structuring joint trusts in separate property states to...

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Structuring Joint Trusts in Separate Property States to Avoid Income and Gift Tax Pitfalls Identifying "Problem" Assets, Coordinating JRTs With Credit Shelter Trusts, Drafting GPOAs, and More 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific TUESDAY, MAY 23, 2017 Presenting a live 90-minute webinar with interactive Q&A The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10. NOTE: If you are seeking CPE credit , you must listen via your computer — phone listening is no longer permitted. Today’s faculty features: Lauren Evans DeJong, Of Counsel, Stahl Cowen Crowley Addis, Chicago Scott K. Tippett, Attorney, The Tippett Law Firm, Oak Ridge, N.C.

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Structuring Joint Trusts in Separate PropertyStates to Avoid Income and Gift Tax PitfallsIdentifying "Problem" Assets, Coordinating JRTs With Credit Shelter Trusts, Drafting GPOAs, and More

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

TUESDAY, MAY 23, 2017

Presenting a live 90-minute webinar with interactive Q&A

The audio portion of the conference may be accessed via the telephone or by using your computer'sspeakers. Please refer to the instructions emailed to registrants for additional information. If youhave any questions, please contact Customer Service at 1-800-926-7926 ext. 10.

NOTE: If you are seeking CPE credit, you must listen via your computer — phone listening is nolonger permitted.

Today’s faculty features:

Lauren Evans DeJong, Of Counsel, Stahl Cowen Crowley Addis, Chicago

Scott K. Tippett, Attorney, The Tippett Law Firm, Oak Ridge, N.C.

Tips for Optimal Quality

Sound QualityIf you are listening via your computer speakers, please note that the qualityof your sound will vary depending on the speed and quality of your internet connection.

If the sound quality is not satisfactory, you may listen via the phone: dial1-866-961-9091 and enter your PIN when prompted. Otherwise, pleasesend us a chat or e-mail [email protected] immediately so we can address theproblem.

If you dialed in and have any difficulties during the call, press *0 for assistance.

NOTE: If you are seeking CPE credit, you must listen via your computer — phonelistening is no longer permitted.

Viewing QualityTo maximize your screen, press the F11 key on your keyboard. To exit full screen,press the F11 key again.

FOR LIVE EVENT ONLY

Sound QualityIf you are listening via your computer speakers, please note that the qualityof your sound will vary depending on the speed and quality of your internet connection.

If the sound quality is not satisfactory, you may listen via the phone: dial1-866-961-9091 and enter your PIN when prompted. Otherwise, pleasesend us a chat or e-mail [email protected] immediately so we can address theproblem.

If you dialed in and have any difficulties during the call, press *0 for assistance.

NOTE: If you are seeking CPE credit, you must listen via your computer — phonelistening is no longer permitted.

Viewing QualityTo maximize your screen, press the F11 key on your keyboard. To exit full screen,press the F11 key again.

Continuing Education Credits

In order for us to process your continuing education credit, you must confirm yourparticipation in this webinar by completing and submitting the AttendanceAffirmation/Evaluation after the webinar.

A link to the Attendance Affirmation/Evaluation will be in the thank you email that youwill receive immediately following the program.

For CPE credits, attendees must participate until the end of the Q&A session andrespond to five prompts during the program plus a single verification code. In addition,you must confirm your participation by completing and submitting an AttendanceAffirmation/Evaluation after the webinar and include the final verification code on theAffirmation of Attendance portion of the form.

For additional information about continuing education, call us at 1-800-926-7926 ext.35.

FOR LIVE EVENT ONLY

In order for us to process your continuing education credit, you must confirm yourparticipation in this webinar by completing and submitting the AttendanceAffirmation/Evaluation after the webinar.

A link to the Attendance Affirmation/Evaluation will be in the thank you email that youwill receive immediately following the program.

For CPE credits, attendees must participate until the end of the Q&A session andrespond to five prompts during the program plus a single verification code. In addition,you must confirm your participation by completing and submitting an AttendanceAffirmation/Evaluation after the webinar and include the final verification code on theAffirmation of Attendance portion of the form.

For additional information about continuing education, call us at 1-800-926-7926 ext.35.

Program Materials

If you have not printed the conference materials for this program, pleasecomplete the following steps:

• Click on the ^ symbol next to “Conference Materials” in the middle of the left-hand column on your screen.

• Click on the tab labeled “Handouts” that appears, and there you will see aPDF of the slides for today's program.

• Double click on the PDF and a separate page will open.

• Print the slides by clicking on the printer icon.

FOR LIVE EVENT ONLY

If you have not printed the conference materials for this program, pleasecomplete the following steps:

• Click on the ^ symbol next to “Conference Materials” in the middle of the left-hand column on your screen.

• Click on the tab labeled “Handouts” that appears, and there you will see aPDF of the slides for today's program.

• Double click on the PDF and a separate page will open.

• Print the slides by clicking on the printer icon.

Agenda Community vs. Common law property overview Tax and non-tax considerations for utilizing a joint

revocable trust (JRT) in a separate property state Gift and estate tax issues to avoid in funding and

administering a JRT in a separate property state Income tax issues and potential advantages of JRTs

Community vs. Common law property overview Tax and non-tax considerations for utilizing a joint

revocable trust (JRT) in a separate property state Gift and estate tax issues to avoid in funding and

administering a JRT in a separate property state Income tax issues and potential advantages of JRTs

5

Community Property Law - Overview What is Community Property? Community. To have community property, there must be a

community (typically a marriage). States differ whether thecommunity property system applies to domestic registeredpartnerships. Nevada says yes; Wisconsin says no.

Nine states plus D.C. provide either civil unions or domesticpartnerships to same-sex couples within the state: California(domestic partnerships), Colorado (civil unions), District ofColumbia (domestic partnerships), Hawaii (civil unions), Illinois(civil unions) Maine (limited domestic partnerships), Nevada(domestic partnerships), New Jersey (civil unions), Oregon(domestic partnerships), Washington (limited domesticpartnerships) and Wisconsin (domestic partnerships).

What is Community Property? Community. To have community property, there must be a

community (typically a marriage). States differ whether thecommunity property system applies to domestic registeredpartnerships. Nevada says yes; Wisconsin says no.

Nine states plus D.C. provide either civil unions or domesticpartnerships to same-sex couples within the state: California(domestic partnerships), Colorado (civil unions), District ofColumbia (domestic partnerships), Hawaii (civil unions), Illinois(civil unions) Maine (limited domestic partnerships), Nevada(domestic partnerships), New Jersey (civil unions), Oregon(domestic partnerships), Washington (limited domesticpartnerships) and Wisconsin (domestic partnerships).

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Community Property Law-Overview The nine (9) community property states are: Arizona California Idaho Louisiana Nevada New Mexico Texas Washington (the state not the District) Wisconsin. Alaska* (opt-in community property state where both parties

may make their property community property). Tennessee* (optional community property trust)

The nine (9) community property states are: Arizona California Idaho Louisiana Nevada New Mexico Texas Washington (the state not the District) Wisconsin. Alaska* (opt-in community property state where both parties

may make their property community property). Tennessee* (optional community property trust)

7

Community Property Law - Overview General Approach. All property of the spouses is either

“community” or “separate” property. Community propertycomes from civil law, while separate property comes fromcommon law. Under common law, title is critical fordetermining ownership. Separate Property. A spouse’s separate property includes: property owned or claimed by the spouse prior to marriage; property acquired during marriage by gift or inheritance; and (in some states) recovery for personal injuries sustained

during marriage, except recovery for loss of earningcapacity.

If separate property is sold or exchanged, the proceeds arealso separate property , but only if the proceeds can betraced to the original separate property.

General Approach. All property of the spouses is either“community” or “separate” property. Community propertycomes from civil law, while separate property comes fromcommon law. Under common law, title is critical fordetermining ownership. Separate Property. A spouse’s separate property includes: property owned or claimed by the spouse prior to marriage; property acquired during marriage by gift or inheritance; and (in some states) recovery for personal injuries sustained

during marriage, except recovery for loss of earningcapacity.

