On December 11, 2001, I’ll be giving a seminar on “Key Issues in Estate Planning and Probate in Oklahoma”, which is sponsored by the National Business Institute.  These are my seminar notes, which ought to be of interest to some of the visitors to my website.

I.  Shifting Value and Transferring Interest; Overview of Federal Estate and Gift Tax Laws


A.  Generation-Skipping Transfer Tax

        a. Generation Skipping Transfer Tax
        b. Application of GST
        c. Direct Skips
        d. Taxable Termination
        e. Taxable Distributions
        f. Examples
                i.    Lifetime Direct Skips
                ii.   Testamentary Direct Skip
                iii.   Lifetime Taxable Termination or Distribution
                iv.   Testamentary Taxable Termination or Distribution
        g. Deductions: Inclusions and Exclusions
        h. Summary

 B.  Methods Of Effectuating Lifetime Transfers

         a.  Gifts
                i. Gift taxes
                ii. Income Taxes
         b. Sales
         c.  Other Types Of Conveyances
                i. Life Estates
                ii. Term of Years
                iii.  GRITS, GRATS, and GRUTS
                       (a). GRITS
                       (b). GRATS and GRUTS

C.  Alternative Methods Of Transfer

         a.  Private Annuities
         b.  Life Insurance And Other Irrevocable Trusts
         c.  Charitable Remainder Trust
         d.  Pooled Income Funds
         e.  Charitable Lead Trusts

II.  Protecting The Passage Of Wealth

A.  Techniques To Decrease Transfer Taxes

         a.  Determine Net Worth First
         b.  The Gross Taxable Estate
         c.  Marital Deduction
         d.  Death of First Spouse
         e.  Using ERISA Contributions To Fund The By-Pass Trust

B.  Strategies To Reduce Income Taxes

        a.  Fiduciary Return  
        b. Decedent’s Returns

C.  Addressing The Issue Of Special Assets

         a. A Brief Introduction To Discount Gifting
         b. Using ERISA Assets For Charities

I.  Shifting Value and Transferring Interest; Overview of Federal Estate and Gift Tax Laws


            When Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”), many changes were made to the Gift and Estate Tax statutes, the most significant of which was the repeal of estate taxes for persons dying in the year of 2010.  If a wealthy person dies in 2011, however, estate taxes must again be considered.  The “Sunset Rule” is the culprit to the legislation, and before we consider other topics, we must first understand what the Sunset Rule is.  Under a procedure enacted in 1974, rules were established which dealt with Congressional Budgets.  One of the rules, known as the Byrd Rule (Senator Byrd from Virginia), made part of the Budget Act of 1990, permits any member of Congress to raise a point of order against extraneous provisions being included in a budget reconciliation bill. If reducing taxes might increase the deficit for a fiscal year beyond the years covered by the reconciliation matter, the law requires 60 Senators to vote in favor of the tax legislation. Failing to attain such a vote means the tax legislation can last no longer than 10 years.  

            Less than 60 Senators voted in favor of EGTRRA, so EGTTRA will expire on December 31, 2010 (unless Congress changes the law again).  So in considering estate taxes, we must remember that the rules have changed, but not forever.

A.  Generation-Skipping Transfer Tax

Probably the beginning point in any Seminar on the Generation Skipping Transfer (“GST”) Tax is to begin with an explanation of how estate taxes are computed; after this, we’ll then explain how to compute the GST tax.  To compute Federal Estate Taxes, the gross estate is tallied, and the tax is then computed using the tax table reproduced below on page two.  Excluded from the gross estate are property interests passing to a surviving spouse which qualify for the marital deduction.  

Let’s take an example.  Suppose Uncle Fred dies in 2001, and leaves his nephew as his sole heir, and that Uncle Fred’s taxable estate is $1,500,000.  Using the tax table below, one can determine the tax to be $555,800.  Let’s also assume Uncle Fred’s estate is entitled to take the entire unified credit of $220,550.  The net tax due to the IRS is the difference between the two, or, $335,250 ($555,800 less $335,250).  IRC §2001

EGTRRA increases the amount of the unified credit over time.  Using the same example, if Uncle Fred dies in 2004, the tax is still the same – $555,800 – but the unified credit increases to $555,800.  Thus, the nephew will inherit $1,500,000, without paying any estate taxes.  Here is the new unified credit table applicable to decedents (the gift tax side of the equation is dealt with later in the outline):

YearTax RateEstate Tax ExemptionEstate Credit
200250%$1,000,000. $345,000.
200349%$1,000,000. $345,000.
200448%$1,500,000. $555,800.
200547%$1,500,000. $555,800.
200646%$2,000,000. $780,800.
200745%$2,000,000. $780,800.
200845%$2,000,000. $780,800.
200945%$3,500,000. $1,455,800
201155%$1,000,000. $345,000.

Here are the tax tables themselves:

Gift and Estate Tax Rates 2001

 Over Not Over Pay+ % on Excess   Of The Amount Over
$3,000,000 $1,290,80055% 

Unified Estate & Gift Tax Credit 2001

Unified CreditExclusion Amount

When Congress passed EGTRRA, the concept of the “unified credit” was modified.  A credit against gift and estate taxes is available, but since Congress did not repeal the gift taxes, changes were made relating to the credit available for gifts (see page six of outline).  

Generation Skipping Transfer Tax.  Although most financial advisors, attorneys or CPAs will never have a client whose heirs are faced with a GST, one must still understand the concept:  the tax on a GST is basically a surcharge made for passing wealth to grandchildren (and other “skip persons”).  A generation skipping transfer (GST) comes about when ‘generation-skipping’ transfers are made to persons more than one generation below the transferor’s generation. The taxable event occurs in four situations: a lifetime direct skip, a testamentary direct skip, a lifetime taxable termination or distribution, or a testamentary termination or distribution.  Stated differently, the tax is owed on three types of GST transfers: taxable terminations, taxable distributions, and direct skips.  

There are several concepts to consider.  First, the GST rate is the maximum estate tax rate, which is 55% through 2001, 50% in 2002, 49% in 2003, 48% in 2004, 47% in 2005, 46% in 2006, and 45% for 2007 through 2009. Under EGTRRA, the GST is repealed in 2010, but then is reinstated (at 55%) in 2011 (when the act “sunsets”).  IRC §§2601-2663

Second, there is a GST exemption of $1,000,000 for every donor, which is indexed for inflation through 2003; the exemption for the year 2001 has been adjusted to $1,060,000.  Under EGTRRA, the exemption is increased to $1,500,000 in 2004 and 2005, $2,000,000 in 2006 through 2008, and $3,500,000 in 2009.  If the act sunsets in 2011, the exemption will return to the inflation-adjusted sum of $1,000,000.

Third, since the GST is (a) a flat tax, (b) imposed at the highest estate tax rate applicable to any transfer of property (lifetime or death), annual gifts of $10,000 or less (the exclusion will be $11,000 in 2002; and $20,000 or $22,000, depending upon when the gift will be made, for spouses who make gifts) should be considered as a valuable estate planning tool, since these gifts are not subject to the GST.  In addition, a donor may also make annual “qualified transfers”, which are not subject to the GST.  Qualified transfers include:

  • Tuition paid to an educational institution that meets the IRS income tax deductible contribution eligibility guidelines.
  • Payments made to a medical care provider by the transferor for such care.

“Qualified transfers” are not subject to any dollar amount limitations so long as they meet the IRC §2503(e) criteria, which is the section dealing with “qualified transfers”. 

Application of GST.  With this background in mind, let’s explore how the GST applies. There are basically three types of generation skipping transfers:

Direct Skips – Any transfer that is subject to any estate (see IRC Chapter 11, §§2001-2210) or gift (see IRC Chapter 12, §§2501-2524) taxes made to a skip person.  A ‘skip person’ is 

(1)   a natural person assigned to a generation which is 2 or more generations below the generation assignment of the transferor, or
(2)   a trust—
         (A) if all interests in such trust are held by skip persons, or
         (B) if—
                (i) there is no person holding an interest in such trust, and
                (ii) at no time after such transfer may a distribution (including distributions on termination) be made from such trust to a nonskip                              
                person.  IRC §2613(a)

Explanatory regulation:  No person holds an interest in the trust and no distributions, other than a distribution the probability of which occurring is so remote as to be negligible (including distributions at the termination of the trust), may be made after the transfer to a person other than a skip person. For this purpose, the probability that a distribution will occur is so remote as to be negligible only if it can be ascertained by actuarial standards that there is less than a 5 percent probability that the distribution will occur.  Reg § 26.2612-1(d)(2)(ii).

Taxable Termination – Any termination of an interest of any beneficiary in a trust unless: a) a non-skip person has an interest in the property, or b) no distribution can be made from the trust to a skip person after the termination.

Taxable Distributions – Any distribution other than a Direct Skip or a Taxable Termination made to a skip person.  Thus, a taxable distribution is any distribution from a trust to a ‘skip person’, other than a taxable termination or a direct skip. The distribution is subject to generation-skipping transfer (GST) tax whether it is made out of trust income or corpus. 

Examples:  To put some meat on the bones, so to speak, let’s consider how this actually works.

Lifetime Direct Skips. First, assume a grandparent has an estate valued at $25,000,000. The grandparent wants to benefit the grandchildren by giving the grandchildren $3,000,000 (assume there is one grandchild). If the gift were made in the year 2001, as a “lifetime direct gift”, it will take $7,207,500 of resources to complete the gift.  Here is how the tax is computed:

The amount to be given to grandchild$3,000,000.
GST applicable rate:55%
Estate/Gift tax rate:55%


GST tax ($3,000,000 x 55%)$1,650,000.
Gift Tax on Gift ($3,000,000 x 55%)$1,650,000.
Gift Tax on GSTT ($1,650,000 x 55%)$907,500.
Total Taxes$4,207,500.
To make a transfer of $3,000,000 it takes$7,207,500.

Testamentary Direct SkipLet’s say the same grandparent wants to leave his grandchild $3,000,000.  To do this through a testamentary gift takes $10,333,333.

Federal Taxable Estate $10,333,333.
GST applicable rate:55%
Estate/Gift tax rate:55%


Federal Estate tax ($10,333,333 x 55%)$5,683,333.
Amount remaining before GSTT$5,683,333.
GSTT ($3,000,000 x 55%)$1,650,000.
Gift remaining for grandchild$3,000,000.

Lifetime Taxable Termination or Distribution.  Suppose the grandparent has established an inter vivos trust, through which a gift is made to a grandchild when a non-skip person dies (i.e., the son of the grandparent).  Assume also there is no change in values of the trust corpus over time, and that the tax is paid out of the property which will ultimately go to the grandchild.  Here is the computation:

Beginning Amount Needed for $3,000,000 gift$10,333,333
GST applicable rate:55%
Estate/Gift tax rate:55%


Federal Estate tax$3,666,666.
Amount remaining before GSTT$6,666,667.
GSTT ($6,666,667 x 55%)$3,666,667.
Gift remaining for grandchild$3,000,000.

