The Anatomy of the Perfect Modern Trust—Part 1Dec 04, 2017  · The Anatomy of the Perfect Modern...

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I f planners advising clients about business and estate planning had to consider just two questions most common to every engage- ment, those questions would be “What do clients really want?” and “What is the best way for them to obtain what they want?” This arti- cle addresses those questions. Regardless of how complicated and disparate the clients’ lives and cir- cumstances may be, there are basic common elements and straightfor- ward common solutions that every planner can recognize and use in every client situation. Most advi- sors concentrate on the wealth shifting process and often do not give adequate attention to wealth receipt planning (i.e., how the recip- ients should receive the transfers). Wealth receipt planning is as important a component of the estate planning process as wealth shifting planning, and often has a greater impact. As a general propo- sition, most children, grandchil- dren, and others are, or are expect- ed to become, competent functional adults—individuals to whom the transferor would transfer wealth outright at the proper time, but for the shield that trusts provide from taxing authorities and other poten- tial claimants. All of us have expe- rienced receiving gifts at some time in our lives that had “strings” attached (e.g., an allowance that could be spent only in a special manner). The typical reaction of the donee is that the imposition of conditions marginalizes the full enjoyment of the gift, even though often the restrictions may have been justifi- able. For the capable, mature, sen- sible recipient of wealth, the gift should be as enabling as possible, subject only to the restraints nec- essary to achieve the protections dis- cussed in this article. The “key” here is to structure the trust to accom- plish those goals. The thought process should be viewed from the following perspective: “If I were receiving a large gift or bequest, what would I want?” Under U.S. law, persons can be given rights, controls, and protec- tions in trust that they cannot “retain” for themselves once they have received the property without the risk of erosion from unneces- sary taxes and creditor exposure. Trusts are not only an essential component of wealth shifting and 3 The Anatomy of the Perfect Modern Trust—Part 1 Estate planners best meet client needs with trusts that satisfy a six-factor “wish list.” RICHARD A. OSHINS AND STEVEN G. SIEGEL RICHARD A. OSHINS MBA, LL.M., AEP (Distinguished), is a member of the law firm of Oshins & Associates, LLC in Las Vegas, Nevada. He concentrates his prac- tice in tax and estate planning, with a substantial emphasis on multigenerational wealth planning— particularly with regard to closely held businesses. He is also a member of the editorial board of ESTATE PLANNING and has lectured extensively on innovative tax and estate planning strategies and is the author or co-author of many articles. STEVEN G. SIEGEL, LL.M. is president of The Siegel Group, which provides consulting services to accountants, attorneys, and financial planners to assist them with the tax, estate, business planning, and compliance issues confronting their clients. Based in Morristown, New Jersey, the group provides services throughout the U.S. The authors would like to thank Prof. Jeffrey A. Schoenblum, Prof. Jerry Hesch, Steve Oshins, and Ed Morrow for their generous help in reviewing this article. Copyright © 2015, Richard A. Oshins and Steven G. Siegel.

Transcript of The Anatomy of the Perfect Modern Trust—Part 1Dec 04, 2017  · The Anatomy of the Perfect Modern...

Page 1: The Anatomy of the Perfect Modern Trust—Part 1Dec 04, 2017  · The Anatomy of the Perfect Modern Trust—Part 1 Estate planners best meet client needs with trusts that satisfy a

If planners advising clients aboutbusiness and estate planning hadto consider just two questionsmost common to every engage-

ment, those questions would be“What do clients really want?” and“What is the best way for them toobtain what they want?” This arti-cle addresses those questions.Regardless of how complicated anddisparate the clients’ lives and cir-cumstances may be, there are basiccommon elements and straightfor-ward common solutions that everyplanner can recognize and use inevery client situation. Most advi-sors concentrate on the wealthshifting process and often do notgive adequate attention to wealthreceipt planning (i.e., how the recip-ients should receive the transfers).

Wealth receipt planning is asimportant a component of theestate planning process as wealthshifting planning, and often has agreater impact. As a general propo-sition, most children, grandchil-dren, and others are, or are expect-

ed to become, competent functionaladults—individuals to whom thetransferor would transfer wealthoutright at the proper time, but forthe shield that trusts provide fromtaxing authorities and other poten-tial claimants. All of us have expe-rienced receiving gifts at some timein our lives that had “strings”attached (e.g., an allowance that

could be spent only in a specialmanner).

The typical reaction of the doneeis that the imposition of conditionsmarginalizes the full enjoyment ofthe gift, even though often therestrictions may have been justifi-able. For the capable, mature, sen-sible recipient of wealth, the giftshould be as enabling as possible,subject only to the restraints nec-essary to achieve the protections dis-cussed in this article. The “key” hereis to structure the trust to accom-plish those goals. The thoughtprocess should be viewed from thefollowing perspective: “If I werereceiving a large gift or bequest,what would I want?”

Under U.S. law, persons can begiven rights, controls, and protec-tions in trust that they cannot“retain” for themselves once theyhave received the property withoutthe risk of erosion from unneces-sary taxes and creditor exposure.Trusts are not only an essentialcomponent of wealth shifting and

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The Anatomy of the Perfect Modern

Trust—Part 1Estate planners best meet client needs withtrusts that satisfy a six-factor “wish l ist.”

RICHARD A. OSHINS AND STEVEN G. SIEGEL

RICHARD A. OSHINS MBA, LL.M., AEP (Distinguished),is a member of the law firm of Oshins & Associates,LLC in Las Vegas, Nevada. He concentrates his prac-tice in tax and estate planning, with a substantialemphasis on multigenerational wealth planning—particularly with regard to closely held businesses.He is also a member of the editorial board of ESTATEPLANNING and has lectured extensively on innovativetax and estate planning strategies and is the authoror co-author of many articles. STEVEN G. SIEGEL,LL.M. is president of The Siegel Group, which providesconsulting services to accountants, attorneys, andfinancial planners to assist them with the tax, estate,business planning, and compliance issues confrontingtheir clients. Based in Morristown, New Jersey, thegroup provides services throughout the U.S. The authorswould like to thank Prof. Jeffrey A. Schoenblum, Prof. Jerry Hesch, Steve Oshins, and Ed Morrow fortheir generous help in reviewing this article. Copyright © 2015, Richard A. Oshins and Steven G. Siegel.

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planning for inheritors who can-not (or should not) own or receiveproperty outright, they are alsoan important ingredient of shiftingassets to the “competent inheritor.”

The strategy discussed below ismore than simply a trust. Rather itis an estate planning process thatwhen planned, structured, imple-mented, and operated correctly willaccomplish more than any tradi-tional estate planning tool.

The essential steps for both theplanner and the client are to deter-mine:

1. Is there a “best” way to passand receive wealth?

2. What is “best”? 3. If there is a “best” trust design

pattern, why aren’t all trustsstructured in that manner?

4. From whose perspectiveshould the decision be made—the transferor’s or the recipi-ent’s—particularly withrespect to a person to whomthe transferor would beinclined to pass the wealthoutright?

5. If there is a “best” design pattern, how should it beexplained to the client so thatthe decision-making processresults in an “informed”choice?

6. How can the virtues of thetrust plan be communicated tothe beneficiary? In addition toexplaining the trust arrange-ment to the client, it is key toexplain the virtues of the trustplan to those receiving theinheritance. Often the receiptof wealth in trust is viewednegatively. It is essential toeach beneficiary’s happinessand peace of mind that he orshe understands that the trustenhances the gift rather thanserves as an impediment.

Wealth receipt planning—what is “best”?Clients generally want to do whatis best for their children, grand-children, and other loved individ-uals, including determining howthese inheritors will receive theirgifts and bequests. The correctmeans for achieving this is alwaystransferring wealth to and keepingit in a trust, unless the amount ofthe transfer is too small.

That conclusion is reachedbecause a properly designed trustsignificantly improves the value ofan inheritance. The prevailing min-imal wealth rules of thumb used bysome in the estate planning indus-try to justify trust planning aremuch too high, often determinedby the estate tax applicable exclu-sion amount. The authors of thisarticle, however, believe that theinitial threshold for using a trust isunder $1 million. A million dollarsis a lot of money to unnecessarilylose or expose to claimants.

It is impossible to select a singlethreshold amount as the standardminimal value to use even as a “ruleof thumb.” Reasonable people canand will disagree in this regard; how-ever, the threshold presently used ismuch too high. Often the selectionis arbitrary and fact-driven. Onthe other hand, most clients andadvisors are typically too dismissiveof initiating discussions of this issue.It is difficult to envision the bene-ficiary who would not be betteroff receiving wealth in trust even ifit was to provide for certain con-tingencies, such as the death of thebeneficiary with children who areincapable of managing such aninheritance.

In addition, with de minimisexceptions, all trusts should incor-porate the same design structure.For the competent inheritor (i.e.,the person to whom the clientwould want to pass wealth out-right, but for the vast benefits of

receiving assets in trust) the trustdesign pattern will contain thesecomponent parts:

A dynastic, discretionary trust(with distribution discretion inthe hands of an independent partywho can be fired and replaced) thatis beneficiary controlled (unless (a)controls are undesirable or (b)impermissible under law to avoidthe taxing authorities and otherclaimants) that encourages the useof trust assets, rather than distri-butions (unless distributions arebeneficial or desirable) and is situsedin a trust-friendly jurisdiction.

In almost all instances, thesetrusts should include features thatare generally not incorporated inthe “typical” trust, including:

• Expanding the list of permissi-ble beneficiaries, although thedistribution standards might becompressed for the subordinatebeneficiaries. This will enablethe inheritors to benefit frombasis-bump planning, create“opportunity shifting” trustsfor the benefiting of certainbeneficiaries to the exclusion ofothers, etc. These enhance-ments are described below.

• Providing that the trust mayown life insurance on the livesof all beneficiaries, and others,where there is an insurableinterest. This facilitates otherplanning for inheritors, suchas avoiding trust funding com-plexities and limitations (seethe discussion below regarding“the ultimate irrevocable lifeinsurance trust”).

• Permitting transfers to sub-trusts for the benefit of one ormore of the beneficiaries,including trusts set up by theindependent trustee or specialtrustee. For instance, assumethat a beneficiary has a favor-able business or investmentopportunity that he or she

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wanted to pursue. It would beunreasonable for the benefici-ary to share the potentiallyenormous fruits of his or herlabor or intellect with siblingsor other more remote benefici-aries. In this situation, thetrustee of a traditional trustwould ordinarily make a distri-bution outright to the benefici-ary who would then start oracquire the favorable opportu-nity. It would be preferable forthe distribution trustee totransfer the ‘seed’ money to atrust for the beneficiary and thebeneficiary’s family to theexclusion of others, including atrust that is a beneficiary defec-tive inheritors trust (BDIT)1 inorder for the beneficiary tomaximize the protectionsinherent in trust planning dis-cussed in this article.

• Allowing the independenttrustee to give, take away, and

design general powers ofappointment (see the discus-sion of tax savings, below).

For the inheritor who is not com-petent, the controls would bereduced, deferred, or not given atall. Certain controls might be treat-ed differently than other controls.

For all beneficiaries, the trustwould provide no enforceablerights or entitlements. As a gener-al rule, rights and entitlementsare harmful and do not add anybenefits that cannot be achieved bydrafting the trust in a more pro-tective manner.

