IRS Notice IR-2018-232; Safeguarding Records

The Internal Revenue Service (“IRS”) just released one of their many informative Notices aimed at taxpayers for the upcoming tax season.  It comes at a time when many of my clients inquire at the end of the tax year about prior year tax returns and safekeeping of records, supporting documentation, old check books, receipts and the like.  It’s a question I constantly hear from clients and friends alike; how long should I keep my returns and records?  Well, the IRS has come out with Notice IR-2018-232 which answers the question.  Below, I have copied the relevant portions of the IRS Notice for your information.  Where appropriate, I have added emphasis to drive the point home.

IRS Issue Number:    IR-2018-232, Inside This Issue; Get Ready for Taxes:

Safekeeping tax records helps for future filing, amended returns, audits

WASHINGTON — With the tax filing season quickly approaching, the Internal Revenue Service wants taxpayers to understand how long to keep tax returns and other documents.

The IRS generally recommends keeping copies of tax returns and supporting documents at least three years. Employment tax records should be kept at least four years after the date that the tax becomes due or paid, whichever is later. Tax records should be kept at least seven years if a return claims a loss from worthless securities or a bad debt deduction. Copies of previously-filed tax returns are helpful in preparing current-year tax returns and making computations if a return needs to be amended.

Safe-keeping records

Tax records should be kept safe and secure regardless of whether they are stored on paper or kept electronically. Paper records should be kept in a secure location, preferably under lock and key, such as a secure desk drawer or a safe. Records retained electronically should be backed up electronically and encrypted when possible. The IRS also suggests scanning paper tax and financial records into a format that can be encrypted and stored securely on a flash drive, CD or DVD with photos or videos of valuables.

Disposing of records

Tax records contain sensitive data such as Social Security numbers, income amounts and bank account information. Tax documents not properly disposed of can land in the hands of criminals and lead to identity theft. Once past their useful date, records should be disposed of properly. Paper tax returns and supporting documents should be shredded before being discarded. Old computers, back-up drives and media contain sensitive data. Deleting stored tax files will not completely erase them. Using special wiping software ensures the removal of sensitive data.

Taxpayers still keeping old tax returns and receipts stuffed in a shoebox may want to rethink their approach. When records are no longer needed the data should be properly destroyed. More information is available on at How long should I keep records?

IRS Urges Travelers Requiring Passports to Pay Their Back Taxes

The Internal Revenue Service issued this Notice (2018-1) last week regarding legislation passed and signed into law in December, 2015.  Until recently, this law was not generally enforced but with the new administration, “taxpayers” who are at risk need to get into a payment program if traveling outside the U.S. is in their plans.  Individuals who are seriously delinquent in their taxes are in jeopardy of having their passports suspended or revoked.

Read the IRS Issue Number (IR-2018-7) below if you fall into this category as a serious delinquent (defined below).


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Issue Number:    IR-2018-7

Inside This Issue

IRS Urges Travelers Requiring Passports to Pay Their Back Taxes or Enter into Payment Agreements; People Owing $51,000 or More Covered

WASHINGTON ─ The Internal Revenue Service today strongly encouraged taxpayers who are seriously behind on their taxes to pay what they owe or enter into a payment agreement with the IRS to avoid putting their passports in jeopardy.

This month, the IRS will begin implementation of new procedures affecting individuals with “seriously delinquent tax debts.” These new procedures implement provisions of the Fixing America’s Surface Transportation (FAST) Act, signed into law in December 2015. The FAST Act requires the IRS to notify the State Department of taxpayers the IRS has certified as owing a seriously delinquent tax debt. See Notice 2018-1. The FAST Act also requires the State Department to deny their passport application or deny renewal of their passport. In some cases, the State Department may revoke their passport.

Taxpayers affected by this law are those with a seriously delinquent tax debt.  A taxpayer with a seriously delinquent tax debt is generally someone who owes the IRS more than $51,000 in back taxes, penalties and interest for which the IRS has filed a Notice of Federal Tax Lien and the period to challenge it has expired or the IRS has issued a levy.

There are several ways taxpayers can avoid having the IRS notify the State Department of their seriously delinquent tax debt. They include the following:

  • Paying the tax debt in full
  • Paying the tax debt timely under an approved installment agreement,
  • Paying the tax debt timely under an accepted offer in compromise,
  • Paying the tax debt timely under the terms of a settlement agreement with the Department of Justice,
  • Having requested or have a pending collection due process appeal with a levy, or
  • Having collection suspended because a taxpayer has made an innocent spouse election or requested innocent spouse relief.