If separate property is sold or exchanged, the proceeds arealso separate property , but only if the proceeds can betraced to the original separate property.

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Community Property Law - Overview Community Property. Everything else. If it is not

separate property, then it is community property.

Income from Separate Property. In five (5) states(Arizona, California, New Mexico, Washington, andWisconsin), income from separate property remainsseparate property. In the other community propertystates, it does not.

Community Property. Everything else. If it is notseparate property, then it is community property.

Income from Separate Property. In five (5) states(Arizona, California, New Mexico, Washington, andWisconsin), income from separate property remainsseparate property. In the other community propertystates, it does not.

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Community Property Law - Overview ISSUE: Problems can arise where income from separate

property is treated as community property, i.e. interest anddividends (which are treated as income) retained in aseparate property brokerage account are treated as “mixed”– part separate property and part community property.

Mixed or Commingled Property. If property ispurchased with community property and separate propertyof one or both spouses, the property will be jointly ownedby the community and separate property estates inproportion to the consideration provided by each.

ISSUE: Problems can arise where income from separateproperty is treated as community property, i.e. interest anddividends (which are treated as income) retained in aseparate property brokerage account are treated as “mixed”– part separate property and part community property.

Mixed or Commingled Property. If property ispurchased with community property and separate propertyof one or both spouses, the property will be jointly ownedby the community and separate property estates inproportion to the consideration provided by each.

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Community Property Law - Overview “Tracing” is required to determine the portion of mixed

property that constitutes separate property.

Presumption of Community Property. Property acquired bythe spouses during marriage while domiciled in a communityproperty state is presumed to be community property. Thepresumption can be rebutted only by showing through clearand convincing evidence establishing the property wasacquired prior to the marriage, by gift or inheritance, or by fundsfrom separate property.

Note: The presumption is in favor of community property. Ifthe source of the property used for acquiring the asset cannot betraced, it is community property.

“Tracing” is required to determine the portion of mixedproperty that constitutes separate property.

Presumption of Community Property. Property acquired bythe spouses during marriage while domiciled in a communityproperty state is presumed to be community property. Thepresumption can be rebutted only by showing through clearand convincing evidence establishing the property wasacquired prior to the marriage, by gift or inheritance, or by fundsfrom separate property.

Note: The presumption is in favor of community property. Ifthe source of the property used for acquiring the asset cannot betraced, it is community property.

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Community Property Law - Overview Title and Possession Is Not Critical. In community

property states, the source of funds, not the manner in whichthe asset is titled, determine whether it is community property.In separate property states, the manner in which the asset istitled generally determines ownership.

EXCEPTIONS: “Sole and Separate Property” & Gifts.Property conveyed to one spouse as that spouse’s “Sole andseparate property” is separate property IF the other spousejoined in the transaction. Absent evidence to the contrary, giftsby one spouse to the other become the separate property of thedonee spouse. If a spouse uses separate property to purchase anasset titled in both spouses’ names, the donor spouse ispresumed to have made a gift of a one-half interest in the asset tothe donee spouse as the donee spouse’s separate property.

Title and Possession Is Not Critical. In communityproperty states, the source of funds, not the manner in whichthe asset is titled, determine whether it is community property.In separate property states, the manner in which the asset istitled generally determines ownership.

EXCEPTIONS: “Sole and Separate Property” & Gifts.Property conveyed to one spouse as that spouse’s “Sole andseparate property” is separate property IF the other spousejoined in the transaction. Absent evidence to the contrary, giftsby one spouse to the other become the separate property of thedonee spouse. If a spouse uses separate property to purchase anasset titled in both spouses’ names, the donor spouse ispresumed to have made a gift of a one-half interest in the asset tothe donee spouse as the donee spouse’s separate property.

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Community Property Law - Overview Inception of Title; Reimbursement Rights. In most

community property states the character of an asset(separate or community property) is determined when theasset is first acquired and its character will not be alteredby a subsequent commingling. A minority of communityproperty states follow the “apportionment rule.” In“inception” states, the expenditure of time or money by onespouse does not change the character of the asset, thoughit may give rise to a right of reimbursement, i.e. a spouseowned an encumbered asset prior to marriage andcommunity property is used to make debt payments duringthe marriage may give rise to a right of reimbursement,subject to an offsetting right of benefit obtained from useof the asset.

Inception of Title; Reimbursement Rights. In mostcommunity property states the character of an asset(separate or community property) is determined when theasset is first acquired and its character will not be alteredby a subsequent commingling. A minority of communityproperty states follow the “apportionment rule.” In“inception” states, the expenditure of time or money by onespouse does not change the character of the asset, thoughit may give rise to a right of reimbursement, i.e. a spouseowned an encumbered asset prior to marriage andcommunity property is used to make debt payments duringthe marriage may give rise to a right of reimbursement,subject to an offsetting right of benefit obtained from useof the asset.

13

Community Property Law - Overview Transmutation. In a majority of community property

states spouses can agree to treat property ascommunity property that would otherwise be separateproperty. Community Property and Foreign Jurisdictions.

Most non-English speaking civil law countries (China,France, Spain, and Latin American countries to name afew) have marital property systems very similar tocommunity property. English speaking countries(England and Canada) generally do not havecommunity property systems.

Transmutation. In a majority of community propertystates spouses can agree to treat property ascommunity property that would otherwise be separateproperty. Community Property and Foreign Jurisdictions.

Most non-English speaking civil law countries (China,France, Spain, and Latin American countries to name afew) have marital property systems very similar tocommunity property. English speaking countries(England and Canada) generally do not havecommunity property systems.

14

Community Property Law - Overview Community Property Trusts (Alaska and

Tennessee). Under legislation in those states,nonresidents can establish community propertytrusts, and if the trust complies with the legislation,property contributed to the trust becomes communityproperty. In Tennessee, when property is distributedout of the community property trust it ceases to becommunity property (T.C.A. Sec. 35-17-108).

Community Property Trusts (Alaska andTennessee). Under legislation in those states,nonresidents can establish community propertytrusts, and if the trust complies with the legislation,property contributed to the trust becomes communityproperty. In Tennessee, when property is distributedout of the community property trust it ceases to becommunity property (T.C.A. Sec. 35-17-108).

15

Community Property Law - Overview

But I do not practice in a community propertystate, so why does all this matter? But I do not practice in a community property

state, so why does all this matter?

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Significance of Characterization of Property Property Rights.

Ownership. Community property assets are owned one-half by each spouse. Management. Community property spouses generally have co-extensive

management rights over community property. Creditor’s Rights. The property’s character (community or separate) determines

what can be reached by the creditor of one spouse. Creditor rules vary amongcommunity property states.

Survivorship Rights. Traditionally community property could not be held asTBE or JTWROS. Some community property states now permit communityproperty to be held with survivorship rights. In Rev. Rul. 87-98 the IRS ruledthat community property with rights of survivorship would continue to berecognized as community property for tax purposes as long as it is recognized ascommunity property under state law.

Ability to Make Gifts. A few community property states prohibit a spouse frommaking a gift of community property. Others permit a spouse to gift propertyover which the spouse has “sole management authority” unless the gift would bea “fraud” on the other spouse’s community property rights.

Property Rights. Ownership. Community property assets are owned one-half by each spouse. Management. Community property spouses generally have co-extensive

management rights over community property. Creditor’s Rights. The property’s character (community or separate) determines

what can be reached by the creditor of one spouse. Creditor rules vary amongcommunity property states.

Survivorship Rights. Traditionally community property could not be held asTBE or JTWROS. Some community property states now permit communityproperty to be held with survivorship rights. In Rev. Rul. 87-98 the IRS ruledthat community property with rights of survivorship would continue to berecognized as community property for tax purposes as long as it is recognized ascommunity property under state law.

Ability to Make Gifts. A few community property states prohibit a spouse frommaking a gift of community property. Others permit a spouse to gift propertyover which the spouse has “sole management authority” unless the gift would bea “fraud” on the other spouse’s community property rights.