What rights, benefits, and controls do clients and inheritors want?The planning desires of every wealthowner can be broken down intosix categories that the authors callthe “Wish List.” As explained inExhibit 1, they are: control, use andenjoyment, flexibility, creditor pro-tection, tax savings, and simplicity.

Donors and testators wouldwant all of the components of theWish List if they were going to bethe recipient of a gift or bequest.All beneficiaries, whether spouses,significant others, children orgrandchildren, or other inheritorswant the same thing. Although their

individual priorities will differ,everyone wants the exact same sixownership attributes.

If a planner can create a vehiclefor a client that achieves each ofthese six desires, the client shouldbe satisfied, and the job is welldone. All clients want to do whatis “best” for their family and otherintended inheritors. The advisor’sjob is to make certain that clientsare making informed decisionsabout what is “best.” The discus-sion that follows suggests a modelthat can achieve each of these goalsfor every client, regardless of whatbusiness, family, and personal issuesthat client presents. The authorscall their model the “Perfect Mod-ern Trust.” It is a trust design pat-tern that will achieve the maximumbenefits and controls associatedwith outright ownership (to theextent desirable by the transferor),but it also provides the maximumpermissible protections allowableby law. To the extent that the recip-ient and the transferor disagreeon the structure, generally thedesires of the transferor will pre-vail. Often, however, the client con-siders the recipient to be a mature,capable, person to whom theywould wish to pass wealth outright,unless there is a better alterna-tive. In such instance, the recom-mended strategy is to transfer thewealth to a trust that maximizesthe (1) benefits, controls, and pro-tections of the beneficiary, (2) isoperationally simple, and (3) isdesigned from the viewpoint of thebeneficiary.

What is the Perfect Modern Trust?The trust design being recom-mended is a beneficiary controlledtrust where the use of trust assets(on a preferential basis) rather thantheir outright ownership is encour-aged, although beneficial and desir-able distributions are allowed.

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EXHIBIT 1Wish List

Wealth owners have the following planning desires:1. Control—Primarily managerial and investment control. 2. Use and enjoyment—The use of gifted and inherited wealth, includ-

ing the income generated by the trust assets, for any purpose untildeath, consistent with family goals and values.

3. Flexibility—The ability to revise or amend a plan if laws or familydynamics change or for any other reason.

4. Creditor protection—Shelter from creditors, including former, divorc-ing, or dissident spouses.

5. Tax savings—Proper avoidance or reduction of all taxes—income,gift, estate, and generation-skipping.

6. Simplicity—Everyone wants to avoid complexity.

1 A BDIT is a trust created and funded by anoth-er person with a gift subject to a lapsing powerof withdrawal so that income is taxed to thepower-holder/beneficiary. The BDIT providesplanning results not obtainable in any otherplanning strategy. The BDIT incorporates theplanning opportunities discussed in thisarticle, plus others. See Oshins, Brody, andMcBride, “The BDIT: A Powerful Wealth Plan-ning Strategy When Properly Designed andImplemented,” LISI (6/22/2011); Hesch,Brody, Oshins, and Rounds, “A Gift FromAbove: Estate Planning On a Higher Plane,”150 Tr. & Est. 17 (November 2011).

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• The trust will have safeguardsin case control by a particularbeneficiary is undesirable orunlawful.

• The trust will be discretionary,with distribution discretion inthe hands of an independenttrustee who can be fired andreplaced. The control of theidentity of the independenttrustee is typically ceded to theprimary trust beneficiary, atthe proper time, generationafter generation, subject to (1) change through a specialpower of appointment if suchcontrol is undesirable, or (2) the grantor of a trust whowants to retain control of theoffice of trustee.

• The trust will be dynastic,designed to last as long as thelaw allows, generally subjectto broad special powers ofappointment to retain flexibil-ity in order to deal withchanged circumstances orchanged laws, provided thateach generation will have theability to amend the trust toreduce (or eliminate) the pow-ers of appointment of succeed-ing generations, if desired. Ifinheriting in trust alwaysimproves the inheritance, itwould be irrational not to pro-vide similar benefits toyounger generation beneficiar-ies. The “in trust” enhance-ments, with appropriate con-trols, is a valuable commoditythat inheritors could not pro-vide for themselves, once theyhave or are entitled to theproperty itself.

• The trust will be sitused in atrust-friendly jurisdiction thatavoids unnecessary, avoidablestate income tax beingimposed on the trust incomeand provides strong protectionagainst creditors’ claims.

Attrition of wealth primarilyarises from mismanagement, law-suits, divorces, and taxes. The well-designed trust with carefully select-ed trustees and control provisionscan avoid unfavorable outcomesfrom all four of these causes.

Trust is beneficiary-controlled bythe competent inheritorEvery beneficiary wants to controlhis or her own destiny. The authors’planning experience indicates thatcontrol is essential to the benefi-ciary’s happiness. Many propertyowners think that trusts are toocontrolling and believe that theymust transfer wealth outright tochildren, grandchildren, and otherloved ones in order to avoid impos-ing too many controls on the recip-ients. Many beneficiaries wouldrather forego the benefits of trustsunless they can be given what theyconsider to be adequate control.

In this article, a beneficiary whois a competent, mature, and capa-ble adult is referred to as a “com-petent inheritor.” The seminal ques-tion to address is whether propertyshould be passed to competentinheritors outright or in trust.Assets received and kept in a prop-erly structured trust have manyadvantages that are not availableto assets owned outright. An excel-lent outline on the topic, com-menting on the magnitude of theexposure of outright distributionsobserves that—

[Many people,] including advisorswho should know better … do notrealize the enormous, unnecessary,and irretrievable loss of assets theirfamilies will likely suffer by failingto appreciate the benefits that pass-ing wealth from generation to gen-eration in trust can achieve.[Emphasis added.]2

The benefits resulting from trans-ferring wealth in trust make inher-itances received in trust far morevaluable to the recipient than inher-itances received outright. Asset pro-

tection and tax sheltering are com-promised when assets are transferredoutright. Accordingly, a properlydesigned beneficiary-controlled trustshould be the vehicle of choice forevery competent inheritor. Such atrust can be designed to give thecompetent inheritor “full control”(as described below) over his or hertrust.

The visceral reaction of manyadvisors and clients is: “But, isn’tthe grantor the one creating thetrust?” Because many clients, aswell as their advisors, are typical-ly exposed to the notion that theclient can, and usually does, imposeconditions on the wealth transfers,most trust forms are designed tosaddle the recipients with unwant-ed limitations. That is contrary tothe basic thesis of this article—thatthe wealth transfers are beingdesigned to (1) do what is “best”for the competent inheritor and (2) the imposition of any unneces-sary restrictions or controls, com-presses the value of the transfer inthe eyes of the inheritors. Clientsand inheritors will often find theimposition of commonly used pro-totype enjoyment inhibitors to besomewhat reprehensible.

A prime illustration of the fore-going is an investment committee.Investment control given to a trustbeneficiary is innocuous, exceptwith respect to life insurance on thebeneficiary’s life. If it is permissi-ble for the competent inheritor tocontrol investments, then why sub-

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2 Keydel and Wallace, ACTEC Symposium;3/6/1999. See also Aucutt, “Structuring TrustArrangements for Flexibility,” 35 U. Miami Inst.Est. Plan., Ch. 9 (2001); Calleton, McBryde,and Oshins, “Building Flexibility and ControlMechanisms Into the Estate Plan—DraftingFrom the Recipient’s Viewpoint,” NYU 61stInst. on Federal Taxation (2003); Oshinsand Oshins, “Protecting & Preserving WealthInto the Next Millennium—Part 1,” 137 Tr. &Est. 52 (September 1998), and Oshins andOshins, “Protecting & Preserving Wealth Intothe Next Millennium—Part 2,” 137 Tr. & Est.68 (October 1998)

3 “If You Don’t Own It, It Can’t Be Taken AwayFrom You,” Rothschild and Rubin 810 TaxManagement Portfolio, p. A-2.

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rogate these powers to an invest-ment committee?

The desire is to come as closeto outright ownership as possible,without compromising the shelters.The fact that a beneficiary hasinvestment control does not alterthe trust protections. A prevailingphilosophy, not to use trusts, isbased on the notion that trustsimpose unnecessary restrictions andcontrols. The beneficiary-con-trolled trust avoids those concerns

The beneficiary-controlled trustoperates under the philosophyespoused by John D. Rockefeller:“Own nothing, but control every-thing.” If the beneficiary ownsnothing, then nothing can be takenaway from the beneficiary.3 Hav-ing legal title to property is not onlyunimportant, it may often be detri-mental, as the property is now sub-ject to adverse creditor claims.Think of the trust as a “wrapper”surrounding and protecting theassets within it for the benefit ofthe inheritor. How can this com-bination be made to work—i.e.,allow donors to select their chosenbeneficiaries and allow the bene-ficiaries to have their desired con-trol—and still provide the “wrap-

per” protection of the beneficiarythrough a trust? The design of the“Perfect Modern Trust” accom-plishes all of these ends.

What if the inheritor is not competent?Where an inheritor is not compe-tent, whether still a minor or inca-pable of management, immature,spoiled, or spendthrift, the Per-fect Modern Trust performs the tra-ditional functions of a trust: pro-tecting the beneficiary against hisor her impairments. The trust assetswill be sheltered from creditors;predators; and, to the greatestextent possible, the taxing author-ities. In such cases, one or moreof the permissible beneficiary con-trols will be adjusted or eliminat-ed by the transferor.

There are three types of benefi-ciary controls:

1. Managerial/investment control.2. Dispositive control (the ability

to adjust the beneficial inter-ests of others).

3. Control over the identity ofthe trustees.

The basic design of the compe-tent inheritor’s trust would be mod-ified to limit or possibly eliminate

entirely any one or more of thethree beneficiary’s controls if he orshe is not considered a competentinheritor. Partial control may begranted, or the beneficiary can begiven the opportunity to earngreater control by reaching appro-priate milestones.

The exception to the general rulethat the competent inheritor willreceive all three of the controls iswhere the transferor desires to limitthe inheritor’s power of disposition.That might be done, for example,where the transferor does not wishan inheritor’s spouse to benefit fromthe transferred wealth. In such a sit-uation, the power of appointmentwould be changed from “to anyoneother than the beneficiary, his estate,or the creditors of either” to a morerestricted class such as “descen-dants.” To prevent the indirect cir-cumvention of undesirable benefi-ciaries, restrictions on the identityof the distribution trustee shouldalso be considered.

The beneficiary controlled trust formatThe competent inheritor wants tobe in full control of his or herwealth, including any wealth that

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has been inherited or is expectedto be inherited. He or she wouldlike to manage the trust and con-trol its investments.

Investment trustee. The primarybeneficiary of the trust can benamed the investment trustee, alsosometimes referred to as the fami-ly trustee or the managementtrustee. The trust will give theinvestment trustee full manageri-al and investment control at theproper time.4 “At the proper time”is often the time or times (if con-trol is staggered, or cascading) ofprojected maturity. The triggerdates are generally decided in thesame manner that outright distri-butions would be determined to beprudent or for some inter vivostransfers, when the transferor iswilling to relinquish control.

The investment trustee (in a ben-eficiary controlled trust, the com-petent inheritor) is given all con-trols over the trust other than thosewhich by law must be given to atrustee who is not also a benefici-ary. Although the investment trusteeis acting in a fiduciary capacity,the trust will have enabling languagethat expands the allowable actions,such as negating limitations used inproto-type trusts (e.g., the “prudentperson” rule, see below). It is under-standable that often restrictions aredesirable for certain trustees; how-ever, it is not sensible to impose themon those persons who fit the defi-nition of the prevailing competentinheritor. These controls will notexpose the trust assets, or either fidu-ciary, to adverse claims from the IRSor from creditors.