A passport won’t be at risk under this program for any taxpayer:

  • Who is in bankruptcy
  • Who is identified by the IRS as a victim of tax-related identity theft
  • Whose account the IRS has determined is currently not collectible due to hardship
  • Who is located within a federally declared disaster area
  • Who has a request pending with the IRS for an installment agreement
  • Who has a pending offer in compromise with the IRS
  • Who has an IRS accepted adjustment that will satisfy the debt in full

For taxpayers serving in a combat zone who owe a seriously delinquent tax debt, the IRS postpones notifying the State Department and the individual’s passport is not subject to denial during this time.

In general, taxpayers behind on their tax obligations should come forward and pay what they owe or enter into a payment plan with the IRS. Frequently, taxpayers qualify for one of several relief programs, including the following:

  • Taxpayers can request a payment agreement with the IRS by filing Form 9465. Taxpayers can download this form from and mail it along with a tax return, bill or notice. Some taxpayers can use the online payment agreement to set up a monthly payment agreement for up to 72 months.
  • Some financially distressed taxpayers may qualify for an offer in compromise. This is an agreement between a taxpayer and the IRS that settles the taxpayer’s tax liabilities for less than the full amount owed. The IRS looks at the taxpayer’s income and assets to determine the taxpayer’s ability to pay. To help determine eligibility, use the Offer in Compromise Pre-Qualifier, a free online tool available on has other tips for taxpayers to catch up on their filing and tax obligations and more information about the revocation or denial of passports because of unpaid taxes.

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Summary: Tax Cuts and Jobs Act of 2017

Summary: Tax Cuts and Jobs Act of 2017 (Re-Printed from Paragon Financial Partners; Insights 4Q 2017)

Tax Cuts and Jobs Act

The Tax Cuts and Jobs Act legislation has been passed by Congress and signed by the President. The Act makes extensive changes that affect both individuals and businesses. Some key provisions of the Act are discussed below. Most provisions are effective for 2018 and revert to the pre-existing laws after 2025 while the corporate tax rate provision is made permanent. Comparisons below are for 2018.

Individual income tax rates 

There are seven regular income tax brackets in 2017 – 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%.

For the years 2018 – 2025 there will be seven tax brackets – 10%, 12%, 22%, 24%, 32%, 35%, and 37%. It’s important to note that these tax brackets will revert back to the 2017 tax brackets after the year 2025. Additionally, these tax brackets do not include the additional 0.9% payroll tax levied by the Affordable Care Act on individuals with incomes exceeding $200,000 (or married couples exceeding $250,000).

Income Bracket Thresholds

Tax Rate  Single      Married Filing Jtly/ Surviving Spouse     Married Filing Separately       Head of Household  Trust/Estate

10%         $0                            $0                                            $0                                            $0                              $0

12%         $9,525                     $19,050                                   $9,525                                     $13,600                   N/A

22%         $38,700                   $77,400                                   $38,700                                   $51,800                   N/A

24%         $82,500                   $165,000                                 $82,500                                   $82,500                   $2,550

32%         $157,500                 $315,000                                 $157,500                                 $157,500                 N/A

35%         $200,000                 $400,000                                 $200,000                                 $200,000                 $9,150

37%         $500,000                 $600,000                                 $300,000                                 $500,000                 $12,500

Standard deduction, itemized deductions, and personal exemptions

Pre-existing law: In general, personal (and dependency) exemptions were available for you, your spouse, and your dependents. Personal exemptions were phased out for those with higher adjusted gross incomes.

You could generally choose to take the standard deduction or to itemize deductions. Additional standard deduction amounts were available if you were blind or age 65 or older.

Itemized deductions included deductions for: medical expenses, state and local taxes, home mortgage interest, investment interest, charitable gifts, casualty and theft losses, job expenses, and other miscellaneous deductions. There was an overall limitation on itemized deductions based on the amount of your adjusted gross income.

New law: The standard deduction is significantly increased, and the additional standard deduction amounts for those over age 65 or blind are still available. The personal and dependency exemptions are no longer available. 5850 Canoga Ave., Suite 400

Many itemized deductions are eliminated or restricted. The overall limitation on itemized deductions based on the amount of your adjusted gross income is eliminated.