18

Significance of Characterization of Property Divorce. The usual starting point is that community

property is divided 50-50 between the spouses and eachspouse keeps his or her separate property. Some statesallow a “just and equitable” division of community propertyby the court. Death. The deceased spouse can dispose of his or her

separate property and his or her one-half interest incommunity property, which includes community propertytitled solely in the name of the other spouse. ALLcommunity property is subject to administration for alimited time, and is therefore subject to the claims ofcreditors.

Divorce. The usual starting point is that communityproperty is divided 50-50 between the spouses and eachspouse keeps his or her separate property. Some statesallow a “just and equitable” division of community propertyby the court. Death. The deceased spouse can dispose of his or her

separate property and his or her one-half interest incommunity property, which includes community propertytitled solely in the name of the other spouse. ALLcommunity property is subject to administration for alimited time, and is therefore subject to the claims ofcreditors.

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Effect of Migrating Between CommunityProperty and Separate Property Jurisdictions American Rule. The Mutability Principle. The law

governing marital property depends upon where the coupleis living from time to time. The law of the state in whichthe married couple is domiciled at the time the property isacquired determines the character of the property soacquired. When spouses move from a community propertyto a separate property state, the property remainscommunity property, including property acquired inseparate property states with community property funds orproceeds of community property. European Rule. The Immutability Principle. The law of

the couple’s first marital domicile determines thecharacter of their property.

American Rule. The Mutability Principle. The lawgoverning marital property depends upon where the coupleis living from time to time. The law of the state in whichthe married couple is domiciled at the time the property isacquired determines the character of the property soacquired. When spouses move from a community propertyto a separate property state, the property remainscommunity property, including property acquired inseparate property states with community property funds orproceeds of community property. European Rule. The Immutability Principle. The law of

the couple’s first marital domicile determines thecharacter of their property.

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Planning Considerations and Strategies forCommunity Property Advice. Counsel clients regarding the property rights

of each spouse, whether spousal agreements or waiversexist, the tax consequences of characterization, andhow rights are affected by divorce and death. Query:Conflict to advise both spouses? Blindsided? Do not be blindsided. Common mistake

by estate planners in common law (separate property)jurisdictions is to unwind community propertywithout considering the impact of doing so, i.e. loss ofdouble basis step up or possibility of fractionalizationdiscounts.

Advice. Counsel clients regarding the property rightsof each spouse, whether spousal agreements or waiversexist, the tax consequences of characterization, andhow rights are affected by divorce and death. Query:Conflict to advise both spouses? Blindsided? Do not be blindsided. Common mistake

by estate planners in common law (separate property)jurisdictions is to unwind community propertywithout considering the impact of doing so, i.e. loss ofdouble basis step up or possibility of fractionalizationdiscounts.

21

Planning Considerations and Strategies forCommunity Property Clients Moved? Always ask clients for a timeline of where

they have lived from the date of marriage to present.Clients may not even realize they own community property. Document. Migrating clients should maintain an

inventory of their assets and records sufficient to trace thesource of funds used to acquire property. Establish Separate Accounts. Establish separate

accounts for community property and separate property oruse revocable trusts to hold community and separateproperty. Avoid commingling community and separateproperty to prevent tracing issues.

Clients Moved? Always ask clients for a timeline of wherethey have lived from the date of marriage to present.Clients may not even realize they own community property. Document. Migrating clients should maintain an

inventory of their assets and records sufficient to trace thesource of funds used to acquire property. Establish Separate Accounts. Establish separate

accounts for community property and separate property oruse revocable trusts to hold community and separateproperty. Avoid commingling community and separateproperty to prevent tracing issues.

22

Planning Considerations and Strategies forCommunity Property Formalize Agreements. Request marital agreements

to document character of property. Beware of a triple-pronged agreement (all currently owned and afteracquired property is community property, separateproperty is on attached schedule, and deceasedspouse’s share of community property passes tosurviving spouse without probate), which could createa problem funding a credit shelter trust.

Formalize Agreements. Request marital agreementsto document character of property. Beware of a triple-pronged agreement (all currently owned and afteracquired property is community property, separateproperty is on attached schedule, and deceasedspouse’s share of community property passes tosurviving spouse without probate), which could createa problem funding a credit shelter trust.

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Planning Considerations and Strategies forCommunity Property Great - You have an agreement prepared in a

foreign country! Foreign spouses often have maritalproperty agreements prepared by a notary adoptingeither a community property or a separate propertyregime. Those agreements are respected in theUnited States for property and tax law purposes. Evenif the client has never lived in a community propertystate in the United States, he or she may have a maritalproperty agreement from a civil law country thatdeems all property community property.

Great - You have an agreement prepared in aforeign country! Foreign spouses often have maritalproperty agreements prepared by a notary adoptingeither a community property or a separate propertyregime. Those agreements are respected in theUnited States for property and tax law purposes. Evenif the client has never lived in a community propertystate in the United States, he or she may have a maritalproperty agreement from a civil law country thatdeems all property community property.

24

Planning Considerations and Strategies forCommunity Property Have You Considered Confirming or Changing the

Character of Property? Consider and discuss withyour client whether the character of property shouldbe confirmed or changed by agreement, conveyance,or partition. Be sure to address the impact of anychange on the spouse’s expectations with respect tothat property. TBE agreements have tax consequencesand ethical issues. The character of property can besegregated in a RLT that specifically identifiesproperty as separate or community property.

Have You Considered Confirming or Changing theCharacter of Property? Consider and discuss withyour client whether the character of property shouldbe confirmed or changed by agreement, conveyance,or partition. Be sure to address the impact of anychange on the spouse’s expectations with respect tothat property. TBE agreements have tax consequencesand ethical issues. The character of property can besegregated in a RLT that specifically identifiesproperty as separate or community property.

25

Planning Considerations and Strategies forCommunity Property Income From Separate Property and Other Reasons to

Change Characterization. Under the laws of Idaho, Louisiana, Texas, and Wisconsin income

from separate property is community property. Clients may want toswitch characterization to keep income as separate property.

Because of the double basis step up with community property, itmay be desirable to change rapidly appreciating separate propertyto community property. For depreciating property, the reverse istrue and clients should consider changing community property toseparate property.

Couples moving from a common law (separate property state) toArizona, Nevada, New Mexico, or Texas may leave no protection forthe non-owner spouse at death because those states do notrecognize “quasi community property.” Clients may wish toconsider changing separate property to community property so thesurviving spouse has protected property rights.

Income From Separate Property and Other Reasons toChange Characterization. Under the laws of Idaho, Louisiana, Texas, and Wisconsin income

from separate property is community property. Clients may want toswitch characterization to keep income as separate property.

Because of the double basis step up with community property, itmay be desirable to change rapidly appreciating separate propertyto community property. For depreciating property, the reverse istrue and clients should consider changing community property toseparate property.

Couples moving from a common law (separate property state) toArizona, Nevada, New Mexico, or Texas may leave no protection forthe non-owner spouse at death because those states do notrecognize “quasi community property.” Clients may wish toconsider changing separate property to community property so thesurviving spouse has protected property rights.

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Planning Considerations and Strategies forCommunity Property Joint Revocable Trusts. Community property

contributed to a joint revocable trust will berecognized as community property for tax purposes aslong as it is still recognized as community propertyunder state law. Contributing property to a one-spouse RLT may not be sufficient to change thecharacter of community property to separate property.See Katz v. United States, 382 F.2d 723 (9th. Cir. 1967).

Joint Revocable Trusts. Community propertycontributed to a joint revocable trust will berecognized as community property for tax purposes aslong as it is still recognized as community propertyunder state law. Contributing property to a one-spouse RLT may not be sufficient to change thecharacter of community property to separate property.See Katz v. United States, 382 F.2d 723 (9th. Cir. 1967).

27

Planning Considerations and Strategies forCommunity Property Know Before You Title (or Re-Title). Couples moving

from community property states should generally avoidtaking title to assets as TBE or JTWROS if purchased withcommunity property funds or proceeds of communityproperty assets. Those designations are generallyinconsistent with community property ownership. Leaving Gifts of Community Property? Gift splitting is

not needed for gifts of community property, but oftenrequires the consent of both spouses. DO NOT make a giftof a community property asset to a trust of which thespouse is a beneficiary IF the desire is to exclude that assetfrom the gross estate of both spouses. The beneficiaryspouse will be treated as making a gift of a one-half interestwith a retained beneficial interest.