Testamentary Taxable Termination or Distribution.  Suppose the grandparent has established a testamentary trust, through which a gift is made to a grandchild when a non-skip person dies (i.e., the son of the grandparent).  Assume also there is no change in values of the trust corpus over time, and that the tax is paid out of the property which will ultimately go to the grandchild.  Here is the computation:

Beginning Amount Needed for $3,000,000 gift$14,814,814
GST applicable rate:55%
Estate/Gift tax rate:55%


Federal Estate tax$8,148,148.
Amount remaining before GSTT  $6,666,667.
GSTT ($6,666,667 x 55%)$3,666,667.
Gift remaining for grandchild  $3,000,000.

Deductions: Inclusions and Exclusions. Every U.S. Citizen is entitled to an exemption, IRC §2631, which may be applied to generation skipping transfers.  The question is, of course, how does this work?  A calculation must be made to determine what can be excluded from the gift.  First, we must determine the “exclusion ratio” by dividing the total value of the gift by the amount of the exemption.  

Suppose granddad and grandma give $4,000,000 to their grandson in 2001.  Both are entitled to deduct an annual gift exemption of $10,000, so the net gift is $3,980,000.  Now we shift into higher math.  First, divide the net gift of $3,980,000 by the $1,060,000, which is the GST exemption permitted for the year 2001.  This produces a factor of .26633166; subtract this number from 1, to compute the inclusion ratio (.7337).  Multiply the inclusion ratio by the applicable maximum estate tax rate (.55 for 2001), to yield the applicable tax rate of .4035.  The tax rate is multiplied by the gift of $3,980,000, to compute the GST tax of $1,606,000.

This same principle applies to wills and trusts; it is advisable to give the Executor or Successor Trustee the power to allocate the GST exemption.  Here is some verbiage which permits such an allocation:

After the decease of both Settlors, Settlors authorize and empower the Trustee to exercise, in Trustee’s sole and absolute discretion, any elections and options given to it by any provision of the Internal Revenue Code, and other statute or Regulation, state or federal, governing the administration of the Settlors’ estate(s) with respect to the following:

(i). Allocating Generation-Skipping Tax Exemption.  To exercise the power to allocate any exemption from the federal tax on generation-skipping transfers provided by IRC §2631 et. seq. to any property with respect to which a Grantor is treated as the transferor, without regard to whether such property is part of a Grantor’s probate estate, and to exclude any such property from such allocation.

(ii). Division of Trusts for Inclusion Ratio Under Generation-Skipping Tax.  To divide any trust created hereunder into separate trusts in order that the inclusion ratio for federal generation-skipping tax purposes for one such trust shall be zero or one.

With respect to the powers granted in paragraphs (i) and (ii) and the paragraph preceding those two paragraphs, Trustee shall have no liability for or obligation to make compensating adjustments between principal and income or in the interests of the beneficiaries by reason of having made or not made any such election.  Any decision made by the Trustee in good faith with respect to the exercise or non-exercise of any such elections shall be binding and conclusive on all interested persons.

Summary.  Suffice to say, if you encounter a GST situation, you should conduct an in-depth analysis, and do lots of research.  This portion of the outline is only an introduction to the subject. 

B. Methods Of Effectuating Lifetime Transfers

For tax purposes, there are only two means of making lifetime transfers: gifts and sales.  Although these categories seem airtight, as with most things in life, these classifications are not always treated as they seem.  So let’s begin with a refresher course on gifts, then we’ll turn to sales.


There are three elements to a gift, which are, a donor intends to make a gift, he completes the gift by delivery to or for the donee, and the donee accepts the gift.  All three elements are required in order to effectuate a completed gift (incomplete gifts are not gifts).  

Gift taxes.  Once a gift has been completed, one must consider the tax ramifications.  In Oklahoma, there are no gift taxes.  However, there are gift taxes at the federal level, and have been since the Revenue Act of 1924.  Although gift taxes have been repealed and reenacted over the course of time, the federal government imposes the tax as an excise tax upon the privilege of making a transfer by gift.  This tax applies to transfers made in trust or otherwise, and to transfers, direct or indirect, of property, be it real or personal, tangible or intangible (IRC § 2511).  

For tax purposes, only completed gifts are taxed, and control of the property is a key issue.  If a “gift” is made to a revocable trust, the grantor still has control of the trust, so the gift is considered as being incomplete, and there are no gift tax ramifications.

Let us assume a completed gift has been made, and gift taxes must be paid.  The gift tax rates are the same as shown on page two; the effective exemption amount is different from estate taxes, beginning in 2004.  After the repeal of estate taxes in 2010, we still have gift taxes to pay (the rates will be the highest income tax rate, currently scheduled to be 35%).  In the year 2010, the estate tax “step-up” in basis is repealed, which means, the heirs of an estate will have the same tax basis as the decedent (for capital gains purposes).  There are two exceptions – spouses leaving property to widows or widowers are entitled for a step-up in basis, up to $4.3 million), and the first $1.3 million in assets transferred to anyone else is entitled to a step-up in basis.  Here are the new gift tax exemptions:

YearTax RateGift Tax ExemptionGift Credit

            In addition to the lifetime gift tax exemptions, donors may deduct the annual exclusion.  The gift tax annual exclusion – $10,000 per donee, for the year 2001, $11,000 for 2002 – is not allowed for gifts of future interests in property.  A future interest is an interest in property, where the right to use, possess, or enjoy the property is postponed until a future date. Although a future interest may vest immediately in the donee, it will be deemed a future interest for gift tax purposes, if the donee cannot enjoy or use it presently. IRC § 2503(b)(1); Reg § 25.2503-2. Future interests include reversions, remainders, and other interests or estates, whether vested or contingent, which do not commence in use, possession, or enjoyment until some future time. Future interests must be reported at their full value for gift tax purposes, but the annual exclusion may not be used. 

Income Taxes.  Once a completed gift has been made, logic would suggest that any income derived from the gifted property be attributed to the donee. That is not always the case.  A starting point in understanding the income tax consequences of a gift requires some knowledge of Helvering vs. Clifford, 309 US 331 (1940).   George Clifford, Jr. appointed himself as trustee of a 5-year trust, and named his wife as beneficiary.  After 5 years the trust corpus returned to Mr. Clifford.  Mr. Clifford had no right to revoke the trust, and the trust stated the income was restricted: it could only be used for the benefit of his wife.  When the case reached the Supreme Court, Justice Douglas held the income was taxable to Mr. Clifford under the general definition of income, formerly Section 22 (a) of the Revenue Act of 1934, now found in Section 61 of the Internal Revenue Code.  Justice Douglas stated:

“So far as dominion and control were concerned, it seems clear that the trust did not effect any substantial change.”

This case created the “Clifford Doctrine”, which Congress codified in 1954.  Thus, when a grantor creates a trust, in many instances the income will be attributed to the grantor (under the codified Clifford Doctrine), not the grantee.  If the grantor gifts property to an irrevocable trust, income earned thereon may be attributed to the grantor.  This topic will be more fully developed later in the outline.


The only other means of effecting of a conveyance, if it is not a gift, is by a sale.  The difficulty with a sale is the seller will be subject to capital gains taxes, and may be subject to recapture of depreciation taken on the property (which is treated as ordinary income).  If the sale is made for inadequate consideration, the IRS might contend that it is a gift.  Because sales are not really part of the topics covered in this seminar, I will not discuss them anymore.

Other Types Of Conveyances

As a freshman in law school, I was taught that property had many attributes, and that each attribute should be considered as a stick – and that the characteristics of property could be analyzed as if property were simply a bundle of sticks. With that analogy fixed in my mind, the professor then began delineating different types of conveyances, each having different characteristics.  

We will use that analogy at this point in the outline, because we are going to consider conveyances of property which are not absolute conveyances; specifically, we will discuss life estates, term of years, GRITS, QPRTs, GRATS and GRUTS.  In each instance, the conveyance made by the grantor splits the ownership interests into something less than what the grantor owns.            

Life Estates

A life estate is created by a conveyance, typically a deed, in which the grantee is given an interest in property for the term of the grantee’s life; when the grantee dies, the remainder interest then becomes vested in whomever the grantor has named in the original conveyance.  A variation of a life estate may be accomplished in a trust:  the trustee is directed to retain title to the property for the life of a person, and upon that person’s death, to convey the remainder interest to another person (or persons).

What are the attributes of ownership, in a life estate?  The life tenant owns the property to the exclusion of anyone else, until death.  Take this example.  The grantor conveys the real estate to himself, for his life or some other life.  The life tenant has possession or enjoyment, or the right to income, during his lifetime.  Upon the death of the life tenant, the property passes to whomever is named as the remainderman.  If this type of conveyance is made by deed (not by a trust instrument), the life tenant can sell his or her interest to someone else.  The buyer in such a case will enjoy the property so long as the seller is alive.  When the seller (the life tenant) dies, the buyer’s interest in the property ends.

Now let’s explore a technique using life estates. During the past few years, many children are concerned about whether they will receive an inheritance when their parents die. Their primary fear is that the inheritance will be lost if the parent is placed in a nursing home, when DHS pays for nursing home bills.  When the parent dies, DHS will demand reimbursement from the estate of the decedent, dollar for dollar, for all expenses paid for by DHS.  

One technique that has been used, with limited success, is the creation of a life estate in the parent, with a remainder interest in the children.  Using actuarial tables, it is possible to compute the value of the life estate.  Suppose a 70 year old parent who is in a nursing home conveys his $100,000 home to himself in October of 2001 (assume an applicable Section 7520 rate of 5.8%), for life, and on his death, the remainder goes to his son.  The value of his life estate can be computed, and for your information, is worth $49,992.  

If the donor is in the nursing home, and owns a life estate in real estate worth $49,992, DHS will not pay for nursing home benefits, to the extent of the value of the life estate – so if a nursing home charges $3,000 a month, DHS will not pay for benefits for 17 months ($3,000 x 17 = $51,000).  After 17 months in a nursing home, with the $3,000 a month being paid for by the parent, it would appear that DHS would begin to pay for nursing home benefits in the 18th month, if we assume the parent had less than $2,000 in cash assets at that time.  When the parent dies, there is no probate of the remainder interest, since it vests immediately in the son.  Under this scenario, however, the question must be asked, who will live in the home and take care of it while the parent is in the nursing home?  If the home is rented, then the income from the rental might disqualify the parent from DHS assistance, if the parent’s income is too much (i.e., more than DHS permits).

Let’s not forget gift taxes: if the life estate is worth $49,992, then the remainder interest is worth $50,008 ($100,000 less $49,992).  This gift is a future interest, and will not qualify for any annual exclusion.  Presumably, the parent will use part of the lifetime gift tax credit, so the parent will not have to pay the gift tax (which is $23,800).

