Introduction

Historically, estate planning has involved using methods to remove assets from the taxable estate of a client (without depleting the wealth of the client or the client’s family) through means that result in little or no gift tax, such as using gift tax annual exclusions, the lifetime exemption[2] and other means, such as creating a so-called grantor retained annuity trust (GRAT) described in Section[3] 2702(b). However,  because of the current large exemptions (nearly $14 million for  transfers in 2025 which are scheduled to be cut in half after 2025, although adjusted for inflation) the focus for individuals whose wealth will not exceed, or not exceed by much, the exemption levels has changed. This article will discuss where such planning seems to be heading and how clients and their advisors can stay ahead of the estate planning game.[4] In addition to discussing such traditional estate planning, which may come back into vogue if exemptions are reduced, it will discuss other planning for individuals referred to as “middle tier clients,” whose wealth likely will not exceed  the gift, estate and generation-skipping transfer exemptions available.

Goals and Concerns of Middle Tier Clients

Preserving (and, Perhaps, Improving) the Lifestyle for the Client and Family. Usually, the focus of estate planning is on avoiding estate and similar taxes. But with the extremely high wealth transfer tax exemptions currently in place, over $13 million in 2025, avoiding estate tax typically is of no or of little concern, even though the estate/gift tax exemptions are to be halved beginning in 2026. Many individuals ultimately conclude that taking care of themselves financially, and typically their spouses, is of utmost importance.

Though some may not undertake any estate planning during their lifetime, many will plan for their loved ones, as well as for themselves. In fact, as will be detailed below, taking care of others may provide a greater opportunity to take care of oneself.

Maintaining one’s lifestyle is more than just maintaining one’s level of wealth for at least three reasons. First, inflation may greatly erode wealth.[5] Second, even if a person can maintain the level of wealth consistent with inflation, the individual’s real spending power likely will have declined in part because the government indices of inflation understate what true inflation is because, for example, the government assumes each consumer will substitute a lower “quality” of goods and services (e.g., pork in lieu of beef) to maintain the appearance of spending power[6] and because any increase in spending likely means more income which, in general, will be more heavily income taxed than at prior levels of income. Third, no index takes into account “Expectation Inflation,” which is that each succeeding generation expects more than the prior one but views it as an entitlement to be able to spend more.[7]

What that seems to suggest is that real spending power, including accounting for inflation expectation, must grow after tax at a rate above the inflation rate. The key to accomplishing that is growth in real wealth. And to accomplish that, at least for most people, is to invest to achieve an investment return, after income tax, well above inflation. Other than being “lucky,” history indicates that, to do that, one must invest heavily in equities.[8]  “If you were to only invest in AAA corporate bonds over time, you can expect a modern yield between 4% and 5%. Historic rates have been higher, sometimes up to 15%, leading to a 30-year average of 6.1%.”[9] Comparisons are difficult, however, on account of different ways returns are taxed.[10] In the United States, under current laws, gains are taxed only when the property is disposed of while current income, interest, dividends and salary is  taxed annually. Moreover, gains on capital assets, such as most stocks, held for more than six months are taxed at much lower rates than interest on bonds is.

Avoiding Creditor Claims. Everyone faces creditors, whether it is for income taxes or interest on indebtedness. Typically, individuals attempt to manage such claims by budgeting, avoiding entering into arrangements that may result in significant claims being made (e.g., being the owner or operator of a business such as waste management that is likely to produce claims), not making guarantees and doing so in a manner that will not erode their lifestyle.  But occasionally, unanticipated claims will arise. An unexpected car accident or some claim that an individual is responsible for someone else’s injury or loss does arise. Insurance can be obtained to cover many of these unanticipated claims,  but insurance premiums erode wealth and do not protect from all claims.

However, one of the most common ways that an unanticipated large claim may arise is through divorce. Not only may a divorce, especially if there are children from the marriage, be financially ruinous it will likely also be emotionally devastating and may reduce normally sound judgment. Very few people would enter a marriage, and then complicate the situation by having children, if they thought divorce would soon occur. It is difficult to determine the divorce rate, but it seems to hover around 50% or so.[11] One’s former spouse typically becomes the major creditor of the individual.

One cannot eliminate all financial claims arising out of a marriage, especially with respect to the couple’s children, but some steps can be taken to reduce the financial harm of a divorce. One is to enter a prenuptial agreement which, depending on many factors including state law, may provide some financial protection.[12]   A prenuptial agreement may also help to reduce the emotional trauma of divorce,  but few consider it, even when entering a second or subsequent marriage.[13]

Getting Descendants to Enter Prenuptial Agreements. One strategy that may result in more prenuptial agreements and, therefore, more protection from claims, is for other members of the family to condition the receipt of benefits by a beneficiary entering into a prenuptial or post nuptial agreement that an independent fiduciary determines will adequately protect against the claims arising in a divorce. To accomplish that, each person leaving bequest for a descendant, or other loved one, should place the property in spendthrift trust for the beneficiary but condition the making of distributions to the beneficiary on the beneficiary having entered an “adequate” prenuptial or postnuptial agreement. A further incentive to get the fiancée[14] to enter into the agreement is to allow the beneficiary to continue the trust, in whole or in part, for the fiancée only if the couple is married at the death of the beneficiary and the beneficiary and spouse having entered into an “adequate” agreement. This takes much of the emotional burden off a beneficiary who is getting married to raise the prenuptial question.

Using Exemptions of Other Family Members. A fair amount has been written about using the exemptions of other family members, such as an elderly ancestor who is unlikely to use his or her estate tax exemption. Although that may make sense, the current owner of property usually would have to make transfers using his or her own exemption to do so. Moreover, Section 1014(e) blocks the automatic change in income tax basis (commonly called the step-up in basis) when a person makes a gift of appreciated assets to someone who dies within a year of the gift and the donor “inherits” (back) the appreciated assets. No final regulations have been issued under Section 1014(e) but attempting to secure a stepped-up basis by transferring assets to another family member for middle-tier clients does not seem to have garnered much attention.

            Avoiding Ruinous Lifestyle Activities. Becoming addicted to drugs, alcohol, or a type of lifestyle, such as being or becoming a spendthrift, which is harmful physically, medically, or emotionally, is also likely to be financially ruinous. See discussion in Koplin, Shenkman & Blattmachr, “Advising Clients About Addiction Matters,” 47 Estate Planning 20 (Feb. 2020). All advisors need to be aware of such matters and need to discuss them openly, although, obviously, privately.

Handling Qualified Plans and IRAs with Special Care.  Many middle-tier clients will have significant holdings in qualified plans and individual retirement accounts (IRAs). Unless the interests are in Roth IRAs, virtually all distributions from the plan or IRA will represent income in respect of a decedent (IRD) within the meaning of Section 691 and will be taxed as ordinary income regardless of how the plan or IRA had income, although the distributions will not be subject to the net investment income tax (NITT) under Section 1411.  Lifetime and estate planning for plans and IRAs is among the most challenging practitioners face. The rules are extraordinarily complex and are somewhat counterintuitive. But most middle-tier clients will have to deal with them. Recent legislation has made estate planning, including income tax planning for those who succeed to interests in plan and IRAs ever more challenging. See generally, Choate, Life and Death Planning for Retirement Benefits (8^th Ed. 2019).  One recent adverse legislative change under the statute known as SECURE was the elimination for most IRA and qualified plan beneficiaries of the ability to “stretch” payments from such plans or IRAs over the life of the beneficiary. One potential option is to try to overcome that limitation by making the benefits payable to a so-called “income only with make-up charitable remainder unitrust” (or NIMCRUT) described in section 664. Even though that may restore some of the benefits of stretching payments from plans and IRAs, the use of a NIMCRUT will complicate planning and, therefore, probably is useable as a practical matter only by families with considerable wealth.[15]

Using Trusts: The Ultimate Estate Planning Tool. Regardless of the plan, whether to reduce wealth transfer or income tax, to allow property to grow free of tax, or lower taxes, and to be used free of creditor claims, including those arising in connection with a divorce, to protect against the ravages of addiction, trusts often offer the best solution. See Blattmachr & Blattmachr, “Even Without Estate Tax the Right Answer Is Still the Same, Put It All in Trust,” Estate Planning Newsletter #2489.  Although some will contend that trusts should not be used because they face the highest income taxes, solid planning can reduce or eliminate that concern and in fact using trusts may reduce income taxes. See discussion in Blattmachr & Shenkman, “Preserving the Benefits of Trusts Despite High Income Tax,” 50 Estate Planning 4 (Jan. 2023).