The limitations on the controlsthat cannot be given to a benefici-ary without disturbing the pro-tection offered by the trust wrap-per are essentially negligible andmeaningless. For all desired andreasonable purposes, the controlsthat may be given to a beneficiary

are essentially the functional equiv-alent of outright ownership and fullcontrol. Thus, the term “full con-trol” is used in this article to meanthe maximum control permittedunder law without exposure to theIRS or other potential creditors.

For example, as mentionedabove, it is not necessary or desir-able to burden the investmenttrustee with a requirement thatinvestments be limited in accor-dance with a “prudent person”rule. Enable the beneficiary toinvest freely for his or her own ben-efit in the following ways:

• Allow acquisition of interestsin closely held businesses.

• Permit investment in assetsthat might be considered“illiquid.”

• Allow discounted minorityinterests to be held in the trust.

By negating the prudent personrule, the beneficiary to whom theclient would be inclined to trans-fer property outright, essentiallyhas the best of all worlds—full con-trol and enjoyment of outrightownership, but the shelter fromclaimants that is not obtainable ifthe assets were received outright.

While one would assume thatthe trust beneficiary will want toserve as the investment trustee andappoint himself or herself to thisrole, such a determination is notnecessarily a given. The flexibilityof the trust allows the trust bene-ficiary to select another to serve asinvestment trustee (e.g., perhaps incase of disability), while still allow-ing the beneficiary the right andpower to replace such trustee. Afterthe replacement, the trust benefi-ciary can then control the identityof the independent trustee.

Committees (e.g., investment anddistribution committees) general-ly are undesirable. The use of com-mittees and trust protectors is often

the antithesis of “full control” and“simplicity.” Often, a potentialinheritor will summarily reject trustplanning because of the perceptionthat it is too controlling or too com-plex. It is not irrational to give upthe substantial protections of trustsif controls were imposed or otherthan minimal complexities inter-fered with their unilateral benefi-cial enjoyment. Unfortunately,rather than simply eliminating theunnecessary restrictions, manyadvisors and clients often dismisstrusts because the option is not ade-quately discussed, if mentioned atall, or the advisor is unaware thatadjustments can be made to elim-inate the concerns. Thus, discus-sion of committee-directed trustsand trust protectors is essential tounderstanding the beneficiary-con-trolled trust design.

Some planners favor the use ofa “directed trust,” where the ben-eficiary directs the actions of theinvestment committee. That is notneeded or desired here. The bene-ficiary can make investment deci-sions on his or her own, and avoidthe complications, restraints, costs,and time delays of a directed trust.A distribution committee may beinclined to exercise more disposi-tive controls than a trustee whomeets the definition of an inde-pendent trustee under Section672(c) and Rev. Rul. 95-58,5 whilethe independent trustee would beexpected to impose no meaning-ful restrictions.

For example, the independenttrustee can be the primary benefi-ciary’s best friend without adverse-ly affecting the planning. From theviewpoint of recipients, distribu-tion and investment committeesinstitute unnecessary sanctions,complexities, and controls that are

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4 The one exception is life insurance on the lifeof the inheritor.

5 1995-2 CB 191. 6 Section 2042.

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unwanted and often consideredas reprehensible.

For the donor/testator with mul-tiple children, each child who meetsthe criteria of a competent inheri-tor will at the inception or even-tually be the investment trustee forhis or her separate trust.

If the donor of property to a trustwishes to use the trust format andserve as the investment trustee, sev-eral other tax concerns must beaddressed. In such instance, a donormay not have control over lifeinsurance policies on his or her ownlife.6 A donor may not retain thevoting rights in the stock of a “con-trolled corporation” within therequirements of Section 2036(b).A donor’s power to distribute trustproperty must be limited by anascertainable standard.

Independent trustee. The use of anindependent trustee is essential tomaximize the benefits and protec-tions of trusts. The authors areoften asked, “If the goal is to startthe trust designing process with abeneficiary-controlled trust andmake adjustments only when desir-able, based on the beneficiaries’profiles, how do we correlateadding a ‘stranger’/‘independenttrustee’ to the design?”

The independent trustee—alsosometimes referred to as the dis-tribution trustee—has all of thepowers over the trust that a trusteewho is also a beneficiary may nothave without exposing the trustassets to creditors or taxes. Addingan independent trustee will permitthe trust to include some tax-sen-sitive benefits and powers that areotherwise not allowable, such asthe ability to make distributionswhich are not within the “ascer-tainable standard,” to give and takeaway general powers of appoint-ment, to acquire life insurance onthe life of a tax sensitive trustee,etc. Moreover, a non-beneficiary

trustee who has sole dispositivepowers enhances creditor protec-tion (as discussed below). Advisorsshould be comfortable explainingthe realities of adding a secondtrustee to enhance and not inter-fere with the inheritor’s enjoymentof the property.

The primary powers given to theindependent trustee are powersover distributions, the power togive and remove general powers ofappointment, and all powers withrespect to life insurance on thelife of the investment trustee. Ifdesired, the independent trusteemay be given additional powers,including managerial powers,which may be broader than onlythose that are impermissible forsomeone who is both trustee andbeneficiary. The trust can be writ-ten to allow these additional pow-ers to be toggled off and on, as mayprove to be desirable.

The independent trustee can beanyone except those personsreferred to in Section 672(c) or inRev. Rul. 95-58. Rev. Rul. 95-58holds that a decedent/grantor’sreservation of an unqualified powerto remove a trustee and to appointan individual or corporate succes-sor trustee that is not related orsubordinate to the decedent/grantorwithin the meaning of Section672(c) is not considered a reser-vation of the trustee’s discretionarypowers of distribution over theproperty transferred by the dece-dent/grantor to the trust. Accord-ingly, the trust corpus is not includ-ed in the decedent’s gross estateunder Sections 2036 or 2038. Sec-tion 672(c) defines the term “relat-ed or subordinate party” to meanany non-adverse party who is:

1. The grantor’s spouse if livingwith the grantor.

2. Any one of the following:

• The grantor’s father, mother,issue, brother, or sister.

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• An employee of the grantor. • A corporation or any

employee of a corporationin which the stock holdingsof the grantor and the trustare significant from theviewpoint of voting control.

• A subordinate employee ofa corporation in which thegrantor is an executive.

It would be highly unusual thatthe controlling beneficiary couldnot find an acceptable person orentity who is not tainted by the Sec-tion 672(c) constraints.

Independent does not mean con-frontational, or someone who is astranger. For instance, the benefi-ciary’s “best friend” is includablein the class of permissible inde-pendent trustees who can be firedand replaced, if the beneficiarydetermines it is desirable (andadvances the purposes of the trust).It should be infrequent that an

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informed recipient will not tradeoff the additional benefits and pro-tections that an independenttrustee/fiduciary provides, for theinconsequential addition of such aco-trustee. At least, that has beenthe experience of the authors intheir practices.

Significantly, the investmenttrustee will be given the power inthe trust to remove and replace theindependent trustee, so long as thereplacement independent trustee isnot himself or herself, or any of therelated or subordinate personsreferred to in Section 672(c) andRev. Rul. 95-58. However, the rightof removal is not permissible if itwas done to improperly influencethe independent trustee to make animpermissible distribution or otherwrongful decision. Although thatconstraint might be unnecessaryunder current tax law, not havingit may result in too much controland have an adverse impact forcreditor rights purposes.7 Thus,safety is enhanced if:

1. The investment trustee has the removal and replacementpower, even though the invest-ment trustee is generally theprimary beneficiary and hasthe power of removal andreplacement in his or hercapacity as the investmenttrustee rather than functioningpersonally.

2. The power to fire and replaceis exercisable in a fiduciarycapacity in order to fully pre-serve the integrity of the trustarrangement. The trust inden-ture should reflect that fiduci-ary duties are imposed.

3. The independent trustee canfight an illegitimate removal inthe courts of the state whichwas selected in the trust docu-ment as controlling jurisdiction.

Legitimate removal would bedefined in the trust indenture in

very broad terms to include itemssuch as a personality conflict,inconvenience, inattention of theindependent trustee, etc.8 The listis very inclusive (but not exclu-sive—using “such as” as the guid-ing criteria), which is the goal ofwealth receipt planning, but shouldbe sufficient to block an obstreper-ous judge from successfully order-ing the primary beneficiary/inde-pendent trustee to fire and replacethe distribution trustee in orderto provide access to the trust assetsfor predators. That conclusion canbe enhanced by precatory languagein the trust indenture indicating thegoals of the trust, with the fully dis-cretionary language being directedto a third person acting in a fidu-ciary manner (i.e., “in the bestinterests of the trust”). Because thetrust is controlled by the favoredbeneficiary, who generally has abroad special power of appoint-ment, it is obvious that the inten-tion of the trust creator was to favorthat beneficiary.

Distributions from the trust are fully discretionaryThe Perfect Modern Trust repre-sents the essence of flexibility. Theindependent trustee is given com-plete discretion as to distributionsto the trust beneficiaries. Becausethe independent trustee has theabsolute discretion to make, or notto make, distributions, the trustwill provide the maximum tax andcreditor protection if the right situsis selected to govern the trust.

The distribution powers shouldbe fully discretionary and not sub-ject to standards. The independenttrustee is a fiduciary and mustrespect all fiduciary rules, as wellas proscriptions and savings claus-es contained in the trust document.The duties of the independenttrustee are to carry out the wishesof the testator or donor, and thesedesires should be apparent from the

enabling language in the trustinstrument. Precatory words suchas happiness, enjoyment, etc.;broad powers of appointment; andmaximum controls over the iden-tity of the trustees are indicative ofthe trust creator’s desire to providemaximum beneficial enjoymentto the competent inheritor whileimmunizing the trust assets fromoutsiders.

Many scriveners limit distribu-tions to the theoretically “safe” lan-guage contained in Section2041(b)(1)(A)—“health, education,support, or maintenance.”9 Ratherthan securing safety, those wordsactually expose the trust.

For estate tax purposes, the dis-positive power for “any purpose”in the hands of an independenttrustee is safe. The estate tax inclu-sion arises only if a decedent pos-sessed rights of distribution to him-self or herself that were notprotected by the ascertainable stan-dard. On the other hand, becausethe ascertainable standards areoften used to provide access tothe trust corpus, a court may deemthose standards to be indicativeof an enforceable right of the ben-eficiary (or a minimal obligation ofthe distribution trustee) and there-fore expose the trust to claimants.Thus, contrary to the normal vis-ceral reaction, full and absolute dis-tribution (or use) discretion willbetter insulate the trust assets thanwill discretion using an ascertain-able standard.10

The draftsperson should con-sider enabling distributions to be

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7 See e.g., Pfannenstiehl v. Pfannenstiehl, Mass.App., Slip # 13-P-906 (2015).

8 See Ltr. Rul. 9303018 for a list of “proper caus-es” for the removal of the independent trusteeto use as guidance in designing a list. Priorto the issuance of Rev. Rul. 95-58, supra note5, Ltr. Rul. 9303018, was the standard guid-ance that draftsman used.