  • The deduction of medical and dental expenses for individuals under age 65 is reduced to 7.5% of AGI from 10% in 2017 and 2018.
  • The deduction for state and local taxes is limited to $10,000. An individual cannot prepay 2018 income taxes in 2017 in order to avoid the dollar limitation in 2018.
  • The deduction for mortgage interest is still available, but the benefit is reduced for some individuals, and interest on home equity loans is no longer deductible.
  • The charitable deduction is still available.
  • The deduction for personal casualty losses is eliminated unless the loss is incurred in a federally declared disaster.

These provisions sunset and revert to pre-existing law after 2025.

Standard deduction, itemized deductions, and personal exemptions

Personal and Dependency Exemptions (you, your spouse, and dependents)

Pre-existing law                                                      New law

Exemption                                               $4,150                                                                     No personal exemption

Standard Deduction

Standard Deduction                                Pre-existing law                                                      New law

Married filing jointly                               $13,000                                                                   $24,000

Head of household                                 $9,550                                                                     $18,000

Single/Married Filing Separately (MFS)                $6,500                                                                     $12,000

Additional aged/blind

Single/head of household                      $1,600                                                                     $1,600

All other filing statuses                          $1,300                                                                     $1,300

Itemized Deductions

Pre-existing law                                                      New law

Medical expenses                                   Yes, if expenses exceed 10% of AGI floor              Yes, reduced to 7.5% of AGI floor

State and local taxes                              Yes, generally all income/real estate taxes          Yes, limited to $10,000 ($5K for MFS)

Home mortgage interest                       Yes, limited to $1MM plus $100K for home eqty  Yes, limited to $750,000 ($375,000 for

MFS); No deduction for home eqty for

All devt incurred after 12/31/2017.



Charitable gifts                                       Yes                                                                          Yes, 50% AGI limit raised to 60% for

Cash gifts to charities

Casualty and theft losses                       Yes                                                                          Federally declared disasters only

Job expenses and certain

miscellaneous deductions                      Yes                                                                          No longer allowed


Child tax credit

Pre-existing law.

The maximum child tax credit was $1,000. The child tax credit was phased out if modified adjusted gross income exceeded certain amounts. If the credit exceeded the tax liability, the child tax credit was refundable up to 15% of the amount of earned income in excess of $3,000 (the earned income threshold).

New law. The maximum child tax credit is increased to $2,000. A nonrefundable credit of $500 is available for qualifying dependents other than qualifying children. The maximum refundable amount of the credit is $1,400, indexed for inflation. The amount at which the credit begins to phase out is increased, and the earned income threshold is lowered to $2,500. The changes to the credit sunset and revert to pre-existing law after 2025.

Child Tax Credit

Pre-existing law                                                                      New law

Maximum credit                                     $1,000                                                                                     $2,000

Non-child dependents                            N/A                                                                                         $500

Maximum refundable                             $1,000                                                                                     $1,400 indexed

Refundable earned income threshold    $3,000                                                                                     $2,500

Credit phase out threshold

Single/head of household                      $75,000                                                                                   $200,000

Married filing jointly                               $110,000                                                                                 $400,000

Married filing separately                        $55,000                                                                                   $200,000


Alternative minimum tax (AMT)

Under the Act, the alternative minimum tax exemptions and exemption phase out thresholds are increased. The AMT changes sunset and revert to pre-existing law after 2025.



Alternative Minimum Tax (AMT)

Pre-existing law                                                                      New law

Max AMT exemption amount                                $86,200 (MFJ), $55,400 (Sngle/HOH),  $109,400 (MFJ), $70,300 (Sngle/HOH)

$43,100 (MFS)                                        $54,700 (MFS)

Exemption phase out threshold             $164,100 (MFJ), $123,100 (Single/HOH), $1MM (MFJ), $500K (Single, HOH, MFS) $82,050 (MFS)

26% rate applies to AMT income

(AMTI) at or below this amount (28%

rate applies to AMTI above this amount) $191,500 (MFJ, Single, HOH),

$95,750 (MFS)                                        $191,500 (MFJ, Single, HOH), $95,750 (MFS)

Kiddie tax

Instead of taxing most unearned income of children at their parents’ tax rates (as under pre-existing law), the Act taxes children’s unearned income using the trust and estate income tax brackets. This provision sunsets and reverts to pre-existing law after 2025.

