is often a portfolio of marketable securities or shares in a family business.

2. Once the transfer is complete, the grantor is no longer responsible for the income tax liability because a NING is a non-grantor trust. As a non-grantor trust, the NING will be a separate entity for federal income tax purposes and will file a Form 1041 return.

3. The trust is responsible for the income tax, and since the trust is set up in Nevada, where there is no state income tax, the income earned on the assets in the Nevada Incomplete Gift Non-Grantor Trust trust is not subject to state income tax.

An experienced attorney should draft a NING trust to ensure it is a non-grantor trust per IRS regulations. Having a properly drafted NING Trust is crucial to shift the income tax liability away from the grantor and to the trust.

Example NING Trust Scenario

Let’s say you have a client who is a successful business owner in California and is looking to sell their business for a significant profit. The client has a basis of $500,000 in the business which is now worth $10 million. If the business owner were to sell the business, they would incur a capital gain of approximately $9.5 million.

Given that California has a state income tax rate of 13.3%, in this scenario, your client would be responsible for paying approximately $1.3 million in California state income taxes, not considering any other facts and circumstances. However, if you set up a NING trust for your client and transfer ownership to the trust, the trustee in Nevada could then sell the business, potentially avoiding the $1.3 million in state income taxes. Of course, federal income tax would be applicable whether the grantor or the trust sold the asset. However, significant state income tax savings are possible using an appropriately structured Nevada Incomplete Gift Non-Grantor Trust.

After the sale, the proceeds could be invested by your client’s preferred financial advisor, and as long as the funds remain in the NING trust, there would be no state income tax liability. Additionally, if your client were to move to a state without state income taxes, they could avoid paying any state taxes on the trust distributions. Many clients set up a NING Trust with the intent of moving to a state without state income taxes before they start taking distributions from the trust. Others simply use the NING Trust as a legacy preservation vehicle for their children.

Ideal Candidate for a NING

The ideal candidate for a NING trust is someone who is looking to sell an asset with a significant capital gain and wants to eliminate or reduce state income taxes. This person may also be looking for asset protection and privacy and may be open to establishing a trust in Nevada to take advantage of the other benefits of Nevada’s favorable trust laws, such as asset protection, perpetual trusts, and privacy. Additionally, the ideal candidate may be open to relocating to a state without a state income tax or is interested in using the trust as a legacy preservation vehicle for their heirs.

Ultimately, the suitability of a Nevada Incomplete Gift Non-Grantor Trust will depend on the individual’s unique financial and personal circumstances and should be evaluated with the help of legal, tax, and financial advisors familiar with this advanced planning technique.

Here are some questions you may want to ask your client to see if a NING strategy makes sense for their situation:

Are you a high-income earner in the top tax brackets and live in a state with a high-income tax environment like California, Massachusetts, or New Jersey?
Do you have intangible assets with an embedded large capital gain that you would want to sell?
Do you plan on moving to a state with no state income tax? Do your beneficiaries reside in a state with no state income tax?
Have you done any estate tax planning? (Assets transferred to a NING trust are still includible in the grantor’s estate at death because the gift is “incomplete” for estate and gift tax purposes.)

Considerations for Establishing a NING

A NING works well if it owns intangible assets, such as shares in a business or a brokerage account. However, a Nevada Incomplete Gift Non-Grantor Trust cannot own tangible assets or assets sourced to the state in which the taxpayer resides. For example, if the asset is physically located in a high-income tax state (source income), the strategy will not work. Sometimes, tangible assets can be converted to intangible assets, but this requires additional careful planning with the help of specialized legal and tax advice.

A NING trust may not work for your client, depending on the state in which your client resides and how that state views the taxation of a trust. New York, for example, has enacted a law to negate the use of the NING trust strategy. Other states automatically impose a state income tax if the grantor is a state resident when the trust is established. Therefore, consulting knowledgeable tax and legal advisors is critical to determine whether the Nevada Incomplete Gift Non-Grantor Trust strategy will work for your client.

