Preserve and protect your legacy. UBS Trust Company, N.A.

Transcription

1 Preserve and protect your legacy UBS Trust Company, N.A.

2 Contents Common trust and estate planning documents Will... 2 Living or revocable trust Living will and health care proxy... 2 Financial durable power of attorney... 2 Trust instrument... 2 Estate planning concepts and definitions... 3 Estate and gift exemptions and tax rates... 3 Annual exclusion gift tax Generation skipping transfer (GST) tax... 3 Exclusion medical and educational expenses... 3 Federal gift and estate tax exemption amounts... 3 Marital deduction... 4 Marital deduction planning dividing assets... 4 Inter vivos trust... 4 Testamentary trust... 4 Types of trusts Revocable living trusts... 5 Qualified domestic trusts (QDOTs)... 7 Dynasty trusts... 8 Charitable remainder trusts (CRTs)... 9 Charitable lead trusts (CLTs) Private foundations Irrevocable life insurance trusts (ILITs) Grantor retained annuity trusts (GRATs) Intentionally defective grantor trusts (IDGTs) Qualified personal residence trusts (QPRTs) This guide is for informational purposes only and should not be relied upon as a primary resource. Clients should carefully review their financial outlook with a professional tax advisor for information regarding or issues concerning the tax implications of making a particular investment or taking any other actions. Federal tax statutes and regulations governing trusts and estates are complex and subject to change. Also, most nontax laws relating to trusts and estates are state-specific, and as such are beyond the scope of this material, though they could have a significant impact on your estate plan. As a result, you should always consult a qualified attorney and/or tax professional regarding your estate planning, including how changes in the tax law may affect your specific situation. UBS Financial Services Inc., its employees and Financial Advisors do not provide tax or legal advice. Therefore, we make no representations regarding the accuracy of the information provided herein. This material is not intended or written to be used, and cannot be used or relied upon, by any taxpayer for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any transaction or tax-related matter(s). Wealth management services in the United States are provided by UBS Financial Services Inc., a registered broker/dealer offering securities, trading, brokerage and related products and services. Trust services are provided by UBS Trust Company, N.A. or another licensed trust company. UBS Trust Company, N.A. is an affiliate of UBS Financial Services Inc. and a subsidiary of UBS AG. Trust investments are not deposits or other obligations of, or guaranteed by, UBS Trust Company, N.A. or UBS AG or any of their affiliates. Trust investments involve investment risks, including possible loss of the principal.

3 Securing your finances and your legacy The financial security of your family may depend not only on how you manage your wealth today, but also on how you protect and preserve it for the future. That s why many of our clients consider trusts as a key component of their estate planning strategy. Personal trusts are commonly used to ensure ongoing management of your assets in the event of your death or disability, to avoid probate, to minimize or eliminate estate and other transfer taxes and to protect your assets across generations. In the following pages, we ll discuss several of the most common types of personal trusts and how, as one significant component of your estate plan, they can help safeguard your wealth, care for your family and preserve your legacy for years to come. 1

4 Common trust and estate planning documents Will Historically, a will has been the primary instrument for planning the distribution of your estate, managing assets after death, appointing executors and guardians and establishing trusts. If you do not have a will, state law governs the distribution of your estate, which may have many unintended and unexpected results. To be sure your will reflects your wishes, it s important to review it periodically and adjust for changes in your personal circumstances and any changes in tax laws. Living or revocable trust A living or revocable trust may be established to provide for the management of assets in the event of your incapacity or illness, and to avoid the time and cost of probate upon death. A revocable trust is most effective when ownership of assets is transferred to the trust during the grantor s life. A separate will is generally still needed to provide instructions for distribution of assets not actually held in the trust at the time of death. Financial durable power of attorney A financial durable power of attorney may be used to appoint a person to act as your agent to carry on your financial affairs. A financial durable power of attorney may eliminate the need for the court to appoint a conservator or guardian to act on your behalf if you are not able to manage your own affairs. Trust instrument A trust instrument is a binding agreement between the grantor (sometimes referred to as the settlor) and trustee that defines the legal rights and duties of the parties and the beneficial enjoyment of the assets placed in trust. In exercising its responsibilities, the trustee is guided by the wishes of the person who created the trust, as set out in the trust agreement, which is, in effect, the charter of the trust. Trust instruments can be as general or as detailed as the grantor wishes. Living will and health care proxy A living will expresses your wishes with respect to the use of life-sustaining measures and the delivery of medical care in the event you become incapacitated by terminal illness. A health care proxy (also called a durable medical power of attorney) additionally addresses these issues and allows you to designate an agent to instruct health care professionals in the event of incapacity. 2

