New §736.0505(3) Assures Tax/
Effective July 1, 2010, new F.S. §736.0505(3) allows married couples to take advantage more easily of one another's estate tax exemptions and, at the same time, to enhance asset protection planning.1 Before enactment of the new statutory provision, it was unclear whether assets contributed to an inter vivos QTIP trust by one spouse that pass in trust for the benefit of the initial donor upon the death of the donor's spouse would be subject to the claims of the donor spouse's creditors, and, therefore, includible in the donor spouse's estate under I.R.C. §20412. The new statute clarifies the asset protection and estate tax benefits of inter vivos QTIP trust planning. As described in this article, inter vivos QTIP trust planning can be enhanced if trusts are created by both the husband and wife, but only if the two trusts are not reciprocal.3
The following example illustrates this technique: Bob and Judy, both attorneys, have been married for 28 years and have four children. Bob and Judy have accumulated a net worth of approximately $13.5 million, of which $3.5 million is equity in their Florida homestead, and $10 million is invested in a joint brokerage account (titled "tenants by the entirety"). Assuming estate taxes are reinstated and the estate tax exemption amount stays at $3.5 million (its 2009 level), Bob and Judy are significantly underutilizing their estate tax exemption amounts. Exhibit 1 shows estate taxes due upon the death of Bob and Judy and the amount of their assets that would be protected from their creditors during their joint lifetimes (assuming they remain married to one another) and upon the death of the first spouse. All jointly held assets pass outright by operation of law to the surviving spouse.
Understanding that Bob and Judy's current estate plan fails to take advantage of the estate tax exemption amount of the first spouse to die, their CPA suggests that Judy's assets be retitled so Bob has $5 million in his revocable trust (thereby avoiding probate and taking advantage of his estate tax exemption if he dies first), and Judy has $5 million in her revocable trust. Each of their revocable trusts directs that an estate tax-exempt gift of the greatest amount that can pass free of estate tax be used to create a trust for the surviving spouse; this trust is intended to pass free of estate tax upon the death of the surviving spouse.
Bob and Judy's desire is to maintain access to all family wealth until the survivor of them passes away, but they do not mind having a portion of the funds held in trust for the surviving spouse, as long as the surviving spouse can serve as a co-trustee or as sole trustee during his or her lifetime, and as long as distributions can be made to the surviving spouse based upon an ascertainable standard (such as for his or her health, maintenance, and support).
Bob and Judy want to confirm their CPA's recommendation, so they consult with their estate planning attorney, Lauren, whose practice combines estate planning with asset protection advice. Lauren explains that converting $10 million of their assets from tenants by the entirety by dividing those assets equally between their respective revocable trusts changes the character of the assets from those that are protected from potential creditors (as long as the debt was not a joint debt of Bob and Judy, and both were living and married to one another), and subjects the entire $10 million to claims of their creditors because assets in a revocable trust are unprotected.4
Exhibit 2 shows estate taxes due upon the death of Bob and Judy and the amount of the assets that would be protected from their creditors during their joint lifetimes and upon the death of the first spouse, assuming they follow their CPA's suggestion. Bob and Judy ask for alternatives that would allow each of them to take advantage of their estate tax exemptions while at the same time not subjecting their assets to exposure to the claims of future creditors.
The new statute provides as follows:
(3) Subject to the provisions of s. 726.105 [This is a reference to Florida's fraudulent transfer statute], for purposes of this section, the assets in:
(a) A trust described in s. 2523(e) of the Internal Revenue Code of 1986, as amended, or a trust for which the election described in s. 2523(f) of the Internal Revenue Code of 1986, as amended, has been made; and
(b) Another trust, to the extent that the assets in the other trust are attributable to a trust described in paragraph (a), shall, after the death of the settlor's spouse, be deemed to have been contributed by the settlor's spouse and not by the settlor.5
As a result of the enactment of §736.0505(3), Bob and Judy can divide the $10 million tenants by the entireties brokerage account equally between them and create separate inter vivos QTIP trusts, taking care that the trusts are not reciprocal.6 Inter vivos QTIP trusts take advantage of new F.S. §736.0505(3) to provide a solution to many of Bob and Judy's tax and asset protection objectives. Rather than maintaining the assets in unprotected revocable trusts (and thereby subjecting $10 million of assets to potential future creditors), assume that Bob created an inter vivos QTIP trust for Judy and transferred $5 million of assets to the trust. Also assume that Bob would only be willing to create the trust for Judy if he had reasonable assurances that, should Judy predecease Bob, he would have access to the $5 million (or such other amount as may be held in the trust upon Judy's death). To maintain flexibility for future planning, the inter vivos QTIP trust can give Judy a testamentary special power of appointment that could be exercised in favor of one or more of Bob, their children, or a charity.7 However, if Bob wants to be certain that, should Judy predecease him, the QTIP trust assets will pass in trust for Bob's benefit, he could draft the inter vivos QTIP trust to require that, should Judy predecease him, the QTIP trust assets would pass into an estate tax-exempt trust for Bob (to the extent of Judy's estate tax exemption amount, as of her date of death), and if Bob survives her, with any remaining assets passing into a testamentary QTIP trust for Bob.8 Use of this technique assures that the assets held in the inter vivos trust for the benefit of Judy are protected from her creditors during Judy's lifetime because the QTIP trust is a spendthrift trust.
