FUNDING TRUSTS: ASSET PLANNING & FINANCING DISTRIBUTIONS

First Run Broadcast: May 2, 2017

Live Replay: February 5, 2018

1:00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes)

Having a trust is only the first step of an effective estate plan. The practical steps of actually

funding the trust is something that’s often overlooked and is a more complex process than at first

appears. Different asset classes – financial assets, stakes in family businesses, unique objects

like art, real estate, etc. – are governed by different methods and rules of assignment. Some

assets – IRAs, 401(k) accounts, certain types of insurance – can’t be transferred at all, or only in

narrow circumstances. Planners must also provide banks or other financial institutions detailed

funding instruction letters and certify trustees. If any of these funding steps are overlooked or

not carefully performed, client trusts will fail of their essential purposes. This program will

provide you with a practical guide to many and complex steps of funding trusts.

• Planning for funding trusts – and how to avoid mistakes

• Identifying funding sources and potential assignment and other problems with each

• Drafting instruction letters and trustee certifications

• Specific issues of working with banks on funding issues

• Assignment of interests – business interests, real estate, financial interests, unique objects

• Treatment of certain assets that are non-assignable – retirement benefits, insurance

contracts, annuities

• Tax planning issues involved with funding trusts

Speaker:

Michael Sneeringer an attorney in the Naples, Florida office of Akerman, LLP, where he has a

national practice focusing on trust and estate planning, probate administration, asset protection

planning, and tax law. He has served as vice chair of the asset protection planning committee of

the ABA’s Real Property, Trust and Estate Section and is an official reporter of the Heckerling

Institute. Mr. Sneeringer received his B.A. from Washington & Jefferson College, his J.D., cum

laude, St. Thomas University School of Law, and his LL.M. from the University of Miami

School of Law.

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Funding Trusts: Asset Planning & Financing Distributions Teleseminar

February 5, 2018 1:00PM – 2:00PM

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Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: February 5, 2018 Seminar Title: Funding Trusts: Asset Planning & Financing Distributions Location: Teleseminar - LIVE Credits: 1.0 MCLE General Credit Program Minutes: 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

Funding Trusts: The Tips and Traps of Ensuring

Client Goals

Presented By:

Michael A. Sneeringer, Esq.1

Akerman LLP – Naples, Florida

(239) 449-5564

michael.sneeringer@akerman.com

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Table of Contents

I. Introduction: Planning for funding trusts – and how to avoid mistakes ..............................1

II. Identifying funding sources and potential assignment and other problems with each ........3

III. Drafting instruction letters and trustee certifications ...........................................................5

IV. Specific issues of working with banks on funding issues ....................................................6

V. Assignment of interests – business interests, real estate, financial interests, unique

objects. .............................................................................................................................................6

VI. Treatment of assets that are non-assignable – retirement benefits, insurance contracts,

annuities ...........................................................................................................................................7

VII. Tax planning issues ..............................................................................................................8

VIII. Conclusion .........................................................................................................................10

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I. Introduction: Planning for funding trusts – and how to avoid mistakes

An attorney reading this outline and listening to the accompanying presentation probably

knows what a trust is and has created a trust. However, what kind of a trust did the attorney

create? Is there a timeframe to put assets in this trust? Why did the attorney create this trust for

the client? This outline will focus on trust funding. While the author is a licensed Florida

attorney, since attorneys may be reviewing this outline from multiple jurisdictions, the author

will use the Uniform Trust Code as a guide in describing and defining certain terms when

applicable.

A. Key Terms. Generally, a trust is created by either: (1) transferring property to

another person or entity (a trustee) during the grantor’s lifetime or upon his or her death; (2)

declaration by the owner of property; or (3) the exercise of a power of appointment in favor of a

trustee.2 To create a trust, a grantor must have capacity to create it, the grantor must indicate an

intention to create it, the trust must have a defined beneficiary (or, be a charitable trust or pet

trust), the trustee must have duties to perform and the same person is not the sole trustee and

beneficiary.3 While there exists the concept of an oral trust, generally, the grantor executes

(through a writing whereby a typed document is presented to the grantor and trustee to sign,

sometimes in front of witnesses and a notary, and other times not) an instrument that contains the

terms of the trust, including any amendments thereto (referred to as a “trust instrument”).4

Once the trust is created, often the next step is to “fund” it.5 There are times when an

irrevocable or revocable trust is funded immediately, or there are times when a trust is created at

the death of the grantor (or funded only upon the grantor’s death). “Funding” is a term of art

used to describe the movement of title of assets from one form of title to the trust. The trustee of

the trust becomes the de-facto “owner” of the trust assets as the trustee is the custodian of the

assets for the benefit of the beneficiaries.

The person who transfers assets to a trust is coined the “transferor” or “assignor.” This

can be the grantor of the trust, or it can be somebody else. For example, when assets are

“decanted” or “moved” from one trust to another, while the assets may come from the grantor of

the first trust, the second trust may have been declared by the trustee, instead of the original

grantor.

B. Planning for Funding Trusts. When a client walks into an attorney’s office and

decides he or she wants to create a trust, once the threshold question of whether the trust will be

funded during the client’s lifetime or upon his or her death is answered, the major point to focus

on next is what should be transferred to the trust. This is not an easy decision.

1. Inter Vivos. An inter vivos trust is created during the grantor’s lifetime.

An inter vivos trust funded during a client’s lifetime may take several forms: revocable trust,

irrevocable trust, incomplete gift and completed gift.

a. Revocable Trust. A trust is revocable where the grantor retains the

power to revoke or terminate the trust. Clients will fund a revocable trust during their lifetimes

with two goals in mind: avoiding probate and planning for incapacity. Assets in a revocable trust

avoid probate and thus negate excess fees and expenses. In avoiding probate, a client may be

able to keep his or her testamentary intent a secret from the public for generally a will becomes

public record upon its receipt by the probate court while a trust would only be public record if it

were a party to a lawsuit or became part of a trust administration.