9 S. Oshins, 39th Annual Heckerling Institute onEstate Planning, “Asset Protection Other ThanSelf-Settled Trusts: Beneficiary ControlledTrusts, FLPs, LLCs, Retirement Plans and OtherCreditor Protection Strategies,” (2005).

10 Id.

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made “for any purpose” in theindependent trustee’s “absolute,uncontrolled, and unreviewable dis-cretion.” Because there is not astandard to enforce, subordinatebeneficiaries, predators, and courtswill not become involved imple-menting perceived legal entitle-ments. In addition, there is a move-ment in some states to take evendiscretionary trusts into accountfor equitable distribution pro-ceedings. A fully discretionary trustwill provide the greatest shelteragainst this contingency

Operationally, the authors’ rec-ommended behavioral pattern isnot to make distributions unlessthere is a reason to make them, suchas beneficial tax planning, or if abeneficiary simply wants a distri-bution even if is tax inefficient.Where the independent trustee isdealing with a beneficiary who is a

competent inheritor, the assump-tion would be that distributionswould be made generously if thecompetent inheritor wants them—even using “happiness” as the cri-teria—unless the competent inher-itor is dealing with creditor ormatrimonial problems, in whichcase distributions may be withheld.The “key” here is that the primarydesign goal is to provide inheritingloved ones with all of the benefitsof outright ownership, but alsopassing on the compelling virtuesof the trust shelter benefits.

For example, if the competentinheritor desired a distribution toacquire an extravagant asset, or totake an expensive excessive vaca-tion, such a distribution would usu-ally not be considered to be prudentunder normal trust administrationpractice. However, because the over-riding goal (reflected in the trust

instrument) of wealth receipt plan-ning is to give the competent inher-itor full beneficial enjoyment of theassets, the distribution should gen-erally be made (unless making itwould be irrational and a breach offiduciary duties—e.g., to acquiredrugs), and is permissible by broadtrust language, such as “happiness.”To do otherwise would be disin-genuous.

Incompetent inheritor. If the inde-pendent trustee is dealing with abeneficiary who is an incompe-tent inheritor, distributions may bewithheld, or made directly to some-one “for the benefit of” the inher-itor such as for the payment of bills,or made carefully to possible thirdparties charged with the care of theincompetent inheritor. If the incom-petent inheritor qualifies as a spe-cial-needs beneficiary, language

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in the trust will guide the inde-pendent trustee as to appropriatedistributions.

In certain circumstances, theincompetent inheritor may have thediscretion to replace the inde-pendent trustee. This discretionmay be limited (where an incom-petent inheritor is still a minor)or eliminated (where an incompe-tent inheritor lacks the capacityto make decisions), depending onthat person’s circumstances.

Situs of the trust is a critical elementDoes the location chosen for the Per-fect Modern Trust matter? Absolute-ly! The situs of the trust is a crucialelement in its success. Many advi-sors simply assume clients want atrust to be administered locally. Butwhy is that a valid assumption? Thesitus of the trust need not be the statewhere the beneficiaries live. If theclient is properly advised aboutthe advantages of certain jurisdic-tions over others, the client will wise-ly select a jurisdiction that offers themost advantages.

If the client favors a local juris-diction with few planning advan-tages over a more distant jurisdic-tion with distinct advantages, theclient has not been well-advised bythe planner. While the location ofeither the investment trustee or theindependent trustee may providesitus for the trust, selection of the“right” jurisdiction is central to thesuccess of the Perfect ModernTrust. Forum shopping is certain-ly an integral part of the estate plan-ning process.

Rule against perpetuities.What arethe distinctions among differentjurisdictions that make the situs ofthe trust such a critical element?First, what is the law in the juris-diction with respect to the ruleagainst perpetuities? Has the rulebeen abolished, or at least extend-

ed for hundreds of years? If so, thatis a primary factor to be consideredin the selection of the jurisdictionof the trust. As discussed furtherbelow, the trust should be dynas-tic—designed to be used and enjoyedby generations of inheritors freefrom diminution by successive gen-erations of transfer tax imposition.

Asset protection. Next, the juris-diction should have the most favor-able laws offering protection fromcreditors. If wealth is received andowned outright by a beneficiary,whether it is gifted or inherited,planning alternatives for creditors’rights purposes are limited. Trustscan have spendthrift clauses to limitthe claims of creditors of the trustbeneficiaries, but some state lawscontain a series of rules allowing“exception creditors”—opportu-nities for certain creditors to takeadvantage of exceptions to spend-thrift clauses.

For example, Delaware providesthat spouses who are beneficiar-ies of discretionary trusts do notreceive protection of their trustassets from alimony claims of adivorced spouse.11 A divorcing ordivorced spouse is the person whois most likely to sue trust benefi-ciaries. Why would advisors evercompromise this protection, absenta compelling reason to do so, whichwould be very unusual? Allowing“exception creditors” is a trustimpediment that should be avoid-ed. Nevada, for example, providesthat no creditor can get at a dis-cretionary trust; therefore, noexceptions are allowed to thespendthrift rule.12

If the trust is located in a statewith unfavorable creditor laws, ajudge in that state could compel thetrustee to make distributions fromthe trust that then become accessi-ble to creditors. In states which donot have favorable asset protec-tion laws, there seems to be an evolv-

ing trend in the law to compress theprotection of spendthrift clauses andexpand access of claimants to trustproperty. The Perfect Modern Trustwill certainly include a spendthriftclause, and will direct trustees to actin a fiduciary capacity and prohib-it compelled distributions, but suchclauses and directions might be over-ruled in a jurisdiction that aggres-sively favors rights for creditors.This is a practical risk that must notbe discounted. The importance ofthe laws of the jurisdiction chosenfor the situs of the trust cannot beminimized.

Some states have amended theirspendthrift statutes to provide thata trustee/beneficiary may distrib-ute trust property to himself or her-self in accordance with an ascer-tainable standard. There are risksthat a beneficiary may move to astate with less protective laws anda recalcitrant judge might ignorethe situs named in the trust instru-ment under the theory that (1) thereare no (or minimal) then-existingcontacts with the original juris-diction and (2) the trustee, the ben-eficiary, and the assets are in frontof him or her.

Some advisors who subscribe tothe ascertainable standard/singletrustee theory have suggested thatthey would caution their clientsof the risk or tell them to have thetrust amended to incorporate pro-tective provisions before they moveto another jurisdiction. Normalbehavioral patterns of clients (i.e.,

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11 Garretson v. Garretson, 306 A. 2d 737 (1973). 12 NRS § 21.090.1(dd). 13 The authors are concerned that with the ever-evolving compression of the spendthrift pro-tections in some jurisdictions, courts will ordera distribution trustee to make distributions,even though that might breach the trust pro-visions and frustrate the intention of the trans-feror, citing an overriding strong public pol-icy of the state deciding the matter, so thatthe aggrieved judgment creditor should pre-vail. From a practical standpoint, what wouldan independent trustee do if a judge simplyordered that the trustee make a distributionor face contempt charges? It is always bet-ter to protect against such a potential risk.

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procrastination) would lead thepresent authors to conclude oth-erwise and that the monitoringroute will fail. This suggests thatthe trust should always be designedto be governed by the laws of a statewith protective statutes, and prefer-ably, the distribution trustee shouldbe located in a protective state.13

Choosing trustee. The selectionof a trust situs requires that therebe adequate contact between thetrust and the selected jurisdiction.Most state laws recognize the situsof the trust based on the locationof the trustee, and the fact that atleast a portion of the trust assetsare administered by the trustee inthe chosen jurisdiction. This con-sideration leads to the importantchoice of designating the trustee inthe chosen jurisdiction.

Clients will appropriately in-quire about the cost of selecting ajurisdiction, especially if it is nottheir “home” state. Assuming theselected trustee will expect to bepaid a fee, what is the cost of essen-tially “renting” a jurisdiction forthe situs of the trust? This does nothave to be an expensive proposi-tion. Many banks in “friendly”trust jurisdictions have adopted rea-

sonable trustee fee policies. Trustcompanies have been created in sev-eral jurisdictions with the idealcombination of favorable (orrepealed) rules against perpetuities,favorable rules providing protec-tion from creditors, and no stateincome tax. There are reputablecompanies that compete for thebusiness of out-of-state trust cre-ators and charge very reasonablefees for serving as the situs trusteeof the trust. The authors often usean independent trustee to act in adual capacity:

1. To make distributions andother tax sensitive decisions.

2. To secure favorable governingtrust laws.

Many of these companies do notinsist that they take on the role ofinvestment manager as a conditionof their engagement. This can bean advantage for the investmenttrustee who does not seek suchadvice, and who wants to keepthe trustee fee under control. Rec-ommending a trust company thatdoes not invest or sell products isalso a desirable attribute for manyadvisors who do sell investmentsor life insurance. Because the inde-pendent trustee can be removed and

replaced at any time by the deci-sion of the investment trustee, theindependent trustee, located in thefavorable situs, has a strong incen-tive (to the extent it is consistentwith his, hers, or its fiduciaryduties) to act cooperatively withthe investment trustee.

Dynastic in design—but stil l f lexibleThe Perfect Modern Trust will bedesigned to last as long as the lawpermits. Selection of the appropri-ate jurisdiction for the situs of thetrust will focus on a state that hasrepealed or significantly extendedthe rule against perpetuities.Accordingly, state law will not bean impediment to the duration ofthe trust. The chosen situs will alsofocus on a state that does notimpose an income tax on theincome of the trust, so that diminu-tion of the trust assets by local tax-ation will not be a concern for thetrust. Compounding of growth overmany years is an extremely pow-erful wealth-building force. Inaddressing the Wish List with theclient, it is reasonable to concludethat all of the benefits that the clientseeks in the Perfect Modern Trustfor his or her children are similar-

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ly desired to be preserved for grand-children and successive generations.

The prevailing philosophy is thatall competent advisors would haverecommended the use of a creditshelter trust when planning formarried spouses (at least prior toportability). Assuming that limit-ing the power of disposition is notan overriding concern, why shouldan inheritance from someone else,such as a parent or grandparent, beplanned for differently than aninheritance from a predeceasingspouse? Once the identity of thetransferor is eliminated, the bene-fits are essentially synonymous.

If a credit shelter trust makessense for the inter-spousal transferthen it should make sense for otherinheritors. If the credit shelter trustwas not best for spousal planning,then the estate planning communi-ty has historically been giving flawedadvice. Because in-trust transfers areso powerful, the same pattern shouldrepeat generation after generation(typically on a per stirpital basis),subject to broad special powers ofappointment to allow amendmentof the trust by the senior generationof inheritors who would havereceived the property outright butfor the virtues of trusts.

Recognize, of course, that overtime change is likely to occur. ThePerfect Modern Trust is designed tobe flexible and adaptable for chang-ing circumstances in the family andin the law. Since trust distributionsare completely discretionary, theindependent trustee is always ableto adapt quickly to any change incircumstances. In addition, the exis-tence of broad special (limited) pow-ers of appointment to beneficiarieswill give future beneficiaries the abil-ity to “fine tune” changing familydynamics. These powers can addresschanging federal and state tax laws,alter the situs of a trust if a juris-diction becomes less favorable(although the authors suggest the

jurisdictional changing provisionsalso always be incorporated into thetrust agreement) or if another juris-diction becomes more favorable,and react to the realities of compe-tent inheritors and incompetentinheritors.

