Post-DOMA Planning

Identifying Estate Planning Techniques No Longer Available
and 
Updating Estate Plans to Reflect New Benefits

Our last article discussed some significant benefits that will now be available to married same-sex couples as well as identifying one estate planning technique that no longer applied to these couples.  In this article, we will expand on some other types of now-outdated planning techniques used in the past to protect and preserve assets for same-sex couples and identify newly applicable estate planning issues affecting married couples.

Many estate planning issues common for married couples arise due to the application of the special valuation rules of Chapter 14 of the Internal Revenue Code (IRC).  These rules do not apply to unmarried couples, who are not considered “members of the family” under section 2407(c) of the IRC,  These rules still do not apply to unmarried same-sex couples, or unmarried heterosexual couples).  Married same-sex couples will need to be aware of how these newly applicable rules affect certain planning tools, including:

Grantor Retained Income Trusts (GRITs);

Qualified Personal Residence Trusts (QPRTs);

IRC Section 2701 compliant preferred partnerships;

vertical slice” investment fund;

carried interest transfer planning;

sales to Intentionally Defective Grantor Trusts;

buy-sell agreements and family limited partnership agreements under IRC Section 2703;

valuation problems under IRC Section 2704; and

marital deduction mismatch problems. 

Couples who have used any of the previously named techniques in crafting their estate plans will likely need to update their plans to reflect the different financial consequences these techniques have for married couples.

One commonly-used planning technique is the Grantor Retained Income Trust (GRIT).  GRITs are irrevocable trusts that allow a grantor to transfer assets to a non-family beneficiary and retain the income interest from those assets.  However, under Chapter 14 of the IRC, the retained income interest does not reduce the value of the gift.  Without this benefit, GRITs are generally considered not a useful planning tool for transfers among family members. 

Another type of trust, a Qualified Personal Residence Trust (QPRT), also has much more limited benefit for married couples.  A QPRT is an irrevocable trust funded by the transfer of a personal residence to a trust beneficiary while retaining in the transferor a right to reside on the property for a term of years.  With a QPRT, a home can be transferred at a reduced gift value.  However, the beneficiary receives the residence subject to carry-over tax basis and may incur substantial capital gains tax on the subsequent sale of the residence.  Therefore, same-sex couples may have been advised to create a QPRT and, prior to the end of the trust, have the grantor purchase the real estate back from the trust, leaving cash in the trust.  Upon the death of the grantor, the real estate would receive a step-up in basis.  The step upped basis is the value of the property as of the date of death of the owner without reference to the price paid for the property.  Therefore, if the property is sold at its new basis there is no capital gains tax to pay. However, when the trust beneficiary is a member of the grantor’s family, the grantor is prohibited from buying the residence back, reducing the potential benefits of a QPRT for married couples.

In addition to the application of Chapter 14 of the IRC to GRITs and QPRTs, there are many other newly applicable tax issues for married same-sex couples.  One issue involves grantor trust rules.  Generally, trusts are taxed as either grantor trusts, where the taxes are paid by the grantor, or non-grantor trusts, where the trust pays its own income taxes. Designating a spouse as a beneficiary causes grantor trust status.  This means that married same-sex couples’ non-grantor trusts with a same-sex spouse as a beneficiary may now be treated as grantor trusts.  Same-sex couples should consult with their legal advisors to determine whether the income tax status of any trusts may have inadvertently changed.  

Married same-sex couples may also want to update their income tax filing status and claimed allowances.  Married couples may file income taxes jointly or separately (joint filing tends to favor spouses when one spouse makes significantly more than the other spouse).  In addition, couples may be able to combine qualifying medical and dental expenses to determine if they meet adjusted gross income (AGI) limits and may also be able to use pre-tax dollars to pay premiums on employer-provided health insurance for a spouse.  It is the opinion of many advisors that same-sex couple that were married under the law of any state should consider amending any prior year federal income tax returns for which the statute of limitation has not run.  However, because of the “marriage penalty” of the federal income tax an amendment and income come taxes due in the future may increase.  And for any surviving spouse where a federal estate tax return was filed and tax was due an amended return should be filed if assets passed to the surviving spouse.

When planning for retirement, same-sex couples also need to take into account newly expected retirement income from Social Security Spousal Retirement Benefits, Disability Benefits, Survivor’s Benefits, and Lump Sum Death Benefits, as well as any additional pension benefits for which they may now qualify.  They should also consider spousal rights in 401(k), profit sharing and other employer sponsored retirement plans.  As part of this all beneficiary designations for all retirement plans should be reviewed to make sure they are still consistent with the wishes of the participant and have not been over ruled by the Retirement Equity Act (REA).  REA gives rights to all spouses in employer sponsored retirement plans and this takes precedence over the beneficiary form that is on file.

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