Planning for incapacity deals with the fact that where assets have already been transferred

to a revocable trust prior to a client’s incapacity, upon the client’s incapacity, he or she will have

provided a mechanism for continuing distributions to or for the benefit of the client/grantor,

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while also choosing the proper person to continue administering the trust as trustee. There are,

of course, other ways of addressing asset management in case of incapacity such as appointing a

legal guardian for the client, or utilizing an attorney-in-fact under a power of attorney to manage

the client’s assets. However, a revocable trust gives the grantor control over the disposition of

assets both during lifetime and upon incapacity since the grantor in essence will be able to pick a

responsible person to serve as successor trustee. Unlike a power of attorney, the trust affords the

grantor’s agent more flexibility. Additionally, a guardianship proceeding to appoint a legal

guardian is time-consuming and expensive.

Often, a gun or firearms trust is simply a revocable trust that becomes irrevocable upon

the grantor’s death. This flexibility allows a gun owner to easily make changes to such trust’s

fiduciaries and beneficiaries (based on each’s ability to possess a firearm) as well as the firearms

owned by the trust.6

b. Irrevocable Trust. At its very core, an irrevocable trust is a trust

that cannot be modified, terminated or amended. As laws have evolved, what an “irrevocable

trust” is has become murky. For example, many states have enacted decanting laws that

essentially render the decanted trust useless (there is now even a Uniform Trust Decanting Act7).

Special needs trusts are often drafted with flexibility so that if federal laws change with regards

to benefits for disabled persons, a trustee or trust protector can amend the trust solely to comply

with the changed federal law (with the goal to not jeopardize a beneficiary’s federal aid).

Additionally, irrevocable trusts meeting a certain dollar threshold can be judicially terminated.8

Irrevocable trusts are funded with a wide variety of assets including life insurance

policies (i.e., an irrevocable life insurance trust or “ILIT”), marketable securities, real property,

interests in closely held businesses, automobiles, artwork, and aircraft, among other assets.

Grantor retained annuity trusts (“GRATs”), qualified personal residence trusts (“QPRTs”) and

charitable trusts are often irrevocable. Funding an irrevocable trust may take the form of either

an incomplete gift or completed gift for federal gift tax purposes.

c. Incomplete gift. Generally, transfers to trusts are structured to

qualify as incomplete gifts for Federal gift tax purposes where grantors of such trusts plan to

transfer assets to the trust in excess of the $5,490,000 (for 2017) lifetime gift tax exemption

amount available under Section 2505 of the Code or desire to maintain a level of control over the

administration of the trust. Section 2501 imposes a tax on the transfer of property by gift. The

gift tax imposed under Section 2501 applies whether the transfer is in trust or otherwise, whether

the transfer is direct or indirect, and regardless of the property transferred.9 Nonetheless, the gift

tax under Section 2501 is imposed only if a donor parts with such dominion and control over the

property in a manner that renders the gift complete.10

If, upon a transfer of property, the donor

reserves any power over its disposition, the gift may be wholly incomplete, or it may be partially

complete and partially incomplete, depending upon all the facts in the particular case.11

Treasury

Regulation § 25.2511-2(b) provides in part that “if a donor transfers property to another in trust

to pay the income to the donor or accumulate it in the discretion of the trustee, and the donor

retains a testamentary power to appoint the remainder among his descendants, no portion of the

transfer is a completed gift.”

While proper structuring of an incomplete gift trust is outside the scope of this outline,

there are several practical approaches to funding an incomplete gift trust. Under most

circumstances, a trust funded with an incomplete gift should not contain assets which are

speculated to appreciate at some point in the future. This is because a more practical approach

would be to fund a completed gift trust with such assets as the grantor can take advantage of

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using an estate “freeze” like technique by locking in a low valuation on assets which the grantor

does not need or will likely not use to sustain his or her lifestyle, while the assets appreciate in

the trust for future beneficiaries.

Where wealth preservation is important and using up a grantor’s unified credit amount is

not, an incomplete gift trust can be funded with assets such as a grantor’s closely held business,

marketable securities, or real property, among others. The key here is that the trust is properly

structured to take advantage of laws applicable to domestic or foreign jurisdictions. Then, once a

jurisdiction is chosen, the grantor needs to be aware of other factors which could hinder the

funding of such a trust. For example, a foreign trust cannot hold S corporation stock. As such, if

the closely held business is an S corporation for federal tax purposes, the grantor is limited to

transferring that asset to a domestic trust. Likewise, if the assets consist of marketable securities

in a Swiss brokerage account, a foreign trust could be a better vehicle to transfer such assets.