Corporate tax rates

Under the Act, corporate income is taxed at a 21% rate.  The corporate alternative minimum tax is repealed. 5850 Canoga Ave., Suite 400

Special provisions for business income of individuals

Under the Act, an individual taxpayer can deduct 20% of domestic qualified business income (excludes compensation) from a partnership, S corporation, or sole proprietorship. The benefit of the deduction is phased out for specified service businesses with taxable income exceeding $157,500 ($315,000 for married filing jointly). The deduction is limited to the greater of (1) 50% of the W-2 wages of the taxpayer, or (2) the sum of (a) 25% of the W-2 wages of the taxpayer, plus (b) 2.5% of the unadjusted basis immediately after acquisition of all qualified property (certain depreciable property). This limit does not apply if taxable income does not exceed $157,500 ($315,000 for married filing jointly), and the limit is phased in for taxable income above those thresholds. This provision sunsets and reverts to pre-existing law after 2025.

Retirement plans

Under the Act, the contribution limits for employer sponsored retirement plans increases to $18,500 from $18,000. However, the Act repeals the special rule permitting a re-characterization to unwind a Roth conversion.

Estate, gift, and generation-skipping transfer tax

The Act doubles the gift and estate tax basic exclusion amount and the generation-skipping transfer tax exemption to about $11,200,000 in 2018. This provision sunsets and reverts to pre-existing law after 2025.

Health insurance individual mandate

The Act eliminates the requirement that individuals must be covered by a health care plan that provides at least minimum essential coverage or pay a penalty tax (the individual shared responsibility payment) for failure to maintain the coverage. The provision is effective for months beginning after December 31, 2018.

Standard Mileage Rates: 2017 & 2018

Standard Mileage Rates: 2017 & 2018

IR-2017-204, Dec. 14, 2017

WASHINGTON ― The Internal Revenue Service today issued the 2018 optional standard mileage rates used to calculate the deductible costs of operating an automobile for business, charitable, medical or moving purposes.

Beginning on Jan. 1, 2018, the standard mileage rates for the use of a car (also vans, pickups or panel trucks) will be:

  • 54.5 cents for every mile of business travel driven, up 1 cent from the rate for 2017.
  • 18 cents per mile driven for medical or moving purposes, up 1 cent from the rate for 2017.
  • 14 cents per mile driven in service of charitable organizations.

The business mileage rate and the medical and moving expense rates each increased 1 cent per mile from the rates for 2017. The charitable rate is set by statute and remains unchanged.

The standard mileage rate for business is based on an annual study of the fixed and variable costs of operating an automobile. The rate for medical and moving purposes is based on the variable costs.

Taxpayers always have the option of calculating the actual costs of using their vehicle rather than using the standard mileage rates.

A taxpayer may not use the business standard mileage rate for a vehicle after using any depreciation method under the Modified Accelerated Cost Recovery System (MACRS) or after claiming a Section 179 deduction for that vehicle. In addition, the business standard mileage rate cannot be used for more than four vehicles used simultaneously. These and other requirements are described in Rev. Proc. 2010-51.

Notice 2018-03, posted today on, contains the standard mileage rates, the amount a taxpayer must use in calculating reductions to basis for depreciation taken under the business standard mileage rate, and the maximum standard automobile cost that a taxpayer may use in computing the allowance under a fixed and variable rate plan.

(Taken from the Internal Revenue Service website)

New 2018 Federal Estate and Gift Tax Rules

New 2018 Federal Estate and Gift Tax Rules 

The Tax Cuts and Jobs Act (the “Act”) was passed by Congress and signed into law by President Trump on December 22, 2107. Among its many changes to the Federal tax code, the Act will double the Federal estate, gift and generation-skipping transfer (“GST”) tax exemption amounts from $5 million to $10 million per individual, with additional inflation adjustments as under prior law.

The increased, inflation-adjusted exemption amounts – approximately $11.2 million for an individual, or a combined $22.4 million for a married couple – are effective for estates of decedents dying, and gifts made, after December 31, 2017 (with potential future inflation adjustments for 2019 and subsequent tax years), but are scheduled to expire on December 31, 2025, after which the relevant Federal estate, gift and GST tax exemption amounts would revert to the prior $5 million amounts, plus the relevant inflation adjustments.