5 Estate planning concepts and definitions For estates of decedents dying and gifts made in 2013 and thereafter, the American Taxpayer Relief Act of 2012 (ATRA) has set the maximum estate, gift and generation-skipping transfer (GST) tax rate at 40%. Under ATRA, estate, gift and GST taxes are unified and exemption amounts available to each individual taxpayer are indexed for inflation. This law is now permanent unlike the years when the transfer tax laws were scheduled to end or sunset. Estate and gift exemptions and tax rates Calendar year Estate tax exemption Gift tax exemption GST exemption Highest estate and gift tax rate Marital deduction to a non-u.s. spouse 2010 N/A* $1 million $5 million Executor may elect zero estate tax rate with 134,000 modified carryover basis adjustment.* Gift tax 35% $5 million $5 million $5 million 35% 136, $5.12 million $5.12 million $5.12 million 35% 139, $5.25 million $5.25 million $5.25 million 40% 143,000 * In the absence of an election by the executor, a 35% maximum estate tax rate applies with a $5 million exemption. Under prior law, the exemption of the first spouse to die would be lost if not used. Now, a surviving spouse may utilize the deceased spouse s unused exemption amount, in addition to his or her own exemption. As a result, the law allows for the portability of the estate tax exemption amount between spouses. Annual exclusion gift tax You may make limited tax-free transfers in cash or in property each year to as many individuals as you wish. This is called the annual gift tax exclusion. Married donors who split gifts with their spouse may each make such tax-free gifts (or twice the inflation-adjusted amount of the exclusion) each year to each donee. The transfer must be a gift of a present interest to qualify for the annual exclusion. For planning purposes, it may make sense for you to set up an annual gift program for children and grandchildren to take full advantage of this exclusion. With the compound effect of investing, these gifts may represent a significant pool of funds that escape transfer taxes. Gifts to minor children or grandchildren can be made to 529 plan accounts, UGMA (Uniform Gifts to Minors Act) or UTMA (Uniform Transfers to Minors Act) accounts, Crummey trusts, irrevocable life insurance trusts (ILITs), or to a minority trust. A minority trust is a trust vehicle (established under Section 2503(c) of the Internal Revenue Code) that holds assets for minors until they attain the age of 21. When minors attain the age of majority, they become entitled to the assets of the trust. Generation-skipping transfer tax In addition to federal estate and gift taxes, a tax known as the generation-skipping transfer (GST) tax is imposed upon transfers during life or upon death to individuals who are two or more generations below that of the donor. The GST tax is assessed at the highest estate tax rate. The tax laws provide each person making a generation-skipping transfer an exemption from the GST tax. The GST exemption is also indexed for inflation. The GST exemption allows you to transfer the exempted amount over your lifetime, or by bequest at death, to grandchildren or other beneficiaries who are in a generation two or more below. Exclusion medical and educational expenses Another exclusion from the federal gift tax applies to the payment of medical and educational expenses for tuition on your behalf, regardless of the relationship between the donor and the recipient. To qualify, the payment of these expenses must be made directly to the educational institution or medical care provider on your behalf. These unlimited exclusions are in addition to the annual gift tax exclusion and represent a particularly effective method for parents and grandparents to transfer wealth without the imposition of federal gift, estate or GST taxes. Federal gift and estate tax exemption amounts In addition to the annual gift tax exclusion, you are permitted to transfer an amount of property during your lifetime or at your death without the imposition of federal transfer taxes. 3

6 Note that both the gift and estate tax exemption amounts are reduced by taxable gifts. If you use up your gift tax exemption amount, you will also have used up the same amount of your estate tax exemption amount. Married individuals may use their exemption amounts together to make tax-free lifetime gifts. For planning purposes, there is often a significant benefit to giving the exemption amount at the earliest possible time during life so that future appreciation and income generated on the assets gifted escape unnecessary taxation. Marital deduction By taking advantage of the unlimited marital deduction, anyone may give to a U.S. citizen spouse during his/her lifetime, or bequeath at death, an unlimited amount of property that is excluded from federal gift or estate taxes. Inter vivos trust An inter vivos trust is any trust that is created during an individual s lifetime. Such trusts include, for example, revocable living trusts, charitable trusts, trusts created for minors and any trust created during life to serve a specific purpose. Testamentary trust A testamentary trust is any trust created under a decedent s will. Testamentary trusts can take many forms. For example, a trust designed to utilize the decedent s remaining applicable exclusion amount is often referred to as a credit shelter trust or bypass trust. Testamentary trusts can also be drafted to qualify for a charitable estate tax deduction and can include charitable remainder trusts and charitable lead trusts. Testamentary trusts are not funded until a person dies and the will is admitted to probate, if required. The unlimited federal gift tax marital deduction is not available when the receiving spouse is a non-u.s. citizen. However, the annual exclusion for gifts to a non-u.s. citizen spouse is significantly higher than the ordinary annual exclusion. This exclusion allows a spouse to make a gift to a non-u.s. citizen spouse free of federal gift tax. To obtain the unlimited federal estate tax marital deduction with respect to transfers occurring at death to a non-u.s. citizen spouse, a special trust called a qualified domestic trust must be used. Marital deduction planning dividing assets A sufficient amount of assets must be owned in each spouse s name to fully use the applicable exclusion amount and the GST tax exemption. A married couple should consult with their legal and tax advisors to determine the proper titling of assets in order to take full advantage of available credits, deductions and exclusions. 4

