Wills and Trusts

Wyatt, Tarrant & Combs, LLP

MAXIMIZING AND MULTIPLYING THE “STEP-UP” IN BASIS – Part V

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MAXIMIZING AND MULTIPLYING THE “STEP-UP” IN BASIS – Part V

Forcing Estate Tax Inclusion

Different Strategies for Causing Estate Tax Inclusion

Give someone – – trustee, advisory committee, or trust protector – – the discretion to grant a general power of appointment or to expand a special power of appointment so it becomes general. The power could be granted shortly before death if the step up in basis is desirable given the tax rates in effect at that time (considering, of course, that when a potential power holder is “shortly before” death may not always be easy to determine).  Should the person with the power to grant or expand the power be a fiduciary?  Should protection be given for a decision to grant or not to grant the power of appointment? Should the  general power be able to be rescinded or modified by the person granting the power?  Where the circumstances are clearly defined, a formula grant of a general power may be easier, and more successful, that a broadly applicable formula.

Terminate the trust and distribute the assets to one or more beneficiaries.  If a beneficiary does not have a taxable estate, then there may be no transfer tax reason to maintain the trust and there may be a negative income tax consequence to such maintenance.  Quite obviously, there may be non-tax detriments to a beneficiary having outright ownership of such assets.  In such instances, transferring assets from a trust that is not includible in the beneficiary’s estate into a new trust over which the beneficiary has a general power of appointment – perhaps one exercisable only with the consent of a non-adverse party to the creditors of the beneficiary’s estate – – may produce a step-up with minimal risk of asset diversion or dissipation.

Include a formula in the trust agreement which would cause estate tax inclusion if appreciation is not sufficient for estate tax benefits to outweigh income tax benefits of a step up

(1)  Example:  I make a gift of $5 million of stock with a basis of 0 to a trust for my children.  Trust agreement provides that on my death, if 40% of the excess of the date of death value of any asset over the date of gift value of the asset is less than 23.8% of the excess of the date of death value of the asset over the basis of the asset, the asset is distributable to my estate.  The formula could be written as follows if (E)*(D-G) < (I)(D-B), asset is distributable, where E=estate tax rate, I=income tax rate, D=date of death value, G=date of gift value, B=basis.  If the value of the stock is $7.5 million at my death, the stock would be distributed to my estate so that I get the income tax benefit of the step up, which exceeds my transfer tax savings.

(2)  Formula creates an “estate tax inclusion period”[1] (“ETIP”) so GST exemption cannot be allocated to the trust.

Appoint the donor as trustee, although many trust agreements provide that the donor may never be named as trustee.

Move the trust from an asset protection jurisdiction to a jurisdiction where donor’s creditors can reach the assets.  This would also require that the donor have some beneficial interest in the trust that would cause it to be a self-settled trust.

Estate could take the position that there was an implied agreement of retained enjoyment under section 2036(a)(1) of the Code.  For example, donor begins living in a home gifted to the trust (perhaps pursuant to a qualified residence trust) without paying rent and takes the position that there was an implied agreement at the outset that the donor would be able to do so.

Use a freeze partnership so that grantor’s retained preferred interest gets a basis adjustment at death.

(1)  Transfers cash flow and appreciation in excess of the donor’s preferred return and liquidation preference

(2)  Section 754 election (discussed below) would allow a corresponding step up to partnership’s inside basis.

(3)  Requires payment of a preferred return to donor, which may be difficult if yield on underlying assets is not sufficient

(4)  Preferred interest valued at zero unless an exception to section 2701 exists or if an exemption to the zero valuation rule exists (for example, a qualified payment interest)

(5)  Even if the section 2701 requirements are not met and preferred interest has a zero value (e.g. because non-cumulative) so that the value of the gift equals the donor’s entire interest in the partnership, at donor’s death the value of preferred is includible in gross estate (put right can ensure that the value at least equals liquidation preference) and there is no transfer tax on the income and appreciation to the extent it exceeds the donor’s preferred return

Tax consequences of estate tax inclusion

Value of property at death is includible in gross estate.

Section 2001(b) of the Code provides that adjusted taxable gifts do not include gifts that are includible in the gross estate.  Thus, there is a distinction between including assets in the estate of a beneficiary and including gifted assets in the estate of the donor.

There is no reduction available for gifts treated as having been made by spouse because of a split gift election, so estate tax inclusion generally should not be used for property for which a split gift election was made.

Question of how much is excluded from adjusted taxable gifts where less than all of the gifted property is includible in the estate (e.g. because of distributions of income or distributions of appreciation)?  The issue does not seem to be addressed sections 2001, 2701 and 2702 of the Code and the Treasury Regulations.  Ought the Code distinguish between these two situations:

I make a completed gift of $5 million of stock with a zero basis to a trust for my children.  During my lifetime any income and appreciation in excess of $5 million is distributed to my children free from transfer tax.  On my death, the remaining $5 million of stock is not includible in my gross estate and is included in my adjusted taxable gifts.  The basis in the stock will not be stepped up to the value on the date of death.

Same as the previous example except that I retain the right to receive trust income during my lifetime.  My income interest does not reduce the value of the gift because it does not meet the requirements of section 2702 of the Code.  All appreciation is distributed to my children during my lifetime.  On my death, the value of the trust assets are included in my estate – – $5,000,000 – – and receive a basis step-up. Are my adjusted taxable gifts reduced by my $5,000,000 gift, or only by the value of my income interest (which was what I retained)?

Turney P. Berry

Louisville, Kentucky


[1] § 2642(f).

Leave a reply. Please note that although this blog may be helpful in informing clients and others who have an interest in information privacy and security, it is not intended to be legal advice. The information on this blog also should not be relied upon to form an attorney-client relationship.

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