|
Monday, April 29, 2024
 |
Case Studies |
Still Time To FLIP?
|
Case:
Jake and Kristine McCarthy, both age 75, created a two-life plus 15-year term net income with makeup charitable remainder unitrust (NIMCRUT) about 10 years ago. They chose a payout rate of 5% and funded the trust with $500,000 of highly appreciated stock. Since Jake was a keen stock investor (and since he liked to keep control of their investments) he decided to self-trustee the unitrust. Since they really did not need the income from the trust, Jake made the decision to invest 100% of the trust assets in an aggressive portfolio consisting of stocks and mutual funds. Periodically, he would buy and sell but, for the most part, he followed a buy-and-hold strategy. Over the years, the dividend yield on these investments has averaged 2% and the capital growth yield has averaged about 10% for a total return of 12%. Because of Jake's investment strategy, the trust has grown to over $1.2 million and the deficit account is now about $250,000.
When the trust agreement was originally drafted, the attorney included two important provisions in the agreement. First of all, Jake and Kristine retained the power to revoke and terminate by will any successive income interests in the trust. In other words, they retained the revocation power on the 15-year interest which would pass to the children. This means that this income interest passing to the children was an incomplete gift for gift tax purposes and, therefore, no gift tax return was required to be filed upon the funding of the trust. Secondly, the trustee was given the discretion to allocate realized capital gains from post-gift appreciation to distributable income.
Jake and Kristine now realize, because of their current financial situation, that they will never need the 5% income from the unitrust or payment from the deficit. Therefore, their desire is to allow the trust to continue building the deficit until they pass away. When they are both gone they would like to see the trust convert from a net income with makeup trust to a standard or straight pay trust which will distribute income to the children for the remaining 15-year term. However, they would like to see some, if not all, of the deficit distributed during the 15-year term.
Question:
Jake recently received the quarterly planned giving newsletter from one his favorite charities which stated that the IRS had given a window of opportunity to "flip" existing net income with makeup trusts to straight pay trusts. "This would be ideal," he thought. "I could flip our unitrust to a straight pay trust after Kristine and I are gone." However, as he continued to read the article, the window has now been extended to June 30, 2000. However, the reformation must be complete by that date.
Jake called his attorney, Susan B. Williams, regarding this article and asked her, "Can we complete the change by the deadline?" He stated to Susan his desire for the deficit to be paid to the children after which a conversion to a straight pay trust would occur. Jake liked the idea of a straight pay trust for both administrative and investment reasons, especially when he will no longer be serving as trustee.
Solution:
Susan, who makes it a point to keep current on rulings and regulations issued from the IRS on estate planning topics, was pleased to inform Jake that there would be sufficient time to complete the FLIP by June 30, 2000. Jake was delighted with this news and asked Susan how to best handle his objectives ultimately for the children - pay back the deficit and then convert the NIMCRUT to a straight pay trust.
Susan stated that the best solution to fulfilling Jake's objectives was to convert the unitrust from the net income format to a straight pay trust effective five years after the passing of both Jake and Kristine. In this way, the trustee could utilize the capital gains provision of the trust to pay back the deficit over a period of five years. Because of the post-gift appreciation inside the trust due to Jake's buy-and-hold strategy, the trust could sell investments, generate capital gains and then pay back the deficit ratably over a 5-year period. Based upon projections and Jake and Kristine's life expectancies, the deficit is expected to exceed $600,000 and, therefore, approximately $120,000 of the deficit would be paid back annually. In addition, the 5% distribution would also be paid to the children during those years.
Jake is very pleased with Susan's strategy and instructs her to draw up the necessary documentation to flip the trust as outlined above. In this way, the deficit will not be "lost" and the children will receive in income substantially more than the fair market value of the trust upon the passing of Jake and Kristine.
|
|
|
|
