Estate Planning

Don’t Wait until Time Is Up

Sara K. Osinski —

Lately, friends, family, and clients seem to be asking the same questions: “When should I think about estate planning? Is it actually necessary for me to have an estate plan?” As life is unpredictable, it is better to start planning sooner rather than later. In fact, upon attaining the legal age of majority in your state of residence (typically at age 18), you should begin considering some form of an estate plan. An individual’s estate planning needs, however, vary based on numerous factors, assessed generally in the timeline below.

Your 20s

Individuals in their 20s are typically focused on starting their careers, acquiring assets, and just living life—death is consequently one of the last things on their minds. In fact, many individuals in their 20s do not consider any form of an estate plan and likely do not believe they need one. While a Will or trust may not be necessary for most individuals in their 20s, “ancillary” estate planning documents, such as a power of attorney, healthcare proxy, and living will, should all be considered. These ancillary documents are also known as “living” estate planning documents because they go into effect while you are alive as soon as they are executed. These ancillary documents appoint an agent or agents to carry out your financial or health wishes, as applicable, in the event you become incapacitated, either temporarily or permanently. These documents may also assist in avoiding the need for the appointment of a guardian or conservator if you were to become incapacitated or unable to care for your own financial and/or medical affairs.

In addition to these ancillary documents, individuals in their 20s should also ensure that all of their bank accounts, brokerage accounts, retirements accounts, and life insurance policies have valid beneficiary designations. By designating a beneficiary on these accounts and policies, you not only control the disposition of your assets, but also may effectively avoid probate at death.

Of course, if you get married, divorced, remarried, have children, buy a home, and/or inherit a large sum of money in your 20s (or at any time), then estate planning becomes more crucial (as discussed in more detail below).

Estate Planning

A Different Kind of IPO: Going “Public” with Your Private Foundation

Andrew M. Logan —

Many philanthropically minded clients have established their own private foundations to support charitable causes they believe in now, and to serve as a vehicle for giving for future generations of their family. While many family foundations flourish for multiple generations, many others struggle to survive for a single generation after the founders are gone. In the latter cases, the governing body (e.g., Board of Directors, Trustees, etc.) of the organization may start to consider terminating its status as a private foundation under Section 507[1]. Clients currently serving as directors or trustees should be aware that termination does not necessarily mean shutting down their organization, as one of the ways to terminate a private foundation is to convert to a public charity.[2]

In order to convert from a private foundation to a public charity, the private foundation must operate as a public charity as described in 509(a)(1), (2), or (3) for a continuous 60-month period, commencing on the first day of the tax year after it notifies the Internal Revenue Service (“IRS”) of its intent to terminate as a private foundation (the “Termination Period”).[3] In general, in order to qualify as a public charity, an organization must fall into one of the following three categories: (1) “per se public charities,” such as churches, schools, and hospitals, that qualify by virtue of the nature of their activities; (2) “publicly supported public charities” that qualify because they receive a substantial amount of their support from the public; or (3) “supporting organizations” that qualify as public charities because they support one or more of the organizations described in (1) and (2).[4]

Estate Planning Estate Tax Gift Tax Income Tax Litigation

A Promise Is a Promise: The Enforceability of Charitable Pledges under New York Law

Haley B. Bybee —

Charitable contributions are often utilized in estate planning to assist a client not only in supporting his or her favorite charities but also to reduce tax liabilities both during life and at death. However, before clients agree to make any charitable contributions, they should understand that the agreements between themselves and charitable organizations, such as pledge agreements, can be binding.

Historically, New York courts have favored enforcing charitable pledges as a matter of public policy and in doing so, courts have relied on three common law contract law theories: (1) unilateral contract, (2) bilateral contract, and (3) promissory estoppel.[1]

Courts have most frequently relied on the theory of unilateral contract to enforce charitable pledges.[2] Under that theory, a charitable pledge or promise to make a future gift constitutes a unilateral offer, and “when accepted by the donee charity by the incurring of liability or detriment . . . [the offer] ripens into a binding contractual obligation of the donor and [is] enforceable against him.”[3] There have been numerous cases in which a donor’s promise to make a charitable contribution has been enforced on this ground.

