When representing a client going through a divorce, you must settle a number of differing property issues. Of particular concern are the special rules governing individual retirement accounts. The recent Tax Court memorandum decision in Kirkpatrick¹ (discussed below) is a reminder that if the transfer of an IRA isn’t properly handled in relation to the divorce, it can lead to adverse, and likely unexpected, tax consequences. 

The Rules

The Internal Revenue Code provides that the transfer of an individual’s interest in a qualified plan or IRA to his spouse or former spouse under a “divorce or separation instrument” isn’t a taxable transfer. Specifically, in relation to IRAs, IRC Section 408(d)(6) states that the transfer of an individual’s interest in an IRA to his spouse or former spouse under a divorce or separation instrument isn’t to be considered a taxable transfer, and such interest at the time of the transfer is to be treated as an IRA of such spouse and not of such individual.² Regarding qualified plans, an alternate payee who’s the spouse or former spouse of the participant is treated as the distributee of any distribution or payment made to the alternate payee under a qualified domestic relations order (QDRO).³ That is, when the transfer is made to the former spouse pursuant to a divorce, the individual’s interest at the time of the transfer is treated as an account of the former spouse. 

Two requirements must be met for the exception of Section 408(d)(6) to apply: (1) There must be a transfer of the IRA participant’s “interest” in the IRA to his spouse or former spouse, and (2) such transfer must have been made under an IRC Section 71(b)(2)(A) divorce or separation instrument.⁴ 

While a QDRO⁵ is required when transferring a portion of a qualified plan pursuant to a divorce, federal law doesn’t require one for IRAs because IRAs aren’t subject to the anti-alienation requirement applicable to qualified plans. Instead, the process of dividing an IRA in a divorce is referred to as a “transfer incident to divorce.” Generally, when splitting an IRA in such cases, the division is completed by working with the IRA custodian to: (1) change the name on the existing IRA to that of the former spouse, or (2) transfer the portion of the IRA awarded to the former spouse to the former spouse’s own IRA. 

Divorce or Separation Instrument

As indicated, the transfer of a retirement plan must be made pursuant to a divorce or separation instrument. For IRA purposes, a “divorce or separation instrument” is a “decree of divorce or separate maintenance or a written instrument incident to such a decree.”⁶ 

Private Letter Ruling 9344027 (Aug. 9, 1993) highlights an example of a transfer that doesn’t satisfy this requirement. In this ruling, married taxpayers separated and entered into a written separation agreement. Under the agreement, one-half of the husband’s IRA was to be transferred to an IRA in the wife’s name. This action, however, was being done pursuant to a private, written separation agreement. The couple wasn’t divorced and wasn’t contemplating filing for divorce, nor were they legally separated. There was no assertion on the part of the taxpayers that the IRA division was in the nature of a transfer under a divorce or separation instrument as defined in the IRC.

The taxpayers requested a ruling that the IRA distribution to the wife wouldn’t be taxable to the husband but would be treated as the wife’s property. The IRS, however, ruled that this wouldn’t qualify as a nontaxable transfer because the proposed distribution was to have been made pursuant to the terms of a private, written separation agreement that wasn’t incident to a divorce or legal separation. There was no indication that the taxpayers intended to present their agreement to a court that had jurisdiction over their marital affairs for the court to enter a decree with respect to the separation agreement. Accordingly, the IRA distribution was taxable to the husband and wasn’t treated as the property of the wife. Practitioners should keep in mind that a separation agreement that isn’t “incident” to a decree of divorce isn’t sufficient to make the IRA transfer nontaxable.

Transfer of Interest in IRA

Even if there’s a proper decree of divorce or separate maintenance or a written instrument, a transfer pursuant to such document can still trigger income tax if the transfer isn’t properly completed. 

For example, if one spouse is ordered to pay the other spouse cash in the divorce settlement and then takes a distribution from his IRA to satisfy such requirement, it results in a taxable transfer. The reasoning behind this conclusion is that the order is for cash rather than a portion of the IRA. Harris⁷ highlighted this result. In that case, the husband was awarded three IRAs under the divorce decree but he was also ordered to pay his former wife’s tax liability from a prior tax year. Because it was the only money available to him at the time, the husband withdrew funds from the IRAs and sent his former spouse a check so that she could satisfy her income tax liability. The husband argued that he shouldn’t be taxed on the IRA distribution because he transferred the money to his former spouse, as required by the divorce decree. The court stated, however, that because the divorce decree didn’t require that the husband transfer an interest in the IRAs to his former spouse, and in fact had allocated the IRAs to the husband, Section 408(d)(6) wasn’t applicable. That is, the IRAs weren’t transferred to his former spouse pursuant to the divorce decree.

In addition, if a taxpayer takes a distribution from his IRA and pays the cash to his former spouse to satisfy the requirement to pay a portion of his IRA to the spouse, that would also be a taxable distribution. The recent Kirkpatrick case illustrates this situation.⁸ In Kirkpatrick, the petitioner, John Kirkpatrick, was ordered in a divorce action to transfer $100,000 to an IRA titled in his wife’s name. To fulfill this obligation, John transferred money from his IRA to his checking account and subsequently wrote a check to his wife. On his income tax return for that year, John reported the IRA distribution as nontaxable. John asserted that nothing in Section 408 or the regulations thereunder offers any specific guidance on the timing of a transfer for it to qualify under the Section 408(d)(6) exception. Therefore, he maintained, it’s logical to assume that any such transfer is nontaxable so long as it occurs in a timeframe beginning with the issuance of a written instrument, such as the court order, and through a judgment of absolute divorce. John pointed out that this was the case here, because his payments were made after the order was issued but before the divorce was finalized. John further argued that the fact that the funds passed through his checking account on the way from him to his spouse’s IRA should have no bearing on the taxability of the exchange because the funds were moved within the allowable time limit for this type of transaction.

The Internal Revenue Service argued that John didn’t transfer any interest in his IRAs to his spouse as no IRA was opened in her name, nor was there any transfer of funds from John’s IRAs to any IRA owned by his spouse. The IRS pointed out that the Tax Court in the past has held that Section 408(d)(6) doesn’t apply to proceeds from an IRA cashed out and paid pursuant to a divorce order or judgment or otherwise transferred to a nonparticipant spouse.⁹

The respondent further argued that the petitioner didn’t comply with the order’s terms because the order required him to transfer in a nontaxable transaction $100,000 into an IRA titled in his wife’s name within 14 days of the order’s entry, which he failed to do. Thus, the respondent argued, the transfers shouldn’t be considered as made under a divorce or separation instrument or written instrument incident to such. The respondent further argued that the primary question is whether there was a transfer of an IRA interest and not whether the distribution and transfer of IRA funds occurred within a certain time.  

The court agreed with the IRS and held that the IRA distribution wasn’t a nontaxable transfer incident to divorce but instead was taxable income to John. Pointing to the two requirements for meeting the Section 408(d)(6) exception, the court clarified that “interest” isn’t synonymous with the money or other assets held in an IRA and that withdrawal of funds from an IRA extinguishes the owner’s interest in that IRA or the appropriate proportion thereof. The court found that, in this case, there wasn’t a transfer of John’s interest in the IRAs to his spouse.¹⁰

To avoid taxation, advise similarly situated taxpayers to have the name of the IRA changed to the name of the former spouse or to directly transfer the funds to the spouse’s own IRA. As highlighted in this case, such taxpayers shouldn’t cash out a portion of the IRA and then write a check to their former spouse. Structuring the transaction in that manner wouldn’t fall under the exception of Section 408(d)(6).

Early Distribution Penalty

Another issue that can come into play with divorces involving IRAs relates to the early distribution penalty under IRC Section 72(t). As noted above, when an IRA transfer is made to the former spouse pursuant to a divorce, the individual’s interest at the time of the transfer is treated as an IRA of the former spouse. Once that occurs, if the former spouse is under age 59½, any distributions he takes will subject him to the early distribution penalty unless an exception under Section 72(t) applies. Accordingly, give careful thought to whether, from a tax standpoint, an IRA is the best asset to award a former spouse if it’s anticipated that the former spouse will need IRA distributions before age 59½.¹¹

On a related matter, one of the exceptions to the early distribution penalty is when the IRA owner takes a series of substantially equal periodic payments.¹² Once such a series is started, it needs to continue until the later of five years or the IRA owner’s attainment of age 59½. Except under limited exceptions, no modification can be made to the series during that time without triggering the 10 percent early distribution penalty retroactively to the start of the series. 

There have, however, been a number of private letter rulings allowing the participants to reduce their series of periodic payments in relation to their new account balance following a divorce. They’ve been allowed to reduce their payments because the IRA balance was reduced after the divorce. In PLR 200202074 (Jan. 11, 2002), for example, the taxpayer maintained an IRA from which he was taking a series of substantially equal periodic payments. During the period of the series, he and his wife divorced, and the wife was awarded one-half of the IRA. As a result, the taxpayer wanted to reduce his monthly distributions from the IRA by 50 percent. The taxpayer requested the IRS to rule that he could reduce his payments without it being considered a modification of his series of substantially equal periodic payments. The IRS allowed the taxpayer to reduce his payments without triggering a modification.

In similar cases, it’s recommended that the taxpayer get his own PLR before reducing his payments to avoid triggering the penalty for a modification, given that there’s no solid support for this under the tax law, and a PLR can only be relied on by the taxpayer who requested it.

Endnotes

1. Kirkpatrick v. Commissioner, T.C. Memo. 2018-20.

2. Internal Revenue Code Section 408(d)(6) and Treasury Regulations Section 1.408-4(g).

3. IRC Section 402(e)(1).

4. See Bunney v. Comm’r, 114 T.C. 259 (2000). In Bunney, the petitioner and his wife were divorced. The divorce judgment ordered that the petitioner’s individual retirement accounts be divided equally between both spouses. Subsequent to that order, the petitioner withdrew funds from his IRAs and transferred a portion of them to his spouse. The court held that the petitioner and not his spouse was taxable on the distributions because the petitioner didn’t transfer any of his interest in his IRAs to his former spouse.

5. See IRC Section 414(p).

6. IRC Section 71(b)(2)(A).

7. Harris, T.C. Memo. 1991-375. 

8. Kirkpatrick, supra note 1.

9. See, e.g., Bunney, supra note 3.  

10. See also Jones v. Comm’r, T.C. Memo. 2000-219. In this case, the petitioner and his wife filed for divorce. The couple subsequently prepared a draft marital settlement agreement that required the husband to transfer his interest in his IRA to the wife. In anticipation of this agreement and a few weeks before the draft was executed, the husband cashed out his IRA and endorsed the distribution check over to the wife. Shortly after that, the husband and wife executed the marital settlement agreement. The court held that the IRA distribution wasn’t excludible from the husband’s income because the distribution didn’t constitute the transfer of the husband’s “interest” in his IRA. 

11. In light of the elimination under the Tax Cuts and Jobs Act of the federal tax deduction for post-2018 alimony payments, practitioners representing a retirement plan owner should also consider advocating for the award to a former spouse of an interest in a retirement plan rather than the payment of alimony. 

12. IRC Section 72(t)(2)(A)(iv).

After the death of (1) a participant in an employer-sponsored tax-qualified retirement plan that’s a defined contribution plan, or (2) an individual who accumulates an individual retirement account, the benefits from those plans/accounts are payable to a beneficiary. In most cases, the beneficiary is designated by the plan participant or IRA owner. When a trust is named as beneficiary, the trustee of the trust so named will frequently establish an inherited IRA, then effectuate a direct, trustee-to-trustee transfer of the decedent’s plan benefits to the inherited IRA. 

Some retirement benefits are payable in cash and securities that may be transferred to the receiving trust’s inherited IRA, while others pay in the form of an annuity.

Some IRAs, including inherited IRAs, are trusteed IRAs, operated by a bank or trust company; others are custodial accounts maintained by an investment firm.

Trust Accountings

When a trust owns an inherited IRA, periodic distributions from that IRA to the trust must be classified partly as trust income and partly as trust principal for trust accounting purposes.

Keep in mind that accounting income isn’t the same thing as taxable income. If it were, all IRA distributions would be “income” in many cases (conversely, Roth IRA distributions would never be “income”). Rather, accounting income for fiduciary accounting purposes is determined under the trust instrument and applicable state law. This, in turn, determines who pays federal (and, if applicable, state) income taxes on the distributed amount. Bear in mind that the top trust federal income tax rate of 37 percent applies at a mere $12,500—far less than for individuals (ranging between $300,000 and $600,000, depending on filing status).

In jurisdictions that have adopted legislation based on the present Uniform Principal and Income Act (UPIA), the answer to classification as trust income versus principal lies in state laws adopting UPIA Section 409 (Section 409). Generally, a trust that receives a distribution from an IRA must classify 10 percent of that distribution as trust accounting income. The remaining 90 percent is classified as trust principal.

For example, say a decedent’s IRA valued at $1 million is payable to a trust, and the IRA earns $30,000 of income during 2018. The trust provides that all income earned on trust property is payable to the decedent’s daughter, Jolene. The trustee withdraws $30,000 to pay the IRA’s income to Jolene. But, Section 409 requires that only $3,000 of the $30,000 distribution (10 percent) is treated as trust income for fiduciary accounting purposes. Because of Section 409, Jolene will receive only $3,000. Not only is the remaining $27,000 not available to distribute to the income beneficiary, but also the trust will be required to pay income taxes at trust income rates on that amount. 

Here’s a true story about how that rule can come as a surprise to trustees. A trust was named as beneficiary of the deceased settlor’s IRA and Roth IRA, as well as an annuity contract. The trust provided that all income was to be paid to the settlor’s son. Discretionary distributions could also be made for the son’s health, education, maintenance and welfare. The son was also granted a limited power of appointment (POA) on his death in favor of the settlor’s descendants. Based on the son’s age, required minimum distributions (RMDs) could be paid to the trust over 36 years. Application of California’s version of Section 409 meant that the son wasn’t going to get the income earned within the IRAs. He was only going to receive 10 percent of each year’s distribution. In any year when the trustee must withdraw more than the RMD to comply with California’s rule that “income” is 10 percent of the IRA’s value, substantial value of tax deferral would be lost, and income taxes would be paid earlier than if RMDs were adhered to. 

There are few exceptions to the 90/10 rule. Characterization by the payer will be respected. But, characterization by the payer is rare—we’ve never seen an occurrence of that. 

Payments to either of two types of trust arrangements qualifying for the estate tax marital deduction will cause the IRA’s income to be classified as trust income of the receiving trustee instead of applying the 90/10 rule: (1) a trust with respect to which a federal estate tax qualified terminable interest property (QTIP) election has been made;¹ and (2) a trust qualifying for the estate tax marital deduction because all income is payable to the surviving spouse for life, and the surviving spouse has a general POA over the trust.² In those marital deduction cases only, the trustee must determine the amount of income earned within the IRA as if the IRA were itself a trust subject to the UPIA, withdraw that amount from the retirement account and distribute that entire amount to the surviving spouse.

The UPIA’s approach to preserving the marital deduction when an IRA is payable to a QTIP trust was crafted to comport with Revenue Ruling 2000-2, holding that a QTIP election with respect to a decedent’s IRA may be made when the trustee of the QTIP trust is the named beneficiary of the IRA, the surviving spouse can compel the trustee to withdraw from the IRA an amount equal to all the income earned on the IRA assets at least annually and no person has a power to appoint any part of the trust property to any person other than the spouse.³

Trust provisions can override Section 409. For example, a trust might require under its terms that the trustee shall distribute to the trust beneficiary immediately on receipt all amounts received by the trust from a private or commercial annuity, an IRA or a pension, profit sharing or stock bonus plan and that such receipts shall not be subject to Section 409.

Rev. Rul. 2006-26

Rev. Rul. 2006-26 provides possible definitions of “income” under the trust laws of  “state X” that apply if the trust is silent. Rev. Rul. 2000-2 was modified and, as modified, was superseded.

A unitrust percentage between 3 percent and 5 percent applied annually to the fair market value of all trust property, including the value of the IRA payable to the trust, is an acceptable definition. The other acceptable definition of income is a traditional one of income that, by its terms, completely avoids provisions comparable to Sections 104(a) and 409(c) and (d) of the UPIA (adopted in California Probate Code Section 16361). Under that definition, income includes dividends and interest and excludes capital gains.

Another example included in the revenue ruling illustrates an acceptable income definition, when a trust that grants a surviving spouse the right to demand withdrawal of all trust income is named as death beneficiary of an IRA, including income earned on property held in the IRA. Under the terms of the trust, the trustee must determine the interest income and dividends realized within the retirement fund. In addition, the trustee was granted the power to allocate the total return of both IRA and non-IRA assets held directly in the trust between income and principal in a manner that fulfills the trustee’s duty of impartiality between the income and remainder beneficiaries. The allocation of the total return of the IRA and the total return of the trust in that manner constituted a reasonable apportionment of the total return on the investments in both the IRA and the trust between the income and remainder beneficiaries under both estate tax marital deduction requirements and trust income tax requirements.

The trust in the example also provides that the trustee must determine each year’s RMD. The trustee was required to withdraw IRA income or the IRA’s RMDs, whichever was greater, and distribute that amount to the surviving spouse.

Proposed UPIA Update

In 2018, the National Conference Of Commissioners On Uniform State Laws published, in draft form for discussion only, the Uniform Fiduciary Income And Principal Act [Formerly Revised Uniform Principal And Income Act]. Former Section 409 has been renumbered Section 408. Proposed Section 408 revised former Section 409’s income allocation provisions, rendering the 90/10 rule applicable only in very limited circumstances. The proposal will generally require trustees to determine income of the retirement plan account (referred to as a “separate fund”) as if it were a separate trust. 

If income can’t be determined, it’s then defined as a unitrust amount between 3 percent and 5 percent. The unitrust percentage is applied to the value of the separate fund’s assets, determined as of the beginning of the trust’s accounting year. If the unitrust method is used, the trust is entitled to a series of periodic payments (an annuity), and if the fund’s value can’t be determined, the amount of annuity payments allocated to income must be determined based on the federal income tax regulations under Internal Revenue Code Section 72, relating to annuities. The interest rate determined under IRC Section 7520 based on monthly payments must be used for this purpose. Note that the UPIA assumes a monthly unitrust payment. Not all unitrusts pay monthly; some pay quarterly, semi-annually or annually. 

Furthermore, when a trust is either under a QTIP election or qualifies for the marital deduction because it’s an IRC Section 2056(b)(5) POA trust paying the spouse all income for life, and all of the separate fund’s income can’t be accessed by the trustee, the trustee must, to the extent requested by the surviving spouse, reclassify trust principal as income and distribute that amount to the surviving spouse.  

Only when the value of the account can’t be determined is 10 percent of the amount received classified as income, with the remaining balance classified as principal.

Planning 

The 90/10 rule isn’t something one who’s unfamiliar with trust law can be expected to understand intuitively. It becomes a trap, a cruel joke on both settlors and their intended beneficiaries. The settlor might instead want a family member to receive income earned within the IRA, yet not understand that the 90/10 rule could defeat accomplishment of that intent.  

Drafting attorneys should, when trusts are being designed, helpfully explain to their clients how this rule operates after death. Likewise, following the settlor’s death, the successor trustee will need coaching.

Intention regarding income isn’t the only consideration. RMDs from inherited IRAs and Roth IRAs regulate the value of income tax deferral. In some cases, the year’s RMD could be less than the IRA’s income. For a beneficiary age 52 or under, the percent that must be withdrawn is less than 3 percent. For a 30-year-old, it’s less than 1.9 percent. 

Trusts may be crafted to avoid the 90/10 rule. One possible method is for the trust instrument to provide that IRA distributions received by the trust during each accounting period shall be allocated to trust income to the extent of income earned within the IRA during that trust’s accounting period (similar to marital deduction trust drafting).  

A further trust provision could say that an amount shall be paid to trust beneficiaries from trust principal equal to the amount, if any, by which income earned within the IRA exceeds the amount of all IRA distributions received in any accounting year. A trust that includes such a provision could define income specifically to include any amount received by the IRA that would be classified as income if realized directly in the hands of the trustee. 

Not all tax-favored retirement benefits come in the form of an account. Retirement annuities payable from an employer-sponsored plan or from an individual retirement annuity might be payable to a trust. Treasury Regulations Section 1.72-6 provides a method for classifying a portion of annuity payments, based on the concept that each payment represents a return of the investment in the contract (principal) versus income. Also, IRAs may invest a portion of assets in a qualified longevity annuity contract. Qualified longevity annuity contracts may include a return of premium feature that guarantees that, if the annuitant dies before receiving payments at least equal to the total premiums paid under the contract, an additional payment is made to ensure that the total payments received are at least equal to the total premiums paid under the contract. That return of premium payment is likely principal and should be so classified under UPIA.

Many of our clients reflexively suggest that their trust be named as beneficiary of their qualified retirement plan or IRA benefits. We must make sure that they’re advised of the consequent trust principal and income allocations required under state law, as well as the resulting income tax consequences. If, after careful consideration, the trust will be named as beneficiary, consider drafting the trust to avoid application of the UPIA.

Endnotes

1. Internal Revenue Code Section 2056(b)(7).

2. IRC Section 2056(b)(5).

3. Revenue Ruling 2000-2 (Jan. 18, 2000); Rev. Rul. 2006-26 (May 30, 2006).

Interest rates are rising, and the trend is expected to continue. Advisors must understand how interest rates impact estate planning and which techniques work best in differing rate environments. Let’s look at some techniques to consider as interest rates climb and review the non-interest rate considerations to keep in mind when making any estate-planning decision.  

High(er) Interest Rate Strategies 

Notwithstanding the current modest uptick in interest rates, estate planners shouldn’t abandon the strategies that work best when interest rates are low, such as intra-family loans, sales to grantor trusts, grantor retained annuity trusts (GRATs) and charitable lead annuity trusts (CLATs), all of which were discussed in Part I of this article.¹ But, as interest rates (and, in turn, the discount rate applicable under Internal Revenue Code Section 7520 (7520 rate)) continue to rise, the following strategies will become increasingly attractive:

• Qualified personal residence trusts (QPRTs); 

• Grantor retained income trusts (GRITs); and

• Charitable remainder annuity trusts (CRATs).

QPRTs

A QPRT is an estate-planning technique in which a grantor transfers the grantor’s personal or vacation residence into an irrevocable trust for the grantor’s desired beneficiaries, while retaining exclusive use of the residence for a term of years. Like GRATs, which work best in a low interest rate environment, QPRTs are explicitly sanctioned in IRC Section 2702. This official stamp of approval makes QPRTs a conservative planning strategy that’s appreciated by risk-averse clients. 

Here’s how a typical QPRT works:

• The present value of the grantor’s retained use of the residence—which is effectively an income interest in the trust property—is determined using the 7520 rate.

• The difference between the fair market value (FMV) of the residence and the present value of the grantor’s retained interest is a gift to the trust.

• In a high interest rate environment, the present value of the grantor’s retained income interest will be higher, and the amount of any remainder gift will therefore be lower.

Accordingly, if all other factors are equal, a QPRT will be more effective at a higher 7520 rate (when the value of the grantor’s income interest is higher) than at a lower 7520 rate (when the value of the grantor’s income interest is lower). (See “QPRT—Lower Interest Rate Environment,” p. 16 and “QPRT—Higher Interest Rate Environment,” p. 16.)

If the grantor dies during the QPRT term, the QPRT will fail, and the entire value of the residence will be included in the grantor’s estate. Thus, in addition to the right to occupy the residence, the grantor of a QPRT retains a reversion in the event of the grantor’s death during the QPRT term. This reversion factors into the value of the gift at inception. The reversion isn’t nearly as interest rate sensitive as the income interest, but can substantially increase the value of the retained interest in the case of an older grantor. The grantor’s age can therefore impact the attractiveness of a QPRT as much, or more than, the 7520 rate.

Other drawbacks associated with QPRTs include:

• The grantor’s need to find a new residence or begin paying rent to the remainder beneficiaries at the end of the QPRT term (though the rent payments work to further reduce the grantor’s taxable estate).

• In certain states, additional steps must be taken so that the grantor can retain valuable property tax benefits, such as local homestead property tax exemptions.

• QPRTs aren’t efficient tools for generation-skipping transfer (GST) tax planning, because the grantor’s GST tax exemption can’t be allocated until the grantor’s term interest terminates under the estate tax inclusion period (ETIP) rules.

