Wills and Trusts

Wyatt, Tarrant & Combs, LLP


Tennessee Trust Lawyers Have More Tools Than Ever Before

Tennessee is without a doubt one of the leading Trust Law jurisdictions, and Tennessee estate planners have more tools than ever before.

In 2000, Tennessee adopted the Uniform Principal and Income Act which provides certainty and safe harbor to Trustees with respect to trust accounting principles. In 2002, the Uniform Prudent Investor Act did the same with respect to the management of trust investments.

In 2004, Tennessee adopted the Uniform Trust Code (one of the first five jurisdictions to adopt it). Although the Trust Code did not diverge significantly from the common law, it made Tennessee Trust Law more accessible and cohesive. Among other things, the Trust Code gave Tennessee attorneys innovative methods such as virtual representation, Non-Judicial Settlement Agreements, and judicial and non-judicial trust modifications and terminations to deal with some of Trust Law’s most vexing issues.

The year 2007 brought a 360 year rule against perpetuities (which coincidentally I may be able to thank for my job!), self-settled asset protection trusts (innocuously named the Tennessee Investment Services Act), and updates to the now non-uniform Tennessee Uniform Trust Code which allowed beneficiaries to serve as their own trustee without jeopardizing the spendthrift protections granted to them by the trust.

The year 2010 brought further Trust Code updates, but most importantly brought the Tennessee Community Property Trust Act which allows a married couple to establish a joint revocable trust that has some unique and advantageous income tax consequences. Even apart from the income tax advantages of the Community Property Trust, the trust has a more subtle benefit: a joint plan. Rather than the traditional tax plan of splitting assets between spouses, this joint trust allows couples to put all of their assets into a single joint trust. Practitioners can tell you that clients have always been uncomfortable splitting up their assets for tax purposes. However, clients have just loved being able to put their assets into a single joint trust. Read more about Community Property Trusts here.

In 2012, Tennessee retroactively repealed the Tennessee Gift Tax and gradually repealed the Tennessee Inheritance Tax through 2016. Read more here.

Finally, 2013 brought comprehensive reform to the (now ironically named) Tennessee Uniform Trust Code. As is discussed in a previous post, 2013’s reform essentially did three things: (1) enhance asset protection for beneficiaries, (2) protected Trustees by giving them far more discretion, and (3) allowed for directed trusts to allow trusts to segregate the roles of investment and trust administration. Another change enhanced the attractiveness of Tennessee Asset Protection Trusts. Read more here.

The Reveal. So. . . What’s next? Come July 1, 2014 Tennessee Attorneys will have yet another arrow in their estate planning quiver: The Tenancy by the Entirety Joint Revocable Trust was signed into law on . Click here for a summary of Public Chapter 829.

A Tenancy by the Entirety Joint Revocable Trust (“TE Trust”) will be immensely useful. Sure, some clients will be more appropriate for a Community Property Trust to get a double basis step-up, but many could use the asset protection advantages of a TE Trust. Generally, whether property is held as tenancy by the entirety is a question of intent and is most often seen with the family home. Now practitioners can take the opportunity to protect their clients (and the surviving spouses most of all) by removing any doubt.

Just like other property held as tenants by the entirety, assets held in the TE Trust will pass free from the creditors of first spouse to die. Joint creditors and creditors of the survivor will still be able to levy against assets held in the trust. Perhaps use of a disclaimer trust in the TE Trust could avoid creditors of the survivor, but that may be pushing it.

Eight other states have specifically authorized such joint trusts. Click here to read more.

This is no do-it-yourself project either. Care must be taken to ensure that upon funding, the intricacies of the notice requirements in the statute have been followed in order to obtain the allowed protection.

Practitioners, update your forms and get ready.

Advisers, keep this in mind for your clients that have any possibility of asset protection issues (i.e., Dr. Klutz).

Stay Tuned.

Rob Malin


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No QTIP Election Unless Necessary to Reduce Estate Tax

If Fred dies in 2011 with a $4,000,000 estate and is survived by his second wife, Mabel, Fred’s estate plan may provide for a QTIP-eligible trust for Mabel’s benefit, remainder to Fred’s children. Although the QTIP election is not necessary in order to zero out Fred’s estate taxes, making a QTIP election could be desirable because of potential increase in basis at Mabel’s subsequent death if the trust assets were included in her estate.