Estate Planning

Transfer on Death Beneficiary Designations for Financial and Real Property Assets

James R. O’Neill —

Transfer on Death (“TOD”), also known as Payable on Death (“POD”), account registrations are a popular way to avoid the requirement to pass assets through probate upon death and operate as an alternative to retitling assets into a revocable trust during life. Typically used with financial accounts, a TOD account registration designates one or more beneficiaries to receive the assets of the account upon death of the account holder directly from the financial institution without the need for probate or estate administration. Similar to designating beneficiaries for retirement and insurance assets, a TOD account registration is accomplished by completing standard beneficiary designation paperwork with the financial institution. Upon the death of the account holder, the designated beneficiary presents to the financial institution a death certificate and documentation that the state or financial institution may require, and the proceeds generally are distributed reasonably promptly. As with a revocable trust, the TOD registration can be changed or revoked at any time during the account holder’s lifetime.

While this technique for avoiding probate is quite easily accomplished, consideration should be given to the overall estate plan, including post-death liquidity needs for taxes and other expenses of the estate, prior to removing assets from the estate through TOD registrations or other beneficiary designations. While accounts with a TOD registration pass outside of the estate with no probate, the assets in the account are subject to estate taxation and generally are not available to the estate for the payment of taxes or other expenses of administration.[1] If all of the decedent’s assets have designated beneficiaries, the question of payment for funeral and other expenses and remaining tax and other obligations of the decedent either requires cooperation among the beneficiaries or becomes a point of contention and potential litigation.

Estate Planning Income Tax

What Makes a Trust Foreign or Domestic—And Why Does It Matter?

Sean R. Weissbart —

Sean Weissbart's headshot photo

The United States is one of two countries in the world that imposes a tax on the worldwide income of its citizens. (The other is the East African country of Eritrea, which imposes a two percent tax on its citizens living abroad, far less than the top rate for U.S. income tax of 37 percent.)

Of course, trusts do not have citizenship like individuals, but trusts that are classified as domestic trusts for U.S. income tax purposes “suffer” the same fate: U.S. income tax is imposed on the worldwide income of the trust even if its income is earned from sources outside the United States or the Settlor and beneficiaries reside outside the United States.

So, what makes a trust a domestic trust and would it be better to avoid this classification? Paradoxically, a trust must meet two tests to be considered a domestic trust, and if it fails either of these tests, it will be classified as a foreign trust.

Capital Gains Tax Estate Planning Income Tax State Tax

NFTs: A Tale of Two Classifications

Sara K. Osinski —

On March 21, 2023, the Department of the Treasury and the Internal Revenue Service (“IRS)” released Notice 2023-27, announcing their intent to provide guidance on classifying certain non-fungible tokens (“NFTs”) as “collectibles,” which could subject owners of NFTs to higher long-term capital gains tax.

Digital assets, such as NFTs and cryptocurrencies, are currently generally classified as “property.” Therefore, under current law, gains from the sale or exchange of NFTs are taxed based on how long such NFT was held by the owner. For instance, if the owner sells an NFT he or she has held onto for one year or less, then the sale of such NFT would be subject to short-term capital gains tax. Short-term capital gains are taxed at the ordinary income rates, and the federal[1] ordinary income tax rates currently range from 10 percent to 37 percent depending on the taxpayer’s taxable income. On the other hand, if the owner sells an NFT he or she has held on to for more than one year, the sale of such NFT would be subject to federal long-term capital gains tax. Long-term capital gains are subject to federal tax at a rate of zero percent, 15 percent, or 20 percent depending on the taxpayer’s taxable income.