Nor should we overlook federal estate taxes: under Section 2036 of the Internal Revenue Code, all property transferred by a decedent, in which he retains an interest for life, is included in the gross estate of the decedent.  Thus, there are no particular estate tax benefits to creating a life estate. 

Transfers which are to take effect only at death are included in the grantor’s taxable estate, under IRC Section 2037, if the decedent retains a reversionary interest worth 5% or more of the value of the property.  In addition, transfers made for insufficient consideration are taxable and are included in the estate under Section 2043, and as well as revocable transfers, which are included under Section 2038.  

Term of Years

Although terms of years are not the sorts of things people think of, when they are planning their estates, the concept is very similar to a lease of real estate – however, the owner for the term of years actually owns the property during that time.  The primary application I’ve used in creating a term of years is in a pre-nuptial agreement, where the prospective husband will grant the prospective wife a term of years (not to exceed her life-time), for his home (where they both will live).  The normal provision in the ante-nuptial agreement is that if the husband dies, and the wife then remarries or co-habits with another person of the opposite sex, the term of years will terminate and the property will then belong to the remaindermen. 

The other applications for terms of years are things that were once very popular, but have now slipped into some disfavor, viz., grantor retained annuity trusts, grantor retained income trusts, and grantor retained unitrusts.  In these trusts, the grantor retains an interest in irrevocably transferred property.  The remainder interest passes to the designated beneficiaries at the end of a specified term, or the grantor’s death.  Each of these types of conveyances deserves a bit more explanation.


GRITS.  A Grantor Retained Income Trust (GRIT) or a Qualified Personal Residence Trust (QPRT), is an irrevocable trust, where the grantor retains an income interest in property for a term of years.  After the term of years, the trustee conveys the remainder interest to named beneficiaries.  Although there is a “future interest” involved, viz., the portion which will be conveyed to the remainder beneficiaries, we must nonetheless consider the gift tax aspects of a GRIT.

Stated differently, when the trust is funded, a future gift is made.  The value of the gift is the excess of the FMV of the transferred property, less the value of the term of years (i.e., that which is retained by the grantor).  To make such a computation, we simply multiply the fair market value of an annuity factor times the term of years.

Assume a 7.6 discount rate, and a term of years of 10 years.  Also assume the grantor places property having an initial value of $100,000 into the trust.  If the grantor is 65 year olds, his interest is worth $63,458.  Subtract this amount from $100,000, to determine the portion of the gift subject to gift tax:  $36,542.  Because this gift is a future interest, it will not qualify for the annual exclusion.  The grantor will have to use all or part of his remaining unified credit, or pay gift tax.  If the grantor is a bit younger, then the value of the grantor’s retained interest might actuarially be 100%.  This would eliminate any gift tax liability.

The advantage of a GRIT is that an individual can transfer a significant value property to others, but pay little or no gift tax.  

A GRIT is, of course, a grantor trust, which means that all income, deductions and credits are treated as if there is no trust and these items are attributable directly to the grantor. 

Should the Grantor die during the term of years, the entire trust principal will be included in the Grantor’s estate, because he owns an interest which does not end before his death.  If gift tax were paid at the outset, then the total estate taxes would be reduced.  If the unified credit were used at the outset, to “pay for the gift tax”, then upon the death of the Grantor, the portion used would be restored to the estate. As a means of purchasing discount dollars to pay for estate taxes, a remainderman beneficiary might purchase life insurance on the life of the grantor, for a term of years.

Under Chapter 14 (special valuation rules), the Internal Revenue Code (§2702) limits the benefits of GRITs, where family members are remainder beneficiaries.  The Treasury tables ordinarily used to value trust interests are disregarded, and retained interests are valued at zero. Thus, a grantor will have 100% gift tax liability, if, after the term of years, the trust corpus is transferred to family members. A “member of the family” means (1) the individual’s spouse, (2) any ancestor or lineal descendant of the individual or the individual’s spouse, (3) any brother or sister of the individual, and (4) any spouse of any individual described in (2) or (3).  Family members do not include nieces and nephews.

One exception to the Chapter 14 rules is an incomplete gift.  If the gift is incomplete, then the property is included in the donor’s estate.  Another exception to the Chapter 14 rules might be the Grantor’s home. A Qualified Personal Residence Trust, or QPRT (sometimes called a ‘residence or house GRIT’), is a safe harbor from the Chapter 14 rules. Suppose a grantor creates a QPRT by transferring his personal residence to a trust and retains the right to use the residence without the payment of rent for a specified period of time. At the end of that period, the residence either passes outright to beneficiaries designated by the grantor (usually members of his family) or continues the trust for their benefit. If the grantor continues to occupy the residence after his retained interest terminates, he must pay fair market value rent to the remaindermen. 

When the grantor transfers his residence to the trust, he is treated as having made a gift to the family members who will receive the residence when his retained interest terminates. The value of the gift is the fair market value of the residence, reduced by the present value of the grantor’s retained interest (the right to live in the residence rent free for the specified period of time). The present value of the retained interest is computed under IRC §7520, which calls for the use of IRS valuation tables and the §7520 interest rate for the month of the transfer. The value of the retained interest is usually more than the rental value of the residence based on market conditions, which, if combined with a nominal growth in the FMV of the residence, results in an a good discount for gift tax purposes.

When the grantor’s retained interest terminates, the residence passes to the remaindermen free of additional gift tax, even though the property may have appreciated in value since the trust was created. Thus, use of a QPRT ‘freezes’ the value of the residence at its market value when the trust is created. If the real estate market is low when the trust is created, the discount in gifting will be even greater.

If the grantor is still living when his retained interest terminates, the residence won’t be includible in his gross estate for estate tax purposes (unless he continues to live in the residence without paying fair market value rent, in which case it will be includible under the retained life estate rule of §2036(a)). If the grantor dies during the term of his retained interest, the residence will be includible in his gross estate under the retained life estate rule. But he won’t be any worse off than he would have been if he hadn’t created the trust in the first place. 

There are some drawbacks to QPRTs:  

  • Loss of ownership during the grantor’s life. 
  • No step-up in basis. When the residence passes to the remaindermen at the end of the trust term, they don’t get a stepped-up basis. Instead, the grantor’s basis carries over to them, so if they sell the residence they will have to pay capital gains tax on any gains made over what the grantor originally paid for the property (plus or minus adjustments to basis). This problem can’t be avoided by having the grantor buy back the residence from the trust before the trust term ends, because the governing instrument of a QPRT must include a provision prohibiting the sale of the residence to the grantor, the grantor’s spouse, or an entity controlled by either of them.  
  • Loss of property tax exemption. The transfer of the residence to a QPRT results in the loss of a homestead property tax exemption in Oklahoma.
  • Inability to mortgage the residence after the QPRT is created. If the grantor needs to raise cash for any reason after creating a QPRT, he can’t do so by mortgaging the residence, because he’s no longer the owner of the residence. 

How do we compute values for QPRTs?  The easiest method is to purchase a computer program, such as Number Cruncher (  If you believe in doing your own math, here’s how it works:

SMART MAN, age 55, transfers his personal residence to a QPRT and retains the right to live in the residence rent-free for 15 years. If Smart Man dies before the end of the 15 years, the trust property is counted as part of his taxable estate. The fair market value of the residence at the time the trust is funded is $2,000,000. Assume a §7520 interest rate of 6.4%. The value of Smart Man’s retained interest is $1,372,298, computed as follows: 

(1) Find the required life
expectancy factors from

    Table 90CM.

       Initial age = 55
       Term of years = 15
       Terminal age = 70

1 minus – value, Table 90CM, age 55 = 89658
1 minus value, Table 90CM, age 70 = 71357

(2) Divide the factor for age 70
       (71357) by the factor for age 55
       71357 / 89658 = .79588

(3) Take the §7520 
       rate for the month the trust is
       created (6.4%, or .064), and add it
       to the number 1.
       1 + .064 = 1.064

(4) Take the figure computed in step

    (3) (1.064) and calculate it to
       the 15th power (because the term
       of the trust is 15 years; if the term
       of the trust were 10 years, you
       would calculate 1.064 to the 10th
       1.06415 = 2.535855

(5) Divide the result in step (2)
       (.79588) by the result in step

    (4) (2.535855).
       .79588 / 2.535855  = .313851

(6) Subtract the result in step (5)
       (.313851) from the number 1.
       1 – .313851 = .686149

(7) Multiply the result in step (6)
       (.686149) by the fair market
       value of the residence
       .686149 X $2,000,000 =  $1,372,298

Thus, the term of years value of Smart Man’s retained interest in his home is $1,372,298. The value of the remainder interest is the difference between the FMV and the retained interest, i.e., $627,702 ($2,000,000 – $1,372,298). Thus, the amount of the taxable gift made by Smart Man on the transfer of the residence to the trust is $627,702. 

In this example, Smart Man retained a contingent principal interest (the right to have the trust property distributed to his estate if he dies before the end of the 15 years).  If he did not retain such an interest, the value of his retained interest would be $1,211,312. That amount is determined by multiplying the fair market value of the residence ($2,000,000) by .605656 (the factor from Table B of the IRS valuation tables for valuing an income interest payable for a term certain of 15 years, using a §7520  interest rate of 6.4%). The value of the taxable gift made by Smart Man on the transfer of the residence to the trust would therefore have been $788,688 ($2,000,000 – $1,211,312). 

Thus, by not retaining a contingent principal interest in the trust, Smart Man can reduce the amount of his taxable gift by $160,986 ($788,688 – $627,702). 

IRS regulations permit a QPRT to be converted to an annuity trust if the trust is not a qualified personal residence trust (for example, if the personal residence were sold).  So, with that pitiful segue into annuity trusts, we will now turn to the topic of GRATs and GRUTs.

GRATS and GRUTs.  A grantor retained annuity trust (GRAT) is another irrevocable trust – the grantor retains a fixed annuity interest in the property transferred to the trust, for a term of years or for life (e.g., if the corpus is $100,000, and the annuity amount is 5%, the grantor will be paid $5,000 per year; this is the interest the grantor retains for the term of years or for his life).  The remainder interest generally passes to the grantor’s designated beneficiaries at the end of the term of years, or at the grantor’s death.  There is a gift tax due on the value of the remainder interest, which is dealt with when the trust is created and funded. 

A grantor retained unitrust (GRUT) is also an irrevocable trust – the grantor retains a fixed interest in the property transferred to the trust, for a term of years or for life, but the fair market value of the trust corpus at the beginning of each year is used to determine the amount paid to the grantor (e.g., if the trust property is worth $100,000, and the payout is 5%, the grantor receives $5,000; if the corpus increases to $200,000, the grantor will receive $10,000 for that year). When the grantor’s retained interest terminates, the trust corpus passes to the remaindermen free of additional gift tax, even if it has appreciated in value. If the grantor is still living when his retained interest terminates, the trust corpus is not includible in his estate for estate tax purposes when he dies because he no longer has any interest in the property. If the grantor dies during the term of his retained interest, part or all of the trust property will be includible in his gross estate. But again, he won’t be any worse off than he would have been if he hadn’t created the trust in the first place. 