7 Types of trusts Revocable living trusts Basic overview A revocable living trust is a trust established by you, the grantor, for your own benefit. Such trusts can be amended by the grantor as provided in the trust instrument. Revocable living trusts are very flexible and, usually, the grantor is the sole initial trustee. They are often used as a will substitute or can work in conjunction with an individual s will. The primary advantages of this arrangement are privacy, probate avoidance and managing assets in the event of the grantor s incapacity. Features Incapacity. In the event of your incapacity, a court may appoint a guardian or conservator to take care of you and/or your property. These proceedings can be time consuming and expensive, not to mention intrusive. Establishing a revocable living trust may avoid the necessity of such a court proceeding. A revocable living trust allows you to provide for the disposition of assets and management of affairs without court intervention and publicity. In addition to revocable living trusts, you should consider a durable power of attorney. A durable power of attorney is used to appoint an agent to manage your financial affairs. Furthermore, a durable power of attorney continues to be effective even after you become incapacitated. Privacy. Privacy is another benefit provided by the use of a revocable living trust. Unlike a will, a trust agreement is not a public document. Transfer of assets to a revocable living trust may avoid publication of your testamentary plan. Probate. Probate is the process by which a court authenticates your will; the court oversees the transfer of property to your beneficiaries. Assets placed in a revocable living trust avoid probate. A revocable living trust can provide speed and flexibility during the administration of your estate. Trustees can make investment decisions without interruption, whereas nobody can change your investments before a will is admitted to probate. If property title is held in the name of the trust rather than your own name, real estate in multiple jurisdictions can be transferred without the time and expense of ancillary probate, which would otherwise be required in each state. You can completely avoid probate if you transfer title to all of your property to a revocable living trust. But this is often difficult to do. A will, often referred to as a pour-over will, is necessary to direct the transfer of any remaining assets you own individually to the trust upon death. 5

8 Administrative flexibility. A revocable living trust established during your lifetime may also provide greater flexibility in the appointment and resignation of trustees, and as to the powers given trustees to reform the trust instrument or change the jurisdiction of the trust to obtain favorable tax treatment. Trusts established under wills often require court approval or permission to resolve these issues. Tax issues. As a result of your retained interests in the trust assets and the ability to revoke or amend the trust, you are considered the owner of the trust assets for tax purposes, you will continue to be taxed on the trust s income, and the trust assets will be included in your gross estate at death. (There is no gift tax on the transfer of property to the trust.) Overview of revocable living trusts Grantor Income generated by trust is taxable to grantor Property transfer Income and principal to grantor Revocable living trust Upon death, assets distributed to beneficiaries, according to terms of trust 6

9 Qualified domestic trusts Basic overview Transfers to a non-u.s. citizen spouse, whether the spouse is a U.S. resident or not, do not qualify for the unlimited marital deduction and, therefore, do not pass free of gift or estate tax as they do where the recipient spouse is a U.S. citizen. If the transfer upon death is made to a qualified domestic trust (QDOT), however, or the recipient spouse transfers the property to a QDOT within a short period after the decedent s death, the transfer may qualify for the unlimited marital deduction and postpone transfer taxes, possibly until the surviving spouse s death. Features Gift and estate tax issues. As mentioned earlier, the unlimited federal gift tax marital deduction is not available to transfers to non-u.s. citizen spouses. However, there is an annual exclusion for gifts to non-u.s. citizen spouses. Property bequeathed at death to a noncitizen spouse will not qualify for the unlimited federal estate tax marital deduction, unless the transfer is made to a QDOT for the sole benefit of the surviving spouse. Overview of qualified domestic trusts First spouse to die Estate tax assessed at first spouse s tax rate on principal distributed to noncitizen spouse during lifetime and on death of noncitizen spouse Qualified domestic trust Income interest to noncitizen spouse Remainder to beneficiaries selected by first spouse to die Qualification. In order to be classified as a QDOT, a trust must contain certain provisions ensuring that the assets will always be within the reach of the IRS, including: The noncitizen spouse receives the income from the trust and is the only beneficiary during his or her lifetime, and At least one trustee must be a U.S. bank or U.S. citizen, and Generally, principal distributions made by the trust to the surviving noncitizen spouse are subject to estate taxes. The assets of the trust are subject to estate tax at the surviving spouse s death. 7

