Utah Business Law Lawyer & Attorney : Strong and Hanni Law Firm : Business Planning, Formation and Consulting

An “ILIT” is an irrevocable trust which is created for the purpose of owning a life insurance policy. The primary goal of an ILIT is to remove the life insurance proceeds from the insured-grantor’s estate. Because such trusts are irrevocable, they cannot be amended or rescinded in any way after their creation. Accordingly, once the grantor contributes an insurance policy into an ILIT, he or she has effectively released any claim to control the property or to change any of the terms of the trust. 

ILITs can be useful tools in creating an effective estate plan.  If it is properly constructed, an ILIT can result in payment of a death benefit to a beneficiary which will not be included in the gross estate of the insured. Furthermore, the ILIT can be designed so that the trust can provide benefits to an insured’s surviving spouse without inclusion of the proceeds in the surviving spouse’s gross estate. However, if the ILIT is not constructed or properly created there is a danger that the proceeds will be included in the decedent’s or the insured’s estate. This could result in an effective estate tax rate of nearly 50%.

In crafting an ILIT, it is vital to avoid the “incidents of ownership” which will result in the inclusion of the insurance proceeds in the insured’s estate.  See IRC § 2042. In addition, the surviving spouse of the insured may not have any incidents of ownership in the ILIT. The result would be that the proceeds are included in the surviving spouse’s gross estate. Incidents of ownership include the power to change the beneficiary, to surrender or cancel the policy, to assign the policy, to revoke an assignment, to pledge the policy for a loan, or to obtain from the insurer a loan against the surrender value of the property. IRC Regs. § 20.2042-1(c)(2). Incidents of ownership also include a reversionary interest in the policy or its proceeds if the value of that interest immediately prior to death exceeds 5% of the value of the policy. IRC Regs. § 20.2042-1(c)(3).

In addition, the life insurance policy must be transferred to the ILIT more than three years prior to the death of the insured. Otherwise, the proceeds of the insurance policy will be included in the insured’s estate. See IRC § 2035. Such transfers are considered taxable gifts based on the insurance policy’s cash surrender value at the time of the transfer. However, the tax cost of transferring a life insurance policy during life could be substantially less than the estate taxes that would otherwise be due upon the individual’s death. Nevertheless, if the insured were to die within three years of the transfer of the insurance policy, the proceeds would be brought back into the insured’s taxable estate.

Another approach is to have the trustee of the ILIT apply for a new life insurance policy on the individual’s life after the ILIT has been created. Proceeds may then be transferred to the ILIT on an annual basis so that the trustee has the funds necessary to make the premium payments for the policy. The annual cash transfers are generally considered taxable gifts. However, because the insured never had any ownership rights in the policy, the policy proceeds would not be included in the insured’s taxable estate even if the individual were to die within three years of the purchase of the policy.

The most common technique for making the cash gifts to an ILIT for the payment of future life insurance premiums is through the annual gift tax exclusion combined with a beneficiary’s unexercised right to withdraw the cash gift. Currently, up to $12,000 per beneficiary of the cash gifts used to pay the premiums can qualify for the annual gift tax exclusion under IRC § 2503(b). The withdrawal right of a beneficiary to use the annual gift includes the unrestricted right for a specified period of time to take the cash before it is contributed to the ILIT and used to pay for the premium. The IRS takes the position that in order to be eligible for the annual gift tax exclusion, holders of the withdrawal rights must (1) have a beneficial interest in the ILIT; and (2) receive an annual notice of the withdrawal right and a reasonable opportunity to exercise the power before it lapses (i.e., thirty (30) days).    

          If you are 70½ years old and have an IRA retirement account, Congress has given you an unusual charitable contribution opportunity during 2007.   IRA’s are wonderful private retirement plans, but withdrawals after the owner’s death are taxable income to the recipient.   State and federal income tax will be paid at the receiver’s income tax rate and reported on the receiver’s tax return.   Further, if your estate is subject to death taxes, your estate must also pay death taxes on the same IRA money that is subject to income tax.   In many scenarios, those IRA dollars can be taxed at a combined rate approaching 80% of the total IRA balance, to satisfy income and death taxes.

          As a result, if you already have sufficient income and assets for your retirement, you may find that taxable IRA monies present a perplexing problem of double taxation.   One partial solution has been to withdraw and spend those IRA monies during retirement, paying the taxes as you go, rather than using other assets for living expenses. However this approach increases your income tax during retirement years. Another solution has been to give those IRA monies to charity at your death by naming a charity as the beneficiary of the IRA.    The IRS has now provided a third alternative.