d. Completed gift. A gift is complete to the whole or any part of

property where a grantor has so parted with dominion and control as to leave him or her no

power to change its disposition.12

Where a gift is complete, generally a tax is imposed.13

A

completed gift trust is generally thought of to be funded with assets that will appreciate in value

in the future, as opposed to more speculative investments or investments that the grantor needs to

keep to support himself. For example, a client’s closely held business that he expects will

appreciate would be better to transfer to a completed gift irrevocable trust, as opposed to the

client’s brokerage account that he uses to pay bills. Clients who want to use all of their unified

credit amount during their lifetime will transfer closely held business interests to a completed gift

trust after the interest has been valued by a quality appraiser who then takes into account

discounts in order to leverage the gift so that the client is able to transfer as much of the interest

to the trust as he can, up to $5,490,000 (for 2017).14

2. Testamentary Trust. A testamentary trust is created upon a testator’s death

pursuant to a direction in such testator’s will. The most basic example is a will that conditionally

provides for continuing trusts, usually when the grantor’s beneficiaries are minors, incompetent

or elderly. This differs from the pour-over will/revocable trust concept described above. The

testamentary trust will be funded with any assets owned by the testator in his or her individual

name. If the trust was created because the beneficiary was a minor, the trust will end once the

beneficiary reaches the age of majority stated in the will. If the trust was created because the

beneficiary was incompetent, the trust can end once the beneficiary is adjudicated competent (or

is deemed competent based on doctors’ evaluations, depending on the terms of the will and

governing law state). The testamentary trust created for an elderly beneficiary will generally end

on such beneficiary’s death. The remainder beneficiaries are usually the testator’s descendants.

II. Identifying funding sources, potential assignments and problems with each Even before the client creates any one of the trusts described in I.B.2. above, the attorney

needs to have formulated a plan of what assets are to be transferred to the trust. A couple of

themes described above translate to this section as well. As noted above, a client’s appreciating

business is the classic example of an asset to fund a completed gift irrevocable trust. Insurance is

another classic example where an irrevocable trust is created to both own and be the beneficiary

of the policy.

To identify funding sources, the attorney should have the client fill out an intake form. It

may not be prudent to do this until an engagement letter has been sent to the client for in the

author’s experience, a client may be hesitant to provide this information prior to becoming a

client of the attorney’s firm. The client needs to be very specific on the intake form. Likewise,

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the attorney needs to carefully review the form. The attorney cannot check his or her common

sense at the door. For example, if the client drives exotic cars and does not report his or her car

collection on the intake form, the attorney needs to be sure to make note of this and follow-up

with the client on the veracity of the form.

Specific assets to pay attention to are closely held business interests, insurance,

retirement account assets, annuities and promissory notes. When the attorney sees these listed, it

is best to ask the client for further information: a copy of an operating agreement for a closely

held business interest; a confirmation of the annuity, retirement account and life insurance

policy’s beneficiary designation and ownership; and a copy of the promissory note. These

documents are necessary to ensure whether a new trust should be created to own such asset. For

example, an operating agreement which has a prohibition from the client transferring a closely

held business interest to a trust may render creating such trust useless. Additionally, clients may

already have their life insurance policies held by trusts, and creating a new trust may be

counterintuitive.

Once the potentially assignable asset is determined, the type of trust to be created can be

decided. For example, life insurance is not going to be transferred to a GRAT; likewise, a trust

structured as an ILIT is not going to hold firearms. Specific trusts are created with certain

terminology to comply either with state law or the Internal Revenue Code (the “Code”). For

example, a QPRT has certain provisions drafted in it to comply with the Code; if those

provisions are omitted, the purpose of the trust is rendered useless.15

Other trusts, such as pet

trusts, are state specific.16

Avoiding assignments that trigger an adverse taxable event is

encouraged.17

There are many problems that can pop up during the funding process. While this is not

an exhaustive list of trusts and their problems, some illustrations are necessary:

A. ILIT. The biggest problem with an ILIT is not assigning enough cash annually to

keep up the premium payment. Clients will often circumvent the formalities of the trust and pay

the insurance premiums directly themselves, instead of using the trustee. If not remediated

properly, this becomes a taxable gift from the grantor (instead of taking advantage of a trust’s

Crummey withdrawal rights).18

Another funding problem is the beneficiary and ownership. The

attorney should initially help the client with the policy application process to ensure proper

titling. If it is an existing policy being transferred, the attorney should take care to avoid the

inclusion of the policy in the decedent’s gross estate under Code Section 2035 by properly

structuring a sale to the newly created ILIT, as opposed to simply filling out a change of

beneficiary designation form. Some clients may rather take the gamble and assign the policy, as

opposed to paying the attorney to draft sale documents (in conjunction with using the policy’s

interpolated reserve value as the sales price). The attorney’s job is to explain all of the risks to

the client and help him or her make an informed decision.

B. Retirement Accounts. Beneficiary designations are one of the biggest issues for

attorneys. Clients often ask their attorney to fill out the beneficiary designation form naming a

trust as the beneficiary. The complication here is that it is the author’s experience that unlike

insurance policy designation forms, retirement account companies have trouble accepting a

client’s retirement account beneficiary designation form where the attorney fills out the form

with any more information than just the name of the trust. For example, the author tends to type

“see attached” on the line corresponding to “change of primary beneficiary” and attach a specific

statement regarding which provisions of the trust apply to the named “primary beneficiary” or

primary beneficiaries. Some brokerages allow this; others will reject the form and direct that the

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beneficiary designation form solely name a trust or human being. If the brokerage will not

accept the form with a “see attached” designation, the client can choose between moving the

account or just naming the trust itself.

With a specific retirement asset such as an individual retirement account (“IRA”), the

client may be better off taking advantage of leaving the beneficiary as the client’s spouse

outright, instead of naming a trust. While a discussion of such a decision is outside the scope of

this article, there are tax and non-tax reasons why an outright designation for an IRA is preferred.

C. GRATs. Funding a GRAT is usually seamless. It is the annual upkeep of a

GRAT that trips up clients, advisors and attorneys. In a typical GRAT, the lifetime beneficiary

(the grantor) receives an annual payment in accordance with the terms of the trust (usually by a

specific date, i.e. the day before the anniversary date of the GRAT). The problem is that often

advisors and clients fail to coordinate the payment by the due date. Not administering the GRAT

in accordance with its terms could cause tax issues and hinder its purpose.