Suppose a wealthy client owns high yielding and rapidly appreciating property, but wants to avoid probate, and is willing to relinquish his interest in the property in the future, as a means of avoiding estate taxes.  GRATs might provide a solution.  Gift taxes are determined when the trust is created and funded, using methods similar to computing taxes for GRITs.  The annuity interest (and in some cases, other retained interests) are subtracted from the fair market value of the assets transferred in trust.  The value of the annuity interest depends on who the remainder beneficiaries are and who retains the annuity, and other interests relative to the transfer.  There are more restrictive and less appealing sets of valuation rules when a family member is a beneficiary.  

In order to create a GRAT or a GRIT, you must either own Number Cruncher or other program, or be familiar with the IRS valuation tables.  To compound these computations, you should be aware that the IRS and the Tax Court do not agree on whether the actuarial probability of the grantor’s death during the fixed term of a GRAT or a GRUT has to be taken into account in valuing his annuity or unitrust interest:  the Tax Court has determined that the retained interest is valued for the fixed term of the trust (Walton, Audrey J., (2000) 115 TC No. 41), but the IRS believes the retained interest is valued using the shorter of the fixed term of the trust or the period ending on the grantor’s death.  Reg § 25.2702-3(e), Ex (5).  Stated differently, Walton stands for the proposition that a GRAT can be created for a term of years with the condition that if the grantor dies during the term, the annuity will continue to be paid to his estate.  If that is the case, then the GRAT could hypothetically have a remainder value of 0 or close to 0.  The trust corpus would, in effect, pass to the remaindermen with no gift or estate taxes.   

To give you an idea of the complexity of making these computations, let’s use this example: SMART WOMAN, age 65, creates a GRAT for a term of ten years and funds the trust with property valued at $1,000,000. SMART WOMAN retains the right to receive $100,000 from the trust each year, with annual payments to be made to her at the end of the year. At the end of 10 years, the property will be transferred to her children.  The §7520 rate for the month in which the trust is created is 7.2%. The present value of the remainder interest (i.e., the gift to the remaindermen) is $370,298, determined as follows: 

(1) Determine the required annuity factor as follows:

       Initial age = 65
       Term of years = 10
       Terminal age = 75

N-factor, Table H (7.2), age 65   =   7671.994
N-factor, Table H (7.2), age 75   =   2215.108
Difference                                      5456.886
D-factor, Table H (7.2), age 65   =   866.5824

 Required annuity factor
         = 5456.886 / 866.5824    =      6.29702

(2) Annuity amount                                      $100,000

(3) Present value of annuityinterest ((1) X (2))                       $629,702

(4) Value of property
       transferred to trust                      $1,000,000

(5) Present value of
       remainder interest

    ((4) minus (3))                            $370,298

In this example, gift taxes will be paid on property worth $370,298.  If the trust corpus produces over 10% a year, SMART WOMAN will have passed $1,000,000 worth of property to her kids but she has only paid gift taxes on $370,298.  Note:  the Chapter 14 rules apply (in part).  Had the parties been unrelated, then IRC §2702 doesn’t apply, and interests are valued according to their actuarial present value using the valuation rules of IRC §7520.  These rules mandate using a discount rate of 120% of the applicable federal annual midterm rate for the month in which the trust is created and funded.  In this instance, the taxable gift would be $304,090.

Let me make a parenthetical comment on interest rates. The 120% applicable federal annual midterm rate and the §7520 rate change monthly and are reported in the IRS cumulative bulletin and various tax services, and in various financial publications, such as the Wall Street Journal.  This rate can also be obtained by visiting or  

Suppose the income earned on the trust corpus is less than the annuity amount; in that case, the shortfall is made up from the principal.  All income and appreciation in excess of that required to pay the annuity accumulates for the benefit of the remainder beneficiary.  Therefore, it is possible to transfer assets to the beneficiary when the trust terminates with values which far exceed their original values.  Such a transfer is not subject to further gift tax.  

I will not attempt to illustrate computations dealing with a GRUT, but will opine that they are more complicated that GRATs.  Using factors similar to those of SMART WOMAN, gift taxes would be paid of approximately $412,000 (where the remainder interest goes to a family member) or approximately $355,000 (where the remainder interest goes to a non-family member).

There are many more options available in creating a GRUT, such as, permitting the trust assets to revert to the grantor’s estate, in the event of the grantor’s premature death.  In addition, the annuity amount can be increased, but not by more than 120% of the prior year’s payout rate.  For example, the trust could provide the annuity payout rate in each subsequent year equal 120% of the prior year’s rate.  If the initial annuity payout rate is 5%, it could increase to 6% in the second year, to 7.2% in the third year, and so on.  

One final thought: GRATs and GRITSs are grantor trusts, which means, there are income tax consequences to the grantor, regardless of what amount is paid to the grantor by the GRAT or GRIT. The grantor will be taxed on income and on realized gains from the sale of assets, even if the income and gains are more than the required trust payments.  



We now depart from GRITs, GRATs, and the like, and move into a concept of wealth transfer known as a private annuity. Today, most people think of annuities as being the life insurance companies’ alternative to an investment in Certificates of Deposit issued by a bank.  An annuity may also be a means of earning income, but deferring taxation on that income until funds are actually withdrawn. These thoughts are useful, but to understand private annuities, we must return to the days of yesteryear, when men were men, women were women, and annuities were annuities.  

Let’s first consider the nature of an annuity. Historically, an annuity is simply an obligation to pay to holder a fixed amount each year until the holder dies; at that time, the borrower owes no more on the obligation.  This instrument, known as a private annuity, occasionally lends itself to some creative estate planning.  

The easiest way of describing how a private annuity can be used is by example.  Let’s say that Stan, age 84, sells a $1,000,000 piece of real estate to his son, George, in exchange for a private annuity.  There is no mortgage given to secure the annuity, but George agrees to pay his Dad, Stan, the sum of $213,306 every year that his dad lives.  When Stan dies, the annuity will not have any balance due, for it is (on Stan’s death) regarded as being paid in full.  Thus, if Stan dies within a couple of years after the transfer, George will have paid Stan the sum of $426,612, but George will owe nothing additional for this $1,000,000 piece of real estate, and there will be no estate tax due on Stan’s death.

Because this transaction is a sale of real estate, the property being transferred is not included in Stan’s gross estate for estate tax purposes (even though he made the transfer within three years of his death).  Stated differently, Stan’s gross estate is now $1,000,000 less than it was (except for the payments of $426,612 which Stan might not have spent before he died).

From a practitioner’s vantage, the difficulty in structuring a private annuity is knowing how much is to be paid to Stan, and what the income tax consequences of the transaction are.  To calculate the amount of the annuity payments, you must know what the §7520 rate of interest is.  If we use the July 1999 §7520 rate of interest, which is 7.2%, for purposes of this illustration, and assume a basis in the real estate of $50,000, and also assume that the annuity payment will be made annually at the end of the period, then we can determine the annual payout to be $213,306 per year.  Using this amount, we can calculate the income tax consequences to Stan, as follows:  $7,246 of the annual annuity payment will not be taxed for income tax purposes, $137,681 will be subject to capital gains tax and $68,378 will be taxed as ordinary income.  All of these calculations are based on a single life expectancy for an 84 year old, which is, 7.4 years.  

Though this outline has made reference to Number Cruncher, you should be made aware of how to buy this program. Go to the website at, for ordering information.  Number Cruncher has dozens of programs which can perform tax calculations described in this outline, including private annuities.   

As an estate planner, the benefit of a private annuity is this – if the owner of the property is in ill health, or might not meet ordinary life expectancy for his or her age, then a private annuity is a good means of eliminating property from the federal taxable estate. Admittedly, the maker of the annuity will have to purchase the property and pay the annuity on an annual basis (or more frequently, if desired).  But that might not be a bad alternative, if the estate tax consequences of leaving the property in the estate outweighs the annual cash outlay for the private annuity. 

There are certainly other uses for private annuities (e.g., they can be prepared for two lives, rather than a single life), but hopefully this illustration will be of use to you in determining whether highly appreciated property should be sold in exchange for a private annuity.


To the uninitiated, estate planning may be likened to Alice’s trip into Wonderland: though there are people in this strange place, they sometimes make no sense when they speak.  Principles of physics are not necessarily in operation, as Alice grows when she drinks and shrinks when she eats; animals talk but abandon logic when they speak; and there is a twist in general semantics.  

Pretend for a moment that you are in a Wonderland.  As you gaze across the landscape, you are approached by a rabbit who begins to talk.  He tells you he is a lawyer who will serve as your guide to the Wonderland of Irrevocable Trusts; his job is to help you understand why and how things work as they do.  So be prepared for surprises.  

First, the rabbit makes a disclaimer: there are lots of things that will not be covered in his short guide to irrevocable trusts.  Says he, “Consider this as a small tray of hors-d’oeures.  What is said here is not the entire meal.”

He hops along the trail and you follow him.  Around the hedge, you see a blackboard nailed to a tree.  The rabbit picks up a piece of chalk, and begins telling you a few concepts about trusts, as he scribbles on the board. And this is what he relates.

A trust is simply an agreement made by a person, which deals with how property will be held and what happens to the property when that person dies. There are three “parties” to every trust:  The person who creates it (the grantor, trustor, settlor), the trustee, and the beneficiaries of the trust.  Most of the time, when a person establishes a trust, he or she reserves the right to change its terms.  This type of trust is known as a “revocable” trust.  When the trust is properly funded, an estate can pass to the beneficiaries, without probate, and depending upon the how the trust is written, some estate taxes can be saved.  

There is another species of trust, where the creator of the trust does not permit any changes in the trust terms – this variety is known as an “irrevocable trust”.  The primary purpose of an irrevocable trust is to permit property to be transferred to beneficiaries, without any probate and without any estate taxes. As with revocable trusts, there are three parties to the irrevocable trust, but the creator of the trust will not be the trustee.  If the grantor wants to serve as trustee of the trust, the assets of the trust will be included in the grantor’s taxable estate, for estate tax purposes.

The rabbit reminds you that when Alice toured Wonderland, she met the Mad Hatter.  He then says, “In the Wonderland of Trusts, there is a Mad Hatter, of sorts, but this one isn’t a person, it is a book of laws:  the Internal Revenue Code of 1986 (the IRC).  At this bend in the road, we must now deal with the tax laws.  When an irrevocable trust is created, under the Internal Revenue Code, a new taxpayer entity is being created, much like a new corporation is formed.  The irrevocable trust will be assigned a tax payer identification number by the Internal Revenue Service, and the trustee of the trust will file an income tax return each year (a Form 1041). 