Rev. Proc. 2001-38 precludes the QTIP election unless doing so reduces the estate tax. Thus a change in basis may be achieved only by giving the surviving spouse some modicum of control over the assets to be included in the spouse’s estate (e.g. a testamentary power of appointment in favor of the creditors of her estate). See e.g. PLRs 200407016, 200603004, and 201112001. The original policy was to help taxpayers avoid inclusion in the survivor’s estate of “unnecessary” assets. Such a policy might support allowing a QTIP election to achieve a basis change at the second spouse’s death but there is scant authority to support the argument.

In PLR 201338003 the surviving spouse or executor properly allocated all assets to the credit shelter trust but listed those assets on Schedule M of the 706 and was deemed to have made a QTIP election. The PLR applied Rev. Proc. 2001-38 to void the QTIP election.

Turney P. Berry
Louisville, Kentucky

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Swapping Assets with Existing IDGTs

In 2011 and 2012, many individuals made significant taxable gifts, using all or a significant portion of their Available Exclusion Amounts because of the risk of that the exemptions would “sunset” back to 2001 levels.  Many of those gifts were made to grantor trusts.

A common power used to achieve grantor trust status for the IDGT is one described under section 675(4)(C), namely giving the grantor, the power, in a non-fiduciary capacity, to reacquire the trust corpus by substituting other property of an equivalent value.[1]  For income tax purposes, transactions between the grantor and the IDGT will be disregarded.[2]  As such, grantors may exercise the power to swap high basis assets for low basis assets without jeopardizing the estate tax includibility of the assets and without having a taxable transaction for income tax purposes.

To maximize the benefits of the swap power, it must be exercised as assets appreciate or are sold over time.  When exercised properly, this can ensure that only those assets that benefit the most from the step-up will be subject to estate inclusion.

If grantor does not have sufficient other assets, repurchase will be difficult – although the donor could borrow cash from a third party.

The income tax consequences if a note is used to repurchase property are uncertain because the trust’s basis in note may equal grantor’s original carryover basis in the asset given to the trust and now reacquired so paying off the note may generate gain).

Because the sudden or unexpected death of the grantor may make a repurchase difficult or impossible, estate planners may want to consider drafting “standby” purchase instruments to facilitate fast implementation of repurchase.

The Obama administration has proposed significant limitations on the ability of grantors to prospectively manage assets that would be includible in the grantor’s estate through the use of this swap power.  Pursuant to the proposal:

If a person who is a deemed owner under the grantor trust rules of all or a portion of a trust engages in a transaction with that trust that constitutes a sale, exchange, or comparable transaction that is disregarded for income tax purposes by reason of the person’s treatment as a deemed owner of the trust, then the portion of the trust attributable to the property received by the trust in that transaction (including all retained income therefrom, appreciation thereon, and reinvestments thereof, net of the amount of the consideration received by the person in that transaction) will be subject to estate tax as part of the gross estate of the deemed owner, will be subject to gift tax at any time during the deemed owner’s life when his or her treatment as a deemed owner of the trust is terminated, and will be treated as a gift by the deemed owner to the extent any distribution is made to another person (except in discharge of the deemed owner’s obligation to the distributee) during the life of the deemed owner.[3]

The proposal would apply to pre-existing IDGTs because it would be effective with regard to trusts that engage in a described transaction on or after the date of enactment

Turney P. Berry

Louisville, Kentucky

[1]§ 675(4)(C) and Rev. Rul. 2008-22, 2008-16 I.R.B. 796.

[2] See Rev. Rul. 85-13, 1985-1 C.B. 184 and PLR 9535026.

[3] Department of the Treasury, Coordinate Certain Income and Transfer Tax Rules Applicable to Grantor Trusts, General Explanation of the Administration’s Fiscal Year 2014 Revenue Proposals (April 2013), p. 145.

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Traditional IRA and Qualified Retirement Assets

In 2013, Investment Company Institute estimated that total retirement assets were over $20 trillion (including government plans, private defined benefit plans, defined contribution plans and individual retirement accounts).[1]  Assets in IRAs and defined contribution plans totaled more than ½ of the total at approximately $11.1 trillion.  Although IRA and qualified retirement assets make up one of the largest asset types of assets owned by individuals, they are one of the most problematic from an estate planning perspective.

