by Ian Shumard | Aug 7, 2018 | Estate Planning, Taxation
Estate planners eager to help their clients make the most of the temporarily doubled estate and gift tax exemption have a daunting array of planning techniques to pick from with no one-size-fits-all solutions.
“We’ve got a whole bunch of options and it’s not possible to say, ‘Oh, this is the best estate plan, this is clearly what you want to do,’ because there are pros and cons to all of these options,” Beth Shapiro Kaufman of Caplin & Drysdale Chtd. said June 25.
One of the most pressing questions for estate planners is how to ensure their clients can benefit from the doubled exemption before it expires. But all except the ultra-wealthy would have to relinquish everything they own to exceed the $11.2 million cap for individuals and $22.4 million cap for couples, Kaufman said at the American Law Institute Continuing Legal Education estate planning conference in Madison, Wisconsin. “They don’t want to impoverish themselves just because Congress gave them bonus exclusion,” she said.
Kaufman’s first recommendation was to create spousal lifetime access trusts (SLATs), which enables the taxpayer to “give the money away without really giving it away” by making the surviving spouse one of the beneficiaries of the SLAT.
Another way donors can use up the estate and gift tax exemption amount without fully relinquishing access to assets is through a qualified terminable interest property (QTIP) trust. Under section 2519, a gift of any part of a QTIP trust triggers a gift tax on the entire trust, Kaufman explained, and while that’s usually an outcome that estate planners want to avoid, when used this way, it allows the client to make a gift equal to the full value of the trust, so that the bonus exemption amount is locked in. Then, because the actual gift consisted of only a small percentage of the trust’s assets to the donor’s children, the rest of the trust’s assets remain in place and the surviving spouse still receives all the income from the trust.
Kaufman said the theory behind this technique is that the QTIP trust’s assets are included in the surviving spouse’s estate under section 2036, and that section 2036 has an offsetting provision that allows any gift tax paid on the assets to be subtracted. “You get to exclude what you already made a gift of during life, thereby locking down use of your bonus exclusion in 2018, even though you’re dying after 2026, and the only part that you actually pay tax on after 2026 is the appreciation on the property,” she explained.
This method is “a little iffier” than the SLAT approach, according to Kaufman. She also said that it’s “not terribly efficient” because it fails to get appreciation on assets out of the estate. But because it can be used by a surviving spouse who is already the beneficiary of a QTIP trust, it’s “nice to have a technique in our quiver for that person.”
Portability Planning
Some taxpayers may prefer to go the simple route and rely on portability of the deceased spouse’s unused exclusion amount to give everything to the spouse when planning around death.
“From a tax perspective, it works,” Kaufman said, explaining that this allows for a step-up in basis on the transferred assets. But she added that planning with portability alone wastes the generation-skipping transfer tax exemption because that exemption is not portable, misses the opportunity to get some creditor protection on those assets, and sacrifices future control of them—factors that can become messy if the surviving spouse remarries.
Kaufman suggested combining the portability approach with a QTIP, which keeps the same benefits of using portability alone and adds both creditor protection for the surviving spouse and protection of the inheritance for the children of the deceased spouse, “because in the QTIP, the first to die controls the ultimate disposition of those assets.”
Estate planners may also want to consider a “Clayton QTIP” — named after the 1992 Fifth Circuit Court case Estate of Clayton v. Commissioner, 876 F.2d 1486 (1992) Kaufman said. That case “established the concept that you could have different provisions apply, depending on whether the QTIP election is actually made or not,” she said, which means that the decision over which assets to put into a credit shelter trust and which to put into a QTIP trust can be delayed up to 15 months after the person has died. That allows a substantial amount of time to determine which technique works better depending on the law in effect at the time of death.
“So it’s a very flexible technique, and flexibility is key under the current law, because we don’t know what’s going to happen,” Kaufman said.
Another flexible approach is to follow the disclaimer method, in which the surviving spouse disclaims some assets being passed on, and can make arrangements so that anything disclaimed goes into a credit shelter trust, Kaufman said. Unlike a QTIP, in which the deceased spouse was able to direct where assets would go after her death, the disclaimer method allows the surviving spouse to proactively disclaim the assets from the marital bequest.
“You’re relying on somebody actually doing something that they may not be willing to do when the time comes, or they may not be competent when the time comes,” Kaufman said.
Falling Into Traps . . . On Purpose
For wealthy clients who have parents or other older relatives that aren’t as well off and have plenty of unused exemption amount, upstream planning techniques can be particularly attractive.
One such technique involves intentionally triggering the “Delaware tax trap” under section 2041. That has always been something to watch out for and avoid, but “now because everything has been turned on its head, the Delaware tax trap is a planning opportunity,” Kaufman said.
She explained that what’s needed is a trust that’s subject to the rule against perpetuities, and then the elder recipient can exercise general power “in a way that blows that rule against perpetuities,” which would make the trust’s assets includable in their estate.
Kaufman cautioned that this may not work in states that have passed laws specifically to protect taxpayers from falling into the Delaware tax trap, and many practitioners have designed trusts with language preventing that from happening. But she said her firm has now started drafting language to keep that option in their trusts.
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This article was written by Jonathan Curry and originally published by Tax Analysts. To learn more about the author and Tax Analysts, please visit http://www.taxanalysts.org . You can also follow Jonathan Curry on Twitter for real-time updates.
