Too often, valuable planning steps fall between the tasks a high-net-worth individual’s various advisors believe to be within their purview. Should the step be addressed by an estate planning attorney, trust officer, insurance consultant, or CPA? The reality is, it shouldn’t matter. If the CPA can identify a worthwhile planning step and bring it up to the individual, regardless of which advisor might be primarily involved in implementing it, the individual will benefit, and the CPA’s importance to the planning process will be reinforced. CPAs are ideally suited to catalyze the following commonly overlooked steps.
1. Monitor Swap Powers in Irrevocable Grantor Trusts
Many grantor trusts include a power given to the settlor who created the trust to substitute personal assets for trust assets of equal value; this is referred to as a “swap power.” This particular technique is nearly ubiquitous for several reasons. First, the power to swap assets itself should characterize the trust as a grantor trust for income tax purposes. Second, the swap power can infuse valuable flexibility into an irrevocable trust and thus be used to revise the estate plan. Third, if the client gifted or sold interests in a family business to the trust, she may wish to swap those business interests back into the estate to obtain a basis step-up on death.
There are a number of issues that advisors should address with respect to swap powers. First, is anyone actually monitoring the trust assets and the potential to use the swap power? Frequently, no one is tracking appreciation of trust assets and the potential for swapping those assets back into the estate for a basis step-up. That requires an awareness of the appreciation in the various assets comprising the trust. Trust assets should be reviewed for highly appreciated assets that might be worth swapping back into the individual’s estate for basis step-up purposes. In addition, the individual’s health is relevant; if it deteriorates, urgent attention to the swap may be advisable. Advisors should also guide individuals to establish personal lines of credit or other resources to fund swaps of trust assets. For elderly or ill individuals, has the advance preparation of the documents necessary to consummate a swap been coordinated so that it can be done quickly if circumstances warrant.
2. Review Planning Implications of Qualified Personal Residence Trusts
Many qualified personal residence trusts (QPRT) were created when the estate and income tax systems were very different. For example, a QPRT may have been created when the estate tax exemption was merely $1 million; now, with the exemption at $5 million (adjusted for inflation), there may be no estate tax benefit whatsoever from the old QPRT. Worse, if the QPRT succeeds and concludes, a potentially highly appreciated house might be transferred to the designated remainder beneficiaries without a step-up in income tax basis. If these trusts are reviewed, it may be possible to identify such situations and take proactive action.
Jane created a 15-year QPRT 12 years ago. Jane’s estate, inclusive of the house, is worth $4 million. While it was anticipated that there would have been a substantial estate tax when the QPRT was created, there will be none now, but a valuable basis step-up will be lost. It may be possible for Jane to sign a lease at $1 per year for life to rent the house following the QPRT term. That lease arguably would cause estate inclusion on Jane’s death, thereby unraveling the now-negative tax effects of the QPRT. This type of planning, however, entails risks. Will the trustee be willing? What liability might the trustee face for violating the trust terms? Will violating the trust terms negate the intended tax effects?
3. Address the Challenges of Aging Individuals
CPAs should discuss later-life planning and practical steps to avoid elder financial abuse with all individuals over a specified age or with health issues (e.g., young-onset Parkinson’s disease). Clients should be educated on how bookkeeping, advisory, and other services can protect them before problems occur. For example, if a CPA writes up the individual’s checkbook and financial transactions quarterly, obvious abuses may come to light. Also, many individuals never actually budget, and many financial forecasts for those who actually engage in the process are based on estimated, not actual, budget figures. Writing up basic financial transactions will enable preparation of real forecasts and models to ascertain whether the individual actually has enough funds to support his lifestyle to age 95 and above. There is much talk in the media about longevity and its impact on planning, but surprisingly few individuals seem to have addressed the real issues in a quantitative manner with their advisors.
Include articles on planning for longevity in firm newsletters and other client communications. Add aging planning points to client review checklists.
