navigating the sea change— planning for married clients · 3 irc §1411 – 3.8% medicare surtax...

Online CLE

Navigating the Sea Change—Planning for Married Clients

1 General CLE credit

From the Oregon State Bar CLE seminar Advanced Estate Planning (2015), presented on June 12, 2015

© 2015 Patrick Green. All rights reserved.

Chapter 4

Navigating the Sea Change—Planning for Married Clients

Patrick Green

Davis Wright Tremaine LLPPortland, Oregon

Contents

I. Sea Change . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–1

II. Historical Marital Planning—“Optimizing” or “Fine Tuning” the Marital Deduction. . . . . 4–4A. Multiplicity of Formulas to “Optimize” the Marital Deduction . . . . . . . . . . . . . 4–4B. Historical Preference? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–6

III. Post–ATRA 2012 World . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–6A. From “Optimizing” to “Maximizing” the Marital Deduction. . . . . . . . . . . . . . . 4–6B. Portability—To Elect or Not to Elect? . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–7C. Analyzing Planning for Marital Clients Today . . . . . . . . . . . . . . . . . . . . . . . 4–7D. Framework for Planning—Decision Tree . . . . . . . . . . . . . . . . . . . . . . . . . . 4–8

IV. Case Studies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–16A. Case Study #1—Married Couple with a $1,000,000 Oregon Estate . . . . . . . . . . . 4–16B. Case Study #2—Married Couple with a $2,000,000 Oregon Estate . . . . . . . . . . . 4–18C. Case Study #3—The Oregon $7,000,000 Estate . . . . . . . . . . . . . . . . . . . . . . 4–20D. Case Study #4—The Oregon $11,000,000 Estate . . . . . . . . . . . . . . . . . . . . . 4–23

Chapter 4—Navigating the Sea Change—Planning for Married Clients

Advanced Estate Planning 4–ii


Advanced Estate Planning 4–1

I. SEA CHANGE

“A big and sudden change; a marked change: transformation” 1

Decades of “traditional estate planning” based upon avoiding the estate tax have been turned upside down due to the dramatic impact of the following, often non-complimentary, developments:

o Larger federal estate tax exemptions that are inflation adjusted

I.R.C. §2010(c)(3)(A): For purposes of this subsection, the basic exclusion amount is $5,000,000.

I.R.C. §2010(c)(3)(B) Inflation Adjustment

In the case of any decedent dying in a calendar year after 2011, the dollar amount in subparagraph (A) shall be increased by an amount equal to—

I.R.C. §2010(c)(3)(B)(i)

such dollar amount, multiplied by

I.R.C. §2010(c)(3)(B)(ii)

the cost-of-living adjustment determined under section 1(f)(3) for such calendar year by substituting “calendar year 2010” for “calendar year 1992” in subparagraph (B) thereof. If any amount as adjusted under the preceding sentence is not a multiple of $10,000, such amount shall be rounded to the nearest multiple of $10,000.

The impact of this is to increase the $5,000,000 basic exclusion amount, previously the “Applicable Exclusion Amount,” from $5,000,000 in 2010 to $5,430,000 or $10,860,000 for a married couple in 2015, an 8.6% increase in just four years. Assuming inflation rates of 3% or 6%, future exemptions could increase as follows:

Rate of Inflation

3% Individual

3% Couple 6% Individual

6% Couple

5 Years $6,294,858 $12,589,716 $7,266,565 $14,533,130 15 Years $8,459,763 $16,919,526 $13,013,311 $26,026,622 25 Years $11,369,214 $22,738,428 $23,304,858 $46,609,716

1 www.merriam-webster.com/dictionary



o Low state estate tax exemptions2

Oregon provides an exemption from the Oregon estate tax of $1,000,000, unindexed for inflation.

Washington’s estate exemption, indexed for inflation, is $2,054,000 for 2015.

o Higher federal and state income taxes and limitations on deductions3

Tax Oregon California Washington

Federal Ordinary

Income Tax Rate + Oregon

Federal Long- term Capital Gain Bracket

20% 20% 20% 39.6%

Federal Net Investment Income Excise Tax

3.8% 3.8% 3.8% 3.8%

State 9.9% 13.3% 0% 9.9% (Oregon) Total 33.7% 37.1% 23.8% 53.3% Effective Rate (state deduction against federal)

31.4% 33.9% 23.8% 49%

Effective Rate w/o 3.8%

27.92% 30.6% 20% 49%

2 ORS 118.010; RCW 83.100.020 3 IRC §1411 – 3.8% Medicare surtax on net investment income; IRC - Higher income tax brackets – new 39.6% (up from 35%) and increased long-term capital gain rate of 20% (up from 15%); Individuals – both rates apply if taxable income exceeds $413,200for single taxpayers and $464,850for married filing jointly; Trusts – New higher rates if taxable income exceeds $12,300 of taxable income for 2015. Effective rates also depend upon other factors such as the phase out of personal exemptions and itemized deductions (Pease amendments).



o Portability4

I.R.C. §2010(c)(2) Applicable Exclusion Amount

For purposes of this subsection, the applicable exclusion amount [“AEA”] is the sum of—

2010(c)(2)(A) the basic exclusion amount [“BEA”] , and

2010(c)(2)(B) in the case of a surviving spouse, the deceased spousal unused exclusion amount [“DSUE”].

A formula for the appropriate Applicable Exclusion amount is as follows:

AEA = BEA + DSUE

A detailed discussion of portability, the election, the computation of the deceased spouses unused exclusion amount (“DSUE”), the identification of the “last deceased spouse”, pros and cons of the portability election, remarriage and lifetime strategies are beyond the scope of this outline except to the extent that the case studies in this outline illustrate the use of portability in planning – a very major and important part of this presentation. Other scholarly presentations and articles have addressed considerations of portability, some of which are referenced in the accompanying bibliography. For purposes of this presentation, I am assuming that the estate value will increase between the first and second deaths of the married couple although it should be kept in mind that bases “step down” as well as “step up”.5

o Same sex marriages6 and “blended families”

Both Supreme Courts of the United States and of Oregon have ruled that couples in same sex marriages qualify for federal and state tax treatment applicable to married individuals of the opposite sex.