Jonathan Curry wrote this article as a result from his attendance at ALI CLE’s Estate Planning in Depth 2018 annual program. More information about this program can be found here:
http://www.ali-cle.org/cz020
by Ian Shumard | Aug 2, 2018 | Business Organization and Corporate Law, Taxation
A provision in the new tax law allowing for tax deferral on some stock options may have been appealing in theory, but six months later, it’s a non-starter for most companies.
IRS guidance could make the provision more attractive, but some of the requirements driving its unpopularity are baked into the statute, according to practitioners.
J. Marc Fosse of Trucker Huss APC told Tax Analysts that he hasn’t seen much interest from clients in offering the deferral election, echoing what other practitioners have been saying for months. Part of that reluctance stems from unanswered questions about the requirements, he said.
Until guidance is issued, the IRS will treat companies as compliant with some of the statutory requirements as long as they make a good-faith effort, but Fosse said employers aren’t reassured. “I don’t know that people will invest the time and resources to figure that out until there’s IRS guidance,” he said.
Fosse remains optimistic that some companies will take an interest if and when the IRS issues favorable clarifications, but he said some of the statute’s tougher requirements — such as the requirement that options be granted to at least 80 percent of employees — will likely remain a deterrent.
Lack of Options
The new deferral election under section 83(i), added by the Tax Cuts and Jobs Act (P.L. 115-97), allows some recipients of stock options and restricted stock units to defer income for up to five years after they would otherwise vest. The concept was introduced in a bipartisan bill called the Empowering Employees Through Stock Ownership Act, a version of which passed the House in 2016.
The deferral option was intended to help employees at private companies who can’t afford the tax consequences of exercising their stock options. While public company employees can exercise options and sell shares to pay their tax bill, private company employees often cannot sell stock to cover the taxes on the excess of the fair market value of the stock, forcing them to forfeit their valuable options.
According to an October 2017 report from the Urban-Brookings Tax Policy Center, the problem has become more common in recent years because successful start-up companies have been staying private longer.
The National Venture Capital Association lobbied for the bill, arguing that stock options are a critical tool for attracting talent to start-ups. “Stock options are particularly important for startups that are often cash strapped and using all resources available to develop and build a novel product,” the group said in a September 2017 letter to Treasury. “But as the U.S. capital markets have become more hostile to small capitalization companies, many startups are opting to stay private longer rather than pursue an [initial public offering].”
All Quiet on the Deferral Front
But the seemingly valuable deferral option has yet to catch on. “One would have thought we’d have seen a clamoring for these plans in January,” Scott P. Spector of Fenwick & West LLP said during a recent American Law Institute Continuing Legal Education webinar. “We’ve seen almost none. . . . I think it’s fascinating that this is out there and no one is taking advantage of it.”
Gerald Audant, also of Fenwick, and Juliano Banuelos of Orrick, Herrington & Sutcliffe LLP, agreed that there’s been little interest. Audant and Banuelos discussed section 83(i) along with Spector at the ALI-CLE event June 14.
Banuelos said section 83(i) is a good idea in concept, but an imperfect solution because the requirements are so restrictive. “It’s pretty unlikely that this is going to see broad-based use, but there will be specialized situations and happenstance situations where it will be used,” Banuelos said.
Fosse agreed, saying that the deferral elections likely will be attractive to only a limited group of private corporations that have a real chance of a liquidity event within a five-year period.
Practitioners appear to agree that the biggest obstacle is the 80 percent requirement, which Fosse said is a particularly high hurdle for larger companies. If part-time employees must be included in the 80 percent calculation, it will be even tougher to meet, Fosse said, but he added that the IRS could find that those employees are excluded.
Another issue is the restriction on a company’s ability to buy back stock. Stock isn’t “qualified” under the statute if the employee can sell it or receive cash in lieu of stock. Therefore, Banuelos said, stock issued with put rights, repurchase rights, or in accordance with net settlement programs is presumably disqualified.
Another problem, according to Fosse, is that the election must be made within 30 days of vesting, but the statute doesn’t say when the option must be exercised and thus when the employee must pay the exercise price. “Because section 83 generally applies only to a transfer of property, it seems logical the option would be exercised in the 30-day period, but Treasury could interpret it differently,” he said.
Guidance Not a Priority?
Potential penalties associated with the statute’s notice requirements are also scaring off employers, Audant said. Employers are required to notify employees that they’re eligible to make a section 83(i) deferral election, and the IRS can assess a $100 fine for each failure to timely provide employee notice, up to $50,000 per year. Audant said the threat of penalties is driving his clients to find ways to make sure they don’t qualify to offer the deferral.
The withholding issue is another major concern that Fosse said needs to be resolved before the provision can be viable. It appears that employers could be on the hook for employees who are unwilling or unable to reimburse the company for withholding obligations, and Fosse said the IRS will need to offer administrative relief to assuage those fears.
“We’re expecting to get further guidance from Treasury that hopefully will make it more user- friendly, but unless some of these substantive provisions . . . are relaxed, I don’t see [section] 83(i) getting a ton of play as intended,” Banuelos said.
Spector expressed doubt that guidance would come soon, noting that section 83(i) wasn’t included in the latest priority guidance plan as one of the projects to implement the TCJA. “I think this will be like the [section] 280G regs, that we’ll see guidance in 14 years,” Spector said. “This is just not on their priority list, and I think that anybody that does this is doing it without guidance.”
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This article was written by Stephanie Cumings and originally published by Tax Analysts. To learn more about the author and Tax Analysts, please visit http://www.taxanalysts.org
Stephanie Cumings wrote this article as a result from her attendance at ALI CLE’s Executive Compensation 2018 annual conference. More information about this program can be found here:
www.ali-cle.org/cz019