While every generation express-es concern about how future gen-erations will fare, there is a greatdeal of concern expressed current-ly that future generations will notsucceed to the same level that cur-rent generations enjoy. That per-ception, regardless of whether itproves to be accurate, certainlyallows advisors to encourage clientsto adopt a dynastic trust to protectand preserve the wealth of the cur-rent wealth creators for future gen-erations as a “hedge” against whatthe future may hold.

Divisible dynastic trustAlthough the trust will be designedto be dynastic, it should not beviewed as a single entity with oneever-increasing “pot” to distribute.Instead, as the family evolves, soshould the trust. To do otherwisetends to reward the lazy, inefficientbeneficiaries and harm hard-work-ing, productive beneficiaries whoseefforts inure to others. As separatefamily branches emerge and sib-lings age and have their own fam-ilies, the trust should be dividedinto separate (but generally equal)trusts to accommodate the dis-parate family interests.

The “pot” trust may be pre-served when members of a gener-ation are young and educationexpenses are a primary focus. Per-haps when the youngest child of ageneration reaches a particular agewhere education expenses are like-ly to have been addressed would bea good time to split the “pot” intoseparate trusts. This suggestion car-ries with it the sense of fairness thatall beneficiaries had the opportu-nity to be educated from the same

“pot.” If the family is especiallywealthy, the “fairness” issue maynot be a concern, and the “pot” canbe split earlier. This division of thetrust into separate trusts can beanalogized to splitting a trust intoexempt and non-exempt genera-tion-skipping trusts.

These separate family trusts willprove to be the most efficient man-ner to administer the ongoing trust.Conflicts among siblings should beavoided. Siblings will not wantshared ownership or shared con-trols. They will want differenttrustees, different investments, dif-ferent advisors and different dis-tribution patterns. If a family mem-ber creates a business within thewrapper of the trust, it may beunfair to share the success—or fail-ure—of that business with otherfamily members who are notinvolved. Accounting and account-ability are simplified and enhancedwhen the trust is divided into sep-arate trusts at the appropriate time.

Tax savingsBefore addressing the many keytax-saving opportunities availablewith the recommended trust design,it is essential to mention that taxeconomies are only one of the ele-ments of the arrangement, and tax-efficient elections should not becontrolling. The goal is to pro-vide full beneficial enjoyment with-out unnecessarily sacrificing theshield from predators that trustsoffer. Often those goals will bemutually exclusive. In that instance,elections will need to be made.

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14 Professor A. James Casner, Harvard LawSchool, Hearings before the House Ways andMeans Committee, 94th Congress, 2d Ses-sion, pt. 2, 1335 (3/15/1976 - 3/23/1976);Cooper, A Voluntary Tax? New Perspectiveson Sophisticated Tax Avoidance (BrookingsInstitution, 1979).

15 Siegel, The Grantor Trust Answer Book(Wolters Kluwer/CCH, 2016).

16 Hesch and Handler, “Evaluating the Some-times Surprising Impact of Grantor Trusts onCompeting Strategies to Transfer Wealth,”NYU 68th Inst. on Federal Taxation (2009).

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Because of the controls of the com-petent inheritor, the selection ofsacrifices is determinable, eitherdirectly or indirectly, by him or her.The resultant decision will not beworse than it would be if the wealthwas owned outright or in an alter-native trust design.

The dynastic feature of the Per-fect Modern Trust is at the core ofits tax-saving characterization. Ithas long been recognized that thefederal estate tax can be viewedas a “voluntary tax.” Planning withtax exemptions and charitable giftscan be designed so that no estatetax need ever be paid.14

The combination of generousexclusions from transfer taxes (i.e.,estate, gift, and generation-skip-ping transfer taxes)—$5.45 millionin 2016, indexed annually for infla-tion—with a dynastic trust designproviding for generation-skippingbequests and powers can allow sub-stantial amounts of assets to passfrom one generation to anotherwithout transfer tax imposition.For many families, timely and ade-quate planning will extinguishtransfer taxes entirely.

The trust is the parent’s dynastytrust funded by the parent. The ben-eficiary has never made a gratu-itous transfer to the trust. For thewealthiest families, exposure totransfer taxes can be significantlyreduced, or if combined with otherplanning strategies, even eliminat-ed. Planning is best started as earlyas possible to both use the avail-able exclusions before appreciationhas occurred and to address anideal asset composition.

Assuming that assets will appre-ciate in value from one generationto the next, there is a compoundingeffect of wealth building throughthe generations. If the trust were notdynastic, and if a tax were imposedas each generation passed onthrough a “voluntary” plan of out-right bequests, that compounding

of wealth would either not occur, oroccur at a far lower rate than woulda dynastic trust which circumventstax as one generation passes itsassets to another.

Modern planning techniques fea-ture trusts employed to use andleverage the generation-skippingexemptions available to single andmarried individuals. Appropriatevaluation discounting, reverseQTIP elections, and skillful use ofgeneral and limited powers ofappointment are among these lever-aging techniques. Grantor trusts15

are being increasingly used toenhance the process of estate deple-tion of wealthy senior family mem-bers while benefitting younger fam-ily members. In most instancesthe “tax burn” as a result of thegrantor trust status (the trustgrantor continues to pay incometaxes on the income of the trustwhile that income passes to thetrust beneficiaries or is accumu-lated in the trust) is more power-ful than both discounting and theuse of freezing techniques com-bined.16

Income taxes. The Perfect ModernTrust addresses concerns aboutstate income taxes by selectingthe situs of the trust in a jurisdic-tion that does not have a stateincome tax, as described above. Thedifference in compounding thegrowth of trust assets by avoidingthe impact of state income taxesover a prolonged period of time isquite dramatic.

What about federal incometaxes? Many planners steer theirclients away from trusts becausethey focus on the severely com-pressed federal income tax ratesimposed on trusts. Trusts reach thehighest tax brackets for the 39.6%rate, the 20% rate on capital gainsand qualified dividends, and thenet investment income tax at thethreshold of just $12,400 in 2016

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(which threshold is adjusted annu-ally for inflation). This thinking(i.e., steering clients away fromtrusts) is too narrow.

A well-conceived complex trustwith the independent trustee giventhe discretion to “sprinkle” incometo, or for the benefit of, all bene-ficiaries is not locked into the high-est tax rates at low thresholds. Dis-tributions to beneficiaries aresubject to income taxation at thethresholds of the beneficiaries,which are dramatically higher thanthe threshold of a trust. Distribu-tions of income by a well-adviseddistribution trustee can be made tobeneficiaries because they need theincome, or want the income, or toprovide appropriate income taxsavings from the trust’s compressedtax brackets. Many beneficiariesare in individual tax brackets wellbelow the top rates. The advisor’swealthiest clients are already in the

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top income tax brackets as indi-viduals, so taxing income in thetrust in the same brackets is not adetrimental factor. If the benefici-ary is permitted to use certain trustassets, such use is not subject toincome taxation.

Bear in mind that the competentinheritor, in the role of investmenttrustee, has the power in the Per-fect Modern Trust to remove andreplace the independent trustee.This should increase the likelihoodthat appropriate and tax-favorabledistributions will be made to thecompetent inheritor.

Tax basis planning.Many plannerscorrectly note the importance ofincome tax basis planning. How-ever, they often advocate outrighttransfers to beneficiaries at the deathof each member of a generation togain the basis step-up under Section1014. Again, it is submitted that thisthinking is too narrow. Basis plan-ning can be managed. The inde-pendent trustee can be given thepower to grant a general power ofappointment to trust beneficiaries.This will allow the beneficiary toappoint the trust property subjectto such a power to themselves, theirestate, their creditors, or to the cred-itors of their estate.

The general power of appoint-ment can be designed so that thepower is in reality non-exercisableto prevent an undesirable exercisewithout affecting its identity as ageneral power of appointment.17 Ifsuch a power is not exercised, thetrust property will pass by defaultin accordance with the trust dis-positive provisions.

Applicable exclusion planning.Many permitted trust beneficiarieswill not have personal estatesexceeding the applicable exclusionfrom transfer taxes. Granting thema general power of appointmentwill require inclusion of the trust

property in their estates, and resultin a date-of-death value basis totheir appointees or to the trust indefault of the exercise of thepower.18 When those estates fallshort of the taxable threshold, thisis a desirable technique with a pos-itive tax planning outcome—improving the value of the assetsin the trust to the surviving trustbeneficiaries.

Many family members have avaluable asset that will expire atdeath if not used—their unusedapplicable exclusion amount. Thegranting of a general power ofappointment to these family mem-bers can absorb their unused exclu-sion while gaining the advantageof a potentially stepped-up basisadjustment. The desired basisadjustment is accomplished herewithin the wrapper of the PerfectModern Trust without the neces-sity to forego the advantages of thetrust in pursuit of the desired basisadjustment.19

Consider incorporating “up-stream beneficiaries” in consider-ation of how the powers of appoint-ment should be exercised. This sug-gests granting powers to parentsand possibly in-laws or others whohave available applicable transfertax and generation-skipping taxexclusions to allow these benefi-ciaries, in turn, to pass assets toother family members in youngergenerations taking advantage of theavailable exclusions.

Some planners may object to thepossible granting of a generalpower of appointment to a bene-ficiary out of concern that such apower may be actually exercisedby the beneficiary in a manner thatmay be viewed as somehow detri-mental to the interests of the fam-ily or the family assets. Does thismean that there must be a diffi-cult choice made between thedesired basis adjustment or a poten-tially unwanted appointment? No.

The general power of appointmentstatus will occur even though (1) the power requires prior noticeof its exercise,20 (2) the powerrequires the consent of a non-adverse party,21 or (3) the benefi-ciary does not know of the exis-tence of the power.22

Alternatively, another techniqueis possible that will accomplish thebasis adjustment at the death of abeneficiary without granting thebeneficiary the “freedom” of a gen-eral power of appointment. That isthe technique known as the“Delaware tax trap.”

Delaware tax trap. While it is cer-tainly the broad general rule thatpossessing or exercising a limitedpower of appointment does notresult in a taxable transfer for fed-eral estate and gift tax purposes, oneimportant exception is notable. Thisexception refers to what is knownas the “Delaware tax trap.”23

Under Delaware’s rule againstperpetuities as it existed prior to1995 (when the rule was abol-ished), the rule applied to trusts cre-ated by the exercise of a power of

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17 Section 2041. See the material below and foot-notes 20 through 22, infra.

18 Sections 1014 and 2041. 19 For those trusts that are not GST exempt,the use of a trust beneficiary’s availableGST exemption is obtainable. Further dis-cussion of that opportunity is beyond thescope of this article.

20 Reg. 20.2041-3(b). 21 Section 2041(b)(1(C)(2). 22 Estate of Freeman, 67 TC 202 (1976). 23 Sections 2041(a)(3) and 2514(d). 24 For two outstanding discussions on this topic,see Morrow, “The Optimal Basis Increase andIncome Tax Efficiency Trust,” available athttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=2436964 (last viewed 10/9/2015) orfrom the author at [email protected];Lee, “Run the Basis and Catch Maximum TaxSavings—Part 1,“ 42 ETPL 3 (January 2015),and Lee, “Run the Basis and Catch MaximumTax Savings—Part 2,” 42 ETPL 11 (February2015) For a comprehensive comparison ofusing a formula general power of appointmentrather than the Delaware tax trap, see Mor-row, “The Optimal Basis Increase and IncomeTax Efficiency Trust,” available athttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=2436964 (last viewed 10/9/2015)or from the author at [email protected].

