In Search of the Perfect Trust

en years ago, this publication considered a hypothetical question: What is the perfect trust?¹ Obviously, the perfect trust is a subjective choice that is based on what must be accomplished in very specific circumstances.

But if one could design a trust that could have flexibility, control, and yet maximize savings in transfer taxes and income taxes (including capital gains), that would be quite an accomplishment. And inventive professionals have attempted to design the perfect trust many times. Over the course of ten years, conditions have changed dramatically, and the criterion for "perfection" has certainly changed.

From Super To Mega

For instance, in the late 1970s and early 1980s, a Supertrust concept was pursued but, as often happens, the world finds out about a useful arrangement it tends to exploit it conspicuously enough to prompt legislation to end the arrangement.²

Other designer arrangements based on gimmicks have failed to pan out as well. In 1993, we considered the MegaTrust^SM, which was more than a gimmick — but it apparently did not catch on and its moment has passed.³

Nevertheless, the most attractive aspect of these arrangements may have been their use of life insurance. In 1993, we concluded that the irrevocable life insurance trust (ILIT) was an ideal arrangement in many respects. Look closely at the designer trusts that followed and you will often find an ILIT.

Ten Years After

It is a transformation that doesn't seem possible. Our estate tax circumstances are now so profoundly different from ten years ago. In 1993, we faced a top rate of 55% with an additional 5% surtax that was designed to offset the benefits of the unified credit and progressive tax rates. Today, we are at 49% and are heading toward no more estate tax in 2010.

There was a totally different mindset ten years ago. Prior to 1982, the top estate tax rate had been 70% for estates in excess of $5 million. In 1993, a top rate of 55% appeared relatively low by comparison. The ambition of the 5% surtax was to make sure that wealthy individuals paid a flat 55% of their estates to the federal government. Today, our nation's objective is to equalize the estate tax by making it zero for all.⁴

For the longest time, the unified credit had been $192,800, which was the equivalent of an exemption of $600,000. Now the exemption amount is up to $1 million and is heading toward $3.5 million in 2009, just before the repeal of the estate tax takes effect.

In 1993, the family home was still the key asset in many estates. But the real estate crash of the late 1980s had rocked home prices and by the late 1990s, the stock market's run up, especially in technology stocks, had boosted stock portfolios. Retirement planning options had expanded greatly, but the utilization of IRAs to receive retirement plan rollovers resulted on IRAs becoming the chief asset of many estates. Today, stock prices have fallen so far over the past three years that home prices have, at least temporarily, made homes the number one asset in more estates once again.

Looking down the road beyond the permanent repeal of the estate tax, the key tax burdens will change and the focus of planning will move toward capital gains and income tax consequences. A gift tax would remain in effect as well.

A Trendsetter

Adaptation to new tax legislation has led to an evolution of the estate planning strategies that are used. New York attorney Jonathan Blattmachr has been at the forefront in designing new approaches. After the arrival of the generation skipping transfer tax as applied by the Tax Reform Act of 1986, Blattmachr outlined the "tripartite will," allocating assets for a credit shelter trust, and dividing the balance to a QTIP trust and a GST trust.⁵

During the early 1990s, With estate tax rates frozen at 55% (plus the 5% surtax), Blattmachr collaborated with Richard Oshins on the MegaTrust^SM, an approach that aspires to create the perfect dynasty trust that could last 120 years or longer by establishing it in a state without a rule against perpetuities.

Naturally, the MegaTrust^SM incorporates a number of advantageous tactics of other trusts-you can give an idea a catchy name and register a service mark for it, but there are no new ideas under the sun. Thus the MegaTrust^SM draws heavily on the communal ownership of assets approach of the Supertrust and combines it with the effectiveness of an irrevocable life insurance trust. It was in conjunction with these large dynasty-sized estates that Blattmachr adapted family reverse split dollar insurance, an arrangement that has now been disallowed with disastrous results.⁶

Nominations For Best Trust

There are, of course, other candidates for the perfect trust. There are some very exotic international trusts. Predictably, any time someone conjures up a trust arrangement, you can count on someone else financing it with life insurance. Thus we now have arrangements such as an offshore private placement life insurance trust (OPPLIT).

The family homestead may lend itself to a combination of strategies — an effective QPRT with a conservation easement over a portion of the property. This can be a homerun in many estates.

And for charitable purposes, a CLT can work well in conjunction with a private foundation, particularly while interest rates are low.⁷

A case can be made for the disclaimer trust. Estates facing estate tax burdens due to a lack of advance planning can sometimes be miraculously repaired by a timely executed disclaimer. A will that creates a disclaimer trust is able to anticipate the future use of a disclaimer and direct the disclaimed assets appropriately, can be ideal.

And there is even something referred to as an "IDIOT® Trust." One would imagine that such a trust would have an extremely broad base of constituents. An IDIOT trust simply combines an intentionally defective irrevocable trust (IDIT) with an irrevocable life insurance trust (ILIT). This combo was created by attorney Michael D. Weinberg to create an intentionally defective irrevocable outstanding trust (IDIOT).

