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Bull, Morreale & Judelson, P.C.
90 Crystal Run Road, Suite 404, Middletown, NY 10941
Phone: (845) 695-2002      Fax: (845) 695-2902
E-mail address: bmjpc@bmjpc.com

MEMORANDUM OF TAX AND NON-TAX PLANNING TECHNIQUES

Introduction. The issues and considerations involved in estate and retirement planning can be very confusing and complicated. This Memorandum summarizes certain recent changes in the tax law and offers some planning techniques that may be applicable in certain circumstances. This presentation is designed for general informational purposes with a view toward enabling you to consider whether any of the planning techniques may be suitable to you.

Estate Tax Law Changes. The June 2001 Economic Growth and Tax Relief and Reconciliation Act ("2001 Act") made significant changes to the Federal Estate Tax Law. A brief summary of the more important changes with respect to the estate tax provisions is enclosed with this Memorandum. The most important changes include the acceleration of the gradual increase in the Federal Exemption Equivalent Amounts from $1,000,000 in 2002 to $3,500,000 in 2009, decrease in the highest marginal estate tax rates and "repeal" of the estate tax.¹

Retirement Tax Law Changes. In January 2001, the Internal Revenue Service issued revised regulations concerning IRAs and qualified retirement plans that liberalized and simplified the Required Minimum Distributions rules for payments of amounts held in these accounts after age 70½. The most important changes in these rules allows for the extension of the deferral period, simplification of the decisions in connection with making beneficiary designations and flexibility for estate and income tax planning after the death of the owner of the IRA or participant in the retirement plan.

Estate Tax Exposure. In the event that your assets exceed the then applicable Exemption Equivalent Amount, you may have estate tax exposure during the nine year phase in period of the increasing Exemption Equivalent Amounts. In addition, the "sunset" provisions of the 2001 Act make the "repeal" of the estate tax effective only for 2010 and inapplicable for years beginning after December 31, 2010 unless further legislation is enacted. The gift tax is not repealed which may indicate that the estate tax may not be permanently repealed. The retention of the gift tax prevents persons from making substantial transfers during their lifetime to guard against the possible reinstatement of any repealed estate tax.

Estate Tax Reduction Techniques. Certain techniques that can reduce the estate tax exposure include the following:

1. Disclaimer and Formula Approaches to divide assets at the time of the death of the first spouse through the implementation of a By-Pass Trust to use all or part of the Exemption Equivalent Amount in the estate of the first spouse to die.
2. By-Pass Trusts that include either optional or mandatory provisions for the accumulation or sprinkling of income so as to maximize the value of the assets in the By-Pass Trust.
3. Life Insurance Trusts to own any substantial life insurance policies so as to remove the policies from your gross estate.
4. Family Limited Partnerships to create tax discounts and non-tax advantages including protection against creditor claims.
5. Generation Skipping Trusts if your children own substantial assets and/or will be receiving a substantial inheritance from you.
6. Gifting to use the annual exemption amount.
7. Gifting to "Defective Grantor Trusts" for the purpose of increasing the amount of the gift by you retaining the income tax liability on the income earned on the assets in the trust.
8. Split interest zeroed out gift to a grantor retained annuity trust.
9. Freeze techniques such as installment sales to "Defective Grantor Trusts," private annuities and self canceling installment notes.
10. "Crummey Power Trusts" for the primary benefit of a spouse which allows for multiple annual exclusion gifts.
11. Split interest gifts with a charity or charities in which you retain a partial interest in the assets, including charitable remainder unitrusts, charitable remainder annuity trusts and charitable lead trusts.

Retirement Planning Techniques. The retirement planning techniques that could be considered include the following:

12. Designating a trust for your spouse as the beneficiary in a manner that may be more tax efficient for estate and income tax planning purposes.
13. Funding a bequest for a grandchild by designating the grandchild as the beneficiary of all or a portion of an IRA to obtain a maximum deferral of the payout period and creditor protection for the grandchild.
14. Funding a charitable bequest by designating the charity as the beneficiary of a dollar amount or a portion of an IRA without losing the ability to obtain the maximum deferral for the balance of the IRA.
15. Incorporating disclaimers in beneficiary designations to provide flexibility to coordinate retirement and estate tax planning.

Non-Tax Planning Techniques. The techniques that could be considered to accomplish non-tax objectives include the following:

16. Revocable Trusts to avoid the expense and inconvenience of probate.
17. Limited Liability Companies to obtain increased liability protection for assets presently owned individually or in a partnership.
18. Expanded Powers of Attorney to authorize disclaimers, making of gifts, establishing revocable trusts and investing in limited partnerships.

