By: C. Arthur Robinson, II

Over the last several years, we have seen a significant, perhaps even a sea-, change in the estate planning environment.  For many years, practitioners were focused on transfer taxes as the tax rates were high and the exemptions were low.  Then, starting in 2000, increasing exemptions and decreasing rates began to turn the planning environment on its head.  This turbulence in estate planning reached its peak in 2010 with the “repeal” of estate taxes.  Subsequently, we have achieved a new island of stability in estate planning.

Currently, with lifetime exclusion amounts being in excess of $5 million, only one-half of one percent of individuals have estates large enough to be subjected to tax above the exclusion amounts.  Therefore, we are now in an environment where income taxes have become a far more important issue.

Over the last 15 years, we have also seen exposure regarding claims and other challenges to wealth preservation become far more prevalent and much more of a concern.  The natural focus on the twin concepts of income tax reduction and asset protection leads to a series of techniques which promise one or both of these benefits.  Some of these techniques are straightforward and pedestrian and have strong statutory authority.  Others are considerably more aggressive and may even represent transactions where the level of risk is unacceptable to some if not most of our clients.
It has been possible for a number of years to use statutorily authorized trusts from a tax perspective to achieve interesting income tax results.  The charitable remainder trust (“CRT”) is probably the most tried-and-true technique that will be discussed in the article, as it combines tax characteristics which are defined by federal tax law as well as providing for a trust which, when properly created, both because it is irrevocable and benefits someone other than the grantor of the trust, will typically enjoy asset protection under a number of state statutes.

The critical aspect of a CRT is that it enables assets to be liquidated and gain to be recognized without tax being paid immediately.  Rather, the tax characteristics flow out as either an annuity or unitrust amount, and tax is paid by the grantor or others over time.  This technique can allow assets to be monetized, facilitate the redeployment of capital, and provide for efficient investment of proceeds without tax having to be paid immediately, which can dramatically increase the real rates of return for clients.

When a CRT is created in a jurisdiction that allows for domestic asset protections trusts, the characteristics of such an asset protection trust can be folded into the CRT and can often provide for greater security for clients.  In fact, asset planning using trusts has become a greater focus in the turbulent environment we now face.  There are approximately 15 states that have some form of a domestic asset protection trust statute, some of which are extremely robust and broad in their application.  Others, like Virginia, are more specific and targeted.

Currently, as taxes and legal claims present the greatest dangers to the preservation of assets, a domestic asset protection trusts is a potential solution to a variety of potential problems.  Careful selection of the situs of such a trust and who will be involved in terms of the connection to a foreign jurisdiction (such as Delaware,) are critical components of designing such trusts.

In some instances, planners have gone further.  Planners have intentionally designed trusts to be non-grantor trusts, meaning the trust is its own taxpayer in certain jurisdictions, such as Delaware and Nevada.  This is done in order to take advantage of the fact that there is no state income tax for trusts in some states.  In these states (currently there are approximately 11 such states,) an intentionally non-grantor trust, sometimes referred to in Delaware as a DING and in Nevada, a NING, has become a savings technique for state income taxes.  For larger transactions where state income taxes vary from 6% to as much as 11%, a savings of these tax amounts, where it can be properly engineered, may very well be possible.

In terms of the spectrum of increasing risks with techniques which are relatively risk-free on one end and techniques sufficiently aggressive to entail a significant amount of risk from a tax or asset protection exposure standpoint, CRTs are on the low-risk end of the spectrum whereas the intentional non grantor trust to save state income taxes is much farther out on the risk spectrum.

It is also well to comment that the question of whether domestic asset protection trust statutes work in all instances, most specifically in the context of a bankruptcy or a claim under family law principles, remains an unsettled question.  Notwithstanding that the statutes on their face putatively appear to provide the protection, several courts have found ways to attack the purported liability shield involved with domestic asset protection trusts, most especially in the context of bankruptcy proceedings and actions brought by family members.

Further out on the spectrum yet are techniques such as deferred sales trusts.  Such trusts take advantage of a narrow planning island that combines recognizing sales of assets on an installment sale basis and having a trust created by an individual be treated as other than that individual for purposes of the related party transactions rules.  This technique, which according to its promoters holds the promise of deferring income taxes on the imminent sale of property, is an extremely aggressive technique and one that may very well not survive a challenge by the Internal Revenue Service.

The planning environment for the use of trusts in the context of income tax planning and asset protection is rapidly evolving, and a series of techniques are being deployed across the country as planners and their clients begin to seek protection from the twin threats of taxes and claims against trust assets.  In these turbulent times, we at Wolcott Rivers Gates are in a position to assist you in evaluating the relative risk of techniques which might be suggested from any number of sources and help you choose a potential solution appropriately tailored for your assets and which entails an acceptable level of risk from your perspective.

Please contact us if we can be of assistance.