        Facing the Real Challenge for Estate Planning for Middle-Tier Clients: Removing Assets from the Client’s Taxable Estate While Obtaining the Step-Up in Basis at Death. Most of what follows in this article consists of what might be viewed as more traditional estate planning, which is to remove assets from the gross estate of its owner to reduce possible estate tax when the owner dies or to avoid gift tax if the property is transferred during lifetime.  However, the large current estate/gift tax exemptions make such planning of little interest to most individuals even those with wealth somewhat above the exemption levels currently in place.  Note that some states still impose an estate tax with exemptions much lower than the Federal exemption. However, these large exemptions have caused individuals and their advisors to look at obtaining the benefit of having assets included in the owner’s estate at death: the automatic, income tax free change in basis.[16]Toward the end of this article, the possibility of accomplishing the goals of but obtaining an income tax free change, typically a step up in basis, even for assets that have been removed from the owner’s gross estate is discussed.[17]

Traditional Estate Planning for the Middle Tier Client

 

Individuals in the “modest” wealth category face special hurdles in estate planning. This article will assume that the “modest” wealth category includes individuals whose net worth does not exceed  the amount of taxable gifts that may be protected by the unified credit, (currently, the equivalent of about $14 million exemption and herein referred to as the “gift tax exemption”. In general, people of modest wealth may not easily be able to afford to give up significant levels of their net worth during lifetime to achieve estate planning goals. However, the lifetime transfer of wealth is one of the most useful ways to reduce estate taxes. Unlike individuals whose wealth is small enough that it most likely will be protected from tax by reason of credits or exemptions, or those whose wealth is so large that an achieved lifestyle almost certainly will continue regardless of how much is transferred during lifetime, individuals of modest wealth face a real tension between opportunities to reduce taxes and protect assets from other claims which may arise, on the one hand, and the need to preserve an adequate base of wealth to ensure the maintenance of a current standard of living on the other.  Also, transferring assets to or for others may protect the wealth the assets represent from claims of the transferor’s creditors.

The advisor to these individuals should carefully consider which planning steps are most appropriate and what level of transfers the individual reasonably can afford to make. Certainly, different problems and potential solutions will arise for each individual, and the plan must be tailored to each person’s unique circumstances and goals. Nonetheless, such individuals need estate and financial planning as much as anyone else does, perhaps even more so. These individuals, in a real sense, cannot afford to “lose” as much of their wealth to taxes, professional fees, claims and costs of administration as the more wealthy people can.

              Assign Life Insurance and Other Non-Income-Producing Assets. A person of modest wealth faces a tension between making lifetime transfers of wealth which will reduce the taxes that will be imposed at death, and his or her desire to maintain a chosen lifestyle. Nevertheless, many individuals even of somewhat modest net worth consume their income but not their capital. This presents a planning opportunity but giving away property while retaining the right to income usually does not achieve any tax reduction or protection of assets from creditors’ claims.[18]

 

On the other hand, many people own assets that likely never will produce income. A common example is a life insurance policy. Although life insurance in certain circumstances can be made to be an excellent income producing asset, where it has a cash or an investment component, most individuals do not “cash-in”  on the policy. Rather they allow the investment component to be maintained within the policy because most policies are structured so that the investment component is constantly being substituted for an ever-decreasing term insurance component.19 Such a case, an insurance policy may be an ideal subject of a gift by the insured.20

The purposes for which the insurance is being maintained, such as to replace earnings lost upon the death of the insured, to pay a debt that will become due or will be payable upon the death of the

insured, or to fund estate taxes, usually can be as readily achieved if someone other than the insured owns

the policy.[19] If the insured holds no “incident of ownership” in the policy at or within three years of death, the proceeds should not be includable in the insured’s estate for federal estate tax purposes except to the extent they are payable to the estate of the insured.21 However, if the insured does hold any incident of ownership at or within three years of death, the proceeds even if paid to someone other than the insured’s estate may be subject to substantial estate tax, even if the balance of the estate does not exceed $14 million.

The most effective way to avoid having insurance proceeds included in the estate of the insured is to have the policy acquired initially by someone other than the insured, typically a trust. Alternatively, if the insured already holds an incident of ownership, e.g., because he or she currently owns the policy, it is generally most effective for the insured to assign all incidents of ownership to someone else at least three years prior to death. Usually, the simplest route is to have the policy already owned or assigned to the individuals whom the insured wishes to benefit from the proceeds, such as children or grandchildren, or a trust for their benefit. A trust typically is the preferred owner of the policy because, among other benefits, the person paying for the policy, typically the insured, may not want an individual who owns it to be able to transfer it someone whom the insured would not want to own it, such as a former child-in-law who dies before the insured parent dies, where the child who owns the policy bequeaths it to his or her spouse rather than the insured’s grandchildren.

A more effective strategy may be to sell life policies the insured owns to a trust that would be excluded from his or her estate. If the trust is a so-called grantor trust for income tax purposes, if the insured’s death is not imminent and the policies are sold for their full fair market value (“FMV”), such a sale appears to avoid income tax recognition and the transfer-within-three-years-of­death rule of Section 2035.22

Having policies owned by one or more individuals may complicate matters in the long run. That may occur, for example, when a child of the insured who owns the policy dies before the insured person. The child’s interest in the policy may pass to someone whom the insured does not wish to own the policy,

such as a former spouse of the pre­deceased child. The solution to this problem is to have the policy owned by a trustee of a trust created by the insured. If the trust is properly structured, the policy proceeds will be used for the purposes intended by the insured and will not be included in his or her gross estate. Although there initially may be more expense involved, trust ownership of the policy may be the more effective and, in the long run, the most efficient method to avoid estate taxes on the proceeds and to guarantee that the proceeds will benefit only those selected by the insured.

For example, trust ownership of the policy will permit the use of a so-called back-up marital deduction provision. This provision will allow the proceeds to qualify for the estate tax marital deduction if the insured is survived by his or her spouse and the proceeds are includable in insured’s estate, because, for example, the insured dies within three years of assigning them.23

 

On the other hand, it is appropriate to emphasize that unless the life insurance is a cash value policy that has been specifically acquired to fund estate taxes, it often lapses prior to the death of the insured. In fact, about 90 percent of term policies are dropped before the insured dies. If that occurs, the creation of the trust and the use of gift tax annual exclusions with respect to the transfer of the policy to the trust and payments of subsequent premiums would be “wasteful.” However, individuals of more modest wealth who have borne the transaction costs of establishing such a trust may be vigilant in maintaining the policy so that it does not lapse.