Upon Judy's death, the assets remaining in the trust will be held in an asset-protected spendthrift trust for Bob's benefit (an estate tax exempt trust) under the terms of the inter vivos QTIP trust.9 Until F.S. §736.0505(3) was enacted, assets passing from the trust back to Bob at Judy's death might have been thought to be subject to the claims of Bob's creditors because Bob created the original trust.10 Bob would have argued that Judy, and not Bob, should he considered as the donor of the trust after Judy's death, so Bob is not properly considered a beneficiary of a trust that he created. This argument would be consistent with IRS Treas. Reg. §25.2523(f)-(1)(f), Example 11, which provides that assets held in an inter vivos QTIP trust - for the benefit of the settlor after the death of his or her spouse - will not be includible in the settlor's taxable estate under Code §§2036 and 2038. Thus, following the tax ownership reasoning, the trust created for Bob upon Judy's death should not be considered settled by Bob.11
F.S. §736.0505(3) makes it unnecessary to analogize to federal estate tax concepts. Under the new statute, if the inter vivos QTIP trust is properly drafted - and assuming the initial transfer to the trust was not a fraudulent conveyance - it is now clear under Florida law that the assets of the inter vivos QTIP trust described in the example above will not be subject to the creditors of the initial donor (Bob) upon the death of the initial donee spouse (Judy), and that the assets passing in trust for Bob's benefit after Judy's death will not be includible in Bob's estate.
There are a number of issues and traps that must be considered when creating an inter vivos QTIP trust, some of which are described briefly below.
• Jurisdiction - The trust must be created in a jurisdiction in which assets that benefit the initial donor spouse in a protected trust will be protected from creditors' claims (as is the case in Florida as a result of new F.S. §736.0505(3)).
• Reciprocal Trusts - If both spouses create an inter vivos QTIP trust, there is a possibility that the IRS could take the position that they were reciprocal.12 Avoidance of reciprocal trust attacks can be accomplished by allowing a considerable amount of time lapse between the creation of the husband's inter vivos QTIP trust and the wife's inter vivos QTIP trust, and by having different dispositive provisions in the trusts, for example: providing for different trustees, different beneficiaries upon the death of the donee spouse, a special power in favor of certain beneficiaries in each trust, or not providing a special power upon the death of the donee spouse at all in one of the trusts. Arizona has addressed the reciprocal trust dilemma by enacting Arizona Revised Statutes §14-10505(E)(4) that, in conjunction with §14-10505(E), provides that a person who would otherwise be treated as a settlor or deemed a settlor of a trust should not be treated as settlor with respect to an irrevocable inter vivos trust created by the settlor's spouse for the benefit of the settlor, regardless of whether or when the settlor also created an irrevocable inter vivos trust with respect to which such spouse is a beneficiary.13
• Divorce - A number of important issues need to be considered before proceeding with creation of the inter vivos QTIP trust. Once created, the inter vivos QTIP trust is irrevocable for the lifetime of the donee spouse, and the trust will not qualify for the gift tax marital deduction if the spouse's interest in the trust automatically terminates in the event of divorce. As a result, even after divorce, the donee spouse will have the benefits of the trust assets. One planning technique may be to limit principal invasions in the event of dissolution of marriage so that, after divorce, only income distributions will be mandated without the consent of a "special trustee." Will the assets in the trust be considered for purposes of determining elective share rights of a surviving spouse? Would the value of assets in the inter vivos QTIP trust be considered in the event of a subsequent dissolution of marriage of the donor and donee spouse? If so, will the terms of discretionary distributions provided in the trust be considered in determining the value of the trust for purposes of computing the division of assets? Some of these issues could be dealt with if each spouse created an inter vivos trust for the benefit of the other spouse.
Inter vivos QTIP trusts can provide very effective tax planning and asset protection benefits, but only if there is certainty about the rights of the creditors of the initial settlor in the trust assets. Florida may be the best state in which to create such a trust, if a sufficient nexus exists to invoke Florida law. Newly enacted F.S. §736.0505(3) provides certainty that assets in an inter vivos QTIP trust that pass in trust after the death of the beneficiary spouse to the initial donor will not be subject to the creditors of the initial donor spouse; combine this with the fact that Florida has no state income or intangible taxes, and it may be an unbeatable combination. Inter vivos QTIP trusts that can continue in trust for the benefit of the initial settlor after the death of a spouse can provide the following benefits: 1) reduction or elimination (depending upon the values of assets and the applicable estate tax exemption amounts) of estate taxes in the estates of both spouses; 2) protection of the trust assets from the claims of creditors of both the settlor and the settlor's spouse; and 3) control of the ultimate disposition of the trust assets by the settlor. If desired, the settlor can assure that the trust assets will be continued in trust for his or her benefit after the death of the beneficiary spouse in a creditor-protected trust not subject to estate taxes at the subsequent death of the settlor.