Know Before You Title (or Re-Title). Couples movingfrom community property states should generally avoidtaking title to assets as TBE or JTWROS if purchased withcommunity property funds or proceeds of communityproperty assets. Those designations are generallyinconsistent with community property ownership. Leaving Gifts of Community Property? Gift splitting is

not needed for gifts of community property, but oftenrequires the consent of both spouses. DO NOT make a giftof a community property asset to a trust of which thespouse is a beneficiary IF the desire is to exclude that assetfrom the gross estate of both spouses. The beneficiaryspouse will be treated as making a gift of a one-half interestwith a retained beneficial interest.

28

Planning Considerations and Strategies forCommunity Property Make Sure Beneficiary Designations Are Correct. Be careful

before naming someone other than the spouse as beneficiary of acommunity property life insurance policy or retirement account.The non-insured/non-participant spouse may be treated asmaking a gift of one-half of the community property asset.

Never Unintentionally Disinherit a Spouse. Typicallyelective share and forced share rules do not apply in communityproperty states because these rules do not exist in those states.As a result a spouse could be disinherited if one spouse ownsmost of the assets when moving from a separate property to acommunity property state. Consider a joint trust to preventunintentionally disinheriting the surviving spouse where assetsare titled predominantly in one spouse’s name.

Make Sure Beneficiary Designations Are Correct. Be carefulbefore naming someone other than the spouse as beneficiary of acommunity property life insurance policy or retirement account.The non-insured/non-participant spouse may be treated asmaking a gift of one-half of the community property asset.

Never Unintentionally Disinherit a Spouse. Typicallyelective share and forced share rules do not apply in communityproperty states because these rules do not exist in those states.As a result a spouse could be disinherited if one spouse ownsmost of the assets when moving from a separate property to acommunity property state. Consider a joint trust to preventunintentionally disinheriting the surviving spouse where assetsare titled predominantly in one spouse’s name.

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Common Law Property – Basics With community property, each spouse’s one-half interest in community property

generally receives a basis adjustment equal to fair market value at the first spouse’s death[IRC Section 1014(b)(6)] = 100% basis adjustment at the first spouse’s death States that apply community property law include Alaska, Arizona, California, Idaho,

Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin

With non-community property, only 50% of any jointly-owned spousal property (JSP)is included in deceased spouse’s estate and eligible for basis adjustment [IRC Section2040(b)] Tracing rules apply if surviving spouse is a non-US citizen 100% stepped-up basis may be available for JSP created prior to 1977 under the so-called

Gallenstein rule

Traditionally, separate revocable trusts are created by each spouse and funded with thecouple’s separate and/or JSP Often requires the severance of joint ownership/tenancy by entirety (TBE) protection to

sufficiently fund credit shelter trust (“CST”) at first spouse’s death Some states (VA, MD, Missouri, Indiana, Illinois Hawaii and DE) preserve TBE character

Deceased spouse’s 50% interest in any JSP can also be disclaimed by surviving spouse intoCST via qualified disclaimer

With community property, each spouse’s one-half interest in community propertygenerally receives a basis adjustment equal to fair market value at the first spouse’s death[IRC Section 1014(b)(6)] = 100% basis adjustment at the first spouse’s death States that apply community property law include Alaska, Arizona, California, Idaho,

Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin

With non-community property, only 50% of any jointly-owned spousal property (JSP)is included in deceased spouse’s estate and eligible for basis adjustment [IRC Section2040(b)] Tracing rules apply if surviving spouse is a non-US citizen 100% stepped-up basis may be available for JSP created prior to 1977 under the so-called

Gallenstein rule

Traditionally, separate revocable trusts are created by each spouse and funded with thecouple’s separate and/or JSP Often requires the severance of joint ownership/tenancy by entirety (TBE) protection to

sufficiently fund credit shelter trust (“CST”) at first spouse’s death Some states (VA, MD, Missouri, Indiana, Illinois Hawaii and DE) preserve TBE character

Deceased spouse’s 50% interest in any JSP can also be disclaimed by surviving spouse intoCST via qualified disclaimer

30

Non-Tax Advantages of Joint SpousalProperty (JSP) and JRTs JSP/JRTs convey a sense of comfort and security to many spouses, because the assets are

perceived as “ours” rather than “mine” or “yours” JSP owned as joint tenants with rights of survivorship (JTWRS) or tenants by the entirety

(TBE) generally avoids probate upon the first spouse’s death and passes automatically byoperation of law to surviving spouse As a result, probate is deferred until the death of the surviving spouse (or their

simultaneous death) JSP is generally not available to fund CST unless qualified disclaimer is made by surviving

spouse TBE character is only available for JSP - confers additional asset protection benefits in that

JSP cannot be used to satisfy creditors of an individual spouse JRTs offer similar advantages of JSP, plus:

Avoids probate of the couple’s assets upon their simultaneous death, and upon thesubsequent death of the surviving spouse

Provide more specific terms and direction as to the desired management and distributionof the couple’s assets in the event of their incapacity

Depending on how JRT is designed, all or a portion of JRT assets may be used to fund CST As previously stated, some states (VA, MD, Missouri, Indiana, Illinois Hawaii and DE)

preserve TBE character (during the couple’s joint lifetime) for TBE property transferred toJRT or separate revocable trusts

JSP/JRTs convey a sense of comfort and security to many spouses, because the assets areperceived as “ours” rather than “mine” or “yours”

JSP owned as joint tenants with rights of survivorship (JTWRS) or tenants by the entirety(TBE) generally avoids probate upon the first spouse’s death and passes automatically byoperation of law to surviving spouse As a result, probate is deferred until the death of the surviving spouse (or their

simultaneous death) JSP is generally not available to fund CST unless qualified disclaimer is made by surviving

spouse TBE character is only available for JSP - confers additional asset protection benefits in that

JSP cannot be used to satisfy creditors of an individual spouse JRTs offer similar advantages of JSP, plus:

Avoids probate of the couple’s assets upon their simultaneous death, and upon thesubsequent death of the surviving spouse

Provide more specific terms and direction as to the desired management and distributionof the couple’s assets in the event of their incapacity

Depending on how JRT is designed, all or a portion of JRT assets may be used to fund CST As previously stated, some states (VA, MD, Missouri, Indiana, Illinois Hawaii and DE)

preserve TBE character (during the couple’s joint lifetime) for TBE property transferred toJRT or separate revocable trusts

31

Increased Use of JRTs in Common LawProperty States Tax law changes made permanent under the American Taxpayer Relief Act of 2012 (“ATRA”) have

eliminated or lessened the need to plan for the Federal estate and gift tax for many married couples Increased Federal estate/gift/GST tax exemption ($5.45MM for 2016) Portability election allows for transfer of deceased spouse’s Federal estate/gift tax exemption amount to

surviving spouse Not available for GST tax or state estate tax purposes In order to make the election, Federal estate tax return must be filed at the first spouse’s death even if the

gross estate does not exceed the exemption amount JRTs are viewed as simpler/cheaper estate planning solution

One trust document vs. two separate trusts for each spouse Alleviates need to divide couple’s joint and/or separate property between two separate trusts

Joint Exempt Step-up Trusts (“JESTs”) and “Community Property” JRTs (formed in AL or TN) may alsoallow couples domiciled in common law property states to obtain 100% stepped-up basis at firstspouse’s death

Given the lack of case law, rulings and other supporting authority concerning JRTs, this seemingly-less complicated planning technique can create unintended pitfalls and complexity, and may not besuitable for every client Particularly couples with significant separate property that desire to maintain its separate character