Arranging for another person or entity to own insurance almost certainly will require the insured to make a taxable gift. Both the assignment of the ownership of an insurance policy to another and the subsequent payment of premiums on a policy owned by another constitute gifts for gift tax purposes. Generally, these gifts can be made to qualify for the gift tax annual exclusion if the policy is assigned to individuals or to a trust.24 Many individuals of modest wealth do not make significant annual exclusion gifts because they feel they cannot afford to give up income-producing assets; therefore, contributions to a life insurance trust are an excellent way of using annual exclusions that would not be used otherwise.

Another category of assets which may be appropriate to give away under the protection of the annual exclusion are items of tangible personal property that have significant intrinsic value, and that the owner is willing to transfer before death. This may include, for example, jewelry, works of art, antiques, and collections. To remove the items from the donor’s taxable estate, gifts need to be “complete” for estate tax purposes.25 For instance, the items should no longer be stored in the donor’s home or otherwise be under the control of their former owner. Furthermore, the new owner should acquire and pay for the insurance on those items. Certainly, if the donor wants to continue to use certain objects,  like jewelry, the donor should not give them away.

Recreational real estate may be another good example of the type of property that could be the subject of a lifetime gift. Although the property may be too valuable to give away at one time under the protection of the annual exclusion under Section 2503, smaller gifts of undivided interests in property can be made and, in fact, may be valued at a discount, i.e., the value of the fractional interest is worth less than an aliquot share of the value of the whole.26 However, continued use of the property should be consistent with the relative ownership of the property. For example, if the original owner gives away an undivided 25% interest in the property, the recipients of the 25% interest should pay, depending on the circumstances, for a quarter of the cost of maintaining the property and should exercise ownership rights and use over a quarter of the property. Moreover, the relative value of the interest retained also should be consistent. For example, if a parent owns a residence in Southampton, New York, retention should reflect that the per month value of the home will likely be much greater for the summer months.  The case of recreational property which constitutes a residence, use of a qualified personal residence trust, discussed in more detail below, also should be considered.

              Estate Building and Income Tax Sheltering with Life Insurance. Certain types of life insurance policies provide greater opportunities to build wealth while sheltering income from taxation. Specifically, so-called variable insurance contracts allow the policy owner to direct how the cash or investment value of the policy is to be invested among a variety of mutual funds. The fund alternatives usually include a blue-chip stock fund, a government bond fund, an international stock fund and so forth. In some cases, these funds may provide significantly better yields when compared to the yields in traditional cash value policies.27

In addition, if an adequate amount of premium is allocated to the cash or investment component, it is possible to have future term premiums paid with the income earned under the policy. Essentially, then the term premiums are paid with pre-tax income that will never be subject to income tax, even if the policy is canceled prior to death.

If the insured has access to the cash or investment component of the policy, all the proceeds paid upon death may be includable in the insured’s taxable estate, even if the insured has only an interest in the cash or investment component and someone else, such as the trustee of an irrevocable life insurance trust, holds all incidents of ownership with respect to the term component of the policy.28 It is possible, though, to structure the ownership of a policy through a split dollar arrangement so that the insured may be able to benefit (at least indirectly) from the policy’s cash value without causing the insurance component to be includable in the insured’s taxable estate.29

 

A split-dollar arrangement might provide for an irrevocable life insurance trust to “own” the term component and the insured’s spouse or an investment company, such as a corporation or limited liability company, to “own” the cash or investment component.30 Upon the insured’s death, the proceeds attributable to the term insurance component should not be includable in the taxable estate of the insured. The insured might own no more than 50% of the voting stock of the corporate owner of the policy’s cash value component (even if the insured holds more than 50% of the total equity). In such a case, the incidents of ownership held by the corporation should not be attributed to the insured shareholder.31

Alternatively, the cash value owner might be a limited partnership of which the insured is a limited partner. The incidents of ownership held by the partnership, which may be structured to be a disregarded entity for income tax purposes, should not be attributed to the insured limited partner.32 Although the corporation or the partnership could make tax-free withdrawals or borrowings from the cash value component of the policy, provided the policy was not a modified endowment contract, the distributions to the insured as a shareholder or partner may be subject to income tax.33

To avoid taxation of the tax-free withdrawal, an Alaska or Delaware, or other jurisdiction providing that self-settled trusts may be structured to be free of the claims of the grantor’s creditors, trust could own the policy, including the cash value component. The trust should be structured so that no incidents of ownership held by the trust will be attributed to the insured even if the insured grantor is eligible to receive distributions, which may include cash withdrawn by the trustee from the policy, from the trust.34

Qualified Personal Residence Trusts. As a general matter, under Section 2702, for purposes of determining the value of a gift of a remainder in property to family members, the value of an income or use interest retained in that property is treated as zero, causing the entire value of the property to be treated as the gift. In other words, no reduction in the value of the gift is made on account of the retained interest because the entire value is attributed to the remainder. However, Section 2702(a)(3)(A) provides an exception when the remainder transferred is in a personal residence the use of which is retained.

This exception permits, by way of example, the owner of a personal residence to give a remainder interest that will take effect after a term of years expires and to value the remainder based on the normal actuarial principles of Section 7520. Usually, the gift of the remainder is made by transferring the home to an irrevocable trust under which the grantor retains the right to the exclusive occupancy and use of the home as a personal residence for a period of years. Such a trust is known as a personal residence trust (“PRT”) or qualified personal residence trust (“QPRT”), depending on its terms.35

To illustrate, assume that a 70-year-old woman makes a gift to her child of a remainder interest in her $1 million home. Assume also that the transfer is made through a QPRT that takes effect in ten years, i.e., the current owner retains the right to use the property as a personal residence for ten years. The trust further provides that the property will revert to the estate of the donor if the donor dies during the retained ten-year term. If all these conditions are met, the gift the property owner would be making upon the creation of the QPRT would be $368,450, if the IRS interest rate used to determine the value of the interest of such a trust determined under Section 7520 were 6%. If the trust has been structured properly and the term-holder survives the ten-year retained term, the property automatically will be transferred to, or held in further trust for, the remainder beneficiaries without any additional gift tax and without any estate tax. One “problem” with an effective QPRT is that the grantor’s entitlement to use the property must end before he or she dies. If death occurs during the retained term, the trust is includable in the grantor’s estate under Section 2036(a). That means that the transfer of the remainder will not be free from any additional tax liability. The client must also be aware that once the retained term ends, he or she no longer has any right to occupy the property. The client must be in a position, at the end of the fixed term, where he or she can afford to vacate the property or rent it from the remainder beneficiaries at FMV.36

 

Another possible application of the personal residence exception under Section 2702(a)(3)(A), is a “split-purchase trust^sm.” This arrangement is a particular form of QPRT in which parents typically purchase life estates in a new home,(such as a retirement home, and a generation-skipping exempt trust that is a grantor trust with respect to one of the parents purchases the remainder interest in the home. Under this arrangement, the parents have the use of the home for life, need not pay rent and, it seems, do not have to survive for any particular period of time. This also can be accomplished for a home already owned by the taxpayer, but the taxpayer should  ensure the house is not undervalued.37 Also, unlike a QPRT, a split-purchase trust arrangement can “leverage” the GST exemption of the parents.38

              Effective Use of the Balance of Annual Exclusions. The annual exclusion may not have an enormous impact on reducing taxes for a person of extraordinary wealth. In fact, for such an individual, other gifts to family members, (such as automobiles, payment for vacations, and similar transfers, often absorb the entire sum of annual exclusions available for them. In the case of a person of more modest means, however, if the annual exclusion is being used for other transfers, such as the payment of premiums on a life insurance contract owned by others, an unused portion of the annual exclusion may remain. For instance, a married person with two children, each of whom is married and has two children of their own, may give  $304,00039 to them each calendar year under the protection of annual exclusions coupled with “gift­splitting” under Section 2513 by the spouse (that is to say, $38,000 to each of these eight individuals). Over a five-year term, such transfers would remove from the client’s estate $1,520,000 and the subsequent income and growth on the gifted property. That could represent a substantial percentage of the client’s wealth. Hence, the use of annual exclusions can produce exceptionally effective estate planning results for persons of modest wealth.