The SCOTUS Windsor case and the SCOSO Geiger v. Kitzhaber cases essentially expand the planning benefits available to married couples regardless of the gender of the couple provided that the marriages are recognized where married with Oregon benefits for Oregon domestic partnerships. Not all states recognize same sex marriages although cases challenging these prohibitions are headed to SCOTUS.

The prevalence of blended families, which often involve multiple marriages with children from previous marriages or relationships, expands the impact of using

4Initial Enactment: Tax Relief Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “2010 TRA”). Now made permanent – see IRC §2010(c) 5 IRC §1014. 6 United States v. Windsor, 570 U.S. __, 133 S. Ct. 2675 (2013); Rev. Rul. 2013-17, 2013-38 I.R.B. 201 (August 28, 2013); Geiger v. Kitzhaber, 994 F. Supp.2d 1128; OAR 105-010-0018, effective January 1, 2014



portability to the advantage of the surviving spouse and the children. The value of a DSUE is considered a valuable asset over which much negotiation may occur in the creation of marital agreements. Also, in blended families, couples should consider irrevocable trusts for the surviving spouse that provide for the survivor but also provide for the children of the decedent to avoid conflicts among the surviving heirs and beneficiaries. This tension will likely involve credit shelter trusts, with benefits for the children, particularly if the current spouse is much younger than the deceased spouse, and with QTIP trust arrangements to allow portability elections at the death of the first spouse to die while designating children of the first spouse to die as remainder beneficiaries.

The incidence of same sex marriages and mixed families today greatly expand the relevance of planning for married couples.

o The huge shift from hard copy documents to digital assets7

While not directly impacting the complexity of analyzing the best choices for analyzing estate tax formulas for married couples, this shift certainly creates some challenges obtaining information unless the surviving spouse has access to online account information.

o Tax law changes: Proposals - Administrations “Green Book”8

Proposals, if enacted into legislation, could also dramatically impact estate planning for married couples. One such proposal would limit the step up in basis rules for assets in a decedent’s estate. This could result in higher income taxes upon the sale of assets for the surviving spouse’s heirs and beneficiaries as well as estate taxes.

Many scholarly articles, some with extensive mathematical analysis, have addressed each of these “sea change” developments. I have included citations to several articles throughout this outline. These sources thoroughly discuss the above developments, law changes and possible planning opportunities. The purpose, however, of this presentation is to focus on issue spotting, to develop an analytical planning approach and to provide tools and language for implementation of effective strategies in some common estate planning engagements.

II. HISTORICAL MARITAL PLANNING – “OPTIMIZING” OR “FINE TUNING” THE MARITAL DEDUCTION

A. Multiplicity of Formulas to “Optimize” the Marital Deduction.

“Optimizing” 9 the marital deduction is the strategy of obtaining just enough marital deduction to reduce the federal estate tax to zero or pretty close to it. The following

7 Uniform Law Commission – The Uniform Fiduciary Access to Digital Assets Act introduced in Oregon in 2015 as SB 369 (not yet enacted ) 8 General Explanations of the Administration’s Fiscal Year 2014 Revenue Proposals



material from my presentation "Playing the Hand you are Dealt - Administering the Marital Funding Formula and Advising the Taxable Estate" at the Oregon State Bar sponsored “Administering the Taxable Estate” CLE on November 20, 200910 summarizes the potpourri of formulas, provides examples and sample language. You may access this article (see link below) to study the variety of marital funding approaches. Here is an edited excerpt from that outline:

Formula. Marital funding formulas follow two main categories, pecuniary or fractional, with a third category involving a single fund that is neither pecuniary nor fractional but may utilize such approaches in making various elections within the single marital fund. There are five pecuniary and two fractional formulas. The nomenclature of the formulas breaks down as follows:

(1) Pecuniary.

(a) True worth marital

(b) Fairly representative marital

(c) Minimum worth marital

(d) True worth exemption (credit shelter)

(e) Fairly representative exemption (credit shelter)

(2) Fractional.

(a) Pro rata

(b) Pick and choose

(3) Single fund marital. Another category involves single fund marital trust funding with various elections available often made as a fractional and sometimes by pecuniary formulas. These would include the following:

(a) Divisible QTIP

(b) Clayton QTIP

(c) Reverse QTIP (for Generation Skipping Transfer Tax exemption)

9 Credit to author for recent characterization of the marital deduction planning as “optimizing” v. “maximizing” and summarizing objectives: Fujimoto, Marcia K., Graham & Dunn, PC, Seattle, WA, “Creatively Using Lifetime and Testamentary QTIP Trusts – A Federal and State of Washington Perspective”, September 2014 10 Link for access: http://www.dwt.com/people/PatrickJGreen/ Go to “Profiles” and click on “Publications” to obtain a link to the outline and PowerPoint: 11.20.09 "Playing the Hand you are Dealt - Administering the Marital Funding Formula and Advising the Taxable Estate"



B. Historical Preference?

Which formulas are used the most? Studies show that most practitioners repeatedly use only a few of the choices which tend to be the ones that they understand and favor. According to one study11 most of the respondents utilized the following marital formulas:

(1) Pre-residuary pecuniary true worth marital

(2) Reverse true worth marital

(3) Fractional pick & choose marital

Note however, that this study was compiled when many state inheritance taxes were not decoupled as now exists in many states, including Oregon. Also, this survey was conducted well before portability and higher exemptions came into law. Which of these formulas would be useful today?