To avoid the mortality risk and other disadvantages of QPRTs, a grantor might instead consider selling the grantor’s residence to a GST tax-exempt grantor trust (that is, a trust that’s treated as owned by the grantor for income tax purposes) in exchange for a promissory note. As in any sale to a grantor trust, the grantor will typically fund the trust with a seed gift to which the grantor’s GST tax exemption is allocated so that the entire trust is GST-tax exempt. Further, using this technique, the grantor needn’t outlive the term of the note for the plan to work (unlike with a QPRT), although some uncertainty remains regarding the treatment of such a note in a grantor’s estate. To continue using the residence, the grantor would need to lease the house back at fair market rent to avoid estate tax inclusion under IRC Section 2036. This cost is offset from a tax perspective because paying rent to a grantor trust moves additional cash out of the grantor’s estate without generating gift or income tax. As noted above and in Part I of this article, however, sales to grantor trusts typically work better in lower interest rate environments (or when the property sold is expected to appreciate substantially).

GRITs 

Mechanically, GRITs are similar to QPRTs. The grantor contributes property to the GRIT and retains an income interest for a specified term, with the remainder passing to the grantor’s chosen beneficiaries.  

Other similarities between GRITs and QPRTs include: 

• The grantor’s retained income interest is valued using the 7520 rate, and the difference between the FMV of the property contributed to the trust and the value of the grantor’s retained interest is a gift to the trust.

• In a high interest rate environment, the present value of the grantor’s retained income interest will be higher, and the amount of any remainder gift will therefore be lower.

• Drawbacks include the fact that the grantor must survive the chosen term of the grantor’s retained interest for the strategy to work, and the ETIP rules will preclude allocation of the grantor’s GST tax exemption prior to expiration of that term.

GRITs were an extremely popular estate-planning tool prior to enactment of IRC Section 2702 in 1990 but now have more limited use. The zero value rule of Section 2702 was intended to prevent the perceived abuse whereby a parent would value the parent’s retained income interest for gift tax purposes based on an assumed income stream to the parent, but then invest the trust differently to provide less actual income to the parent, such as investing in non-dividend paying growth stocks. Section 2702 thus prevents a grantor from establishing a GRIT (other than a statutorily approved GRAT or QPRT) for a “member of the family,” which is defined by Section 2704(c)(2) to mean an “individual’s spouse, any ancestor or lineal descendant of such individual or such individual’s spouse, any brother or sister of the individual and any spouse of any ancestor or lineal descendant of such individual or such individual’s spouse, or any spouse of any brother or sister of the individual.” However, GRITs may still be created for the benefit of unrelated persons and certain relatives such as nieces, nephews and more distant relatives, who are outside the definition of family members under Section 2704(c)(2).

CRATs

A CRAT is an estate-planning technique in which the grantor transfers property to the trust and the grantor (or another person designated by the grantor, such as a spouse or child) retains an annuity interest in the transferred property for life or a specified term, with any remaining assets passing to charity when the annuity period ends. Although a CRAT is effectively the inverse of a CLAT from a mechanical perspective, it’s treated somewhat differently for tax purposes.    

Here’s how a typical CRAT works for tax purposes:

• The grantor contributes property to the CRAT in return for an annuity stream that’s valued using the 7520 rate.

• The grantor receives a current income tax deduction equal to the value of the gift to charity, which is the difference between the value of the assets contributed to the CRAT and the value of the retained annuity interest. The gift to charity must be equal to at least 10 percent of the value of the property contributed to the CRAT.

• As the 7520 rate increases, the present value of the retained annuity interest will decrease and the amount of any remainder gift will therefore increase (along with the grantor’s potential income tax deduction).  (See “CRAT—Lower Interest Rate Environment,” this page, and “CRAT—Higher Interest Rate Environment,” p. 19.)

• If the annuity stream is payable to someone other than the grantor’s spouse, then gift tax considerations will also apply.

A CRAT can be a particularly useful tool for avoiding or deferring capital gains tax on the disposition of highly appreciated assets because the CRAT itself is income tax-exempt. (The annuity payments are taxable to the recipient, however, and are deemed to carry out ordinary income, capital gains, tax-free income and return of principal according to a tiered system.) A CRAT can thus give the grantor or other individuals access to increased cash flow in the form of defined annuity payments until the annuity period ends and the remaining assets pass to charity. 

As noted above, the principal reason that CRATs are attractive in a high interest rate environment is the potential for an increased income tax deduction. If rates are too low, however, CRATs may not even be an available technique for some grantors because certain levels of annuity payments could cause the actuarial value of the remainder interest to fall below the 10 percent minimum requirement. Further, in the case of a CRAT that features a lifetime annuity, low interest rates could also make it impossible to select a young annuity beneficiary, as the anticipated annuity payments would cause the CRAT to fail either the minimum 10 percent remainder requirement or the separate 5 percent probability of exhaustion test (or both).

Other Factors 

Of course, interest rates alone shouldn’t dictate a client’s estate-planning decisions. There are many other tax and non-tax considerations that may impact whether a certain estate-planning technique makes sense in a particular client’s situation.  

Let’s consider some of these factors:

• Asset values and federal and state estate tax exemption levels. In the absence of planning, will assets (taking into account portability to the extent appropriate) meaningfully exceed available federal and state estate tax exemptions so that the costs of planning are justified?

• Life expectancy. If the grantor isn’t likely to survive the chosen term of the retained interest, strategies such as GRATs, QPRTs and GRITs may be ineffective.

• Actual financial returns. Certain strategies may produce (albeit reduced) benefits even in a non-optimal interest rate environment. For example, in the case of a GRAT or sale to a grantor trust that would typically work best in a lower interest rate environment, if the potential investment return exceeds even high prevailing interest rates, these strategies may nevertheless be effective. Similarly, there’s little point to implementing a GRAT or sale to a grantor trust even in a low interest rate environment if the contributed assets aren’t expected to meaningfully outperform the hurdle rate.

• Client dispositive goals. Clients have widely differing interests and goals. For example, not all clients are charitably inclined, so no matter where interest rates go, CLATs or CRATs may never be appropriate for such clients. On the other hand, certain planning techniques, such as charitable remainder unitrusts,  which aren’t interest rate sensitive, may be best suited to address specific client goals.

• Family circumstances. Some grantors will have a greater need (whether real or perceived) to retain full control of and access to their assets than others. Other grantors may have differing views on the timing and amount of gifts to descendants and the possible impact of such gifts on their descendants’ motivation.

Effective estate planning requires that advisors be cognizant of the environment in which they’re planning. Notwithstanding the key role that they play in many estate-planning strategies, interest rates are only one of the factors to consider. In an otherwise unlimited landscape of planning techniques, however, focusing on interest rates, at least at the outset, can help advisors narrow the options and reduce confusion for their clients.          

Endnote

1. Kerry O’Rourke Perri, Dana M. Foley and Alistair “Sandy” Christopher, “Estate Planning In a Rising Interest Rate Environment: Part I,” Trusts & Estates (June 2018). 

—This article is adapted from a presentation given by the authors at the 2017 ABA Real Property, Trusts and Estates Committee Spring Symposia in Denver.

—In this publication, White & Case means the international legal practice comprising White & Case LLP, a New York State registered limited liability partnership, White & Case LLP, a limited liability partnership incorporated under English law and all other affiliated partnerships, companies and entities. 

The Sherman Brothers got it right: It’s a small world after all. Mobility is a feature of modern life. Parents may stay in their native countries while their children move abroad for study or work. Executives may do tours of duty in foreign countries, where they acquire assets and purchase property. Love may bring citizens of different countries together, requiring careful planning for inevitable inter-spousal transfers. Global financial markets may entice investors to seek direct investment abroad. Changes in international reporting regimes incentivize forum shopping for privacy seekers. Cross-border planning is no longer a rare event, although the complex applicable U.S. rules make it a rarified skill.

That’s why it’s important to know the U.S. income, gift and estate tax rules as they apply to non-U.S. persons. We’ll summarize those rules and describe some common transfer tax planning strategies so planners can confidently advise their clients about basic cross-border planning. Note that for purposes of this article, “person” refers to an individual.

Income Tax

The United States imposes income tax on a worldwide basis on its citizens and residents. It also imposes gift, estate and generation-skipping transfer (GST) taxes on a worldwide basis on transfers by its citizens or residents. A foreign person becomes subject to U.S. income tax when he becomes a U.S. resident and subject to U.S. transfer taxes when he establishes U.S. domicile.¹ The definitions of “residence” and “domicile” are often discussed interchangeably, when in fact they aren’t the same. 

A non-U.S. citizen becomes a U.S. resident for income tax purposes by either obtaining a green card (thereby becoming a lawful permanent resident) or meeting the substantial presence test.² A person is substantially present if he’s in the United States 183 days or more in a particular year. The test includes a weighted formula that considers an individual’s presence over a 3-year period. Generally, if a person is present in the United States for no more than 120 days in any given year, he can avoid being substantially present. 

There are certain exceptions to the substantial presence test. For example, a person in the United States on a full-time student, teacher or trainee visa won’t become a U.S. resident for income tax purposes, nor will an employee of an international organization who’s in the United States for work.³ If a person is in the United States and can’t leave because of a medical condition, he won’t be considered “in” the United States for any day the condition prevents him from leaving.⁴ If the medical condition is pre-existing, however, and the person came to the United States for treatment, every day in the United States counts.  

On the other hand, the determination of a person’s domicile for U.S. transfer tax purposes requires a completely different analysis. A non-U.S. citizen becomes a domiciliary when he lives in the United States and has the intention to remain indefinitely.⁵ The taxpayer’s intent is a crucial factor. Physical presence without the requisite intent isn’t enough to constitute domicile: “Either without the other is insufficient.”⁶ 

Because state of mind is hard to analyze, we look to objective factors to help us determine whether a person’s domicile has changed to the United States, including: statements of intent (in visa applications, tax returns, and wills); length of U.S. residency; differences in style of living in United States and abroad; continuing ties to a former country; location of business interests; and places where community, club and religious affiliations, voter registration and driver licenses are maintained.⁷ A careful planner will regularly help his client consider how these factors add up so the client never finds that he slid unaware into U.S. domicile. 

Interestingly, holding a green card doesn’t mean you have U.S. domicile. A green card holder is automatically subject to U.S. income tax on worldwide income, but may still be exempt from the transfer taxes because a green card only gives its holder the right to reside and take a job in the United States. It doesn’t mean the holder intends to stay indefinitely. In fact, there’s a presumption that a person’s current domicile will continue.⁸ While a green card may be strong evidence of a change of domicile, other factors can overcome it. 

The concepts of residence and domicile are distinct, but the singular term “non-resident alien” is often used to describe a person who isn’t a U.S. citizen, a U.S. resident or a U.S. domiciliary—that is, a person who isn’t subject to either the income tax or the transfer taxes. In this article, we use the terms “foreign person” and “non-U.S. person” to refer to such an individual.  

Foreign Trusts

Everyone has choices about how to engage in estate planning. Trusts may be the best choice for high-net-worth individuals (regardless of whether they’re U.S. persons or foreign persons), but they’re not the only choice. Some clients will be happy relying on a default testamentary regime, such as intestate succession, forced heirship and community property survivorship rights. Some will reside in places where the probate process is relatively efficient and therefore an acceptable option. 

Assuming a trust is appropriate, the question turns to whether a foreign trust makes sense. Asset protection is probably the most common reason for establishing a foreign trust, but estate planners are drawn to them for other reasons. By choosing to have another jurisdiction’s laws govern a trust, a client can avoid forced heirship or community property survivorship rights under his country’s laws. 

In general, a foreign trust is one that’s governed by and administered under another country’s laws. If (1) a court within the United States can exercise primary supervision over the administration of a trust, and (2) only a U.S. person has control over substantial decisions regarding the trust, the trust is a domestic (U.S.) trust.⁹ Any trust that isn’t a domestic trust is a foreign one.¹⁰ If a non-U.S. trustee, trust protector, advisor, grantor or beneficiary can control a substantial decision, the trust will fail the second prong of the test. A simple veto power held by a non-U.S. person is enough to result in foreign trust status.

Foreign Trust With U.S. Beneficiary

From an income tax point of view, there are generally two types of trusts. If a trust is a grantor trust, income, deductions and credits flow through to the grantor of the trust.¹¹ In non-grantor trusts, the trust or its beneficiaries bear the income tax burden.  

When a U.S. person creates a foreign trust that has a U.S. beneficiary, the grantor is treated as the owner of the trust property and its income during his lifetime regardless of whether he retains any kind of interest in the trust.¹² A trust has a U.S. beneficiary unless: (1) no part of the income or principal may be paid to or held for the benefit of a U.S. person, and (2) no part of the income or principal would be paid to a U.S. person if the trust were terminated.¹³ There’s a rebuttable presumption that a foreign trust created by a U.S. person has a U.S. beneficiary.¹⁴ As a result of these rules, it’s difficult for a U.S. person to shift income away from himself by establishing a foreign trust.

Alternatively, when a non-U.S. person creates a foreign trust with a U.S. beneficiary, the U.S. beneficiary is generally responsible for U.S. income tax on any distributions to or for the beneficiary. Unless the trustee provides adequate information about the trust’s income, distributions will be treated as accumulation distributions subject to an anti-deferral regime known as the “throwback rule.” That rule offsets any tax advantage a beneficiary may receive if the trustee times a distribution so it occurs in a low tax rate year. Accumulation distributions are taxed as ordinary income. They also bear an interest charge for each year of accumulation.

To avoid the throwback rules, a non-U.S. person can structure the foreign trust with a U.S. beneficiary to be a foreign grantor trust under narrow circumstances. Generally, either: (1) the non-U.S. person must retain the right to revoke the trust, or (2) the trust is irrevocable and only allows distributions during the grantor’s lifetime to the grantor or his spouse.¹⁵

Moreover, foreign trusts that are established by a non-U.S. person for non-U.S. beneficiaries remain taxwise if: (1) the trust is established in a low tax jurisdiction; and (2) the non-U.S. person establishes the trust more than five years before establishing U.S. residency.¹⁶

Legislation passed in 1996 also authorizes the Internal Revenue Service to recharacterize transfers from a foreign trust to a U.S. beneficiary, directly or through a non-U.S. intermediary, as a taxable distribution rather than a gift.¹⁷ A foreign grantor may still withdraw assets from a foreign grantor trust and then make taxable gifts to a U.S. beneficiary so long as those gifts are reported. These reporting requirements are exacting, and planners should look to Notice 97-34 for fuller guidance on them.  

Non-U.S. Person Domestic Trust

Most domestic trusts established by non-U.S. persons will be classified as non-grantor trusts, obviating any potential income tax advantage because the trust assets would be subject to income tax annually, though if the non-U.S. person later establishes residency, the formerly non-grantor trust can be reclassified as a grantor trust.¹⁸   

Reporting Requirements

If a U.S. person receives gifts from someone he knows or has reason to know is a foreign person and if the gifts exceed $100,000 in the aggregate, the U.S. person is  required to file Form 3520.¹⁹ If the gifts qualify as direct medical or tuition payments, reporting isn’t required. The IRS may treat unreported gifts as income, and the recipient is subject to a penalty of 5 percent of the value of the gift for each month in which the gift wasn’t properly reported, up to a maximum of 25 percent of the value received.  

If a U.S. person receives a distribution from a trust that he knows or has reason to know is a foreign trust, he’s required to file Form 3520 reporting the name of the trust and the aggregate amount of distributions received from it.²⁰ Generally, these distributions will be included in the beneficiary’s gross income. Failure to report a distribution results in a 35 percent penalty of the gross amount of the distribution.²¹ Form 3520 is also required whenever a U.S. person creates a foreign trust or makes a transfer to one.²²

If a foreign trust is deemed to have a U.S. owner, the trustee must file Form 3520A annually to satisfy the U.S. reporting obligations.²³ If the trustee fails to file the form, the U.S. owner must do so. To assist the U.S. owner and U.S. beneficiaries in monitoring the reporting requirements, the trustee must provide them with copies of the form or other statements containing the information necessary for the owner to prepare and file the form.

Ironically, many non-U.S. persons now view the United States as an attractive safe harbor jurisdiction for asset protection and privacy planning purposes. In particular, many countries around the world (including historic tax havens) have adopted the Common Reporting Standard (CRS) that requires automatic annual reporting of tax and financial information, including the reporting of assets held in trust from the jurisdiction where the trust is sitused to the non-U.S. person’s home country.²⁴ However, the United States hasn’t signed onto CRS, meaning that sensitive details about a domestic trust created by a non-U.S. person may go unreported in the non-U.S. person’s home country.²⁵ The United States’ reluctance to sign on to CRS has been a boon to international clients.

Estate Tax 

For non-U.S. persons, the estate tax only applies to U.S. situs assets that they own.²⁶ U.S. citizens and residents have an exclusion that currently protects approximately $11.2 million in assets. In sharp contrast, the exclusion available to a non-U.S. person only protects $60,000 of U.S. situs assets.²⁷ Every dollar in value beyond that low limit is subject to the estate tax, with the tax rate starting at 26 percent. 

Tax treaties may change this. For example, under the U.S.-Canada Tax Treaty, a Canadian who owns U.S. situs assets has a U.S. estate tax exclusion equal to the greater of $60,000 or the exclusion available to a U.S. person multiplied by the ratio of the decedent’s U.S. situs assets to his worldwide assets.²⁸ If a Canadian dies with a $25 million worldwide estate, including $3.75 million of U.S. situs assets, his exclusion under the treaty would be $1.68 million or 15 percent of the $11.2 million exclusion available to a U.S. person. Japan is the only Asian country that has entered into an estate tax treaty with the United States. 

The U.S. situs assets in a non-U.S. person’s gross estate are subject to estate tax.²⁹ The rules defining situs aren’t always clear, but generally, the following are U.S. situs assets:

• Real estate in the United States;³⁰ 

• Personal property located in the United States, whether tangible or intangible;³¹

• Physical currency in the United States, including cash on deposit with a U.S. financial institution;³²

• Stock in a U.S. corporation;³³ and

• Debt obligations of a U.S. person.³⁴

The Internal Revenue Code doesn’t address the situs of partnership interests. Nor do the Treasury regulations. If the partnership should be respected as a separate legal entity, then an interest in it is intangible personal property. Commentators tend to agree that if the partnership owns U.S. situs property or engages in a U.S. trade or business, then an interest in the partnership has U.S. situs.³⁵ Commentators also agree that if the partnership shouldn’t be respected as a separate legal entity, then its situs should be determined by the location of its assets and activity.  

Life insurance proceeds are taxable in the estates of U.S. citizens and residents if they hold any incidents of ownership in connection with the policy, but proceeds from a policy on a non-U.S. person’s life aren’t subject to estate tax even if the non-U.S. person is both the owner and the insured.³⁶ This difference makes life insurance planning particularly attractive for non-U.S. persons.  

Outright testamentary gifts to a U.S. citizen spouse qualify for an unlimited marital deduction. The deduction also applies to bequests in trust for a U.S. citizen spouse if a qualified terminable interest election is made. Testamentary gifts to non-U.S. citizen spouses don’t qualify for the unlimited marital deduction.³⁷ The only way to defer estate taxes on a bequest to non-U.S. citizen spouses is by employing a qualified domestic trust (QDOT).³⁸ 

Gift Tax

A non-U.S. person is subject to gift tax on gratuitous transfers of U.S. situs real property, tangible personal property located in the United States on the date of the gift and physical currency that’s situated in the United States, including cash on deposit with a U.S. financial institution.³⁹

The exclusion that allows U.S. citizens and residents to transfer $11.2 million of gifts tax-free isn’t available to non-U.S. persons. The $15,000 annual gift tax exclusion, however, is available to them, as are the unlimited exclusions for direct medical and tuition payments.⁴⁰ Gift splitting isn’t allowed if either spouse is a non-U.S. person. 

The gift tax isn’t imposed on lifetime transfers of intangible personal property even if that property has a U.S. situs.⁴¹ This is a notable difference to the estate tax rules. Shares in a U.S. corporation are intangible personal property that would be subject to the estate tax at a non-U.S. person’s death; however, those shares can be transferred during life free of gift tax. The gift tax treatment of partnership interests is unclear. The IRS won’t issue rulings on whether a partnership interest is intangible personal property for gift tax purposes. Thus, planners should be mindful that the gift tax analysis is probably the same as the estate tax analysis described above.  

An unlimited marital deduction is available for lifetime gifts by non-U.S. persons to their U.S. citizen spouses, but, gifts to a spouse who isn’t a U.S. citizen are subject to gift tax after the first $152,000 (indexed for inflation).⁴² This special exclusion is annual. Gifts in trust to a spouse may not qualify for the marital deduction, requiring the use of either a qualified terminable interest property trust or a QDOT, depending on whether the donee spouse is or isn’t a U.S. citizen.⁴³

Gifts could be made outright to a beneficiary, but if they’re substantial, they should be made in a properly structured trust so the assets don’t become part of the beneficiary’s taxable estate. To avoid estate tax inclusion in the grantor’s estate, the grantor shouldn’t have any retained interests under IRC Sections 2035 through 2038.⁴⁴ 

Choices of situs and governing law for a trust are important. A trust established under California law must terminate in about 90 years, but a trust established in Delaware can last 365 years, and one established in South Dakota can last in perpetuity.⁴⁵ If asset protection is an objective, the grantor can choose to use the laws of a state that allows self-settled domestic asset protection trusts. In this circumstance, the grantor shouldn’t serve as a trustee.

Six Strategies to Consider

Because the United States can impose its transfer taxes on non-U.S. persons only in limited situations, special planning opportunities are available to them. The key is to implement effective strategies before establishing U.S. domicile. Some common planning strategies include:

1. Owning foreign corporations. Foreign corporations have a special place in estate planning for non-U.S. persons. They aren’t subject to the estate tax because they aren’t U.S. situs assets, and they’re excluded from the gift tax as intangible personal property. Consequently, a non-U.S. person can create a foreign corporation to invest in U.S. situs assets, and he can make lifetime gifts of his interest in the corporation to his children, including those living in the United States, without incurring any U.S. transfer tax. If he dies while he’s still a non-U.S. person, the investments will escape the estate tax.  

While there’s no clearly acceptable timeline for funding a foreign corporation to invest in or transfer control of U.S. situs assets, the planner should remember the step transaction doctrine. Suppose a non-U.S. person converts cash on deposit with a U.S. financial institution (a U.S. situs asset) to shares of a foreign corporation (a non-U.S. situs asset) and soon makes a gift of the shares. The IRS may treat him as if he made a gift of the U.S. situs cash.

The foreign corporation must engage in legitimate business activities and operate at an arm’s length. Otherwise, the corporate form may be ignored and ownership determined as if the arrangement were a trust. As discussed below, the IRS may assert that a non-U.S. person who’s either a trustee or a beneficiary of a trust actually owns the trust assets for all tax purposes. 

We would be remiss if we failed to point out three important income tax aspects of owning a foreign corporation.  

First, if a U.S. person recognizes gains from the sale of shares in a foreign corporation that receives the majority of its income as passive income, the gains may be taxed as ordinary income, not capital gains.⁴⁶ A non-U.S. person should divest himself of such holdings before becoming a U.S. person. 

Second, if the foreign corporation sells U.S. situs assets, there will be a loss of the long-term capital gains (LTCG) preference, which applies only to individuals and non-grantor trusts.⁴⁷ Thus, the foreign corporation will be taxed at corporate tax rates, though this problem has been somewhat alleviated now that the U.S. corporate tax rate has fallen to 21 percent.

Third, with regard to a foreign corporation that owns U.S. real estate, there’s a possibility that the use of the home by the shareholder or the shareholder’s family will give rise to imputed rental income. In a solely U.S. domestic situation, the typical approach to this issue has been to deny deductions to the corporation and treat the excess fair rental value over any actual rent as a constructive dividend. However, this treatment may be largely irrelevant to a foreign corporation and a non-U.S. person shareholder. Thus, the IRS may rely instead on the transfer pricing rules of IRC Section 482, which, although not clear, could be used to create a payment of income between parties that isn’t limited to allocating actual income.⁴⁸

2. Giving away foreign assets. Gifting foreign assets is the first step to consider. Transfer taxes only come into play when U.S. situs assets are involved, so if the non-U.S. person has children or grandchildren in or who may want to come to the United States, his first consideration should be to complete irrevocable gifts of foreign assets. Such gifts will be free of U.S. gift tax, no matter how much the gift is worth. And, because the assets will no longer belong to the non-domiciliary, if he later becomes a U.S. domiciliary, the gift will have reduced his taxable estate. Thus, gifts of non-U.S. situs assets by a non-U.S. person who intends to become a U.S. domiciliary is an effective form of pre-immigration planning.   