 

On the other hand, that effectiveness highlights the tension that may arise when the client may wish to make such maximum use of his or her annual exclusions, but the individual does not own sufficient non-income-producing property with which to make the transfers. If that is the case, a client would have to make annual exclusion gifts of income-producing assets. If the client does so, then neither the gifted assets nor the income they produced may be made available directly to the donor. The individual simply may not be able to afford such a loss of income, so gifts of income-producing property must be considered carefully.

However, the individual might be able to continue to benefit indirectly from the income of the gifted property without causing estate tax inclusion by transferring assets under the protection of the annual exclusion to a trust, the income of which the trustee is permitted to distribute to the grantor’s spouse. The spouse, in his or her discretion, then could use the assets for the benefit of the grantor. In fact, there is no reason that the grantor needs even to name the precise person who is a beneficiary of the trust. The grantor could define his or her spouse in such a trust “as the person to whom the grantor is married at the time such distribution is made.”40

 

Although a spouse may not “gift­ split” with respect to gifts made to himself, herself or a trust of which he or she is a beneficiary, the non­donor spouse can gift-split transfers to a Crummey trust41 for the benefit of the gift-splitting spouse and others, as long as the other beneficiaries have Crummey powers.42 The reason is that the gift to the Crummey trust is treated for gift tax purposes as made to the individuals who hold the power to withdraw the property transferred to the trust, rather than as a gift to the spouse, even though the spouse is a beneficiary of the trust. Hence, the grantor could continue to enjoy the trust property to the extent it is made available to and through his or her spouse. Of course, when that spouse dies, the property would no longer be available via the spouse for the grantor. While it is true that each spouse could create such a trust for the other, the trusts should be structured so that the benefits and controls granted to the spouses are sufficiently different so as to avoid application of the so-called reciprocal trust doctrine.43 Under that doctrine, the trusts may be “uncrossed,” with the effect that each spouse is treated as though he or she created the trust for his or her own benefit. This will cause estate tax inclusion to the extent that inclusion would have occurred if the spouse who is the trust beneficiary had created that trust.44

 

With careful drafting, it is possible to structure the trusts so that the benefits and controls granted to the spouses are sufficiently different so that the reciprocal trust doctrine will not apply.45 Nevertheless, it does mean that upon the death of the first spouse to die, only one-half of the assets will remain in trust for the benefit of the surviving spouse, unless the trust continues for the benefit of the spouse who created that trust. However, that continuing benefit, as a general rule, will cause that trust to be includable in the gross estate of the grantor for federal estate tax purposes on account of the “creditors’ rights” doctrine. Generally, the creditors of the grantor can attach trust assets to the extent the trustee must or, in the exercise of discretion by a fiduciary, may distribute them to the grantor.46 To that extent, the trust assets will be includable in the grantor’s estate.47

              Sell-Settled Trust Options. Several states including Alaska, Delaware, Nevada, Oklahoma, Rhode Island, South Dakota, as well as several “offshore” jurisdictions, subject to limitations in some cases and somewhat different rules, have adopted legislation that provides that a trust created under that jurisdiction’s law is not subject to claims by creditors of the grantor, even if the grantor is eligible, in the exercise of the discretion of another person acting as trustee, to receive distributions from the trust, provided, however, that among other conditions, the transfer to the trust must not have been for the purpose of defrauding a creditor. Because the trust assets are not subject to the claims of the grantor’s creditors, an Alaska trust, for example, of which the grantor is a discretionary beneficiary should not be includable in the grantor’s gross estate for federal estate tax purposes unless the grantor retains some further right or power that otherwise causes the trust to be includable in his or her estate.48

 

Under the laws of states that permit these types of self-settled trusts, an individual could make annual exclusion gifts to a discretionary trust for the benefit of family members and himself or herself, and yet still keep the assets out of his or her taxable estate. Estate tax inclusion can be triggered, though, if the grantor receives all the income or if the trustee makes regular distributions that are nearly equal to the trust’s income. In such cases, the IRS and the courts may find that there was an understanding between the grantor and the trustee to pay income to the grantor, and so the property will be included in the grantor’s estate on the grounds that the grantor retained possession, income, or enjoyment of the property of the trust.49 An alternative to a pure self-settled trust is to consider a special power of appointment trust. See O’Connor, Gans & Blattmachr, “SPATs: A Flexible Asset Protection Alternative to DAPTs,” 46 Estate Planning 3 (February 2019).

Potential Use of the Gift Tax Exemption and the GST Exemption. Many individuals of more modest wealth cannot afford to make large gifts because they cannot afford to give up the income from the assets that would be given away. Yet a transferor can benefit indirectly through a spouse from the income from property transferred to the trust by using the self-settled trust option in a state such as Alaska, the transferor can remain eligible to receive distributions from gifted property and nonetheless exclude its value from his or her gross estate. Consequently, the grantor could make gifts in excess of the amount covered by the annual exclusion, such as the amount of any remaining gift tax exemption, without losing the benefit of that income. This opens up certain attractive estate planning options.

For example, the generation skipping transfer (“GST”) tax Regulations allow the immediate allocation of GST exemption to a lifetime QTIP trust described in Section 2523(e), even though no gift tax will be paid on the transfer if the QTIP election is made on a timely-filed gift tax return.50 A QTIP trust that one spouse creates for the other will not be includable in the estate of the grantor-spouse if the grantor-spouse retains a secondary income interest in the trust, unless the estate of the beneficiary spouse elects for any continuing trust to qualify for QTIP treatment in his or her own estate, or unless the spouse creating the trust otherwise held a general power of appointment described in Section 2041. The creation of such a lifetime QTIP trust will permit the effective use of the grantor’s GST exemption.

Notwithstanding the GST tax benefits, transfers to a QTIP trust will qualify for the gift tax marital deduction51, so will not make use of the grantor’s gift tax exemption. In planning, use of the unified credit may be more important than the use of the GST exemption.52 If so, the property owner could create a trust for his or her spouse which intentionally does not qualify for the marital deduction, but which will not generate gift tax on account of the use of the exemption.

 

In this case, the grantor should not retain a secondary income interest following the death of his or her spouse because the retention of such an interest will cause the trust to be includable in the grantor’s estate under Section 2036(a)(1), effectively nullifying the grantor’s use of his or her gift tax exemption. In fact, in many American jurisdictions, except those like Alaska, discussed above, the mere eligibility, as opposed to entitlement, to receive distributions from the trust will cause estate tax inclusion on account of the creditors’ rights doctrine discussed earlier.53

The potential estate tax inclusion again points to the self-settled trust option. A property owner could transfer an amount equal to his or her unused gift tax exemption equivalent to, for example, an Alaska or Delaware trust, remain eligible in the discretion of the trustee to receive distributions, and still make a completed transfer for estate and gift tax purposes.54 Additionally, Alaska, Delaware, and several other jurisdictions effectively have repealed the rule against perpetuities, thus permitting the trust to be unlimited in duration. In Alaska and certain other states, the trust generally will be subject to state income tax only to the extent the income is allocable either to a grantor who is subject to that tax, such as under the grantor trust rules of Section 671 et seq., or to a beneficiary who is subject to a state income tax.55 Otherwise, the trust will not be subject to the state income tax. This can result in substantial savings over the term of the trust.