10 Dynasty trusts Basic overview Historically, state law has limited the duration of a trust, which is required to terminate within a definable period. Certain states have amended their trust law to permit trusts to continue in perpetuity for certain types of property. These perpetual trusts are known as dynasty trusts. Since the trust is not required to terminate, future appreciation and income generated by the assets in the trust are removed from individual ownership and, therefore, from exposure to estate and gift taxes after the initial transfer. Overview of dynasty trusts Grantor Irrevocable property transfer Dynasty trust* Features Under current law, the impact of transfer taxes assessed on future generations can be dramatic. Assets may be significantly eroded at each generational level. Tax planning. A perpetual dynasty trust may allow a certain percentage of assets to grow, without erosion by transfer taxes at each generation, for the benefit of your descendants. Such a trust can be funded with your applicable exclusion amount and GST tax exemption to allow for all future income and appreciation to accrue outside of your taxable estate and for the benefit of future generations, without the imposition of transfer taxes. For planning purposes, there is a significant benefit if these exemptions are used at the earliest possible time during life so that future appreciation and income generated on the assets gifted are removed from your estate. Gift/estate tax may be assessed on initial transfer into trust, but not thereafter. GST tax may be assessed on initial transfer or thereafter if initial gift is in excess of GST exemption. * Perpetual ** Future generations Beneficiaries** Planning issues. Be sure to carefully assess actual tax rates, including state transfer taxes and exemptions, with your attorney or professional tax advisors. 8

11 Charitable remainder trusts Basic overview A charitable remainder trust (CRT) is an irrevocable trust in which the grantor, or beneficiaries designated by the grantor, retain an interest for life or a term of years, not to exceed 20 years, with the remainder passing to charity. The grantor is entitled to an income tax deduction, subject to limitations based on adjusted gross income, in the year the trust is established for the actuarial value of the remainder interest passing to charity. If the retained interest is transferred to children, grandchildren or other noncharitable recipients, it would be subject to gift, estate and/or GST taxes. Features Trust formats. There are two types of charitable remainder trusts, a charitable remainder annuity trust (CRAT) and a charitable remainder unitrust (CRUT). Distributions from a charitable remainder annuity trust are made at least annually to the beneficiary based upon a fixed dollar amount, which is calculated as the fixed percentage (minimum of 5% and a maximum of 50%) of the initial value of the trust. Additional contributions of property to a CRAT are not permitted. The annuity distribution for a CRAT will remain constant regardless of any later changes in asset value. Overview of charitable remainder trusts Grantor Income tax deduction for actuarial value of remainder interest to charity Irrevocable property transfer Annuity or unitrust payment each year to grantor Charitable remainder trust Remainder to charity at end of term of years or lives A charitable remainder unitrust makes distributions to a beneficiary at least annually based upon a fixed percentage, which has to be at least 5% and no more than 50% of the fair market value of the trust as determined each year. Unlike a charitable remainder annuity trust, additional property can be contributed to a CRUT. If the trust property grows in value, the unitrust payment will increase. However, a decrease in the value of the trust property will result in a decreasing unitrust payment. Charitable income tax deduction. A charitable income tax deduction may be available equal to the present value of the remainder interest that will pass to charity based upon the payment distribution rate and the relevant federal interest rates. The rate set by the IRS for the month of the contribution (referred to as the 7520 rate) or the two prior months may be used to determine the maximum income tax deduction for the donor. There are several requirements that must be strictly complied with in order for a charitable remainder trust to qualify as a tax-exempt entity. One requirement is that the present value of the remainder interest to charity must equal at least 10% of the value of the trust property at the time of its contribution to the trust. Funding a charitable remainder trust with cash will result in an income tax deduction limitation of 50% of the donor s adjusted gross income (AGI), if the remainder beneficiary is a public charity, or 30% if the remainder beneficiary is a private foundation. If the trust is funded with long-term appreciated property, the donor s income tax deduction is based upon the fair market value of the property at the time of contribution, limited to 30% of the donor s AGI, or 20% of the donor s AGI if the remainder is distributable to a private foundation. If short-term appreciated property is used to fund the trust, the donor s cost basis rather than the property s fair market value will be the deductible amount for income tax purposes, limited to 50% of the donor s adjusted gross income, or 30% of the donor s AGI if the remainder beneficiary is a private foundation. Individuals charitable deductions are also subject to the overall limitation on itemized deductions. 9