If the donee later becomes a U.S. person, the parties must be careful of a special income tax attribution rule that will apply if the donee creates a grantor trust that benefits the donor. In that case, the donor will be treated as the owner of the transferred assets, and he’ll bear the income tax on income from that portion of the trust estate.⁴⁹ It’s easy to imagine the situation in which a grantor wants to name a parent as a permissible beneficiary of a trust. When working with clients who have family members outside the United States, the planner must explore past intra-family transfers carefully.  

3. Making gifts of cash from foreign bank. Cash is considered tangible personal property, and transfers of it are subject to the gift tax if the cash is on deposit with a U.S. financial institution.⁵⁰ So, the transfer of a non-U.S. person’s cash on deposit with a New York bank account is a taxable gift, but the transfer of assets held by the same person in a foreign bank is not.⁵¹ Because seemingly unrelated financial institutions can be co-owned or otherwise associated with each other, the planner should work carefully with the client to make sure that the funds are in no way withdrawn from a U.S. financial institution.  

4. Buying U.S. real estate. It’s increasingly common for non-U.S. persons to buy U.S. real estate, often as second homes or as investment properties. Chinese buyers, for example, spent $28.6 billion on U.S. homes in 2015, with the most investments being made in California and Washington state.⁵² 

If a non-U.S. person owns U.S. real estate, it will be included in his gross estate for estate tax purposes.⁵³ If he gives the real estate away while he’s alive, the transfer will be subject to gift tax.⁵⁴ It would be better if the buyer creates and funds a foreign corporation that purchases the property. As discussed above, if the corporate formalities are observed, an interest in a foreign corporation is intangible personal property that escapes both transfer taxes.  

It’s important to plan well ahead of any purchase so the corporation is able to purchase the property. If the non-U.S. person buyer takes title in his own name and then transfers the property to a foreign corporation, the transfer will likely be subject to income tax as if the property were sold. While using a foreign corporation is good transfer tax planning, as discussed above, if the buyer becomes a U.S. person and subsequently sells the property, he won’t be able to take advantage of the lower individual LTCG rates.⁵⁵ If instead, the shareholder of the foreign corporation remains a non-U.S. person and if the foreign stock is sold, then no U.S. capital gains will be incurred.⁵⁶ However, the purchase of stock won’t cause a step-up in basis in the underlying real property, thus subjecting the purchaser with future capital gains on the sale of real estate. This could be important as it will likely factor into the price the purchaser is willing to pay for the foreign stock. 

Alternatively, depending on the buyer’s objectives, an irrevocable foreign or domestic trust could be used to purchase the real estate. The trust should be created and funded well before the purchase so the trust is clearly the buyer. Because banks resist lending to irrevocable trusts, the grantor should contribute enough to fund the entire purchase. The grantor shouldn’t be a trustee of the trust. Use of the trust assets may appear to be a retained interest, so the safest approach is for the grantor to have no beneficial interest in the trust unless it’s fully within the discretion of an independent trustee. If his spouse and children are beneficiaries, he may use the property as their guest. If he uses the property regularly, it would be safer for him to pay a fair market rent for his use, or the buyer can retain a portion of the property (perhaps 15 percent) and enter into a co-tenancy agreement with the trust for the maintenance and use of the property such that the buyer’s use of the property is attributed to the buyer’s percentage of ownership. 

Using an irrevocable domestic trust doesn’t result in any income tax benefits, but it can have significant transfer tax benefits. These trusts can serve as dynasty trusts for the grantor’s U.S. descendants without GST tax issues.  

5. Funding a trust with stock in U.S. corporations.Recall that the gift tax doesn’t apply to transfers of intangible personal property even if it’s U.S. situs. As a result, a non-U.S. person can fund a trust for U.S. beneficiaries with shares of stock of a U.S. corporation free of gift tax, removing those shares from his estate. This is a unique planning opportunity based on the difference between gift tax and estate tax treatment of shares in a U.S. corporation.  

6. Obtaining life insurance. Life insurance is a tried and true tool in estate planning. Because proceeds from a policy owned by a U.S. citizen or resident are subject to estate tax, careful planning, an irrevocable life insurance trust and attention to detail to the terms of the policy are necessary to protect those proceeds. On the other hand, proceeds from a policy on the life of a non-U.S. person aren’t subject to estate tax because they aren’t U.S. situs assets.⁵⁷ The life insurance policy (whether issued by a U.S. insurer or a foreign insurer) is treated as an intangible property, meaning that the policy itself can also be gifted by a non-U.S. person during life without triggering gift tax.  

This special rule only applies to policies insuring a non-U.S. person’s life. If a non-U.S. person owns a policy on a U.S. person’s life, the value of that policy (not the death benefits) will be included in the gross estate of the non-U.S. person. 

If a non-U.S. person plans to live in the United States and wants to hedge against the risk of inadvertently establishing U.S. domicile, he should consider putting life insurance in place while he’s in the United States. If his immigration plans go awry, his family will have the proceeds to cover the potential estate tax.  

Plan Ahead

Planning for non-U.S. persons is complicated. The issues are complex, and the rules are sometimes counterintuitive—even for seasoned U.S.-based tax planners. Explaining these concepts to a foreign person or foreign advisor requires patience, but the income and transfer tax savings can be remarkable.       

Endnotes

1. Internal Revenue Code Section 7701(a)(30); Treasury Regulations Section 20.0-1(b)(1). 

2. IRC Section 7701(b)(1)(A)(i), 7701(b)(1)(A)(iii).

3. Section 7701(b)(5)(A), 7701(b)(5)(B).

4. Section 7701(b)(3)(D).

5. Treas. Regs. Section 20.0-1(b)(1). 

6. Mitchell v. United States, 88 U.S. 350, 353 (1875). 

7. See Estate of Jan Willem Nienhuys, 17 T.C. 1149 (1952); Revenue Ruling  80-209. 

8. Mitchell, supra note 6. 

9. Section 7701(a)(30).

10. Section 7701(a)(31).

11. IRC Sections 671 to 679.

12. Section 679.

13. Section 679(c)(2)(C).

14. Section 679(d).

15. IRC Section 672(f)(2).

16. Section 679(a)(4)(A).

17. Section 672(f)(4).

18. Section 672(f)(1).

19. IRC Section 6039F.

20. IRC Section 6048(c). 

21. IRC Section 6677(a).

22. IRC Section 6048.

23. Section 6048(b).

24. See OECD Automatic Exchange Portal, www.oecd.org/tax/automatic-exchange/common-reporting-standard. 

25. This result would be altered if the United States and the non-U.S. person’s home country have entered into an intergovernmental agreement under the Foreign Account Tax Compliance Act.

26. IRC Sections 2101, 2103 and 2104. 

27. IRC Section 2102(b)(1). 

28. Tax Convention, U.S.-Canada, Paragraph 2 of Article XXIX B (Taxes Imposed by Reason of Death) (1995 Protocol). 

29. Section 2103.

30. Treas. Regs. Section 20.2104-1(a)(1).

31. Ibid. at (a)(2).

32. See, e.g., Blodgett v. Silberman, 277 U.S. 1 (1928), Internal Revenue Service General Counsel Memorandum (GCM) 36860 (1976), Private Letter Ruling 7737063 (June 17, 1977).

33. Section 2104(a).

34. See supra note 30.

35. See Diana S.C. Zeydel and Grace Chung, “Estate Planning for Noncitizens and Nonresident Aliens: What Were Those Rules Again,” Journal of Taxation (2007), at p. 1; see also Glenn G. Fox, “U.S. Estate Planning for Nonresident Aliens from Treaty Countries, a comparison of Germany, Austria, France and the United Kingdom,” https://bit.ly/2GJqShc (May 17, 2007), at p. 5, citing Sanchez v. Bowers, 70 F.2d 715 (2d Cir. 1934).

36. IRC Section 2042, IRC Section 2105(a).

37. IRC Section 2056(d)(1).

38. Section 2056(d)(2).

39. Treas. Regs. Sections 25.2511-3(a) and (b).

40. IRC Section 2503(e). 

41. IRC Section 2501(a)(2).

42. IRC Section 2523(a).

43. Section 2523(b).

44. Section 2104(b).

45. See Cal. Prob. Code Section 21205; Nev. Rev. Stat. Sections 111.103 to 111.1039; South Dakota repealed its rule against perpetuities in 1983.  

46. IRC Section 1291(a) et seq.

47. Rev. Rul. 84-139.

48. See, e.g., Transport Manufacturing & Equipment Co. v. Mommr, 434 F.2d 373 (8th Cir. 1970), aff’g T.C. Memo. 1964-190; Treas. Regs. Section 1.482-1(f)(2)(ii).

49. IRC Section 675(f)(5).

50. IRS GCM 36,860 (Sept. 24, 1976); Treas. Regs. Section 25.2511-3(b).

51. See Jorgensen v. U.S., 152 F. Supp. 73 (Ct. Cl. 1957); PLR 200340015 (Oct. 3, 2003).

52. Janet I. Tu, “Affluent Chinese see upscale safe haven in Seattle area” (citing statistics provided by the National Association of Realtors) Seattle Times (Jan. 16, 2016), www.seattletimes.com/business/economy/affluent-
chinese-see-upscale-haven-in-seattle-area. 

53. Treas. Regs. Section 20.2104-1(a)(1).

54. Treas. Regs. Sections 25.2511-3(a)(1) and (b)(1).

55. IRC Sections 1(h) and 1201.

56. IRC Section 897(c).

57. Section 2105(a).

In the August 2017 issue of Trusts & Estates, Emily Kembell artfully framed the moment when an estate-planning attorney’s heart may skip a beat. The client wants a revocable trust drafted that will also serve as the beneficiary of a traditional individual retirement account.¹ The engagement has lurking danger.

Step 1, describing the beneficiaries’ interests following the IRA owner’s death, presents no challenges. The trust’s terms include mandatory income and discretionary principal distributions to a beneficiary for life (lifetime beneficiary). At this beneficiary’s death, two other individuals (primary remaindermen) share a right to complete distribution of the trust’s assets. But, the outright distribution comes with a condition. The primary remaindermen must reach a specified age: If underage at the lifetime beneficiary’s death, the interest stays in a separate trust until the primary remaindermen attain the specified age. Step 2 occurs if a primary remainderman dies prematurely: The client names an individual and a favorite charity (secondary remaindermen) to take outright distribution in equal shares. In addition, the trust’s governing instrument authorizes the trustee to accumulate IRA distributions and protects the beneficiaries against creditors.

Step 2 may bring the anxiety. The trust’s terms will earn the drafter a journey through the final Treasury regulations (the regulations) governing required distributions from the IRA.² Among other issues, the regulations interact to create the IRA’s payout period, known as the “applicable distribution period” (ADP). The longer the ADP, the more income tax the trustee can potentially defer when withdrawing the annual required minimum distribution (RMD).  

A Regulatory Swamp? 

If the goal is to ensure a long ADP, the drafter will plunge headlong into a specific set of regulations to assess whether the trust’s terms can achieve this goal. Initially, they spell out the procedural requirements the governing instrument and trustee must satisfy to treat the beneficiaries as if the account owner had named them directly.³ Then, the regulations turn to the “big issue,” filtering the multiple beneficiaries named in the governing instrument to capture the ones creating the ADP.

Treas. Regs. Section 1.401(a)(9)-5, Q&A-7(A-7) acts as the filter and initially traps all the trust’s beneficiaries. If the trust only has individuals, known as “designated beneficiaries,” the oldest beneficiary’s life expectancy will create the ADP.⁴ However, a non-individual beneficiary, such as an estate or charity, will disqualify use of an individual beneficiary’s life expectancy even if the trust has one or more individual beneficiaries.⁵ This structure will likely reduce the ADP, accelerating payment of income tax.

A beneficiary with a contingent interest further complicates the filter’s operation. The regulation states that a beneficiary’s “contingent right” under the trust’s terms factors into the ADP’s determination.⁶ But, a different part of the regulation, specifically, Treas. Regs. Section 1.401(a)(9)-5, Q&A-7(c)(1), suggests that another contingency will exclude certain beneficiaries from consideration. 

The regulation’s text doesn’t explain the facts creating this contingency. Instead, it uses the term “mere potential successor” to identify an excluded beneficiary. The regulation and an accompanying example involving a trust that may accumulate IRA distributions only name an individual with a lifetime right to the trust’s income and primary remaindermen who take outright distribution at the trust’s termination. They’re the only beneficiaries the trustee must consider in determining the ADP.⁷ The regulation dodges the effect of a primary remainderman dying before taking outright distribution and a secondary remainderman succeeding to this interest.

If this sounds like entering a regulatory swamp, you’ve been warned. Since the effective date of the regulations (Jan. 1, 2003), the Internal Revenue Service hasn’t issued any authoritative guidance to clarify the meaning of a “mere potential successor.” The only insight comes from IRS private letter rulings, which can’t be cited as precedent.⁸ Analysis of several PLRs has concluded that the trustee must search for and count a secondary remainderman when a primary remainderman survives creation of the trust, but could predecease the lifetime beneficiary without satisfying the condition for outright distribution.⁹

Another PLR, obtained by my former employer, Wells Fargo Bank, casts doubt whether the trustee must consider a secondary remainderman. In the PLR, the IRS disregarded several secondary remaindermen as “mere potential successors” even though the beneficiaries entitled to outright distribution hadn’t satisfied the required conditions at the IRA owner’s death.¹⁰

The PLR states that the IRA owner died at age 59 survived by a child, two grandchildren and two siblings. His testamentary trust provides the child with a lifetime right to the trust’s net income. The child and grandchildren may also request discretionary distributions of principal during the child’s lifetime.   

The governing instrument then lists the conditions for outright distribution of the trust’s assets. The child must reach age 50. If not, then the grandchildren take outright distribution unless any are under age 21. In that event, the trust still terminates with a grandchild’s share to be held in a separate trust.    

If a grandchild dies before turning 21, the trust share passes to the estate. If all grandchildren predecease the child, who then dies before reaching 50, the IRA owner’s siblings take outright distribution. Finally, if the siblings are deceased, several charities step up as the outright beneficiaries.

The trustee sought the PLR to continue relying on the child’s lengthy life expectancy to calculate the annual RMD and avoid an alternative scenario with potentially devastating tax consequences. As the IRA owner died before the required beginning date,¹¹ another regulation would require complete distribution within five years after the IRA owner’s death (the so-called “5-year rule”).¹² The IRS would reach this result by deeming the child, obviously under 50, to have died immediately after the IRA owner, followed one minute later by the grandchildren who were under age 21. Their estates then take outright and immediate distribution of the trust’s assets, including accumulated and future IRA payments.¹³

After reciting the applicable regulations, the IRS found that the only beneficiaries the trustee must consider for purposes of measuring the ADP are the child and grandchildren.¹⁴ The IRS excluded the other beneficiaries as “mere potential successors.” 

Kembell’s article succinctly diagnosed the PLR’s problem: 

It’s understandable and unsurprising that the [child and grandchildren] must be considered.  What’s less clear is why the IRS deemed the [grandchildren’s estates] siblings and charities as ‘mere successor beneficiaries within the meaning of the regulations.’¹⁵

The comment highlighting the PLR’s lack of clarity calls out the regulations’ silence. But, the IRS left a clue. The phrase “within the meaning of the regulations” suggests the IRS may have relied on another source to break the regulations’ silence and explain the operation of the mere potential successor rule.  

The source, ironically, lies within Treasury Decision (TD) 8987, a document that published the regulations in 2002.¹⁶ The TD’s preamble, according to the IRS Internal Revenue Manual, “explains the rule.”¹⁷ Reviewing its explanation should uncover a regulation’s “meaning.” 

As shown in “Comparing Provisions,” p. 32, the text in the preamble’s “Explanation of Provisions” describes the conditions creating a “mere potential successor.” “Comparing Provisions” also includes a side-by-side comparison of the language of the applicable regulation and the TD’s preamble. The italicized language in the preamble doesn’t appear in Treas. Regs. Section 1.401(a)(9)-5, Q&A-7(c)(1), which mentions but doesn’t explain who’s a “mere potential successor.”¹⁸ The preamble does so by creating an “exception from the multiple beneficiary rules for death contingencies” that otherwise count to measure the ADP.  

The exception effectively creates a contingency that excludes beneficiaries falling under the mere potential successor rule. The preamble’s text sets its parameters. If a primary remainderman survives creation of the trust at the IRA owner’s death but should die before receiving outright distribution of its assets, the successor to this interest isn’t a beneficiary for purposes of measuring the ADP. Another commentator believes the IRS configured the regulation to avoid speculation whether a primary remainderman will live to take outright distribution and eliminate the need to consider default beneficiaries.¹⁹  

In everyday practice, a well-drafted trust includes secondary remaindermen. The TD’s preamble recognizes this omission from the applicable regulation and fills the gap by excluding them from consideration.²⁰  

Significance of Preamble

Unlike a PLR, a TD has universal application. The Internal Revenue Manual states a TD “is cited as legal authority and is binding on all taxpayers and the IRS, unless invalidated.”²¹ To my knowledge, the IRS hasn’t invalidated this part of the preamble to TD 8987.  

“Comparing Provisions” includes the complete text of the Internal Revenue Manual’s comment on a TD’s authority.  

Applying TD’s Language

At the IRA owner’s death, the TD’s preamble effectively lays out a three-part approach to analyze which beneficiaries the trustee must include to determine the ADP:  

• Identify the beneficiaries who survived the IRA owner.

• Focus on any conditions linked to a beneficial interest. 

• Segregate the beneficiaries who could only take an interest if another beneficiary should die before satisfying condition(s) to receive the interest.

Now, let’s apply this analysis to the hypothetical trust discussed in the article’s opening paragraphs. Assume all the named beneficiaries will survive the IRA owner.  The TD’s preamble considers the secondary remaindermen (an individual and charity) as “mere potential successors.” According to the preamble, they “could [only] be entitled to a portion of the [IRA, including accumulated IRA distributions held in trust] by becoming the successor to the interest of [another beneficiary] after that beneficiary’s death.”²² The trustee takes the remaining individuals, lifetime beneficiary and primary remainderman into consideration to measure the ADP.

Further Insight Into IRS Thinking

In the PLR, the IRS touched on the role of state property law in reaching its conclusion.  

This ruling expresses no opinion on the property rights of the parties under state law, and only provides a ruling on the impact of federal tax law on the specific facts presented.

A reasonable inference is that the IRS will look to the trust’s terms and ignore state law classifications of the beneficiaries’ interests to determine the ADP. Under state common and statutory law, a remainderman may have an unconditional (vested) right to complete distribution of the trust’s assets on the lifetime beneficiary’s death or a contingent right requiring satisfaction of one or more conditions.²³ 

Equally important, the preamble’s language confirms an implicit element of the regulations. The IRS has effectively created its own definition of contingencies a trustee must consider for purposes of determining the ADP. An includible contingency exists when the trust’s terms conditionally or unconditionally delay a primary remainderman’s access to the trust’s principal until the lifetime beneficiary’s death.²⁴ By contrast, an excludable contingency arises if a primary remainderman’s successor has no independent beneficial interest in the trust and takes solely due to the primary remainderman’s death. In the PLR, the IRS treated the grandchildren as primary remaindermen even though their interest in outright distribution depended completely on the child’s untimely death. The IRS most likely deemed the grandchildren’s interest to be independent of the child’s to be consistent with the regulations.  

PLR is an “Outlier”

The PLR’s exclusion of the secondary remaindermen has drawn criticism. The universally respected commentator, Natalie B. Choate, called it an “outlier that may represent a change of IRS policy or may just be an IRS mistake.”²⁵ The basis for the criticism is the IRS “ignored” the IRA owner’s siblings in determining the ADP if the child and grandchildren died before reaching the respective ages for outright distribution.²⁶

Viewed through the lens of the TD’s preamble, the PLR doesn’t reflect a change of policy. The status of the grandchildren’s estates, the siblings and charities as “mere potential successors” adheres to the preamble’s language. These beneficiaries have no independent beneficial interest in the trust’s assets.  

The IRS, however, did make a mistake by not integrating the preamble’s text into the regulation to define the term “mere potential successor.” The IRS could achieve this goal by issuing new binding guidance with examples that track the text of the TD’s preamble and highlight the beneficiaries who are “mere potential successors.”   

The probability of the IRS issuing this guidance long after the regulations’ release is low.²⁷ Nonetheless, the preamble’s text on which all practitioners may rely offers the opportunity to preserve a lengthy ADP even if the secondary remaindermen include an individual much older than the primary remainderman or an entity like a charity.  The alternative solution, seeking an expensive PLR to obtain this result, may now have less appeal.

Preamble Provides Explanation

The final regulations governing required distributions from retirement plans, including IRAs, left a deafening silence when a trust is the beneficiary. The regulations didn’t explain the effect on the ADP if a trust’s primary remainderman dies before the date when this beneficiary takes outright distribution of the trust’s assets, including accumulated and future IRA distributions and, under the trust’s terms, a secondary remainderman becomes entitled to this interest. 

The preamble to the TD that released the regulations supplies the missing explanation. A secondary remainderman has no significance in determining the ADP. 

Trusts with dispositive terms that follow the preamble will enable trustees to cite its binding authority on the IRS. This result should calm the drafter’s mind in preparing the trust’s governing instrument.                       

Endnotes

1. Emily Kembell, “Designating Beneficiaries for Retirement Plans,” Trusts & Estates (August 2017).

2. Treasury Regulations Section 1.408-8, Q&A-1 (an individual retirement account is subject to the required minimum distribution rules in Treas. Regs. Section 1.401(a)(9)-1 through Section 1.401(a)(9)-9 for qualified retirement plans).

3. Treas. Regs. Section 1.401(a)(9)-4, Q&A-5.

4. Treas. Regs. Section 1.401(a)(9)-5, Q&A-7(a)(1).

5. Treas. Regs. Section 1.401(a)(9)-5, Q&A-7(a)(2) and Section 1.401(a)(9)-4, Q&A-3.

6. Treas. Regs. Section 1.401(a)(9)-5, Q&A-7(b).

7. Treas. Regs. Section 1.401((a)(9)-5, Q&A-7(c)(1) (flush language); Treas. Regs. Section 1.401((a)(9)-5, Q&A-7(c)(3) Example One; the regulations also include a second example in which the trustee must distribute all IRA distributions to the lifetime beneficiary. As the trust can’t accumulate IRA distributions, it simply acts as a conduit, making a primary remainderman a “mere potential successor.” See Treas. Regs. Section 1.401(a)(9)-5, Q&A-7(c)(3), Example Two. Further discussion of the conduit trust exception to the mere potential successor rule is beyond the scope of this article.  

8. Internal Revenue Code Section 6110(k)(3) (private letter rulings may not be cited or used as precedent); the PLRs are:  200438044 (June 22, 2004), 200522012 (Feb. 14, 2005) and 20060026 (Dec. 13, 2005).  

9. Natalie B. Choate, Life and Death Planning for Retirement Benefits (7th ed. 2011) (Life and Death), at pp. 441-442; Natalie B. Choate, “IRA Mistakes and How to Fix Them: the 203 Best and Worst Planning Ideas for Your Client’s Retirement Benefits” (“IRA Mistakes”), 34th Annual Advanced Estate Planning Institute of the Cincinnati Bar Association (March 24, 2017), at p. 107.  

10. PLR 201633025 (May 18, 2016). For a detailed discussion of this PLR, see David S. Sennett and Brandon A.S. Ross, “‘Mere Potential Successor’ Can Cause IRA Payout Confusion,” Estate Planning (November 2017), at pp. 9-17.

11. Treas. Regs. Section 1.408-8, Q&A-3 (April 1 of the calendar year following the calendar year in which the IRA owner attains 70).

12. Treas. Regs. Section 1.401(a)(9)-3, Q&A-2 (the IRA must be distributed by Dec. 31 following the fifth anniversary of the IRA owner’s death). 

13. This analysis is based on the so-called “snapshot rule.” See Choate, Life and Death, supra, note 9, at p. 440. For an example applying the snapshot rule, see Natalie B. Choate, “Making Retirement Benefits Payable to Trusts,” 39 Annual UCLA/CEB Estate Planning Institute (April 2017), at pp. 43-46.

14. The Internal Revenue Service rationale: the child is “taken into account” as she receives the trust’s net income and “is entitled to a distribution of the entire trust if she attains age 50”; the grandchildren “are also taken into account as the trustee may make discretionary distributions of principal to them during the child’s life in addition to their contingent interest in the remainder of the Trust if the child dies before receiving full distribution of the Trust at age 50.”