25 Rev. Rul. 2004-64, 2004-2 CB 7.

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appointment measured from thetime of the power’s exercise, ratherthan from the time of the trust’screation. Thus, a perpetual trustwas possible in Delaware by sim-ply creating and exercising succes-sive powers of appointment.

To prevent this result, Congressenacted what became Section2041(a)(3), which subjects a trustto federal estate tax at a benefi-ciary’s death if the beneficiary“exercises a power of appointmentcreated after October 21, 1942 bycreating another power of appoint-ment which under applicable locallaw can be validly exercised so asto postpone the vesting of anyestate or interest in such property,or suspend the absolute ownershipor power of alienation of suchproperty, for a period ascertaina-ble without regard to the date ofthe creation of the first power.”In short, the Delaware tax trap maybe an issue when a beneficiary mayexercise a non-general power ofappointment to create a successivenon-general power of appointmentthat can extend the term of the trustbeyond the duration originally con-templated.

Consider using the Delaware taxtrap as a strategy to intentionallyinclude property in a decedent’sestate that would otherwise beexcluded where the decedent exer-cises the limited power so as to“spring” the trap.24 This should beconsidered in an estate where theestate tax and GST exclusions willnot be exceeded, but where astepped-up basis at the death ofthe power-holder can be obtainedby having the power-holder exercisethe power—resulting in an estateinclusion that will not be subjectto transfer tax, will not give thepower-holder a possibly “danger-ous” general power of appointment,but that will achieve a date of deathvalue as the basis for the heirs.

Basis bump planning. This impor-tant focus on the basis of inherit-ed assets may be referred to as“basis bump planning.” It is at theintersection of estate planning andincome tax planning. Because manyfamily members are likely to havepersonal estates that fall short ofthe applicable transfer tax exclu-sion available to them, having anactive independent trustee or trustprotector monitoring the wealth offamily members will allow thetrustee to grant appropriate pow-ers of appointment to those per-sons with “room” in their person-al wealth to accept additional assetsas includable in their estates fortransfer tax purposes without gen-erating transfer tax liability, andeither exercising such powers infavor of surviving trust benefici-aries to be continued to be held inthe dynastic trust, or allowing thesame result to occur through lapseprovisions if the powers are notexercised.

Consider the benefits of thisplanning when the family assetsmay consist of low-basis real estateinvestments that may have been thesubject of a series of Section 1031exchanges, or properties with neg-ative basis implications. The oppor-tunity to gain a step-up in the basisof these assets for depreciation orsale purposes is substantial. Thisplanning avoids any implicationsof the applicability of Section1014(e) (which denies basis adjust-ments when property is transferredby a person to another who dieswithin one year and the propertyreturns to the original transfer-or). Here, the independent trusteeor trust protector can grant theappropriate power of appointmentin close proximity to the recipient’sdeath, and the rules of Sections2041 and 1014 should allow theestate inclusion and the corre-sponding basis adjustment.

Grantor trust. Where beneficiarieshave their own assets outside thePerfect Modern Trust, planningsuggests that they be owned in agrantor trust designed to have allof the income taxed to the grantor.Strategies designed to cause thetrust grantor to “tax burn” the trustassets and deplete his or her estatein the payment of income taxes areuseful not only in the context ofincome tax planning, but they alsoserve to compress the grantor’sestate for purposes of possible cred-itor access.

When the grantor pays his or herown income tax liability, therebyreducing his or her estate, thegrantor is satisfying his or her ownobligations, and is not making agift to other trust beneficiaries orcommitting a fraud on creditors.25

Moreover, the grantor trust statuswill enable the trust to sell beforedeath low-basis assets to the ben-eficiary in exchange for high-basisassets or cash of the same amount.That exchange is a very powerfulplanning opportunity and can takeplace at any time before death.

ConclusionThe Perfect Modern Trust is anestate planner’s answer to a vari-ety of client needs and wishes. It canallow a client to maximize the con-trol granted over trust assets whileallowing flexibility for changed cir-cumstances, asset protection fromcreditors, and favorable tax treat-ment. Part 2 of this article, whichwill be published in a subsequentissue of ESTATE PLANNING, willexplore how the Perfect ModernTrust outperforms conventionaltrust planning techniques and willidentify common client miscon-ceptions that estate planners shouldbe prepared to clear up. ■

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With estate planning oftenfocused on strategies to shiftwealth, the wealth receiptplanning component of

estate plans may receive inadequateattention. Yet wealth receipt plan-ning can be the more significantfactor in the long run. Trusts area key to both the shifting andreceipt aspects.1 Part 1 of this arti-cle,2 which was published in theJanuary 2016 issue of ESTATEPLANNING, began an exploration ofa solution to these estate planningissues: the Perfect Modern Trust.That discussion is continued below.

Better than conventional trust planningAsset protection is as much a partof modern estate planning as is taxplanning.3 For most people, los-ing wealth to the taxing authori-ties is more tolerable than losing itto creditors or divorcing spouses.Most of the transfer tax avoidanceplanning techniques are equallyapplicable to creditor protection

sheltering, and one of the mostpowerful strategies is to use trustswith little, if any, trust depletiondue to unnecessary distributions. Beneficiary-taxed grantor trusts

under Section 678 substantiallyincrease the estate depletion bothfor tax and asset protection con-sequences. Similar to the conceptnoted in Part 1 of this article that

the estate tax is a “voluntary tax,”4

the exposure of family assets topotential claimants in manyinstances is elective as well. Formost families who follow the rec-ommended planning, as well as tak-ing advantage of other commonplanning strategies, their wealthcan be passed generation after gen-eration free of unnecessary estatedepletion. Assets that are transferred in

trust are given more respect byinheritors than those same assetswould be given if they were trans-ferred outright and commingledwith the recipient’s other assets.There is a far greater probabilitythat inheritors will remember andappreciate a gift or bequest in trust.In addition, there is also a muchgreater probability that trust assetswill be invested or spent in a moreprudent manner than if they losttheir identity and were simply partof the aggregated personal wealthof the recipient.

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The Anatomy of the Perfect Modern

Trust—Part 2Educate clients to understand the advantages that a well-designed

and administered trust has over outright bequests.

RICHARD A. OSHINS AND STEVEN G. SIEGEL

RICHARD A. OSHINS MBA, LL.M., AEP (Distinguished),is a member of the law firm of Oshins & Associates,LLC in Las Vegas, Nevada. He concentrates his prac-tice in tax and estate planning, with a substantialemphasis on multigenerational wealth planning—particularly with regard to closely held businesses.He is also a member of the editorial board of ESTATEPLANNING and has lectured extensively on innovative taxand estate planning strategies and is the author or co-author of many articles. STEVEN G. SIEGEL, LL.M. is president of The Siegel Group, which providesconsulting services to accountants, attorneys, andfinancial planners to assist them with the tax, estate,business planning, and compliance issues confrontingtheir clients. Based in Morristown, New Jersey, thegroup provides services throughout the U.S. The authorswould like to thank Prof. Jeffrey A. Schoenblum, Prof.Jerry Hesch, Steve Oshins, and Ed Morrow for theirgenerous help in reviewing this article. Copyright © 2016, Richard A. Oshins and Steven G. Siegel.

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Conventional tax and trust plan-ning does not guide clients prop-erly and asks clients the wrongquestions. Asking the client,“When do you want your childrento receive their inheritance?” is thewrong question. The better ques-tion is, “How do you want yourchildren to receive their inheri-tance?”—accompanied by anexplanation of the differencesbetween outright inheritance andinheritance using a properly craft-ed trust. Clients generally listen to their

advisors when business planning isdiscussed. Advisors use their expe-rience to take the lead in providingbusiness planning advice. Estateplanning for the client’s loved onesis certainly no less important. Advi-sors should not be passive in theseplanning engagements. An advisor would not recom-

mend to a client a business entitythat could be pierced by creditorsor subjected to unnecessary incometaxes. Neither would an advisorallow a client to make such achoice. Clients have no problemaccepting advice to wrap their busi-ness assets in a protective entity.They should be similarly recep-tive to wrapping their personalassets in a protective trust. Withproper and thorough explanationof the benefits and the ability toadjust controls using the trust

wrapper, clients will recognize thebenefits of trust planning for theirheirs that the heirs cannot pro-vide for themselves. Clients should be made to

understand that trusts are not justa good idea for beneficiaries wholack capacity. Properly and care-fully advised, clients will normal-ly do what their advisers tell themto do. If they do not see the wis-dom in the advice being provid-ed, the advisors have not ade-quately explained the disparities,and they need to try harder.

Conventional trust techniques to be avoidedA fundamental credo of physicians,similarly applicable in the estateplanning process, is “First, do noharm.” That principal is frequent-ly violated by advisors, however,often as a result of attempting toimprove the trust without ade-quately factoring into the equationthe detrimental concessions thatoccur. Consider some of the “stan-dard” techniques advisors typical-ly recommend, none of which arehelpful to the goal of proper fam-ily estate and tax planning:

1. Pay out the income annuallyor more frequently.

2. HEMS (health, education,maintenance, and support)withdrawal rights.

3. The annual lapsing right towithdraw the greater of 5% or$5,000 of the trust corpus.

4. Staggered distributions, suchas one-third at 25; one-half ofthe balance at age 30, and theremainder at age 35.

5. Investment committees. 6. Distribution committees.

Under the theory that “more isnot always better,” does the inclu-sion of the foregoing attributes helpthe competent inheritor (i.e., a ben-eficiary who is a competent, mature,and capable adult)? If their inclu-

sion does not help but instead impos-es unnecessary controls, complexi-ties, exposure, or costs, then theyshould not be included in the plan-ning. As a general rule, entitlements,enforceable rights, and force-outsare not beneficial. Rather, they canbe extremely harmful. Unnecessarycommittees add complexities whichinterfere with the essentially unin-terrupted enjoyment that most com-petent inheritors desire.

Avoid required income paymentsWhen income from a trust must bepaid to a beneficiary, the incomethat is paid out, or that which thebeneficiary is entitled to receive,becomes part of the beneficiary’spersonally owned estate unlessspent, and has thereby “leaked out”of the protective trust wrapper.Why not make distributions onlywhen they are needed? Further-more, consider these issues:

• Where does the beneficiarylive? If the beneficiary’s stateof domicile has an income tax,the distribution from a trust ina no-tax state will now be sub-jected to the income tax of ataxing state.

• Paying out all of the income,especially if to a single benefi-ciary, does not allow for theflexibility of paying income tomultiple beneficiaries to shiftincome and take advantage ofmultiple tax brackets.

• If the required income benefi-ciary has creditor concerns,the mandatory distributionsare exposed to creditors’claims at any time.

What if there is an existing irrev-ocable trust that forces out income?First, consider decanting the trust.Decanting a trust that provides enti-tlements is prohibited in most juris-dictions. Six states,5 however, allowthe elimination of enforceablerights in the decanting process.

1 This article does not discuss the virtues ofprofessional trustees. For those virtues, pleasesee Akers, “Structuring Trustee Powers toAvoid a Tax Catastrophe (or Twenty ThingsYou Need to Know About Selecting a Trusteeand Structuring Trustee Powers),” Hawaii TaxInstitute, 11/5/2014.