D. Revocable/Testamentary Trusts. Once a revocable trust becomes irrevocable or

upon the creation of a testamentary trust, the trustee should take great care to fund it as soon as

possible. Certain issues can hinder the speedy funding of a testamentary trust. For example, if

the assets are transferred from the grantor’s estate, certain assets may need a court order to move

from one form of ownership to another (such as real property, cash or marketable securities).

III. Drafting instruction letters and trustee certifications A. Instruction Letters. An “instruction letter” for funding a trust can take various

forms. Once a client has signed a trust (revocable or irrevocable), the drafting attorney will

provide the client with an “instruction letter” that may also be known as a funding letter or

funding memorandum. This letter describes the transaction, what was signed and how to title

assets in the name of the trust. This letter is generally accompanied with a sample letter to the

trustee that the grantor can use to fund his or her trust.

If the signed trust is irrevocable, generally its funding will be part of a transfer or

planning concept (such as funding a GRAT, QPRT, etc.). In this case, where the transfer is of

specific assets and for a specific purpose (usually to an irrevocable trust in the form of an

incomplete or completed gift), the letter will discuss the transfer and the accompanying tax

reporting necessary to properly report the transfer to the IRS.

If the signed trust is revocable (or if the signed will creates a testamentary trust), funding

does not take place right away. The letter will paint a broader picture of what assets can be

transferred to the trust and how the trustee should go about completing such transfers. This letter

will not so much discuss the tax aspects, as it will instruct the grantor and trustee on how to

administer and fund in the future. This letter is written as if the attorney will not be available for

questions at the time of funding. In the author’s experience, this differs from an irrevocable trust

because the attorney will generally be hands on in funding an irrevocable trust during a client’s

lifetime.

B. Trustee Certification. Banks and other third parties will ask for a copy of the trust

instrument prior to creating an account or completing an assignment of interest with the trust. To

protect the privacy of the grantor and beneficiaries, the Uniform Trust Code outlines a procedure

whereby a certification of trust may be furnished in lieu of the full trust instrument.19

The

official comments to the Uniform Trust Code indicate that a trustee certification provision was

included to “protect the privacy of a trust instrument by discouraging requests from persons other

than beneficiaries for complete copies of the [trust] instrument in order to verify a trustee’s

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authority.”20

The procedure entails creating a document for signature by the trustee in the

presence of a notary which contains at least the following information:

1. States that the trust exists;

2. The date the trust instrument was executed;

3. The identity of the grantor;

4. The identity and address of the current trustee;

5. The powers of the trustee;

6. The revocability or irrevocability of the trust and the identity of any

person holding a power to revoke the trust;

7. The authority of cotrustees to sign or otherwise authenticate;

8. Whether all or less than all of the trustees are required in order to exercise

their powers;

9. The trust’s taxpayer identification number;

10. The manner of taking title to trust property.21

IV. Specific issues of working with banks on funding issues

The trustee will often want to open a bank account for the trust. In working with a bank

to open an account, the trustee should be prepared to either turn over a fully executed copy of the

trust or a trustee certification.

Realistically, there should be no difference in service when a corporate fiduciary is

trustee of the trust as opposed to an individual. However, it is the author’s experience that a

corporate fiduciary tends to have an easier time dealing with banks based on a corporate

fiduciary’s team approach, across the board experience and sheer manpower.

A. Human Trustee. An individual trustee will have a larger workload and may

charge greater trustee fees. This is because often, an individual will bill hourly for services as

opposed to an annual fee based on the percentage of the account assets. The grantor will have to

trust such trustee as he will have access to all account information. The human trustee also has

to keep abreast of the various tax filing deadlines (federal and state).

B. Corporate Fiduciary as Trustee. As previously described, a corporate fiduciary

will charge its fees typically based on a percentage of the assets under management. If the

corporate fiduciary has a banking arm, the trustee fees and bank account fees may be combined

into one fee. A corporate fiduciary will have an easier time focusing on the duties of being a

trustee as opposed to an individual who may or may not function as a fiduciary for a living. A

corporate fiduciary has deeper pockets for purposes of liability should it be liable to the grantor

or beneficiaries in a tort action. Additionally, a corporate fiduciary will most likely have a

comprehensive system to remind itself when taxes and other deadlines come due.

V. Assignment of interests – business interests, real estate, financial interests, unique

objects A. Business Interests. Business interests may come in the form of an active business,

a family owned company or a speculative interest (such as an interest in venture capital).

Funding a trust with an active business is the most tricky. For starters, many lawyers lack the

sophistication to properly assign such an asset which may be subject to state and federal law.

For example, transferring an interest in an alcohol distributor could come under scrutiny as

typically states grant licenses or may have laws in place regarding who may own an interest in

such a business. Closely held businesses generally are a better asset to transfer in trust,

especially where the goal is to transfer a growing business asset to future generations. Where the

business is speculative or the grantor is looking to receive warrants or future profits (i.e.,

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following an investment in a technology startup), a trust would prove to be a perfect vehicle to

receive the interests prior to their increase in value.

B. Real Estate. The most common real estate transaction with a trust involves the

creation of a QPRT for grantors to assign their interest in an appreciating property (sometimes a

vacation home or second property). The attorney and client need to decide whether the trust

should directly own the property or whether a disregarded entity (e.g., a single-member LLC)

should initially take title to the property, followed by an assignment of the disregarded entity

interest to the trust. Where there are foreign beneficiaries of a United States (“U.S.”) trust and

such trust sells real estate with a U.S. situs the Foreign Investors in U.S. Real Property Tax Act

(“FIRPTA”) may apply.22

C. Financial Interests. As described throughout this outline, financial interests are

typically used to fund trusts. These may include a portfolio of marketable securities, cash,

bonds, and an insurance policy (i.e., through an ILIT). Additionally, trusts may be designated as

the beneficiary of certain retirement accounts upon the principal’s death (see discussion, below).