15. Kembell, supra, note 1, at p. 49. 

16. Treasury  Decision (TD) 8987.

17. Internal Revenue  Manual (Manual) Part 32.1.1.2.5 (2018).

18. Interestingly, Treas. Regs. Section 1.401(a)(9)-5, Q&A-7(c)(1) as written in the 2001 proposed Treasury regulations included verbatim the first italicized sentence. The IRS moved this text from the final version of this regulation to the TD’s preamble.

19. See Gair Bennett Petrie, Price on Contemporary Estate Planning (2015 ed.), at p. 13,017 (“regulation did not speculate as to who would be default beneficiaries” (if remaindermen failed to survive the lifetime beneficiary)).

20. The trustee’s submission requesting the PLR didn’t refer to or cite the preamble to TD 8987.

21. Manual, supra note 17.  

22. Supra note 16.  

23. Sheldon F. Kurtz, Moynihan’s Introduction to the Law of Real Property (5th ed. 2011), at p. 159.

24. Treas. Regs. Section 1.401(a)(9)-5, Q&A-7(c)(3)(iii).

25. Choate, “IRA Mistakes,” supra note 9, at p. 109.

26. The PLR’s description of the siblings’ interest isn’t clear. The PLR states that if a grandchild dies before reaching 21, “[this] beneficiary’s share is paid to the beneficiary’s personal representative.” The actual terms of the trust give the siblings outright distribution if the grandchildren predecease the child who then fails to turn 50 or if the child and grandchildren don’t survive the IRA owner. The trustee in its PLR request offered the former scenario as an alternative ruling. The oldest sibling’s life expectancy would determine the applicable distribution period in the event the IRS rejected continued reliance on the child’s life expectancy. The IRS didn’t accept this alternative.

27. The American College of Estate and Trust Counsel has repeatedly asked the IRS to publish authoritative guidance to explain the “mere potential successor rule.” See Kembell, supra note 1, at p. 48.

Last March, Don came to see me with his daughter, Janna. We did his estate planning years ago. Everything was in order, in good shape.

But Don wasn’t. At 81, his frailties and dogged, worsening memory problems were getting the better of him. He fell a couple of times and knew he was “darn lucky” he didn’t break a leg or hip. Added good fortune: Each time he fell, he was near enough to friends so that he was able to get immediate assistance. Janna was terrified that the next time he fell, he wouldn’t be so lucky. 

Don was determined to stay at home, and while Janna preferred that he move to a senior community with support around him, she reluctantly agreed. Don accepted two hours of home care assistance each day, but no more. Janna worried about her dad. She desperately needed to find ways to make sure he was safe living on his own. She needed a way to stay connected and keep an eye on him in a non-intrusive way. Otherwise, she knew she wouldn’t be able to sleep at night.

More estate and elder law planning wasn’t going to keep Don out of a facility and safe at home. Don and Janna needed a different type of planning or, more accurately, a new type of technology-enabled assistance if his goals were to be achieved. 

Helpful Tools

Technology. Artificial intelligence (AI). Words that excite us. Words that scare us. Words and opportunities that offer hope to countless members of our client communities.

Many practitioners, not entirely without reason, fear that more powerful technology and AI will increasingly depersonalize our work efficiency¹ on behalf of clients like Don. This is particularly true when we explore the world of high tech and new tech tools that are perfect for Don and so many others who wish to stay at home. 

Before exploring new tools to keep Don safe at home, consider the fact that the next generation of clients—like Janna—are comfortable with technological  and AI-based services. They expect us to be similarly comfortable. They’ll reward those of us who position ourselves as trusted advisors who can address, in a multigenerational way,² their challenges comprehensively, beyond the legal realm.

There are many ways to accomplish this. Here, I focus on how we can help our clients and their children navigate and understand the myriad new technologies and AI-based tools that can empower them to age in place, at home, in a safer and less isolated way than has ever been previously possible. 

Aging in place is a goal for virtually everyone. According to AARP, 90 percent of seniors would like to stay at home as they age.³ Unfortunately, age-related declines in mobility, hearing, sight and mental capacity can make this difficult or unsafe. 

As indicated above, we can provide invaluable guidance to families as they look for solutions. We’ll ideally become aware of the new world of technologies that can help. We needn’t be experts, but we should offer information about different tools for aging safely at home. We’ll add them to our planning toolkits. Doing so can save clients immensely in caregiver expenses. It can help us to cultivate and maintain stronger, more lasting relationships with multiple generations of clients—just as I did with Don and Janna. 

Three Key Technologies

Here are three categories of key technologies, with some useful examples. I also offer three ideas for how to implement this information into your practice in ways that will help—and impress—your clients. 

In-Home and Remote Monitoring

Janna’s worry about her father’s health, and the possibility of another fall, is common. If he’s living at home without a caregiver, how will she—or anyone—know if he falls and can’t reach the phone to call for help? What if he forgets to take his medication? How can she be sure that he stays safe when no one is there? 

There’s a developing category of technologies and associated sensors that can help to solve this. Wearable technologies like watches or wristbands can help to alert loved ones if there’s a fall or other accident. Sensors on a refrigerator or cabinets can help to make sure there are no sudden changes in a parent’s daily activities and health. 

Some examples:

• Remote home access and video tools that monitor who’s coming and going from a home in a secure way, like the Ring Video Doorbell.

• Remote or wearable sensors or smartwatches that can detect or even predict when a fall or other health issue may be imminent, like the MyNotifi by Medhab, UnaliWear’s Kanega watch or SafelyYou’s wall mounted cameras and software algorithms.

• All-inclusive integrated sensor systems that can monitor an entire house for falls or other issues, like Alarm.com’s Wellness system.

Nothing, of course, is simple. Privacy is a major issue. How much monitoring is a parent willing to accept? A balance must be struck. However, these types of technologies can ensure that, in the event of an emergency, help can be on the way within minutes. They can also alert children and other loved ones to changes that warrant in-person check-ins. Paradoxically, seemingly intrusive monitors can allow a parent to live with greater autonomy and independence, without the need for round-the-clock in-person care.

In-Home Aids

Often, an inability to manage the house or to remember important or mundane tasks can result in the need for extensive in-home care or a move to an assisted living facility. In Don’s case, Janna was concerned about problems that she saw in his daily activities. He was forgetting to turn off the TV, heating the home excessively and forgetting to take his medication. He wasn’t keeping fresh food in his home.

Here, too, there are many new and existing tools that can address issues like those facing Don. 

Examples of these tools:

• Digital thermostats that can efficiently manage heating and cooling in a home without the need for daily management, including Nest Learning Thermostats, Ecobee4 or Honeywell’s Lyric. These can also be linked with full “Smart home” hubs.

• “Smart” refrigerators that can keep track of food storage and even automatically order groceries when needed, including the Samsung Family Hub.

• “Smart” pill dispensers that can help a user keep track of necessary medications with reminders and assistance, including the Medminder pill dispenser. 

• Remote light switches and electricity management tools that can efficiently and effectively control when lights are on or off, including the Wemo Light Switch. 

As I outline, there are many solutions available on the market that can help adult children to keep an eye on an elder parent and make sure help is alerted in case of emergencies. There are solutions to help manage a home and remind an elder to keep up with daily necessities. However, this can get overwhelming, and some of these solutions have been developed by startups that may or may not exist in the near future. 

Smart Home Hubs

How can a family effectively bring it all together in a simple way? Smart home hubs are one answer. Amazon’s Alexa and Google Home are the two most prominent offerings in this area. Because they’re primarily voice-activated, they’re easy and intuitive to use for even those who aren’t technologically inclined. Because they’re backed by two of the most powerful tech companies on earth—Amazon and Google—they’ll no doubt stand the test of time, and numerous developers and partners will work to create new systems and sensors that are compatible. 

These systems are also increasingly powered by AI. They’re getting better at understanding the nuances of verbal communication. They’re increasingly able to get to know their primary users and to effectively assist them. This is when AI can be most efficiently leveraged to help an aging parent. 

Because of this, I often recommend that families start with these systems or hubs. Many of the tools outlined above are already compatible with Alexa and/or Google Home. And, there’s no doubt that future systems will be, as well. Amazon also recently introduced Alexa Echo Show, which now includes a video screen to make video communication easier—another enhanced way for families to stay in touch with an at-risk parent.

Implementation 

Yes, this can all seem a bit overwhelming. How can we effectively advise our clients about these tools? How can we thereby deepen our relationships and enhance our role as trusted advisors to our clients and their families on a multigenerational level? 

Here are three ways you can address these challenges:

1. Add this to your client meeting checklist. When you meet with clients and their families about issues related to living safely and independently at home, make it a standard practice to bring up the idea of using these tools in the home. Create a basic handout —it can be as simple as a bullet point checklist—that offers an overview of specific types of tools that are available. 

The mere act of bringing this up in meetings enhances your position as a general advisor—beyond the legal realm. 

2. Offer client or community seminars about exciting new tools to help clients live safely and independently at home, longer. Urge clients to bring their adult children to the seminar.

Partner with a local technology expert, or even a merchant, who can speak knowledgeably about these new tools and how to implement them. 

3. Create a partnership with local experts, care managers or gerontologists who specialize in helping families in this area. Reach out to individuals in the community who appear to be offering such products or services. Get to know them. Vet them. Consider setting up a referral relationship with them. While you don’t need to be an expert and don’t necessarily have to give advice about these tools, your referral to a trusted third party will further position you as trusted advisor to clients and their families. Your local Alzheimer’s Association chapter, for example, will be thrilled to hear from you and know they have a supportive professional in the community. Look for a local chapter of Aging 2.0 (aging2.com), a wonderful, national organization that’s helping entrepreneurs develop new technologies for elders. 

Brave New World

It’s a brave new world we live in. Technology and AI are developing exponentially each year. As elders and their families face the challenge of remaining at home as health declines and frailty emerges, their need for expert guidance—legal and otherwise—is without limit. 

We must embrace progress. By expanding and enhancing our role as multigenerational trusted advisors and reasonably savvy home technology advisors, we can help countless members of our client communities remain at home. Isn’t that where we all want to age?   

Endnotes

1. www.popularmechanics.com/technology/robots/a18839164/ai-beats-human-lawyers-at-lawyering/.

2. See Mark R. Gilfix and Michael Gilfix, “A New Paradigm: Truly Multigenerational Planning,” Trusts & Estates (September 2015).

3. www.aarp.org/content/dam/aarp/livable-communities/learn/research/the-united-states-of-aging-survey-2012-aarp.pdf.

The modern family will encounter many significant issues as they age, not the least of which are wealth preservation and health care. We, as estate-planning attorneys, are positioned to counsel both individuals and families as they plan for and endure these distinct matters. While clients are concerned about both of these topics, there’s a division between the two. For example, those who are concerned about federal estate taxation are less concerned about accessing and paying for health care, and those who are focused on accessing and paying for health care aren’t as concerned about taxation. Interestingly we, as attorneys, also have a similar dividing line as to our practices. Those of us who select the wealth issues will generally build an estate planning and taxation practice, and those who focus on the health care issues will develop an elder law practice. Despite the division, there’s significant overlap between these two areas of law, for example, both involve real property, trusts, wills, agency, intestacy, capital gains taxation, asset protection, incapacity planning and, of course, family dynamics. But, there’s one distinguishing aspect or focus that simply delineates the two disciplines: wealth and health. The remaining non-shared areas are what separates and defines these wealth and health practices: estate accumulation and taxation for the estate-planning attorney and government benefits eligibility and long-term care (LTC) for the elder law attorney.

Elder Law

So, what exactly is “elder law”? The National Academy of Elder Law Attorneys (www.naela.org) put out a solid definition prior to expanding its mission to include special needs planning. NAELA defined elder law as “a holistic practice” and explained that an elder law attorney:

1. handles general estate-planning issues and counsels clients about planning for incapacity with alternative decision-making documents;

2. assists clients in planning for possible LTC needs, including nursing home care; and

3. helps locate the appropriate type of care, coordinating private and public resources to finance the cost of care and working to ensure clients’ rights to quality care.¹ 

Elder law itself can trace its roots back to 1965 when the Social Security Act was signed into law, creating both the Medicare and Medicaid programs. Medicare, as we still see today, is the health insurance program for the medical needs of the aged and disabled. Medicaid, on the other hand, was created as a medical and LTC program for those who are financially eligible only. As these programs evolved, it was the elderly that mostly used the Medicare program for their medical needs and the Medicaid program for LTC expenses. This was, in my opinion, not only the eventual beginning of elder law due to the need for attorney representation during government agency appeals, but also the birth of our current, divided health care delivery system.    

With regard to the elderly, Medicare provides benefits for acute medical needs, that is, primary care, hospitalization, prescription drug coverage and rehabilitation services. Medicaid, on the other hand, provides benefits for LTC, that is, assistance with chronic or custodial needs, such as the activities of daily living in both residential and facility settings.  

Two Systems

The result of this division is two separate systems for financing care: one for acute medical needs of the aged and disabled of all financial means and the other for the chronic, LTC health needs of the impoverished. Despite some well-intentioned federal and state attempts, we don’t as of yet have one government program for the financially stable that covers both the medical and chronic LTC needs of the aging population. This dichotomy translates into the two following potential scenarios:

1. A financially stable individual with above-average income who develops cancer has his acute medical needs met financially through his Medicare insurance.

2. That financially stable individual with the same above-average income developing Alzheimer’s disease has to privately fund the necessary chronic health LTC that he may need for the next 15 years.  

Generally, one has insurance coverage based on age, and the other may have insurance coverage based on a financial inability to pay. It appears that your client’s diagnosis determines whether he has medical insurance coverage or not. 

This dichotomy fostered the growth of the elder law field as the middle class primarily needed to employ attorneys to help them gain that sought-after financial eligibility for Medicaid should they be struck with a chronic, long-term illness versus a defined medical condition covered by Medicare.  

Paying for Chronic Care

As Medicare doesn’t have LTC benefits, there are three ways in which an elderly client can pay for his chronic care: (1) private payment with personal funds that can exceed $7,000 per month for home care or $16,000 per month for nursing home care in the New York metro area, (2) a robust LTC insurance policy that has both home care and nursing care benefits, or (3) by becoming financially eligible through divestiture for the Medicaid program. This divestiture is often accomplished through asset protection strategies involving gifting and irrevocable income-only trusts. The complexity of the Medicaid transfer penalties, combined with each state’s related law, can make for a very complicated and cumbersome eligibility attempt. In addition, should a care need arise prior to eligibility, a number of scenarios can greatly complicate the elder client’s needs in an LTC situation, for example, lack of pre-planning or a crisis medical event or even diminished capacity, none of which fit nicely into the typical acute medical model that’s familiar to all of us: illness, doctor visit, hospitalization, medication and recovery process. The chronic, long-term patient, however, may follow this typical medical model trajectory but a complication with a chronic issue such as dementia will certainly derail the best efforts of the most willing clients, doctors and caregivers. 

Can we assume, therefore, that because we have two types of patients and two types of financial payment systems, we also have two independent models to deliver the necessary care? Unfortunately, the general answer is no. The above timeline I referenced of illness, doctor visit, hospitalization, medication and recovery is, in the LTC context, usually extended to include rehabilitation placement and then discharge with short-term intermittent home care or placement assistance if an LTC nursing facility is ultimately needed. This cycle can occur for years, usually leaving the elder and family confused and frustrated, as these chronic illnesses often don’t fit into nice, black and white boxes as easily as an oft-predictable medical condition might.

Inadequate Model 

I’ve seen in my practice over the last 20 years that the medical model of care generally isn’t adequately equipped to assist the elderly client suffering from long-term chronic issues such as Alzheimer’s disease, depression and Parkinson’s disease. As such, there are deficiencies in the current medical model of care, that is, a lack of care coordination and active follow-up and patients and caregivers being inadequately trained to manage illnesses. In essence, an acute care medical model is neither designed to support the elderly client in the day-to-day self-management of his chronic illnesses nor to coordinate or advocate for good chronic illness care on an ongoing basis.² A helpful way to visualize the differences is that the care needed under the medical model is usually received in medical facilities, such as the doctor’s office, hospital or rehabilitation facility, and there are set protocols for the health care team, the patient and the caregivers to follow, whereas the chronic, long-term patient and her caregivers may face their toughest challenges outside of those trusted medical environments and in between those visits. 

Through the years, there have been noble attempts by federal, state and private initiatives to improve the chronic care delivery system, most notably, The Chronic Care Model as developed by the Improving Chronic Illness Care Initiative. This model calls for the transformation of health care from a system that’s reactive —responding mainly when an individual is sick—to one that’s proactive and focused on keeping an individual as healthy as possible. The goal of this model is to have an “informed, activated patient” working with a “prepared, proactive practice team,” and between the two, there are “productive interactions” that result in “improved health outcomes.”³ To achieve this, the delivery of chronic care services will require:

• A systematic approach to emphasizing self-management;

^• Care planning with an inter-disciplinary team;

• An emphasis on ongoing assessment and follow-up; and 

• A proactive focus on keeping an individual as healthy as possible no matter where she lives (home, assisted living or nursing home facility).⁴ 

Chronic Care Issues

As the U.S. population ages, the number of people needing LTC and chronic care services will rise. On average, according to AARP, 52 percent of individuals who turn 65 years of age today will develop a severe disability that will require LTC services for a period of approximately two years.⁵ Due to the complicated, unknown paths that these chronic illnesses may take, chronic care raises a tremendous amount of issues best summarized by these three questions:

1. How does a client get the best quality care no matter where he’s living and thereby maintain or improve the quality of life?

2. How does a client access all benefits available and understand which coverage or benefit pays for which service?

3. How does a client protect the maximum resources and income so that expensive LTC costs don’t consume life savings, thereby allowing for provision of a spouse and children if necessary?⁶ 

Three Business Models

I’ve found there are three different business models that  elder law attorneys can use in their practices to assist families with these issues.  

Medicaid planning attorney. This model focuses on asset protection and applying for Medicaid benefits. In this fee-for-service transactional model, the attorney will undertake the legal and financial work, while the family will cobble together their own health care team of care managers and advocates to assist with the numerous care needs. This attorney only answers the third question above.

Elder law attorney. Here, the attorney will undertake the asset protection and Medicaid benefits like the Medicaid planning attorney, but she recognizes that the need for care interventions, coordination and care is a driving force and will therefore refer the family to a non-attorney business that offers care management and advocacy services. The result is that this attorney is still only answering the third question but has referred the family to an outside service that will help with the first two questions. This is also a fee-for-service, transactional model, in which the law firm only undertakes the legal and financial aspects.

Life care planning. In this model, the elder law firm answers all three questions. The focus of the practice is primarily the elderly client’s care needs and secondarily, the assets. Life care planning is an innovative and “holistic, elder-centered approach to the practice of law that helps families respond to every challenge caused by chronic illness or disability of an elderly loved one.”⁷ A life care plan model is different from the other two models in three ways: (1) a life care plan is generally for a period of time such as one year versus a singular transaction that allows the firm to work with the family through the unknown twists and turns that their loved one will undoubtedly face; (2) life care planning is interdisciplinary, which means a care advocate will be on staff working under the attorney’s supervision. This allows for a unified approach to the law and care goals; and (3) life care plan engagements are usually all-inclusive in nature so as to be able to assist the elderly client and family no matter where the care needs lead them. For example, the firm can assist with bundled services, such as estate planning and asset protection, the financial and medical eligibility for Medicaid programs for both home care and nursing home care and LTC navigation, advocacy, coordination and support.⁸ 

The life care planning model of practice was developed in the 1990s by Tennessee elder law attorney Timothy L. Takacs as a way to assist elder clients in navigating their way through their chronic care needs. As other law firms began to also use this model, the need for support, resources and guidance grew and resulted in the creation of the Life Care Planning Law Firms Association (LCPLFA). Life care planning law firms use a tool called the “Elder Care Continuum” to help families understand the natural progression of aging and its impact on a loved one’s health, mobility, housing and financial resources.⁹ (See “The Elder Care Continuum,” this page.)

While the other two models of practice generally focus on saving the elder’s money to pass on to the next generation, the LCPLFA website states that:

Life Care Planning focuses on using the elderly client’s money for the elder’s benefit. In a Life Care Planning law firm, an inter-disciplinary team of elder law attorneys, care coordinators and others work together to develop an estate plan, protect assets, qualify for public benefits, coordinate care, provide education and decision-making support, advocate for high-quality care and intervene if there are problems with care providers.¹⁰    

I believe that to create a prepared, proactive practice and still focus on the legal aspects of the engagement, the elder law attorney should have the care component in-house. That need is fulfilled by a geriatric professional, such as a social worker, registered nurse or other geriatric health professional who can step into that advocacy role and guide the client and caregivers. The role of this elder care coordinator is to help clients and families identify care problems and assist in solving them, assist families in identifying and arranging in-home help or other services and review medical issues and offer referrals to other geriatric specialists. It’s primarily through the elder care coordinator’s efforts that the client is truly supported through her chronic care journey. 

True Evolution

As a practice, the organic growth of elder law has been a true evolution born of the pre-existing discipline of estate planning and then matured through legislative entitlements and the resulting quagmires and finally compounded by the harsh realities of aging, illness and the financing of the care. Benjamin Franklin has been quoted as stating that “in this world nothing can be said to be certain, except death and taxes” and not only is it true to this day, but also, we know that estate-planning attorneys are well-positioned to help with both. However, before death often comes illness, and the elder law attorney will always be there to guide and assist his aging clients through some of the toughest times they’ll ever face. Gratefully, the business of elder law, just like the hardiest of my clients, shows no signs of slowing down. See “For More Information,” this page, for additional resources available to attorneys.   

Increasingly, older adult couples are choosing to cohabitate without getting married. A recent study shows that roughly one quarter of the nation’s cohabitating couples are individuals over the age of 50.¹ The majority of these individuals have been married before. The reasons for choosing not to get married vary widely, but it isn’t uncommon for older adults to remain single to avoid negative consequences such as forfeiting a survivor’s pension or health insurance. While the choice to forgo marriage for many is logical prior to the need for long-term care (LTC), the choice not to marry can make paying for LTC and asset protection planning to pay for LTC costs challenging.

Early Planning

It’s critical for all planners, including elder and special needs law attorneys, to consider all methods of planning for LTC and asset protection for unmarried couples. Ideally, couples and their professional advisors begin thinking about the potential need for LTC well before either party develops a chronic illness and long before the need arises. The unmarried couple planning early may work with their financial professional and attorney to develop a financial and legal plan that allows both parties to self-insure. This requires careful planning, saving and investing; however, early planning may make this possible. Another asset protection option that requires early planning is for one or both parties to consider the purchase of an LTC insurance policy. An appropriate LTC insurance policy means that the couple will be able to pay privately, and the assets of either or both aren’t affected by the need for LTC. If there’s a disparity of wealth between partners, then the wealthier partner may choose to purchase an LTC insurance policy for the less well-off partner simply to avoid the issues that come with planning for public benefits later. 

Later Planning

Unfortunately, many couples (married or unmarried) don’t consider the need and high cost of LTC until it’s too late to either purchase an LTC insurance policy or accumulate the wealth necessary to self-insure. In such instances, many look to public benefits to assist with the payment of LTC expenses.  

In contemplation of the need for a spouse remaining in the community (the community spouse) to maintain some income and assets so as to not be completely impoverished (and likely dependent on additional public benefit programs), Medicaid policy provides for certain protections. These protections include exempting a certain amount of the couple’s countable resources, the amount commonly referred to as the “community spouse resource allowance” (CSRA).² In addition, Medicaid will allow a monthly contribution of income from a Medicaid-eligible spouse living in a nursing facility to his community spouse. This is known as the “minimum monthly maintenance needs allowance” (MMMNA).³ Also, transfers between spouses aren’t considered uncompensated for Medicaid purposes.⁴ Above and beyond that which Medicaid allows, elder law practitioners have a number of strategies that can protect almost all of a married couples’ assets and have at least one spouse become eligible for Medicaid benefits. Unfortunately, these same protections aren’t available to unmarried cohabitating couples, regardless of the length of the relationship, how intertwined the couples’ finances are or how dependent one partner may be on the other for financial support. This failure of Medicaid policy to allow for such protections may seem counterintuitive because deeming rules apply to couples who are “living together in the same household and holding themselves out as a married couple to the community in which they live.”⁵ Yet, no protection or allowance is made for similarly situated unmarried couples who need LTC, regardless of how their finances are managed.⁶ 

Because there are no protections built into Medicaid policy for unmarried couples, elder law practitioners must approach public benefits planning differently than they would for a married couple. They could advise the couple to get married. There’s no length of time a couple must be married for the community spouse to be allowed to keep the CSRA and be entitled to the MMMNA. In addition to the spousal protections afforded by Medicaid, the home would be exempt so long as the community spouse resides there, and certain strategies like the name on the check rule could be used.⁷ Getting married has the added advantage of allowing unlimited transfers into the name of the community spouse without penalty. Ultimately, the plan must be agreeable to both parties, and there are additional considerations like capacity to marry, inheritances and children from previous relationships, but the marriage of the parties can make planning to protect the community spouse much easier.