12 You may carry over most unused charitable deductions for up to five years, subject to future AGI limitations. The calculation of the charitable income tax deduction depends on several factors, which must be considered by your tax professional. Other income tax considerations. Qualified charitable remainder trusts are tax-exempt entities. One of the important advantages of a CRT is that no immediate capital gains taxes are imposed on assets sold in the trust. This means that highly appreciated stock gifted to a CRT can be sold by the trustee and reinvested in a diversified portfolio, thus reducing risk without the value being diminished by the payment of capital gains tax. However, the annuity or unitrust amount distributed to the noncharitable recipient carries out the trust s income based on the character of the income earned by the trust first ordinary income, followed by shortterm capital gains, long-term capital gains, tax-exempt income and, finally, principal. Estate planning. Many times, individuals who establish charitable remainder trusts desire to replace the assets gifted to the trust, and which eventually pass to charity, by purchasing life insurance. The cash flow generated by a charitable remainder trust may be used to pay life insurance premiums on a policy insuring the donor. The insurance policy may be held by a separate irrevocable trust, which allows the distribution of insurance proceeds to the beneficiaries to pass estate tax-free on the donor s death. This type of separate insurance trust is often referred to as a wealth replacement trust. The donor s children and grandchildren are often the beneficiaries of this trust. Charitable remainder trusts are subject to the rules applicable to private foundations, which, among other things, may (1) prohibit certain acts of self dealing between the trust and persons considered related to the trust (disqualified persons); (2) impose excise taxes on certain inappropriate expenditures by the trust (taxable expenditures); and (3) impose excise taxes on risky investments (so-called jeopardizing investments). 10

13 Charitable lead trusts Basic overview A charitable lead trust (CLT) is an irrevocable trust in which annual payments are made to a charity chosen by you for a term of years, generally, and the remainder interest is paid to your designated beneficiaries. Trust formats. Charitable lead trusts may be created during your lifetime (inter vivos trust) or are established upon your death (testamentary trust). Regardless of when the trusts are established, charitable lead trusts must be in the form of either a charitable lead unitrust (CLUT) or a charitable lead annuity trust (CLAT) in order to obtain an estate, gift or income tax deduction. Features A charitable lead unitrust makes distributions to charitable beneficiaries at least annually based upon a fixed percentage of the fair market value of the trust assets as recalculated annually. Unlike a charitable remainder trust, there is no upper or lower limit on a CLUT payout. If the trust property grows in value, the unitrust payment to charity will increase. A decrease in the value of the trust property, however, will result in a decreasing unitrust payment to charity. Distributions of a fixed dollar amount are made at least annually from charitable lead annuity trusts to a charitable beneficiary. The annuity amount is usually based on a percentage of the initial fair market value of the assets contributed to the trust. The annuity distribution for a CLAT will remain constant regardless of increases or decreases in the value of the trust. Transfer tax. The present value of the remainder interest that will pass to the noncharitable beneficiaries is a taxable transfer and will be subject to tax if it exceeds your available applicable exclusion amount. A CLAT may be structured to, in effect, zero out the taxable amount if the actuarial value of the payout to charity equals the fair market value of the assets transferred to the CLAT. 11

14 Income tax issues. If established as a nongrantor trust, the CLT is taxed as a complex trust and is allowed a charitable income tax deduction for amounts paid out of gross income to a qualified charity. Unlike an individual, however, a nongrantor charitable lead trust is generally able to deduct 100% of the charitable distributions (i.e., there are no AGI limitations). If a CLT is a grantor trust, the donor recognizes each year all the trust s income. In the year that the trust is established, the donor will also receive an immediate income tax deduction equal to the value of the lead interest. (The deduction is based on the present value of future payments, whereas the grantor must report the full value of income earned by the trust every year without any charitable deduction.) Charitable lead trusts are also subject to the private foundation rules described in the charitable remainder trust section. Since there is a current charitable interest, many states require a separate filing of an annual report with the attorney general of that state. The attorney general oversees the charitable interest to make sure that the CLT does not enter into any prohibited transactions that would jeopardize its charitable purpose or pose a conflict of interest. Estate planning. The CLAT may be a particularly useful estate planning tool when interest rates are low. Assets can potentially be transferred to younger generations with little or no estate and gift taxes while making charitable gifts at the same time. The charitable deduction is based on the present value of the charitable interest, which is then subtracted from the value of the property contributed to the trust before the gift or estate tax is computed. The term and payout rate for a charitable lead annuity trust can be chosen so that the present value of the charitable interest is equal to the value of the property contributed to the trust, so no gift or estate tax consequences would result: the trust would be zeroed out. The computation of the present value of the charitable interest is based, in part, on the existing interest rates as provided by the IRS monthly (7520) rate. The lower the 7520 rate, the higher the present value of the charitable lead annuity interest and the easier it would be to zero out the trust. Overview of charitable lead trusts Grantor Irrevocable property transfer Charitable lead trust Transfer tax assessed on actuarial value of remainder interest to beneficiaries exceeding applicable exclusion amounts (and GST exemption, if applicable) Annuity or unitrust interest to charity for term of years or lives Remainder to beneficiaries at end of term 12