Only through December 31, 2007, an IRA owner who is at least 70½ years of age, can direct his or her IRA to cut a check directly to a charity for up to $100,000 and the gift will satisfy the IRA owner’s minimum withdrawal requirements up to $100,000 (which will not be taxable to the owner) and a spouse can make a like distribution from a spousal IRA account with the same results   By so doing, the owner (and spouse) will satisfy the minimum withdrawal requirements for 2007 (without incurring income tax liability) will reduce the total amount of IRA funds exposed to double taxation, can make available up to $200,000 from cash flow for other uses and can help a charity of choice with a significant gift.

Written Scott R. Jenkins

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As many of our clients know, the current estate tax exemption in the United States is $2,000,000 (this $2,000,000 exemption is scheduled to change in future years). This means that if a U.S. citizen dies in 2007 with a gross estate (i.e., roughly your net worth) of less than $2,000,000, then no estate taxes are owed and no estate tax return need even be filed with the IRS. 

The maximum estate tax rate for a person dying in 2007 is 45%. This means that after the $2 million exemption is applied, your taxable estate would be subject to this wealth transfer tax equal to 45% of the value of those assets.

If an estate is larger than $2,000,000, we want our clients to know that it is possible to effectively “zero-out” your estate tax bill. Depending upon the net worth involved, advanced planning techniques necessarily involve some degree of complexity and a higher risk of IRS audit. Advanced estate planning often also involves life insurance in order to replace estate taxes paid. Some of our clients have opted for simplicity at the price of paying more estate taxes. 

We strongly recommend that basic foundational estate planning documents be put into place to ensure that husband and wife each take full advantage of the $2,000,000 estate tax exemption. These foundational documents include separate trusts for husband and wife, separate “pourover” wills for husband and wife, and other collateral documents. Many of our clients with net worth larger than $2,000,000 have executed these important foundational documents. With these documents and appropriate asset titling in place, a married couple can leave up to $4,000,000 to their children free of any U.S. estate tax. 

We have clients with net worth in excess of $4,000,000 who have not yet gone beyond the basic foundational documents in order to “zero out” their future estate tax bill. These additional techniques involve strategies such as the following: ownership of life insurance in an irrevocable life insurance trust or in an LLC owned by the children; forming a family foundation and transferring assets to it; engaging in other charitable giving techniques such as charitable remainder trusts; forming family limited liability companies and gifting away interests in it; combining various types of trusts such as grantor retained annuity trusts, qualified personal residence trusts, etc.

If you have a desire to zero-out your net estate tax bill, we would be happy to sit down with you and explore these additional estate planning strategies.

One important component of almost every estate tax savings plan is to shrink your estate through a regular, annual gift-giving program to your children and other descendants. The annual gift tax exclusion (i.e., the amount you can gift each year to each donee) is $12,000. In addition, each U.S. citizen has a lifetime gift tax exemption of $1,000,000. This is over and above the annual exclusion. Gifting away $1,000,000 worth of assets now is a good way to leverage the shrinking of your taxable estate, since a gift today also carves out of your estate the future appreciation or growth in value on the assets that you gifted away.

If you would like assistance in any of these areas, please feel free to contact any member of the Strong & Hanni Business and Estate Planning Group.

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Frequently we are asked by clients whether they should have a Will or a Trust. This article briefly describes these two estate planning tools and some of the issues raised by the client inquiries.

A Will "speaks" at a person’s death. It is a blueprint for the probate that will follow by designating who will be in charge, his or her authority, formalities to be observed, who will be the guardian of your minor children and who will receive your property. If you don’t have a Will, the state legislature decides these matters for you through the intestacy laws of the states where you live and where you own property, which may be very different from what you desire. If you own property in more than one state, probate proceedings will be need to be conducted in those states as well. A Will cannot avoid guardianship or conservatorship proceedings, and does not provide a method of managing your assets when you reach the point in your life where you cannot manage them any longer.

A Trust is a different way of owning title to your assets and is created by an agreement entered into by a grantor (person who creates the Trust) with a trustee (manager of the Trust) for beneficiaries (people who use and enjoy Trust assets). Many people who create Trusts initially serve in all three positions. When they become unable to manage their assets, the person they have designated as successor trustee takes over. Often this is a gradual process that is facilitated through the use of powers of attorney signed when the Trust is created. People with a Trust still have a Will, which transfers any assets that are not in the Trust to the Trust at the death of the grantor. It is important to transfer all of your assets to the Trust if you want the successor trustee to be able to manage them if you become ill, or if avoiding probate in all of the states where you own property was a goal you had when you created the Trust.

The state and federal legislatures frequently change the laws and tax provisions which affect all of us, including Wills and Trusts. We recommend that estate planning be reviewed whenever there is a significant change in your life or in the law, and at least every five years. In recent years, the Utah legislature has changed and added new laws regarding personal representatives of estates and trustees. Most people do not want some of these rules to apply to them or their family members. However, you must add special language to your Will or Trust to have the law not apply.

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