In many respects, the irrevocable life insurance trust that helped make trusts "super" or "mega" in the 1980s and 1990s is still going to be a useful arrangement. Being able to anticipate insurance proceeds when capital gains fall due will be especially useful.

Of course, the simple alternative to any of these all-in-one arrangements is to have several trusts, each handling the specific variables of each situation. Each trust can be used to address particular assets and beneficiaries. A simple trust can be accomplishing its own tasks more efficiently than some trust that is trying too hard to be all things for all purposes. In the end, a trust that tries to do conflicting tasks may be overly complex and self defeating.

The People's Trust

By the time a trust has been super sized enough to need a trademark, it is likely to have become self conscious and overdone, like a deluxe banana split with too many toppings. The typical client has basic needs that are better served with a standard trust, not some ILIT/FLP/QPRT/QTIP/ GST/Crummey/ Mega^SM SuperDynasty Trust that takes too many accountants and attorneys to comprehend.

Measuring trusts strictly in terms of tax savings clearly results in plans that cannot meet the non-tax objectives…such as keeping things simple. There are also the simplest of objectives: loyalty, fairness, and charity.

Measured in terms of flexibility, the revocable living trust remains the most adaptable, simple, and useful trust. Moreover, a familiar arrangement that is simple and understandable provides trustees and beneficiaries with a smoothly operating trust that everyone can have confidence in. These arrangements have "trust" in their name for a reason.

TECHNICAL REFERENCES

¹ Moshman, "In Search of the Perfect Trust", The Estate Analyst (June, 1993).

² The Supertrust was a concept and book published by Frank Weisz in 1978. An irrevocable life insurance trust with a defective grantor status was used. It relied heavily on the deduction for personal interest, and this deduction was eliminated by the Tax Reform Act of 1986.

³ MegaTrust^SM is essentially a dynasty trust that avoids transfer taxes and incorporates the use of life insurance. A special feature resembles a concept used in "The Family Estate Trust," or "American Birthright Trust," i.e., a do-it-yourself tax evasion scheme. In the context of a MegaTrust^SM, it was contemplated that a centralized trustee would be empowered with great discretion. The trust could accumulate assets without supplementing any living expenses of beneficiaries. The trust would acquire properties to be used as residences for beneficiaries, but without allowing beneficiaries to have ownership. In theory, beneficiaries would not even own the jewelry they utilize. In this manner, $1 million would supposedly grow to $3.3 billion over the course of 120 years. See, Oshins and Blattmachr, "The Megatrust; An Ideal Wealth Preservation Tool", Trust & Estates, November 1991, beginning at pg. 20. The MegaTrust^SM is a service mark held by Jonathan Blattmachr and Richard Oshins and is licensed to Alfred J. Olsen and Susan K. Smith. Caveats: This arrangement is based on the avoidance of transfer taxes that may no longer exist, growth rates and conservation of assets that are improbable, and a communal family sharing model that few families would consider realistic. Nevertheless, in theory, the MegaTrust^SM arrangement can still be useful for general asset protection purposes. These trusts can be coordinated with other techniques, such as the family limited partnership. See, Gibbs, A family limited partnership as the centerpiece of an estate plan, http://www.unionresource.com/Articles/Centerpiece.htm.

⁴ Under the Economic Tax Recovery Act of 1981, the top rate was lowered by 5% a year. It was supposed to reach 50% in 1985, but it kept getting interrupted along the way. Congress returned with the Tax Reform Act of 1984 and froze the rate at 55% until 1988. The Tax Reform Act of 1986 added the 5% surtax on estates exceeding $10 million and up to $21,040,000 to offset the value of the progressive rates and the unified credit (a total of $552,000). The Revenue Act of 1987 then postponed the reduction of the top rate to 50% until 1993. The Omnibus Budget Reconciliation Act of 1993 restored the 55% top rate retroactive to January 1, 1993. The Taxpayer Relief Act of 1997 inadvertently reduced the 5% surtax so that it only would apply between $10 million and $17,184,000 to offset the progressive rates and not the unified credit. The Economic Growth and Tax Relief Reconciliation Act of 2001 finally eliminated the surtax altogether and lowered the top estate and gift tax rate to 50% effective January 1, 2002 — 17 years later than 1985 as Congress intended in 1981. The top estate tax rate is currently 49% and will continue dropping. If the estate tax repeal is not made permanent, the top estate tax rate will return to 55% in 2011.

⁵ Blattmachr, "The Tripartite Will: A New Form of Marital Deduction", 127 T&E 4, p. 47 (April, 1988).

⁶ Jonathan Blattmachr and Michael Brown obtained an IRS ruling in 1996 that led them to develop the family reverse split-dollar life insurance arrangement. Widespread abuse of the arrangement was reported by The New York Times on July 28, 2002. The Treasury responded in less than three weeks with Notice 2002-59. See, Moshman, "Treasury Addresses Split Dollar and Current Issues", The Estate Analyst (Sept., 2002).

⁷ Silk and Lintott, "Using a CLT and Private Foundation to Nearly Eliminate Estate Tax", 29 EP 1, p 22 (Jan., 2002); Moshman, "A Timely Strategy", The Estate Analyst (Oct., 2002).

© K.S.