15 Private foundations Basic overview A private foundation is an entity organized exclusively for a charitable purpose. Individuals with deep interests in philanthropy may wish to establish a private foundation as a permanent vehicle for their charitable giving. A private foundation provides you with a high level of control and flexibility for using your assets for charitable purposes. Overview of private foundations Grantor Donor receives charitable income tax deduction Irrevocable property transfer Private foundation Annual distributions to charitable recipients Features A private foundation may be organized as either a corporation or a trust. Both options allow you to design your own comprehensive giving program for the foundation when it is created or leave decisions to the discretion of the foundation s governing body (i.e., trustees or board of directors). Within 27 months of forming the foundation, you must file an application for tax-exempt status (Form 1023) with the Internal Revenue Service. If the exemption is granted, donations to the foundation will be deductible for income, gift and estate tax purposes. Income tax: Your income tax deduction for contributions to a private foundation is limited. Contributions of cash will result in an income tax deduction limitation of 30% of your adjusted gross income. If the foundation is funded with long-term appreciated property, the income tax deduction is limited to 20% of your AGI. Furthermore, the amount deductible is not the fair market value of the property but only its basis. There is an exception to this rule when the appreciated property is composed of publicly traded securities. In that case, the amount of the contribution is the fair market value of the securities at the time of the gift (subject to AGI limits). If short-term appreciated property is used to fund the trust, the donor s cost basis rather than the property s fair market value will be the deductible amount for income tax purposes, limited to 30% of your adjusted gross income. If your adjusted gross income limits the currently deductible amount, you may carry over the unused deduction for up to five years, subject to future AGI limitations. Excise tax: Private foundations are generally not subject to standard income taxes. However, there is a maximum 2% excise tax assessed on investment income generated by the foundation. This tax may be reduced to 1% if the foundation meets certain distribution requirements. 13

16 Charitable distribution and filing requirements: A foundation is required to distribute to charities each year 5% of the combined fair market value of all the foundation s assets. The foundation is also required to file Form 990-PF with the Internal Revenue Service annually and may be required to file an annual report in the state where the foundation was established or in which it operates. Private foundations are also subject to the private foundation rules described in the charitable remainder trust section (application may differ as between private foundations and charitable trusts). Making a gift to a donor advised fund generally results in higher current income tax deductions compared to making a gift to a private foundation, both for contributions of cash (50% of AGI as opposed to 30% for most foundations) and of appreciated assets (30% of AGI as opposed to 20%). Most importantly, by adopting the donor advised fund approach, you are relieved of administrative burdens, including the preparation and filing of tax and informational returns. Some donor advised funds are created and managed by investment companies, while others are created within and operated by community foundations. Donor advised funds: The administrative burdens involved in the creation, management and operation of a private foundation may lead you to pursue an alternate course. Transferring assets to a donor advised fund (DAF) operated by a public charity is one alternative. With a DAF you make a contribution to a public charity that manages the fund and receives and considers recommendations made by you regarding distributions and the investment of the fund s assets. 14

17 Irrevocable life insurance trusts Basic overview Using life insurance within your estate plan can help you achieve various objectives, which may include replacement of an income stream for your surviving spouse and other family members after your death, or wealth replacement when assets are gifted to charitable organizations, or estate liquidity. Although life insurance is a valuable component of an estate plan, it must be properly structured for it to provide tax benefits. If a decedent has incidents of ownership in an insurance policy at any time during the three years before death, the death proceeds from the insurance policy are generally included in the estate and are subject to estate taxation. Generally, you are deemed to be the owner of an insurance policy if you, among other things, can change the beneficiary, assign or cancel the policy or use the policy as collateral for a loan. Most clients insurance-related estate planning objective is to prevent insurance proceeds from being subject to estate taxes. Features An irrevocable life insurance trust (ILIT) may be used to avoid inclusion of insurance proceeds in your estate. In addition to elimination or reduction of estate taxes, insurance trusts may also accomplish non-tax-related goals. Structure: Typically, life insurance trusts are irrevocable and can be funded or unfunded. An unfunded insurance trust is one that holds a life insurance policy and no other assets. A funded insurance trust holds other assets besides the policy, usually with the purpose of providing funds to pay the policy premiums. There is an irrevocable assignment of all ownership interests in the insurance policy to the trust, and the trustee becomes the legal owner of all the rights to the insurance policy. In addition, the trust is designated as the beneficiary of the death benefit proceeds. When you transfer a life insurance policy to an irrevocable trust, you have made a transfer that is subject to the gift tax, unless it qualifies for the annual exclusion. If you transfer an existing policy to an insurance trust, you must live three years past the date of transfer in order to avoid inclusion of the life insurance proceeds in your estate. By contrast, if the insurance trust acquired a new insurance policy that you never owned, the threeyear shadow period does not apply. 15