IRA and qualified retirement assets are not transferable during the lifetime of the owner,[2] so the assets are never candidates for lifetime gifts unless the owner is willing to incur a taxable distribution of the assets.  As such, to the extent not drawn-down prior to death, the assets are includible in the estate for transfer tax purposes,[3] and by definition, the assets will use some or all of the decedent’s Applicable Exclusion Amount, unless the assets to surviving spouse under the marital deduction under section 2056 of the Code or to a charitable organization under section 2055 of the Code.[4]  To make things worse, IRA and qualified retirement assets are considered income in respect (IRD) under section 691 of the Code.[5]   IRD assets are not entitled to a “step-up” in basis,[6] and all distributions (whether paid over time or not) to a beneficiary are taxable as ordinary income.[7]  Even though the beneficiary is entitled to an income tax deduction[8] (“IRD deduction”) for estate taxes payable by virtue of the inclusion of the assets, there is no Federal income tax deduction for state death taxes that might be payable, and given the reduced Federal transfer tax rate of 40% and the cost-of-living increase on the Applicable Exclusion Amount, many taxpayers will have very little or no IRD deduction to shelter the on-going ordinary income tax problem.

A distribution from a decedent’s IRA to a surviving spouse may be “rolled over” to another qualified retirement plan or IRA, thereby deferring the recognition of income.[9]  In addition, if the surviving spouse is the beneficiary of all or a portion of the decedent’s IRA, the surviving spouse may also elect to treat the decedent’s IRA as his or her own IRA.[10]  In both of the foregoing cases, the IRD problem discussed above continues after the death of the surviving spouse (unless the surviving spouse remarries).

Contrast the foregoing treatment with Roth individual retirement plans (“Roth IRAs”).[11]  Roth IRA assets are treated similarly to assets in a traditional IRA in that: (i) the account itself is not subject to income tax;[12] (ii) distributions to designated beneficiaries are subject to essentially the same required minimum distribution rules after the death of the original Roth IRA owner;[13] and (iii) surviving spouses may treat a Roth IRA as his or her own and from that date forward the Roth IRA will be treated as if it were established for the benefit of the surviving spouse.[14]  In contrast to a traditional IRA, distributions to a qualified beneficiary are not taxable to the beneficiary,[15] and as discussed above, are not subject to the Medicare tax.[16]  The overall result for decedents with Roth IRA assets, the qualified beneficiaries of the Roth IRA effectively receive the benefit of a “step-up” in basis.  Since 2010,[17] all taxpayers regardless of adjusted gross income[18] could convert traditional IRA assets into a Roth IRA.  The conversion is considered a taxable event causing the converted amount to be includible in gross income and taxable at ordinary income tax rates.[19]  Direct taxable rollovers from qualified company-based retirement accounts (section 401(k), profit sharing, 403(b), and section 457 plans) into a Roth IRA.[20]  Individuals who have excess qualified retirement assets, have sufficient funds to pay the resulting tax liability from outside of the retirement account, and who are not planning to donate the asset to a charitable organization are great candidates to do a Roth IRA conversion.  Notwithstanding the clear benefits of passing the Roth IRA assets to children and grandchildren outside of the scope of the IRD provisions, not many individuals are willing to pay the income tax cost of the conversion.

Turney P. Berry

Louisville, Kentucky

[1] Investment Company Institute, Release: Quarterly Retirement Data, First Quarter 2013, http://www.ici.org/research/stats/retirement/ret_13_q1,  (03/31/201).

[2] See the anti-alienation provision in § 401(a)(13)(A).

[3] § 2039(a).

[4] The IRS has taken the position that qualified retirement assets used to fund a pecuniary bequest to a charitable organization will be considered an income recognition event, triggering ordinary income.  CCA 200644020.

[5] See e.g., Ballard v. Commissioner, T.C. Memo 1992-217, Hess v. Commissioner, 271 F.2d 104 (3d Cir. 1959), Rev. Rul. 92-47, 1992-1 C.B. 198, Rev. Rul. 69-297, 1969-1 C.B. 131, PLR 9132021, and GCM 39858 (9/9/91).

[6] § 1014(c).

[7] §§ 72, 402(a) and 408(d)(1), assuming the decedent owner had no nondeductible contributions.  See § 72(b)(1) and (e)(8).

[8] § 691(c)(1).

[9] § 402(c)(9).

[10] Treas. Reg. § 1.408-8, Q&A-5(a).

[11] § 408A.

[12] Treas. Reg. § 1.408A-1, Q&A-1(b).

[13] Treas. Reg. § 1.408A-6, Q&A-14.  One specific exception is the “at-least-as-rapidly” rule under § 401(a)(9)(B)(i).