2 Oshins and Siegel, “The Anatomy of the Per-fect Modern Trust—Part 1,” 43 ETPL 3 (Jan-uary 2016).

3 Fox and Huft, “Asset Protection and DynastyTrusts.” 37 Real Property, Probate and TrustJ. 287 (Summer 2002).

4 Professor A. James Casner, Harvard LawSchool, Hearings before the House Ways andMeans Committee, 94th Congress, 2d Ses-sion, pt. 2, 1335 (3/15/1976 - 3/23/1976);Cooper, A Voluntary Tax? New Perspectiveson Sophisticated Tax Avoidance (BrookingsInstitution, 1979).

5 Delaware, Missouri, Nevada, Ohio, South Carolina, and South Dakota.

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If decanting is impermissibleunder the then-applicable state law,consider a change in situs to a statethat permits a change to a discre-tionary trust format. If that is notallowable, consider placing thetrust assets into an LLC wrapperwhere the LLC is taxed as a disre-garded entity. This should result inblocking the force-out of distri-butions from the trust by virtueof state trust accounting laws as thetrust will not have any trustaccounting income to distribute.Where distributions are not advis-able, this can be a valuable pro-tection. For instance, the LLCwould block distributions to a ben-eficiary who is being sued, or hasan estate tax exposure. Where dis-tributions are appropriate, discre-tion and flexibility have not beencompromised.

Avoid allowing HEMS distributionsThe Internal Revenue Code permitstrust beneficiaries to have the rightto withdraw from a trust basedon an ascertainable standard (i.e.,HEMS) without resulting in estatetax inclusion.6Often this techniqueis used where the trustee is also abeneficiary in order to avoid theimposition of general power ofappointment status under Section2041(b)(1)(A). Just because the Code permits

certain rights to exist does not meanthat they should be used. In manyinstances, because a beneficiary hasan entitlement, due to its enforce-ability, the rights actually com-promise the benefits that can beobtained with better planning. Providing such a provision in a

conventional trust may place thecreditor protection of the benefi-ciaries at risk. The statutes of somestates—but not all—protect bene-ficiaries from creditors’ claimswhen the trust has an ascertaina-ble standard for distributions. Howwill a judge in the state where a

trustee/beneficiary resides andwhere the creditors have assertedclaims view a HEMS standard, ifprotection is repugnant to thatstate’s strong public policy and isdifferent from the governing lawof the state selected in the instru-ment?7 Even if the governing lawof the trust state protects the ben-eficiary, the domicile of the bene-ficiary and the presence of credi-tors in a different state may yield adifferent result. The standard of “support” is

judicially defined differently fromone state to another. Will “support”referenced in a trust be extended toa divorcing spouse? Is the spend-thrift clause in the trust documenta sufficient protection against allcreditors, or will exception credi-tors be permitted to attach trustassets by either statute or judicialdetermination? Why expose theclient to any of these risks? A whol-ly discretionary trust controlled byan independent trustee in a pro-tective jurisdiction provides themost protection and the most flex-ibility for the beneficiaries. The advice to avoid giving a ben-

eficiary HEMS access is applicableboth to typical HEMS trusts wherethe beneficiary is also the soletrustee as well as the perceivedenhancement that some advisorssuggest where the trust design pro-vides unlimited sprinkling powerby an independent trustee plusenabling the favored beneficiary towithdraw or demand a distributionfor HEMS purposes. The theoret-ical advantage is that the comfortof the beneficiary is increased. Theactual result is that the power ofthe independent trustee to blockthe trust assets from creditors andpredators is negated, because of theentitlements given to the benefici-ary. In such instance, more is less. The reason for concern about

the evolution of theories to over-ride spendthrift protections can be

illustrated by the Pfannenstiehl 8case where the appellate court inMassachusetts concluded that a dis-cretionary HEMS trust with inde-pendent trustees (the beneficiary’sbrother and lawyer) having the dis-tribution control, in a divorce pro-ceeding was part of the maritalestate for equitable distributionpurposes.9 This expanding theoryof attack on spendthrift trust plan-ning should be disconcerting toadvisors who recommend HEMSstandards, especially if the deci-sion-making capacity is in thehands of a beneficiary/trustee.Therefore, the authors suggest:

1. The totally discretionary trustpattern.

2. An independent trustee,preferably located in a protec-tive jurisdiction.

3. Use of applicable state laws ofthe favorable situs.

Avoid giving the trust beneficiarythe “5 and 5” powerAnother power that often seemsinnocuous (except to the extent thatsuch right is owned at death) to mostestate planners, which is allowed bythe Code, is the lapsing right to with-draw the greater of 5% or $5,000of the trust corpus annually.10 The“5 and 5” noncumulative powerof withdrawal given to a benefici-ary to elect annually to withdrawa defined portion of the trust fundis a mistake on many levels. A decedent’s possessing this

power at death subjects the prop-erty that is withdrawable at death

6 Section 2041(b)(1)(A). 7 Oshins, 39th Annual Heckerling Institute onEstate Planning, “Asset Protection Other ThanSelf-Settled Trusts: Beneficiary ControlledTrusts, FLPs, LLCs, Retirement Plans andOther Creditor Protection Strategies,” (2005);Hirsch, Macauley, and Butcher, “Interest inIrrevocable Trust Is Marital Asset,” Tr. & Est.(9/9/2015).

8 Pfannenstiehl v. Pfannenstiehl, Mass. App.,Slip # 13-P-906 (2015).

9 Hirsch, Macauley, and Butcher, supra note7.

10 Section 2041(b)(2).

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to being included in the decedent’sestate. Some advisors suggest lim-iting the exercise of the power tothe month of December, or even tojust December 31. The typical jus-tification for providing this poweris that it enhances the comfort ofthe beneficiary. Contrarily, itaccomplishes the opposite. Itunnecessarily potentially exposesthe trust assets to creditors, includ-ing divorcing spouses. The withdrawal right exposes

the assets to creditors who canenforce the withdrawal right everytime it is available to the benefici-ary. Compressing the withdrawalperiod, perhaps even to the last dayof the year, will reduce the poten-tial estate tax inclusion period;however, the creditor’s right issueis not repaired. The potential estatedepletion from creditors will con-tinue to exist. Control by the dis-tribution trustee is a far moreattractive alternative without theunnecessary risk. The 5 and 5 power can result

in numerous time-consuming andexpensive administrative com-plexities. In Ltr. Rul. 9034004, theIRS concluded that where a bene-ficiary of a 5 and 5 power did notexercise the power, there was anaccelerating exposure to incometax liability every year (i.e., tax thebeneficiary on 5% of the incomethe first year, 5% of the income plus5% of 95% of the income the sec-ond year, and so on for successiveyears). Why expose the client andthe client’s heirs to these issueswhen a flexible discretionary trustwith none of these risks is an avail-able alternative?11

Avoid required distributions at designated agesClients generally want to do whatis best for their children. Most

believe that absent obvious prob-lems, their children are, or will atsome point become, capable ben-eficiaries. Accordingly, clients areoften receptive to “force out” trustprovisions where the trust princi-pal is to be distributed in incre-ments, often at ages 25, 30, and 35.The “theory” often explained byadvisors here is that if the kids“mess up” at one age, they will haveanother chance to succeed severalyears later. Many clients are impressed by

what they believe is some wonder-ful creativity on the part of the advi-sor. Forcing assets out of a shelteredtrust into the hands of beneficiar-ies, which unnecessarily exposes theinherited wealth to loss to the taxcollector, creditors, and divorcingor dissident spouses, is not beingcreative. All force-outs should bevisualized as partial terminations.Trust terminations or partial trustterminations also terminate the trustbenefits. If a client wants to give chil-dren multiple “bites of the apple,”the client can use the “staggered dis-tribution” philosophy but the trans-fer should be to a beneficiary-con-trolled trust, which will preserve thetrust benefits, rather than to theinheritor outright. Clients often favor the idea that

their beneficiaries should enjoy theirinherited wealth without what theymay see as “unnecessary restric-tions.” However, why expose theclients and their heirs to the unnec-essary risks of outright ownershipwhen that goal can be achieved byproviding similar control in a ben-eficiary-controlled trust? Otherwise,creditors and predators can simplybe standing by waiting for theappointed birthday to pounce. If the alternative is a protective

trust with flexible distributions paidwhen appropriate, with all of thebeneficiary controls—without therisk—described here, why intro-duce the potential harm associat-

11 Discussion of additional increased complex-ities and potential costs are beyond the scopeof this article.

ed with distributions at specifiedages? A fully discretionary trustwith distributions controlled by anindependent trustee will maximizethe protection of all beneficiariesfrom claimants and taxes. The competent inheritor, and

each succeeding competent inher-itor, will have all of the powersavailable under the law that willnot compromise the creditor andtaxation protections sought. Withno distribution entitlements and nodesigned force-outs, the trust wrap-per can shelter the family assets.Clients, with the planner’s guid-ance, have the opportunity to deter-mine who will inherit and enjoytheir wealth. The options are: fam-ily and friends, charities, creditors,or the taxing authorities. Certain-ly, the preferable options are fam-ily, friends, and charities, with theminimum depletion to the taxauthorities and none to claimants.

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Anticipate concerns and objectionsAn important step in counselingclients, is for advisors to anticipatethe concerns and objections thattypical clients may have to theintended planning.

Too complex. The client may erro-neously think a trust is too com-plex. Yet, when the assets are in atrust, the investment trustee (whocan be the primary beneficiary, atthe proper time—i.e., the antici-pated attainment of maturity),manages the trust, controls theinvestments, determines the iden-tity of the independent trustee, anddoes everything the law allows tobe done without risking adverse taxor creditor issues. The independ-ent trustee addresses distributions.Properly designed and adminis-tered, this should be easier for theclient to deal with than a revoca-ble trust where the client must dealwith titling and reporting—with notax or creditor protection. When the client says, “All I want

is a simple will,” the client is fail-ing to realize the unnecessary lossof assets that can occur that a trustcan protect against. Real com-plexity would arise if there is adivorce or lawsuit and all of theassets owned outright or in a rev-ocable trust were “in play.” Busi-ness assets may have to be pur-chased from a divorcing spouse,complex appraisals might berequired—much of which can beavoided if assets are held in a third-party-created trust wrapper withcreditor protection. From a practical perspective,

in operation it is anticipated thatthe Perfect Modern Trust will makefew if any distributions becauseof the “use” trust preference. If dis-tributions are necessary, in mostinstances it will be good that thetrust is in place as a protective vehi-cle for the beneficiary.

Because it is a “use” trust, thetrust will be operated in a mannersimilar to a revocable trust withtwo exceptions. First, beneficiar-ies will be prohibited from makinggifts to the trust. Second, an incometax return must be filed for the trustunless it is a grantor trust. If it isnot a grantor trust, the income taxsavings will generally well exceedthe costs and complexities of filingan income tax return. The distri-bution trustee can elect to make taxbeneficial distributions, or retainincome in the trust if deemedadvantageous (e.g., save stateincome taxes) and make such elec-tions as are determined to be in thebest interests of the beneficiaries,taking into account, but not beingcontrolled by, tax efficiencies.

Too expensive. The client maythink trusts are too expensive. Infact, the opposite is true over time.The trust assets are not commin-gled with the beneficiary’s otherassets, leaving fewer assets to betaxed at the beneficiary’s death.The assets in the dynastic GSTexempt trust are not taxed at thedeath of any beneficiary. Stateincome tax can be often be avoid-ed by the careful choice of the trustsitus, careful drafting, and properchoice of trustees. The magnitude of the state

income tax savings is dependent onthe nature of the underlying trustassets and possible other factors.Creditor avoidance should be clear,resulting in fewer creditor claimsand less creditor success if claimsare made. There will be divorces atsome generational level. If a mar-riage ends in divorce, the trustwrapper provides appropriate pro-tection. All of these factors willsave, not cost, the family money.