Special Power of Appointment Trust (SLAT). As discussed above, an alternative to a self-settled trust, which protects a trust created for oneself from the claims of creditors, is to create a so-called Special Power of Appointment Trust. As explained in the first published article on the concept, a property owner would create a trust for the benefit of members of the settlor’s family which provides that the trustee cannot through “decanting” or otherwise make any discretionary distribution to or for the settlor, but under which at least one person, acting in a non-fiduciary capacity and who is not a beneficiary of the trust, may exercise a power of appointment in favor of a class which would include the settlor, such as any descendant of the settlor’s mother.56

 

               Accessing Income Tax-Free States. Only seven states have no income tax: Alaska, Florida, Nevada, South Dakota, Texas, Washington (State), and Wyoming. Others have no tax on self-employment taxes and salaries,(see New Hampshire and Tennessee. An individual can move to one of those states and avoid income taxation, but in many cases that may not be practicable, desirable, or even effective from a holistic perspective. If the individual’s children or other chosen objects of bounty live in states or locations with income taxes, income generated on any property transferred to them will be subject to the applicable state and local income tax. However, by creating trusts under the laws of one of the seven listed states, it may be possible to avoid income tax on trust income that is not currently distributed to such beneficiaries even if the beneficiaries live in a state or locality with an income tax.

If a trust is created in a state with an income tax, careful planning may reduce or minimize the trust’s and the beneficiaries’ state and local income tax liabilities. For example, New York is effectively a state income tax haven for trusts created by individuals who reside outside of that state. Except for New York-source income, essentially income derived by the operation of a business in New York, New York imposes a tax on trust income only if the grantor was domiciled in the state at the time the trust became irrevocable.57 New Jersey has a similar rule.58 Delaware, in contrast, does not impose an income tax on income retained in a trust sited there unless the beneficiary is a Delaware resident.59

Of course, some states have far reaching income tax rules that seek to tax trusts created in other jurisdictions. For example, California imposes income tax on a trust created by a non-resident if a trustee is a resident of that state and even if the grantor had no connection with the state.60 In fact, California attempts to impose its income tax on the retained income of a trust created by a non-resident if any non-discretionary beneficiary is a resident of California, even if none of the trustees is a California resident.61

Using a Charitable Remainder Trust to Build Wealth and Generate Income. In the case of clients who are charitably inclined, charitable remainder trusts (“CRTs”) described in Section 664 may provide two benefits for individuals in the modest wealth category. First, an income, gift, or estate tax deduction may be allowed for the actuarial value of the remainder interest committed to charity. Second, and often more significantly, the trust is exempt from tax for any year in which it does not have unrelated business taxable income (“UBTl”).62

 

This may, for example, allow for a grantor to contribute to a CRT appreciated assets that the trustee later sells without imposition of income tax, provided that: (1) no UBTI is received in the year of sale by the trust, and (2) the gain is not attributed to the grantor.61 Being able to sell assets without paying tax on the gain provides an enhanced base of wealth for the taxpayer. The size of the annual payment from a charitable remainder unitrust (“CRUT”) to the designated non-charitable beneficiaries will be directly proportional to the value of the trust. Hence, by avoiding the imposition of tax on gain recognized and retained by the trust, a larger base of wealth is available to generate payments to the individual beneficiaries.

One common misconception about CRTs is that they may benefit only the grantor and, perhaps, the grantor’s spouse. The reason is that all, or a significant part, of the trust will be includable in the estate of the grantor upon his or her death because of the retention of the annuity or unitrust payments.63 Moreover, if the trust is only for the grantor or the grantor’s spouse, assuming the spouse is a US citizen, then no gift tax will be owed with respect to the initial transfer to the trust and no estate tax will be owed with respect to assets includable in the grantor’s estate at death.64Yet just as a CRT can benefit the grantor’s spouse after the death of the grantor, the trust may also be continued for the benefit of the grantor’s descendants. If descendants are trust beneficiaries, it is necessary to structure the trust so that the remainder interest for charity is at least equal to 10% of the initial net FMV of the property placed in the trust.65 By retaining the power to terminate the interests of all or any of the grantor’s descendants by the grantor’s will, no gift tax will be payable upon the creation of the trust.66 The trust, however, will be includable in the grantor’s estate.67 If the grantor’s spouse and descendants or the grantor’s descendants alone are beneficiaries of the trust, the grantor’s estate pays tax on the present value, calculated as of the grantor’s date of death, of the interest in the trust committed to such successor individual beneficiaries.

Whether the grantor will want to continue the trust after his or her death for the benefit of his or her descendants will depend on a variety of factors. For example, if the interest of the grantor’s spouse in the trust is anticipated on an actuarial basis to be minimal, e.g., if the grantor’s spouse is older or the grantor is willing to make the grantor’s spouse a mere discretionary beneficiary, continuing the trust for the benefit of the grantor’s descendants may be advantageous from an economic perspective. Although estate tax will be payable upon the death of the grantor because the successor interest of the grantor’s spouse and descendants will be fully subject to estate tax and no marital deduction will be available, the interest for the benefit of the grantor’s descendants in the trust is likely to be substantial. Furthermore, on a future-value basis, the descendants’ interest likely exceeds what the descendants would have received if the value of the property had been bequeathed directly to them, after taking into account the estate tax liability and the future income tax liability on earnings from the transferred property.

However, if the grantor’s spouse’s interest in the trust is likely to be substantial, e.g., the grantor has given the spouse a fixed interest in the trust and the spouse is young, it may not make economic sense to give the property directly to the grantor’s descendants. The present value of the successor beneficiaries’ interest in the trust property will be subject to estate tax, and all the property received from the trust by the surviving spouse to the extent not expended by him or her will be included in the surviving spouse’s estate upon his or her subsequent death, and likely will be subject to estate tax. In this situation, the grantor’s descendants are unlikely to receive a substantial benefit from the trust, especially in light of the 10% minimum value of the charitable remainder requirement.

A net income CRUT, with or without “make-up” provisions, that pays out to the beneficiaries the lesser of the unitrust amount or trust fiduciary accounting income can provide an opportunity for taxable income to accumulate tax-free in effect, until such time as the trustee decides to invest the assets to generate current trust income that can be distributed to the grantor or other trust beneficiaries.68 The tax-free build-up may provide an enhanced base of wealth for the grantor, and, if appropriate, the grantor’s spouse and other family members. This enhanced base of wealth could provide the grantor with a degree of financial comfort that will make the grantor feel more financially secure in making gifts of other assets to remove them from his or her estate.

Medical Care and Tuition Payments. Direct payments to a health care provider for the medical care of another person and direct payments of tuition to an educational institution for another person are not subject to gift tax.69 This means that a grandparent, for example, may pay the tuition for a child, a grandchild, or any other individual from nursery school to post-graduate education free of gift tax. Combined with any annual exclusion gifts that such grandparent may make these transfers over time can remove significant amounts from the donor’s estate tax base.

Furthermore, even though the payments for medical care and tuition must be made directly to the health care provider or educational institution to fall under the exclusion, there are some convenient ways to affect such payments. For example, a property owner might open a joint checking account with each of his or her adult children. In many states, the creation of such account is not considered a gift to the child even though the account is in joint name.70 Only to the extent that the child draws on the account will the gift be complete. If the child draws on the account only by writing a check directly to the provider of medical care or the educational institution, the transfer should not be subject to gift tax under Section 2503(e). Any amounts reimbursed, such as by medical insurance, could be contributed to that account and withdrawn by the person who opened the account.