III. POST-ATRA 201212 WORLD

Much to the surprise of many estate planning professionals, ATRA offered up generous exemptions following the 2012 scramble to establish and document large gifts arrangements before the exemptions reverted to lower levels anticipated by the law at that time. Due to these exemptions and the establishment of “portability”, much of the estate planning that has occurred to avoid estate tax has become unnecessary and perhaps harmful to our client’s beneficiaries given newly increased income tax rates imposed upon individuals and trusts. Employing traditional formulas designed to “optimize” the marital deduction and to avoid federal estate tax may now result in locking in the historical basis of assets at values included in the estate of the first spouse’s death, usually into a “credit shelter trust”13 Due to increasing longevity, the basis of assets in a credit shelter trust may be woefully below fair market value at the much later death of the surviving spouse. Sale of such assets by the beneficiaries can generate large income tax bills even though the estate would pass estate tax free for a “moderately wealthy” couple.14

A. From “optimizing” to “maximizing” the Marital Deduction.

The focus for today’s estate planning has shifted from “optimizing” the marital deduction to “maximizing” the marital deduction. We now must address three major estate tax objectives while attempting to address the increasingly important income tax objective and to weigh the multiple possible outcomes15. The problem, of course, is that meeting all of these objectives is

11 Moore & Pennell, Practicing What We Preach: Esoteric or Essential? , 27 U. Miami Inst. Est. Plan, ¶1211 (1993) (survey of University of Miami Estate Planning Instituted registrants) 12 American Taxpayer Relief Act of 2012 (“ATRA”), Pub. L. 112-240, 112h Cong. (Jan. 22, 2013) 13 “Credit Shelter Trust” will be used in this outline to describe what is also known as a “bypass trust” or “exemption trust” designed to capture the full exemption equivalent provided by I.R.C. §2010, currently $5,430,000 in 2015. 14 Up to a net worth of $10,680,000 in 2015. 15Credit to author for summarizing objectives and contrasting marital trust strategies: Fujimoto, Marcia K., Graham & Dunn, PC, Seattle, WA, “Creatively Using Lifetime and Testamentary QTIP Trusts – A Federal and State of Washington Perspective”, September 2014



becoming increasingly difficult without implementing new and often complex strategies. These objectives may be stated as follows:

Estate tax objectives:

1. Maximize amount passing to spouse estate tax free (done by “optimizing” the federal marital share)

2. Delay federal and state estate tax until death of surviving spouse (on the marital share, Oregon Special Marital Property, Washington QTIP, etc.)

3. Maximize amount passing to beneficiaries at death of surviving spouse

Income tax objective and comparison:

1. Maximize basis for income tax purposes at death of surviving spouse (done with maximizing federal marital share)

2. Weighing the income against the estate tax outcomes.

B. Portability – to elect or not to elect?

Advising the surviving spouse on electing portability at the deceased spouse’s death involves many assumptions and calculations. Since the outcomes can vary significantly based upon multiple unknown future factors, it will become increasingly important to document the decision and the process involved in arriving at that decision. The surviving spouse’s heirs and beneficiaries will have the benefit of hindsight and will be able to present calculations that, based upon now known facts, will show the dollar outcomes disputing the previous decision. If the surviving spouse chooses not to elect portability, the conventional wisdom suggests that the attorney place a declaration signed by the surviving spouse that they have been fully advised of the consequences of forgoing the election into the file to document the decision (sample letter cited in referenced article).16

C. Analyzing Planning for Marital Clients today.

How does our experience with traditional marital formula planning work in today’s environment and what are the most effective formulas? Does the sea change require that we throw out the traditional formulas including the credit shelter trust? Is the credit shelter trust really “dead”. 17 Ms. Zeydel’s articles introduce terminology that addresses the use of “portability” and provide a framework for an analysis for structuring planning. Other articles list factors to consider in addressing the need for trust planning for a surviving spouse and electing

16 Cheyne, Jeffrey, “The Perils of Portability”, Oregon Estate Planning and Administration Section Newsletter, Vol. XXXI, No. 2, May 2014 17Zeydel, Diana S.C., “Portability or No: The Death of the Credit Shelter Trust,” Journal of Taxation, May 2013; “Planning With Portability”, Portland Estate Planning Council Annual Seminar, February 2014 and other article.



portability. 18 Another author provides an excellent decision tree for developing a plan for today’s married clients. 19

D. Framework for Planning – Decision Tree

1. Lifetime Trust or Will?

How important is avoiding probate to this couple? Will the extra cost of establishing and funding a revocable living trust be worth the benefits of a trust administration versus an estate administration (incapacity, privacy, avoidance of court fees, speed, etc.)?

2. Irrevocable Trust for Surviving Spouse or Not?

A number of factors control this decision:

• Non-tax issues such as in marriages where there are children from previous marriages or relationships, where the possibility of remarriage and change in disposition to the decedent’s children may occur and where the need for management, avoidance of undue influence and asset protection may be present.

• Costs of trust administration during life of surviving spouse (trustee, accounting and legal fees and possible higher income taxes)

3. Portability Approaches – to elect or not to elect that is the question: Factors to consider:

• Cost. Filing a federal estate tax return for the election when the taxable estate as below the Oregon filing threshold of $1,000,000 is a separate cost while filing the federal return for an Oregon estate in excess of $1,000,000 is an incremental cost as federal schedules from the federal 706 return must be included in any event with that Oregon return.

• Size of estate. If the combined estate is between $5,430,000 and $10,860,000, the choice if file for portability is more compelling since appreciation of assets is likely if the life expectancy of the surviving is long or the type of assets are likely to appreciate substantially. Basis step up for income tax savings become important.

18 Bannen, John T. & Occhetti, Kristin A., “The DSUE Coin Flip”, Trusts and Estates, August 2014. 19 Granstaff, Charles A., “Portability + QTIP”, Trusts & Estates, August 2014.



• Choices for Portability20 include:

o Pure Portability – outright to spouse

o Portability Plan – designated in trust for spouse

o Credit Shelter Trust at Death of First Spouse to Die

o Lifetime grantor trusts with variations including the “Supercharged Credit Shelter Trust”21

• Formulas include:

o Disclaimers into traditional credit shelter trusts for Oregon exemptions only, for federal exemption or into a qualified terminable interest property trust (“QTIP” trust) – the later to allow for reverse QTIP elections or other partial elections

o QTIP trust qualified under IRC §2056(b)(7)

o QTIP trust with Clayton provisions for partial elections which provide for directing income to beneficiaries other than the surviving spouse or with “cascading” provisions for layers of exempt trusts

4. Formula Analysis

a. Disclaimer

On the surface, disclaimers appear to be the simplest approach to drafting and, for that reason, they are appealing. However, they can be deceptively complex with many traps for the unwary. The use of disclaimers in estate administrations is governed by I.R.C. §2046 which simply directs one to I.R.C. §2518 for the details. Section 2518 provides that a “qualified disclaimer” treats the interest in property as if it had never been transferred to the person making the disclaimer. The statute outlines the requirements and permits partial disclaimers which afford an opportunity for tax planning if the married couple is comfortable in permitting the surviving spouse to disclaim.

