The New Estate-Planning Environment

Most 2012 trusts should have been irrevocable, grantor and dynastic in nature, meaning they would continue for a long period of time to maximize tax and other benefits. However, this category of trusts is described typically to include only children and other descendants as beneficiaries. Thus, neither the client/grantor nor spouse were made beneficiaries of these trusts. While in most instances this type of irrevocable trust should have been used only by the wealthiest taxpayers that would never need access to the assets in the trust, in some instances aggressive or inexperienced practitioners established purely dynastic trusts when it really may not have been advisable for the clients. In any event, when faced with irrevocable transfers to these types of trusts, unless the trust itself can be pierced, benefits may only be available to the children of the marriage, not to either spouse.

Spousal Lifetime Access Trust (SLAT)

This type of trust can be illustrated in the following simplistic manner. The husband sets up an irrevocable, grantor, dynastic trust for the wife and children, and all future descendants. The husband is not a beneficiary of the trust. Because the trust was established as a grantor trust, the husband (and since a joint return is likely filed during marriage, both spouses on a joint return) would report all trust income and pay the income tax. If the wife needed distributions they could be made to her, but typically, these were discouraged to avoid any implication of an “arrangement” between the trustee and the wife as to distributions, and to maximize the assets inside the protective envelope of the trust. If a divorce occurs, a range of issues would have to be addressed and considered. Who is the trustee of the trust? If the trustee is a family member or other friend/confidant of the husband, can a resignation be negotiated as part of the settlement?

SLAT with Broad Limited Power of Appointment

This type of trust can be illustrated in the following simplistic manner. Again, the husband sets up an irrevocable, grantor, dynastic trust for the wife and children, and all future descendants. The unspoken word is that while the wife is alive, the husband indirectly benefits from the trust, since the wife can receive distributions and use them in a manner that benefits both of them. For example, if the wife has the SLAT buy a vacation home, the husband would have use of the home as a result of his marital relationship.

What if the wife predeceases the husband? The husband might be out of luck. A technique that might appear in some SLATs would be to grant the wife a testamentary power of appointment. This is a right to designate who can enjoy the property after her death. If the power of appointment is appropriate, limiting this right will not cause the SLAT assets to be included in the wife's estate. If the power is as broad as can be (generally speaking, the wife could appoint to a class of persons excluding her creditors, the creditors of her estate and her estate) it will not cause SLAT assets to be included in her estate, but it will arguably permit her to appoint the assets back to the husband in a trust that will not cause estate inclusion for him. Since the trust was initially formed by the husband, the trust probably had to be formed in a state that permits self-settled trusts. As mentioned in Part One of this article, the four most popular are Alaska, Delaware, Nevada and South Dakota.

And what does all this mean to the matrimonial practitioner? If the power of appointment is not exercised to protect the husband, he may lose out on access to substantial marital assets. Thus, the nuances of each such trust must be first understood, and then to the extent feasible, addressed.

Non-Reciprocal SLAT

This concept can be illustrated by a simple example. The concern many wealthy clients had with a SLAT was that if, continuing the above example, the couple divorced, or the wife predeceased the husband and the limited power of appointment technique was not used, how would the husband access assets? The solution for some couples was for each of the spouses to establish a trust for the other. However, if this was done, the trusts could not be mirror images of each other. Otherwise, the IRS could unravel the trusts and cause each spouse's trust to be included in his or her estate, thus defeating the entire tax plan. The result in many instances was for the estate planner to draft intentional differences into each SLAT.

Thus, great care should be taken in reviewing the dual SLATs to identify each difference. These will often include differences in powers of appointment (the right to appoint or designated who will enjoy the property either during the spouse/power-holder's lifetime or at death). Care should be taken to ascertain if agreements as to how these powers might be exercised should be negotiated. Other differences should also be factored into the settlement negotiations. Practitioners confronting non-reciprocal SLATs, who assume reviewing one trust means they understand the other trust as well, could short-change their client in a material way.

DAPTs

In many instances, clients were unwilling to make large irrevocable transfers if they could not be beneficiaries of the trust. Since most state laws will not permit self-settled trusts, these trusts had to be formed in jurisdictions that permit them, e.g, the four most popular noted above. Since both spouses may be beneficiaries of such a trust, it may be feasible to divide the trust and perhaps have each spouse forfeit his/her rights in one of the divided trusts. This raises a host of potential issues, but it may afford some leeway toward resolving the matrimonial settlement. Bear in mind that most such trusts named institutional trustees with broad discretion to make (or not make) distributions.