Tax law changes made permanent under the American Taxpayer Relief Act of 2012 (“ATRA”) haveeliminated or lessened the need to plan for the Federal estate and gift tax for many married couples Increased Federal estate/gift/GST tax exemption ($5.45MM for 2016) Portability election allows for transfer of deceased spouse’s Federal estate/gift tax exemption amount to

surviving spouse Not available for GST tax or state estate tax purposes In order to make the election, Federal estate tax return must be filed at the first spouse’s death even if the

gross estate does not exceed the exemption amount JRTs are viewed as simpler/cheaper estate planning solution

One trust document vs. two separate trusts for each spouse Alleviates need to divide couple’s joint and/or separate property between two separate trusts

Joint Exempt Step-up Trusts (“JESTs”) and “Community Property” JRTs (formed in AL or TN) may alsoallow couples domiciled in common law property states to obtain 100% stepped-up basis at firstspouse’s death

Given the lack of case law, rulings and other supporting authority concerning JRTs, this seemingly-less complicated planning technique can create unintended pitfalls and complexity, and may not besuitable for every client Particularly couples with significant separate property that desire to maintain its separate character

32

Basic Design Alternatives of JRTs(Non-Community Property)

Separate Share JRT Estate Equalization (or other defined undivided

fractional share) JRT General Power of Appointment “Add-On” feature

(JEST)

Separate Share JRT Estate Equalization (or other defined undivided

fractional share) JRT General Power of Appointment “Add-On” feature

(JEST)

33

Separate Share JRT Separate shares are created and maintained for joint property contributed to

the trust, and for any separate property contributed by each respective spouse Both spouses are co-trustees Spouses retain joint right to income and principal with regard to the joint

property share, and unilateral right to income and principal with regard totheir respective share of separate property

Spouses retain joint right to amend and revoke with regard to the jointproperty share, and unilateral right to amend and revoke with regard to theirrespective share of separate property Can be cumbersome to revoke/unwind upon divorce if separate shares are not

maintained Upon first spouse’s death, deceased spouse’s 50% share of joint property, and of

all of his or her separate property, is directed to CST (or to the survivingspouse’s share, with ability to disclaim to CST)

Surviving spouse retains right to income and principal, and right to amend/revoke, over surviving spouse’s share

Separate shares are created and maintained for joint property contributed tothe trust, and for any separate property contributed by each respective spouse

Both spouses are co-trustees Spouses retain joint right to income and principal with regard to the joint

property share, and unilateral right to income and principal with regard totheir respective share of separate property

Spouses retain joint right to amend and revoke with regard to the jointproperty share, and unilateral right to amend and revoke with regard to theirrespective share of separate property Can be cumbersome to revoke/unwind upon divorce if separate shares are not

maintained Upon first spouse’s death, deceased spouse’s 50% share of joint property, and of

all of his or her separate property, is directed to CST (or to the survivingspouse’s share, with ability to disclaim to CST)

Surviving spouse retains right to income and principal, and right to amend/revoke, over surviving spouse’s share

34

Separate Share JRT Example Husband (H) and Wife (W) contribute $4 million of joint spousal property to

the JRT, which is directed to Share A of the JRT (Joint Spousal Share) H contributes $4 million of separately-owned property, which directed to Share

B (H’s Separate Property Share) W contributes $2 million of separately-owned property to the JRT, which is

directed to Share C (W’s Separate Property Share) During the spouse’s joint lifetime, they are each entitled to distributions of

income and/or principal from their share of the trust assets (i.e., 50% of jointspousal property and 100% of separately-owned property contributed by eachrespective spouse), and either spouse has the unilateral right to revoke the trustand receive outright distribution of his or her share of the trust assets

At H’s death, his one-half share of Share A and all of Share B becomeirrevocable and are directed to Share C (Survivor’s Share) In the alternative, H’s share of Share A and Share B can be directed (or

disclaimed by W) to CST up to H’s unused estate tax exemption amount, withany remaining assets in excess of this amount directed to Survivor’s Share (orQTIP Marital Trust)

Husband (H) and Wife (W) contribute $4 million of joint spousal property tothe JRT, which is directed to Share A of the JRT (Joint Spousal Share)

H contributes $4 million of separately-owned property, which directed to ShareB (H’s Separate Property Share)

W contributes $2 million of separately-owned property to the JRT, which isdirected to Share C (W’s Separate Property Share)

During the spouse’s joint lifetime, they are each entitled to distributions ofincome and/or principal from their share of the trust assets (i.e., 50% of jointspousal property and 100% of separately-owned property contributed by eachrespective spouse), and either spouse has the unilateral right to revoke the trustand receive outright distribution of his or her share of the trust assets

At H’s death, his one-half share of Share A and all of Share B becomeirrevocable and are directed to Share C (Survivor’s Share) In the alternative, H’s share of Share A and Share B can be directed (or

disclaimed by W) to CST up to H’s unused estate tax exemption amount, withany remaining assets in excess of this amount directed to Survivor’s Share (orQTIP Marital Trust)

35

Estate Equalization JRT Each spouse owns or is deemed to own (via deemed gifts upon contribution of any

separate property to the trust) an undivided 50% (or other stated fractional share) of thetrust assets

No separate shares are maintained Both spouses are co-trustees During their joint lifetime, they are each entitled to equal (pro rata) distributions of

income and/or principal from the trust assets, and either spouse has the unilateral rightto revoke the trust and receive outright distribution of his or her undivided 50% (or otherfractional percentage) share of the trust May also provide for automatic revocation and 50/50 (pro rata) distribution upon divorce,

unless decree of divorce directs or the spouses mutually agree otherwise Upon first spouse’s death, deceased spouse’s 50% share is directed to CST (or to the

surviving spouse’s share, with ability to disclaim to CST) May not fully utilize first spouse’s exemption amount, but portability election could be

made to transfer any unused exemption to surviving spouse Similar to JSP, disclaimer may not be possible if surviving spouse accepts benefits from the

property to be disclaimed Surviving spouse retains right to income and principal, and right to amend/revoke, over

surviving spouse’s share

Each spouse owns or is deemed to own (via deemed gifts upon contribution of anyseparate property to the trust) an undivided 50% (or other stated fractional share) of thetrust assets

No separate shares are maintained Both spouses are co-trustees During their joint lifetime, they are each entitled to equal (pro rata) distributions of

income and/or principal from the trust assets, and either spouse has the unilateral rightto revoke the trust and receive outright distribution of his or her undivided 50% (or otherfractional percentage) share of the trust May also provide for automatic revocation and 50/50 (pro rata) distribution upon divorce,

unless decree of divorce directs or the spouses mutually agree otherwise Upon first spouse’s death, deceased spouse’s 50% share is directed to CST (or to the

surviving spouse’s share, with ability to disclaim to CST) May not fully utilize first spouse’s exemption amount, but portability election could be

made to transfer any unused exemption to surviving spouse Similar to JSP, disclaimer may not be possible if surviving spouse accepts benefits from the

property to be disclaimed Surviving spouse retains right to income and principal, and right to amend/revoke, over

surviving spouse’s share

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Estate Equalization JRT Example H and W contribute $4 million of joint spousal property to the JRT H contributes $4 million of separately-owned property to the JRT W contributes $2 million of separately-owned property to the JRT The terms of the JRT provide that, upon contribution of assets to the trust and

at all times thereafter, each spouse is deemed to own an undivided 50% of thetrust assets ($10 million x 50% = $5 million) as tenants in common Separate shares are not created or maintained

During their joint lifetime, they are each entitled to equal distributions ofincome and/or principal from the trust assets, and either spouse has theunilateral right to revoke the trust and receive outright distribution of his orher undivided 50% share of the trust assets

At H’s death, his one-half share of the JRT becomes irrevocable and is directedto the Survivor’s Share. In the alternative, H’s 50% share can be directed (or disclaimed by W) to a CST

up to H’s unused estate tax exemption amount, with any remaining assets inexcess of this amount directed to Survivor’s Share (or QTIP Marital Trust)

H and W contribute $4 million of joint spousal property to the JRT H contributes $4 million of separately-owned property to the JRT W contributes $2 million of separately-owned property to the JRT The terms of the JRT provide that, upon contribution of assets to the trust and

at all times thereafter, each spouse is deemed to own an undivided 50% of thetrust assets ($10 million x 50% = $5 million) as tenants in common Separate shares are not created or maintained

