The Upstream Or Reverse Estate Plan
By: Randall A. Denha, J.D., LL.M.
When most advisors and their clients consider estate planning, conventional wisdom is to focus any transfers “downstream” to future generations for tax opportunity. Most advisors want to remove assets out of a senior generation member’s estate and place it into a junior member’s estate. The idea is that since the estate tax is designed to impose a tax upon each generation upon their passing, moving assets to the next generation prior to the death of the senior generation will escape estate tax on those gifted assets. Therefore, the government will not have an opportunity to tax these gifted moneys and these same moneys can then be gifted again in later years by the recipients of these gifts.
Oftentimes, many think about how to structure the estate and financial plan so as to provide for children, grandchildren, and other younger beneficiaries. The perspective is always, “How can we benefit future generations?” While this is a key aspect of any estate plan, there is not enough focus on the reverse: “upstream” estate planning. As part of the “upstream” estate plan, clients should also focus upon how any such gifts and inheritances they expect to receive should be structured in order to benefit themselves, whether for tax or non-tax reasons. For example, if a physician gifts money to his or her parent (absent any fraudulent intent) then those moneys left in trust for the benefit of the physician child after the death of the parent can be further protected, if properly structured.
Basic estate planning usually involves creating a living trust for the purpose of avoiding conservatorship in the event of incapacity and avoiding probate upon death. There is no question that for the vast majority of clients, being able to avoid the cost, expense, frustration, and other hassles with conservatorship and probate is worth the legal fee in creating such an important document. Sadly, many advisors and clients have not seen additional benefits of creating a living trust beyond avoiding conservatorship and probate. As a result, provided the beneficiaries are mature enough to manage their inheritances, most living trusts terminate upon the death of the client(s) and the beneficiaries receive their inheritances free of trust, in their own name(s). This is simple, straight-forward, easy-to-understand estate planning. However, there is much more than meets the eye.
Recently, the trend in estate planning, especially in light of the economy, concern over divorce and the resulting dramatic increase in litigation, is to keep inheritances in trust for beneficiaries. The reason is because when a Trust is created for the benefit of a third party, the Trust can provide so many more benefits beyond avoiding conservatorship and probate such as creditor protection for the third party beneficiary in the event of divorces, frivolous lawsuits or extraordinary health care bills and even additional estate tax protection for the third party beneficiary. If the beneficiary is mature, the beneficiary can even be in charge of his/her Trust share.
However, the above protections are only effective if a trust is created by someone else for the benefit of a third party. To say it differently, in the state of Michigan and many other states (but not all) you cannot enjoy the same benefits if you try to create such a trust for yourself.
Rather than simply asking your potential benefactors (parents, grandparents, etc.) to structure their estate planning in order to provide “in trust” inheritances rather than outright inheritances, another method is to gift assets “upstream” to the senior generation member. The idea is to consider using your gift tax exclusions so that such amounts are gifted to a modest parent by using gifts or modest gifts with sales of assets. Upon the death of the parent (i.e. senior generation member), the assets would be returned to the child with an increased tax basis and structured to be protected from creditor and predators! Of course this is an oversimplification as there are numerous tax issues to navigate, but it can be done.
With an increased gift and estate tax exclusion of $5.34 million, this type of planning is very realistic and should be considered by persons who have asset(s) that are likely to appreciate or who have estates that are valuable and wish to gift these same assets to a parent or grandparent whose estate is not so valuable, but who would likely name the child/grandchild as a beneficiary of their trust.
THIS ARTICLE MAY NOT BE USED FOR PENALTY PROTECTION. THE MATERIAL IS BASED UPON GENERAL TAX RULES AND FOR INFORMATION PURPOSES ONLY. IT IS NOT INTENDED AS LEGAL OR TAX ADVICE AND TAXPAYERS SHOULD CONSULT THEIR OWN LEGAL AND TAX ADVISORS AS TO THEIR SPECIFIC SITUATION.