Estate Planning Exemption Capture Planning Generation-Skipping Transfer (“GST”) Tax

Proposed Resurrection of the Common Law Rule against Perpetuities—At Least for GST Tax Purposes

Kyle G. Durante 

There is one common law rule that haunts most law students, and many legal practitioners: “no interest is good unless it must vest, if at all, not later than twenty-one years after some life in being at the creation of the interest.” This rule, known as the rule against perpetuities, has many applications, but, most importantly, it limits the duration that an irrevocable trust may remain in existence. This rule was initially adopted in an effort to limit dead-hand control over property by requiring property to vest in a beneficiary within a certain period of time.

Generally, at common law, an irrevocable trust could remain in existence for a period of time not exceeding 21 years after the death of all members of a particular class of persons who were alive at the time the perpetuities period began. For an irrevocable trust, generally, the perpetuities period will begin on the date the trust was created. While some states, such as New York,[1] continue to follow the common law rule, a number of states, such as New Jersey, Pennsylvania, Delaware, and South Dakota,[2] have completely abrogated the rule, while others have extended the period of time that an irrevocable trust may remain in existence, such as Connecticut (which applies an 800 year period in gross) and Florida (which applies a 1,000 year period in gross).

Estate Planning Income Tax Spousal Rights

Beware of the SLAT Divorce Trap

Andrew M. Logan

The Spousal Lifetime Access Trust, or SLAT, has become one of the most popular estate planning strategies employed by married couples. It is an irrevocable trust created by one spouse (the “grantor”) for the benefit of the other spouse and, usually, other family members. Like many irrevocable trusts, the assets transferred to a SLAT, along with any appreciation generated after the transfer, should be removed from the grantor’s and beneficiary-spouse’s estate for estate tax purposes. One of the unique benefits of a SLAT is that it allows the grantor to retain indirect access to the trust’s assets through distributions to the beneficiary-spouse. SLATs seemingly provide a way for grantors to “have their cake and eat it too,” but there may be unanticipated tax consequences to the grantor if the marriage to the beneficiary-spouse ends in divorce.

Because the grantor’s spouse is a beneficiary, a SLAT is usually taxed as a so-called “grantor trust” for income tax purposes. This means that the grantor is responsible for paying the SLAT’s income and capital gains taxes, even though the SLAT’s assets have been removed from the grantor’s estate for estate tax purposes. Under current law, the grantor’s payment of the SLAT’s income tax liabilities is in effect an additional tax-free gift to the SLAT each year. These payments allow the assets of the SLAT to grow without being depleted by the payment of income taxes.

As long as the grantor and the beneficiary-spouse are married, they will both be able to reap the benefits of the SLAT.[1] However, if they divorce, the grantor will not only lose indirect access to the SLAT’s assets, but will also remain liable for its income taxes if the beneficiary-spouse remains a beneficiary of the SLAT following the divorce.[2] Section 672(e) of the Internal Revenue Code , the so-called “spousal unity rule,” provides that the grantor is treated as holding any power or interest held by the grantor’s spouse at the time the power or interest was created, even if that individual subsequently ceases to be the grantor’s spouse.

Consider the following example. In 2020, George created a SLAT for the benefit of his then spouse, Sally, which provided for discretionary income and principal distributions to Sally during her lifetime. In 2023, George and Sally divorced and the trust agreement provides that Sally will continue to be a permissible beneficiary of the SLAT even after a divorce. Accordingly, following the divorce, the SLAT will likely remain a grantor trust as to George because the spousal unity rule only looks at when Sally’s interest in the trust was created, and not at the time of the George and Sally’s divorce. This means that George will continue to be responsible for paying the taxes[3] on the SLAT’s assets, even though he no longer has indirect access to the trust property.[4] Fortunately for couples who are contemplating creating a new SLAT, the effects of the “divorce trap” can be mitigated with proper planning and structuring. For couples with existing SLATs, they should carefully review the trust terms to confirm what happens in the event of divorce. It may be possible to address the “divorce trap” issues in a post-nuptial agreement and/or a trust modification or decanting.

[1] Of course, if the beneficiary-spouse predeceases the grantor, the grantor would then lose his or her indirect access to the trust property.