Where the bank account is in a foreign country, certain additional filing requirements are

necessary. Often the grantor will make only one gift and subsequently leave the trust assets

alone to let them grow. Subject to income, gift and generation-skipping transfer taxes, this “one

time gift” is best utilized to beneficiaries such as children and grandchildren.

D. Unique Objects. Automobiles, furniture, furnishings and other non-valuable

personal effects (i.e., tangible personal property) should become part of a statement of tangible

personal property and disposed of pursuant to the client’s will. Where such assets are more

valuable, generally, they will be owned by a disregarded entity (a single-member limited liability

company), and such disregarded entity will have a trust as its sole member. Such valuable assets

include, but are not limited to: horses, exotic cars, art and jewelry. Additionally, clients may also

have unusual collections that would similarly be an appropriate asset for a trust (e.g., a handbag

collection, stamps, comic books).

VI. Treatment of assets that are non-assignable – retirement benefits, insurance

contracts, annuities.

The disposition of certain assets upon death is determined based on contractual principals

as opposed to a direction in a will or trust. The assets in such category include, but are not

limited to, retirement benefits, insurance contracts and annuities.

A. Retirement Benefits. The words “retirement benefits” may include, but is not

limited to, certain pension agreements, 401(k) plans or IRAs. The disposition of these assets is

controlled not by the direction in a decedent’s will or trust, but by the terms of the retirement

plan itself. For example, many pensions expire either at the decedent or surviving spouse’s

death. A 401(k) plan or IRA’s disposition is generally based on what the beneficiary designation

form indicates.

The disposition of retirement benefits that continue at death (i.e., 401(k) and IRA) is tax

driven. Generally, the first beneficiary, for such retirement plan accounts should be outright to

the surviving spouse. While such a tax driven discussion is outside the scope of this outline, the

surviving spouse most likely enjoys income-tax advantages that are lost if a trust becomes the

primary beneficiary of such accounts. On the other hand, it may be appropriate to designate

trusts created for children as contingent beneficiaries in the event that the spouse does not

survive the decedent. In conjunction with funding retirement benefits, it is recommended that

the client consult with not only the drafting attorney, but also his or her accountant or other tax

adviser before such designation is made.

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If certain requirements are met, the IRS allows the beneficiaries of a trust to be treated as

the designated beneficiaries of the client’s 401(k) plan or IRA, which will preserve the right to

pay the death benefits over the lifetimes of the trust beneficiaries. A discussion on such “stretch-

out” treatment is outside the scope of this outline; however, there are certain rules that must be

followed to garner such treatment.

B. Insurance Contracts. As previously noted, a life insurance policy is generally

owned by an ILIT, and the ILIT is the beneficiary of said policy. The ILIT structure is not for

everyone due to cost and ongoing maintenance. In such case, a revocable trust that becomes

irrevocable upon death or a testamentary trust is the proper vehicle to be the ultimate beneficiary

of the policy. The lawyer and client need to work closely with the client’s insurance advisor to

make sure that the insurer receives a completed beneficiary designation form, naming the trust as

the beneficiary.

C. Annuities. Like retirement benefits, the initial beneficiary of tax-deferred

annuities should be the surviving spouse, followed by a properly structured revocable or

testamentary trust.

VII. Tax planning issues When funding a trust, the attorney needs to advise the grantor on income tax, gift

tax, estate tax and generation-skipping transfer tax. Once the trust is funded, depending on the

type of trust, certain federal tax and informational returns may be necessary. If the trust is

classified as a foreign trust or has a foreign bank account over a certain dollar threshold, the

trustee will need to file additional returns. Certain tax related forms for trusts include, but are

not limited to:

A. Form 709. A grantor must report a transfer to his trust, domestic and foreign, on a

Form 709 U.S. Gift (and Generation-Skipping Transfer) Tax Return (a “Gift Tax Return”).23

A

Gift Tax Return will need to be filed whether the gift is designed as an “incomplete gift” (the

donor of the trust property has retained such dominion and control (within the meaning of

Treasury Regulations §25.2511-2) over the assets transferred to the trust as to render the gift

incomplete for federal gift tax purposes) or “completed gift” (the donor has not retained

dominion and control over the assets transferred to the trust).24

B. Form 1041 and Form 1040NR for Trusts. The trust, whether domestic or foreign,

should file its own Form 1041.25

The trustee of the trust is required to file a statement referred to

as a grantor trust information letter. This statement must be attached to the Form 1041 to report

the income of the trust. The form and attached statement should be filed with the appropriate

IRS Service Center by the fifteenth day of the fourth month following the close of the taxable

year of the trust. If the trust is a “grantor trust,” this will correspond to the grantor’s taxable

year. The person preparing this return for the trust should check the box in the upper left corner

of the return to indicate that the return is for a grantor-type trust or for a complex type trust, as

the case may be. No income should be reported by the trust on its Form 1041 if the trust is a

wholly owned grantor trust. Instead, the return for the trust should identify its grantor as the

person to whom the income, deductions, and credits of the trust are taxable.