Estate planning in 2018 will be focused on reviewing Wills and other testamentary documents in light of the increased Federal exemption amounts, taking into account:

The continued availability of a “step-up” in income tax basis at death to determine which assets should be included in any testamentary trusts or other testamentary dispositions and assets that should be directly inherited by beneficiaries so that a proper analysis of income tax and estate tax consequences can be appropriately made;

The possibility that current plans may include one or more “formula dispositions” of the type described below that may require immediate attention because they are no longer appropriate or otherwise have unintended consequences;

Any relevant state level estate taxes, such as the repeal, in 2018, of the New Jersey Estate Tax;

The scheduled January 1, 2026 reduction in the new Federal exemption amounts (and the

possibility of sooner changes as part of future tax legislation); and

Any other changed family or financial circumstances.

There should be a renewed interest, especially by those individuals who have already exhausted their prior exemption amounts, in making lifetime gifts to take advantage of the Act’s increased exemption amounts while they are available.

Increased attention should be made to certain state level income tax planning, including whether any state income tax savings can be achieved through the use of certain “non-grantor trust” structures.

Formula Dispositions

Some testamentary plans may include so-called “formula dispositions” in an amount equal to the Federal or applicable state estate tax exemption amount, or other tax influenced dispositions, that should be reviewed to determine whether they continue to be appropriate.

For example, in the past it was not uncommon for a decedent’s Will to include a “credit shelter disposition” to a “credit shelter trust” or other “disclaimer-type” trust that included children as beneficiaries, with the balance of the estate passing to or in trust for a surviving spouse. Credit shelter dispositions were often defined by a formula expressed in terms of the maximum amount that could pass at death from the decedent’s estate free of Federal estate tax. With a significantly increased Federal estate tax exemption amount, such a disposition could result in unanticipated state level estate tax or, if a spouse is not a named beneficiary of the credit shelter trust, in significantly reduced assets being available to a surviving spouse. Formula dispositions tied to a decedent’s unused estate, GST or other exemption potentially could have similar results.

Accordingly, individuals should consult with their advisors to determine whether their estate

planning documents contain any dispositions determined by a formula referring to an “exemption equivalent amount,” “applicable credit amount,” or “unused GST exemption,” or other dispositions that could have unintended consequences in light of tax or other changes that have taken place since those documents were first executed.

State Transfer Tax Developments

New Jersey

The New Jersey estate tax is scheduled to be repealed effective January 1, 2018. New Jersey will, however, retain its separate inheritance tax, which does not generally apply to transfers to a spouse, child or grandchild. The New Jersey inheritance tax is based on the relationship between the decedent and the beneficiary receiving assets from the decedent. Under the inheritance tax, transfers to siblings are generally taxed at a rate beginning at 11% (top rate is 16%) and transfers to others are taxed at a rate of 15% or 16% (New Jersey inheritance tax is also deductible for Federal estate tax purposes, to the extent a Federal estate tax would otherwise be payable).


(Taken from Davis, Polk & Wardell, LLP, Client Memorandum to Morgan Stanley  clients)

Why Do We Need Estate Planning?

Why Do Estate Tax Planning?

  • Protecting lifestyle and cash needs of surviving spouse;
  • Protecting liquidity of estate and to provide for estate taxes and other expenses due within 9 months of death;
  • Protecting inheritance of children.

The Survivor’s Choice (Disclaimer) Trust or the Unified Credit Trust

As a general rule, estate tax planning is generally recommended for those NJ residents who decease with assets with a date of death value in excess of $675,000, which is the threshold for New Jersey estate tax filing and possible estate tax liability.  For those clients who are not domiciled in New Jersey, the value of the estate is generally those that are in excess of the federal exemption amount, in excess of $5.43 million.

The uncertainty which has prevailed in federal estate tax law since the passage of the massive federal tax legislation which took effect on January 1, 2002, has led those of us who practice in the estate tax planning arena, to re-evaluate how we do traditional federal estate tax planning.  New Jersey, on the other hand, has held the line on the artificially low estate tax exemption threshold used under federal estate tax law in 2001.  Although there are bills in the NJ legislature which would increase the estate tax threshold to $1 million, no bill has passed.