The rabbit twitches his nose and you hear a soft whistle as he sighs through his teeth.  “But remember, we are in the Wonderland of Trusts, and under the Internal Revenue Code, the trust will not pay income tax, even though there is taxable income.”  Under the IRC, the grantor will pay the income tax (because the grantor has retained certain rights under the trust terms, such as substituting trust property, or naming his or her spouse as a discretionary beneficiary; see IRC §§671-679).  Stated differently, the Internal Revenue Code has a section devoted to “grantor trusts”. These provisions of the Code simply attribute trust income to the grantor, who then reports the income on his 1040 tax return.

With these concepts in mind, the rabbit hops away from the blackboard and runs up a hill.  You follow him to a vista, and from this vantage, can see several beautiful destinations.  The rabbit points to the island in the West.  He tells you this is the Island of Life Insurance Perks. You ask, what benefits are found on this island?  The rabbit explains, “Under the IRC, insurance policies may earn income and grow in value, but the owner of the policy does not have to report the increase in value or earnings on his or her income tax return.  Thus, if an irrevocable trust owns life insurance, which grows in value, the grantor will not have to pay income tax on the growth in value, and when he or she dies, the policy will be paid to the beneficiaries without any income or estate taxes.”   

Traditionally, the trustee of irrevocable trusts owns life insurance on the life of the grantor.  Under the Internal Revenue Code, earnings and growth under life insurance policies are not taxed, for income tax purposes, to the grantor.  Thus, if the trust grows in value, due to an increase in value of the life insurance policy, this growth in value will not be attributed to the grantor.

There are certain precautions that must be taken in establishing an irrevocable life insurance trust (fondly known as an “ILIT”).  Under the IRC, if the grantor retains some incident of ownership over the life insurance policy, the policy (even though owned by the ILIT) will be included in the grantor’s taxable estate (for estate tax purposes).  The primary safeguard to avoid falling into this trap is to name an independent trustee (someone other than the grantor), who will simply hold the insurance policy until the grantor dies, then collect the insurance proceeds and distribute them to the beneficiaries without being obligated to pay gift or estate taxes.

Now let us consider an obvious fact: insurance must be purchased, and the insurance company will want its premium, as a condition to issuing the policy and keeping it in force. The grantor (who is the insured) usually pays the premium, but the grantor is not permitted to write checks to the insurance company directly (remember, there is an IRC rule which prohibits this from being done).  So, the grantor will give the premium to the beneficiaries.  However, the beneficiaries (say a 23 year old son) might keep the money and not pay the premium.  So, says the rabbit, ” What do we do, what do we do?”

He then answers his own question.  The grantor will give the premium to the independent trustee of the ILIT, who will, in turn, write the beneficiaries a letter, along these terms:

“Dear John:

Your dad has given me $10,000, which is a gift to you.  You have thirty days to pick up the money.  If you don’t pick it up in 30 days, I will use the money to pay the next year’s premium on the life insurance policy I own (as Trustee) on your dad’s life.”

                                                            The Bank Trust Department

Hopefully, the premium will be less than $10,000 dollars per year for each donee (beneficiary), so there will be no federal gift taxes to pay (one is permitted to gift $10,000 a year to a donee, without being required to pay gift taxes). Gifts above that amount are taxable (see Tax Rates on page two).

Let’s examine this a bit closer.  In order to constitute a gift, there must be three elements:  Donative intent, delivery of the gift, and acceptance of the gift.  The Internal Revenue Service has taken the position that if the donee has a right to pick up the money from the trustee of the ILIT and keep it, but declines to do so, a completed gift is nonetheless made.  This position had its origin in the famous case of Crummey vs. Commissioner, (397 F2d 82, 9 Cir., 1968); after that case was decided, the right to withdraw a gift from an ILIT was labeled as the “Crummey Power of Withdrawal”, or simply put, the “Crummey Power”.  

Thus, in the traditional setting, when the grantor dies, the insurance proceeds will be collected by the trustee who will then distribute the same to the children.  The children are expected to use the proceeds to pay for estate taxes, or if there are no estate taxes, then to keep the proceeds.  

The rabbit then draws your attention to a forest, which seems to be full of briars, but also has a very pretty lake in its center. He says, “Let’s consider some other uses of irrevocable trusts”, and begins talking like a lawyer.  You remember him mentioning one interesting application discussed in the Journal of the American Society of CLU & ChFC, September, 1997, entitled The WRAP Trust.  The article (by James G. Blase) is extremely interesting, and should be referenced for further details.  However, the gist of a WRAP trust is this:  As cash value in an insurance policy (owned by the ILIT) increases, the trustee borrows from the policy, and loans the cash to the Grantor, in exchange for the Grantor’s note and pledge of assets (this is a secured loan). The grantor will presumably spend the cash.  When the grantor dies, the ILIT owns a note from the Grantor’s estate, but also holds the securities the Grantor has pledged, as collateral for the loan.  The trustee of the ILIT will collect the debt by using the pledged assets (thereby reducing the size of the grantor’s federal taxable estate).  

The rabbit then points to a deep gorge, with a beautiful river cutting its way into fiords in the distance. He explains that another avant-garde application for irrevocable trusts involves the concept of arbitrage.  Here’s how it might work:  the grantor loans large sums of money to the irrevocable trust, which in turn, agrees to repay the grantor principal and interest.  Since the Internal Revenue Service will regard this as a wash transaction for income tax purposes, the Grantor will not realize taxable income (one does not report income payable to oneself).  For purposes of the transaction, however, an interest rate will be used on the note (which will be the Applicable Federal Rate, or AFR). 

Let’s use an example.  Suppose the AFR is 7%, and the grantor loans the irrevocable trust $1,000,000.  Each year the trust will pay him $70,000 in “interest”; the Grantor will not report the interest on his income tax return, because one does not report income paid by oneself to oneself.  Let’s also assume that the trust assets increase in value 15% during the year.   If part of the growth is attributed to capital gains distributions (e.g., from mutual funds), the grantor will, of course, report the capital gains on his tax personal income tax return (remember, this is a grantor trust).   

When the grantor dies, the irrevocable trust owns assets which have increased in value (remember, the assets grew at 15%, but the ILIT paid interest to the Grantor at 7%; thus, the arbitrage difference in rates is 8% – and this increase in value is then distributed to the heirs without any gift or estate taxes).  On the Grantor’s death, the ILIT assets are distributed to the beneficiaries, without any gift or estate taxes.

However, there is one other issue which must be dealt with, and that is, the ILIT owes the Grantor’s estate the principal balance of the loan, plus any accrued interest which has not been paid.  This loan increases the value of the Grantor’s estate, for estate tax purposes – but the note might be designed as a self-canceling note.  If that is the design of the instrument, then nothing is reported in the Grantor’s estate.  

By this time, the sun is setting and it is becoming dark.  The rabbit extends his paw, to shake your hand as he prepares to depart.  He closes by saying that ordinary rules and common logic do not apply when irrevocable trusts are created.  There are complex tax issues which must be dealt with in designing any irrevocable trust, but hopefully, the topics in this portion of the outline will be of interest, and some of the ideas mentioned might apply to your client’s affairs.


With the repeal of Estate Taxes in 2010, and the possibility of a permanent repeal of Estate taxes, it appears we might still be faced with additional income taxes, which will require us to keep more sets of records.  And our heirs will have “one more tax” to pay, which will be in the nature of additional income taxes.  Since brevity is the essence of clarity, let me give you my concluding thoughts: charitable remainder trusts may be of more value if the estate taxes are permanently repealed.

As things now stand, when a person dies, the heirs inherit the property at the fair market value at the date of death – thus, the heirs will have a new tax “cost” basis, and there are no additional taxes on the “step-up” in basis.  If the estate taxes are permanently repealed after year 2010, Congress will probably eliminate the benefit of the set-up in basis (under current legislation, there is a partial step-up in basis, for those dying in 2010:  $1.3 million for every person, and $4.3 million for property left to the spouse).  Assume, for purposes of this section of the outline, that my heirs acquire my estate, without an estate tax, but that my estate is not eligible for a step-up in basis.  My heirs’ cost basis will be the same as mine, for income and capital gains purposes.  If I paid $70,000 for commercial real estate in 1985, and depreciated it as a business property, my heirs inherit my cost basis:  after I die, and assuming the estate taxes are repealed, there will be no estate tax to be paid.  However, when the commercial real estate is sold by my children, they will have two income taxes to pay: 

(a) Capital gains tax based on the difference between their sales price (let’s say $150,000) and my purchase price ($70,000).  If long term capital gains rates remain at 20%, then that part of the tax bill will be $16,000 ($150,000 – $70,000 = $80,000 x 20% = $16,000).  

(b)  In addition, they will be taxed at ordinary income tax rates, for all of the depreciation I have taken on the property (e.g., $50,000) – this tax is called “recapture of depreciation”.  If my children are in the 27.5% income tax bracket, this tax will be $13,750 ($50,000 x 27.5% = $13,750).  

Thus, the total income tax to be paid when the commercial real estate is sold by children is $33,750 ($16,000 + $13,750 = $29,750).

So how might we plan around this scenario?  I might create a Charitable Remainder Trust (Reg. §1.664-1), to eliminate the income taxes for me and my heirs.  First, I would locate and retain a sharp accountant and lawyer to help create the trust; I would probably ask them to modify one of the forms the Treasury Department has promulgated (that ought to save some legal and accounting fees).  The agreement would provide that during my lifetime, and during the lifetime of my spouse, the trustee would pay me 5% of the fair market value of property every year (I will have to pay income taxes on this annual payment).  Secondly, I will have the property appraised, on an annual basis (this requirement is part of the agreement, which is a Charitable Remainder Unitrust, as opposed to a Charitable Remainder Annuity Trust).  Third, I will be able to take an income tax deduction for donating the property to charity, based on some very complicated calculations (the amount of the deduction depends on the value of the property, the life expectancies of me and my wife, using a variable rate of interest established by the Treasury Department).  And finally, I will have to find a good charity, which will own the trust property after my wife and I die.

Once the trust has been established, the trustee can then sell the commercial real estate, and pay no income tax (the CRT is, in effect, treated as a private foundation, but the CRT is not required to attain tax exempt status, by filing a Form 1023).  Thus, there are no capital gains taxes to pay, nor are there any ordinary income taxes to pay for recapture of depreciation.  The proceeds from the sale will be retained until both my wife and I are deceased.

When both my wife and I are deceased, the charity named in the trust will inherit whatever is left in the trust corpus.  As a technical note, the charity is required to receive at least 10% of the value of the CRT, and this qualifying determination will be made before the trust is established.  In addition, the amount paid to the grantor cannot be less than 5% nor more than 50% of the trust corpus.