During their joint lifetime, they are each entitled to equal distributions ofincome and/or principal from the trust assets, and either spouse has theunilateral right to revoke the trust and receive outright distribution of his orher undivided 50% share of the trust assets

At H’s death, his one-half share of the JRT becomes irrevocable and is directedto the Survivor’s Share. In the alternative, H’s 50% share can be directed (or disclaimed by W) to a CST

up to H’s unused estate tax exemption amount, with any remaining assets inexcess of this amount directed to Survivor’s Share (or QTIP Marital Trust)

38

General Power of Appointment “Add-On” Equalization or Separate Share JRT plan designs are utilized

during the spouse’s joint lifetime Upon the first spouse’s death, the deceased spouse has a

testamentary general power of appointment over part or allof the trust assets In default of such exercise, the deceased spouse’s

remaining estate tax exemption amount is directed to CST- any excess is directed to surviving spouse’s share Surviving spouse retains right to income and principal, and

right to amend/revoke, over surviving spouse’s share Goal is to obtain maximum funding of CST and potential

100% stepped-up basis at first spouse’s death (JEST) Can also be utilized using separate revocable trusts

Equalization or Separate Share JRT plan designs are utilizedduring the spouse’s joint lifetime Upon the first spouse’s death, the deceased spouse has a

testamentary general power of appointment over part or allof the trust assets In default of such exercise, the deceased spouse’s

remaining estate tax exemption amount is directed to CST- any excess is directed to surviving spouse’s share Surviving spouse retains right to income and principal, and

right to amend/revoke, over surviving spouse’s share Goal is to obtain maximum funding of CST and potential

100% stepped-up basis at first spouse’s death (JEST) Can also be utilized using separate revocable trusts

39

Marital Law Considerations for JSP/JRTs When separate property owned by an individual spouse is re-titled into

the couple’s joint names—or contributed to a Separate Share JRT andseparate shares are not properly maintained, or to an EquateEqualization JRT where each spouse is deemed to own fifty percent ofthe trust assets regardless of the proportionate value of assetscontributed—there is generally a presumption in most states that theproperty has been gifted to the marital estate

In order to rebut this presumption and demonstrate the couple’s intentto avoid any marital gift or transmutation upon funding a JRT, aseparate written agreement should be executed by the parties to affirmthat assets currently held or after-acquired as non-marital propertyshall remain non-marital property (and any marital property owned oracquired during the marriage shall remain marital property), and thatany re-titling of such property is being done for estate planningpurposes only

When separate property owned by an individual spouse is re-titled intothe couple’s joint names—or contributed to a Separate Share JRT andseparate shares are not properly maintained, or to an EquateEqualization JRT where each spouse is deemed to own fifty percent ofthe trust assets regardless of the proportionate value of assetscontributed—there is generally a presumption in most states that theproperty has been gifted to the marital estate

In order to rebut this presumption and demonstrate the couple’s intentto avoid any marital gift or transmutation upon funding a JRT, aseparate written agreement should be executed by the parties to affirmthat assets currently held or after-acquired as non-marital propertyshall remain non-marital property (and any marital property owned oracquired during the marriage shall remain marital property), and thatany re-titling of such property is being done for estate planningpurposes only

40

Four Basic Questions for JRTsWhat portion of the trust does each spouse own

during their lifetime?What portion of the trust is included in the estate of

the first spouse to die for estate tax purposes, as well asfor income tax purposes in determining what portionof the trust is eligible for a stepped-up basis?What portion of the trust remains revocable after the

first spouse’s death?What portion of the trust is includible in the estate of

the surviving spouse?

What portion of the trust does each spouse ownduring their lifetime?What portion of the trust is included in the estate of

the first spouse to die for estate tax purposes, as well asfor income tax purposes in determining what portionof the trust is eligible for a stepped-up basis?What portion of the trust remains revocable after the

first spouse’s death?What portion of the trust is includible in the estate of

the surviving spouse?41

JRTs - Federal Gift Tax Issues(Non-Community Property) Potential gift to non-donor spouse upon contribution of unequal amounts of any

separate property to JRT without each spouse having a unilateral right to revoke Donor spouse’s joint revocation power does not make gift incomplete if only exercisable

jointly with, or only with the consent of, a person who has a substantial adverse interest(i.e., non-donor spouse)

Gift would a “terminable interest” (i.e., life estate) that may not qualify for the unlimitedgift tax marital deduction under IRC Section 2523(e) or 2523(f) Would not be considered “qualifying income interest” eligible for QTIP treatment under IRC Section

2523(f) because the donee spouse does not have the exclusive right to income from the gifted funds To avoid this issue, each spouse should retain a unilateral right to revoke over his or her

share of trust assets Even if unilateral right to revoke over separate property is retained for Separate Share JRT, may be

difficult to exercise if separate shares are not maintained

Potential gift by surviving spouse to remainder beneficiaries when CST portion of JRTbecomes irrevocable at first spouse’s death Any such gift can be rendered incomplete if surviving spouse retains a testamentary

special power of appointment over the CST

Potential gift to non-donor spouse upon contribution of unequal amounts of anyseparate property to JRT without each spouse having a unilateral right to revoke Donor spouse’s joint revocation power does not make gift incomplete if only exercisable

jointly with, or only with the consent of, a person who has a substantial adverse interest(i.e., non-donor spouse)

Gift would a “terminable interest” (i.e., life estate) that may not qualify for the unlimitedgift tax marital deduction under IRC Section 2523(e) or 2523(f) Would not be considered “qualifying income interest” eligible for QTIP treatment under IRC Section

2523(f) because the donee spouse does not have the exclusive right to income from the gifted funds To avoid this issue, each spouse should retain a unilateral right to revoke over his or her

share of trust assets Even if unilateral right to revoke over separate property is retained for Separate Share JRT, may be

difficult to exercise if separate shares are not maintained

Potential gift by surviving spouse to remainder beneficiaries when CST portion of JRTbecomes irrevocable at first spouse’s death Any such gift can be rendered incomplete if surviving spouse retains a testamentary

special power of appointment over the CST

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JRTs – Federal Estate Tax Issues(Non-Community Property) May be unclear what portion of JRT is includible in deceased spouse’s estate

Affects what portion of the trust assets would be eligible for stepped-up basis at firstspouse’s death

“Qualified joint interest” treatment under IRC Section 2040(b) only applies to propertyheld by spouses as TBE or JTWRS

To the extent spouse contributed property to the trust and retained a right to alter, amend,revoke, or terminate such interest (either alone or in conjunction with any other person),property would be includible in his or her estate under IRC Section 2038

To the extent spouse has general power of appointment over part or all of the trust assets,trust assets would be includible in his or her estate under IRC Section 2041 IRS says no stepped-up basis for portion of trust assets contributed by the surviving spouse, under

IRC Section 1014(e) [PLRs 200101021 and 200210051] Tracing may be required to determine character/ownership of trust assets, if separate

shares are not maintained

Potential inclusion of CST assets in surviving spouse’s estate under IRC Section2036(a)(1) if he or she is treated as a contributor/transferor of these assets, particularlywith Separate Share JRT where separate shares for separate property are not maintained IRS ruled favorably on this (no inclusion) for JRT where general power of appointment was

given to first spouse to die [PLRs 200101021 and 200210051 – see next slide(s)]

May be unclear what portion of JRT is includible in deceased spouse’s estate Affects what portion of the trust assets would be eligible for stepped-up basis at first

spouse’s death “Qualified joint interest” treatment under IRC Section 2040(b) only applies to property

held by spouses as TBE or JTWRS To the extent spouse contributed property to the trust and retained a right to alter, amend,

revoke, or terminate such interest (either alone or in conjunction with any other person),property would be includible in his or her estate under IRC Section 2038

To the extent spouse has general power of appointment over part or all of the trust assets,trust assets would be includible in his or her estate under IRC Section 2041 IRS says no stepped-up basis for portion of trust assets contributed by the surviving spouse, under