Fear of unpredictable future. Theclient does not know how familymembers will “turn out”—and

fears law changes. This concern isan argument for the Perfect Mod-ern Trust, not against it. Ratherthan mandating outright distribu-tions at designated ages and “hop-ing” for the best, this trust is flex-ible in its design. The primary beneficiary and

subsequent primary beneficiariescan be given a limited power ofappointment to transfer the wealthin the trust to anyone except thepower-holder, him or herself, thecreditors of the power-holder, theestate of the power-holder, or thecreditors of the estate of the power-holder. This limited power ofappointment can be exercised toappoint property outright or in fur-ther trust. The model of the PerfectModern Trust would suggest thatthis power be given generation aftergeneration in order either to con-tinue with the trust design, amendthe present trust design, or createnew trusts for the beneficiariesunless personal factors or lawchanges make it undesirable orunwise to give the power to the suc-cessor generation or to continuewith the trust structure. The power can be used to com-

press or expand the class of poten-tial recipients as circumstances dic-tate. Essentially it is a power tore-write the trust. (It may be help-ful to the client’s and the benefici-aries’ understanding to refer to thisas a “re-write power” rather thana special power of appointment).Accordingly, it gives a person asmuch power and flexibility over thetrust as would be the case if theproperty was owned outright—except there is more wealth to passalong and less tax and potentialcreditor liability to address.

The ultimate irrevocable l ife insurance trust (ILIT)The Perfect Modern Trust is an idealvehicle for the acquisition of lifeinsurance on the lives of the trust

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beneficiaries or others on whom thetrust has an insurable interest. Con-sider the two primary componentsof a permanent life insurance poli-cy—the lifetime benefit of the insidebuild-up and the death benefit. Bothare often considered to be very valu-able attributes. In traditional estate planning,

an election often must be madebetween the two—minimize estatetaxes or preserve access to the cashvalue. If the insured owns the lifeinsurance policy to preserve accessto the inside build-up, the insured’sestate will face inclusion of the pol-icy proceeds at death. If the insuredarranges for the policy to be ownedin an ILIT, the estate tax inclusioncan be avoided, but the ability toaccess the inside build-up duringlifetime is sacrificed. Placing an existing life insurance

policy into an ILIT may involve gifttax consequences by either requir-ing some use of the donor’s appli-cable transfer tax exclusion amountor requiring tax to be paid. Theestate tax avoidance compromisesthe insured’s access to the cash value.Borrowing the cash value of the pol-icy can be problematical for theinsured as it may expose the deathbenefits to the transfer tax system.

The Perfect Modern Trust solvesthese concerns. The investmenttrustee can acquire life insurance onany beneficiary of the trust with oneexception—he or she cannot acquirelife insurance or make any otherdecisions with respect to life insur-ance where he or she is an insured.That is a meaningless restrictionbecause life insurance on the life ofthe investment trustee can beacquired by the independent trusteeor a special trustee who would beexpected to follow the guidance ofthe “tainted” investment trustee.Where the trustee is an insured, inaddition to requiring that all deci-sions on that life insurance policybe made by the independent trustee,the insured beneficiary cannot havea power of appointment over thepolicy or its proceeds. Subject to the foregoing, the

trustee can access the inside build-up if necessary or desirable. Becausethe beneficiary will not have anyincidents of ownership in such poli-cies, there is no concern of estateinclusion and no limitation onaccess to the policy’s inside build-up. Think of this opportunity as a“cascading” funded ILIT—everytrust beneficiary in successive gen-erations can be an insured.

Because the trust will have assets,generally the ability to fund life insur-ance premiums is simplified. Thecomplexities of meeting Crummeynotice requirements, using the annu-al exclusion, and needless use of theunified credit is avoided forever. It may be very advantageous to

acquire the policies when theinsureds are young in order to lockin the most favorable premium rates.The client, and subsequently thetrustees, should certainly recognizethe wisdom of this planning oppor-tunity. In effect, the life insurance ismuch more valuable to the insuredif he or she does not have to electbetween access or estate tax savingsas to which benefit should prevail.

Trust for all typesCan the Perfect Modern Trust be“nimble” enough to be the rightplanning choice in a variety of verydisparate circumstances that clientsmay present? Absolutely. To illus-trate the wide range of possible cir-cumstances the trust can addresssuccessfully, consider an exampleof a client with seven children. Thechildren are equally loved andrespected, and the client wants totreat all of them equally. However,

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the client identifies unique issuesand concerns for each child.

Affluent physician. Child #1 is asuccessful surgeon earning a seven-or eight-figure annual income.Child #1 needs creditor protection,especially from potential malprac-tice claims. Matrimonial protec-tion could also be an issue. Distri-butions from the trust may not beadvisable in order to avoid estatetax exposure. Depending on statelaw, in many instances, state incometaxes can be avoided on certaintrust-owned assets and Child #1can serve as the investment trustee. Perhaps the trust for Child #1

owns an office building with a lowbasis. The independent trusteecould give other trust beneficiarieswith estates that fall below theapplicable exclusion amount a gen-eral power of appointment at deathover the building to the extent itwill not result in an estate tax. Atthe death of the power-holder, theasset will be includable in his or herestate and there would be a newstepped-up basis to its then fairmarket value even though thepower might not be exercised. Asa result of the new basis, therewould be a new depreciationopportunity to shelter incometaxes. Having the proper trust situs is

very important to Child #1 becauseof the state income tax savingspotential, as well as the potentialcreditor risk due to Child #1’s occu-pation. Although distributions arepermissible, they probably will notbe made from the trust. If Child #1is in the top bracket based on otherincome, there is no federal tax detri-ment by leaving the income in thetrust. If Child #1 needs money,preferably the money will be loanedfrom the trust to Child #1 at mar-ket rates and the loan will besecured so that it has preferenceover others.

Affluent business owner. Child #2is a wealthy, successful businessowner. Child #2 has an estate taxproblem. The trust will allow busi-ness investments to be made out-side of the transfer tax system. Ifthe trust is a beneficiary-taxed trust(e.g., a beneficiary defective inher-itors trust (BDIT)) under Section678, Child #2 will pay income taxeson the trust income, which will helpburn off the assets otherwise includ-able in Child #2’s estate. Certain-ly creditor and matrimonial pro-tection is important here as well. For all inheritors, particularly of

this profile, the allowable distribu-tees should include the client, theclient’s descendants (preferablyincluding the spouses of all of themso that if a blood beneficiary is beingsued, a distribution might be madeto the spouse), and trusts for any ofthe foregoing—including one thatis set up by the independent trustee.Enabling the independent trustee toset up a trust for the benefit of apermissible beneficiary (including thecompetent inheritor or any other ben-eficiary), as an alternative to outrightdistributions, creates some powerfulplanning opportunities. In suchinstance, the independent trustee canmake a distribution to a second trustsubject to a lapsing Crummey powerof withdrawal. That would create aBDIT for the beneficiary. The secondtrust could invest in a favorable busi-ness opportunity or acquire assetsfrom Child #2 income tax-free, andthe trust income would tax burnChild #2’s estate. To illustrate, assume that Child

#2 had a child (“the grandchild”)who also enjoyed economic successsimilar to Child #2. The inde-pendent trustee could create twoseparate trusts, one for Child #2and one for the grandchild.Although subject to variation, onetrust would be controlled by andtaxed to Child #2. The other wouldbe controlled by and taxed to the

grandchild. The potential of estatedepletion as a result of grantor truststatus, opportunity shifting, andinstallment sales is very compelling.

Spendthrift. Child #3 is a spend-thrift. The trust would be modifiedto address this situation and reducethe controls of Child #3. In par-ticular, the right to control the iden-tity of the independent distributiontrustee would be limited.

Serial marriages. Child #4 is mar-rying for the fourth or fifth time ormarrying someone who has beenmarried multiple times. The trustwill protect Child #4’s inheritedwealth from being lost in a divorce. A third-party trust created in a

jurisdiction that protects assets fromsupport claims is much less sus-ceptible to attack in a matrimonialsituation than a pre-nuptial agree-ment designed to protect assetsowned outright by the divorcing par-ties. In addition, telling an intend-ed spouse that the assets were inher-ited in a trust is generally a muchmore comfortable discussion thanasking a potential spouse for a pre-nuptial agreement.

Distrusted in-law. Child #5 is mar-ried to a spouse who is disliked andnot trusted by the client. The clientdoes not want this in-law spouseto be an heir, preferring to keepall inheritances in the bloodlineof the family. Here, the power of disposition

is a key factor and must be limit-ed. The trust will be modified tomake certain that the scope of thespecial power of appointment isrestricted to persons in the blood-line of Child #5. Other modifica-tions may address and limit theability of Child #5 to select the inde-pendent trustee who might makeunnecessary distributions whichcould be recycled to the in-lawspouse.

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Unproductive heir. Child #6 is a“trust fund baby,” an unproduc-tive person with no ambition whosimply is waiting to receive theanticipated inheritance. Here, thetrust would be drafted to limit thecontrols of Child #6, as well asthe power to determine the identi-ty of the independent trustee. The client remains hopeful that

Child #6 will become a responsiblemember of society and does not wantChild #6 to be able to rely on thetrust except possibly for necessaryhelp, such as medical need and pos-sibly educational funds to pursue ameaningful educational degree.

Special needs. Child #7 is a personwith special needs. These needs maybe permanent, in the nature of aphysical disability, or in the natureof substance abuse, gambling addic-tion, or criminality. The trust forChild #7 would either minimize oreliminate beneficiary control. Therewould not be an opportunity forChild #7 to remove and appointan independent trustee. A careful-ly selected independent trustee—anddesignated successors—would beinstructed to address issues of thedistribution and use of the trustproperty, being mindful of publicassistance opportunities if available.

ConclusionWith proper explanation, therational client will understand andembrace the Perfect Modern Trust.Given the disparity in benefitsbetween (1) inheriting property out-right and the tax and creditor risksit involves and (2) inheriting prop-erty in trust with the protectionsand enhancements it provides, withproper guidance, clients can andwill make the correct decision.Most clients come to their advisorswanting to do what is “best” fortheir children and other heirs. In the planning process, it is

often helpful to show clients the

Wish List of control, use and enjoy-ment, flexibility, creditor protec-tion, tax savings, and simplicity(described in Part 1 of the arti-cle). Then ask the clients if theywere going to receive an inheri-tance, (1) which of the componentson the Wish List would they want,and (2) which of the items wouldthey not care about. In the authors’experience, without exception,clients who are candid want all sixof the Wish List elements. The next question is which of

the six components the client wouldwant to give to his or her lovedones. A reasonable assumption isthat the client would want to pro-vide all beneficiaries with the shel-

ter protections (asset protectionand tax avoidance). Every clientwants simplicity. Thus, the onlyvariables are the controls, whichwould have to be modified for thoseinheritors that the client would notbe inclined to give the wealth tooutright. The Perfect Modern Trust satis-

fies all of the items on the client WishList. It is flexible in its design toallow sufficient control for thosecapable of having control and suf-ficient protections for all potentialbeneficiaries, both those capable andthose incapable. It should beembraced as the solution to the plan-ning process that all clients seek andall advisors strive to provide. ■