NINGs are complex trust structures that must be drafted according to specific rules to achieve the planning benefits. Therefore, working with a qualified attorney with experience creating such complex trusts is critical.

Nevada Directed Trusts

Directed trusts are a relatively modern estate planning tool that allow for the separation of investment management and trustee duties. With a directed trust, the trustee has limited responsibilities, and the grantor can appoint outside advisors to manage investments or direct distributions to beneficiaries. Directed trusts have gained popularity in recent years in estate planning. Nevada has become a go-to state for many individuals and families seeking to establish directed trusts due to its excellent directed trust statutes and other favorable trust laws.

What is a Directed Trust?

A directed trust is a trust structure in which the trustee is directed by one or more designated individuals or entities in making certain decisions related to the trust administration. The person or entity that directs the trustee is called the directing party or directing advisor. Some examples of directing parties include an investment advisor, a distribution committee, or a trust protector. The responsibilities of a directed trustee generally involve the following:

Carrying out the instructions given by the directing party.
Maintaining legal ownership of the trust’s assets.
Providing for the preparation of tax returns.
Maintaining trust records.
Accounting to the beneficiaries.

The trust document outlines the specific duties and responsibilities of the directed trustee and other trust participants.

Choosing the Right State: Why Nevada

Nevada has become a popular state for directed trusts due to its favorable trust laws, including its directed trust statutes. Nevada statutes permit directed trusts and provide certain protections for directed trustees. One of these protections is that a directed trustee is not held responsible for the actions of the advisor with discretion under the trust agreement, as long as the trustee acts in good faith and does not engage in willful misconduct or gross negligence.

Additionally, the law in Nevada considers a trust advisor to be a fiduciary by default unless the trust instrument specifies otherwise. This means that the trust advisor is legally obligated to act in the best interests of the beneficiaries and to exercise reasonable care, skill, and caution in carrying out his or her duties.

In addition to its directed trust statutes, Nevada law offers numerous other benefits for modern trust planning, such as no state income tax, asset protection, and the ability to create perpetual trusts.

Directed Trust Structures: Different Responsibilities for Different Roles

In a directed trust, various roles can be defined in the trust instrument. One of the key roles is the investment advisor, who is responsible for directing the trustee on investment decisions. The investment advisor can be a financial advisor, a family member, or even the grantor of the trust. Another critical role is the distribution advisor, who directs the trustee on distribution decisions. The distribution advisor can be the same person as the directing advisor or a different individual altogether. It should be noted however, that in most scenarios, the grantor should not act as distribution advisor.

Sometimes, a trust protector may also be appointed to oversee the trustee’s actions and ensure the trust’s terms are followed correctly. In addition, the trust protector may have other powers defined in the trust, such as removing the trustee and appointing a successor or changing the trust situs.

The roles and responsibilities of each participant are defined in the trust document. Depending on how the trust is drafted, it can be directed for investment, distribution, or both. This means that the directing advisor and distribution advisor can direct the trustee on specific investment choices and distribution decisions, allowing for a more tailored and customized approach to managing and distributing the trust assets.

Modern Trusts: Directed Versus Delegated

Before the inception of the modern-day directed trust, most trusts were drafted the old way: either a single trustee held all powers and responsibilities, or joint trustees shared equal authority and responsibility. The problem with this structure is that trustees, in many cases, were not the best choice for managing the trust assets. At the same time, a manager of a closely held family business or an investment advisor was not fully equipped to undertake all aspects of trust administration. If the trustee lacked the expertise to perform all necessary trustee functions, such as investing trust assets, the trustee’s only option was to delegate those duties to a professional equipped to perform the function. The solution to this problem? Update modern trust laws to allow for the separation of trustee duties and responsibilities – hence the modern-day directed trust.

The main difference between directed and delegated trusts is the trustee’s level of responsibility. In a directed trust, the advisor has the power to direct the trustee, while in a delegated trust, the trustee is responsible for making investment and distribution decisions. In a delegated trust scenario, the trustee is responsible for all trustee duties, including investment and distribution decisions, and can delegate some or all of those duties to other professionals. However, the trustee remains responsible for ensuring the delegated duties are appropriately executed. In contrast, since a directed trust separates the powers and responsibilities between the trustee and other participants, the trustee responsible for carrying out the directives of the other participants is relieved of liability for complying with those directives, unless the trustee acted in bad faith. This division of responsibilities allows for greater flexibility and customization for trust management.