Many of these trusts were more sophisticated than the typical trusts with which most matrimonial practitioners are familiar. Many have more than just a “trustee.” For example, it has grown more common for wealthy taxpayers to name a trust investment adviser, who can control trust investments; a trust protector, who may have a range of authority (depending on the preferences of the draftsperson); a loan director, who could make loans of trust assets to the grantor without adequate security (to further secure the coveted grantor trust status discussed above), and even a separate distribution committee. Matrimonial practitioners, who are not versed in these concepts, would be advised to have all these relationships and relevant trust provisions reviewed and explained, because each may have its own relevance to the divorce process. In other words, it may be desirable to negotiate limitations on these persons, or even resignations from some that are particularly undesirable.

Another potential landmine is the definition of “spouse” in many of these sophisticated 2012 trusts. Some of these trusts did not name a particular spouse, but used a convention often referred to as a “floating spouse clause.” Using this approach, whomever the client happens to be married to at a particular time would be the spousal beneficiary of the trust. Missing this definition could have a client assume he or she remains a beneficiary of a large trust, when in fact, as soon as the marriage terminates, that status also terminates.

An additional common drafting technique for these trusts should be noted. It was common in the past to provide that distributions could be made, even by a spouse who is co-trustee, to maintain that spouse's standard of living (ascertainable standard in tax jargon). However, this approach has begun to give way to more modern drafting concepts, which, due to the size of many 2012 transfers, will more often be used in the 2012 trust agreements practitioners confront. This approach is to name an independent trustee and grant a purely discretionary distribution standard, which eliminates any ascertainable interest in the trust to attack in a matrimonial action.

An issue matrimonial practitioners may face in the near term is arguing that the 2012 transfers were pre-divorce planning and that they should be set aside or at least evaluated in that light. The problem with this argument is that 2012 transfers may be different from any other year. The reality was that the last quarter of 2012 was a veritable estate-planning feeding frenzy as wealthy taxpayers sought to lock in the benefits discussed above before the law changed. Once President Obama was re-elected, that feeding frenzy grew into an outright panic. Many estate planners completed more transfers in the last six weeks of 2012 than in most prior years. Thus, to argue that a late 2012 transfer was a pre-divorce planning maneuver may be unusually difficult. So many wealthy people were making transfers that it is hard to imagine how the common estate tax planning motive could be disproved.

Risks and Issues with 2012 Transfers

While a host of issues were raised above in the discussions of 2012 planning, there are myriad other issues that might affect a post-2012 matrimonial action. Consider the following.

Gift-splitting

If one spouse makes gifts to a trust for which neither spouse is a beneficiary, the spouses can elect to divide or “split” the gifts on the 2012 gift tax returns. This would attribute half of the gift to each spouse. While there are a host of planning issues this might entail, an important implication for matrimonial practitioners is that if the non-donor spouse gift-splits, that spouse would have to file a 2012 gift tax return. Once that return is signed, that non-donor gift-splitting spouse would be hard-pressed to deny he or she understood or agreed to the transfer if he or she signed a gift tax return expressly agreeing to it. This is most likely to occur with dynastic trusts defined above, or outright gifts.

Estate-Planning Engagement Letters

In attempting to evaluate what happened in the melee of 2012 gift-giving, review the engagement letters that were signed. If your client claims he or she did not understand or was not informed of the transfers, did he or she sign an engagement letter agreeing to the planning?

Spousal Waivers

Some estate planners routinely had spouses waive any rights or claims they might have to the assets transferred to a trust. Be certain to inquire as part of the initial document collection if such a waiver existed and whether or not it was signed.

Swap Power Abuse

A common means of securing the coveted grantor trust status discussed above was to include in the trust document the right of the grantor to swap or exchange trust assets for other assets of equivalent value. This could give the grantor spouse the right to swap in cash for the business interests or other assets the trust holds. This could be a useful technique to remove assets from the trust that are desired to settle the matrimonial action. It could also be used proactively in a manner to change the composition of trust assets that may have been presumed in the divorce negotiations. Again, the typical sophisticated 2012 trust may be very different from the simplistic trusts that had been so common. The size and volume of 2012 transfers as compared with transfers many wealthy clients made in prior years often justified this additional sophistication. Be certain to understand all aspects of any trust that might be involved to avoid unpleasant surprises.

Martin M. Shenkman, CPA, MBA, PFS, AEP, JD, a member of this newsletter's Board of Editors, is an attorney in private practice in Paramus, NJ, and New York City.'

The simplest 2012 transfers were mere outright gifts of assets or business interests from parents or other benefactors to their children or other heirs. These may have been accomplished by writing checks, transferring securities or assigning interests in entities. The problem with these types of transfers is that they would be exposed to taxes, creditors and divorce in the hands of the heirs. While this may not constitute prudent planning, some wealthy clients did it simply to avoid the costs and/or complexity of transfers into irrevocable trusts.