C. Form 3520. Form 3520, “Annual Return to Report Transactions with Foreign

Trusts and Receipt of Certain Foreign Gifts” is used to report the information required by

Section 6048 of the Code. A U.S. person who establishes a foreign trust or transfers assets to a

foreign trust must report the establishment of the trust or the transfer of assets to it on a Form

3520. The Form 3520 is also required to be filed on an annual basis by the grantor of a foreign

trust. The return is required to be filed annually with the IRS Service Center even if the grantor

9

did not make any transfers to the trust during the applicable period. The penalty for failing to

file this return is thirty-five percent (35%) of the amount transferred.26

Furthermore, additional

ten thousand dollar ($10,000) penalties may be imposed throughout each 30-day period (or

fraction thereof) for persisting in failing to file such a return after notice is received from the

Service.27

The Form 3520 is due to be filed on the date that the personal income tax return is due

for the grantor (typically, April 15).

D. Form 3520-A. A Form 3520-A is used to report the information required by

Section 6048(b) of the Code. A U.S. person who is treated as the owner of a foreign trust under

the grantor trust rules is responsible for ensuring that the trustee of a foreign trust files a Form

3520-A annually. The trustee of the foreign trust is responsible for filing this return; however,

the penalty for failing to file this return is enforced against the grantor of the trust.28

The penalty

for failing to file this return is 5% of the trust assets that are treated as owned by the grantor.29

Furthermore, additional ten thousand dollar ($10,000) penalties may be imposed each 30-day

period (or fraction thereof) for persisting in failing to file after receipt of notice from the IRS.30

It is important to note that this return is due by the fifteenth day of the third month following the

close of the grantor’s tax year (unless the return is extended pursuant to Form 7004). In practice,

many return preparers fail to recognize that the due date for this return is one month before the

due date of the grantor’s personal income tax return, resulting in potential penalties.

E. Foreign Trust Statements. The trustee of a foreign trust that is a grantor trust is

required to provide a Foreign Grantor Trust Owner Statement to the U.S. grantor when the

trustee files Form 3520-A. (This form is included on page 3 of Form 3520-A.) At present, it

appears that no noncompliance penalty is applicable for failure to comply with this rule.

Additionally, the taxpayer is supposed to notify the IRS of any inconsistency between the

taxpayer’s income tax return and the information contained in the Foreign Grantor Trust Owner

Statement.31

F. Form 1040NR and 1042-S. Over the past decade, the IRS has intimated that it

will one day issue a Form 1041NR for use by foreign trusts filing U.S. tax returns. At present,

the IRS has not published this form. When this form is published, it may become the most

appropriate form for a foreign trust to file annually.32

It should also be noted that the instructions

to Form 1040NR currently provide that it should be used to report the income of a foreign trust.

The first page of Form 1040NR also provides a box for the taxpayer to check indicating whether

the taxpayer is an individual or an estate or trust. A Form 1042-S is required in certain cases to

report distributions of U.S. source income to a non-U.S. person.

G. Authorization of Agent Agreement. For a foreign trust, an Authorization of Agent

Agreement should be filed to notify the IRS regarding who is appointed to serve as the U.S.

agent of the trust. The name, address, and taxpayer identification number of the U.S. agent must

be included on Forms 3520 and 3520-A.

H. FinCEN Form 114 (Report of Foreign Bank and Financial Accounts) and Other

Filing Related to Foreign Accounts. FinCEN Form 114 must be filed by U.S. persons to report

certain information regarding a financial interest in, or signature authority over, foreign financial

accounts, including accounts held in a foreign trust in certain cases. With regard to trusts, a U.S.

person has a financial interest in foreign financial accounts for which the owner of record (or

holder of legal title) is one of the following:

(1) A trust of which the United States person: (i) is the trust grantor and (ii)

has an ownership interest in the trust for United States federal tax purposes.

10

(2) A trust in which the U.S. person has a greater than 50 percent present

beneficial interest in the assets or income of the trust for the calendar year.

For tax year 2016, the Report of Foreign Bank and Financial Accounts (the “FBAR”)

must be filed by April 15th

of the succeeding year (that is, April 15, 2017) with the Department

of the Treasury, with a maximum extension for a six (6)-month period ending on October 15th

.33

It should be noted that Section 6038D of the Code imposes similar reporting requirements.34

The

FBAR is only available electronically through the BSA E-Filing System, which allows the filer

to enter the calendar year reported, including past years, on the online FinCEN Report 114.

I. Form 8938. Form 8938, Statement of Specified Foreign Financial Assets, is

generally required if an individual U.S. person (including residents, certain nonresident aliens,

and residents of Puerto Rico or a U.S. possession) files a federal income tax or information

return with the IRS and had an interest in a foreign financial account or asset that exceeded

$50,000 on the last day of the tax year or seventy-five thousand dollars ($75,000) at any point

during the year.35

The reporting is done on Form 8938 and, commencing with returns filed in

2012, is attached to the annual return for tax years beginning after March 18, 2010. Id. It is

proposed (but not yet required), that Form 8938 be filed by domestic corporations, partnerships,

and trusts, as specified in regulations that have not yet been issued. It appears the intent is to

require reporting by entities that may be used by individuals to hide assets.

J. Foreign Trust Beneficiary Statement. A U.S. beneficiary of a foreign trust must

provide the IRS with information regarding the proper tax treatment of any distributions from the

trust. In this regard, the trustee of a foreign trust must furnish (as applicable) a Foreign Grantor

Trust Beneficiary Statement (included on page 4 of Form 3520-A) or a Foreign Nongrantor Trust

Beneficiary Statement to any U.S. beneficiary who receives a distribution from the trust during

the year. The statements must be furnished to the U.S. beneficiary by the fifteenth (15th

) day of

the third (3rd

) month following the close of the trust’s taxable year. (In the case of a grantor

trust, this will correspond to the grantor’s taxable year.) A U.S. beneficiary of a foreign grantor

trust with a U.S. grantor should also notify the IRS of any inconsistency between the U.S.

beneficiary’s income tax return and the information contained in the Foreign Grantor Trust

Beneficiary Statement.