On January 1, 2013, Congress passed, and the President signed, on January 2, 2013, The American Taxpayer Relief Act of 2012 (the “Act”), a permanent fix for the federal estate tax rules so that the federal exemption amount, adjusted for inflation after 2011 means that a person who dies in 2015 can transfer up to $5.43 million (or $10.86 million for a married couple, as adjusted by lifetime taxable gifts) at death without incurring any federal estate taxes.  The Act permanently capped the maximum estate and GST tax rate at 40% and also makes the concept of portability of the estate and gift tax exemption amount, permanent.  However, the GST exemption amount is not subject to portability.

Prior to the passage of the estate tax legislation, estate tax planning for estates in excess of $675,000  was generally performed with the use of the Will which included the Tax Credit Trust, Unified Credit Shelter Trust, By-Pass Trust or “A”/”B” Trust.  Prior to the permanent passage of the $5 million exemption amount, and even now, with Congress’ propensity to tinker with the tax code, we always have some uncertainty in the federal estate tax area.  Whether to use the Credit Shelter Trust, traditional for years in federal estate tax planning, or the “Survivor’s Choice Trust”, will likely depend on the particular facts and circumstances of your client’s estate plan, whether federal or state driven.

The “Survivor’s Choice Trust”, unlike the Credit Shelter Trust, provides the surviving spouse with greater flexibility in determining just how much of the decedent spouse’s estate should be left outright to the surviving spouse and how much should be left in trust to be sheltered by the existing exemption amount.  However, the Survivor’s Choice Trust also places a greater burden on post-mortem estate tax planning with respect to decisions to be made by the surviving spouse as well as the professionals who are assisting, such as the attorney, accountant or certified financial planner.   In addition, there is a greater emphasis on the timing of the post-mortem planning since a qualified disclaimer (pursuant to Internal Revenue Code Section 2518) must generally be filed with the appropriate surrogate court within nine months after date of death.  If a disclaimer is to be used solely for state purposes, and not to be qualified under IRC Section 2518, the NJ Surrogates’ Court has permitted the filing of a disclaimer beyond the nine month period.

The Survivor’s Choice Trust provides the type of flexibility that the Credit Shelter Trust does not with respect to the needs of the surviving spouse.  With the Credit Shelter Trust, a set amount of assets was required to be transferred into the trust, usually by way of a formula.  With the uncertainty of what type of legislation Congress will pass hopefully pass in the next few years, the use of the Credit Shelter Trust might create a situation where the amount required to be transferred into the trust is more than is needed under current law at the time of death.  As a result, the surviving spouse does not have the ability to access the needed inheritance which is now in a trust controlled by a trustee, albeit, friendly in most cases.  With the Survivor’s Choice Trust, it is the surviving spouse who determines how much of the decedent spouse’s estate is transferred outright and into the trust, thereby permitting the surviving spouse the needed assets and control of the flow of funds.

The Survivor’s Choice Trust is only one vehicle used to reduce federal estate taxes.  When one or both spouses have life insurance, the irrevocable life insurance trust should be considered.

Irrevocable Life Insurance Trust

The irrevocable life insurance trust is the owner of the life insurance policy on the life of the insured and is also the recipient of the life insurance proceeds which would otherwise be included in the estate of the spouse who owns the policy.  Since the life insurance trust is a separate entity, the life insurance proceeds, when payable to the trust as the beneficiary, is not included in the estate of either spouse but passes to the children (or other beneficiary) after providing the surviving spouse with income for life.


Gift-giving is one effective way of reducing the estate.  Under Rev. Proc. 2012-41, the annual gift exclusion amount went up to $14,000 ($28,000 if married and the non-giving spouse elect to make a gift of $14,000 as well).  This is the first time there has been an increase in the annual gift exclusion since 2009.   If the value of the gift given to a donee is in excess of $14,000 ($28,000 if married), the donor will be subject to gift tax although whether the donor actually sends a check to the IRS will depend on several factors, such as how much of the lifetime gift exemption has previously been used..  The amount of the gift will be reflected in the value of the estate at death and the unified tax credit given to the estate will be reduced accordingly.  With respect to GST planning, the Act makes permanent the unification of the estate tax and GST tax exclusion amounts.  For 2015, a person can transfer up to $5.43 million to grandchildren without paying any GST tax.

Intentionally Defective Grantor Trust (“Idgt”)

Sophisticated estate tax planners have long used the oddly named intentionally defective grantor trust (IDGT) as an effective estate planning tool. The IDGT can freeze the value of an asset for estate planning purposes, while effectively transferring funds out of the estate free of gift taxes. The IRS, with one caveat, recently reaffirmed this planning technique (see Rev. Rul. 2004-64).