Irrevocable trusts. If the couple is considering the cost of LTC at a time when it’s too late to purchase LTC insurance or to amass the necessary savings to self-insure, but when the need for care is years away, the couple can create irrevocable trusts and contribute certain assets to the irrevocable trust or trusts. When properly drafted, the transfer of assets to the trust is considered an uncompensated transfer that may leave the grantor ineligible for Medicaid for a period of up to five years.⁸ However, the assets held in the trust are considered exempt for purposes of Medicaid eligibility. Irrevocable trusts for public benefits planning may take several forms; however, they may be drafted such that the grantor retains the right to income distributions. In circumstances in which the assets are income-producing and it’s the income necessary to maintain the couples’ lifestyle or is necessary so that one partner may remain in the community, then the grantor may make both himself and his partner beneficiaries of the income, allowing either of them to remain independent in the community even after one has a need for LTC and Medicaid benefits. In addition to liquid assets, real property can be transferred into the trust and a lease agreement executed with the trustee that allows the partner remaining in the community (the community partner) to continue to live in the property. The irrevocable trust plan has the added benefit of ensuring that the assets pass to the desired heirs of the grantor at the appropriate time. The grantor may provide that remaining trust assets pass to desired heirs at the death of the grantor, or the grantor may have assets continue in trust for the benefit of the remaining partner and then pass at the remaining partner’s death.  

Transfer of assets. Still another option, which is only logical if it’s clear which partner will have the need for LTC benefits, is to transfer assets from the partner needing care and benefits to the other. While this transfer would be considered uncompensated and leave the transferring partner ineligible for Medicaid benefits for a period of time up to five years, the assets would be exempt for Medicaid eligibility purposes because Medicaid wouldn’t examine the assets of the community partner. While this is a simple strategy, it leaves the assets transferred to the community partner vulnerable should the community partner later need assistance in paying for nursing care and would leave the transferred assets subject to the estate plan of the community partner. This may result in the unintentional disinheritance of individuals for whom the first partner intended to benefit. Another possible option that gives the transferring partner more control over the ultimate disposition of the assets is for each partner to create reciprocal third-party special needs trusts naming the other partner as the beneficiary for his life and then ultimately disposing of the assets to whom the grantor intended at the death of their partner. When considering such strategy, it’s prudent to make the trusts different enough such that the reciprocal trust doctrine wouldn’t apply. Simply leaving the ultimate disposition to different beneficiaries may be enough to alleviate any concern.

Reverse half a loaf plan. Should unmarried couples not have sufficient time to wait out the penalty period of up to five years, they could implement some version of a reverse half a loaf plan. In that plan, assets are transferred to a third party, in this case the community partner, a Medicaid application is then filed and a penalty period is assessed. Depending on state law, one version of the reverse half a loaf requires the income of the institutionalized partner to be paid to the facility, and any deficit is paid from the gifted funds. After a calculated period of time, the initial gift is effectively reduced, and a second Medicaid application is filed. At the filing of the second application, the Medicaid agency will evaluate the net gift and determine that the relevant penalty on the net gift has already run. The result is that the community partner will still maintain a portion of the institutionalized partner’s assets, which can then be used to supplement the institutionalized partner’s care and assist in supporting the community partner. Another version of the reverse half a loaf is one in which a smaller amount is transferred to the community partner, and some of the institutionalized partner’s assets are used to purchase a Medicaid-compliant annuity which, when combined with the institutionalized partner’s income, is almost sufficient to cover the monthly cost of care. Any shortfall may be supplemented by the assets held by the community partner.

Crisis Strategies

Other and more specific and targeted asset protection strategies may also be implemented. If the partner needing nursing care is the owner of the primary residence, the residence can’t be transferred to the partner remaining in the community without a transfer penalty. However, the partner owning the property can sell a remainder interest in the real property to the community partner. A life estate is exempt for Medicaid eligibility purposes for the institutionalized partner, and the sale can be structured such that the purchase price is financed with a promissory note that meets necessary Medicaid requirements.⁹ So long as the note payments don’t increase the income to beyond acceptable state limits, the partner in the nursing facility can become Medicaid-eligible, while the community partner can maintain the home. If this strategy is implemented,  carefully consider the ultimate disposition of the real estate. If the estate plan of the partner in the nursing facility would leave the property in a different manner, then consideration must be given to the estate plan of the community partner. 

Statement of intent to return home. If the institutionalized partner owns the home and the community partner lives in the home but doesn’t have the liquidity to purchase the home or a remainder interest in the home, then in many states, the institutionalized partner may sign a statement as to his intent to return home.  This causes the real property to remain non-countable for purposes of the institutionalized partner’s Medicaid eligibility. Additionally, the institutionalized partner may consider giving or selling a small percentage interest in the home (perhaps even as small as 1 percent). It has the added benefit of allowing the community partner to live rent-free in the home and to use his income to pay for utilities and maintenance expenses. These payments are critical because many states don’t allow home maintenance expenses to be deducted from the required co-pay to the facility while the individual is eligible for Medicaid.  

Purchase of life estate. Similarly, if the community partner is the owner of the property and the partner entering the nursing facility has excess countable liquid assets, then the partner entering the nursing facility can purchase a life estate in the home of the community partner. The life estate interest is exempt for Medicaid eligibility purposes, and the transaction isn’t considered an uncompensated transfer if the institutionalized partner lived in the home for one year because the partner living in the facility received an asset of value in exchange for the cash payment.

Still further options are to have the partner entering the nursing facility purchase items that can be titled in his name and are exempt for Medicaid eligibility purposes, but that can be used for the benefit of the community partner. Vehicles or burial plots are examples.

Undue hardship exception. Another option to protect real property by making it an exempt asset is to use the exception that exempts property whose sale would cause undue hardship for the other owner.¹⁰ This is useful if the couple owns the property jointly. Presumably the other partner is residing in the home. The couple can demonstrate the hardship by showing that moving would be physically difficult for the community partner due to age or medical condition. Income, the lack of a paying job (when appropriate) and the difficulty in obtaining a new mortgage, lack of additional assets and other financial factors can further be used to demonstrate hardship.

Care agreement. A strategy to protect and transfer liquid assets may be to have the partner in need of care make payments to the healthy partner to provide care. Such payments need to be made pursuant to a care agreement that’s valid pursuant to state law and meets the requirement of the state Medicaid plan. Typically, such agreements must specifically state the services to be provided and the location of such services, as well as outline the amount to be paid for the services. The caregiver/partner will be required to keep track of his time caregiving as well as the services provided. Most practitioners suggest that the arrangement be evaluated to determine if the caregiver is an independent contractor or household employee as required by the Internal Revenue Service, and either a 1099-MIS may be issued or payroll will need to be established and a W-2 issued at the end of the year. If the arrangement appears to be more of an employer/employee relationship, payroll can often be established using a local accounting firm or bookkeeper, or there are online companies that will establish payroll and make necessary income tax withholdings and payroll tax.

Domestic partnership agreement. California state courts will recognize a registered domestic partnership agreement. These agreements establish the financial terms and responsibilities for unmarried couples and can include how property is divided in the event of a separation and the agreement to provide support. If one of the partners (presumably the wealthier partner) has agreed to provide financial support in the event of separation to the other partner and it’s the supporting partner needing care, then it appears as if the partner in need of support may pursue court action for the agreed on support. As with other court orders, should the court order support, then it’s binding and won’t cause a transfer penalty for Medicaid purposes and may establish a stream of income that must be paid to the community partner much like the MMMNA. At this time, only California recognizes registered domestic partnerships between unmarried heterosexual couples, but other states may follow suit.

Variety of Factors

While asset protection planning and LTC planning for unmarried couples can be challenging, they’re not impossible. The strategy chosen will depend on the age, health, earning capacity and family situation of both partners. Early planning may result in private payment through either LTC insurance or self-insuring. Later planning may require the use of trusts and the contemplation of uncompensated transfers. Crisis planning may require creative purchase and sale strategies.  Regardless of wealth or timing, the practitioner will be able to find a solution to assist unmarried couples in their asset protection and LTC planning that will leave both partners protected and cared for.                      

Endnotes

1. Renee Stepler, “Number of U.S. adults cohabiting with a partner continues to rise, especially among those 50 and older,” Pew Research Center (April 6, 2017), www.pewresearch.org/fact-tank/2017/04/06/number-of-u-s-adults-cohabiting....

2. 42 U.S.C. Section 1396r-5(c).

3. 42 U.S.C. Section 1396r-5(d)(3).

4. 42 U.S.C. Section 1396r-5(f).

5. SI501.50.

6. “Deeming” is the concept that another person’s income and resources are available to pay for food and shelter costs for an individual who’s eligible for supplemental security income (SSI) purposes. With the exception of a few states, eligibility for SSI results in immediate eligibility for Medicaid.  

7. 42 U.S.C. Section 1396r-5(b). The “name on the check” rule is the policy that attributes income payable to a certain individual to be solely the income of that individual. Thus, if the individual retirement account of the institutionalized spouse is paid to the community spouse, then the annuity payments are considered to belong to the community spouse rather than the institutionalized spouse. This often allows a couple to protect the entirety of a qualified retirement plan despite the ownership of the plan.

8. 42 U.S.C. Section 1396p(c).

9. POMS Section SI1110.515.

10. POMS Section SI 1130.130.

Claims of undue influence are on the rise. More wills, testamentary gifts and inter vivos gifts are challenged as being void because of undue influence. The increase is due in part to more individuals writing wills and making significant gifts at later ages. Put bluntly, the older the testator or donor, the more likely that he suffers from loss of memory or dementia. With more testators and donors being age 80 or older, more will have memory deficits or dementia, and more wills and gifts will be challenged. Although a decline in memory or even dementia isn’t conclusive evidence of undue influence, it does create possible grounds to challenge the validity of testamentary or inter vivos gifts. 

Undue influence is also more often triggered because older testators and donors mean older legatees and older donees, in particular, older children. These older testators or donors often make bequests and gifts that aren’t equal among the children or grandchildren. For example, when a 40 year old writes a will, he’s likely to name his three children, ages 10, seven and five, as equal beneficiaries. The same person at age 80 will have children ages 50, 47 and 45 and, in light of the children’s circumstances, may not leave them equal shares. The child on his third marriage may be left less. The child who has a special needs child may be left a greater share of the estate. And, the child who has alcohol dependency issues may be left a share in trust with any benefits contingent on keeping sober. An unequal bequest is more likely to be challenged on grounds of undue influence.

Second marriages and later life marriages are also fertile grounds for claims of undue influence. Bequests to a spouse of a later life marriage are frequently challenged by the children of the earlier marriage. Even an equal distribution doesn’t ensure that no claim of undue influence will be made as disgruntled descendants sue to get what they believe is rightfully theirs.

How to Prove

A successful claim of undue influence requires proof of all the elements, which vary somewhat from state to state in part because some states have statutes that define undue influence while others rely on common law. Even states that use the common law have different ways of defining undue influence. However, all states define undue influence as occurring when a will, a specific bequest or a gift represents the will of the influencer and not that of the testator/donor.

Generally, although not always stated as such, four elements must be proved to successfully maintain a claim of undue influence: (1) the testator/donor was susceptible to the influence of others; (2) the testator/donor and influencer had a confidential relationship;
(3) the influencer used that relationship to effect a change in the distribution of property in the will or gift; and (4) the change didn’t express the desires of the testator/donor or, as some courts state it, was unconscionable. Although not a required element, most claims of undue influence allege that the testator/donor had diminished mental capacity and so was susceptible to being unduly influenced.  

Burden of Proof

States also vary in who has the burden of proof. The Restatement (Third) of Property Section 8.3 places the burden of proof on the party claiming undue influence. Many states apply this rule on the basis that because a testator/donor is presumed to have mental capacity, the undue influence, just as with a claim of incapacity, must be proven. Other states create a rebuttable presumption of undue influence that the alleged influencer must overcome if it’s been shown that the alleged influencer was in a confidential relationship with the testator/donor.

Recent Court Decisions

The great majority of undue influence cases are decided by the facts with very few being considered by the state’s highest court. There have been, however, a few state Supreme Court cases decided recently that reviewed the elements and the law of undue influence. 

The Montana Supreme Court considered whether a claim of undue influence was proven when a mother transferred the majority of the shares in a company that owned the family farm to one son at the expense of another son.¹ The court held there was no undue influence despite expert medical testimony that the mother suffered from dementia and despite the fact that the son who was benefited was found to have a confidential relationship with his mother. The court held that the evidence presented was mere suspicion of undue influence. What was required was a showing of specific acts of undue influence to meet the burden of proof. The court didn’t articulate what kinds of acts prove undue influence. Apparently, the mere act of encouraging the transfer wasn’t in and of itself sufficient proof of undue influence. 

What’s noteworthy is that the court cited the independent reasons that the mother had for making the gift, including divesting the company stock to avoid it being liable for nursing home care. Apparently, the mother engaged in Medicaid planning by reducing her assets by making a gift and hoping not to need to apply for Medicaid for at least five years, thereby avoiding the penalty period for gifts. The lesson is that when making gifts with an eye towards protecting assets when later applying for Medicaid, the parties should consider a possible challenge to the gifts based on a claim of undue influence.

The Virginia Supreme Court was asked to decide whether a party appointed in a will as a trustee could be found to have engaged in undue influence in order to have been named as trustee.² The decedent executed a will and a revocable trust. Both were drafted by his brother. The trust appointed the brother as trustee on the death of the settlor. The brother wasn’t a beneficiary of the will and had no rights of distribution under the trust. As trustee, however, he was allowed fees. He was also the executor under the will and so was entitled to compensation. The decedent’s wife, who claimed the brother had engaged in undue influence, argued that the brother not only would be compensated but also that he had discretion as trustee over distributions from the trust, which would allow him to potentially distribute trust assets to his own children. 

The court held that such uncertain and contingent possibility of a future benefit didn’t make the brother a beneficiary. Although the brother was in a confidential relationship, he didn’t procure the execution of a will or trust that favored him. The latter was necessary to create a presumption that he’d engaged in undue influence and so placed the burden of proof on him to overcome the presumption of no undue influence. 

The Mississippi Supreme Court determined that a holder of a power of attorney (POA) could be found to exercise undue influence when she amended certificates of deposit (CDs) by naming her children as co-owners.³ An adult daughter was her mother’s agent under a financial POA. She was also her mother’s caregiver. The daughter used the power to delete named owners from the CDs and replace them with her own daughters, the grandchildren of the mother. The deleted owners sued to overturn the change. The court found that because the mother’s name was also on the CDs, the change of names wasn’t a completed gift and so couldn’t be
challenged under the undue influence doctrine.

Instead, the court found that the daughter had exercised undue influence in her capacity as agent when she used her authority under the POA to change the names on the CDs. The court found a confidential relationship between the mother and the daughter, which created a presumption of undue influence that the daughter failed to rebut. Unlike many states, Mississippi doesn’t hold that a POA in itself creates a confidential relationship. However, the court found that a confidential relationship existed because the daughter served as her mother’s caregiver and had a close bond with her. The mother’s reliance and dependence on the daughter created a fiduciary, confidential relationship. Nevertheless, the presumption of undue influence requires more. In this case, the daughter’s use of the POA to benefit her own children when in a confidential relationship was an abuse of the relationship that created a presumption of undue influence.  

The court went on to state that if the daughter could show that she acted in good faith, she could overcome the presumption that she’d engaged in undue influence. She couldn’t, however, because the daughter never consulted her mother about the changes that the daughter made in secret. The court concluded that the daughter had failed to show by clear and convincing evidence that she had rebutted the presumption that her acts had constituted undue influence. 

The Mississippi case is notable for applying the doctrine of undue influence to overturn the acts of an agent acting under a POA. The case also highlights the importance of who has the burden of proof in a case involving a claim of undue influence. Finally, the requirement that the individual accused of undue influence had to overcome the presumption by clear and convincing evidence, and not just by a preponderance of the evidence, underscores the importance of who has the burden of proof.   

Endnotes

1. Larson v. Larson, 406 P.3d 925 (Montana 2017).

2. Kim v. Kim, 807 S.E.2d 216 (Va. 2017).

3. Johnson v. Johnson, 237 So.3d 698 (Miss. 2017).

It’s now possible to establish here in the United States, a non-charitable private foundation (NCPF), an entity that was heretofore reserved for select jurisdictions outside the United States. At the moment, however, you may only establish such an entity in one state, New Hampshire, which, in mid-2017, adopted the country’s first NCPF law.¹ Is this a small step for a state and a giant leap for U.S. estate planning? Or, is it merely an awkward attempt to go where no state has gone before?  

When you think about it, here in the United States, we have only one basic vehicle for estate planning—the trust. Sure, we have limited liability companies, corporations and the like, but they don’t provide anywhere near the opportunities for the same long-term family and tax planning, creditor protection and estate distribution that we have with trusts. Numerous commentators (myself included) have repeatedly observed that the trust is the most flexible document in an estate plan. And, we know that trusts are used the world over—or are they? While the answer is generally yes at present, it’s only recently from a historic standpoint that many civil law jurisdictions have recognized the trust,² which originated in a common law jurisdiction. So, what did they do before that? Most of them used NCPFs.

NCPFs vs. Trusts

The NCPF isn’t established to benefit the public, and thus, its terms are strictly private. It’s almost as common in those civil law jurisdictions that use NCPFs as trusts are in common law jurisdictions. NCPFs, like trusts, are typically established to hold family wealth for the benefit of a family. From there, however, the similarities fade. While a trust is a relationship between the trustee and the beneficiaries, with the trustee owing an affirmative fiduciary duty to the beneficiaries, the NCPF is a separate legal entity managed by directors, in which the directors owe a duty primarily to the NCPF itself and only secondarily, if at all, to the beneficiaries.³ While a traditional common law trust would fail for lack of beneficiaries who have the inherent right to enforce the trust, an NCPF could be established with no beneficiaries, or it could be structured so that, depending on the jurisdiction, the beneficiaries have very limited or no rights. Further, many civil law jurisdictions don’t recognize any fiduciary duty (other than good faith) between the directors of the NCPF and its beneficiaries.⁴ For this reason, many practitioners believe that the NCPF offers more creditor protection than a trust.  

The Act

For U.S. estate-planning attorneys, except for those who are active in international estate planning, all of the foregoing may be academic, because up to now, no U.S. state would recognize the NCPF. However, we now have one state that’s adopted NCPF law, so the questions arise: What’s it all about, and how can we use it? The New Hampshire Foundation Act (the Act) permits the establishment of an NCPF which, as in the foreign jurisdictions, will be a separate legal entity, not dependent on the existence of any beneficiaries, so long as it has a purpose.⁵ For some reason, however, the apparent intention of the New Hampshire legislature wasn’t to create a statute that, if followed as is, allows the formation of an NCPF of the type used in the civil law jurisdictions. Instead, as explained below, the statute seems to result in the formation of an entity that, for all practical purposes, would operate as a trust, cloaked in a legal entity called an NCPF. For example, if we were to form an “off-the-shelf” New Hampshire NCPF following the statute as drafted, we would have an NCPF that the directors have a duty to manage “solely in the interests of the foundation’s purposes and the beneficiaries’ interests,” along with duties of impartiality, prudence, as well as duties to keep the beneficiaries reasonably informed and to maintain records.⁶ Sound like a trust?

The strange thing about the Act is that it allows every one of the foregoing duties to be eliminated by providing in the bylaws that there will be no such duties on the part of the directors. This is because every one of the foregoing duties is preceded by, “unless the governing documents provide otherwise.”⁷ The only duty that you can’t override is the duty of good faith.⁸ For example, the directors may keep sloppy records, or even no records at all, so long as they do so in good faith. In addition to the statutory duties to the beneficiaries, the Act allows a beneficiary to challenge any action taken by the NCPF.⁹ This could be comparable to a beneficiary’s right under a trust, and the Act doesn’t allow this right to be removed by the bylaws.  

Interestingly, then, we can eliminate virtually all of the directors’ duties, and the beneficiaries would still have the right to challenge the directors’ acts. But, if we eliminate the duty of prudence, the duty of impartiality, the duty to keep records and the duty to keep beneficiaries informed, and yes, even the duty to manage the NCPF in the interests of the beneficiaries and the NCPF’s purpose, on what basis could the beneficiaries sustain a challenge since there are no duties (other than the duty of good faith, but as to what)? Perhaps such an arrangement is unlikely to occur, but why is the Act drafted in such an odd manner? 

Similar to the default duties, are the default provisions for the “reserved” powers of the founder?¹⁰ Once again, we see the default phrase “unless the governing documents provide otherwise,” and the section goes on to provide that the founder will be held to have retained extensive powers over the trust, whoops, I mean NCPF, including the power to amend or restate the bylaws, dissolve the NCPF, remove and replace directors and direct distributions.¹¹ In effect, these powers, together with the default duties mentioned above, would make the NCPF almost the exact legal equivalent of a revocable trust, and if that’s what we want, why are we messing with an NCPF?

The traditional civil law foundation is one established by an individual with some wealth that she wishes to place in a vehicle that will accomplish her wishes for herself and her family’s benefit, but with minimal interference from descendants or other relatives after her death and minimal interference from creditors. She wants it to continue that way for generations. Although most jurisdictions allow beneficiaries limited rights to information and standing to address a breach of duty (to the NCPF, not to themselves)—the beneficiaries generally have no rights to interfere with the management of the NCPF or the discretion of the directors.¹² To accomplish this with a New Hampshire NCPF, the bylaws would have to be drafted to negate almost every duty of the directors and most powers of the founder. Further, it should be noted that it isn’t clear whether the duty in a given case could be split. That is, instead of deleting the duty to act “solely in the interests of the foundation’s purpose and the beneficiaries’ interest,”¹³ could we say, “solely in the interests of the foundation’s purposes?” If so, perhaps that would allow us to get much closer to a real NCPF.

And, speaking of purposes, the Act provides that the NCPF must have a purpose,¹⁴ though it needn’t have any beneficiaries. One of the essential requirements for an entity or a trust that’s established for a purpose rather than for a beneficiary is that there must be some provision for the oversight or enforcement of the purpose if the directors or trustees aren’t complying with their obligation to carry out the purpose. Thus, every jurisdiction that recognizes the purpose trust or purpose NCPF mandates that the governing document contain provisions for the appointment of an enforcer.¹⁵ The Act contains no mention at all of the requirement of an enforcer in such a case, meaning that unless the drafter thought to provide for one, if there was wrongdoing or a breach of duty in managing a New Hampshire purpose NCPF, it would be left to chance that someone may come forward to file a petition in court requesting the appointment of an enforcer to address the problem.¹⁶

Some commentators have suggested that having NCPF law here in the United States may attract foreign individuals who are familiar with the NCPF or even encourage a migration of an existing foreign NCPF. In fact, the Act does contain a provision allowing the registration of a foreign NCPF.¹⁷ Such registration allows the foreign NCPF to engage in any “registerable activity” in the state. This would include most usual investment activities but excludes the carrying on of a business. One problem is that once registered under the Act, the foreign NCPF has “the same duties, restrictions, penalties, and liabilities…imposed on a foundation of like character.”¹⁸ It’s unclear what’s meant by an NCPF of “like character,” but if it means a New Hampshire NCPF of like character (which is likely the case, as otherwise the state would have to examine and interpret the law of the applicable foreign jurisdiction), then that could present a serious problem for the foreign NCPF, as it’s highly unlikely that the duties and restrictions imposed by the Act would be the same as those of the foreign jurisdiction, and no doubt the foreign directors wouldn’t want to adopt new duties and restrictions that may not be in compliance with their law or that may expose them to new liabilities. If, however, it turned out that you can overcome such hurdles, it’s feasible to picture a situation in which a foreign NCPF that had U.S. beneficiaries wished to establish a U.S. presence, and it might consider registering here and establishing an investment account for the convenience of the U.S. beneficiaries. The complicated international tax considerations, however, are another matter, as are the U.S. tax considerations, which I’ll deal with in a future article. There’s another thing about the foreign NCPF rules that could discourage registration. With a domestic New Hampshire NCPF (and foreign NCPFs), the names of the directors may be kept private, but for a foreign NCPF registered in New Hampshire, the certificate of registration must disclose the names and addresses of the foreign NCPF’s directors.¹⁹

The last comment I wish to make, and which I feel is one of the most important, is this: New Hampshire, like virtually all of our states, is a common law state, and when a matter dealing with a civil law NCPF (established in New Hampshire) arises before a New Hampshire judge who presumably would have no familiarity with civil law, will she view it and judge it based on trust law, especially because the statute is clearly fashioned with trust law in mind? Or, will it be viewed as a “real” civil law private foundation, like a corporation with no beneficiaries? With absolutely no precedent (other than foreign law, if they would be willing to consider it) or even treatises to guide the judiciary, we may have a long wait before the several kinks in this new law are ironed out.            