More significant transfers that were better planned were made to irrevocable trusts. While there are undoubtedly more than 50 shades of variation in all the trusts that were used, most might be classified into one of the common broad categories below. The following explains in general terms some of the common 2012 trust variations and some of the impact each might have to a future matrimonial action. Bear in mind that different estate planners might use different names for these trusts. The goal is to illustrate the general concepts and how they might affect future divorce actions.

Dynasty Trust

Most 2012 trusts should have been irrevocable, grantor and dynastic in nature, meaning they would continue for a long period of time to maximize tax and other benefits. However, this category of trusts is described typically to include only children and other descendants as beneficiaries. Thus, neither the client/grantor nor spouse were made beneficiaries of these trusts. While in most instances this type of irrevocable trust should have been used only by the wealthiest taxpayers that would never need access to the assets in the trust, in some instances aggressive or inexperienced practitioners established purely dynastic trusts when it really may not have been advisable for the clients. In any event, when faced with irrevocable transfers to these types of trusts, unless the trust itself can be pierced, benefits may only be available to the children of the marriage, not to either spouse.

Spousal Lifetime Access Trust (SLAT)

This type of trust can be illustrated in the following simplistic manner. The husband sets up an irrevocable, grantor, dynastic trust for the wife and children, and all future descendants. The husband is not a beneficiary of the trust. Because the trust was established as a grantor trust, the husband (and since a joint return is likely filed during marriage, both spouses on a joint return) would report all trust income and pay the income tax. If the wife needed distributions they could be made to her, but typically, these were discouraged to avoid any implication of an “arrangement” between the trustee and the wife as to distributions, and to maximize the assets inside the protective envelope of the trust. If a divorce occurs, a range of issues would have to be addressed and considered. Who is the trustee of the trust? If the trustee is a family member or other friend/confidant of the husband, can a resignation be negotiated as part of the settlement?

SLAT with Broad Limited Power of Appointment

This type of trust can be illustrated in the following simplistic manner. Again, the husband sets up an irrevocable, grantor, dynastic trust for the wife and children, and all future descendants. The unspoken word is that while the wife is alive, the husband indirectly benefits from the trust, since the wife can receive distributions and use them in a manner that benefits both of them. For example, if the wife has the SLAT buy a vacation home, the husband would have use of the home as a result of his marital relationship.

What if the wife predeceases the husband? The husband might be out of luck. A technique that might appear in some SLATs would be to grant the wife a testamentary power of appointment. This is a right to designate who can enjoy the property after her death. If the power of appointment is appropriate, limiting this right will not cause the SLAT assets to be included in the wife's estate. If the power is as broad as can be (generally speaking, the wife could appoint to a class of persons excluding her creditors, the creditors of her estate and her estate) it will not cause SLAT assets to be included in her estate, but it will arguably permit her to appoint the assets back to the husband in a trust that will not cause estate inclusion for him. Since the trust was initially formed by the husband, the trust probably had to be formed in a state that permits self-settled trusts. As mentioned in Part One of this article, the four most popular are Alaska, Delaware, Nevada and South Dakota.

And what does all this mean to the matrimonial practitioner? If the power of appointment is not exercised to protect the husband, he may lose out on access to substantial marital assets. Thus, the nuances of each such trust must be first understood, and then to the extent feasible, addressed.

Non-Reciprocal SLAT

This concept can be illustrated by a simple example. The concern many wealthy clients had with a SLAT was that if, continuing the above example, the couple divorced, or the wife predeceased the husband and the limited power of appointment technique was not used, how would the husband access assets? The solution for some couples was for each of the spouses to establish a trust for the other. However, if this was done, the trusts could not be mirror images of each other. Otherwise, the IRS could unravel the trusts and cause each spouse's trust to be included in his or her estate, thus defeating the entire tax plan. The result in many instances was for the estate planner to draft intentional differences into each SLAT.

Thus, great care should be taken in reviewing the dual SLATs to identify each difference. These will often include differences in powers of appointment (the right to appoint or designated who will enjoy the property either during the spouse/power-holder's lifetime or at death). Care should be taken to ascertain if agreements as to how these powers might be exercised should be negotiated. Other differences should also be factored into the settlement negotiations. Practitioners confronting non-reciprocal SLATs, who assume reviewing one trust means they understand the other trust as well, could short-change their client in a material way.

DAPTs

In many instances, clients were unwilling to make large irrevocable transfers if they could not be beneficiaries of the trust. Since most state laws will not permit self-settled trusts, these trusts had to be formed in jurisdictions that permit them, e.g, the four most popular noted above. Since both spouses may be beneficiaries of such a trust, it may be feasible to divide the trust and perhaps have each spouse forfeit his/her rights in one of the divided trusts. This raises a host of potential issues, but it may afford some leeway toward resolving the matrimonial settlement. Bear in mind that most such trusts named institutional trustees with broad discretion to make (or not make) distributions.