Limited Liability Entities for Asset Protection and Tax Planning. A family holding company, whether in the form of a limited partnership, limited liability company (“LLC”), business trust or other entity, may provide asset protection and tax benefits for the property owner and his or her family. Contribution of assets to such an entity changes the nature of the assets. For example, the contribution of real estate to a limited partnership in exchange for limited partnership units changes what is owned from real estate to limited partnership units. Such limited partnership units are generally less marketable than is the underlying real estate. This reduction in marketability has two important effects.

First, partnership assets of lesser value are less attractive. As a general rule, a partnership agreement may provide that anyone who attaches a partnership interest does not become substituted as a limited partner for purposes of voting and management decisions, to the extent these rights are granted to the limited partners under the partnership agreement or local law, but becomes instead a naked assignee of the economic interests that the units represent. Such an assignee probably will be taxed on a pro rata portion of the partnership’s income as though he or she were a partner.71 If regular distributions are not made, the units could become a liability for the assignee, because income taxes will be due on income attributed to the assignee without a corresponding receipt of property from the partnership to pay those taxes, with no corresponding economic benefit. Creditors therefore tend to stay away from limited partnership interests.

A second effect of the reduced marketability of partnership interests, in comparison with the underlying property, is an almost certain corresponding reduction in value. Lower valuation typically means lower gift, estate, or GST taxation. Unfortunately, it usually also means a lower income tax-free step-up in basis under Section 1014(a) upon the transfer at death because the basis of most inherited assets is equal to their estate tax value.

              Special Care in Handling Interests in Qualified Plans, IRAs, and Other IRD. Despite the fact that the income tax basis of most property passing at death is equal to its estate tax value, a number of exceptions exist. The most common one is for “income in respect of a decedent,” or “IRD.”72 IRD consists of income to which the decedent was entitled at death, but which is not properly includable in the decedent’s pre­ death income tax return. Accrued interest on a bond, certain declared but unpaid dividends, the inherent profit in certain installment sale notes, and deferred compensation are common types of IRD. Interests in qualified plans and IRAs, which often represent a substantial portion of the worth of a person of modest wealth, are almost always IRD. As a consequence, they could be exposed to estate tax and income tax as well as other taxes.73 In many cases, over 75% of the value in such qualified plans and IRAs may be eroded by taxes.

Because of the significant income tax exposure, persons of modest wealth should consider the possibility of making qualified plans and IRAs payable to a CRT upon the death of the “owner” of the retirement account.74 Unfortunately for taxpayers, this may effectively avoid the income tax on the contributed property, but it marginally will reduce or have no impact on the estate tax due to the inclusion of the interest in the descendant’s estate. Hence, the ability to pay those estate taxes, such as with life insurance proceeds, must exist if one makes the qualified plan and IRA proceeds payable to a CRT. Use of a CRT can result in a substantial increase in the net value of the economic benefit in such a plan and thus the interests to which the decedent’s beneficiaries will succeed.

Ensuring Full Use of the Estate Tax Exemption. Not infrequently, a married couple in the modest wealth range will not have adequate assets to ensure that the taxable estate of the first spouse to die will be sufficient to use his or her entire federal estate tax exemption. That may be especially important because the exemption, now over $13 million, is significantly larger than the exemption that is scheduled for years after 2025, about $7 million.

For example, if the couple now has $12 million and the assets are owned equally between them, and the first spouse dies before 2026, his or her estate would underutilize the available exemption. If the survivor dies after 2025, the couple’s property will be unnecessarily subject to estate tax. The “better plan” would have been for the first spouse to die to have at least $12 million, rather than $6 million, in his or her estate assuming death before 2026, so the survivor would have nothing in his or her estate to be taxed when the survivor later dies, whether the exemption had been cut in half or not.  The better plan might be to ensure the survivor has enough in his or her estate to use the then available exemption and to secure the income tax free step up in basis at death.

SLATs. Married couples may also be able to use their exemptions without losing all benefits from the assets transferred by creating what is known as a “spousal lifetime access trust” (SLAT). A spouse would create a trust for the other but in a form not qualifying for the gift tax marital deduction and therefore would not cause the trust to be included in the gross estate of the beneficiary spouse. Such a trust is normally purely discretionary, that is distributions are not mandated by can be made to the beneficiary spouse in the discretion of an appropriate trustee. The spouse could be given the right to demand distributions or to take them for health, education, maintenance, and support although, in some jurisdictions, which may make the trust subject to the claims of creditors of the beneficiary spouse.  Such a trust almost certainly will be a grantor trust with respect to the grantor trust who thereby must include the trust’s income into the grantor’s income.  Assuming the trustee will make “appropriate” distributions to the beneficiary spouse, the couple can continue to enjoy the benefits of the property.

Of course, the interest in the trust will end when the beneficiary spouse dies. If that spouse is given a special power of appointment that spouse could exercise the power to continue the trust for the grantor trust. To avoid an argument that there was some type of “pre-arrangement” that that would happen and potentially make the trust subject to the claims of the grantor spouse, the power of appointment should not be granted to the beneficiary spouse until later by the trustee.

Each spouse could create a SLAT for the other although it is possible that the so-called “reciprocal trust” doctrine. See Estate of Grace, supra. It is uncertain how different the two trusts must be in order to foreclose the doctrine from applying.75  A better plan may be for one of the spouses to create a SPAT which should avoid the doctrine in its entirety.

There is a potential danger in a spouse creating a trust for the other. The trust almost certainly will be, as suggested above, a grantor trust as to the grantor spouse who will have to report all the trust’s income on the grantor’s personal income tax return.  If the spouses separate or divorce, the grantor spouse will continue to have to include the trust’s income. To avoid that, the trust agreement should either provide that the beneficial interest of the beneficiary spouse in the trust will end if the spouses separate or divorce or provide that distributions can be made to the spouse only with the consent of an adverse party. As long as there is no other provision to make it a grantor trust, it should no longer be a grantor trust.

              Elder Law Considerations. Although it is beyond the scope of this article, practitioners who represent individuals of mid-level wealth may also wish to consider the appropriateness of so-called elder law matters, such as supplemental and special needs trust planning to preserve or procure government entitlements, expanded powers of attorney, and burial rights issues. 76

               

Achieving the Impossible: Estate Tax Exclusion but a Step-Up in Basis at Death. Although few gave it any credence when it was first mentioned in 2002, strong arguments exist that assets in a grantor trust (other than ones which never get a change in basis at death such as IRD) have their basis changed when the grantor dies77 even though not included in the client’s gross estate.[20]As has been mentioned elsewhere, although many, including the IRS, said that no such change in basis occurs, no one has offered an explanation of why several politicians have proposed legislation to prevent such a change occurring and why the IRS itself has issued a revenue ruling claiming no such change occurs upon death. In any event, it seems abundantly clear that such a result, as a practical matter, can be achieved by having the grantor buy the assets back from the grantor trust in exchange for cash or other high basis assets even shortly before death. Hence, as a practical matter, the seemingly impossible dream can be achieved.78

Summary and Conclusions

The primary focus of estate planning for the middle tier client likely no longer is removing assets from the owner’s gross estate but rather building and preserving wealth, providing opportunities to protect assets from waste and claims of creditors and, to the extent assets are transferred prior to death for asset protection or other reasons, having them held in a grantor trust currently may be the best plan as it may also permit being able, under current law, to obtain an income tax free step-up in basis when the client dies.

Estate planning for individuals of more modest wealth is challenging because these clients may face estate taxes but do not have such a large base of wealth that they can “afford” to make large lifetime gifts or other transfers to reduce estate taxes. Nevertheless, careful planning using any number of the arrangements discussed in this article often may help to reduce these taxes.

[1] Portions of this article are derived from other articles Jonathan Blattmachr has written alone or with others.

[2] Although it is common to refer to the lifetime exemption, there has not been one since 1977. Rather, a lifetime transfer is protected from tax by reason of the so-called “unified credit” under Section 2010.