How The Idgt Works

Example: Individual G creates an irrevocable inter vivos trust as the grantor, using an unrelated third-party trustee. He then sells to the trust an asset which is likely to appreciate, in return for an installment note (usually with a balloon payment), bearing an interest rate at the applicable Federal rate (AFR). The trust beneficiaries are G’s heirs. To make certain that the asset’s fair market value is reflected by the installment note, G has the asset appraised. This ensures that the transfer is not treated as a gift under Sec. 2512(b).  If G has no seed money (some commentators have suggested that 10% of the value of the asset to be purchased should be the “seed” money gifted to the trust initially by G) to fund a purchase of the asset by the trust, then, in certain circumstances, G can transfer the property to the trust, thereby triggering the unified gift exemption amount and causing the filing of a gift tax return for the year in which the gift to the trust was made by G.

By intentionally retaining a minor power (discussed below), G triggers the Sec. 671 grantor trust rules, causing the trust’s net income to be taxed to G (in the same way as a revocable living trust). Some of the more commonly retained minor powers that trigger these rules include G’S rights under Sec. 675(4) to substitute property of equal value for the property originally transferred, and to borrow from the trust without adequate security under Sec. 675(2).

Although the ‘trust is disregarded for income tax purposes (i.e., all income from the trust asset is reported by G directly on his individual return, and the gain on the sale, as well as the interest income/expense on the installment note, is completely disregarded), the transfer is respected for estate tax purposes (i.e., the asset is no longer in G’s estate); for such purposes, G owns an installment note.

Because G must report the asset’s income, he must pay the related income tax. Thus, while the asset’s future appreciation and any income received from it grow shielded from estate tax, G continues to pay the income tax on the earnings accruing to the beneficiaries. By paying an expense which is economically that of the beneficiaries, the IDGT in effect allows G to make additional gifts without paying gift tax or using his annual exclusion. As a result, an asset with annual taxable income (as well as potential future appreciation) is more suitable for an IDGT than, for example, raw land or a non-dividend-paying stock.

Rev. Rul. 2004-64

For any grantor trust established after Oct. 3, 2004, Rev. Rul. 2004-64 will nullify the technique described above by including the trust assets in the grantors estate under Sec. 2036(a)(1) if the trust’s governing instrument or local law requires the trust to reimburse the grantor for the income tax he or she paid on the trust income. If the trust’s governing instrument or local law provides only that the trustee has the discretion to reimburse the grantor for taxes paid, this will not cause the trust assets to be included in the grantor’s estate, unless it can be shown that there was a pre-existing arrangement between the grantor and the trustee for such reimbursement. Thus, mast documents should be drafted by legal counsel experienced with IDGTs and local mast law.


An IDGT can often be more advantageous than the commonly used grantor retained annuity trust (GRAT), because it does not require the grantor to live for a set period of time in order to remove the appreciating asset from the estate (as is required under a GRAT).  Additionally, the AFR interest paid under the installment note, which flows back into the grantor’s estate, is less than the 120%-of-AFR annuity payment which is required under the GRAT rules.

Sophisticated taxpayers, who wish to engage in an asset freeze, while transferring additional sums free of gift tax, should consider an IDGT.

Why We Need A Life Insurance Trust

The primary role of life insurance in estate planning is to provide cash at the death of the insured in order to provide for survivor lost income, to provide for a cash inheritance and to provide for the payment of expenses of the estate of the deceased insured, including the payment of taxes at death. The Irrevocable Life Insurance Trust (“ILIT”) is a legal entity which created inter vivos which allows the insured to set aside assets, usually insurance policies, which are potentially shielded from estate taxes while making the assets available to family members immediately after the death of the insured.  The benefit of having the ILIT is the payment of estate settlement expenses and inheritance estate tax free.  In exchange for this benefit, the insured must surrender control over the insurance and any other assets held in the trust.

