Estate and Tax Planning
June 15, 2005
In This Issue:
- Advance Health Care Directives/ Living Will and Proxy Compared
- Parallel GRATs
The Living Will is an advance statement of intent concerning medical treatment. In a basic way it deals with the evidentiary problem presented when the patient is not able to personally give instructions.
With a Living Will each potential medical condition is to be specified, along with the desired treatment for that condition. It is often not realistic to expect the principal (that is, the patient) to be so specific. Nevertheless, the Living Will can be useful to the extent it states the precondition in general rather than specific terms.
However, the generality with which the precondition is stated leads to uncertainty whether the condition has been satisfied and the statement of intent applies. Any such uncertainty may delay compliance by the health care provider or invite a dispute instituted by family members with different views. Thus, if a Living Will is used, it should express the intent of the principal but not employ troublesome phrases such as: "terminal illness", "meaningful quality of life", "extraordinary" treatment and "heroic measures".
For these reasons, the Living Will is less flexible than a Health Care Proxy. The Health Care Proxy gives the designated agent the same authority that the principal would have to make decisions at the time of the illness. The agent may function in situations other than where death is imminent. The principal may select anyone to be the agent; however, he may not select his attending physician. The Health Care Proxy must display only one of the instructions given the agent by the principal; namely, it must state whether the principal has authorized artificial hydration or nutrition.
Of course, a good deal of discretion is conferred upon the person selected as agent. That person should be known to the principal to be reliable, to have demonstrated good judgment and should be confident that the intent of the principal is understood.
Some states prescribe a priority of relatives to consult in making health care decisions concerning an incompetent individual. The HCP may specify any person to act as agent, as long that person is not the attending physician.
Multi-State Problems
When an individual is hospitalized in a state other than his domicile, he may not have executed a document in the form used in that state. The question arises then whether the state of hospitalization will recognize the authority of the agent granted under the law of the state of domicile.
Some (but not all) States have legislation that provides that if a HCP is validly executed in a foreign State, it is considered validly executed in the domestic State. The legislation frequently (but not always) provides that the agent so designated shall have the authority granted to domestic agents and not the authority granted by the foreign state.
New York, Florida, Massachusetts and New Jersey have legislation. Connecticut is silent.
Parallel GRATS
Valuation techniques are intended to reduce the estate or gift tax cost by invoking those sections of Chapter 14 of the Internal Revenue Code that prescribe discounts for property transferred either at death or during life. In recent years, these techniques have been getting unprecedented attention.
First the treatise writers propose some form of ownership that they say will warrant a discount on the value of the property owned in that way and transferred. Then the Internal Revenue Service challenges the asserted discount by conducting an audit of the transferor's tax return and writing a Tax (or a District) Court brief that expresses indignation or outrage. Then the trial Court writes an intemperate opinion that sides with either the government or the taxpayer. Further opinions by the Circuit Courts re-align the law, sometimes sending the case back to the lower court for re-consideration. All that is clear to a literate and impartial observer is that a tendentious reading of the Code will not be persuasive, if taxpayer neglects the details of either creating or operating the arrangement.
One suggestion for securing a discount that seems modest, sincere and close to the language of the Code is called Parallel GRATs by the fellow who first proposed it, Richard B. Covey, Esq.
The Set-up:
1. Husband and wife each create a GRAT ("grantor retained annuity trust"). The terms of these trusts are parallel.
2. More specifically, the husband retains an annuity for one year from the GRAT he creates and provides that his interest will be followed by an annuity paid to his wife during the balance of her life. The husband directs that, on his wife's death, the trust will terminate and the corpus will be paid to his then-living children. The husband reserves the right to terminate the trust by a provision in his Will,. If exercised, that right would end the annuity for his wife and recover the corpus of the trust for his executor causing that property to pass under his Will as a part of his estate.
3. Likewise, the wife creates a similar GRAT. She keeps a one year annuity interest and gives her husband an annuity interest for life, reserving the right to terminate the trust by a provision in her Will.