³ Throughout this article, the term “section” refers to a section of the Internal Revenue Code of 1986 (26 USC) as amended, except as otherwise noted.

[4] Several proposals have been made to “toughen” the wealth transfer tax rules and, in part, provide new income tax realization provisions such as recognition of gain on appreciated assets upon lifetime transfer or upon the death of their owner. See, e.g., American Housing and Economic Mobility Act of 2024, introduced by Representative Emanuel Cleaver (D. Mo). However, the Republican sweep in the fall of 2024 of the Presidency, the US House and the US Senate has caused many believe that no reduction in exemptions will occur.

[5] See https://www.investopedia.com/inflation-rate-by-year-7253832.

[6] See, e.g., https://inspiredeconomist.com/articles/cost-of-living-adjustment-cola/.

[7] When I graduated from law school in 1970, no one anticipated that beginning lawyers and their secretaries  would go to Hawaii for winter vacations, etc. Now, everyone expects such increases in lifestyle but view it as just keeping pace with the world.

[8] “The average yearly return of the S&P 500 is 10 .52% over the last 30 years, as of the end of May 2024. This assumes dividends are reinvested. Adjusted for inflation, the 30-year average stock market return (including dividends) is 7.78%.”

https://www.google.com/search?sca_esv=04b33ea2095d5ad7&sca_upv=1&q=What+is+the+average+return+of+the+S%26P+500+in+30+years%3F&sa=X&ved=2ahUKEwiTkby4y8qHAxUwElkFHZL0KycQzmd6BAgSEAY&biw=1536&bih=827&dpr=1.25

[9]https://www.google.com/search?q=what+is+the+average+return+on+a+quality+bonds+in+30+years&sca_esv=04b33ea2095d5ad7&sca_upv=1&biw=1536&bih=827&ei=QaymZuuCdCuiLMP3tPF8Qc&oq=What+is+the+average+return+on+A+quality+bonds+&gs_lp=Egxnd3Mtd2l6LXNlcnAiLldoYXQgaXMgdGhlIGF2ZXJhZ2UgcmV0dXJuIG9uIEEgcXVhbGl0eSBib25kcyAqAggAMgUQIRigATIFECEYoAEyBRAhGKABMgUQIRirAjIFECEYqwJIi68BUPUKWNWbAXAHeAGQAQCYAYsCoAGsL6oBBzMxLjI2LjK4AQHIAQD4AQGYAiugAr8gwgIKEAAYsAMY1gQYR8ICCBAAGAcYCBgewgILEAAYgAQYhgMYigXCAggQABiiBBiJBcICCBAAGIAEGKIEwgIGEAAYCBgewgIIEAAYCBgNGB7CAgYQABgWGB7CAgsQABiABBiRAhiKBcICBRAAGIAEmAMAiAYBkAYIkgcHMjIuMTkuMqAHtYsE&sclient=gws-wiz-serp.

[10] For example, long-term capital gains (gains on capital assets held for more than six months) and dividends (even if the dividend is paid within six months of acquiring the dividend paying stock) are taxed at a much lower rate than certain other types of income (e.g., interest on corporate bonds).  Moreover, gains normally are not taxed until the asset is sold which gains can often be entirely avoided by holding the asset until the death of the owner. See Section 1041(a).s.

[11] See discussion at https://www.forbes.com/advisor/legal/divorce/divorce-statistics/.  One of the reasons the divorce rate is hard to determine is marriages (or the lives of those who get married) last for an extended period. For example, if one looks at the number of people who were born in 1940 who married but ultimately died, one could determine very precisely what the divorce rate was for those people. But that rate likely would be different for people born in 1970 and many of them may be living way beyond 2025.

[12] Postnuptial agreements may also provide protection although they are rarely entered outside of anticipating a divorce.

[13] A 2022 Harris poll found 15% of Americans have a prenup, up from 3% in 2010. https://pewlaw.com/2023/07/25/what-every-couple-should-know-about-postmarital-agreements/

[14] Although fiancée and fiancé are not gender-neutral terms, no suggestion of one gender being more prone to enter prenuptial agreements is intended in this article.

[15] See Blattmachr, Shenkman & Bigge, “Potential Benefit of Paying Qualified Plan Benefits to a CRT,” 51 Estate Planning 3 (Feb/Mar 2024).

[16] Although inclusion in the gross estate could result in a step down in basis in some cases, it seems, on account of inflation and other factors, that most assets have their basis increase upon the death of their owners under Section 1014. Income in respect of a decedent (IRD), dealt with primarily in Section 691, such as interests in traditional (non-Roth) IRAs and qualified (retirement) plans, does not have its basis changed upon death.

[17] See, generally, Blattmachr & Rivlin, “Searching for Basis in Estate Planning: Less Tax for Heirs,” 41 Estate Planning 3 (Aug. 2014).

18 See, e.g., Section 2036(a)(1); Restatement (3d) of Trusts, §§ 57-60; Willbanks, Federal Taxation of Wealth Transfers 241 (2004).

 

19 See “Some Advanced Considerations and Uses of Life Insurance in Estate Planning,” especially Chart 3, The Chase Review (Winter 1997).

20 For a wealthier individual who is willing to make only a limited amount of lifetime gifts, a gift of an asset other than an insurance policy may be more appropriate for several reasons. First, often the policy lapses (e.g., is terminated by failure to pay premiums) before the death of the insured. In such a case, there will be no reduction of estate tax because the subject of the gift (i.e., the life insurance policy) will have lapsed prior to the death of the insured donor. Second, as a general matter, it is preferable to give those assets which have the greatest potential for growth. Many insurance policies are designed to emphasize preservation of value rather than high growth. These are just two of many reasons why an asset other than a life insurance policy may be a preferred subject of a gift by an individual of more substantial wealth. For a more detailed discussion of lifetime gifts of insurance policies and other estate planning with insurance, see Blattmachr, The Complete Guide to Wealth Preservation and Estate Planning 545-621 (1999).

21 Sections 2042 and 2035(a).

22 See, e.g., Gans and Blattmachr, “Life Insurance and Some Common 2035/2036 Problems: A Suggested Remedy,” 139 Tr. & Est. 58 (May 2000)

23 Usually, it will be best for the estate-tax-includable insurance proceeds, if the insured is married and wishes to benefit the spouse, to pass under the irrevocable life insurance trust agreement into a trust that can qualify for the marital deduction, by election under Section 2056(b)(7), as qualified terminable interest property (“QTIP”). That way, the insured’s executor can determine, by the election, how much should be made to qualify for the marital deduction. See, generally, Blattmachr & Slade, “Building an Effective Life Insurance Trust,” 129 Tr. & Est. 29 (May 1990). In addition, special considerations will arise if the surviving spouse is not a U.S. citizen. See Section 2056(d).

24 See “Building an Effective Life Insurance Trust,” supra.

25 A gift is complete when, under the principles of Reg. 25.2511-2(c), the donor has given up dominion and control of the property. Even if the gift is complete under those principles, the property nonetheless may be included in the donor’s gross estate at death on account of a retained interest or power. See IRC Sections 2036, 2037, and 2038.

26 Cf. Lefrak v. Commissioner, TCM 1993-526.

27 Basis generally equals the sum of premiums paid, including that portion used to pay for the term insurance protection, reduced by amounts previously withdrawn.

28 Not all variable policies permit withdrawals. Universal type policies usually do. In any case, some insurance companies impose charges called “surrender charges” on amounts withdrawn. It is important to consider whether commissions, premium taxes and “management” fees are so significant that they offset the benefits of the income tax build-up “inside” the policy.