All of this sounds good, but notice what has happened:  I no longer own the commercial real estate – after the trust has been created, all my wife and I own is the right to receive income while we are alive.  Once we are deceased, the charity inherits the trust corpus.  So my children will not inherit the $150,000 commercial real estate.  To replace this “lost wealth”, I will probably arrange for the purchase of a life insurance policy for $150,000 (perhaps a second to die policy), and arrange for the policy to be owned by an irrevocable life insurance trust, or by my children directly.  If the estate taxes are permanently repealed, then I might decide to own the policy myself (as things now stand, if I have any incidents of ownership over the policy, it is counted as part of my taxable estate, for estate tax purposes – to keep the policy out my taxable estate, it must be owned by someone else, viz., my children or the trustee of an ILIT).

So what have we done with this process?  First, we have eliminated any income taxes on the sale of the commercial real estate.  Second, we have provided an income stream (which is taxable as income) for me and my wife.  Third, my wife and I will be able to deduct part of the gift’s value, as a charitable donation.  Fourth, the charity will receive an inheritance when my wife and I die.  And fifth, my children will inherit (without income or estate taxes) the face value of a life insurance policy.

With these benefits, there are also some burdens: I have to purchase a life insurance policy to replace the wealth I have transferred to the CRT (more insurance premiums), and I have limited my income from the commercial real estate to a minimum of 5% per year.  I will have more tax returns to file (the CRT will have to file income tax returns), and I will have to pay more legal and accounting fees to create the CRT.

So there you have it.  Whether or not Congress permanently repeals the estate taxes, charitable remainder trusts are important estate and income tax planning tools.  So let’s conclude this portion of the outline with this thought:  if Congress permanently repeals the Estate Taxes, leaving our heirs with Capital Gains Taxes and ordinary income taxes to pay on the sale of capital assets, it would appear that Charitable Remainder Trusts will play a more prominent part of the estate planning process. 


A variation of a charitable remainder trust is a pooled income fund.  In essence, the donor transfers property which will be commingled with other property, and at the same time, conveys an irrevocable interest in the property to a 50%-type charitable organization (under the CRT rules, there is no requirement that a 50%-type charity, i.e., a public charity, be designated as the remainderman beneficiary).  The donor retains a life-income interest in the property for himself or for one or more persons.  Unlike CRTs, however, there is no requirement that the 10% minimum rule applies to the charitable remainder beneficiary.


A charitable lead trust is, in essence, a gift to a charity for a term of years.  After the completion of the term of years, the remaining trust corpus is distributed to the grantor’s children or other beneficiaries (even the grantor may be a reversionary beneficiary).  If the income interest is either a guaranteed annuity interest or a unitrust interest, the donor will receive a charitable income tax deduction (which is subject to a 30% AGI limitation), if the donor is also considered as the owner of the income.  Normally, the donor will not want to be considered as the owner of the income. Since the grantor normally retains no interest in the property transferred to the trust, the income is taxed to the trust. The trust can deduct each year the charitable contributions it makes out of income, without regard to the percentage limitations on charitable contribution deductions which apply to individual donors. 

CLTs are subject to the private foundation rules, which are to be avoided (and are beyond the scope of this outline).  If the remainder beneficiary is someone other than the donor, the remaining corpus passes to the remaindermen without additional gift or estate taxes.

There are two types of CLTs: annuity trusts and unitrusts.  The primary difference between the two relates to whether the trust corpus is revalued each year (in a CLAT, the assets are not revalued; in CLUTs, the assets are revalued).  

When the grantor transfers property to this trust, the remainder interests are subject to gift taxes.  Because the remainder interest is reduced by the value of the charitable contribution of the annuity or unitrust interest, the gift taxes are usually at a minimum. The value of the assets transferred into such trust are not included in the grantor’s estate. The amount of the taxable gift incurred at the inception of the trust will, under the unified transfer tax system, be added to the grantor’s taxable estate for the purpose of determining the estate tax bracket applicable to his estate. 



Smart estate planning involves more than having a will, even a fairly complex one.  It takes into account a realistic assessment of net worth, intelligent use of the marital deduction, and gift-giving programs that can reduce future taxes.  It should also include trusts that will keep an estate out of probate, and the use of other trusts to  minimize or avoid taxes.

Determine Net Worth First.  The starting point begins with an assessment of a client’s actual net worth.  This assessment will also give a fair indication of how much of the estate is potentially taxable.

Once we know the size of the estate and the potential estate tax, we can advise clients to take specific steps to eliminate tax in some cases, minimize it in others, and insure that there’s money on hand to pay what’s due.

The Gross Taxable Estate.  For valuation purposes, the gross taxable estate includes every type of property you own “to the extent of your interest in it.”  For citizens and legal residents, this includes all property, wherever it’s located.  Also included is property that the client may have disposed of legally, but has continued to control during his lifetime.  And the gross taxable estate may include transfers of property with a retained life estate, transfers that take effect at death and transfers that are conditional on survivorship.

Marital Deduction.  Clients can leave an unlimited amount of their estates to their spouses, free of federal estate tax.  In addition, gifts can be made to spouses without any gift tax consequences.  (There are restrictions on gifts to spouses who aren’t US citizens, although careful planning can avoid many of these taxes.)

Death of First Spouse.  Tax problems generally will not arise until a spouse dies.  Then, unless some planning has been done, anything valued over $675,000 will be subject to progressively steep taxes.  Although the Estate Taxes have been repealed, effective in 2010, there are estate taxes to consider before 2010, and in the year 2011 and after.  The unified credit is increased, on a phased-in basis, over a nine year period.  The applicable amounts are:  $1,000,000 for decedents dying in 2002-2003; $1,500,000 in 2004 and 2005; $2,000,000 in 2006, 2007 and 2008; $3,500,000 in 2009.  Due to the design of our tax legislation, however, the estate taxes will be reinstated in the year 2011, unless Congress agrees to extend the repeal of the estate taxes at that time.

With proper planning, a married couple can shelter as much as $1.35 million from federal estate taxes with a fairly simple device – a revocable living trust.  Using a revocable living trust, each spouse in effect passes along $675,000 free of federal estate taxes (or twice the applicable unified credit).

Here’s an example of how to shelter your estate:  First, divide your property equally between the spouses; this allocation can be done through a trust.

Use of Trust During Your Lifetimes.  Because the trust instrument is revocable – that is, it can be changed – clients will not have to file any additional tax returns.  As a matter of fact, clients will be able to use their property much the same way as they now use it.   The primary difference in owning property in trust is this – title to the property will be in the name of a trustee (for example, Sam Jones, Trustee).  

When one of the clients dies, one part of the trust (valued up to $675,000) will pay the other spouse income for life.  The trust can also allow the surviving spouse to use the assets, if necessary.  This portion of the trust is taxed, but the tax will always be equal to the unified credit, so there is no tax to pay.

Meantime, the surviving spouse also has the unlimited use of the other $675,000  during his or her lifetime.  On the death of the surviving spouse, the money in both trusts will go to their beneficiaries (children, for example), without any federal estate taxes.

The same idea can be used for larger estates.  For example, on a $2 million estate, if the money were simply left to a spouse, with no tax sheltering trusts, and the surviving spouse then willed the estate to the children, the federal and state death taxes would total approximately $560,250.

By using a trust arrangement, the tax bill is reduced to $260,000, which represents a savings of about $300,000.


Distributions from ERISA Funds and non-Roth IRA’S have always been a challenge in estate planning.  Before December 30, 1997, when the IRS released Prop. Reg. §1.401(a)(9)-1 (reproduced below; this regulation has been recently amended as part of a comprehensive overhaul of the 1987 proposed regulation, which deals with IRAs; the January 12, 2001 proposed regulation has not changed the verbiage of  the 1997 version), there were several risks in naming a trust as the beneficiary of the IRA.  First, there was a serious question as to whether a trust qualified as a “designated beneficiary”.  The general rule is that designated beneficiaries must be living persons.  A “trust” is not a living person, and accordingly, would not qualify as being a “designated beneficiary”.  In addition, the effective income tax rates for trusts is much higher than those paid by individuals.  In the year 2000, for example, the marginal tax rate for trusts earning taxable income in excess of $8,650 is 39.1%.  Contrasting that tax rate with a married couple filing jointly, the couple will not enter the 39.1% arena unless their taxable income exceeds $297,300. Thus, even if a trust could qualify as a “designated beneficiary”, the trust would have to pay income taxes of 39.1% for income received in excess of $8,650 (this benchmark would apply to most IRAs).

All of those fears were allayed when the Treasury Department amended the proposed regulations under §1.404(a)(9)-1, and the sun broke through the clouds. The purpose of this portion of the outline is to give a thumbnail sketch of what happened – but for purposes of this part of the outline, all ERISA contributions will be referred to as IRAs (note, however, that the planning tools described in this article are not available for all ERISA contributions; each case will have to be dealt with separately, depending on the terms of the §401(k) plan, the §403(b) plan, and so forth).  In addition, I am not considering Roth IRAs – I am only dealing with conventional IRAs.

First, the definitions.  As you may or may not know, IRA distributions made at death are not made to “death beneficiaries”.  The IRS refers to the recipients as “designated beneficiaries”.  Suppose a trust were named as a “designated beneficiary” of the IRA.  What are the income tax consequences of such a designation?

Under the proposed regulation, the IRS conceded that trusts are merely conduits, and the trustee will not have to pay income taxes using the accelerated trust tax tables.  In the answer given to question D-5 of the proposed regulation, the Treasury Department made the following statement: “(The) trust itself may not be the designated beneficiary (of an IRA) even through the trust is named as a beneficiary.  However, (if) the requirements (below) are met, distributions made to the trust will be treated as (being) paid to the beneficiaries of the trust . . . “.  This sentence is very important, because the IRS is, in effect, permitting the trust to be “taxed” as a partnership, i.e., the trust pays no income tax at all.  The income tax on the IRA distribution is to be paid by the trust beneficiaries at their respective income tax rates. 

Because it sounds so good to say it, let me say it again:  this provision of the proposed regulation acknowledges that trusts are conduits, through which income may flow to the beneficiaries, and the trust is not taxed using the trust income tax tables – the income will be taxed using the tax tables of the individual beneficiaries.  In order to qualify for this tax treatment, however, the following conditions must be met: 

(1) The trust must be a valid trust under state law, or would be but for the fact there is no corpus.

(2)  The trust must be revocable by will, or by its terms, becomes irrevocable upon the death of the owner of the IRA.

(3)  The beneficiaries of the trust must be identifiable from the trust instrument.

(4)  Documentation relating to the above items 1-3 must be provided to the IRA plan administrator. The trustee can identify the beneficiaries of the trust even after death of the Settlor of the trust – such designation must, however, be made nine months after death.  In lieu of making such an identification, the plan administrator can be given a copy of the trust.  