4. Further, each spouse executes a Will that provides that, if he or she is the first to die, the GRAT that he or she has created will terminate and the corpus of the trust will be distributed by the trustee to the executor of that spouse's Will and pass under that Will into a different trust; that is, a testamentary marital deduction trust for the life of the spouse who survives.
5. In each GRAT, the rate of the annuity will be set by reference to the rate prescribed by the AFR ("applicable Federal rate") tables in effect for the month in which the GRATs are created. The objective of setting the rate in this way is to employ an annuity rate that under the AFR valuation tables will result in the value of the one year annuity retained by the respective grantor and the lifetime annuity given to the grantor's spouse being equal to the value of the property contributed to the GRAT.
6. In determining the value of the property placed in the GRAT, the grantor may use any method for discounting value available for gift tax purposes. If such an inside discount is used, the minimum annuity will be reduced.
7. As a result of setting the annuity rate in the manner described above, neither spouse will have made a taxable gift. That is, the benefit conferred by each GRAT on the children who survive the spouse of the grantor of that GRAT will have an actuarial value of zero, because the value of the contribution will not exceed the actuarial value attributed to the preceding (that is, "retained") annuity interests.
The Play:
1. Assume both husband and wife live for a year and the spouse of each of them begins to receive the prescribed annuity from the GRAT created by the other. The husband is the first to die. His death comes five years after the GRATs were created.
2. The GRAT that the wife created for her husband will terminate and the corpus will be paid to the surviving children. The GRAT the husband created for his wife will terminate and the corpus will be paid to his executor who in turn will distribute the property to the trustee of the marital trust. Later when the wife dies, the corpus of the marital trust will be subject to tax to the extent its value exceeds her estate tax AEA. Of course, the estate tax may have been repealed by the time she dies.
The Assessment:
1. The creation of Parallel GRATs will not represent a taxable gift. The death of the husband will not result in any estate or gift tax on the wife's contribution to the GRAT she created. The only tax imposed on the property contributed to either GRAT will be an estate tax imposed (if it is the husband who dies first) on the husband's contribution to the GRAT he created for his wife and it will be payable at the time of his wife's death.
2. The tax payable will be one half the tax that would have been payable if the Parallel GRATs had not been created. The earnings and appreciation on the property the wife contributed from the date of her husband's death will be enjoyed by (and taxed to) their children.
3. The strategy should work for any amount.
The spouse with greater assets can give the other spouse whatever
is needed to make a matching contribution to the other GRAT.
The strategy will work for couples with an aggregate estate
of any amount.
However, it is limited in its usefulness at both the high and the low ends. At the high end, the strategy does not address the problems posed by the Chapter 13 tax on generation-skipping transfers. At the low end, the strategy will not "work" if the surviving spouse would not be able to maintain an appropriate standard of living without access to the funds contributed to the terminated GRAT.
4. The remaining question is whether the parallel GRATs arrangement is a "mere device" for the transfer of property at a discount. At one point, the Code says, in determining the value of property transferred, an arrangement in which the property is held or transferred should be ignored if that arrangement is a device. Courts have given the term "device" an unusually subjective interpretation.
While it has been famously said that a taxpayer need not arrange his affairs to assure the fiscal needs of the government, nevertheless the assertion of a discount is more likely to be persuasive if it can be shown that non-tax motives were also at work. The Parallel GRATs proposal is not a natural disposition of property. That is to say, there seems to be little more than tax considerations to recommend creating Parallel GRATs. Nevertheless, the Code that prescribes the elements that define a GRAT and assigns a discount. For that reason, it seems to many that the Code itself assures the discount will be available.
Changes at Dunnington
The Firm has relocated its offices to 477 Madison Avenue as of April 1, 2005. We are now on the northeast corner of Madison Avenue and 51st Street. Our telephone numbers and facsimile number have remained the same. None of our e-mail addresses has changed.
We are excited about our new space. In fact, we would welcome anyone who would like to visit..
We have also added a new Practice Group. Carol A. Sigmond has joined us as a Dunnington Partner to continue her practice in Construction Litigation and Arbitration. She has added Michael A. Kofsky to our of Counsel team and Khadija Laaroussi to our Legal Assistant team.
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