The voluminous discussions during the conferences at the 46th Annual Heckerling Institute on Estate Planning held in January 2012 in Orlando, Fla. are a lot to digest. To make it easier, we’ve summarized in a series of articles some of the ideas culled from the many programs and organized them topically. Part II of this series focuses on loan planning, individual retirement accounts and retirement plans, will drafting and portability.

Loan Planning

1. Loan interest. The minimum interest rate for a nine year loan is presently a mere 1.17 percent, so intra-family loans can be attractive. Too often, clients don’t contact counsel to prepare notes, or the client prepares a loan using a a form off the Internet. If the loan is secured by a child/borrower’s home, the child may qualify for a home mortgage interest deduction. The parent/lender would still have interest income to report regardless of whether the child/borrower qualified for a deduction. Clients too often focus on estate transfers and neglect the potential income tax consequences. Practitioners should endeavor to safeguard mortgage interest deductions for the child when feasible. Encourage clients to have counsel prepare a proper loan, secure it with a mortgage and record it. The recording might be especially useful if there’s a claimant pursuing the child/borrower or a divorce.
2. Loans to a grantor trust in the current interest environment. The February 2012 mid-term applicable federal rate (AFR) is a historically low 1.12 percent. Loans to the trust for nine years may be paid, on an interest-only basis, back to the grantor. Any earnings by the trust in excess of the low AFR for the nine-year period remain in the trust for the benefit of lower generations, transfer tax-free. This should be a trust that creditors of the children and grandchildren generally won’t have access to. Also, the grantor can pay the income tax on trust earnings. Also, similar to a note used in connection with a sale transaction, the interest income earned by the grantor with respect to the note shouldn’t be taxed to the grantor.
3. Refinance prior family loans. As interest rates started to decline years ago, many wealthy families used intra-family loans as a wealth strategy. However, as rates have continued to decline to their current rates, many clients that have previously engaged in family loans with interest rates much higher than those currently in effect may benefit by refinancing. A refinance of a loan to current interest rates will reduce the required repayment to the parent and thereby decrease her assets and save estate taxes. An argument that the reduction is a gift should fail, especially if the trust could obtain independent financing at lower rates and repay the parent. To be safe, some changes in the loan terms could be negotiated in exchange for the lower rate, for example, shorten the remaining term of the loan, thereby providing the consideration for the lower interest rate.

IRAs and Retirement Plans
1. Surviving spouse and IRA. A surviving spouse can rollover a deceased spouse’s IRA (and rely on portability to preserve the exclusion of the deceased spouse). While rollovers are a preferable choice for most estates, there are times when the spousal rollover isn’t advisable. One such situation is when the surviving spouse is young, say age 49, and she’ll need access to some of the assets in the IRA to fund living expenses. If she withdraws money from a rollover IRA, she’ll face not only income tax, but also a penalty for early withdrawal. So, when a surviving spouse plans to roll over her deceased spouse's IRA and she’s under age 59 ½, it may be prudent to leave enough money in the deceased spouse’s IRA account to cover the withdrawals the surviving spouse will need until she reaches age 59 ½ to avoid penalties. So a partial rollover may be wiser than a complete rollover.
2. IRA realities. Stretch IRAs are a goal of many plans and lots of planning is done to accomplish this tax wonder. But does it work? An AXA study concluded that 87 percent of children liquidate an inherited IRA within one year of death. All the great planning to stretch an IRA is really pretty much for naught in many cases. When interpreting this statistic, note that it doesn’t identify liquidation based on size of the IRA. Many smaller IRAs may not warrant the stretch or a trust. Regardless, one key take-home message of the statistic is that far more clients should seriously consider using trusts as beneficiaries of IRAs to protect heirs from themselves. Proper planning may also involve telling the children about these “stretch” rules so they have to defer the tax. Be careful, Congress may try to limit the use of stretch IRAs.
3. Not all Roth plans permit recharacterization. There has been much media attention on the right to recharacterize the conversion of a regular IRA to a Roth IRA if the plan assets decline in value. The assumption that all Roth accounts can be recharacterized is incorrect, and clients may err in their planning because of this misconception. If a client consummates an in-plan rollover of her 401(k) into a Roth account in that plan, it could be a significant tax benefit. Similar to a conversion of a traditional IRA into a Roth, the client will have to pay income tax on the value of the plan in excess of her income tax basis. But with an in-plan rollover, the client can’t change her mind like she can with a conversion of a regular IRA to a Roth. She can’t recharacterize an in-plan Roth rollover if the plan assets decline in value.
4. IRAs can retire the estate tax. There are several clever applications of IRA planning to minimize or avoid estate tax. A client can convert her IRA to a Roth IRA on her deathbed. The income tax liability should reduce the estate tax or even eliminate it. Example: Grandma has $4.1million cash and a $1 million IRA. Grandma transfers $300,000 into a Roth IRA leaving $700,000 in her taxable IRA. Because of the $300,000 Roth conversion, she has a $300,000 taxable income. If she lives, she can recharacterize it. If she dies, her executor can pay the income tax triggered from this partial conversion. Grandma’s heirs will inherit her $5 million estate. What if the stock market increased while Grandma was in the hospital? That could trigger more estate tax. Grandma could have simply listed a charity as a contingent beneficiary of her IRA. After her death, her heirs could disclaim the amount to charity that would be necessary to eliminate any estate tax. Both the disclaimer and the right to recharacterize the Roth conversion can provide considerable planning flexibility. Clients can further enhance the flexibility by naming a donor-advised fund instead of a specific charity as beneficiary.
5. The $5.12 million dollar gift exemption. As 2012 moves on toward 2013 with no likely action by Congress, some clients will want to use all or part of their $5.12 million gift tax exemption. The fun starts once the decision to gift is made. First, remember to advise the client not to gift unless she’s certain that she’ll have enough resources for herself. The first step prior to any major gift plan should be a budget and financial plan so that the client can quantify her needs. Next, consider which assets should be gifted—high basis assets are best. Remember the emotional issues of giving up control. If you live in a “decoupled” estate tax state, factor in the state estate tax savings.