The statute contains a number of parts, each of which can present problems in the application:

“2518(a) General Rule. For purposes of this subtitle, if a person makes a qualified disclaimer with respect to any interest in property, this subtitle shall apply with respect to such interest as if the interest had never been transferred to such person.

20 Zeydel, Portland Estate Planning Counsel Annual Seminar, p. 33. 21 Zeydel, ibid, p. 32 et seq. but beyond the scope of this presentation



2518(b) Qualified Disclaimer Defined. For purposes of subsection (a), the term “qualified disclaimer” means an irrevocable and unqualified refusal by a person to accept an interest in property but only if—

2518(b)(1) such refusal is in writing,

2518(b)(2) such writing is received by the transferor of the interest, his legal representative, or the holder of the legal title to the property to which the interest relates not later than the date which is 9 months after the later of—

2518(b)(2)(A) the day on which the transfer creating the interest in such person is made, or

2518(b)(2)(B) the day on which such person attains age 21,

2518(b)(3) such person has not accepted the interest or any of its benefits, and

2518(b)(4) as a result of such refusal, the interest passes without any direction on the part of the person making the disclaimer and passes either—

2518(b)(4)(A) to the spouse of the decedent, or

2518(b)(4)(B) to a person other than the person making the disclaimer.

2518(c) Other Rules

2518(c)(1) Disclaimer Of Undivided Portion Of Interest

A disclaimer with respect to an undivided portion of an interest which meets the requirements of the preceding sentence shall be treated as a qualified disclaimer of such portion of the interest.

2518(c)(2) Powers

A power with respect to property shall be treated as an interest in such property.

2518(c)(3) Certain Transfers Treated As Disclaimers

A written transfer of the transferor's entire interest in the property—

2518(c)(3)(A)

which meets requirements similar to the requirements of paragraphs (2) and (3) of subsection (b), and

2518(c)(3)(B)



which is to a person or persons who would have received the property had the transferor made a qualified disclaimer (within the meaning of subsection (b)), shall be treated as a qualified disclaimer.”

In the context of planning for marital couples, the goal is to maximize the marital deduction. Thus, the disclaimer will likely be a partial disclaimer limited to the Oregon exemption or possibly equal to the federal basic exclusion amount to fund a credit shelter trust. A partial disclaimer of an undivided portion of an interest in property can qualify but the disclaimed portion needs to be a fraction or percentage of the interest over the complete time of the disclaimant’s interest in the property. The Internal Revenue service disapproves of a disclaimer of a “horizontal interest”. For example, if a decedent gave the surviving spouse a piece of commercial property, the spouse could not retain a life estate and disclaim a remainder interest.

A disclaimer of an undivided portion (but not all) of an interest in property is treated as a qualified disclaimer if it satisfies the requirements of §2518(b).22 The undivided portion of the disclaimant's entire interest must consist of a fraction or percentage of each interest or right of the Disclaimant in the property and must extend over the entire term of the disclaimant's interest in that property and any conversions thereof. The regulations prohibit a “horizontal” disclaimer. Thus, a disclaimer of a remainder interest in a bequest of a fee interest, while retaining a life estate, is not treated as a qualified disclaimer.23

How should the disclaimer of a partial interest be drafted? Here are some approved forms:

• A pecuniary amount based upon a specific amount of tax to be paid in a decedent’s estate24

• A “zero tax” formula25

• A surviving spouse may disclaim a portion that goes into an exemption or bypass trust and still enjoy the income and principal from the trust (subject to an ascertainable standard) although the trust should not contain any power to appoint by the surviving spouse 26

• A fractional disclaimer may be utilized as well. An example for the Oregon Exemption Trust may be used as follows:

“Balance to Surviving Settlor. The balance of such trust property shall be distributed to the surviving Settlor, provided, however, that unless the surviving Settlor directs otherwise in

22 IRC §2518(c)(1). 23 IRC Regs. §25.2518-3(b) and §25.2518-3(d), Ex. (2) 24 PLR 9437029 25 PLR 9435014 26 IRC §2518(b)(4) and 2517(c)(2)



writing, such property shall be added to and disposed of as a part of the trust created under Paragraph (A) of this Article, but provided further, that if the surviving Settlor disclaims all or any portion of the balance of such trust property, such property or portion thereof so disclaimed by the surviving Settlor shall not be made part of such trust created under Paragraph (A) of this Article, and shall instead be held in a separate trust for the benefit of the surviving Settlor during his or her life, as follows:

Oregon Exemption Trust. [provide for terms and conditions of trust]”

The portion disclaimed could be done by a fraction which does not necessarily need to be described in the governing document but could be administered and applied as follows:

The surviving Settlor may disclaim a fraction of the balance of the trust property equal to an amount calculated by a fraction, the numerator of which shall equal the amount of the deceased Settlor’s Oregon Estate tax exemption available under ORS Chapter 118 or it’s then equivalent statute and the denominator shall equal the value of balance of trust property as finally determined for federal estate tax purposes passing to the surviving Settlor under the above paragraph.

b. Qualified Terminable Interest Property Trust (“QTIP”)

The disclaimer approach generally provides an outright marital gift or distribution from the deceased spouse’s trust to the surviving spouse’s revocable trust while giving the surviving spouse a right to disclaim a portion into a disclaimer trust. That approach works reasonably well in long-term marriages with children from the same marriage. In second marriages with children from the previous marriage, spouses will more likely than not will want to avoid the anxiety associated with the question of whether a disclaimer will be made. Instead, a QTIP trust coupled with a portability election will more likely serve the triple objectives of providing for the decedent’s surviving spouse for life, providing an inheritance for the decedent’s children from a prior marriage and achieving a stepped up basis on the couple’s entire estate at the death of the survivor. 27

An election over an appropriate portion of the QTIP trust will qualify that portion for the marital deduction while the decedent’s applicable exclusion can be applied to the unelected portion. Since many estates will fall below the combined applicable exclusions of both spouses, maximizing the marital deduction at the first death may provide a full step up in basis of all of the couple’s assets at the death of the surviving spouse since the elected portion of the QTIP and the survivor’s assets will be included in the survivor’s taxable estate.