IRC Section 1014(e) [PLRs 200101021 and 200210051] Tracing may be required to determine character/ownership of trust assets, if separate

shares are not maintained

Potential inclusion of CST assets in surviving spouse’s estate under IRC Section2036(a)(1) if he or she is treated as a contributor/transferor of these assets, particularlywith Separate Share JRT where separate shares for separate property are not maintained IRS ruled favorably on this (no inclusion) for JRT where general power of appointment was

given to first spouse to die [PLRs 200101021 and 200210051 – see next slide(s)]

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Limited IRS Rulings on JRTs(Non-Community Property) PLR 200101021 Facts JRT funded solely with TBE property Either spouse had unilateral right to revoke; if exercised, an undivided 50%

interest in the trust property was returned to each spouse as tenants in common First spouse to die had testamentary general power of appointment over all of the

trust assets; upon failure to exercise, amount equal to remaining exemptionamount passed to Credit Shelter Trust, any excess amount passed outright to thesurviving spouse

IRS ruled as follows: No completed gift upon funding due to unilateral right to revoke Deceased spouse’s one-half of the trust assets included in his/her estate under

IRC Section 2038, surviving spouse’s one-half of trust assets included deceasedspouse’s estate under IRC Section 2041

Completed gift of surviving spouse’s one-half of trust assets to deceased spouse atfirst spouse’s death – qualifies for the gift tax marital deduction and preventsstepped-up basis in this portion under IRC Section 1014(e)

Credit Shelter Trust not includible in surviving spouse’s estate because theproperty is treated as passing from the deceased spouse and not from thesurviving spouse

PLR 200101021 Facts JRT funded solely with TBE property Either spouse had unilateral right to revoke; if exercised, an undivided 50%

interest in the trust property was returned to each spouse as tenants in common First spouse to die had testamentary general power of appointment over all of the

trust assets; upon failure to exercise, amount equal to remaining exemptionamount passed to Credit Shelter Trust, any excess amount passed outright to thesurviving spouse

IRS ruled as follows: No completed gift upon funding due to unilateral right to revoke Deceased spouse’s one-half of the trust assets included in his/her estate under

IRC Section 2038, surviving spouse’s one-half of trust assets included deceasedspouse’s estate under IRC Section 2041

Completed gift of surviving spouse’s one-half of trust assets to deceased spouse atfirst spouse’s death – qualifies for the gift tax marital deduction and preventsstepped-up basis in this portion under IRC Section 1014(e)

Credit Shelter Trust not includible in surviving spouse’s estate because theproperty is treated as passing from the deceased spouse and not from thesurviving spouse

44

Limited IRS Rulings on JRTs(Non-Community Property) PLR 200210051

Facts JRT funded with JTWRS and/or separate property Either spouse had unilateral right to revoke; if exercised, trust property was to be distributed in

accordance with the direction of both spouses Each spouse also had a unilateral power to withdraw principal (lifetime general power of

appointment) Upon first spouse’s death, trust was divided into Credit Shelter Trust (up to deceased spouse’s

remaining exemption amount) and Marital Trust IRS ruled as follows:

Portion of trust property transferred to the trust by the deceased spouse was included in his/herestate under IRC Section 2038, portion contributed by the surviving spouse included in deceasedspouse’s estate under IRC Section 2041

Completed gift of surviving spouse’s entire interest in the trust to deceased spouse at first spouse’sdeath – qualifies for the gift tax marital deduction and prevents stepped-up basis in this portionunder IRC Section 1014(e)

Credit Shelter Trust not includible in surviving spouse’s estate because the property is treated aspassing from the deceased spouse and not from the surviving spouse

See also PLRs 200403094 and 200604028 (similar rulings involving separate revocabletrusts where the first spouse to die is granted a general power of appointment over assetsof the other spouse’s revocable trust)

PLR 200210051 Facts

JRT funded with JTWRS and/or separate property Either spouse had unilateral right to revoke; if exercised, trust property was to be distributed in

accordance with the direction of both spouses Each spouse also had a unilateral power to withdraw principal (lifetime general power of

appointment) Upon first spouse’s death, trust was divided into Credit Shelter Trust (up to deceased spouse’s

remaining exemption amount) and Marital Trust IRS ruled as follows:

Portion of trust property transferred to the trust by the deceased spouse was included in his/herestate under IRC Section 2038, portion contributed by the surviving spouse included in deceasedspouse’s estate under IRC Section 2041

Completed gift of surviving spouse’s entire interest in the trust to deceased spouse at first spouse’sdeath – qualifies for the gift tax marital deduction and prevents stepped-up basis in this portionunder IRC Section 1014(e)

Credit Shelter Trust not includible in surviving spouse’s estate because the property is treated aspassing from the deceased spouse and not from the surviving spouse

See also PLRs 200403094 and 200604028 (similar rulings involving separate revocabletrusts where the first spouse to die is granted a general power of appointment over assetsof the other spouse’s revocable trust)

45

Limited IRS Rulings on JRTs(Non-Community Property) PLR 201429009 Estate Equalization JRT was used, and the surviving spouse (as trustee)

failed to divide the trust assets at the first spouse’s death between theFamily Trust (with the deceased spouse’s one-half share of the trustassets) and the Survivor’s Trust (with the surviving spouse’s one-halfshare of the trust assets), as directed by the trust document – rather, allassets were administered as a combined trust

Upon subsequent advice by estate planning counsel, corrective actionwas taken to properly allocate assets between the Family Trust and theSurvivor’s Share

Through a forensic review of the historical financial records, thesurviving spouse was able to ascertain and track the assets whichshould have been allocated to the Family Trust at the deceased spouse’sdeath

Accordingly, the IRS ruled that the value of the assets of the FamilyTrust were not includible in the surviving spouse’s estate

PLR 201429009 Estate Equalization JRT was used, and the surviving spouse (as trustee)

failed to divide the trust assets at the first spouse’s death between theFamily Trust (with the deceased spouse’s one-half share of the trustassets) and the Survivor’s Trust (with the surviving spouse’s one-halfshare of the trust assets), as directed by the trust document – rather, allassets were administered as a combined trust

Upon subsequent advice by estate planning counsel, corrective actionwas taken to properly allocate assets between the Family Trust and theSurvivor’s Share

Through a forensic review of the historical financial records, thesurviving spouse was able to ascertain and track the assets whichshould have been allocated to the Family Trust at the deceased spouse’sdeath

Accordingly, the IRS ruled that the value of the assets of the FamilyTrust were not includible in the surviving spouse’s estate

46

JRTs - Federal Income Tax Issues(Non-Community Property) Amount includible in estate of first spouse to die is generally eligible for

stepped-up basis, unless IRC Section 1014(e) applies Tracing may be required if separate shares are not maintained for Separate

Share JRT, or if portion of JRT assets includible in deceased spouse’s estatecannot otherwise be determined under the terms of the JRT

Can trustee pick and choose assets upon division at the first spouse’s death, ordoes fractional interest of each asset have to be used?

Other reporting issues similar to joint spousal accounts/JSP Only one spouse’s SSN can be used during joint lifetime Separate EIN must be obtained for deceased spouse’s portion of trust at first

spouse’s death (“administrative trust”) and for CST/ Marital Trust Surviving spouse’s SSN should be used for Survivor’s Share

Can be cumbersome/confusing having one trust document for deceased share’sirrevocable portion and surviving spouse’s revocable portion after first spouse’sdeath Consider transferring surviving spouse’s portion into newly-created separate

revocable trust for surviving spouse

Amount includible in estate of first spouse to die is generally eligible forstepped-up basis, unless IRC Section 1014(e) applies Tracing may be required if separate shares are not maintained for Separate

Share JRT, or if portion of JRT assets includible in deceased spouse’s estatecannot otherwise be determined under the terms of the JRT

Can trustee pick and choose assets upon division at the first spouse’s death, ordoes fractional interest of each asset have to be used?