[14] Treas. Reg. § 1.408A-2, Q&A-4.

[15] § 408A(d)(1).

[16] § 1411(c)(5).

[17] Tax Increase Prevention and Reconciliation Act of 2005, P.L. 109-222, effective for tax years beginning after December 31, 2009.

[18] Prior to this change, only taxpayers having less than $100,000 in modified adjusted gross income could convert a Traditional IRA to a Roth IRA.  Former § 408A(c)(3)(B).

[19] § 408A(d)(3)(A)(i).

[20] See Notice 2008-30, 2008-12 I.R.B. 638 (3/24/2008) and Notice 2009-75, 2009-39 I.R.B. 436 (9/28/2009). § 408A(d)(3)(A).

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The Nature of Particular Assets

  1. Generally

Understanding how and to what extent assets will benefit from a “step-up” in basis is critical to the estate planning process today.  Obviously, certain assets like highly-appreciated assets will benefit more from the “step-up” in basis at death than cash (which has a basis equal to its face value which is equal to its fair market value) or property at a loss (a “step-down” in basis).  Moreover, appreciated assets like gold that are considered “collectibles”[1] under the Code, benefit more from a step-up in basis than other appreciated capital assets because the Federal long-term capital gain tax rate for collectibles is 28%, rather than 20%.

If one were to list asset categories or types, starting with those that benefit the most from the “step-up” in basis and ending with those that benefit the least (or actually suffer a “step-down” in basis), it might look as follows:

(1) Creator-owned intellectual property (copyrights, patents, and trademarks), intangible assets, and artwork;

(2) “Negative basis” commercial real property limited partnership interests;

(3) Investor/collector-owned artwork, gold, and other collectibles;

(4) Low basis stock or other capital asset;

(5) Roth IRA assets;

(6) High basis stock;

(7) Cash;

(8) Stock or other capital asset that is at a loss;

(9) Variable annuities; and

(10) Traditional IRA and qualified plan assets.

A full discussion of every asset type listed above is beyond the scope of these materials, but a number of them deserve additional consideration and discussion and will be featured in the upcoming posts under this topic.

Turney P. Berry

Louisville, Kentucky

[1] § 1(h)(4).

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Community Property and Elective/Consensual Community Property

As mentioned in part one of this series of posts, the Code provides a special rule for community property.  section 1014(b)(6) of the Code provides that “property which represents the surviving spouse’s one-half share of community property held by the decedent and the surviving spouse under the community property laws of any State, or possession of the United States or any foreign country, if at least one-half of the whole of the community interest in such property was includible in determining the value of the decedent’s gross estate”[1] shall be deemed to have been acquired from or to have passed from the decedent.

There are currently nine community property states.: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.  There are two states that are separate property states but they allow couples to convert or elect to treat their property as community property: Alaska[2] and Tennessee.[3]  Generally, these elective or “consensual community property” laws allow resident and nonresident couples to classify property as community property by transferring the property to a qualifying trust.  Generally, for nonresidents, a qualifying trust requires at least one trustee who is a resident of the state or a company authorized to act as a fiduciary of such state, and specific language declaring the trust asset as community property.

Clearly, for residents of separate property states, taking advantage of the “consensual community property” laws of another state has the potential for a basis adjustment under section 1014(b)(6) of the Code.  There has been no direct ruling on whether that would be the case under the laws of Alaska or Tennessee.  However, a number of commentators have argued that assets in such “consensual community property” arrangements would, indeed, receive a full “step-up” in basis under section 1014(b)(6) of the Code.[4]  A professional fiduciary must be designated in Alaska or Tennessee in order to invoke the respective statutes and the administrative expense ought be weighed against the potential benefit, taking into consideration the uncertainty.

Turney P. Berry

Louisville, Kentucky

[1] § 1014(b)(6).

[2] Alaska Stat. 34.77.010 et al.  (Alaska Community Property Act).

[3] Tenn. Code Ann. § 35-17-101 et al. (Tennessee Community Property Trust Act of 2010).

[4] Jonathan G. Blattmachr and Howard M. Zaritsky, Alaska Consensual Community Property Law and Property Trust, __ Trusts & Estates 65 (Nov. 1998), Jonathan G. Blattmachr, Howard M. Zaritsky and Mark L. Ascher. Tax Planning with Consensual Community Property: Alaska’s New Community Property Law, 33 Real Prop. Probate and Tr. J. 615 (Winter 1999).