K. Examples of State Filings. Generally, there are no filings for trusts at the state

level in states such as Nevada, Florida, South Dakota or Delaware. However, Alaska imposes a

duty to register trusts.36

VIII. Conclusion Funding is merely part of the overall trust process. It can be the easiest or hardest part,

depending on facts and circumstances. One final note, with any trust related matter there are

certain steps to consider:

A. Think carefully: be prepared to adroitly review a potential client’s financial

picture, as well as learn the client’s family dynamics, in order to come up with a plan of action to

discuss with the client.

B. Communicate clearly: clearly communicate the plan of action to the client using

concepts and terms that the client will understand.

C. Be persistent: after communicating the plan, follow-up with the client in order to

ascertain whether the client will go through with the plan (i.e., sign and fund the trust).

D. Be patient: the client may take days, months or years before he or she decides to

go through with the plan.

11

E. Use blue ink: the client is ready to initiate the plan; it might be easiest if the client

signs off on the plan using a blue ink pen (i.e., sign the trust using a blue pen) (note: blue ink is

not required; it is the author’s preference).

F. Process: once the documents are signed; scan and copy the signed documents,

including any trusts.

G. Vault: determine whether the original documents, such as any trust instruments,

should remain with the attorney at his law firm’s vault, or remain with the client.

H. Create letter: create the funding letter to review why the trust was created and

outline the next steps.

I. Taxes and reporting: pay any taxes associated with the funding and report the

transfer of assets as necessary.

J. Follow-up annually: make sure the trust was funded or that required annual

actions took place. 1 Portions of this outline are taken from: Michael Sneeringer, “Trusts”, Lexis Practice Advisor, Florida Business and

Commercial Module (Jan. 27, 2017); Stephan R. Leimberg, et. all, The Tools & Techniques of Trust Planning

(National Underwriter ed.) (2016). 2 Unif. Trust Code § 401.

3 Id. at 402(a).

4 Id. at 103(19).

5 This outline will not address unique or complicated trust structuring.

6 See generally Michael A. Sneeringer, Gun Trusts—What’s All the Fuss?, 31 Prob. & Prop. 11 (Mar./Apr. 2017).

7 See Uniform Trust Decanting Act, Nat’l Conf. of Commissioners on Unif. State Laws, July 2015,

http://www.uniformlaws.org/shared/docs/trustdecanting/UTDA_Final%20Act.pdf. 8 Unif. Trust Code § 414.

9 I.R.C. § 2511(a).

10 Treas. Reg. § 25.2511-2.

11 Treas. Reg. § 25.2511-2(b).

12 Id.

13 I.R.C. § 2501.

14 A discussion on formula gifting is outside the scope of this article. See Paige K. Ben-Yaacov, Formula Clauses:

Are Two Donees Better Than One?, 29 Prob. & Prop. (Nov./Dec. 2015). 15

See e.g., Jonathan E. Gopman, et. al., In re Ferrante: Not Modifying Trust to Comply with Tax Law Creates

Bankruptcy Nightmare, LISI Asset Protection Planning Newsletter #311, Nov. 10, 2015, available at

leimbergservices.com. 16

Unif. Trust Code § 408. 17

This described in more detail in Section VII, below. 18

See discussion at Jonathan E. Gopman, et. al, Mikel v. Commissioner: Another Crummey Result for the IRS, LISI

Estate Planning Newsletter #2301, Apr. 14, 2015, available at leimbergservices.com. 19

See Unif. Trust Code § 1013. 20

Nat’l. Conf. of Commissioners on Unif. State Laws, Uniform Trust Code 184 (2010),

http://www.uniformlaws.org/shared/docs/trust_code/utc_final_rev2010.pdf. 21

Unif. Trust Code § 1013(a). 22

See IRS, Definitions of Terms and Procedures Unique to FIRPTA, Sept. 2, 2016,

https://www.irs.gov/individuals/international-taxpayers/definitions-of-terms-and-procedures-unique-to-firpta (last

visited Apr. 28, 2017). 23

See I.R.C. § 6019. 24

See Regs. §§25.2511-2(j) and 25.6019-3. 25

Regs. § 1.671-4. 26

I.R.C. § 6677(a). 27

I.R.C. § 6677(a). 28

I.R.C. § 6677(b)(1). 29

See I.R.C. §§ 6677(a), (b)(2).

12

30

I.R.C. §§ 6677(a), (b)(2). 31

See I.R.C. §§ 6048(d)(5), 6034A(c). 32

See McNamara, New Foreign Trust Tax Form Project: 1041NR, 38 The Tax Adviser 516 (Sept. 2007). 33

See H.R. 3236, Sec. 2006(b)(11). 34

See Weller & Gonzales, Final Regulations on Specified Foreign Financial Asset Reporting By Domestic Entities,

Steve Leimberg’s International Tax Planning Newsletter #7 (Apr. 20, 2016). 35

I.R.C. § 6038D. See Internal Revenue Bulletin 2014-53. 36

See Alaska Stat. § 13.36.005.

Funding Trusts: The Tips and Traps of Ensuring Client Goals

Michael A. Sneeringer, Esq.