Endnotes

1. New Hampshire Foundation Act (the Act), RSA 564-F.

2. Liechtenstein is the first civil law jurisdiction to formally adopt a trust statute (1926), the Persons and Companies Act of 1926, Articles. 894-932. 

3. For a more thorough comparison of trusts and private foundations, see Alexander A. Bove, Jr., “Should Your Client Have a Non-charitable Foundation?” Trusts & Estates (November 2009).

4. See, e.g., Cook Islands Foundations Act 2012, Section 24 (3). The duties of the members of the council of a foundation are owed to the council (foundation) itself and not to its beneficiaries.  

5. RSA 564-F:6-601(a).

6. Ibid.; RSA 564-F:11-1103 et seq.

7. Ibid. 

8. RSA 564-F:2-201(m).

9. Ibid.; RSA 564-F:16-1601 (d)(3).

10. Ibid.; RSA 564-F:7-702.

11. RSA 564-F:7-702(b).

12. The beneficiaries of the private foundation can’t rely on the rights, powers and entitlements that can be enforced in equity by the beneficiaries of a trust. Paolo Panico, Private Foundations, Law & Practice, Section 4.128, Oxford University Press (2014).

13. RSA 564-F:11-1102 (a).

14. Supra, note 5.

15. See, e.g., Section 13(1)(e) Trusts (Special Provisions) Act 1989 Bermuda; Al W. King III, “Trusts Without Beneficiaries,” Trusts & Estates (February 2015).

16. Although the Act allows for the appointment of a protector, there’s no requirement that the foundation have one. RSA 564-F:12-1201 (a).

17. RSA 564-F:21.

18. RSA 564-F:21-2105 (b)(2).

19. RSA 564-F:21-2102 (b)(2).

The estate-planning process is difficult for many of our clients. Clients usually have a lot at stake financially and emotionally when they engage an estate planner. The fact that others often have an intense interest in the outcome of estate planning doesn’t make planning any easier for the client or, for that matter, the estate planner. 

Further complicating matters is that there’s usually a wide gap between the knowledge of estate planning that the estate planner possesses compared to that of the client. This disparity adds to the client’s perplexity because it can create feelings of helplessness and dependence.

What does this wide gap in knowledge mean? The estate planner is in a unique position of confidence,  looked to as “one who knows.”¹ There are legal and psychological burdens that come with this position. What makes this even more difficult is that the client often cedes the power over the process to the estate planner. How many times have your clients asked you, “What do you think I should do?” Estate planners risk fashioning themselves as rescuers, the client’s knight in shining armor. There’s also a seductive opportunity for the estate planner to take on a role as omniscient and omnipotent, which is a grave error that many estate planners make.

Proper Role 

Consider the following question: What’s the estate planner’s role in the estate-planning process? To do exactly what the clients say that they want? To educate clients?  To be a zealous advocate for the clients? To be the messenger of mortality? To assist clients in transmitting their property with the lowest possible tax consequences? To help clients put together a legally binding estate plan that can withstand attack by disgruntled third parties?

It’s probably some or all of the above. Surely, the estate planner should refrain from being just a pawn of the client. However, the estate planner who focuses on the transfer of property with minimum tax consequences is abdicating part of his counseling responsibility to his client. There’s a big difference between being an estate planner in the truest sense of the term and an estate or tax technician. Despite the misgivings of the late trusts and estates attorney Joseph Trachtman of Hughes, Hubbard & Reed in New York and Professor Thomas Shaffer of Notre Dame Law School in Indiana about the term “estate planner” (instead of the term “lawyer”),² being an estate planner is a far nobler calling than “estate technician,” as the term now applies to non-lawyers as well. 

Good Estate-Planning Result

Every estate planner and client should be in pursuit of a good estate-planning result, whatever that is for that particular client. What’s a good estate-planning result? While estate planners certainly can quibble with the answer to this question, it’s been shown that good results don’t happen nearly as often as they should.³ Probate and trust litigation is on the rise, as people discover that Mark Twain was correct: You never really know someone until you share an inheritance with them. Elder financial abuse also is sharply up, which inevitably leads to undue influence claims. Why? And, what can we estate planners do about it? We can do a lot if we placed more emphasis on our counseling function.

I define a “good estate-planning result” as one in which property is properly transmitted as desired, and family relations among the survivors aren’t harmed during the estate-planning and administration process.  

Notice that conspicuously absent from this definition is any mention of taxes. Taxes have always been the easiest piece of the estate-planning puzzle, yet the overwhelming majority of estate planners still focus their attention almost solely on the tax piece, probably because it’s easiest to solve and easiest to demonstrate quantifiable, tangible results.⁴ This misfocus has contributed to several problems for planners and clients alike.

Over focus on taxes has resulted in the commoditization of estate-planning services, as estate planners joust over who’s developed or who uses the best tax planning mousetrap, which has led to a sharp increase in do-it-yourself one-size-fits-all estate planning. For the myopic tax crowd, the jig is up, courtesy of Congress, which has essentially repealed federal transfer taxes for all but a few thousand people. 

The Path

The model, entitled the “Path of Most Resistance” (the Path), p. 54, represents an attempt, feeble and amateurish as it may be, to depict why a good estate-planning result is so hard to achieve by focusing attention on the obstacles in its path. I began tinkering with creating such an explanatory model back in the mid-to-late 1990s, and it’s evolved a bit over time. However, its basic structure has remained intact since its inception.

As the Path illustrates, there are several players in the estate-planning play. I realize that most clients have more than two estate-planning professionals or advisors assisting them, but the larger point is that having more than one advisor itself creates potential obstacles in the path toward a good estate-planning result. Space and complexity of illustration caused me to use two advisors as a surrogate for the reality that the client may have three or more advisors who are attempting to render services to the client and the client’s family. The same is true for the last category of receivers and others, when one is used as a placeholder for as many as the client has to consider. I purposely chose to use only one client even though spouses often do joint estate planning because each individual must separately negotiate the obstacles in the path of a good estate-planning result.⁵

Fiduciaries and trust protectors are included in either the intended beneficiaries or advisor categories. In this era of increasing slicing and dicing of fiduciary duties in vehicles  like directed trusts, the role of fiduciary and trust protector can be vastly different from situation to situation.

In the Path, the items above the orange arrow represent views and common experiences in the past with life and estate matters among all of the players. The items below the orange arrow are witnessed in each of the respective players in the estate-planning play. The Path is intended to illustrate that many things must happen for a good estate-planning result to occur. That is, there are lots of moving parts and opportunities for the process to go awry. The Path also illustrates that the planning process can go backwards too if the wrong events occur at the wrong time.

Behind the Scenes

Some past experiences are common to all of the players in the estate-planning play. These are set out above the orange line.

Prior inheritance experience. Past personal experience as an inheritor, fiduciary or beneficiary can go a long way toward informing one’s views on wills, trusts, probate and estate-planning advisors. This past experience applies to estate planners too. People who’ve survived a contested trust and estate matter often are more guarded, even jaded a bit, by the experience. People who have no experience with trusts and estates matters are frightened of them, often because of horror stories that they’ve heard from others. Nevertheless, this past experience impacts how people think. 

Tip: Pre-death intergenerational communication can go a long way to reducing rancor in trust and estate administration in large part by properly setting the expectations of the receivers. Once the client has died, the purposeful estate plan will be administered with complete transparency and frequent communication to minimize things going off the rails.

Listening/communication skills. Most people think that they’re better listeners than they are.⁶ Some people are more verbal than others, while others are more visual. Because a significant part of communication is body language,⁷ it’s very important to watch the other conversant’s body language.⁸ We all have different styles and levels of skill in both listening and communication.⁹ It behooves an estate planner to be familiar with listening and communication styles so that he can better serve his clients and work collaboratively with other estate planners. 

Tip: The purposeful estate planner should maintain solid eye contact with the clients during the interview, particularly during times of tension or points when there’s some uncertainty, angst or disagreement.

Attitude toward death/fear or dislike of talking about death. Human beings are unique in being able to think about death, but most people would rather not think about it—their own or that of anyone else. Some people simply can’t consciously contemplate their own demise, which can be an obstacle in estate planning. Again, estate planners aren’t immune to this; most estate planners are just as reluctant to discuss a client’s future death as the client himself because this discussion reminds the estate planner of his own mortality.¹⁰

Tip: Consider taking the lead on being vulnerable and discussing death openly and honestly. It’s okay not to like talking about death and be fearful of it, but fears faced out in the light tend to dissolve or be significantly reduced.

Inner child issues. Many people can trace or at least attribute a problem to something in their childhood. Author John Bradshaw¹¹ has written extensively about how childhood wounds manifest themselves as we age. It’s important for estate planners to understand that some adult actions, particularly actions that seem negative or over reactionary, may have their genesis in childhood, particularly in working with family businesses.

Tip: Practice mindfulness and being more self-aware of your feelings and past. If an interaction or exchange with a client or another player brings up feelings within you, first label those feelings and then attempt to find their source.

Relations with spouses/children/in-laws/descendants. When I happily reported the birth of my first child to one of my mentors in estate planning, the late Gerry LeVan, he told me that he was halfway toward becoming a good estate planner, but that he wouldn’t become a good estate planner until his first grandchild was born. Gerry was right. Indeed, after the birth of my first child, I began looking at documents that I was drafting differently and shifted many of my default provisions quite a bit, just because of the birth. My son’s birth made me a better estate planner because I could now more readily empathize with parents. Some people have precarious relationships with family members, and divorce often creates more acrimony as the former spouses often force their loved ones to take sides.

Tip: Again, self-awareness of your own feelings and past experiences can go a long way toward identifying and dealing with feelings.

Mental and physical health. It’s undeniable that the health—mental and physical—of everyone in the estate-planning play impacts the estate-planning process. People who’ve had brushes with death often are far more appreciative of each day of life than those who’ve been healthy for their entire lives. Mental health issues often lurk in the shadows of codependency and enabling, when some family members look after other family members, often to the detriment of both, and apologize and cover for the sick family member. This is particularly rampant when a family member suffers from drug and alcohol addiction.

Tip: We’re all different and have different past experiences. Status of our physical and mental health significantly impacts our bandwidth and outlook on life. Age factors in here as well. Be aware of your feelings about physical and mental health, which often are informed by your past experiences.

Relations with siblings/parents. Clearly, one’s relationships with one’s own siblings and parents, whether living or dead, have an effect on how one views relations of others with their siblings and parents. Contrast the “one big happy family,” whose  members truly love and respect each other, both the good and the bad, with the dysfunctional family whose communications have broken down, and the members have taken sides and gone into battle station mode. 

Tip: Be aware of these relationships and how they’ve informed your views on estate planning for your clients.

Attitude toward wealth. Some people inherit significant wealth or are raised in affluent homes, while others grow up under less fortunate circumstances. These experiences often affect attitudes about wealth. Some are jealous, while others are oblivious to what other people’s experiences are regarding wealth. Some people understand the value of hard work and savings, while others feel entitled to wealth. Inheritors may not view their wealth as their own because they didn’t create it. Contrast that with the individual who created the wealth, whose very persona often is inextricably intertwined with that wealth.¹²

Tip: It’s important to figure out how the family came into their wealth because that will give clues as to how the wealth is perceived and how it will be administered and passed on, especially if the wealth wasn’t created in your client’s generation.

Other life experiences. This catch-all category can include bankruptcy, termination of employment, being a defendant in a lawsuit, jail, tax problems and divorce. The purposeful estate planner won’t forget that these potentialities may be present and impact the client’s decisions.

Tip: Your initial client questionnaire must ask some broad general life experiences questions, because, for example, the client who’s gone through a nasty divorce or a bankruptcy may be far more guarded than the client who hasn’t had these experiences.

Personality type. While everyone is unique in some respects, there are recognized personality patterns.¹³ Some personality types blend well with others, while other types don’t.

Tip: Make yourself familiar with personality types, because this knowledge will prove invaluable in getting through to clients of all types. Again, self-awareness is the key. 

The Client

Clearly, the star of our play is the client. As stated earlier, some clients have significant experience with estate planning, but for many, this trek is a maiden voyage.

Distrust/fear of advisors/fear of loss of control of planning process. Clients often are novices in dealing with advisors, although some may have significant experience. Fear of loss of control of the estate-planning process keeps many more from tending to their planning than most estate planners realize. 

Tip: The key is humility on your part and the willingness to let the client be in control of the process. I realize that this tact flies in the face of some sales training that teaches how to gain control and eliminate objections. However, the purposeful estate planner will insist that the client be in full control of the estate-planning process, with the estate planner acting as guide and counselor.

Fear of costs. Given that many estate-planning clients possess little experience in dealing with advisors, it isn’t unusual to see people put off their estate planning simply out of fear of the cost.

Tip: Don’t live and die by the time sheet, which was a terrible development because it attempted to quantify value through increments of time. The problem is that value and time aren’t co-linear. A planner can render splendid advice in minutes that saves a client millions of dollars. On the other hand, spending five hours at your hourly rate on a routine will drafting assignment isn’t going to make a client very happy unless the bill is significantly adjusted downward. Talk about fees up front and periodically. Put things in writing. Use flat fee arrangements when appropriate.

Feelings about taxes. While the federal estate tax under current law applies to a very few, although a number of states still have a significant estate tax, feelings about estate taxes often occupy a client’s mind. Some people are hell bent on paying no estate tax, while others recognize that they won’t personally ever have to pay their own estate taxes.

Tip: Most estate planners are pretty quick to point out that typically, no federal estate tax will be due (no doubt in some substantial part to their excellent work), so nothing further need be said here.

The Advisor

As stated earlier, the Path depicts two advisors but isn’t intended to imply that a client may not have more than two. The more advisors, the greater the risk of more problems because when more people are involved, they bring more personal experiences and baggage into the situation.  

Don’t misinterpret what I’m saying here: The client should have as many advisors as he feels is necessary or appropriate. I’m a big believer in referrals and collaboration simply because it was my experience that clients get better service and a better estate plan. However, having more advisors creates a situation that must be watched and managed. I’ve seen estate-planning engagements fall apart because the advisors were incapable of cooperating and collaborating, which is a bad result for the client and can add to the negative experiences that the client will take to the next advisor, if any.

Ethical constraints. Each of the estate-planning subspecialties have their own ethical rules and conventions. These ethics rules impact subspecialties differently. The legal ethics rules insert some additional complexities in the estate-planning process, particularly in the areas of confidentiality and conflicts of interest. It’s imperative that the planner’s engagement letter permits complete and total access to all of a client’s advisors.

Tip: Make sure that the engagement letter casts a wide net over the people with whom you may communicate to allow you to communicate with those third parties. That list could include children or other descendants, family business employees, lawyers, CPAs, investment advisors, fiduciaries (trustees, etc.), financial planners, life insurance agents, wealth psychologists and, in some cases, access to the client’s treating physician.

Limitations/teachings/philosophy of particular subspecialty. Each estate-planning subspecialty brings its own mindset and philosophy into an estate-planning engagement. This often is clearly reflected in the factfinders of a particular subspecialty, which tend to focus more attention on the areas covered by that particular subspecialty. For example, lawyer factfinders tend to focus attention on property, while life insurance factfinders might focus attention on life insurance. Moreover, different advisors in the same subspecialty may have vastly different philosophies about estate planning. It’s critical that advisors check their egos and biases at the door before getting down to work with an open mind and collaboratively on a client’s situation.

Tip: Try true collaboration just once. If it goes right, you’ll never want to work any other way again. With collaboration comes diversity of professional backgrounds, educational and experiential pedigrees; different manners of training; and significant knowledge about a certain aspect of the client’s estate plan. This diverse strength of the group exceeds the strength of the sum of its individual members. This excess is called synergy.

Fear of lawsuit. Every professional advisor lives in some fear of being sued by a client. Estate-planning advisors practice defensively to minimize the risk of lawsuits. Some of these defensive actions negatively impact the relationship with a client, particularly when the client doesn’t appreciate the risk of a course of action that the advisor recommends.

Tip: Again, one thing that most estate planners do well is practice defensively. I can only repeat nationally recognized estate-planning attorney Howard Zaritsky’s sage and timeless advice to simply be nice.¹⁴ To everyone. Lawyers are notorious for not being nice.

Need for business. Many advisors constantly search for new business. In a way, this is the flipside of the fear of lawsuit discussed above. Some estate planners are better at giving safe “yes” answers to clients, who always want to hear “yes” and loathe hearing “no.” Unfortunately, some estate planners spend an inordinate amount of time telling clients “no” when there’s a safe “yes” answer that simply requires fresh thinking. 

Tip: The safe strategy is to view potential clients cautiously in that they could be either an opportunity or a curse. Some clients are more trustworthy than others; some clients are more aggressive than others. Sometimes, estate planners who are worried about their level of business will take in just about any client, when a more selective policy makes far more sense.

“Lead dog” syndrome. Some advisors, particularly those with some product to sell, are trained to gain control of a situation. This behavior often conflicts with other advisors, especially those who also desire to be in charge of the client’s estate planning. When advisors joust for the desired position of quarterback on the estate-planning team, it can delay or even end the planning.

Tip: Be a good example to those with whom you’re supposed to be collaborating by keeping your ego in check and inviting them to do the same.

Self-interest. Let’s face it, advisors are in business for themselves and have families to feed or employees to pay. Even though just about every subspecialty of estate planning has ethical responsibilities to clients, it would be foolhardy to expect advisors not to act in their own self-interest at some point in an engagement.

Tip: Put the interests of your client first.

Fear of collection of fees. This fear differs greatly from subspecialty to subspecialty. When an advisor commences an engagement without having first secured payment for services, this fear can impact how much work the advisor will do before being assured of being compensated, which can impact the venture toward the good estate-planning result.

Tip: It’s perfectly acceptable to require a client who’s asking for a lot of work to be done to put up a retainer in good faith to cover the work.

Loved Ones/Intended Beneficiaries

This category includes those who believe that they’ll receive something from the client at death.

Fear of loss of person. Most people who have a potential interest in a client’s estate have a relationship with the client. Quite often, these people fear the client’s death as much or even more so than the client or the client’s advisors. In fact, I’ve witnessed this fear be so palpable that, when expressed, it ended the client’s estate planning because the mere notion of the client’s death was too great to bear for the family member. The family member’s horror at the mere notion of the client’s death was triggered by the family member’s fear of loss of the client. The family member acted out much like an infant whose parent leaves his side.

Tip: Address fears and feelings head on with transparency. Intergenerational communication is important in the quest for a good estate-planning result.

Self-interest. As with the advisors, we should expect people in this category to act or argue out of self-interest. There’s nothing inherently wrong with looking out for one’s best interests until it crosses the line and becomes either undue influence or even outright misappropriation.

Tip: Many lay fiduciaries make big mistakes by failing to see the difference between owning property outright and holding the legal title to that property in trust and as trustee for the benefit of someone else. This is when the estate planner must clearly and, if need be, forcefully, inform the client that being a fiduciary is a potential source of great liability.

Not getting the whole story. I’ve found that intergenerational estate planning is best when the client communicated the estate plan and the reasons for it to the potential receivers during the client’s lifetime. Nevertheless, it was far more common for clients to keep quiet about their estate plans during lifetime, despite my advice to the contrary. Some of the saddest and most unfortunate situations I’ve ever witnessed was when a deceased parent left a smaller amount to a child than what the parent gave to the child’s siblings without explaining why this was done.

Quite often, this unfortunate and inadvisable practice leads to post-death administration difficulties as relationships among the survivors are torn asunder, including litigation. However, the larger problem is the psychological damage that it does to the child, who’s left to wonder for the rest of his life whether his parent loved him as much as the parent loved the siblings, because many people believe that the relative bequest level is the ultimate final barometer of love, even though this isn’t true in the vast majority of cases.

Tip: It’s been said before, but it bears repeating: Intergenerational estate planning is best.

Note that this is the first installment of a three-part article about the human side of estate planning. In the second installment, I’ll introduce three psychological phenomena that shroud every day estate planning. In the third, I’ll explore mortality salience (reminders about death), other fears that clients experience in estate planning, concluding with an introduction of two tools that might assist estate planners with their clients: motivational interviewing and appreciative inquiry.   

Endnotes

1. Louis H. Hamel, Jr. and Timothy J. Davis, “Transference and Countertransference in the Lawyer-Client Relationship: Psychoanalysis Applied in Estate Planning,” 25 Psychoanalytic Psychology, at pp. 590-601 (2008).

2. Thomas L. Shaffer, Death, Property, and Lawyers (Dunellen Press 1970), at pp. 1-2.

3. In a study conducted by Roy Williams and Vic Preisser, of 3,250 wealthy families, research indicated a mere 30 percent success rate in keeping wealth in a family, which equated to global research finding the same percentage of success. See Roy Williams and Vic Preisser, Preparing Heirs: Five Steps to a Successful Transition of Family Wealth and Values (Robert D. Reed Publishers 2003).

4. Akin to a Jenny Craig before and after picture/testimonial, most estate planners proudly crow over how much tax their brilliant planning has saved and bill accordingly.

5. This perhaps sidesteps the inherent ethical issues attendant to representing a couple jointly. In the “Path of Most Resistance,” p. 54, spouses are each considered separate clients. This should by no means be considered an endorsement of the legal ethics decision to represent a couple as separate clients, because I’m uncertain that this tact may be safely done by a lawyer.

6. See, e.g., Michael P. Nichols, The Lost Art of Listening (The Guildford Press 2009).

7. Dr. Albert Mehrabian, author of Silent Messages, conducted several studies on nonverbal communication. He found that 7 percent of any message is conveyed through words, 38 percent through certain vocal elements and
55 percent through nonverbal elements (facial expressions, gestures, posture, etc).

8. See generally Jo-Ellan Dimitrius and Mark Mazzarella, Reading People (Random House 1998).

9. See generally Benedict Carey, How We Learn (Random House 2014).

10. Shaffer, supra note 2, at pp. 115 and 118.

11. John Bradshaw, Homecoming: Reclaiming and Championing Your Inner Child (Bantam 1990).

12. Jean Paul Sartre, Being and Nothingness (1943): “The totality of my possessions reflects the totality of my being. I am what I have. What is mine is myself.”

13. See, e.g., Isabel Briggs Myers and Peter B. Myers, Gifts Differing: Understanding Personality Types (Davies-Black 1995) and David Keirsey and Marilyn Bates, Please Understand Me: Character & Temperament Types (Prometheus Nemesis Book Company 1984). 

14. Howard Zaritsky, “Eight Basic Rules of Practical Practice,” set forth in The Tools & Techniques of Estate Planning 18th Ed. (National Underwriter 2017), at p. 118.

Family office (FO) goals, structures, leadership and challenges are as complex and distinct as the families themselves. Although each FO approach and structure is unique, all FOs must address the challenges presented by potentially divergent goals, incentives, constituencies and duties. These types of forces—some obvious, others more subtle—result in potential or actual conflicts of interest that FO leadership must identify and address, regardless of the specific structure. And not surprisingly, the more complex your client’s FO structure becomes or the more that it attempts to accomplish, the more challenges that can arise relating to addressing competing duties or concerns and potential or actual conflicts of interest.  

Successful families have been using FOs for generations to manage everything from family wealth, to philanthropy, to cybersecurity. FOs act as a central hub for the management of the family’s wealth and related affairs, such as accounting and legal work. Although the practical or legal structure of a given FO often varies, high-net-worth families are attracted to the office structure because FOs provide much needed sophisticated financial and organizational services through a dedicated vehicle, giving some level of personalized attention, mentoring and leadership tailored to each family’s unique needs and objectives. But, regardless of the structure, objectives or governance of a given FO, there will be potential conflicts around every turn that must be identified, resolved or avoided to maximize the success of the FO. The first generation’s goals and objectives may not suit future generations, leading to conflicts or potential conflicts that can directly affect everyone connected to the FO. Adequately preparing for and handling that evolution will allow the family to maximize its wealth and objectives for as long as possible. But, if the FO is unprepared for those changes, it could result in a loss of value, family discord or even the dissolution of the FO.    

