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Learning Experiences in CRT Design – Henry & Associates

Learning Experiences in CRT Design – Henry & Associates

Learning Experiences in CRT Design with Families

What to do when a couple isn’t insurable and a wealth replacement trust using life insurance isn’t economically affordable?  A typical solution is to name children as successor income beneficiaries to the CRT.  Factor in the §1089 TRA-97 10% charitable remainder requirement and naming younger income beneficiaries becomes much more difficult.  Many advisors have also forgotten another area in the Code that might cause them further difficulty in beneficiary planning.   Although there’s a natural desire of a client to include children in a CRT, advisors must explain that when a non-spouse is included as an income beneficiary, there’s a taxable gift involved.  If the trust names the spouse and children, then not only are the children receiving taxable gifts, so is the spouse, as the unlimited marital deduction* is lost.  There are solutions in a family situation when using a multi-generational CRT that might be worth considering:

1. To avoid making a taxable gift to a child when creating an inter-vivos CRT, retain the right to revoke the income interest by Will.  Since the gift is incomplete, the value of the CRT’s income interest becomes an estate tax liability if the right to receive income hasn’t been revoked.  In the meantime, the income beneficiary ages and the charitable remainder increases, and that may reduce the transfer cost.  Unless the trust value appreciates significantly, the estate tax value to the heir will be less than the original gift tax value.

* Because of ERTA (1981), a person can gift during lifetime or leave a surviving spouse his/her entire estate free of the federal estate tax, no matter the amount, except for certain terminable interests in property.  Now, only non-terminable or “qualified” terminable interests are eligible as unlimited marital deductions under I.R.C. §2056(b).  What’s terminable?  A terminable interest means the interest will end at the spouse’s death; for example, a life income interest in a trust.  The purpose of the terminable interest rule has been to deny any marital deduction at the first spouse’s death if the property will escape taxation at the second spouse’s death.  There are two “qualified” terminable interests under Code §2056(b) that qualify for gift and estate tax marital deductions.  One is for a “qualifying income interest for life” that passes to the surviving (donee) spouse from the deceased (donor) spouse with the following three conditions:

(1) a surviving spouse must be entitled to all the income from the property, payable annually or at more frequent intervals;

(2) no person can have a power to appoint any part of the property to any person other than the surviving spouse;

(3) the executor must elect to deduct the property on the federal estate tax return. This election is irrevocable. Note that a trust that paid the spouse an income for a term of years (rather than life) could not qualify, nor could a trust that terminated on the occurrence of a contingency (such as the spouse’s remarriage) PLR 8347090 (8-26-83).

The other qualifying terminable interest happens when the surviving spouse is the only income beneficiary of a charitable remainder trust.  The surviving spouse need not have a life income interest, as an income interest limited to just a period of years could still qualify I.R.C. §2056(b)(8).  The IRS, in Technical Advice Memorandum 8730004, noted that a CRT with two successive non-charitable beneficiaries lost the use of the marital deduction. The ruling related to a testamentary charitable remainder trust in which the decedent had named a surviving spouse followed by another non-charitable beneficiary. The Service ruled that since the Code specifies a surviving spouse to be the only non-charitable beneficiary, the interest, therefore, did not qualify for the marital deduction §2056(b)(8).  — ACCESS AUS 1997