18 With an unfunded trust, someone must make contributions to the trust to provide the trustee with funds to pay the premiums due on the insurance policy. To qualify these contributions as present interest gifts under the gift tax annual exclusion rules, beneficiaries are given the power to withdraw the contributions up to a certain amount each year. The trustee notifies the beneficiaries of the contribution and of their right to withdraw these funds. This withdrawal right lapses after a period of time if not exercised. If the beneficiaries do not exercise their right of withdrawal, the trustee may use the contributions to pay the premiums. After the death of the insured, the trust terms may instruct the trustee to make outright distributions to family members or may direct the trustee to hold the proceeds in trust over a number of years. The trust may name the insured s spouse, children, grandchildren or other individuals as beneficiaries. An insurance trust may, by its terms, be a dynasty trust, if drafted with that goal in mind. Example: A husband and wife establish a charitable remainder unitrust (CRUT). Upon their death, trust assets will be distributed outright to their alma mater. They fund this trust with a contribution of assets worth $2 million. Although they are pleased they can benefit their university, they want to replace these assets so that they can also leave funds to their grandchildren and great-grandchildren. At the same time they establish their charitable remainder unitrust, the couple also establishes an ILIT for the benefit of their grandchildren and great-grandchildren. The trustee obtains a second-to-die insurance policy insuring their lives, which will pay death proceeds to the trust of $2 million upon the death of the survivor. Each year, the couple makes a gift to the trust from the cash flow they receive from the CRUT in an amount that will enable the trustee to pay the premiums on the second-to-die insurance policy. Upon the couple s death, the grandchildren and great-grandchildren will be the beneficiaries of this trust. The trustee will be empowered to sprinkle income and principal to any of the beneficiaries in the trustee s discretion for the recipient s health, education, maintenance and support. In order to avoid any generation-skipping taxes, husband and wife will file gift tax returns allocating their GST exemptions to the gifts to the trust. Since the insurance trust always owned the insurance policy, the death proceeds would not be included in the estate of either the husband or the wife upon their deaths, regardless of how soon they die after the trust acquired the policy. Planning issues: The above example illustrates one use of an ILIT, that of wealth replacement when the insured makes a charitable gift. It also shows one way of avoiding estate taxation of insurance proceeds. Overview of irrevocable life insurance trusts Grantor Irrevocable transfer of funds and/ or a life insurance policy to trust Annual gifts to trust to pay insurance premiums Irrevocable life insurance trust* Insurance proceeds benefit designated persons in trust *Holds insurance policy. 16

19 Grantor retained annuity trusts Basic overview A grantor retained annuity trust (GRAT) is an irrevocable trust in which you retain an interest for a period of years, with the remainder passing to designated beneficiaries. Future appreciation from this property may be removed from your estate provided that you survive the term of the trust. GRATs funded with high growth-potential assets may provide you with significant transfer tax savings. Growth of an asset in excess of the rate used in valuing the gift for transfer tax purposes will pass to the remainder beneficiaries without transfer taxes. Overview of grantor retained annuity trusts Grantor Gift tax paid on actuarial value of remainder interest exceeding applicable exclusion amount Irrevocable property transfer Annuity payment each year to grantor Grantor retained annuity trust Remainder to beneficiaries at end of term Features Estate and gift tax issues: A portion of the property contributed to a GRAT is a gift to the remainder beneficiaries. The value of the gift is determined by subtracting the present value of the interest retained by the grantor (based upon the relevant federal interest rate, known as the 7520 rate) from the fair market value of the assets contributed to the trust. As with a charitable remainder trust, the valuation will vary depending on the length of the retained interest term, the amount of the annual payment and the current interest rates at the time of funding. The term and payout rate of a GRAT can be selected so that little or no gift is made. Since the gift is of a future interest, the annual gift tax exclusion is not available. However, you may use a portion or all of your applicable exclusion amount to offset the gift tax. In the event of your death during the term of the trust, some or all of the trust property will be included in your taxable estate. It will be taxed at its fair market value as of the date of death, just as if the trust had never been established. It is, therefore, important to select a term that you will likely survive. If you survive the term, all property remaining in the trust, including appreciation, will pass to the remainder beneficiaries without the imposition of additional gift or estate taxes. 17