Marital Situations - Disclaimer Or Formula Approach. Several points that are applicable for married individuals with substantial assets:

1. The Disclaimer Approach gives a surviving spouse complete flexibility to determine whether or not to "divide the residuary estate" to effectuate estate tax planning at the time of the death of the first spouse by directing that assets up to the Exemption Equivalent Amount be placed in a By-Pass Trust for the benefit of the surviving spouse, but which trust will not be includable in the surviving spouse's estate.
2. The Formula Approach forces the Exemption Equivalent Amount into a By-Pass Trust or a gift for the children. The only clear tax advantage of the Formula Approach over the Disclaimer Approach is that under the Formula Approach when the Exemption Equivalent Amount is placed in a trust for the benefit of the surviving spouse, the surviving spouse may be given a limited power of appointment over the assets in the trust.
3. In most situations where the spouses are willing to give the surviving spouse complete and unrestricted flexibility, the changes under the 2001 Act, with the increasing Exemption Equivalent Amount and uncertainties as to "repeal," the Disclaimer Approach becomes even more preferable than the Formula Approach.
4. As a result of the 2001 Act, particular attention should be given to the need to revise an existing estate plan based on the Formula Approach that divides the residuary estate between the surviving spouse and children [rather than a division between an outright or marital trust gift for the spouse and a By-Pass Trust for the benefit of the surviving spouse]. As the Federal Exemption Equivalent Amount increases, a greater part of the estate will be passing for the benefit of the children. Furthermore, if the Federal estate tax is completely repealed, then under the Formula Approach, there would be no estate tax and the entire residuary estate would pass to the children to the exclusion of the surviving spouse.
5. One final very technical point. In limited circumstances, there can be two significant potential tax advantages that may be created by placing the assets for the surviving spouse in a Qualified Terminable Interest Trust ("Q-Tip Trust"), rather than giving the assets outright to the surviving spouse.²

Personal Considerations. The personal and non tax aspects of an estate plan that should be reviewed include the following: (i) the amount of specific gifts to children upon the death of the first spouse, (ii) gifts for grandchildren, (iii) gifts for charitable beneficiaries, (iv) change in the manner of making residuary gifts to children from a trust format to an outright gift or change in the age or ages when your children are entitled to receive all or part of the income or principal of the trust, (v) designation of executors, (vi) designation of trustees and (vii) designation of guardians for any minor children should there be no surviving spouse.

General Conclusions. This Memorandum is being sent to all our clients. Therefore, it is not practical to individualize the manner and extent to which the changes in the law and the planning techniques may be applicable in individual situations. However, we are comfortable in setting forth certain general observations:

1. Regardless of the extent of your assets, for married couples whose existing estate plan uses the Formula Approach, your estate plan should be reviewed.
2. If your assets are less than the Exemption Equivalent Amount, the 2001 Act should not require any changes to your estate plan. Please remember that even if your assets are less than the Exemption Equivalent Amount, if you are married and your estate plan uses the Formula Approach, you should review your estate plan.
3. For married couples with assets in excess of the Exemption Equivalent Amount, whose existing estate plan uses the Disclaimer Approach, the 2001 Act should not under most circumstances require any changes to your estate plan. Whether or not the 2001 Act or the changes in the IRS regulations concerning IRAs and qualified retirement plans require modifications in your situation from a tax perspective, this may be an appropriate time to review your estate and/or retirement planning.

¹ Please note that if you are married and your estate plan incorporates the Formula Approach, rather than the Disclaimer Approach, it is very important that you carefully consider the changes made by the 2001 Act that are explained in this Memorandum under the sections entitled "Marital Situations - Disclaimer Or Formula Approach" and "General Conclusions."

² First, the Q-Tip Trust gives the executor the flexibility to obtain a six month extension to determine whether to qualify the Q-Tip Trust for the marital deduction so as to equalize the estates should the surviving spouse die within the six month period. Second, the Q-Tip Trust enables the estate of the surviving spouse to receive a credit for previously taxed property if the surviving spouse dies within ten years of the first spouse and the executor decides not to qualify the entire Q-Tip Trust for the marital deduction.

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The information you obtain at this site is not, nor is it intended to be, legal advice. You should consult an attorney for individual advice regarding your own situation.

IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the U.S. Internal Revenue Service, we inform you that any tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, by any taxpayer for the purpose of (1) avoiding tax-related penalties under the U.S. Internal Revenue Code or (2) promoting, marketing or recommending to another party any tax-related matters addressed herein.

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