Will Drafting
1. Disclaimer planning and special needs issues. If a client or a loved one is diagnosed with Alzheimer’s disease, she should plan and act quickly. Too often, people are in denial. If they don’t address elder care issues quickly, opportunities may be lost. The client, even with a diagnosis of Alzheimer’s disease, may still have testamentary capacity. If the client has sufficient capacity (competence), she should sign a medical proxy, will and power of attorney. The client’s spouse should set up a special needs trust for the client’s benefit in case the spouse predeceases. Don't rely on portability. Many people assume the spouse with Alzheimer’s will die first and if not, she can disclaim assets bequeathed from the other spouse. Neither assumption may prove correct. In New York, a disclaimer isn’t treated as a fraudulent transfer by the disclaiming beneficiary, except in the context of Medicaid. So if the wife, for example, is diagnosed with Alzheimer’s disease, but the husband dies first, the wife (or her agent) could disclaim the assets bequeathed to her under husband’s will. But in New York and certain other states, this disclaimer won’t protect the assets from Medicaid. This is the minority rule, so it might work elsewhere.
2. Beneficiary flexible trusts. When a client wants to leave assets to her child, consider the “beneficiary flexible trust.” With some trusts, the terms can be very flexible for the beneficiary but still provide tax, creditor and marital protections.

Portability
1. Portability/qualified terminable interest property (QTIP). A commonly talked about downside to portability is that it isn’t effective for generation-skipping transfer (GST) tax purposes. But there may be a solution. Portability may be more attractive when the marital deduction, instead of outright to the surviving spouse, can be a QTIP marital trust. Either approach will avoid tax on the first spouse’s death. But with a QTIP, the executor can make a reverse GST election to take advantage of the GST tax exemption of the first-to-die spouse (since portability won’t apply for GST tax purposes). This approach to the marital deduction can mitigate some of the negative implications of portability.
2. Portability benefits and concerns. If a client dies and didn’t plan properly (title to assets, appropriate trust under her will), then the surviving spouse would have lost out on the estate tax exclusion. But under the 2010 portability rules (which only apply to 2011 and 2012 deaths unless Congress extends the law or makes portability permanent), the surviving spouse might be able to benefit anyway since the first to die spouse’s exclusion may be available to her through portability. Most tax attorneys downplay portability because appreciation in assets after the death of the first spouse isn’t removed from the surviving spouse’s estate. In contrast, appreciation would be removed if the first spouse’s estate instead transferred assets to a bypass trust to benefit of the survivor. Assets in a bypass trust can appreciate, yet the assets remain outside of the surviving spouse’s estate. But if a significant portion of the assets are in IRAs and those fund the bypass trust, the mandatory distributions the surviving spouse will have to take out if the trust is structured as a conduit bypass trust will diminish the trust assets significantly over time. Substantial dollars may flow out of the bypass trust to the surviving spouse’s estate. In this context, portability doesn’t have the negative consequences that many practitioners fear. Generalizations on the disadvantages of portability planning are dangerous. Practitioners need to consider the specific assets, the realistic likelihood of appreciation, spending patterns and more.
3. DSUEA. The new portability acronym “deceased spouse unused exclusion amount” is the amount a client can get to use her deceased spouse’s exclusion. The portability rules include the concept of privity. Suppose John and Jane are married and John dies. Jane can use his exclusion, but if Jane gets remarried to Frank, Frank can “inherit” Jane’s exclusion but not the exclusion John “gave” to Jane. This is privity. However, there may be a means of circumventing this limitation. Jane can use Frank’s exclusion if she makes lifetime gifts. If Jane gets remarried to Frank, can Frank join Jane in gift splitting? Gift splitting might arguably enable one spouse to make a large gift and have the other non-donor spouse treat the gift as if were half hers. Can Frank make a gift and have Jane gift split thereby using some of John’s exclusion to cover a gift by Frank? While the law isn’t clear, this may be a possibility.