27 See IRC §§2010(c), 2056(b)(7) and 2056(b)(10)



Oregon resident decedents of moderate wealth may wish to elect all of the QTIP for a marital deduction with the exception of a sufficient portion to use the $1,000,000 Oregon exemption. That strategy provides up to two Oregon exemptions saving between $100,000 and $160,000 depending upon the Oregon estate tax rate applicable at the surviving spouse’s death.

Partial QTIP elections are permitted and language should be drafted into the estate plan to anticipate their use. Although drafting QTIP marital language for second marriages is often advisable, including QTIP provisions for surviving spouses of first marriages allows time to evaluate the best course of action at the death of the first spouse and to make the QTIP election that yields the best tax outcome.

Self-adjusting formula elections, generally in the form of fractions or percentages28 lead to better tax outcomes as using and reporting a specific fraction or percentage for a partial election can lead to unintended consequences should additional property or previous reported lifetime taxable gifts be discovered after filing the return or should the values be adjusted upon audit. If a specific fraction or percentage is reported and the values of the taxable estate increase or decrease, the elected portion may exceed or fall short of the desired amount. Since the election, once made, is irrevocable, the tax consequences will be set in stone and cannot be changed. 29

An example of this would be where the QTIP trust from the deceased spouse’s estate equals $4,000,000 and the surviving spouse wishes to elect 75% of that amount for a QTIP to maximize the marital deduction and to elect the DSUE of $3,000,000. That unelected portion would equal $1,000,000 and would qualify for the Oregon exemption. If later, the estate values increased to $6,000,000 due to reasons stated above, the 75% election would result in an unelected portion of $1,500,000 [$6M - (75% x $6M )]. That would cause the Oregon estate tax to apply at the first death to $500,000 resulting in a tax of approximately $50,000.

A self-adjusting formula would generally describe the results that the formula is designed to achieve such as setting aside an unelected portion to fund the Oregon exemption trust of $1,000,000. The fraction consists of a numerator equal to the amount exemption desired and a denominator of the portion of the estate to which the fraction is applied, e.g. the “residuary estate”. Where using a QTIP approach, the fraction for the Oregon exemption trust may look like the following:

“Oregon Exemption Trust. A fraction of the QTIP trust, unelected for purposes of the marital deduction, shall fund a subtrust entitled “The Oregon Exemption Trust” calculated as follows: The numerator shall equal the amount of the deceased Settlor’s Oregon Estate tax exemption available under ORS Chapter 118 or it’s then equivalent statute and the denominator shall equal the value of assets in the QTIP trust as finally determined for federal estate tax purposes. The fraction of the QTIP trust so set aside shall be held by the Trustee in the Oregon

28 Regs. §20.2056(b)-7(b)(2)(i) 29 IRC §2056(b)(7)(B)(v).



Exemption Trust as a separate trust for the benefit of the surviving Settlor during his or her life, as follows: [describe terms and conditions of trust].”

Regulations provide examples of acceptable formulas and also permit divisions into separate trusts for the elected and nonelected portions. The divided trusts must be funded on a fractional or percentage basis although it is not necessary to fund each separate trust with a fraction or percentage of each asset30.

Note that the divisions need to be made no later than the end of the estate or trust administration following the decedent’s death. If the division has not been made by the time of filing the federal estate tax return, the intent to make the division must be included on the return. Although the costs of administering separate trusts may increase, accounting and reporting will be easier. The Perhaps more importantly, the chances of achieving desired results from the election or non-election decision is greatly enhanced. By contrast, using a single trust for both elected and non-elected portions requires periodic reappraisals and calculations involving “rolling fractions” to keep accurate records identifying the portions of the trust.31

A “Clayton”32 approach may also be used as a variation of the QTIP approach. An example of the language that can fund a federal exemption trust with targeted elections for Oregon Special Marital Property and a non-elected portion for OSMP purposes within that federal exemption trust equal to the Oregon estate tax exemption follows:

“Division of Decedent’s Share – Clayton. After the payment of the distributions and obligations described in Paragraphs Error! Reference source not found., ___, and ___, the balance of the Decedent’s Share shall be administered pursuant to Paragraph ___ (the “Marital Trust”); provided, however, that any portion of the trust estate for which a marital deduction election for federal estate tax purposes is not made pursuant to Section 2056(b)(7) of the Code, if any, shall be set aside in a separate trust (the “Oregon Special Marital Property Trust”) and shall be applied as provided in Paragraph ___; further provided, however, that any portion of the Oregon Special Marital Property Trust for which an Oregon special marital property election for Oregon estate tax purposes is not made pursuant to ORS 118.013-118.016 shall be set aside in a separate trust (the “Exemption Trust”) and shall be applied as provided in Paragraph ___.

For purposes of the division of the trust estate pursuant to this Paragraph ___, if any, values assigned to all assets shall be those finally determined for federal estate tax purposes.

The Trustee shall have unrestricted discretion to determine which assets or fractional shares of assets shall be allocated to the Oregon Special Marital Property Trust and the Exemption Trust, if any; provided, however, that the

30 Regs. §20.2056(b)-7(h), Exs. 7, 8. 31 Regs. §20.2044-1(e), 32 Estate of Clayton v. Commissioner, 97 TC 327 (1991), rev’d, 976 F. 2d 1486 (5th Cir. 1992)



Trustee shall first allocate to the Oregon Special Marital Property Trust or the Exemption Trust any asset with respect to which a marital deduction for federal estate tax purposes is not allowable due to its character or restrictions associated with it; further provided, however, that the Trustee shall first allocate to the Exemption Trust, to the extent such assets represent a part of the trust estate, any asset with respect to which an Oregon special marital property election is not allowable due to its character or restrictions associated with it; and further provided, however, that allocations of assets to the Oregon Special Marital Property Trust and the Exemption Trust shall be fairly representative of the appreciation and depreciation to the date or dates of each allocation of all the assets available for allocation to such trusts by the Trustee.”