1

2

• Key Terms

• Planning for Funding Trusts

o Inter Vivos

Revocable Trust

Irrevocable Trust

Incomplete Gift

Completed Gift

o Testamentary Trust

Introduction

3

• Formulate a Plan

• Client Intake Form

• Specific Assets to Pay Attention to:

– Closely Held Business Interests

– Insurance

– Retirement Account Assets

– Annuities

– Promissory Notes

Identifying Funding Sources and Potential Assignments

4

• ILIT

• Retirement Accounts

• GRATs

• Revocable/Testamentary Trusts

Problems with Identifying Funding Sources and Potential Assignments

5

TRANSFER IN TRUST TO: TRUSTEE, as Trustees of the GRANTOR Revocable Trust, U/A/D May 2, 2017

In accordance with Article 2 of the above designated “GRANTOR Revocable Trust,” created under Agreement dated May 2, 2017, whereby the Grantor reserves to himself or any other person the right to add at any time to the principal of the Trust therein created, I, GRANTOR, do hereby give, assign and transfer unto the Trustees of the “GRANTOR Revocable Trust” the following property: [Describe property]

I DO FURTHER DECLARE that the above-described property is to be held, administered and distributed as part of the “GRANTOR Revocable Trust.” SIGNED this day of __________________________, 20_____. GRANTOR (Signature of GRANTOR)

Drafting Instruction Letters (Sample Letter to Trustee)

6

STATE OF _____________

COUNTY OF ___________

CERTIFICATION OF TRUST

BEFORE ME, the undersigned authority, personally appeared _____________________________ ("Affiant") who deposes and says:

1. This Certification pertains to the following trust (insert name of trust and reference any amendments thereto____________(the “Trust”).

2. The Trust, executed on ________________, currently exists and has not been revoked, modified or amended in any manner.

3. Title to the trust property described on Exhibit “A” attached hereto and made a part hereof (the “Property”) is currently vested as follows: ___________________________________________.

4. The conveyance or mortgage by the trustees of the Trust in favor of the following purchaser or lender is an arms-length transaction for consideration and the purchaser or lender is not a beneficiary of the Trust: _____________________________.

5. Listed below are: (A) The name of each settlor of the Trust; (B) Whether the settlor is single, married or deceased; and (C) Whether the Property is the homestead of the settlor or was the homestead of the settlor at the date of death: (A) Name of Settlor:____________ (B) Status (Single, Married or Deceased)? ________ (C) Was the Property the Settlor’s Homestead? (Yes or No)

6. If any settlor listed above is deceased and the Property was the homestead of that settlor at the date of death, I hereby represent that said settlor was not survived by a spouse or minor child.

7. Affiant, whose address is ____________________, is a currently acting trustee of the Trust. The other currently acting co-trustees and their addresses are: _____________________________.

(continued next slide)

Drafting Trustee Certifications ( Sample Certification for Real Property Purchase & Sale)

7

8. The Trust is ___ revocable or ___ irrevocable; If revocable, the person(s) holding a power to revoke the Trust is/are the settlor(s) unless indicated below.

If person(s) other than the settlor(s) of the Trust have power of revocation, such person(s) are : ________________.

9. The trustees of the Trust have full power and authority to mortgage and convey the Property without the consent of any beneficiary.

10. The Trust requires ____ all or ____ less than all of the trustees to exercise the powers of the trustees to convey or mortgage the Property. If less than all trustees are required, the following trustees can execute a deed or mortgage pertaining to the Property without the necessity of any other co-trustees signing or otherwise authenticating the instrument:_______________________.

11. An authentic copy of the Trust, pertinent excerpts from the Trust or related documents may be attached hereto as Exhibit “B” and, if so, shall be incorporated herein and shall be made a part hereof.

___________________________

(Signature of Affiant)

___________________________

(Print Name of Affiant)

Sworn and subscribed to before me, a Notary Public, this day of , 201__ , by _________________

_______________who _____ was personally known to me or ____ produced the following as identification:_________________________________.

____________________________

(Signature of Notary)

_____________________________

(Print Name of Notary)

Drafting Trustee Certifications ( Sample Certification for Real Property Purchase & Sale)

8

• Bank not Serving as Trustee:

Certifications

Value of Account

Access to Account

Annual Work

Specific Issues of Working with Banks on Funding Issues

9

• Bank Serving as Trustee: o Fees o Cooperation o Division of Work o Annual and Ongoing Work

Specific Issues of Working with Banks on Funding Issues

10

Assignment of Interests

• Business Interests

• Real Estate

• Financial Interests

• Unique Objects

11

• Active Business

• Family Owned Company

• Venture Capital

• Taxation of Business

Assignment of Business Interests

12

• QPRT

• Use of Disregarded Entity

• Homestead

• FIRPTA

Assignment of Real Estate

13

• Portfolio of Marketable Securities

• One-Time Gift

• Retirement Assets

• Insurance

• Foreign Accounts

Assignment of Financial Interests

14

Assignment of Unique Objects

• Tangible Personal Property (nominal value)

• Unique Assets:

• Horses

• Exotic Cars

• Art

• Expensive Jewelry

• Use LLC Wrapper?

15

• 401(k)

• IRA

Spouse as beneficiary, outright

Stretch Out Treatment

Treatment of Assets that are Non-Assignable (Retirement Benefits)

16

• ILIT

• Revocable (becoming irrevocable) or Testamentary Trust

– Change of Beneficiary Form

– Estate Tax Consequences

Treatment of Assets that are Non-Assignable (Insurance Contracts)

17

• Basis

• Incomplete Gift

• Completed Gift

Tax Planning Issues

18

• Foreign Trust

• Tax Forms

• Gift Tax

• Estate Tax

• Income Tax Planning Considerations

Tax Planning Issues

19

THINK CAREFULLY!

COMMUNICATE CLEARLY!

BE PERSISTENT!

BE PATIENT!

USE BLUE INK!

PROCESS!

VAULT!

CREATE LETTER!

TAXES AND REPORTING!

FOLLOW-UP ANNUALLY (OR MORE FREQUENTLY)!

Conclusion