[2] The trust agreement will typically address the beneficiary-spouse’s interest in the SLAT following a divorce. The trust agreement may provide that the beneficiary-spouse will continue to be a beneficiary following a divorce or will cease to be a beneficiary. The spousal unity rule is only implicated if the beneficiary-spouse continues to be a beneficiary following the divorce.

[3] In a number of states, the trust agreement can include a provision authorizing an independent trustee, in the independent trustee’s discretion, to make distributions to the grantor to reimburse the grantor for the income tax liabilities of the SLAT. If this reimbursement provision is structured correctly, it should not result in the assets of the SLAT being includable in the grantor’s estate for estate tax purposes.

[4] Prior to the Tax Cuts and Jobs Act of 2017, following a divorce from a spouse who continued to be a beneficiary of a SLAT, if distributions were made to the former spouse, the SLAT’s taxable income, up to the amount of distributable net income, could have been carried out to the spouse, potentially reducing the income to be reported on the grantor’s personal income tax returns. However, following the 2017 Act, this is no longer the case, and the grantor must carry the full amount of the SLAT’s income tax liabilities on his or her personal returns, regardless of whether distributions are made to the former spouse.

Estate Planning

Before You Pack Your Swimsuit. . .

Haley B. Bybee —

With most of the world finally back open to visitors, people are more eager to travel than ever before. Whether you are planning an African safari, a Caribbean cruise, or the ultimate Patagonia adventure, your pre-travel checklist should always include a review of your estate plan and related documents. So, before you pack your swimsuit for your next vacation, follow the steps outlined below.

  1. Call Your Estate Planning Attorney. Often, clients wait until the week before their trip to contact their attorneys about putting together an estate plan. Although it is possible to prepare and execute a set of estate planning documents within a week, it is preferable to give yourself time to consider your estate planning options and make thoughtful decisions. Depending on the complexity of your estate plan, it could take anywhere from weeks to months to complete your plan. For that reason, as soon as your book your trip (or well before you book your trip), give your attorney a call to discuss your estate plan.
  2. Review or Execute a Power of Attorney and Healthcare Proxy and Discuss with Your Agents. Clients are sometimes surprised to know that their “estate plans” include documents that are effective during their lifetimes. Financial Powers of Attorney and Healthcare Proxies allow you to name an agent who may make financial decisions and healthcare decisions, respectively, on your behalf. These documents are often coupled with a Living Will and Health Insurance Portability and Accountability Act (“HIPAA”) Authorization, which will guide your agents in their decision making and give them access to essential information about your health. Before you embark on your next voyage, you should not only execute these documents but also advise your designated agents of your travel plans, your banking information, healthcare wishes and, crucially, where the original documents are located. You may also wish to send copies of the documents to your agents. In the unlikely event of an accident, your agents should be ready to act and know where to find your Power of Attorney, Healthcare Proxy, Living Will, and HIPAA Authorization.
  3. Name Guardians for Your Minor Children. Whether you are bringing your children with you or traveling solo, you should name a guardian for your minor children in your Will or in a separate document. If you fail to name a guardian for your children, after your death a court will independently select a guardian. When selecting a guardian, it is important that you discuss the decision with your child’s other parent[1] and the potential guardian. You may also include special language in your Will expressing your wishes about your child’s schooling, extracurricular activities, and general care. In addition, you may give the named guardian specific funds that may be used to renovate the guardian’s home to allow your children to comfortably live with him or her. It is recommended you revisit your guardianship designations before your vacation and every few years to ensure that the named guardian is still willing and capable of caring for your minor children.
  4. Sign Your Will and Trust. Wills and trusts are the backbone of every estate plan. They contain instructions that direct the disposition of your assets. Trusts are a particularly useful tool for avoiding probate and reducing administrative burdens in the administration of your estate. Clients generally have an idea about how they would like their assets to be distributed upon death but sometimes have difficulty determining who to name as beneficiaries if none of their descendants or close relatives survive them. Clients frequently name charities or their “heirs-at-law” (i.e., closest living relatives) as so-called “contingent beneficiaries.” Although it is unlikely that contingent beneficiaries will ever benefit from your estate, it is important to identify them in your estate plan, especially when the entire family is going on vacation together. For instance, consider the Steinberg family, late of Scarsdale, New York, who were all killed in a plane accident in Costa Rica on December 31, 2017.
  5. Tell Your Friends and/or Family Where to Find Your Documents. After taking the time to prepare and sign your estate planning documents, it is crucial you advise your friends or family where to find such documents. Copies of some documents may be accepted by some institutions, but it is important that your friends or family know where originals are kept. It is also important that your documents are accessible to your friends or family. For example, your friends or family may not have access to your safety deposit box. For that reason, we always recommend that your attorney keep an original set of your documents, and you give your attorney’s contact information to your friends or family.