Finally, a QTIP trust offers a great advantage in administering moderately to extremely wealthy estates where full utilization of both spouse’s generation skipping transfer tax exemption is important. Because the GST exemption is not portable as is the DSUE, failure to take advantage of the first spouse’s GST exemption at their death results in only one available GST exemption. By using a QTIP trust, the personal representative or trustee may decide to elect to preserve the deceased spouse’s basic exclusion amount for portability but also to make what is known as a “Reverse QTIP Election”33 which assigns the deceased spouse’s unused GST exemption to the QTIP property even though that property will now be treated as owned by the surviving spouse at his or her death under the Code.34 By assigning the GST exemption of the deceased spouse to a portion of the QTIP elected under this provision, the first GST exemption is not wasted and the surviving spouse’s personal representative or trustee may also apply their GST exemption at the death of the surviving spouse. This combined GST exemption (currently equal to the combined basic exclusion amount of $10,860,000) can be especially valuable to a family business or farming operation where the assets will be maintained without further estate taxes for multiple generations in trusts established in jurisdictions with no rule against perpetuities limitations on trust duration.

Mention of Rev. Proc. 2001-3835 is appropriate as the IRS had addressed the effect of an unnecessary QTIP election which was not needed to reduce the estate tax to zero – a “maximum” marital deduction. Where such an election had been made but turned out to be unnecessary, the Service permitted a surviving spouse’s estate to later reverse or undo the prior election with the effect of excluding the previously elected portion from the surviving spouse’s estate as would have been required under IRC §2044 if the QTIP election had remained in place. This strategy offers some flexibility by, in effect, providing a “second look” to see if using a marital deduction at the first death was most advantageous or not, whereas, an irrevocable portability election must be made at the death of the first spouse to die. There is some speculation that the IRS might limit the scope or use of this election unless the QTIP election was “inadvertent”.36

33 IRC §2652(a)(3) 34 IRC §2044 35 Rev. Proc. 2001-38, 2001-24 I.R.B. 1335 (6/11/2001) 36 Zeydel, Portland Estate Planning Counsel Annual Seminar, p. 29



A full discussion of managing QTIP and Reverse QTIP elected and nonelected trust portions is fascinating but well beyond the scope of this presentation.

2. CASE STUDIES

A. Case Study #1 – Married couple with a $1,000,000 Oregon estate.

This couple is on the cusp of exposure to the Oregon estate tax but has little concern about federal estate tax. Unless values of their assets increase significantly during their lifetimes or the life of the survivor, it is highly unlikely that federal estate tax will ever be a problem. The major planning opportunities would focus on whether or not this couple should consider implementing joint (or separate) revocable living trusts or simply rely upon wills with or without testamentary trusts. That decision primarily involves a decision weighing the costs and time involved with probate compared with a the costs involved in establishing, funding and maintaining lifetime trusts – a decision that may result in using wills and letting their children pick up the probate costs saving the parents the cost of establishing the trusts. Of course, a testamentary trust could be established within the wills for property management for the surviving spouse coupled with a simple disclaimer into a disclaimer trust if saving Oregon estate tax becomes important at the second death.

Although a couple with an estate valued between $1,000,000 and $2,000,000 may be perceived as “wealthy” from the perspective of the Oregon Estate Tax, do they really need a “credit shelter trust” or even an Oregon equivalent to capture the Oregon exemption of $1,000,000? A careful analysis of the economic opportunities and costs associated with establishing trusts and other strategies to minimize estate tax needs to be weighed against the associated cost of establishing, funding and tax filings for a trust.

The following chart shows the increase of the estate at assumed rates of growth from 1-3% which could be looked at as a net after tax and after distribution figure. While there is some exposure to the Oregon estate tax at the second death, it is also probable that the surviving spouse may consume the earnings or growth from the trust during their lifetime. The costs of maintaining a trust and annual tax filings would diminish the growth and work to keep the value relatively stable. Also, allowing the property to pass entirely to the surviving spouse or to the surviving spouse’s revocable living trust permits a step up in basis for the beneficiaries of the surviving spouse. The step up in basis can be achieved with a QTIP trust if an irrevocable trust for the survivor is recommended.



Assume the following facts:

• The surviving spouse lived 15 years and hadn’t consumed any of the growth

• The growth at 2% annually would equal $1,345,868.

• Assume half of the $1,000,000, or $500,000, funded an Oregon exemption trust at the first death.

• The Oregon exemption trust and the surviving spouse’s estate would each have appreciated to $672,934 (one-half of the $1,345,868 total estate) at the second death.

• The children immediately sold the assets after the second death.

• The surviving spouse does not elect portability.

• What are the tax consequences of using an Oregon exemption trust compared with an outright gift of the decedent’s share to the surviving spouse, or in the alternative, in a QTIP trust where a marital election is made?

Combined Gross Assets at First Death 1000000Estimated Asset Growth Rate 0.02

Additional Surviving Years Value of Appreciated AssetsAfter Tax Rate of Return

0.01 0.02 0.030 1,000,000.00 1,000,000.00 1,000,000.00 1 1,010,000.00 1,020,000.00 1,030,000.00 2 1,020,100.00 1,040,400.00 1,060,900.00 3 1,030,301.00 1,061,208.00 1,092,727.00 4 1,040,604.01 1,082,432.16 1,125,508.81 5 1,051,010.05 1,104,080.80 1,159,274.07 6 1,061,520.15 1,126,162.42 1,194,052.30 7 1,072,135.35 1,148,685.67 1,229,873.87 8 1,082,856.71 1,171,659.38 1,266,770.08 9 1,093,685.27 1,195,092.57 1,304,773.18

10 1,104,622.13 1,218,994.42 1,343,916.38 11 1,115,668.35 1,243,374.31 1,384,233.87 12 1,126,825.03 1,268,241.79 1,425,760.89 13 1,138,093.28 1,293,606.63 1,468,533.71 14 1,149,474.21 1,319,478.76 1,512,589.72 15 1,160,968.96 1,345,868.34 1,557,967.42



USING AN OREGON EXEMPTION TRUST

Value of assets at second death with 2% annual appreciation

Basis Gain Oregon Estate Tax

Capital Gains @ 30%/28%

Oregon Exemption Trust

672,934 500,000 172,934 0 51,880/ 48,422

Survivor’s Estate

672,934 672,934 0 0 0

FORGOING AN OREGON EXEMPTION TRUST

Survivor’s Estate

$1,345,868 1,345,868 0 $34,586 0

It appears that conventional planning that mandated an Oregon exemption trust would create capital gain taxes exceeding the Oregon estate tax by $17,294 with the 3.8% surtax applying or $13,836 without the 3.8% surtax applying ($51,880 – 34,586; $48,422 – 34,586). In addition, trust maintenance costs including trustee fees, accounting and tax reporting fees and legal fees must be considered as an additional cost of maintaining the Oregon exemption trust for an estate at this level of wealth

B. Case Study #2 – Married couple with a $2,000,000 Oregon estate.

Look at the possible outcomes with the following assumptions:

• Same 2% annual appreciation as in Case Study #1

• Oregon Exemption Trust of $1,000,000 at first death and survivor’s keeps $1,000,000.