29 This arrangement is described in detail in the Winter 1997 issue of The Chase Review.

30 Rev. Rul. 82-165, 1982-1 CB 117.

31 See, e.g., PLR  9636033 (not precedent).

32 Reg. 20.2042-1(c)(6).

33 Rev. Rul. 83-147, 1983-2 CB 158.

34 If the partnership is an entity that is disregarded for federal income tax purposes under Reg. 301.7701-3, the withdrawal will not otherwise be subject to income tax.

35 Cf. PLR 9434028 (not precedent) (incidents of ownership held by trust were not attributed to beneficiary who was not a trustee but whose life was insured under policy owned by the trust).

36 See Reg. 25.2702-5.

37 Note that standard mortality assumptions must be used until the taxpayer has a known medical condition and the probability for survival for the term is less than 50%. With a newly purchased home, its value will almost always be the purchase price and so the value of the terms use (or life use purchase) will be almost always definitely determined. But with a pre-existing home, the taxpayer must be sure the home is not undervalued the remainder purchased may be viewed in part a gift, potentially triggering Section 2036(a)(1).

38 The IRS has ruled privately (not precedent pursuant to Section 6110(k)) that renting the home to the grantor after the retained use period ends will not cause the value of the home to be includable in the grantor’s estate if the grantor pays full and adequate rent. Cf. PLR. 9626041and 9425028 (not precedent).

39 See, generally, Blattmachr, “Split-Purchase Trusts^sm vs. Qualified Personal Residence Trusts,” 138 Tr. & Est. 56 (Feb. 1999).

40 Although the annual exclusion under Section 2503(b) is $18,000, the exclusion must cover not only what might be called “Estate Planning” gifts but holiday, birthday, and similar gifts. Hence, these examples assume only $18,000 is available for the estate planning gifts.

41 See Rev. Rul. 80-255, 1980-2 CB 272; Estate of Tully v, Commissioner, 528 F.2d 1401 (Ct. Cl. 1976).

42 A trust, transfers to which qualify for the annual exclusion by reason of the power of the beneficiaries immediately to withdraw the property transferred, is often called a “Crummey trust” after the well-known case of Crummey v, Commissioner, 397 F.2d 82, 22 AFTR2d 6023 (CA-9, 1968).

43 Reg. 2513-1.

444 See, Slade, “The Evolution of the Reciprocal Trust Doctrine Since Grace and Its Application in Current Estate Planning,” 17 Tax Mgt. Est., Gifts & Tr. J. 71 (May-June 1992); Steiner & Shenkman, “Beware of the Reciprocal Trust Doctrine,” Tr & Est. (April 2012).

45 United States v. Estate of Grace, 395 U.S. 316, 23 AFTR2d 69-1954 (S. Ct., 1969)

46 Cf. Estate of Green v. United States, 68 F.3d 151, 76 AFTR2d95-7094 (CA-6, 1995).

47 47  See Restatement (3d) of Trusts, §§ 57-60.

48 Rev. Rul. 77-384, 1977-2 CB 198.

49 See Rev. Rul. 76-103, 1976-1 CB 293; Estate of German, 7 Ct. Cl. 641, 55 AFTR2d 85-1577 (Cl. Ct., 1985); PLR 9837007 (not precedent).

50 Reg. 26.2652-2. However, if the donor’s spouse is not a U.S. citizen, the transfer cannot qualify for the gift tax marital deduction. Section 2523(i)(1).

51 The marital deduction for transfers to a QTIP type is not automatically allowed but is allowed by election under Section 2523(f) or 2056(b)(7).

52 See, e.g., Section 2036(a)(1); see also Estate of Skinner, 197 F. Supp. 726, 8 AFTR2d 607 (DC Pa., 1961).

53 Reg. 26.2652-2. However, if the donor’s spouse is not a U.S. citizen, the transfer cannot qualify for the gift tax marital deduction. Section 2523(i)(1).

54 Because the GST tax usually can be postponed for a much longer period of time than can gift and estate tax, use of the GST exemption may be viewed as having less immediate benefit than use of the gift tax exemption.

55 Rev. Rul. 76-103, supra note 31.

56 Some states impose income tax on trust income if the granter, trustee, or beneficiary resides in that state. See, e.g., N.Y. Tax Law§ 605. Also, states with income taxes generally impose their income taxes on income earned in that state.

57 N.Y. Tax Law §§ 601, 605(b)(3).

58 N.J. Stat. Ann.§ 54A:2-1

59 Del. Code Ann. 30 §§1131 et. seq.

60 See, e.g., Cal. Rev. & Tax Code § 17742.

61 Id.

62 Section 664(c).

61 See, e.g., PLR 9452026 (not precedent) (gain recognized by the trust on appreciated assets contributed to the trust will be attributed to the granter only if the trustee legally is obligated to sell the transferred assets).

63 See, e.g., Rev. Rul. 82-105, 1982-1 CB 133.

64 Sections 2056(b)(8) and 2055(a). Special rules apply if the spouse is not a U.S. citizen. See Section 2056A.

65 Section 664(d)(2)(D).

66 Regs. 1.664-2(a)(3) and 25.2511-2(c).

67 Section 2038.

68 If a CRT with a make-up provision is chosen, then deficiencies are made up in subsequent years in which trust income exceeds the unitrust amount.

69 Section 2503(e).

70 Reg. 25.2511-1(h}(4). In states where the opening of a joint account may be a completed gift, it might be appropriate to have the joint tenants enter into an agreement that the non-contributing tenant may draw on the account only as an attorney-in-fact for the contributing tenant and only for purposes of paying medical care and tuition payments under Section 2503(e). Accordingly, there will be no completed gift from the contributing tenant to the non-contributing tenant on the opening of the account because withdrawals will be only for the benefit of the contributing tenant or will qualify for the exclusion under Section 2503(e}.

71 Evans v. Commissioner, 447 F.2d 547, 28 AFTR2d 71-5465 (CA-7, 1971); Rev. Rul. 77-137, 1977-1 CB 178; but see GCM 36960 (12/20/76) (distinguishing Evans and suggesting that a transferee is treated as a tax partner only if the transferee has “dominion and control” over the transferred partnership interest).

72 See Sections 691(a) and 1014(c)

73 See, generally, Blattmachr and Gans, “Planning for IRD After Elimination of the State Death Tax Credit,” 33 Estate Planning 3 (Mar. 2006).

74 See Blattmachr, Shenkman & Bigge, supra.

75 See, e.g., PLR 20040394 and 200101021. See, generally, Gans and Blattmachr, “Making Spousal Estate Tax Exemptions Transferable,” 19 Prob. & Prop. 10 (Nov./Dec. 2005).

76 See, generally, Regan, Morgan, and English, Tax, Estate & Financial Planning for the Elderly, Ch. 17 (Matthew Bender)

77 See Blattmachr, Gans & Jacobson, “Income Tax Effects of Termination of Grantor Trust Status by Reason of the Grantor’s Death,”118 JTaxn,149 (Sept. 2002)

78 See Gans & Blattmachr, “Grantor Trust Assets and Section 1014: New IRS Ruling Doesn’t Solve the Problem.” 139 JTaxn 16 (Sept. 2023). As the article points out, having the grantor buy assets back from the trust prior to death not only avoids the arguments made in Rev. Rul. 2023-2 that there is no step up for assets in a grantor trust that are not in the decedent’s gross estate, but the grantor can also pick and choose what assets to buy back and those which for a number of reasons (e.g., a decline in value) should not be.  Because timing of death often is unpredictable, it may be that the grantor should regularly buy assets back from the trust and then sell them back to the trust, all free of income tax under Rev. Rul. 85-13, 1985-1 CB 184.