4. Evaluate the Administration of Irrevocable Trusts
Other than tax compliance, or paying an insurance premium, many individuals ignore the formalities of the irrevocable trusts they create. Many, perhaps most, administrative matters are readily within the purview of the CPA, not the attorney. Has a bank account been created in the name of the trust? Was a tax identification number assigned to the trust? Has that number been properly used on the bank account and other trust assets? Have tax returns been filed for the trust using the appropriate characterization as simple, complex, or grantor? If the trust requires annual demand or Crummey powers, are copies of the signed notices in the permanent file for all prior years? Does the trust have mandatory distribution dates? Has the trust ended years earlier? (This is not uncommon.) If the trust holds S corporation stock, does it meet the requirements to do so? Does the trust serve any reasonable purpose? Trusts are sometimes created, for example, to pay for a grandchild’s education, and were never wound down after the objective was concluded, even if the dollars in the trust no longer warrant the cost of maintaining the trust.
When was the last time the trustee confirmed that the signers on trust bank accounts, or the trustees listed on trust insurance policies, are the current trustees? If there have been changes in fiduciaries over the years (e.g., a trustee resigned or died), often the underlying records with critical third parties are not updated. Encourage individuals to address these matters before they become problematic.
When was the last time the trustee reviewed the trust investments or insurance policies? It is common for a client to pick an insurance policy and never have it reviewed over ensuing decades. This can be a disaster in the making. Encourage every trustee of every life insurance trust to have the policies reviewed every few years to check the current ratings of the insurance carrier, assess policy performance, obtain new in-force illustrations, evaluate the continued appropriateness of the coverage within the overall plan, and more.
5. Evaluate Decanting Trusts
When preparing a Form 1041 for a client’s trust, consider whether the trust is optimally structured for income tax purposes, both state and federal. Discuss with the trustee, if appropriate, the possible benefits of changing the income tax situs of trusts in high-tax jurisdictions to see if, on a preliminary basis, the individual should review this with counsel. In some instances, decanting an old, less-than-optimal trust into a new, better-crafted one can save tax costs that offset the cost of the process within the first tax year. Decanting can be described as creating a new trust with identical beneficiaries but improved administrative provisions; the old trust is then merged or poured into the new trust, and the old trust terminates.
Consider including a short memorandum or letter with all Forms 1041 advising clients to meet with a CPA or attorney to review possible issues with old trusts that might warrant corrective action. Include articles in client communications recommending the review of all insurance, credit shelter (bypass), and other existing irrevocable trusts. A credit shelter trust may have been set up on the first spouse’s death to save estate tax at a time when the exemption was only $1 million. Now, there may be no estate tax savings, and the trust may merely create hassles and costs, or worse, prevent valuable income tax basis adjustments upon the death of a surviving spouse. Individuals with trusts that distribute assets at specified ages (e.g., when a child attains age 30) should review the possible benefits of decanting with their estate planners.
6. Estate Tax Repeal Doesn’t Mean Planning Should Stop
Individuals should continue to plan, regardless of current (or future) estate tax uncertainty. Even if the Trump administration succeeds in repealing the estate tax, the repeal may have a 10-year “fuse,” and a future administration may reinstate the estate tax (as has happened three times already). But for many individuals, estate planning, including irrevocable trust planning, was never only about estate tax minimization. It provides valuable asset protection benefits, protection in the case of divorce, and protection from elder financial abuse and even identity theft. Planning should continue.
Encourage individuals in planning meetings to pursue planning for asset protection concerns that tax reform will not affect. Communicate the continued importance of estate planning in firm newsletters and other client communications. Contact wealthier/larger individuals directly and encourage them to set up meetings to continue planning.
Too often, CPAs wait for individuals to request assistance with estate planning when they should be proactive. Too often CPAs assume that because certain aspects of estate planning entail legal documents, those matters are outside the CPA’s purview and should be handled only by an attorney. In many cases identified above, this is simply not true. But even for those matters that do require legal counsel, the CPA can serve as the catalyst to push the client to meet with the estate planning attorney. Without this first push, that meeting may never occur, and the planning will never be addressed.