• 15 years between first and second deaths.

• Children sell all assets after the death of the surviving parent.



USING AN OREGON EXEMPTION TRUST

Value of assets at second death with appreciation

Basis Gain Oregon Estate Tax

Capital Gains @ 30%

Oregon Exemption Trust

$1,345,868 1,000,000 345,868 0 $103,760

Survivor’s Estate

$1,345,868 $1,345,868 0 $35,00037 0

FORGOING AN OREGON EXEMPTION TRUST

Survivor’s Estate

$2,691,737 $2,691,737 0 $172,153

0

Sale of assets with OR Exp Trust + SS’s Estate

$138,760 = + 35,000 +103,760

Sale of assets without OR Exp Trust + SS’s Estate

Difference: $33,393 Additional tax

$172,153

It appears from this simple example that capital gain taxes on the sale of assets

distributed from the Oregon exemption trust combined with Oregon estate taxes on the survivor’s estate total $138,760 but forgoing an Oregon exemption trust increases Oregon estate tax to $172,153). This example favors using the Oregon exemption trust. Several approaches would provide this outcome for the children of the parents:

• The decedent’s estate passed outright to the surviving spouse and the spouse disclaims into an Oregon exemption trust.

• The decedent’s estate passes into a QTIP trust and a QTIP election was made for the surviving spouse in excess of the Oregon exemption.

• The decedent’s estate passes to a QTIP trust and a QTIP election was made for the surviving spouse over the Oregon exemption and portability was elected (to hedge against loss of the DSUE).

• The decedent’s estate passed to a general appointment marital trust for the surviving spouse in excess of the Oregon exemption.

37 Rounded



Since the estate of the deceased spouse to die first exceeded the Oregon filing threshold for filing an OR 706 and the instructions require filing federal schedules with the Oregon return, it seems that it will be a small incremental cost for surviving spouses in this circumstance to file for portability to use the DSUE.

C. Case Study #3 – The Oregon $7,000,000 estate.

Obviously, this “moderately wealthy” couple will experience both Oregon and federal estate tax on the death of the survivor absent further planning or steps taken at the first death. A graphic illustration shows the importance of addressing portability planning since the combined estates could equal almost $15,000,000 at 5% appreciation and almost $33,500,000 at 8% appreciation. Portability will provide federal estate tax savings at 5% and 8% appreciation if the surviving spouse survives the deceased spouse by 10 years and 5 years respectively. To save further estate tax beyond what portability will provide, the plan would need to consider additional strategies outside of this presentation.

In this example, the personal representative may very well elect portability at the death of the first spouse to die. Therefore, the estate plan should anticipate that alternative in the governing documents. Methods to achieve portability involve the following approaches:

• Outright to surviving spouse

• Distribute decedent’s share in trust to surviving spouse’s revocable trust portion

• Distribute decedent’s share to a general appointment marital trust for surviving spouse

$-

$5,000,000

$10,000,000

$15,000,000

$20,000,000

$25,000,000

$30,000,000

$35,000,000

$40,000,000

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Valu

e of

Est

ate

Surviving Spouse Life Expectancy

5% 8% 11% Surviving Spouse's Exemption Combined Exemption



• Permit a disclaimer to create an Oregon exemption trust of $1,000,000 at the first death to save on Oregon estate tax at the death of the survivor (worth $100,000 to $160,000 alone on the OET rates of 10-16% as well as on the appreciation in the Oregon exemption trust).

• Provide a QTIP trust for the surviving spouse with election strategies at the death of the first spouse as follows:

o QTIP election – for all or for the portion in excess of the $1,000,000 Oregon exemption

o Reverse QTIP election – to preserve the deceased spouse’s GST exemption (generation skipping transfer tax) which is not allowed to be ported over to the survivor on a portability election

o Fractional or pecuniary? (see prior discussion in 3.D above)

How much wealth can be transferred in this scenario if maximizing wealth transfer is the key driver? The following chart and graph illustrates the wealth transfer under 3 scenarios which look at portability and a credit shelter trust for one-half of the estate and no other planning:

• 100% marital deduction with portability ($18,439,110)

• Funding a bypass trust equal to one-half of the estate $3,500,000 ($7M/2) with the sale of 100% of the assets at the second death ($19,199,369)

• Funding a bypass trust equal to one-half of the estate $3,500,000 ($7M/2) with never selling the assets (could be important with family businesses, farm or ranch property or other “legacy” assets) ($21,480,147)



Graphically, this can be illustrated37 as follows:

3737 The Portability Calculator, Keebler Tax, Financial and Wealth Software, Inc., d/b/a Keebler Software (2014)

Total Wealth TransferPortability Bypass Trust

Additional Surviving Years 100% Liquidation at Second Death No Liquidation

0 2015 7,000,000 7,000,000 7,000,000 1 2016 7,560,000 7,476,000 7,560,000 2 2017 8,164,800 7,990,080 8,164,800 3 2018 8,817,984 8,545,286 8,817,984 4 2019 9,523,423 9,144,909 9,523,423 5 2020 10,285,297 9,792,502 10,285,297 6 2021 11,108,120 10,491,902 11,108,120 7 2022 11,882,062 11,247,254 11,996,770 8 2023 12,509,907 12,063,035 12,956,511 9 2024 13,183,819 12,944,078 13,993,032