In light of the recent statutory change, inter vivos QTIP trusts can now be considered by anyone desiring both to take full advantage of his or her estate tax exemption and to maintain asset protection for their assets.
1 FLA. STAT. §736.0505 (3).
2 Barry A. Nelson, Asset Protection for Estate Planners, Address at the 43rd Annual Heckerling Institute on Estate Planning (Jan. 2009), in 43rd Annual Heckerling Institute on Estate Planning at 18-15-18-20 (Matthew Bender, Pub., 2009); Mitchell M. Gans, Jonathan G. Blattmachr & Diana S.C. Zeydel, Supercharged Credit Shelter Trust, 21 probate & Prop. 52 (July/August 2007); Dana R. Irwin , Removing the Scaffolding: The QTIP Provisions and the Ownership Fiction, 84 Neb. L. Rev. 571 (2005).
3 See Gans, Blattmachr, and Zeydel, Supercharged Credit at 58-59.
4 FLA. STAT. §736.0505(1)(a) ("The property of a revocable trust is subject to the claims of the settlor's creditors during the settlor's lifetime to the extent the property would not otherwise be exempt by law if owned directly by the settlor").
5 FLA. STAT. §736.0505(3).
6 This should only be done if Bob and Judy do not have existing debt because once assets held as tenants by the entirety are divided and retitled in their respective names, assets that previously were protected from creditors as tenants by the entirety (assuming no joint debt) would be subject to creditor's claims of Bob and Judy since they will have outright ownership of $5 million each prior to contributing such assets to the new QTIP trusts. Reciprocal trusts must be avoided. See endnote 2 for articles addressing the reciprocal trust issue in great detail.
7 A special power of appointment provides the power holder with the right to distribute property, subject to the power, to a limited class of beneficiaries or alternatively to a broad class that excludes the power holder, the power holder's estate, the power holder's creditors, or the creditors of the power holder's estate. See I.R.C. §2041.
8 The mandatory reversion in favor of Bob would be even more critical if he had his four children from a prior marriage and he wanted to be certain that upon his death the assets would a) pass for his benefit if he survives Judy or b) to his children if he predeceases Judy or disclaims the interest otherwise passing to him upon Judy's death.
9 This article assumes assets in a spendthrift trust are protected from general creditors. Exception creditors, such as the IRS or child support, may circumvent spendthrift protection. See FLA. STAT. §736.0503(2): "To the extent provided in subsection (3), a spendthrift provision is unenforceable against: (a) A beneficiary's child, spouse, or former spouse who has a judgment or court order against the beneficiary for support or maintenance. (b) A judgment creditor who has provided services for the protection of a beneficiary's interest in the trust. (c) A claim of this state or the United States to the extent a law of this state or a federal law so provides."
10 See FLA. STAT. §736.0505(1)(b) ("With respect to an irrevocable trust, a creditor or assignee of the settlor may reach the maximum amount that can be distributed to or for the settlor's benefit"). If the original settlor of an inter vivos QTIP trust is also treated as the settlor of the trust for his or her benefit after the death of the initial beneficiary spouse, under Florida law prior to §736.0505(3), the settlor's creditors could reach the trust assets in satisfaction of their claims.
11 26 C.F.R. §25.2523 (f)(1)(f), Ex. 11.
12 See Gans, Blattmachr, and Zeydel, Supercharged Credit, for a thorough analysis of reciprocal trusts.
13 A.R.S. §14-10505(E).
Richard R. Gans is a shareholder in the Sarasota firm of Fergeson, Skipper, Shaw, Keyser, Baron & Tirabassi, P.A. He is certified by The Florida Bar in wills, trusts, and estates and is a fellow of the American College of Trust and Estate Counsel. Mr. Gans is active in the Real Property, Probate and Trust Law Section of The Florida Bar, where he serves as chair of the section's Estate and Trust Tax Planning Committee.
Barry A. Nelson is founder of the law offices of Nelson & Nelson, P.A. and The Victory School for Children with Autism, both in North Miami Beach. He is Florida Bar board certified in both taxation and wills, trusts, and estates. Mr. Nelson is a member of the American College of Trust and Estate Counsel and serves as chair of its Asset Protection Committee. He received his LL.M. and J.D., cum laude, from the University of Miami School of Law.
This column is submitted on behalf of the Real Property, Probate and Trust Law Section, Brian J. Felcoski, chair, and William P. Sklar and Kristen Lynch, editors.
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