Ultimately, completing your estate plan before you leave town will allow you to know that (1) someone trustworthy will be making decisions on your behalf in the event of an accident and (2) your loved ones are taken care of in the event of your death. So, before you pack your swimsuit to go scuba diving at the Great Barrier Reef, swimming with the sharks in the Maldives, or relaxing with a drink on the beach in the Seychelles, give the Tax, Benefits, and Private Client practice group at Blank Rome a call.

[1] It is strongly encouraged for both parents to name the same guardians in their Wills as the Will of the second parent to die will control who is appointed as guardian. This is typically not a concern for parents who are in an intact marriage, but issues may arise when parents are separated or divorced.

Estate Planning Estate Tax Exemption Capture Planning Gift Tax

IRC Section 2701 and Gifts of Carried Interests

James R. O’Neill —

James O'Neill's headshot photo

The transfer in the course of estate planning of a fund manager’s carried interest early in the life of a fund (when the carried interest has a modest value) can be an attractive way in which to remove anticipated future appreciation from the manager’s estate at a nominal gift tax cost. However, any transfer of a carried interest could be subject to the special valuation rules of Internal Revenue Code (“IRC”) Section 2701 and result in an unexpected deemed gift and substantial gift tax liability. If the entire carried interest is transferred, the capital interest in the fund retained by the manager may be valued at zero for gift tax purposes under Section 2701, and the manager may be deemed to have made a gift of his entire interest in the fund, including his capital interest, rather than just the carried interest.

One way to achieve the desired estate planning result and avoid the applicability of Section 2701 is the sale of a derivative, based on the performance of the manager’s carried interest, rather than a transfer of the carried interest itself. Typically, the sale would be made to an intentionally defective grantor trust (also simply known as a “grantor trust”) for the benefit of family members. The use of a derivative contract to transfer the value of the carried interest does not require the actual transfer of the carried interest itself, thereby avoiding the applicability of Section 2701. Under this approach, the manager enters into a derivative contract with the trust agreeing to pay the trust at a future settlement date, usually set near the end of the fund’s life, the fair market value of the carried interest on the settlement date. For more aggressive planning, the payment may be set in the derivative contract as a multiple of the value of the carried interest on the settlement date. The derivative contract also can be structured so that the payment is required only after the carried interest has exceeded a certain total return, using a hurdle amount. For its part, the trust pays to the manager upon execution of the derivative contract the present value of the trust’s right to receive the future payment on the settlement date. That present value is determined by an appraisal of the trust’s future right (at current fair market value) upon execution of the derivative contract, which is generally significantly less than what the trust will actually receive upon the settlement date.

For example, if the present value of the trust’s right to receive the future payment based on the carried interest is appraised currently at $500,000, the trust pays the manager that amount upon execution of the derivative contract. If the value of that carried interest is five million dollars at the future settlement date, the manager pays to the trust that five million dollars on the settlement date at conclusion of the term of the derivative contract. A gift tax return is filed to report the sale to the trust (and a zero-dollar gift) of the appraised value of the derivative based on the carried interest to start the running of the statute of limitations for the Internal Revenue Service to audit the gift tax return. Given that the derivative was sold to the trust and there is no reportable gift value, there are no gift tax consequences associated with the sale.