Transfers with Retained Beneficial Enjoyment

Question 1

Transfers with retained life estate (estate tax section)

Answer 1

2036

Question 2

Necessity for retained interest to be legally enforceable? (2036)

Answer 2

Retained interest does NOT always need to be legally enforceable.
Retained interest has been included in instances when an informal agreement can be implied that allows decedent’s continued use of transferred property. Also ability to use property may count even if not exercised.

Question 3

Can transferor lease back transferred property under 2036?

Answer 3

Yes, but must be an arm’s-length lease. Subject to sham and other doctrines, especially if terms of lease not complied with.

Question 4

Effect of co-occupancy on 2036 analysis?

Answer 4

If transferee is a spouse and transferor continues living with them, likely escapes 2036 as natural consequence of having spouse. Analysis can be grayer if occupancy is with child.

Question 5

Meaning of Enjoyment of Property under 2036(a)?

Answer 5

Common meaning cited as substantial present economic benefit. However, there have been cases where voting control of transferred entity interests have been considered enjoyment.

Question 6

Does Right to Income under 2036(a) need to be legally enforceable?

Answer 6

No, an implied agreement between decedent and third-party such as a trustee that distributions would be made upon request to decedent held to trigger inclusion of trust assets under 2036.

Question 7

Indirect rights to income (2036)

Answer 7

Inclusion if income payments can be applied towards decedents obligations.
Therefore, transfers in trust that make distributions to wife and children in satisfaction of transferor’s legal support obligations will cause asset inclusion. (Unless the contribution to the trust discharged the obligation)
Can avoid legal support issues if trustee has discretion over distributions.

Question 8

Period for which beneficial interest must be retained for 2036 inclusion

Answer 8

2036 applies if retained interest term is (1) for decedent’s life; (2) for any period not ascertainable without reference to decedent’s death; and (3) for any period which does not in fact end before decedent’s death.

Question 9

Must transfer be made by decedent for 2036 purposes?

Answer 9

No, certain constructive transfers may still be included.

Question 10

Common Constructive Transfers for 2036 purposes

Answer 10

(1) Reciprocal Trust Doctrine: Involves two individuals who fund lifetime trusts for the benefit of the other rather than themselves. Courts may “un-cross” trusts and treat as each beneficiary funding their own trust causing inclusion. Doctrine applied if trusts are interrelated and that arrangement leaves settlors in approximately the same economic position if they had created trusts naming themselves as life beneficiaries (Estate of Grace SC). Important factors are timing of transfers and uniformity of trust terms.

(2) Surviving Souse Elections: ???

Question 11

Application if transfer is made for full and adequate consideration?

Answer 11

These transactions are expressly excluded from the application of 2036.

Question 12

Family LLC/Partnerships and 2036(a) concerns

Answer 12

Only danger is if implied understanding among the parties that transferor of property to partnership would retain economic benefit of that property. Easily avoidable if not dumb.
Common circumstances supporting an imlied agreement include (1) transferor’s continued rent-free use of property such as residence; (2) use of partnership funds to pay personal expenses or make gifts to family members; (3) Ability of transferor to pledge LLC property as collateral for personal loans; (4) contribution of bulk of transferor’s assets to LLC; and (5) transferor’s elderly age.

Question 13

2036(b) Concerns

Answer 13

Don’t transfer stock and allow transferor to retain voting interest. Has no application to non-voting stock.

Question 14

2036 Life Estate interaction with 2035 Transfers Within Three Years of Death

Answer 14

Decedent who makes a transfer with a retained life interest may renounce such life estate to avoid 2036 estate inclusion but if it’s done within three years of death, it will be included under 2035

Question 15

Common Estate Planning Techniques that gave rise to Section 2702

Answer 15

Grantor retained income trust (GRIT): Grantor contributes assets that would appreciate to a trust. Grantor retains income interest for 20 years. Amount in gift would only be actuarial value of remainder. As long as grantor survived income period, property would also not be included in estate.

Question 16

General rule of 2702

Answer 16

Creates general rule that retained interest is assigned a value of zero and gift of remainder is valued at entire amount of transferred property unless retained interest is a qualified interest.

Question 17

Qualified interests under 2702

Answer 17

Qualified Interests include (1) Right to received fixed amounts payable not less than annually; (2) Right to receive payments equal to fixed percentage of trust assets no less than annually; and (3) any noncontingent remainder interest if all other interests in trust are described in (1) or (2).

Question 18

Scope of 2702

Answer 18

Only applies when transfers with retained interest are made in trust to family. Subsection (c) provides circumstances when section applies despite not being in trust.

Question 19

Common Trust utilized in aftermath of 2702

Answer 19

GRAT: Generally satisfy 2702(b)(1). If contributing assets that outperform 7520 discount rate, appreciation in excess will pass to remainder beneficiary free of gift tax and, if the grantor survives the term of the retained interest, free of estate tax as well.

Question 20

Important regulations for GRATs

Answer 20

25.2702-3(b)
Qualfied annuity interest need not provide level payments as long as a given year’s payment does not exceed 120% of previous year’s. Annual payment may be expressed as a fixed % of initial FMV of trust property.

Question 21

Prevalent Qualified Annuity Interest planning technique

Answer 21

Zeroed-Out GRAT
Design interest to equal entire value of trust property so gift of remainder interest in property is valued at zero. To achieve zero value for remainder, qualified annuity interest payments must be made to the grantor’s estate if the grantor dies within the trust term. Fails if trust property appreciation does not exceed 7520 rate or if grantor does not survive trust term, but in such case, taxpayer is in same position as before transaction. Approved by TC in Walton v. Commissioner.

Question 22

2702 Personal Residences Exception

Answer 22

2702 does not apply if trust property consists solely of a residence to be used as a personal residence by persons holding a term interest in the trust (Grantor with retained interest). Regulations provide two types of trusts that will satisfy exception: (1) Personal Residence Trust; and (2) Qualified Personal Residence Trust

Personal Residence Trust prohibits sale of residence during original trust term and no asset can be in trust other than residence including cash to pay expenses.

Qualified Personal Residence Trust permits cash to be held for expenses or improvements. QPRT is also permitted to sell residence and apply proceeds toward a replacement property. If grantor survives term of retained interest, they may pay rent to the trust to continue living in home, which may provide additional reduction of estate. Grantor cannot buy back property during trust term or afterwards so long as trust is grantor trust for income tax purposes.