20 Intentionally defective grantor trusts Basic overview An intentionally defective grantor trust (IDGT) is a trust that is not included in your estate for estate tax purposes, even though you remain liable for the tax on the income and capital gains generated on the trust s assets. In effect, you are generally able to transfer additional amounts, free of gift tax, equal to the taxes you paid on the trust income. Overview of intentionally defective grantor trusts Grantor Irrevocable property transfer Trust income taxed to grantor allows trust to grow free of tax Intentionally defective grantor trust Features The origins of an IDGT lie in the fact that ownership is defined differently for transfer tax (i.e., gift and estate) purposes than for income tax purposes. Thus, certain powers you retain may cause you to be taxable each year as owner of all trust income and capital gains without affecting the estate planning goal of removing trust assets and all future appreciation from further transfer taxes. The term defective is a bit of a misnomer: it is often beneficial from an estate planning perspective for you to be able to pay the tax on the income and gains generated by the trust without the payment being considered a gift. All income earned by trust is taxable to grantor. Transfer tax paid on taxable transfers exceeding applicable exclusion amount (and GST exemption, if applicable) Beneficiaries 18

21 Qualified personal residence trusts Basic overview A qualified personal residence trust (QPRT) involves an irrevocable transfer of your personal residence to a trust where you retain the right to live in the residence for a fixed period of years. At the end of the fixed term, the residence is transferred to beneficiaries designated by you, either outright or in trust. Although the transfer is subject to gift tax, the value of the transfer is equal only to the value of the remainder interest to the beneficiaries. This value is calculated by subtracting the actuarial value of the interest you retain as determined based on the relevant interest rate (the 7520 rate) and on IRS annuity tables, from the initial value of the home. Features Gift taxes: The value of the remainder interest in the trust property is considered a gift to the remainder beneficiaries upon contribution of the property to the trust. The gift to the remainder beneficiaries is a future interest that does not qualify for the annual gift tax exclusion. Therefore, you must use your federal applicable exclusion amount or pay a gift tax to the extent that the applicable exclusion amount has been fully utilized. The value of the taxable gift to the remainder beneficiaries is based upon the 7520 rate for the month that the property is contributed to the trust. The gift value is the fair market value of the property less the present value of your retained rent-free income interest. Any appreciation of the property in excess of the federal applicable rate passes to the remainder beneficiaries free of additional gift or estate taxes. Overview of qualified personal residence trusts Grantor Gift tax paid on actuarial value of remainder interest exceeding applicable exclusion amount Irrevocable residential property transfer Grantor retains right to use residence for term of years Qualified personal residence trust Residence to beneficiaries at end of term Estate taxes: If you die during the income term of the QPRT, the value of the property at the date of death will be included in your taxable estate, just as if the trust were never established. It is, therefore, important to select a term that you will likely survive. If you survive the trust term, the trust property is excluded from your taxable estate. Income taxes: A QPRT is a grantor trust for income tax purposes. Therefore, your ownership interest in the property is the same for income tax purposes as before your contribution to the trust. You may deduct all interest and taxes applicable to the personal residence. However, any contribution for capital improvements or the principal component of mortgage payments would be an additional contribution to the trust, taxable for transfer tax purposes, so un-mortgaged real estate is generally preferable for use in a QPRT. 19

22 Sale or transfer of property: The trustee of a QPRT is not permitted to sell the residence held by the trust to you or your spouse during the original term of the trust. The governing instrument, however, may permit the trustee to sell the residence to other persons. Example: A widow, age 60, transfers her personal residence valued at $700,000 to a QPRT, retaining a 15-year term to live in the residence on a rent-free basis. The federal interest rate used to value the gift to the remainder beneficiaries is 1.4%. The taxable gift to the beneficiaries is $418,810, which cannot be offset by the annual gift-tax exclusion since it is a gift of a future interest. However, she may use her applicable exclusion amount if she has not fully used it previously for other gifts. If she survives the term, the value of the personal residence passing to her children at the end of 15 years, based upon a 4% growth rate, is $1,260,660, with no additional transfer taxes due. The value of the residence is frozen upon creation of the trust so that future appreciation escapes estate taxation at the termination of the trust. Is a personal trust right for your estate planning strategy? It may be time for us to have a conversation. Please contact your UBS Financial Advisor so we can evaluate appropriate trust options for you and for recommendations that are strategically aligned with your wealth preservation, estate and legacy goals. Upon transfer to the QPRT, the gift is complete. As a result, the value of the residence and all future appreciation on the residence are removed from the transferor s estate, unless, as noted above, the transferor dies during the QPRT term. 20

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