10 2025 13,907,485 13,895,604 15,112,475 11 2026 14,684,884 14,923,252 16,321,473 12 2027 15,524,314 16,033,112 17,627,191 13 2028 16,426,420 17,028,288 18,833,893 14 2029 17,396,213 18,074,231 20,108,284 15 2030 18,439,110 19,199,369 21,480,147

$5,500,000

$7,500,000

$9,500,000

$11,500,000

$13,500,000

$15,500,000

$17,500,000

$19,500,000

$21,500,000

$23,500,000

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Wea

lth T

rans

fer

Portability100% Liquidation at Second DeathNo Liquidation



D. Case Study #4 – The Oregon $11,000,000 estate.

This couple is on the higher end of “moderate” wealth and will very likely need more planning than that which can come from pure portability as the beneficiary’s inheritance will be subject to substantial Oregon and federal estate taxes on the death of the surviving parent. A graphic illustration shows the importance of addressing portability planning since the combined estates could equal almost $23,000,000 at 5% appreciation and almost $35,000,000 at 8% appreciation. Portability alone will provide federal estate tax savings if the surviving spouse survives dies within just 1-3 years of the deceased spouse. Planning for this couple cries out for techniques that do not use their federal exemptions and that remove assets out of their Oregon estates. These techniques might include Grantor Retained Annuity Trusts (“GRATs”)38 or sales to Intentionally Defective Grantor Trusts (“IDGTs”)39 that use very little of the basic exclusion amount and preserve the DSUE. Should the surviving spouse decide to use the DSUE for lifetime gifts, shifting growth on rapidly appreciating assets can effectively remove the increase from the taxable estate. The carryover basis problem can be addressed by using a grantor trust and swapping high basis assets (such as cash) for the appreciated assets in the trust, allowing a “stepped up basis” without inclusion in the surviving spouse’s estate at death.40 Many other strategies, beyond the scope of this presentation, can be employed during the lives of the spouses.

38 I.R.C. §2702, §7520, Reg. §20.2036-1(c)(2), §25.2702-2, §25.2702-3; Walton v. Commissioner, 115 T.C. 589 (2000)); Notice 2003-72, 2003-44 I.R.B. 964 (announcing IRS acquiescence in Walton) 39 Rev.Rul.85-13, 1985-1 C.B. 184 40 See J. Blattmachr, M. Gans & H. Jacobson “Income Tax Effects of Termination of Grantor Trust Status by Reason of the Grantor’s Death, “ 97 JTAX 149 (September 2002)

$-

$10,000,000

$20,000,000

$30,000,000

$40,000,000

$50,000,000

$60,000,000

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Valu

e of

Est

ate

Surviving Spouse Life Expectancy

5% 8% 11% Surviving Spouse's Exemption Combined Exemption



How much wealth can be transferred in this scenario if maximizing wealth transfer is the key driver? The following chart and graph illustrates the wealth transfer under 3 scenarios which look at portability and a credit shelter trust for one-half of the estate and no other planning:

• 100% marital deduction with portability ($26,052,316)

• Funding a bypass trust equal to one-half of the estate $5,500,000 ($11M/2) with the sale of 100% of the assets at the second death ($26,762,615)

• Funding a bypass trust equal to one-half of the estate $5,500,000 ($11M/2) with never selling the assets (could be important with family businesses, farm or ranch property or other “legacy” assets) ($30,787,645)

Additional Surviving Years Value of Appreciated AssetsAfter Tax Rate of Return

5% 8% 11%-$ 11,000,000$ 11000000 11000000

1$ 11,550,000$ 11880000 122100002$ 12,127,500$ 12830400 135531003$ 12,733,875$ 13856832 150439414$ 13,370,569$ 14965378.56 16698774.515$ 14,039,097$ 16162608.84 18535639.716$ 14,741,052$ 17455617.55 20574560.077$ 15,478,105$ 18852066.96 22837761.688$ 16,252,010$ 20360232.31 25349915.479$ 17,064,610$ 21989050.9 28138406.17

10$ 17,917,841$ 23748174.97 31233630.8511$ 18,813,733$ 25648028.97 34669330.2412$ 19,754,420$ 27699871.29 38482956.5713$ 20,742,141$ 29915860.99 42716081.7914$ 21,779,248$ 32309129.87 47414850.7915$ 22,868,210$ 34893860.26 52630484.37



Graphically, this can be illustrated as follows:

0 2015 10,960,000$ 10,960,000$ 10,960,000$ 1 2016 11,532,000$ 11,558,160$ 11,706,400$ 2 2017 12,146,240$ 12,200,653$ 12,508,992$ 3 2018 12,806,099$ 12,891,025$ 13,372,271$ 4 2019 13,519,227$ 13,637,107$ 14,305,093$ 5 2020 14,285,565$ 14,439,036$ 15,308,701$ 6 2021 15,109,371$ 15,301,278$ 16,388,757$ 7 2022 15,995,240$ 16,228,661$ 17,551,377$ 8 2023 16,952,139$ 17,230,394$ 18,807,167$ 9 2024 17,981,431$ 18,308,105$ 20,159,261$ 10 2025 19,088,905$ 19,467,873$ 21,615,361$ 11 2026 20,280,817$ 20,716,263$ 23,183,790$ 12 2027 21,567,923$ 22,064,364$ 24,877,534$ 13 2028 22,953,517$ 23,515,834$ 26,702,296$ 14 2029 24,445,478$ 25,078,940$ 28,668,560$ 15 2030 26,052,316$ 26,762,615$ 30,787,645$

Additional Surviving Years

100% Liquidation at Second Death

No Liquidation

Total Wealth Transfer

PortabilityBypass Trust

$5,500,000

$10,500,000

$15,500,000

$20,500,000

$25,500,000

$30,500,000

$35,500,000

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Wea

lth T

rans

fer

Portability

100% Liquidation at Second Death

No Liquidation



In conclusion, much has changed in the last three to five years that has impacted the estate planning practice. Most particularly, existing plans of many clients that were based upon previous strategies designed to optimize rather than maximize the marital deduction will benefit from a fresh view. These changes offer challenges and major opportunities to reconnect with our clients and to offer valuable updates to their plans that will introduce flexibility and sometimes simplicity to achieve improved outcomes for their heirs and beneficiaries.

navigating the sea change— planning for married clients · 3 irc §1411 – 3.8% medicare surtax...

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