With this proposed amendment now in place, we now have enhanced estate planning opportunities.  Let me give you an example of what I am talking about, using Dick and Jane Smith as a hypothetical case study.  Dick is a retired oil company executive, and has rolled his §401(k) plan into an IRA, now worth 1.8 million dollars.  The remainder of Dick and Jane’s assets consists of their $400,000 home and some personal effects.  Since Dick cannot transfer his IRA to his wife, at least before his death, his wife is in an awkward situation, because her assets are less than the unified credit equivalent, viz., $675,000.  

Even though Dick and Jane have established an A-B tax credit sheltered trust, they cannot take full advantage of the By-Pass Trust provisions, which will save estate taxes only if $675,000 of Dick’s assets are shifted to the By-Pass Trust upon his death.  As things now stand, when Dick dies, Jane will inherit all of his IRA, which will not be taxed for estate tax purposes (it qualifies for the marital deduction).  The remainder of Dick’s assets, which are half of the $400,000 joint assets, or $200,000, will be placed in the tax credit trust (i.e., the By-Pass trust).  Thus, the A-Trust (the marital deduction trust) now owns Dick’s IRA, i.e., 1.8 million and half of their joint assets (the $200,000 attributable to Jane).  In summary, when Jane dies, she owns 2.0 million in assets, which will be taxed for estate tax purposes (the federal estate taxes are $780,800, less the unified credit of $220,550, or a net tax bill of $560,250).  The By-Pass trust, which owns $200,000 in assets, is not taxed again on her death. 

Stated differently, what is missing in the equation is a complete funding of the By-Pass trust on Dick’s death.  Had the By-Pass trust been completely funded, the estate taxes saved would equal $213,750.  

After the Treasury Department released its amendment to the proposed regulation, Dick and Jane can amend the IRA designated beneficiary, and name the Trustee of the Dick and Jane Smith Trust as the beneficiary.  If that were done, and upon Dick’s death, the trustee can allocate enough of the IRA funds to the B-Trust, thereby using the entire Unified Credit.  In our example, the sum of $675,000 of IRA funds can be allocated to the B-Trust.  The balance of Dick’s estate will be treated as marital deduction property.  Through the combined “deductions” available to Jane (the marital deduction and the unified credit), there will be no estate taxes on Dick’s death.  Furthermore, when Jane dies, there will be no additional estate tax on the B-trust, since it was “taxed” at Dick’s death (Jane will, however, receive distributions from the B-Trust, during her lifetime).  At her death, Jane’s heirs will be paying estate taxes on an estate of $1,525,000 (note: the B-Trust, consisting of $675,000 in assets, is not part of her taxable estate); the heirs will be entitled to use the unified credit of $220,550 against the tax of $567,050, which reduces the federal estate tax to $346,500.  Using this traditional A-B trust scenario, we will save $213,750 in federal estate taxes. 

Assume, for a minute, that Dick is deceased, and Jane has survived him. The question now becomes, how is the trustee of the By-Pass Trust going to distribute the IRA?  Since the IRA has been allocated to the B-Trust, which is irrevocable (it is not a marital deduction trust), and since withdrawals from IRAs are taxable for income tax purposes, how is it to be distributed to Jane?  Presumably the trustee of the Credit Sheltered Trust would not distribute all of the IRA funds at once, because of the increased income taxes that must be paid by the beneficiary (a lump sum distribution to Jane of all of the $675,000 would be subject to a 39.1% marginal tax rate).  So there must be some planning on how the IRA is to be paid to Jane, through the By-Pass trust.

If Dick died before reaching the required beginning date (age 70 ½), then payments from the IRA could be made over the life span of the oldest beneficiary named under the Credit Sheltered Trust.  In the above example, since Jane is the life tenant of Trust B, distributions are based on her life expectancy.  

But suppose Dick had reached age 70 ½, his required beginning date, and was taking distributions under his IRA.  If that happened, the trustee would distribute the remainder of the IRA, using whatever distribution period Dick had elected.  If he had elected the fixed method, then distributions would be based on his remaining life.  If he had elected distributions under a joint life, then distributions would continue to be made on that basis.

Because the surviving spouse, in this case Jane, might need some income options on her own behalf, I still believe it advisable to name Jane as the primary beneficiary of the IRA.  She is entitled to disclaim her ownership interest in the IRA, in favor of the By-Pass trust; thus, if she disclaimed enough of the IRAs to fund the B-trust, then she will have received though the back door what she would have received through the front – with the benefit that the Tax-Sheltered Trust is now fully funded, and substantial estate taxes will be saved by the heirs of the Smith trust.  

In summary, the purpose of this portion of the outline is to set forth, perhaps in an over-simplified presentation, changes in how trusts are taxed.  These issues are very complex, for both income tax purposes and for estate tax purposes – to use some of these ideas requires preparation and signing of fairly complicated IRA beneficiary designation forms (ironically, several investment and brokerage firms have not yet approved the use of these forms). Though there will be a downside in expenses (finding someone to assist in preparing the beneficiary designation forms), there is an upside, because of what can now be done.  Using the recent proposed Treasury regulation, persons such as Dick, who is top heavy in his IRA holdings, will be able to do normal estate planning, namely, using part of his own assets (the IRAs) to fund the By-Pass Tax Sheltered Trust.  

Here is the critical proposed regulation:

Prop. Reg. §1.401(a)(9)-1

PAR.2.  Section 1.401 (a)(9)-1 as proposed to be added at 52 FR 28075, July 27, 1987, is amended by 

            1. Revising Q&A D-5.

            2. Revising Q&A D-6.

            3. Adding Q&A D-7.

            The additions and revisions read as follows:

                                                            * * * * * * * *

            D. Determination of the Designated Beneficiary

                                                            * * * * * * * *       

D-5.  Q.  If a trust is named as a beneficiary of an employee, will the beneficiaries of the trust with respect to the trust’s interest in the employee’s benefit be treated as having been designated as beneficiaries of the employee under the plan for purposes of determining the distribution period under section 401(a)(9)(A)(ii)?

A. (a) Pursuant to D-2A of this section, only an individual may be a designated beneficiary for purposes of determining the distribution period under section 401(a)(9)(A)(ii).  Consequently, a trust itself may not be the designated beneficiary even though the trust is named as a beneficiary.  However, if the requirements of paragraph (b) of this D-5 are met, distributions made to the trust will be treated as paid to the beneficiaries of the trust with respect to the trust’s interest in the employee’s benefit, and the beneficiaries of the trust will be treated as having been designated as beneficiaries of the employee under the plan for purposes of determining the distribution period under section 401(a)(9)(A)(ii).  If, as of any date on or after the employee’s required beginning date, a trust is named as beneficiary of the employee and the requirements in paragraph (b) of this D-5 are not met, the employee will be treated as not having a designated beneficiary under the plan for purposes of section 401(a)(9)(A)(ii).  Consequently, for calendar years beginning after that date, distribution must be made over the employee’s life (or over the period which would have been the employee’s remaining life expectancy determined as if no beneficiary had been designated as of the employee’s required beginning date).

            (b)  The requirements of this paragraph (b) are met if, as of the later of the date on which the trust is named as a beneficiary of the employee, or the employee’s required beginning date, and as of all subsequent periods during which the trust is named as beneficiary, the following requirements are met:

            (1)  The trust is a valid trust under state law, or would be but for the fact that there is no corpus.

            (2)  The trust is irrevocable or will, by its terms, become irrevocable upon the death of the employee.

            (3)  The beneficiaries of the trust who are beneficiaries with respect to the trust’s interest in the employee’s benefit are identifiable from the trust instrument within the meaning of D-2 of this section.

            (4)  The documentation described in D-7 of this section has been provided to the plan administrator.

            (c)  In the case of payments to a trust having more than one beneficiary, see E-5 of this section for the rules for determining the designated beneficiary whose life expectancy will be used to determine the distribution period.  If the beneficiary of the trust named as beneficiary is another trust, the beneficiaries of the other trust will be treated as having been designated as beneficiaries of the employee under the plan for purposes of determining the distribution period under section 401 (a)(9)(A)(ii), provided that the requirements of paragraph (b) of this D-5 are satisfied with respect to such other trust in addition to the trust named as beneficiary.

            D-6. Q.  If a trust is named as a beneficiary of an employee, will the beneficiaries of the trust with respect to the trust’s interest in the employee’s benefit be treated as designated beneficiaries under the plan with respect to the employee for purposes of determining the distribution period under section 401(a)(9)(B)(iii) or (iv):?

            A.  (a)  If a trust is named as a beneficiary of an employee and the requirements of paragraph (b) of D-5 of this section are satisfied as of the date of the employee’s death or, in the case of the documentation described in D-7 of this section, by the end of the ninth month beginning after the employee’s date of death, then distributions to the trust for purposes of section 401(a)(9) will be treated as being paid to the appropriate beneficiary of the trust with respect to the trust’s interest in the employee’s benefit, and all beneficiaries of the trust with respect to the trust’s interest in the employee’s benefit  will be treated as designed beneficiaries of the employee under the plan for purposes of determining the distribution period under section 401 (a)(9)(B)(iii) and (iv).  If the beneficiary of the trust named as beneficiary is another trust, the beneficiaries of the other trust will be treated as having been designated as beneficiaries of the employee under the plan for purposes of determining the distribution period under section 401(a)(9)(B)(iii) and (iv), provided that the requirements of paragraph (b) of D-5 of this section are satisfied with respect to such other trusts in addition to the trust named as beneficiary.  If a trust is named as a beneficiary of an employee and if the requirements of paragraph (b) of D-5 of this section are not satisfied as of the dates specified in the first sentence of this paragraph, the employee will be treated as not having a designated beneficiary under the plan.  Consequently, distribution must be made in accordance with the five-year rule in section 401(a)(9)(B)(ii).

            (b)  The rules of D-5 of this section and this D-6 also apply for purposes of applying the provisions of section 401(a)(9)(B)(iv)(II) if a trust is named as a beneficiary of the employee’s surviving spouse.  In the case of payments to a trust having more than one beneficiary, see E-5 of this section for the rules for determining the designated beneficiary whose life expectancy will be used to determine the distribution period.

D-7. Q.  If a trust is named as a beneficiary of an employee, what documentation must be provided to the plan administrator so that the beneficiaries of the trust who are beneficiaries with respect to the trust’s interest in the employee’s benefit are identifiable to the plan administrator?

            A. (a)  Required distributions commencing before death.  In order to satisfy the requirement of paragraph (b)(4) of D-5 of this section for distributions required under section 401(a)(9) to commence before the death of an employee, the employee must comply with either paragraph (a)(1) or (2) of this D-7:

            (1)  The employee provides to the plan administrator a copy of the trust instrument and agrees that if the trust instrument is amended at any time in the future, the employee will, within a reasonable time, provide to the plan administrator a copy of each such amendment. 