Many of these trusts were more sophisticated than the typical trusts with which most matrimonial practitioners are familiar. Many have more than just a “trustee.” For example, it has grown more common for wealthy taxpayers to name a trust investment adviser, who can control trust investments; a trust protector, who may have a range of authority (depending on the preferences of the draftsperson); a loan director, who could make loans of trust assets to the grantor without adequate security (to further secure the coveted grantor trust status discussed above), and even a separate distribution committee. Matrimonial practitioners, who are not versed in these concepts, would be advised to have all these relationships and relevant trust provisions reviewed and explained, because each may have its own relevance to the divorce process. In other words, it may be desirable to negotiate limitations on these persons, or even resignations from some that are particularly undesirable.

Another potential landmine is the definition of “spouse” in many of these sophisticated 2012 trusts. Some of these trusts did not name a particular spouse, but used a convention often referred to as a “floating spouse clause.” Using this approach, whomever the client happens to be married to at a particular time would be the spousal beneficiary of the trust. Missing this definition could have a client assume he or she remains a beneficiary of a large trust, when in fact, as soon as the marriage terminates, that status also terminates.

An additional common drafting technique for these trusts should be noted. It was common in the past to provide that distributions could be made, even by a spouse who is co-trustee, to maintain that spouse's standard of living (ascertainable standard in tax jargon). However, this approach has begun to give way to more modern drafting concepts, which, due to the size of many 2012 transfers, will more often be used in the 2012 trust agreements practitioners confront. This approach is to name an independent trustee and grant a purely discretionary distribution standard, which eliminates any ascertainable interest in the trust to attack in a matrimonial action.

An issue matrimonial practitioners may face in the near term is arguing that the 2012 transfers were pre-divorce planning and that they should be set aside or at least evaluated in that light. The problem with this argument is that 2012 transfers may be different from any other year. The reality was that the last quarter of 2012 was a veritable estate-planning feeding frenzy as wealthy taxpayers sought to lock in the benefits discussed above before the law changed. Once President Obama was re-elected, that feeding frenzy grew into an outright panic. Many estate planners completed more transfers in the last six weeks of 2012 than in most prior years. Thus, to argue that a late 2012 transfer was a pre-divorce planning maneuver may be unusually difficult. So many wealthy people were making transfers that it is hard to imagine how the common estate tax planning motive could be disproved.

Risks and Issues with 2012 Transfers

While a host of issues were raised above in the discussions of 2012 planning, there are myriad other issues that might affect a post-2012 matrimonial action. Consider the following.

Gift-splitting

If one spouse makes gifts to a trust for which neither spouse is a beneficiary, the spouses can elect to divide or “split” the gifts on the 2012 gift tax returns. This would attribute half of the gift to each spouse. While there are a host of planning issues this might entail, an important implication for matrimonial practitioners is that if the non-donor spouse gift-splits, that spouse would have to file a 2012 gift tax return. Once that return is signed, that non-donor gift-splitting spouse would be hard-pressed to deny he or she understood or agreed to the transfer if he or she signed a gift tax return expressly agreeing to it. This is most likely to occur with dynastic trusts defined above, or outright gifts.

Estate-Planning Engagement Letters

In attempting to evaluate what happened in the melee of 2012 gift-giving, review the engagement letters that were signed. If your client claims he or she did not understand or was not informed of the transfers, did he or she sign an engagement letter agreeing to the planning?

Spousal Waivers

Some estate planners routinely had spouses waive any rights or claims they might have to the assets transferred to a trust. Be certain to inquire as part of the initial document collection if such a waiver existed and whether or not it was signed.

Swap Power Abuse

A common means of securing the coveted grantor trust status discussed above was to include in the trust document the right of the grantor to swap or exchange trust assets for other assets of equivalent value. This could give the grantor spouse the right to swap in cash for the business interests or other assets the trust holds. This could be a useful technique to remove assets from the trust that are desired to settle the matrimonial action. It could also be used proactively in a manner to change the composition of trust assets that may have been presumed in the divorce negotiations. Again, the typical sophisticated 2012 trust may be very different from the simplistic trusts that had been so common. The size and volume of 2012 transfers as compared with transfers many wealthy clients made in prior years often justified this additional sophistication. Be certain to understand all aspects of any trust that might be involved to avoid unpleasant surprises.

Martin M. Shenkman, CPA, MBA, PFS, AEP, JD, a member of this newsletter's Board of Editors, is an attorney in private practice in Paramus, NJ, and New York City.'