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Are You Funding, Gifting Or Transferring Money Or Property Into A Trust This Year? Be very careful with the retroactive rules!

By Michael B. Nelson, Esq. - Email Editor

Date : February 25, 2010

In recent years, it is becoming more complicated for newly created trusts to be funded without incurring tax liabilities from the outset. In general estate planning, the Estate Planner creates a Living Trust and the client is the Settlor, Grantor, Trustee and Beneficiary. The sole purpose of a Living Trust is to allow the decedent’s estate pour over at the date of death into a Living Trust which at date of creation, usually, has the decedent’s primary residence. However, if you are trying to accomplish Asset Protection, the Living Trust is not the proper vehicle or method by any stretch of the imagination.

Internal Revenue Code Section 2511(c) became effective January 1, 2010 with the repeal of the estate tax; IRC§2511 (c) states:

Treatment of certain transfers in trust notwithstanding any other provision of this section and except as provided in regulations, a transfer in trust shall be treated as a transfer of property by gift, unless the trust is treated as wholly owned by the donor or the donor’s spouse under subpart E of part I of subchapter J.

Without careful reading of the above Section a comforting conclusion may be determined that transfers to a trusts may bring in gift taxation. However, the language is much more sobering. IRC§2511(c) acts to address entire transfers in trust after December 31, 2009 in which the transfers are deemed to be a gift of the entire interest in the property transferred, whether the transferor retains the entire or part of the interest transferred in the trust. As an example, where a transferor makes a transfer of property to a trust and retaining partial interest or right to current or future income then that specific transfer will be subject to gift tax on the of the entire interest in the property transferred. As noted, the one exception pursuant to IRC§2511(c) is where a transferor is the owner of the entire trust in accordance with the existing income taxation grantor trust rules.

Also, be alert in planning where the Grantor retains powers over the corpus so as to make the Grantor the corpus owner for income tax purposes. An example would be the Grantor retaining the power to substitute other property as corpus with the result of the Grantor being deemed as the owner of the entire interest in the property transferred. IRC§2511(c) changes this by subjecting the entire value of the property to gift tax upon its transfer to the trust, unless the Grantor is treated under the income tax Grantor trust rules as owning both the income and the corpus of the trust. A Qualified Personal Residence Trust, “QPRT”, is an example of one type of transfer entrapped by this new law. The transfer of the residence to the QPRT would trigger immediate gift tax on the full value of the residence, unless the Grantor retained powers over the trust corpus to make the Grantor the owner of the corpus for income tax purposes. Normally, this type of transaction is designed to contain under the QPRT the preservation of the Grantor’s right to use the IRC§121 exclusion in view that the residence may be sold during the term of the QPRT. Note, careful drafting of the QPRT should not allow for the recognition of IRC§2511(c) taxation on the entire value of the residence.

Interestingly, the new law provides authority to the U.S. Treasury to note an exception wherein the gift to a charitable remainder trust is a transfer subject to gift tax on the full value of the property transferred with a potential offsetting charitable deduction for the value of the remainder interest only. Caution: the estate tax bill passed by the House of Representatives in December of 2009 contained a provision repealing IRC§2511(c). If the estate tax is reinstated retroactively, as many of us expect, then IRC§ 2511(c) will, presumably, be repealed retroactively. But until that event happens with Congressional approval, you will be well advised to defer any transfers in trust that might be affected by IRC§2511(c). We cannot predict exactly what Congress will do in this arena and for now all transfers in trust are fully taxable gifts. Keep this issue in mind as you track the progress of the estate tax legislation. Should the IRC§2511(c) survive through the issuance of Temporary Regulations or Regulations, the language will have a profoundly burdensome effect as it relates to transfers in trust under the gift tax laws retroactively. Exactly how far reaching the law will be in looking back has yet to be determined. At this time we know the law will look back to January 1, 2010.

CONCLUSION:

Be very careful when you create and/or fund any trusts in 2010. You will need to consult with a very experienced and skilled trust legal counsel on these matters. Also, some of the proposed tax legislation may be crafted to look back into 2009 at funding and transfers into trusts. Yes, that is right! There have been times in which the I.R.S. has retroactively drafted tax laws as well as “look-back” rules to capture tax revenues for acts or transfers that occurred in a prior year. At this writing, there seems to be more than a sense that the I.R.S. may well try to look back to year 2009. This is certainly one way of generating increased revenues without taxes being increased one single dime on individuals earning less than $250,000, as President Obama advocates.

Feel free to email us at info@trustmakers.com or call to discuss your options.

Taking Action If you have a company, foundation or trust outside the US borders and want to know if you have correctly set it up for structural and/or tax purposes our advisors are now handling these cases. Please reply to info@trustmakers.com.

By Michael B. Nelson, Esq.
TrustMakers.com

 

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