Key Sources of Conflict 

There are a number of ways that a newly forming or established FO may encounter thorny situations that necessitate addressing conflicting goals, duties or interests. Some common areas of potential conflicts that FOs may face include: 

Divergent views within the family. These include conflicts: (1) arising between those advocating for wealth creation versus use of wealth or balancing private use versus philanthropic use; (2) on types of asset management, including industry focus, importance of family legacy, appetite for risk and extent of asset manager independence; and (3) on leadership succession and role of the family matriarch and/or patriarch.

Issues that arise from providing financial services. These include: (1) difference in rates for financial services depending on family status (for example, owners charged less), which may result in disparate treatment by the professionals and family discord; (2) multi-family offices (MFOs) that sell affiliated financial products, which may result in a conflict between the professional’s duty to the family and his self-interest; and (3) compensation or evaluation structure for financial services professionals incentivizing the selling of affiliated products, which may result in pitting the professional’s monetary self-interest against his duty to make the most prudent investment decisions.

Employment issues. These include: (1) a biased compensation and evaluation system (for example, nepotism, preferred salary for family members, advancement for sons over daughters and hiring family members as independent contractors), which may result in putting family goals in conflict with state and federal employment laws; and (2) an informal management structure with ambiguous roles and responsibilities, which could lead to inefficiencies, conflicts and negative impacts on performance.

Regulatory concerns. These include conflicts arising among jurisdictional requirements on issues such as privacy, disclosure, employment laws, taxes and immigration, which may impact the family’s management structure, expansion goals and risk profile.

Hiring of counsel. These include (1) counsel asked to represent both FO business entities and individuals in personal estate planning or other matters, leading to duty of loyalty conflicts, confidentiality and other ethical issues and, in adverse matters, to joint defense and privilege issues; (2) conflicts arising from multi-client scenarios, particularly when the FO is structured through numerous related entities; and (3) family members acting as trustees of family trusts or serving on boards of directors or trustees related to the FO, which may lead to conflicts between the fiduciary’s personal interest and the interest of the beneficiaries he serves.

Each item on this issue-spotting list, which is by no means exhaustive, could be the subject of a separate article. The FO may require your advice, as legal counsel, to ensure that the conflicts are minimized and resolved in a compliant manner. But, it’s often up to the FO leadership or the family itself to recognize when an issue may require your advice. To assist in that goal, share the following tips with your FO clients to aid them in self-evaluation and conflict avoidance.

Ten Tips 

Discuss these 10 tips with your FO clients.

1. Identify the FO goals and objectives. Just like any company, those providing services to an FO—whether in-house or as an outside advisor—should always keep in mind the specific goals and objectives of the FO in question. Unlike the typical corporate entity, the goal of which is almost always to maximize profit, an FO may have multiple objectives, including philanthropy, legacy or commitment to a certain business or market segment. Many potential internal philosophical and leadership conflicts may be avoided by having the FO objectives identified in writing and adhered to by its professionals.

2. Choose a structure and governance aimed at avoiding ambiguity. An FO’s governance and structure is imperative to the success and longevity of the family’s wealth. Whether there’s a single decision maker who speaks to advisors and then makes decisions on his own or a robust board of directors with power to make FO decisions, a clear structure that identifies how decisions will be made is vital. In addition, the FO structure should be set up to anticipate: (1) family succession issues to avoid power struggles in future generations, and (2) the role of independent non-family members in leadership to address the potential that future generations lack the interest or ability to run FO affairs. Ambiguity in the FO decision-making process or in the mechanism to choose future leadership is a frequent source of internal conflict. The structure should also be robust enough to address what must be done for the FO to evolve should future generations decide to alter the objectives.

3. Commit to the structure and avoid informality. Often, the difficulty with appropriately structuring the FO is adding formality to the informal world of family relations. Formalizing the structure, however, is an important safeguard against conflict stemming from ambiguity or lack of clarity in decision making. A professionally prepared operating agreement or other document governing how decisions are made and the flow of communication can create structures and systems to maximize communication and identify and address conflicts. Although this point may be obvious for larger sophisticated FOs, it’s important that all FOs consider whether they’ve adequately documented their management structure and thought about that structure. This will ensure that anyone in a decision-making role—whether part of the family or not—adheres to the family’s stated goals and objectives. The operating agreement should outline the mechanism by which the decision maker can consider differing opinions and make an informed decision in a manner that limits infighting as much as possible. In addition, committing to a formal structure and adhering to its form will permit professionals retained by the FO to understand and address their ethical obligations and avoid potential conflicts of interest.

4. Ensure the proper dissemination of information. Many conflicts arise due to a lack of proper information dissemination. Professionals and family members need adequate access to information to assess objectives, performance and conflicts of interest. Regular family meetings are an important way to review past performance and assess or create future objectives. Family meetings often serve as meaningful platforms to make significant decisions, with participants receiving and discussing the same information to make an informed recommendation or decision. In addition to meetings, it’s important the FO professionals regularly receive information on what’s happening throughout the enterprise to avoid the possibility of one professional of the FO conducting business in a manner that may present a conflict situation with other family business. The meetings should also allow advisors to share information on applicable laws or market forces relevant to FO business and reduce the risk that some family members receive incomplete information.

5. Scrutinize all aspects of MFOs. Due to increasing FO costs, many wealthy families join MFOs so that the costs are shared among multiple families invested in a given office. MFOs are often directed by a lead family with assets managed under one system. While cost savings often drive the success of MFOs, the number of families pooling their money together, with varying circumstances and objectives, increases the risk that potential conflicts become actual conflicts. This is especially true when one family has an ownership interest in the MFO, while other families are simply passive investors. Families considering or already engaged with an MFO should understand every existing aspect of office structure to make sure that their interests are sufficiently protected. Specifically address the tips above regarding goals, structure, decision making and communication. And, to the extent a family may be forced to compromise a goal or objective to participate in the MFO, make this clear to the entire family.

6. Coordinate satellite offices. MFOs are sometimes used when a family wants a satellite office in another jurisdiction for foreign investments. Having such a satellite or outpost office can provide support to family members living in or frequently traveling to another country. In some instances in which only discrete services are needed, an FO can create a joint venture with an existing MFO established in the other region. The primary FO can then rely on the local knowledge and capabilities of the satellite office, without having to investigate the rules and regulations of the foreign country. To avoid conflicts or managerial inefficiency, FO professionals should conduct due diligence with respect to all of the potential satellite offices. The diligence should include scrutinizing the investment approach and compensation structure, as well as handling the engagement of professionals. Specifically address the tips above regarding goals, structure, decision making and communication when coordinating a satellite office.  

7. Pay special attention to how individuals are getting paid and for systemic incentives. Families must always perform their due diligence when hiring any advisor. Although qualifications and performance are important, the FO professional and client should always understand how the financial advisor or planner is being compensated to ensure that there are no adverse incentives in play. For example, a larger financial institution may incentivize advisors to push one of its affiliated products by making such metrics a factor in compensation or advancement. If the advisor is servicing more than one family, you should help families consider how the advisors address the differing needs of different families and should have systems in place to protect family confidentiality. The FO must always scrutinize its advisors to ensure that it’s receiving the most practical, cost-efficient and beneficial advice.

8. Identify the client early and often. You, as the lawyer representing the FO or its affiliates, whether in-house or external, should take special care to consider the ethical and conflict issues triggered by representing the business manifestation of what’s really a myriad of individual interests. You must carefully craft an engagement agreement to identify the specific entity or parties covered by the engagement and obtain the appropriate conflict waivers when required. Once the representation is set, you must take special care to avoid mission creep, with non-client affiliated parties seeking legal advice and assistance. And, you should clearly and repeatedly state attorney limitations. For example, you must make it clear when communicating with family members that you only represent the FO. Indeed, ignoring conflicts of interest can lead to your being disqualified from representing the FO.  

9. Avoid becoming a personal advisor. If you’re a tax advisor, you’re an important member of the FO legal team. While under certain circumstances, estate planning within a family can occur with the same attorney with appropriate conflict waivers, the analysis becomes more complicated when the tax advisor is representing an entity or trustee in an FO setting.  There may be actual conflicts of interest that prohibit you from providing personal estate planning or personal legal advice for an individual family member on matters involving the family business. But, even if the conflict is waivable, you need to consider carefully whether you can harmonize the personal work conducted for a family member with the existing duties to the FO and its stated goals. Often, requiring separate counsel will avoid serious problems such as the individual attempting to use personal representation as a basis for disqualification or termination. 

10. Consult with client early and often. Consulting with your FO client early will allow you to spot potential conflicts and advise how the effects can be minimized or altogether avoided. And, while not every conflict in the FO setting is avoidable, the damage caused by the conflict may be minimized if you’re involved before the conflict becomes a distraction to the operation. You can also help scrutinize regulatory and tax issues that can detract from the family goals or can propose changes that prioritize family objectives in response to ever changing regulations (for example, taking advantage of a December 2017 tax opinion finding that FOs are treated like a business for expense deduction purposes and maximizing the benefits and structural advantages of the 2018 tax reforms). You can also seek advice from employment advisors who can review compensation and employment contracts to make sure that the family objectives for treatment of specific individuals, favorable or less favorable, is consistent with the jurisdiction’s employment laws.

Staying on Course

While the individualized services that an FO provides are attractive to many families, the merging of a complex business structure with family legacy planning is inherently vulnerable to diverging interests and priorities. Some of these divisions rise to the level of actual conflicts of interest. Careful planning and constant review of FO structure and procedures are the best ways to implement and further a business designed to minimize and resolve such conflicts. Taking the necessary safeguards to prevent the conflicts allow the FO to function exactly as it was intended: to achieve the family’s goals and objectives.              

It’s subtle. It’s anecdotal. But, it’s happening.

More women are becoming involved in their family’s single family offices (SFOs). Matriarchs, daughters, granddaughters and even, in some cases, in-laws, are finding a range of roles stewarding their family wealth. In tandem, more women are becoming substantial wealth creators, and with their new-found wealth, they’re setting up their own SFOs.¹ This rise in the influence of women is boosting a change that’s occurring in the tenor of SFOs and how they’re seeking to be served from wealth management providers and advisors. 

Women tend to take a holistic approach to how they feel about money.² They often look at wealth in terms of how it can be used to help achieve things that are important to them. This may include providing support to their community, causes, organizations and family. They’re also often concerned about the potential negative impacts of their wealth on their children. This isn’t to say that men don’t care about these issues. They do. But, this fuller focus is far more pronounced with women when they approach wealth management.

It’s no secret. Women are different from men when it comes to how they interact and relate to others. A primary difference is women prioritize relationships over transactions. This means, when it comes to working with service providers, trust is key. As one second-generation Millennial who runs her family’s office says of choosing service providers, “A sense of trust is very important.”³ A study by Maddox Smye, LLC puts hard data to this sentiment.⁴ When asked to rank three purchase considerations, women said trust was the most important consideration, followed by liking the product/service and then price. Men led with price, followed by liking the product, with trust being last.⁵ 

Taken together, these differences mean as more women become involved in their SFOs or start their own SFOs, the breadth of services that are presented, how they fit together to meet a family’s overall objective of what it wishes to achieve with its wealth and how providers interact with SFOs will need to evolve. Service providers are already under pressure to be more relationship-based and holistic. The rise of women, even if incremental, is helping to keep the pressure on.

The good news is this evolution has begun. But, it’s far from arrived. 

As the Millennial SFO head says, referring to conversations she has had with lawyers and advisors, “They’re trying to convince me of their value but haven’t shown me what they do and how it will help me.”⁶ 

Women as Change Drivers

The great wealth transition coupled with the rise and recognition of women increasingly controlling the purse strings is leading wealth management firms to place a larger emphasis on meeting the needs of women. 

Also, firms recognize that most wealth management offerings are commoditized. Firms need to be best of breed to succeed. 

To succeed, providers must also demonstrate that they’re listening to their clients and presenting solutions that can help them achieve their goals. They need to bring all areas of a family’s wealth together and synthesize these as part of a total plan. This is the case across the ultra-affluent service provider spectrum—including multi-family offices (MFOs), private banks and trust companies, individual advisors, attorneys and money managers. Women are associated with responding to this type of approach though it’s what many types of ultra-affluent clients are seeking. The focus on serving women, combined with the rise of women in decision-making and decision-influencing roles, is helping to focus client-centric efforts that bridge goals and challenges to understandable actionable solutions.

“The industry is starting to catch up with what has always been wanted. It doesn’t have to do with if a client is a man or a woman. But maybe women caught on faster,” says Russ Alan Prince, president of consultancy Prince & Associates, who’s conducted extensive research for over 20 years on the ultra-affluent and SFOs. “You need to be client-centric for real—not just on paper,” he adds.⁷ 

For issues that ultra-wealthy women are concerned about, see “Common Concerns,” this page. 

The Journey

Not so long ago, women from ultra-affluent families were expected to hand over the management of their wealth to husbands or brothers. For many Traditionalists (those born between 1925-1945) and Baby Boomers (those born between 1945-1965), the idea of taking the reins of their wealth or actively participating in their SFOs simply wasn’t in the lexicon. 

As women make strides toward gender parity, they increasingly see themselves as having a seat at the SFO table. Women now control 51 percent of the total wealth in the United States, with 44 percent of women now the primary breadwinners for their family.⁸ They earn the majority of college degrees⁹ and at this year’s Winter Olympics, women had record representation, accounting for almost 50 percent of the athletes, which is up from 40 percent in 2014.¹⁰ It makes sense that as they expand their horizons and opportunities, they’re  contributing more in their family’s SFO. 

“In the old days, the patriarch ran the family office and there was no board. Now there is more enlightened governance,” says Linda Mack, president of Mack International, LLC, which specializes in providing C-suite retained executive search and strategic consulting solutions to SFOs. Now, the majority of SFOs, and almost all of those with assets north of $1 billion, are run by non-family professionals, she notes, adding that family members do run the smaller SFOs.¹¹ 

It’s on the board of the SFOs where family members—and increasingly now, female family members—can be found. A diverse board can be more thoughtful, provide different perspectives and help sustain the SFO for multiple generations. The board is the voice to the head of the SFO. It defines the metrics for success, performance and pay of the SFO executives. Women are becoming part of that diversity as boards begin to better reflect the family members the SFO serves.

SFO leaders need the sensitivity to communicate equally to all branches and generations and to make everyone feel they have equal access. Women are equated with high emotional intelligence (EQ),¹² a leadership trait that’s increasingly associated with success, says Mack, who this year was named a Top Woman in Wealth Management by Family Wealth Report. Women already have a place at the helm of SFOs as non-family executives. More women, however, will likely be sought out to lead SFOs, particularly as more women serve on the boards and greater value is placed on leaders having high EQ. 

In cases in which women family members have training, experience and expertise in investments, they may now have roles on the investment committee or be responsible for setting strategy and choosing investments. This type of knowledge, though not common, is now more prevalent among women than a generation ago. For managers to succeed with women, they may need to change their approach. The Millennial SFO head who’s also responsible for selecting outside money managers notes she often conducts preliminary screens on managers by phone. Here too, she often finds the interactions problematic. “Often a marketer who is most often a man will speak for 30 minutes without stopping. I need a conversation. I don’t need to be told.”¹³

In many families, women have always contributed to the SFO. They often carve out roles in areas such as philanthropy and education committees. These committees are central to the overall movement of approaching wealth management from a fuller perspective, beyond investments, accounting and tax. 

As more women family members join their SFO boards, take on key responsibilities for selecting service providers and find roles within the SFOs, they’ll exert greater influence on the professionals who run their SFOs and the service providers seeking their business.

Women in Senior MFO Roles

There’s a significant change in the wealth management industry toward providing integrated services. The conversation has changed since 2008, notes Jamie McLaughlin, head of consultancy J. H. McLaughlin & Co., LLC.¹⁴ The industry is moving away from an investment orientation and trying to help clients understand the purpose of their wealth and how it can help fulfill what’s most important to them. Listening and discovery are central to the client experience.

Providers to the ultra-affluent, and commercial MFOs in particular, have a unique feature compared to other areas of finance. Women are strongly represented at the most senior level. For example, MFOs including Hawthorn and Pitcairn are headed by women. This reflects the focus on EQ and the need to have listeners and understanders. Also, women have been working in wealth management for many years.  

For many, serving the ultra-affluent wasn’t an area of finance that was perceived as a place to make your name until the last decade. Areas such as investment banking, mortgage-backed securities, emerging markets and corporate banking were the domain of men. “In 1985 you could not give away these jobs,” joked one woman who rose to be a senior leader in the family office space. “Everyone wanted to be in corporate banking. Women saw the opportunity, took positions and leadership roles and that stuck,” she says.¹⁵“They are increasing their responsibility with their tenure. They have the command, applied knowledge and intrinsic skills,” adds McLaughlin. “It is thought that women can carry the dialogue better, deeper and differently.”¹⁶

Mentoring and Education 

There’s a need for mentoring and education, to empower women family members to understand financial information and have the comfort level and confidence to demonstrate it. “It’s harder for women to get on the board. Even with the same qualifications as a man, they often don’t show well. They need confidence around finance,” says a non-family SFO executive who also serves as a board member for a number of SFOs. There are built-in biases in family systems, and there are preconceived notions, she notes. “Because you’re so-and-so’s son or daughter, you aren’t capable. This can be particularly inhibiting for women in the families.”¹⁷ 

Indeed, a daughter building her role in her family’s SFO concurs. “I need a more meaningful way to be spoken to. Mentorship is ideal. I can’t hire anyone who will care more than I care. I need to know how to do it even if I may outsource,” she said, referring to manager selection and other core family office decisions. She added she would like to find one-on-one mentorship or women-only classes on sophisticated wealth management subjects—such as private equity, hedge fund due diligence and risk management.¹⁸

The Millennial SFO head noted training was key to her taking on more responsibilities in her family’s SFO. She started at the bottom and over a period of five years learned not only how to run the SFO but also how to invest. “I started at the bottom. I had a fund. I did P&L [profit and loss] reconciliations, operations, a little research on investments,” she said.¹⁹ 

Finding a Seat at the Table

Families are, in some cases, actively opening opportunities for women to join. “I never felt resistance about becoming involved. My family was really happy about it. They wanted me to be interested,” said the second generation Millennial who’s managing investments in and running her family’s office.²⁰ 

Others families merely aren’t blocking efforts for the women to have a voice. “My age is the last remnant of old-school,” said the second-generation daughter who’s carving out a role for herself in her family’s office. “I had to assert myself intentionally, and I continue to have to do that. I and other women my age see bias. We have talked about that.”²¹ 

It’s important to recognize that SFOs are extremely situational. It’s common for SFOs to find it challenging to engage and garner interest from those they serve. Whether women in the family step into roles in the SFO is often a reflection of the family’s dynamics. As the non-family SFO executive noted, “It is amazing and surprising. I would expect more women to take roles in the family office. I have seen daughters step up almost begrudgingly. It is very dependent on who the owner of the money is. If the creator is a man, daughters may or may not step up. Sons often overshadow them.”²² 

Another SFO executive adds that even in cases in which there’s support from the patriarch for women to be involved in the office and there are no sons, the women may not care to be involved. As with any heirs, men or women, sometimes it’s a matter of timing, what’s going on in their lives and personal interest. 

The New SFOs

The new SFOs that women are setting up are, from the get-go, beginning with a comprehensive, holistic approach to managing the family and its wealth.  Traditionally, SFOs have started with investments, often after a substantial liquidity event and gradually built out services over the years. “Women in particular, but especially those under age 50, have a much more holistic perspective. It isn’t just investing; it isn’t just accounting. When women create money, their SFOs have much more of a family orientation,” says Prince.²³ 

When women set up SFOs, they often include services such as education, family banks, concierge medicine and philanthropy. Education efforts help teach financial literacy, how the office works and what the advisors do. The family banks, in part, are a way to fund, encourage and teach entrepreneurial pursuits while also providing a means to give access to capital in general. Concierge medicine provides unique access when health issues arise and fits in with a focus on wellness and healthy living. A philanthropic component ensures the wealth is being deployed in ways to positively impact local communities and society at large.

Part of this expansive approach to initial services is a result of how women think about wealth. But, part is also because there’s far more awareness now of what a family office is and can offer. “More families are saying, ‘Let me understand the range and start with the range of services,’” Prince says.²⁴ 

The rise of women is infusing energy and focus into efforts by firms to take holistic client-centric approaches. Culture change and execution won’t, however, be easy. Those who can truly look at the larger question of what’s the purpose of wealth and how can it be deployed and managed to help fulfill client goals will be positioned to differentiate themselves from competitors. 

—The views expressed in this article are those of Mindy F. Rosenthal individually and shouldn’t be construed to be the position of PNC Bank, National Association or any of its affiliates.

Endnotes

1. Russ Alan Prince and Hannah Shaw Grove, Women of Wealth, Understanding Today’s Affluent Female Investor, ISBN: 978-1-938130-32-8 Library of Congress Control Number: 2004105329.

2. “The New Wealth Paradigm: How Affluent Women Are Taking Control of Their Futures,” 2009 Campden Research/Relative Solutions.

3. June 29, 2018 phone interview with an ultra-affluent daughter who runs her family’s single family office (SFO).

4. Maddox Smye, LLC.

5. Ibid.

6. Supra note 3. 

7. June 26, 2018 phone interview with Russ Alan Prince, president of consultancy Prince & Associates. 

8. 2014-2015 Prudential Research Study, “Financial Experience & Behaviors Among Women,” www.olympic.org/women-in-sport/background/statistics.

9. National Center for Education Statistics, “Table 318.30: Bachelor’s, Master’s, and Doctor’s Degrees Conferred by Postsecondary Institutions, by Sex of Student and Discipline Division: 2013-14,” 2015 Digest of Education Statistics.

10. Supra note 4.

11. June 14, 2018 phone interview with Linda Mack, president of Mack International, LLC. 

12. Korn Ferry study, www.psychologytoday.com/us/blog/mind-the-manager/201603/new-research-women-consistently-outperform-men-in-eq.

13. Supra note 3. 

14. June 20, 2018 phone interview with Jamie McLaughlin, head of consultancy, J. H. McLaughlin & Co., LLC. 

15. June 13, 2018 phone interview with a former senior bank executive and SFO head.

16. Supra note 14. 

17. Supra note 15.

18. June 22, 2018 phone interview with a second-generation daughter who works in her family’s SFO.

19. Supra note 3. 

20. Ibid. 

21. Supra note 18.

22. Supra note 15.

23. Supra note 7.

24. Ibid. 

It’s a paradox: Some family owner groups in the third, fourth, fifth generation and beyond have sophisticated governance structures and a history of embracing world-class family business advisory help. They may have even been awarded global recognition for best practices in governance. But, a growing sense of dissatisfaction has crept in among the family owners. As an advisor, you can feel it too—low attendance among family owners at meetings, a disinterested and quiet room even if attendees show up and a sense that members are just going through the motions and rubber-stamping decisions. Decisions don’t feel representative of the family’s interests. Something just doesn’t feel right, as if the glue holding the system together is disintegrating. What’s going on?

“Empty structures syndrome” is a term we use to describe a situation in which family owners have come to feel little authority over, or psychological ownership of, their family business governance. This malaise may occur in the family, board, management and/or owner domains and can go in one of two directions: increased tension and overt conflict or apathy and owner disengagement. Either situation, if left unaddressed, can ultimately lead to a splintering of the stakeholder group. As an advisor, neither scenario is one in which you want to find yourself. Not only do you risk getting blamed for the dysfunction or caught in the crossfire of family tensions—the prospect of litigation can be enough to make any advisor want to keep his head down—but also it’s not very rewarding to work with clients who seem apathetic as you try to guide them through the predictable challenges of owning assets collectively. Are you dealing with empty structures syndrome in your work? Here’s how to recognize when empty structures may have taken over.

Four Main Inconsistencies

What does empty structures syndrome look like? Four main inconsistencies typically signify empty structures syndrome:

1. There are well-crafted mission, vision, purpose and/or values statements. There may even be detailed rules, processes and decision structures, but concern or dissent is growing in the family owner group about the family’s common purpose. Mistrust and suspicion about other family members’ values are on the rise.

2. There may be sophisticated programs and procedures for owner development and meeting planning, but there’s decreasing interest to serve on boards and councils or participate in meetings. Those who continue to show up feel burdened and disappointed at others’ lack of commitment. Those who don’t serve, and sometimes even those who do, disengage from the governance process almost entirely.