Solving for Separation of Trustee Duties: “Old and Cold” Trust Documents

What about all the trusts drafted without the flexibility of the directed trust? Plenty of “old and cold” trust documents were drafted before the widespread inception of directed trusts. These trusts do not provide for the separation of trustee duties. As a result, regardless of who controls the trust assets, the trustee remains responsible which often results in difficulty finding a trustee willing to serve with an outside investment advisor who manages the trust assets. In these cases, there are generally three options.

Option 1: Decant the Trust to a Directed Trust with Updated Terms or Create a Non-Judicial Settlement Agreement
Nevada has favorable laws which give trustees the ability to decant a trust to one with updated, modern terms that allow for separation of trustee duties. This will involve the help of a skilled trust attorney familiar with complex trust structures. Nevada also has a well-established Non-Judicial Settlement process, which allows interested parties in a trust agreement to correct mistakes, address ambiguities, and change administrative provisions without the need for court approval.
Option 2: Find a Trustee Who Will Delegate
Another option, if the terms of a trust do not provide for the separation of trustee duties, is to find a trustee willing to delegate investment management authority to a non-trustee investment advisor. However, because of the increased liability to the trustee under this arrangement, delegated trusts generally incur higher trust administration fees than directed trusts. In addition, under this arrangement, the trustee is required to take on additional monitoring, due diligence, and oversight actions with respect to the investment activities.
Option 3: Create an “LLC Wrapper” for Trust Assets to be Managed by Non-Trustee Advisor
A third option to mitigate risk for the trustee and allow a non-trustee to manage trust assets is to create an LLC and structure ownership so that the only asset at the trust level is an LLC of which the trust is a sole member. In this scenario, the investment advisor or a family member may be appointed as manager of the LLC and will manage the underlying assets held in the LLC.

Summary

Estate planning attorneys should consider using directed trusts because they can be a valuable tool for clients seeking more control over investment and distribution decisions than traditionally structured trusts. Directed trusts have gained popularity in recent years, and Nevada has become a popular state for directed trusts due to its favorable trust laws. Directed trusts offer flexibility and customization for trust management, allowing for tailored investment and distribution decisions. Compared to delegated trusts, where the trustee is responsible for all trustee duties, directed trusts divide powers and responsibilities between the trustee and other participants. However, as always, it is important to carefully consider all aspects of a trust structure and seek the guidance of legal and financial professionals when creating a trust.

What is a Spousal Lifetime Access Trust (SLAT)?

By Mariam Hall

A Spousal Lifetime Access Trust (SLAT) is an irrevocable trust created by one spouse for the benefit of the other spouse. The grantor uses their gift tax exemption to make a gift to the SLAT for the benefit of their spouse. Similar to other planning techniques to make completed gifts that are outside of the grantor’s estate, the grantor gives up his or her right to the property transferred into the trust while the beneficiary spouse maintains access to that same property.

The goal of a SLAT is to get assets out of a grantor’s estate and into a trust that can provide financial support for one’s spouse while sheltering those assets and any future growth from estate and gift tax. By creating a trust for one’s spouse, the grantor may continue to benefit from the property through the spouse without concern of creditor claims or estate tax inclusion.

Key Considerations When Creating a SLAT

There are several important considerations to keep in mind when setting up a SLAT. For example, who will be the trustee as the grantor should not serve as trustee? Who will the beneficiaries be – Spouse, children, other descendants? Do you want to assign a trust protector and what duties will be assigned to them, such as the power to remove a trustee? How will the trust be funded? Are both spouses using a SLAT? If so, it is very important to avoid reciprocal trust doctrines. Do you need language regarding the possibility of divorce? Learn more here about the key considerations when creating a SLAT.