Other reporting issues similar to joint spousal accounts/JSP Only one spouse’s SSN can be used during joint lifetime Separate EIN must be obtained for deceased spouse’s portion of trust at first

spouse’s death (“administrative trust”) and for CST/ Marital Trust Surviving spouse’s SSN should be used for Survivor’s Share

Can be cumbersome/confusing having one trust document for deceased share’sirrevocable portion and surviving spouse’s revocable portion after first spouse’sdeath Consider transferring surviving spouse’s portion into newly-created separate

revocable trust for surviving spouse

47

JESTs Gist of the PLRs [200101021, 200210051, 200403094 and 200604028 ] is

that IRC Section 1014(e) precludes a basis adjustment for the survivingspouse’s share of trust assets subject to the deceased spouse’s power ofappointment and includible in the deceased spouse’s estate, becausesuch property: Was acquired by the decedent by gift during the 1-year period ending

on the date of the decedent's death, and Is acquired from the decedent by (or passes from the decedent to) the

donor of such property (i.e., surviving spouse), either directly orindirectly, pursuant to the deceased spouse’s exercise, or failure toexercise, the general power of appointment

JEST authors argue that 1014(e) should not apply if the assets are notpassing outright to the surviving spouse, but rather to CST They suggest avoiding this argument by not having the surviving

spouse as a beneficiary of CST funded with the deceased spouse’s assets

Gist of the PLRs [200101021, 200210051, 200403094 and 200604028 ] isthat IRC Section 1014(e) precludes a basis adjustment for the survivingspouse’s share of trust assets subject to the deceased spouse’s power ofappointment and includible in the deceased spouse’s estate, becausesuch property: Was acquired by the decedent by gift during the 1-year period ending

on the date of the decedent's death, and Is acquired from the decedent by (or passes from the decedent to) the

donor of such property (i.e., surviving spouse), either directly orindirectly, pursuant to the deceased spouse’s exercise, or failure toexercise, the general power of appointment

JEST authors argue that 1014(e) should not apply if the assets are notpassing outright to the surviving spouse, but rather to CST They suggest avoiding this argument by not having the surviving

spouse as a beneficiary of CST funded with the deceased spouse’s assets

48

49

“Community Property” JRTs Statutes in AL and TN allow nonresidents to establish a community property trust, and to potentially

convert property transferred to the trust to community property At least one trustee must be a resident of the state See Alaska Stat. §§ 34.77.020 - 34.77.995; 4.Tenn. Code Ann. §35-17-101, et seq.

IRC Section 1014(b)(6) says the surviving spouse’s one-half share of community property held “underthe community property laws of any state” shall be eligible for a stepped-up basis

US Supreme Court ruled that a statute allowing spouses to elect a community property system underOklahoma law would not be recognized for federal income tax reporting purposes. [Commissioner v.Harmon, 323 U.S. 44 (1944)] “The Harmon decision should also apply to the Alaska system for income reporting purposes.” [Internal Revenue

Manual, Section 25.18.1.1.2] Case was decided prior to the allowance of joint returns – IRS argued income should be included on husband’s

separate return under the assignment of income doctrine

Rev. Rul. 77-359 - Washington couple agreed to convert their separate property to communityproperty. IRS ruled that conversion was effective for federal tax purposes, but added “ To the extent that theagreement affects the income from separate property and not the separate property itself, the Service will not permitthe spouses to split that income for Federal income tax purposes where they file separate income tax returns.”

See Blattmachr, Zaritsky and Ascher, “Tax Planning with Consensual Community Property: Alaska’sNew Community Property Law,” 33 Real Property, Probate and Trust Journal (Winter 1999).

Statutes in AL and TN allow nonresidents to establish a community property trust, and to potentiallyconvert property transferred to the trust to community property At least one trustee must be a resident of the state See Alaska Stat. §§ 34.77.020 - 34.77.995; 4.Tenn. Code Ann. §35-17-101, et seq.

IRC Section 1014(b)(6) says the surviving spouse’s one-half share of community property held “underthe community property laws of any state” shall be eligible for a stepped-up basis

US Supreme Court ruled that a statute allowing spouses to elect a community property system underOklahoma law would not be recognized for federal income tax reporting purposes. [Commissioner v.Harmon, 323 U.S. 44 (1944)] “The Harmon decision should also apply to the Alaska system for income reporting purposes.” [Internal Revenue

Manual, Section 25.18.1.1.2] Case was decided prior to the allowance of joint returns – IRS argued income should be included on husband’s

separate return under the assignment of income doctrine

Rev. Rul. 77-359 - Washington couple agreed to convert their separate property to communityproperty. IRS ruled that conversion was effective for federal tax purposes, but added “ To the extent that theagreement affects the income from separate property and not the separate property itself, the Service will not permitthe spouses to split that income for Federal income tax purposes where they file separate income tax returns.”

See Blattmachr, Zaritsky and Ascher, “Tax Planning with Consensual Community Property: Alaska’sNew Community Property Law,” 33 Real Property, Probate and Trust Journal (Winter 1999).

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Additional Resources Louis S. Harrison and Emily J. Kuo, “The Good, the Bad, and the Innovative:

The Evolution of Joint Spousal Trusts in Today's Estate Planning,” ACTEC FallMeeting Professional Program (2013)

John H. Martin, “The Joint Trust: Estate Planning in a New Environment,” 39REAL PROP. PROB. & TR. J. 275 (Summer 2004)

J. Lee E. Osborne, “Joint Trusts,” Virginia CLE Douglas W. Conner 35th AnnualAdvanced Estate Planning and Administration Seminar (2014)

Alan S. Gassman, Christopher J. Denicolo and Kacie Hohnadell, “JEST OffersSerious Estate Planning Plus for Spouses—Part 1,” EST. PLAN. Oct. 2013); AlanS. Gassman, Christopher J. Denicolo and Kacie Hohnadell, “JEST Offers SeriousEstate Planning Plus for Spouses—Part 2,” EST. PLAN. (Nov. 2013)

Michael D. Mulligan, “Is It Safer to Use a Power of Appointment inPredeceasing Spouse to Avoid Wasting Applicable Exclusion Amount?” 32Estates Gifts and Trusts Journal 191 (2007)

Jonathan G. Blattmachr, Howard M. Zaritsky and Mark L. Ascher, “TaxPlanning with Consensual Community Property: Alaska’s New CommunityProperty Law” 33 REAL PROP. PROB. & TR. J. 615 (Winter 1999)

Louis S. Harrison and Emily J. Kuo, “The Good, the Bad, and the Innovative:The Evolution of Joint Spousal Trusts in Today's Estate Planning,” ACTEC FallMeeting Professional Program (2013)

John H. Martin, “The Joint Trust: Estate Planning in a New Environment,” 39REAL PROP. PROB. & TR. J. 275 (Summer 2004)

J. Lee E. Osborne, “Joint Trusts,” Virginia CLE Douglas W. Conner 35th AnnualAdvanced Estate Planning and Administration Seminar (2014)

Alan S. Gassman, Christopher J. Denicolo and Kacie Hohnadell, “JEST OffersSerious Estate Planning Plus for Spouses—Part 1,” EST. PLAN. Oct. 2013); AlanS. Gassman, Christopher J. Denicolo and Kacie Hohnadell, “JEST Offers SeriousEstate Planning Plus for Spouses—Part 2,” EST. PLAN. (Nov. 2013)

Michael D. Mulligan, “Is It Safer to Use a Power of Appointment inPredeceasing Spouse to Avoid Wasting Applicable Exclusion Amount?” 32Estates Gifts and Trusts Journal 191 (2007)

Jonathan G. Blattmachr, Howard M. Zaritsky and Mark L. Ascher, “TaxPlanning with Consensual Community Property: Alaska’s New CommunityProperty Law” 33 REAL PROP. PROB. & TR. J. 615 (Winter 1999)

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Lauren Evans DeJong, Of CounselStahl Cowen Crowley AddisChicago, [email protected]

Scott K. Tippett, AttorneyThe Tippett Law FirmOak Ridge, [email protected]

Lauren Evans DeJong, Of CounselStahl Cowen Crowley AddisChicago, [email protected]

Scott K. Tippett, AttorneyThe Tippett Law FirmOak Ridge, [email protected]

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