3. Formal decision groups exist to represent individuals’ interests and enforce rules and guidelines in existing structures and beyond, but these groups decline to act when members break the rules, in small or large ways.

4. Communication guidelines and forums for discussion exist, but regular leaks occur. People avoid addressing the real issues in the forums designed for open discussion. Instead, they share complaints with like-minded individuals, telephone-game style, often in pre- or post-meeting huddles. 

Increasing Family Tensions 

Consider one family (all identifying characteristics have been changed): The first generation patriarch established an investment management company in the late 1970s. Through tax planning and gifting, he transferred ownership in trust to his four children in the late 1990s. As part of that process, he established a board, including his most trusted non-family advisor in a non-voting role, to make investment decisions. But in practice, he retained all decision-making power.

Over the years, he approved two investments that benefited his two eldest children without consulting their siblings or the board. No one challenged the patriarch. Later, when the patriarch’s health began to fail, he withdrew from the board, leaving the four siblings and his trusted advisor to manage investments. The board met regularly, but only to review a list of investments and the performance of other current investments.

Fast forward: Two years after the patriarch passed, one of the younger siblings proposed an investment that would unequally benefit himself and his sister, to the detriment of the two elder siblings. The investment also violated one of the unwritten rules established by the patriarch. The trusted advisor was caught in the middle, listening to complaints not only on both sides of the conflict within the board but also from the wider family, with whom he had established strong relationships over the years. The wider family saw this investment proposal as payback for the earlier decisions that favored the older siblings. Despite many informal objections, the board failed to block the investment. Reacting to this impasse, one of the older brothers stopped coming to board meetings, while the other hired a lawyer to closely review the books. The trusted advisor was at a loss for what to do.

Ultimately, nothing came of the objections. Today, the family continues to grumble about the lack of leadership on the board, and several have wondered out loud if it’s time to take their own portion of the portfolio elsewhere.

Reason for Increased Tensions 

In the above example (and in other empty structures situations), governance becomes obligatory: The family continues to go through the motions, acting as if occupying the governance roles and holding meetings equate to having a collective, energized purpose as owners and family members. But, the structures don’t reflect the needs and priorities of the current generation. And often, no one is willing to say this.

Even worse, and even if the family’s trusted advisors are seen as neutral, the governance structures are perceived as politicized, controlled by an individual, a generation or a branch. So, family beneficiaries and owners don’t trust the structures and subsequently don’t use them for the most important functions: cross-generational and cross-branch communication. Tensions mount because the most important conversations aren’t happening.

What’s Missing?

When we see this situation in our practice, we ask: What purpose should be served by the governance processes? What were these structures and practices set up to achieve? In many cases, we can look back to an earlier time and see that governance was designed to serve a purpose defined by the prior generation. In the example above (and in many other family enterprises), the real purpose of governance (meaning, the underlying emotional purpose) is to reassure the patriarch that the family will stay together.

The problem is, when a family owner group gets larger and more diverse, the purpose of governance—and of collective ownership—is defined quite differently by each family owner. At this stage, no one person has the patriarchal authority to say what the purpose is, and if someone tries, others see these statements as political, serving the generational or branch interests of the speaker. What we see, of course, is that family dynamics influence how purpose is expressed and taken up. In the face of a generational transition, purpose (and in turn, governance) needs to be redefined and so re-energized.

Let’s be clear: These families often retain a sense of connectedness even if they feel alienated from the governance structures that are supposed to facilitate their collective ownership of the business. The spark is still there. They may enjoy each other’s company. They may feel loyal to the business, to the employees and executives and to the customers. They almost always revere the family business history and legacy.

But, these feelings rarely generate a connection or sense of common purpose strong enough to align the family’s diverse interests. What they’ve lost is the compelling reason to exercise the discipline of governance when that discipline might create conflict. They wonder if doing what’s best for the whole (the business, the family) will be what’s best for themselves and their families. They certainly don’t have the confidence that the structures are strong enough to survive a direct expression of the different interests within the owner group. As a result, without parental referees, many family groups disengage to get along. But, there’s hope for families who are locked in empty structures, and advisors can play a critical role in helping them find a way forward.

Identifying an Empty Structure

Even when advisors have thought through and meticulously prepared governance and shareholder documents, it doesn’t always follow that the structures and processes that have been set up will actually work for the family in practice. Don’t assume just because there might be a family or ownership council in place that the group is functioning well. Advisors can play an important role in recognizing empty structures and setting the family on a more productive course:

1. Ask each entity within the existing governance groups to self-assess at least annually. Some questions to consider include: 

• Is the structure sustainable?

• Are discussions candid and direct? 

• Do pre- or post-meetings dominate decision making? 

• Are heart-of-the-matter issues addressed or punted to future sessions?

• Is now the time for leadership to turn over? Is there a mechanism in place for that to happen?

2. Ask stakeholders about how satisfied they are that the current governance is meeting their needs. In addition, pay close attention to the conversations about these issues among the family stakeholders. Informal and private conversations can often surface tensions that aren’t addressed in broader groups. 

Of course, identifying empty structures is only the first step. Advisors often can also help facilitate a discussion with families to help reinvigorate their governance structures and re-establish their ownership over them.  

Re-energizing Governance

Usually, when there are empty structures, no one has asked the current owner group: “What’s your purpose?” Tweaking or overhauling governance should come only after the owner group has engaged in a process to answer this question. Advisors can guide families to consider, discuss and begin to define (or redefine) their purpose. In our experience, we’ve found that these stakeholders often become energized and begin the process to redefine their purpose—if they’re able to accomplish three major tasks:

1. Find the genuine connections among family members and build from there.

2. Discuss together what they’re proud of in the legacy and agree on what they want their children to learn.

3. Commit together to something larger than individual interests, something that connects them to the family business legacy but goes beyond. These commitments usually include some shared community and/or charitable causes.

Your goal, as an advisor, can be to start the conversations on purpose and legacy. Once those are clarified, then you can help the family refresh its governance structures to serve that purpose and legacy for the current generation of owners—and the next one, as well. Your mutual goal should be to strip away any unnecessary elements of governance and to build support for areas of need. Don’t shy away from asking challenging questions and addressing tough issues that arise. Sometimes, the most effective way for a group to refresh is to address the proverbial elephant in the room, even when that communication requires difficult conversations. 

An additional way to re-energize governance is to be sure that the right people, with the right mandate, are having the right conversations about the right issues. A comprehensive governance system creates clear separation among the roles and responsibilities of the owners, board, management and family members. While that may sound straightforward, it can be tricky to get it right—and any confusion can accelerate the onset of empty structures. Roles and boundaries that made sense for one generation may not work for the next, or the business may have evolved far beyond what the original thinking anticipated.

When working with family members who own a business together, we’ve found it helpful to use an analogy of a “four-room model” as a framework to clarify the often-muddled roles of family participation in the family business. The model creates separate forums for the different types of conversations and decisions belonging to each of the four rooms: the owner room, the board room, the management room and the family room.

There must be clear boundaries between the appropriate dialogue and decision-making processes from one room to the next. Especially in family businesses, in which one individual may play multiple roles, it’s important to know what perspective he’s coming from during different conversations. Re-energizing the formal and informal governance structures in a family enterprise can help redefine and realign the right roles and responsibilities that make sense for the current and future generations of ownership and their vision.

Avoiding Empty Structures Syndrome

The best way to solve empty structures syndrome is to be cautious as you design governance in the first place. As advisors, finding ways to keep family owners feeling empowered is critical to having an engaged ownership group. With all the good intentions in the world, even a great trustee can unintentionally trigger passive behaviors in family owners by not:

• providing the information owners need to understand what they own;

• encouraging owner education on business, financial and ownership topics; and

• consulting owners on key decisions, even when the trustee has the power to make those decisions without consultation.

In addition, if trustees are too invested in taking care of the beneficiaries, they often reinforce passive and disengaged behaviors. They can unwittingly make the owner group dependent by efficiently setting the agenda, running all meetings (and keeping them to a minimum) and restricting who gets to see what information. And, when trustees do meet with the owner group, it’s essential that they don’t over-structure the time together. As an advisor, don’t take up all of the air in the room.  Leave time and space for the owners to contemplate decisions and contribute to the conversation. Accept less efficiency for the benefit of deeper understanding and personal connections. Even when the intentions are good, the energy for participants to be engaged tends to get sapped away when someone in authority is controlling the room.

Final Thoughts

Even excellent governance practices don’t ensure that family enterprises will function well. Lack of psychological ownership and decreased engagement with governance often creep into systems when they get larger. In fact, empty structures might be a natural development within family business systems if collective interests aren’t revisited, purpose isn’t redefined and governance doesn’t evolve with each new generation. As trusted advisors, it’s incumbent on us to spot these empty structures as they develop. When we do, we can shape our own roles to strike the right balance between competent guidance and unintentional enabling, spark the client conversations necessary to define their collective purpose and help our clients re-energize their governance structures and practices. 

Professor James J. White contends that any transfer to an asset protection trust is a fraudulent transfer “pure and simple.” (These are commonly also known as self-settled trusts because the trust is created or settled in whole or in part for the benefit of the settlor himself.) He doesn’t attempt to camouflage his disdain for such trusts. His ultimate conclusion is that the 17 or so state legislatures that have passed some form of asset protection for self-settled trusts were essentially duped by lawyers, bankers and others. It should be noted that asset protection trust legislation varies from state to state. Prof. White doesn’t list Arizona or Florida as asset protection jurisdictions even though they immunize the assets of the settlor who creates a trust for his spouse which, on the spouse’s death, remain in trust for the benefit of the settlor. He also doesn’t mention the several states that permit a trustee to reimburse the settlor for income taxes the settlor owes on income attributed to the settlor under the grantor trust rules, which would include a trust in which the settlor isn’t otherwise a discretionary beneficiary but who benefits from reimbursement by the trust for his income tax liability.

The article essentially begins by providing a brief history of asset protection trusts, focusing primarily on those in the Cook Islands and then those in Alaska and Delaware. This history portion of the article concludes that the purpose of such legislation is to protect assets from ex-wives and malpractice plaintiffs.

Prof. White then discusses how some states have revised their fraudulent conveyance (or transfer) acts, pointing out that these changes make it more difficult to attach the assets in a self-settled trust. It should be noted that these state law changes may also make it more difficult to attach assets owned by anyone against whom a judgment is sought, not just a self-settled trust.  Also, not all states that have enacted asset protection trust legislation have changed their fraudulent transfer statutes in conjunction with such legislation.

All states have some sort of fraudulent transfer law under which certain transfers may be set aside and thereby become attachable by a transferor’s creditors. These laws apply whether the fraudulent transfer is to a self-settled trust or to anyone else. As the article points out, Section 548(e) of the U.S. Bankruptcy Code essentially says a transfer to a self-settled trust (or similar device) may be set aside if it was made within 10 years of the filing of the petition for bankruptcy and “with an actual intent to hinder, delay or defraud” a creditor. The article continues by pointing out that it will be difficult in some cases to prove actual intent. It then continues by pointing out that there’s a question under the laws of many states whether the transfer may be struck down as fraudulent only if the creditor is a current one as opposed to a future (unknown) creditor and that the law as to the meaning of a future creditor isn’t certain.

The article discusses the important and complicated issues of jurisdiction and choice of law. It mentions that determining which law should apply isn’t certain in many cases. It discusses at quite some length the tension between Restatement (Second) of Conflict of Laws Sections 270 and 273, which deal with ascertaining which state’s law will determine the validity of a trust, on the one hand, and the general ability of a settlor to determine which state’s law will control the rights of creditors of a beneficiary to attach interests in the trusts, on the other. It points out that some settlors have made it fairly easy to have the law of the forum of the lawsuit apply because the settlor hasn’t set up sufficient connections with the law of the state declared in the trust as controlling. 

Toward the end of the article, the author discusses the use of limited liability companies and the possibility of acquiring a home in a state that provides complete or significant homestead protection, indicating his general displeasure with those because they can be used to protect assets from creditor claims. It seems that his arguments here prove too much. The law has long allowed businesses to be operated in entities, such as corporations, which may protect the owner’s personal assets from claims against the business as a general rule. 

Although the purpose of the article apparently is to stem the tide of states passing asset protection legislation, it indirectly provides guidance on how to increase the chances of a self-settled trust successfully reducing the risk of the trust assets being attached by a creditor of the settlor.

Unfortunately, the article fails to acknowledge that there are reasons, which probably the vast majority of people believe are legitimate and not unfair, for creating self-settled trusts. These include the use of an individual retirement account. They also include the creation of a self-settled trust to use the temporary increase in the estate, gift and generation-skipping transfer tax exemption (scheduled to disappear after 2025) by a taxpayer who doesn’t believe he can afford permanently to give up access to so much wealth. To prevent the trust property from being included in the settlor’s gross estate for federal estate tax purposes (which would defeat the planning), the trust must be created in a self-settled trust jurisdiction. In addition, someone may wish to create a trust to reduce state income taxes but not to make a taxable gift in creating the trust. This planning is accomplished using what are commonly called “incomplete gift trusts” (ING trusts). Essentially, to create such a trust, the grantor must retain an interest in the trust, and the Internal Revenue Service will only rule favorably if the trust is created in a self-settled trust jurisdiction (such as Alaska, Delaware or Nevada). Few, it seems, would regard the creation of a trust to reduce estate or income taxes as improper or unfair. These trusts aren’t being created to “defraud” creditors unless one views an attempt to reduce taxes in compliance with the Internal Revenue Code as “cheating” the government.

As Prof. White details, domestic (U.S.) asset protection trusts that are proven to have been created to hinder, delay or defraud creditors haven’t generally been successful. He points out that creating such a trust outside of the United States, such as in the Cook Islands, provides much greater protection. These foreign trusts may be more expensive to create, but an individual with a serious creditor problem should consider going offshore rather than using a domestic trust because the possibility of a creditor defeating such a trust is much reduced.

Unfortunately, the author doesn’t tell us where he draws the line on legitimate asset protection steps, including between using self-settled trusts (such as to create an IRA or an ING trust) and using other types of trusts. He seems to condemn any use of self-settled trusts. It seems doubtful that his essay will stop states from adopting self-settled trust legislation. Although the author contends that transfers to self-settled trusts are per se fraudulent, that isn’t the current law, but he apparently hopes it will become so. 

More than 50 percent of adult Americans don’t have a will. Lack of a will may result in what the author calls “donative error,” when the individual’s donative preferences aren’t aligned with her state’s intestacy statutes. Many individuals lack the motivation to engage in estate planning, whether due to laziness, procrastination or discomfort discussing death. If an individual does have the motivation to execute a will, she may lack the resources to do so effectively because she can’t afford to hire a lawyer. If the individual does undertake to write a will and either doesn’t understand the law herself or has incompetent counsel, donative error may result because a court misconstrues or rejects a decedent’s will due to technical deficiencies. 

The author asserts that formalistic probate rules are in tension with the probate system’s emphasis on donative intent and that the segment of the population that bears the burden of donative errors in the probate system is the middle class. The author urges simplification of probate rules to reduce the unequal distribution of undeserved donative errors among the middle class—individuals who lack access to legal knowledge or the resources to retain an attorney.

The article suggests two areas in which probate rules can be simplified. The first relates to will drafting and execution. For example, states could authorize other classes of professionals to draft wills or could expand the validity of holographic wills (those wholly in the handwriting of the testator) to allow an individual to be more self-reliant in his planning. Formalities relating to will execution could be liberalized. Laymen generally don’t understand the formalities required to execute a will. For example, many individuals believe a document is “legal” if it’s notarized. Only two states, Colorado and North Dakota, permit a will that’s merely been notarized to be admitted to probate. Legislative requirements, however, typically require a writing, signature and attestation by two witnesses. Adopting notarization may be a reasonable reform to reduce donative errors.

The author recognizes that formalities in the will execution process serve various functions, most importantly protecting the testator from being unduly influenced or coerced. Permitting non-attorneys to draft wills may not achieve donative intent. Retaining probate formalities to address these concerns may outweigh reducing inequality in the distribution of donative errors. The second area of probate simplification, therefore, focuses on probate court flexibility in dealing with imperfectly drafted or executed wills.

Other authors have proposed broadening the rules of judicial construction, for example by permitting judges to examine a wider range of evidence than the four corners of the will or by allowing courts to reform wills, particularly when there’s clear and convincing evidence of the decedent’s intent. Legislatures may be unwilling, however, to adopt reforms that require more fact-intensive inquiry by already burdened probate courts.

The author has taken a novel approach in suggesting probate reform not solely for its own sake but also to achieve “distributive justice” for a particular demographic of society.

Trusts and estates law has a rich archive of legal history and scholarly analyses with regard to property rights that’s largely evolved with the concerns and priorities of today’s heirs. When wills and trusts fall short of meeting the emotional and practical needs of beneficiaries, there are often remedies in law that can embrace the intent of the decedent yet adjust for the compelling situations of heirs. When the decedent’s property is a body of artistic work, however, intellectual property (IP) law applies. Unlike trusts and estates law, the author argues, IP law to date shows less flexibility and lacks the scholarly body of work to thoughtfully address the range of emotional and economic issues of today’s inheritors of IP estates.   

Professsor Gilden posits that when an artist dies, there’s often an inherent conflict between the desires of the heirs and the desires of the public. Even as the artist’s family is mourning, they’re often immediately thrust into situations that require legal responses to protect their personal privacy and the artist’s body of work. Guardians and inheritors of an artist’s art, music and writing may have many reasons to want to limit access to the body of work, while public fans and scholars may wish to see the work freely available for enjoyment and future development in the public domain. When conflicts arise, IP law has been the governing doctrine. In this article, Prof. Gilden reviews the limitations of IP law’s scholarly body of work in balancing non-economic concerns of heirs, and he suggests future remedies that might allow IP law to better acknowledge and bridge the legitimate competing priorities of heirs and artistic fans.

The article launches with the concept that when an artist dies, there are two parallel processes of mourning; one for the heirs and family who may be engulfed in grief, while a second begins for fans who immediately wish to celebrate and amplify the artist’s music, books, artwork and speeches. Even as these dual mourning periods begin, family members who inherit IP rights have the sole power to start controlling the commercial use of the artist’s work and limiting public access. Prof. Gilden reports that to date, heirs who have actively limited public access to an artist’s work have often been viewed as greedy or vindictive. On the contrary, he continues, IP heirs have a range of legitimate emotional reasons to wish to limit access including “remedying exploitation, protecting family privacy and maintaining the dignity of the deceased.” 

Prof. Gilden next reviews a number of cases in which families have successfully argued in court to restrict the use of an artist’s likeness or body of work. He reports that in most of these cases, the heirs’ primary argument wasn’t economic. He further highlights that when an economic interest was argued, it was often from a position that the artist was economically exploited during her lifetime, and the estate should have the opportunity to remedy the financial shortcomings from life. Many times, heirs have prevailed in court to expand the application of copyright and right of publicity laws for the non-economic benefit of living family. Despite this success, Prof. Gilden points out, scholarly work on IP law continues to primarily assume heirs only care about financial gain. He strongly argues that while the courts have begun to adjust, scholarly work hasn’t.

In contrast, notes Prof. Gilden, other areas of law regularly adjudicate between private personal interests and public interest and have a rich body of scholarly law reflecting this. Estate law in particular regularly addresses issues of business succession and unique property transfer. These conflicts aren’t always just about the economic value but also the emotional attachment the inheritance creates between the deceased and the heirs, creating or maintaining an enduring legacy. Estate planning, therefore, often includes a compassionate understanding of the emotional issues of heirs to help reduce conflict at a time when all involved parties are most likely to be distraught with grief and heightened emotional reactions. Likewise, in areas of organ donation, medical research and even disposition of bodies, Prof. Gilden offers examples that highlight the scholarly work that’s considered how the law can successfully balance private concerns and public interest.

To better address the common competing struggles between IP estates and the public, Prof. Gilden suggests first embracing the concept of “parallel mourning,” in which the family and the public are both processing a death simultaneously with similar emotional goals. The author encourages IP law to acknowledge that both sets of mourners (public and private) are working to construct an enduring legacy of the artist even as their concepts of fair use may be at odds. This approach might particularly influence questions of “transformative use” in law, in which the author suggests parallel mourning concepts can help assure that emotional, cultural and ethical issues are given equal weight when assessing the future or immediate use of artistic work in the public domain. Next, there’s a profound need to better integrate estate planning into the IP system, as too many artists die without explicitly naming a steward for their body of work. Prof. Gilden suggests a more explicit registration process for IP might even include requiring a registrant to proactively name who’ll be the legal guardian of her work after death. Finally, Prof. Gilden supports growing efforts to amend the Copyright Act’s termination of transfers provisions to more clearly designate and enforce successors over the 70 years of copyright protection post-mortem. These remedies are all meant to move IP law and practice toward a more nuanced approach that doesn’t simply adjudicate economic interests, but thoughtfully acknowledges both the IP heirs’ and the public’s parallel desires for a celebrated, lasting legacy.

Professor William Drennan’s article, “Conspicuous Philanthropy: Reconciling Contract and Tax Laws,” and Prof. Joel S. Newman’s response to it, “Conspicuous Philanthropy: A Response,” both center on the question: What’s the fair market value (FMV) of naming rights, specifically in the non-commercial context?

This question has obvious and, perhaps, hitherto overlooked, implications for the tax deductibility of large charitable donations. As Prof. Drennan points out, donors have the burden of proving the amount they gave to charity in excess of the benefits they received in return from the donee (citing United States v. American Bar Endowment). 

That is, if you donate $10.5 million to the symphony hall at Lincoln Center in New York City to pay for (greatly needed) renovations and get your name on the building in the bargain, then perhaps $1 million of that sum is the value of those naming rights. In that case, the FMV of the actual gift portion of the sum transferred (net of the value of the naming rights) is only $9.5 million. It would follow, then, that if the donee later wants to remove your name from the building, it would have to pay you to buy back those same rights, perhaps at a value that’s increased since the original purchase.

This is essentially what happened to the Fisher family. They donated $10.5 million in 1973 and, in return, the same symphony hall was renamed “Avery Fisher Hall” in perpetuity. But few renovations, no matter how spectacular, last forever. Thus, in 2014, media mogul David Geffen offered a very handsome $500 million to again renovate the hall, renaming it “David Geffen Hall”—also, in perpetuity. This didn’t go down well with the Fisher family, but they did receive compensation, after some back and forth, of $15 million. Prof. Newman calculates (using the prime rate) that the 1973 present value of the $15 million (in 2014) equals approximately $640,000, but admits that this isn’t much better than “a guess.” 

Profs. Drennan and Newman both believe that valuing naming rights—in non-commercial situations —is essentially impossible. They reach this conclusion by assuming that commercial valuations are irrelevant. When a private enterprise contributes millions to name a sports arena, for example,  the “STAPLES Center,” presumably there are hard commercial calculations and negotiations determining the advertising benefit of that investment. Because such calculations are essentially impossible for a private family like the Fishers, the two contexts aren’t comparable. 

Needless to say, if the task of determining the value of naming rights for such donors is impossible, then the burden of proving the excess of the donation over the benefit received is in itself impossible. Therefore, should the Internal Revenue Service take this position, donors will always fail to get their tax deductions, and perhaps such naming rights to prominent buildings (for example, at universities and cultural centers) will lose much of their value. 

Prof. Drennan’s solution is a negotiation between the donor and donee’s counsel that specifically allocates a value to the naming rights. In the bargaining between the two parties, a value can thus be set. At first blush, it would seem that the tax deductibility of the excess would be the donor’s main concern, and the donor would therefore argue for a lower valuation of the naming rights. It’s harder to see why the donee’s counsel would care. Prof. Newman points out that this value can be compared with liquidated damages in case the donee reneges on the deal and changes the building’s name. It’s the donor and donee’s contract counsel who would negotiate, with the donor asking for the highest possible value and the donee asking for the lowest value (to better free the donee’s options up in the case of future fundraising needs and opportunities). Prof. Newman suggests that treating this value as simply an estimate of liquidated damages essentially solves the problem of naming things in perpetuity, when circumstances change (as they often do) and give rise to new requirements. 

With the very substantial tax motivations in play here, however, and with the clear asymmetry of salience of those motivations between the donor and donee (the donor would clearly care very much more than the donee), this negotiation process would seem to be more hypothetical than real. And, are perhaps both professors a bit quick to dismiss the commercial deals as a benchmark here? Building owners, after all, have options. They may grant naming rights to anyone, whether commercial or non-commercial, and might favor the highest bidder in most cases. And, who’s to say that a family’s desire for its name on a building isn’t as strong as the purely financial motivations of a business?