            (2)  The employee—

            (i)  Provides to the plan administrator a list of all of the beneficiaries of the trust (including contingent and remainderman beneficiaries with a description of the conditions on their entitlement);

            (ii)  Certifies that, to the best of the employee’s knowledge, this list is correct and complete and that the requirements of paragraphs (b)(1), (2), and (3) of D-5 of this section are satisfied;

            (iii)  Agrees to provide corrected certifications to the extent that an amendment changes any information previously certified; and 

            (iv)  Agrees to provide a copy of the trust instrument to the plan administrator upon demand.

            (b)  Required distributions after death.  In order to satisfy the documentation  requirement of this D-7 for required distributions after death, by the end of the ninth month beginning after the death of the employee, the trustee of the trust must either –

            (1) Provide the plan administrator with a final list of all of the beneficiaries of the trust (including contingent and remainderman beneficiaries with a description of the conditions on their entitlement) as of the date of death; certify that , to the best of the trustee’s knowledge, this list is correct and complete and that the requirements of paragraph (b)(1), (2), and (3) of D-5 of this section are satisfied as of the date of death; and agree to provide a copy of the trust instrument to the plan administrator upon demand; or 

            (2) Provide the plan administrator with a copy of the actual trust document for the trust that is named as a beneficiary of the employee under the plan as of the employee’s date of death.

            (c)  Relief for discrepancy between trust instrument and employee certifications or earlier trust instruments. (1) if required distributions are determined based on the information provided to the plan administrator  in certifications or trust instruments described in paragraph (a) (1), (a)(2) or (b) of this D-7, a plan will not fail to satisfy section 401(a)(9) merely because the actual terms of the trust instrument are inconsistent with the information in those certifications or trust instruments previously provided to the plan administrator, but only if the plan administrator reasonably relied on the information provided and the minimum required distributions for calendar years after the calendar year in which the discrepancy is discovered are determined based on the actual terms of the trust instrument.  For purposes of determining whether the plan satisfied section 401(a)(9) for calendar years after the calendar year in which the discrepancy is discovered, if the actual beneficiaries under the trust instrument are different from the beneficiaries previously certified or listed in the trust instrument previously provided to the plan administrator, or the trust instrument specifying the actual beneficiaries does not satisfy the other requirements of paragraph (b) of D-5 of this section, the minimum required distribution will be determined by treating the beneficiaries of the employee as having been changed in the calendar year in which the discrepancy was discovered to conform to the corrected information and by applying change in beneficiary provisions of E-5 of this section.

            (2)  For purposes of determining the amount of the excise tax under section 4974, the minimum required distribution is determined for any year based on the actual terms of the trust in effect during the year.


Within the context of this outline, it would be trite to say that income taxes can be reduced by investing in double tax exempt bonds.  However, income taxes are always an issue in estate planning (reference the above materials on using IRAs), and in post-mortem tax planning, and we should at least consider what returns must be filed.


The first question to answer is whether a fiduciary income tax return must be filed.  This is determined by considering the following:

  1. Is there any income producing property or after-death income which will require the filing of a Form 1041?  If that is the case, then, 
  2. Should the estate file for an extension of time to file the Form 1041?
  3. Should the estate use a fiscal or calendar year? 
  4. Will administration expenses and losses be claimed as income tax deductions or estate tax deductions?     
  5. Will the estate redeem any corporate stock?
  6. Will the estate have to make quarterly income tax deposits?
  7. If the estate is subject to ancillary administration in another state, will a fiduciary income tax return be required for that state?
  8. Can the income be distributed to the heirs, rather than being taxed at the Form 1041 level?

In all likelihood, there are limited tools to use in a post-mortem setting, to reduce income taxes.  The above list of questions will at least serve as a checklist of the tools that are available.


I believe everyone knows that joint Form 1040 can be filed in the year of the decedent’s death, but after that, the surviving spouse must file the Form 1040 as a single person.  If a Form 1041 has been filed for the estate, income and expenses can be funneled to the surviving spouse using a Form K-1, and reported on the Form 1040 – the timing of when to distribute the income (the year of death, when a joint return is filed, or the year after death – which requires a fiscal year election on the Form 1041 – and filing a single taxpayer return) should be analyzed.  Timing of when to report the income might achieve a slight income tax savings.  

Other than the timing issues, and use of the Form 1041 K-1, which might distribute losses as well as income items, here are a list of questions which relate to the decedent’s income tax return, for the year of death:

  1. Is a Form 1040 required to be filed?
  2. If there is a surviving spouse, should a joint return be filed?
  3. Did the surviving spouse file a Form 1040 without the executor’s consent?
  4. Did the decedent own any unused tax credits?
  5. Who is entitled to keep the tax refund, the surviving spouse or the executor (should a Form 1310 be filed)?  Conversely, if there are taxes to pay, who pays for them, the estate or the spouse?
  6. Who will pay the income taxes, the executor or the surviving spouse?
  7. If there are any unpaid medical expenses, they can be deducted on the estate tax return or the income tax return (providing the estate pays the expenses within a year of death)

In addition to these questions, the surviving spouse occasionally is unaware that he or she might have to begin filing estimated income tax returns.  Because of the need to develop a cash flow system, perhaps budgeting, and assessment of estate taxes, it is advisable to educate clients as quickly as possible about the changes in their fiscal affairs.



For several years, I have been asked by clients if there were any “understandable” articles which they might read, on the topic of discounting the value of gifts.  There are, of course, hundreds of articles written on the topic, but none of them (to my knowledge) are concise enough to be understood by someone who is not an accountant, a lawyer, a CLU or a Registered Investment Advisor.  For this reason, I am going to try, in as few words as possible, to do the impossible, and explain how the value of a gift can be discounted.

Part of the problem in understanding this subject ties directly to the terminology used.  So let’s abandon the topic for a moment, and consider the Sunday newspapers.  Most of the space is taken up by ads, and it is easy to locate lots of sales being held at lots of businesses.  For example, in last Sunday’s paper, a $30 golf club could be purchased for $15.  From a legal point of view, the merchant is offering a “discount” in price.  Thus, for the sum of $30, a purchaser is entitled to buy two golf clubs for the price of one.

The same principle applies in gifting.  However, special techniques must be used in order to attain these same results.  

Let me explain this.  If I were to give one share of IBM stock to my son, the value of the gift would be about $100.  Under the current Federal Gift Tax laws, I could give him 100 shares, which would be worth $10,000, without having to pay any federal gift taxes (the gift taxes begin when the value of the gift exceeds $10,000 a year).  As you know, the gift tax rates begin at 18%, and increase to 55%, depending on the value of the gift made.  Because these rates are substantial, I would prefer not to pay gift taxes, and simply give no more than $10,000 to my son each year (I am permitted to do so, without paying gift taxes – those gifts are not taxed, because they are equal to the “annual exclusion” amount of $10,000).

Suppose, however, that I form a small family company, and put 200 shares of IBM stock in the company, together with other property (such as, undeveloped real estate worth $80,000).  The company is now worth $100,000 ($20,000 in IBM stock and $80,000 in real estate).  When the company is formed, I will own all of the stock in my name.  The purpose of the company is to manage the property, and increase its value over time.

At Christmas time, instead of giving my son some cash, or instead of making a direct gift of the IBM stock and some of the real estate, I decide to give him some stock in the family company.  Because of the gift taxes, I do not want to make a gift worth more than $10,000.  After all, who wants to pay gift taxes?

If I give him 10,000 shares of the family company stock, he would then own 10% of the company and I would owe no gift tax.  But let’s explore the possibility of discounting the value of the stock, so that he receives more stock, but for gift tax purposes, the value of the stock is worth only $10,000.

Remember the two-for-one golf club example?  For $30, I can buy two golf clubs, instead of one, because Oshman’s has discounted the price by 50%.  That same principle is used in gifts.  Hypothetically, I can give him twice as much stock in the family company (in terms of shares), but only value the shares at half of their worth.

Since we aren’t dealing with merchandise at a store, how am I permitted to give my son 20,000 shares of the family company, but only treat it as a $10,000 gift?  First, my son, who receives these shares, will not be able to control the operations of the family company.  He is a minority shareholder, and cannot control who is elected to corporate office (directors or officers), nor does he have any say so in determining the company’s policies in its business affairs. Furthermore, my son will not be able to sell his stock in the company.  There is no ready market for these shares, and no prudent investor would buy them.  In effect, my son owns a “worthless” asset.  For these reasons, the shares aren’t worth very much, and in a gift tax setting, I can discount the value of the stock when I decide what it is really worth.  

Stated differently, if the child owns 20,000 shares of IBM stock directly, my son will have some rights as a stockholder, in the sense that he may attend the annual shareholders’ meeting, vote for the directors, and reasonably expect to receive a financial statement, and perhaps even be paid a dividend.  Those characteristics are not available in my family company, because I want to control all of its operations, and have designed it to accomplish that objective.  

In addition to the “control of operations” issue, another reason to permit a discount in value of the family company shares is that the stock cannot be sold.  If my son owned 20,000 shares of IBM stock, he would merely call his stockbroker and order the stock to be sold.  In the family company, however, my son will not be able to sell the 20,000 shares, because they are not traded on any stock exchange or over the counter, and the company will have placed restrictions on transfer of its shares (in its bylaws).  In addition, there is no ready market for selling those shares.  If my son were to walk through the neighborhood and knock on doors, and attempt to entice the neighbors to buy his family company stock, he would have a difficult time.  After all, who wants to own a minority stockholder interest in a company controlled by me?

For these reasons, the Internal Revenue Service reluctantly permits discounts in valuation, so that each year, a parent can gift $10,000 of property to numerous donees, without paying any gift taxes – by giving stock in the family company as the property that is given away, the recipient in effect receives more shares of stock, but the gift is treated, for gift tax purposes, as being worth $10,000 (remember, this is equal to the annual gift tax exclusion of $10,000, which means, there is no gift tax to pay).

Let me end this portion of the outline with two other comments:  First, families usually select a family company form other than a corporation.  The most popular forms of organization are limited liability companies or family limited partnerships.  The manager of the LLC or the general partner of a limited partnership is, in effect, an organizational dictator – the members of the LLC or the limited partners have few rights, and those forms of organization are generally taxed as a partnership, rather than as a corporation.  Gifts are either made in “units” of the LLC or as limited partnership interests.

Second, the amount of the discount for gift tax purposes is normally not 50%, as illustrated in this article.  The amount of the discount will usually be 15% to 40%.


This portion of the outline will not deal with Roth IRAs, but will address an obvious solution for clients who plan on giving a portion of their estate to a charity.  Since there is a charitable deduction (for estate tax purposes), gifts to charities at death are desirable.  If such a gift is contemplated, the client might also consider using part of an IRA account as the means of funding such a gift.  If the charity receives the IRA, the charity will pay no income tax thereon.  So ERISA assets are unique assets to use, to accomplish charitable gifts.

© 2001 James H. Beauchamp