TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Saturday, January 19, 2013

WSJ: Can You Trust Your Kid With $5.25 Million?

WSJWall Street Journal:  Can You Trust Your Kid With $5.25 Million?:

Wealthy families got a holiday gift on Jan. 1, when Congress agreed on permanent estate-tax rules that are much more generous than many financial planners had expected. Some aren't celebrating, however. Instead, they are grappling with new questions about how best to set up trusts for their heirs—while keeping a measure of control over their wealth.

Under the new rules, a taxpayer may shield up to $5.25 million from estate taxes ($10.5 million for couples), and must pay 40% on amounts over the exemption, up from 35% last year. Had Congress done nothing, the exemption would have fallen to $1 million ($2 million for couples), and the rate would have jumped to 55%.

On top of that, the estate and gift tax remain unified, meaning an individual can use his entire exemption to make gifts while alive.

Now that the uncertainty has been lifted, some ultrawealthy families are wondering whether they want to leave heirs that much tax-free money after all. Can their children handle a payday of as much as $10.5 million without losing their motivation to work hard and be productive? ...

There is a solution for such situations: the "quiet," or "silent," trust, which keeps the children in the dark about their wealth until later. ...

What about families that already have set up their estate plans? There was a burst of activity late last year in particular, when people rushed to lock in favorable tax rules before the possible change on Jan. 1. ...

For families that rushed to capture last year's tax breaks without thinking through all of the emotional consequences, there is good news: A few simple techniques can help you get back some control over when your heirs can collect money and how. ... [E]xperts say there are moves that can be made now to address the thorniest estate-planning issues. Here's what you can do.

  • Keep it Quiet. ... During last year's estate-planning bonanza, demand spiked for quiet trusts in particular, experts say. While only about 13 states explicitly allow them, some 19 others have rules implying they are permitted—and more states are pushing to make them legal, including New Jersey and Maryland. Even if you live in a state that frowns on quiet trusts, you could open one in a state that allows them. ... Quiet trusts are controversial among estate planners, in part because they make it harder for trustees to do their job of keeping heirs informed about their investments.
  • Tweak for Control. Families can build in ways to revise their estate-planning vehicles down the road. One common tweak to trusts holding big, new gifts: adding spouses as potential beneficiaries, so they can tap into the trust if need be. A similar tool is the "nonreciprocal" spousal lifetime-access trust, in which the surviving spouse has continued access to the deceased spouse's trust. The key is to make sure the rights, interests and powers that each spouse grants to the other aren't identical, or even similar enough for the IRS to challenge. ... Another popular technique is called "decanting," which allows the trustee to move assets among various trusts. ...
  • Liquidate the Trust? With the estate-tax exemption made permanent, families with less than $10.5 million who had set up trusts to hold annual gifts to kids and grandkids might be tempted to cancel them and distribute the money under the new lifetime gift-tax exemption of $5.25 million ($10.5 million for couples). That way, they wouldn't have to pay the fees involved in maintaining a trust, file separate income-tax returns for it or deal with administrative hassles. But there are some big caveats to liquidating a trust. If your heir gets divorced, an ex-spouse could get part of the money. And the kids would get the money while you are alive, meaning you might see them spend it in ways you consider financially irresponsible.

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