    1. Irrevocability – The ILIT must be irrevocable when created. Retaining the right to exercise any control over the assets held in the trust will cause the trust property to be included in your estate and subject to estate tax.  Furthermore, the terms of the trust and the beneficiary designations must also be irrevocable.  This is an important distinction in contrast to the Revocable Living Trust where a grantor always has the right to terminate, change or revoke any or all provisions of the trust.
    1. Payments of Premium; Crummy Powers – The trustee, in order to make the required premium payment to the insurance company in order to keep the policy in force, will usually receive gifts from the insured or the insured’s spouse. The whole concept of the “gifts” to the trust is to qualify the payments for the gift tax annual exclusion.  Normally, a premium payment from the insured or the insured’s spouse is deemed to be a gift of a “future interest” because the trust beneficiaries do not possess a present right to receive benefits during the lifetime of the insured.  The gift tax annual exclusion is only permitted for “present interest” gifts.  However, if the beneficiaries are given “Crummy Powers”, that is, the right of a beneficiary to request the trustee to distribute premium payment gifts of a “present interest” to them currently, the premium gifts made to the trust are considered gifts of a present interest, qualify for the gift tax annual exclusion of $14,000 for each trust beneficiary or $28,000 per beneficiary with the consent of the insured and his or her spouse.
    1. Limiting Right of Withdrawal – Under Section 2514(e) of the Internal Revenue Code (“IRC”), the right of withdrawal for each beneficiary must be limited to the greater of $5,000 or 5% of the trust corpus. This limit is necessary so that the withdrawal beneficiaries will not be deemed to have made a gift to the other trust beneficiaries when the power of the withdrawal beneficiary lapses.  In the case of only one trust beneficiary, the limitation is not a concern since a failure to exercise the withdrawal power will not result in a transfer to anyone other than the beneficiary who failed to exercise the withdrawal right.  Accordingly, the sole beneficiary can be given a withdrawal right equal to $14,000.
    1. Trustees – A major objective of the trust is to avoid having the trust assets included in the estate of the Grantor or the Grantor’s spouse. Accordingly, the Grantor cannot act as the trustee since the Grantor would retain rights over the transferred property which would cause inclusion in the Grantor’s estate.  However, to ensure some limited control over administration of the trust assets, the Grantor’s spouse can be appointed as the trustee.  However, a trust must be drafted in order to having the Grantor’s spouse as the owner of the trust.  Consequently, the trust must restrict the spouse-trustee’s powers by eliminating any general power of appointment as defined under IRC Section 2041.  In doing so, the trust also eliminates the powers under IRC Section 678 that would cause income inclusion to the Grantor’s spouse.  Consequently, a Co-Trustee must be named to exercise discretionary powers not available to the Grantor’s spouse.  There is no limitation on how many trustees may be appointed.
    1. Administration of the Trust; Taxes; Fees – Once the trust is set up, the trustee can purchase additional life insurance for the insured without having the insurance subject to the 3-year transfer rule.  The trustee accounts to the beneficiaries, usually at quarterly internals, distributes income (and any principal) at least quarterly to the named beneficiary, usually the surviving spouse and prepares or causes to prepare Fiduciary Income Tax Returns on Form 1041 if the trust has taxable income in any year.  The trust has its own Employer Identification Number issued to it by the Internal Revenue Service.  The trustee has broad powers to administer the trust and has the ability to do whatever it takes to carry out its duties as a fiduciary.  A trustee has the right to statutory fees based on income and corpus.
    1. Spendthrift Provisions – The assets of the trust are usually insulated from attack by creditors. A “Spendthrift Clause” in the trust is incorporated to protect a beneficiary from his or her own acts or indiscretions.  This includes the sale or assignment of an interest in the trust to be established for his or her benefit.  The clause will usually  protect beneficiaries from creditors in the event of a business failure or an aggrieved spouse in a divorce proceeding.
    1. Execution of Trust – There are no set rules which govern the execution of an irrevocable trust agreement under state law. Accordingly, once the agreement is drafted and is ready for execution, an attorney may want, but is not required, to have it witnessed in the same formality as one would have a will executed.
    1. Post-Execution – The attorney must advise the client to execute change of ownership forms with the insurance company who has issued the policy if existing policies are to be transferred into the trust. An attorney must review with the client which policies are in force, how to set up the checking account for the trustee, the mechanics of paying the premium and providing advice on how to give notice to beneficiaries each year with respect to the “Crummy Powers.”  Merely setting up a trust for a client and not advising with respect to the mechanics of transferring existing policies or instructions on what the trustee should do in purchasing new insurance for the client could lead to a malpractice action against the attorney.