Wills, Trusts & Estates Prof Blog

Income Tax Symposium

A Matter of High Interest: How a Quiet Change to an Actuarial Assumption Turbocharges the Life Insurance Tax Shelter

Andrew Granato recently authored an article entitled, A Matter of High Interest: How a Quiet Change to an Actuarial Assumption Turbocharges the Life Insurance Tax Shelter , Draft of Connecticut Insurance Law Journal, Forthcoming (2022). Provided below is the abstract to the Article:

Draft: America’s lengthy income tax code and financial regulations are notoriously full of special treatment for the politically favored. Academics and policymakers argue the relative merits of different approaches to tax and regulatory policy – given the complexity of economic life, should the law attempt to be highly tailored and specific? Or does the exacting approach risk getting lost in the weeds? This Article will showcase the limits of a highly technical approach to policy with the first analysis of an almost completely unnoticed sea change in life insurance tax law, one that engorges a tax shelter at a moment of great attention to laws that enable the wealthiest members of society to face lower effective tax rates than their secretaries.

Life insurance has received extremely favorable federal tax treatment since the inception of the federal income tax. In the 1980s, in response to an increasing wave of policies smuggling traditional investment products into products calling themselves life insurance, Congress formalized a mathematical definition of life insurance policies directly into the Internal Revenue Code (§ 7702). § 7702, a fully realized actuarial simulation, placed quantifiable limits on the degree to which policyholders could treat a life insurance policy like an investment (such as a mutual fund) rather than as insurance protection.

For decades, the provision was left alone; however, buried in the 2020 COVID-19 omnibus relief bill, Congress included – with essentially no public debate– a change to a key actuarial assumption of the § 7702 test. The result, though heavily obscured by layers of mathematics, was that § 7702 was made substantially more permissive, giving policyholders much greater leeway to use life insurance policies as conduits for tax-exempt wealth accumulation, rather than mere protection of beneficiaries in the event of the worst. After over thirty years of near-total absence of analysis of Congress’ life insurance definition in the legal literature, this paper resurrects the history, purpose, and structural limitations of § 7702 and the hyper-technical approach to tax policy it embodies. It further provides the first exhaustive analysis of the new world of life insurance after the stealth § 7702 amendment, one in which swathes of the industry are preparing to – as the Democratic Party eyes loophole crackdowns on the wealthy – leverage their extraordinary tax advantage into a new role at the center of high-end tax avoidance.

ACTEC Shares Useful Resources

ACTEC 2022 Pocket Tax Tables  (helpful resource for professionals)

The ACTEC Pocket Tax Tables guide is a handy resource available for download as a pdf, online and mobile devices, and as a printed booklet. Content includes tables for Income Tax; Social Security; Estate and Gift Tax; Generation-Skipping Transfer Tax; Treasury Unisex Actuarial Table Examples; Inflation-Adjusted Numbers; Life Expectancy Tables; Qualified Plans, including SECURE Act details; Interest Rates; and Charitable Deduction.

ACTEC Trust and Estate Talk  (podcast series for professionals)

The Future of Digital Assets and the Dollar  Estate planning and family law attorneys share what to be aware of and some pitfalls when drafting premarital agreements and prenups.

Capital Letter No. 56: The Administration’s Fiscal Year 2023 Budget Proposals 

ACTEC Fellow Ronald D. Aucutt offers commentary regarding the Treasury Department's "General Explanations of the Administration's Fiscal Year 2023 Revenue Proposals" and how it provides a few new and a lot of previously presented ideas.

ACTEC Trust and Estate Talk  (podcast series for professionals)

California Tax Trap and Residency for Trusts - Words of caution for trust fiduciaries, beneficiaries and residents; CA has liberal definitions of who is considered a resident and subjected to tax on trusts.  

14 States That Won't Tax Your Pension

Some states have pension exclusion with limitations based on age and/or income. Most states tax "at least a portion of income from private sector defined benefit plans." However, there are 14 states that don't tax pension income at all, despite your age or how much money you have. 

Below is a list of the 14 states that don't tax pension income: 

• Alabama
• Alaska 
• Florida 
• Hawaii
• Illinois 
• Mississippi
• Nevada
• New Hampshire 
• Pennsylvania 
• South Dakota
• Tennessee
• Texas
• Washington 
• Wyoming 

See Rocky Mengle, 14 States That Won't Tax Your Pension, Kiplinger, April 6, 2022. 

Special thanks to David S. Luber (Florida Probate Attorney) for bringing this article to my attention.

Article: Dynasty 529 Plans and Structural Inequality

Victoria J. Haneman recently published an article entitled, Dynasty 529 Plans and Structural Inequality, Wills, Trusts, & Estates Law ejournal (2022). Provided below is the abstract to the Article:

The tax advantages available through 529 accounts, such as the potential for perpetual tax-free growth, have been maximized by the wealth defense industry that operates to the advantage of high income and wealth families in the United States. This essay is more a thought piece than a polemic, with the goal of starting a conversation on an important issue not often discussed: a 2018 change to the 529 structure slipped into the Tax Cuts and Jobs Act (TCJA) has essentially turned 529 plans into a government-subsidized school voucher scheme for the wealthy. Through this change, the dynasty education trust has become an even more attractive umbrella under which multiple 529 accounts may be managed by an affluent family to pay not just for college but also all private school (K-12) on a tax-sheltered basis.

 

Oscar nominees will receive gift bags worth nearly $140,000—but they could come with a hefty tax bill

The 94th Academy Awards this Sunday will host a slew of Hollywood A-listers hoping to walk out with an Oscar Statuette. 25 of the nominees will also receive a gift bag worth over $137,000. 

The gift bag is given to the five nominees in each of the four acting categories and nominees for "Best Director." The gift bag includes a collection of expensive items, including gold-infused olive oil and even up to $10,000 worth of plastic surgery. 

Unfortunately, if the gift bag is accepted by the nominees, they will also be accepting a "hefty tax burden." The tax must be applied because the gift bags are not technically "gifts" that were given "solely out of affection, respect or similar impulses for the recipients. . ." 

According to Eric Bronnenkant, head of Tax at Betterment, it comes down to intent. With the gift bag, the intent of providing these gift bags is to influence behavior and get celebrities to use a certain product or go on a specific vacation. 

Thus, the value of the gifts is calculated as income on the recipients' taxes. 

See Nicolas Vega, Oscar nominees will receive gift bags worth nearly $140,000—but they could come with a hefty tax bill, CNBC, March 27, 2022. 

Special thanks to David S. Luber (Florida Probate Attorney) for bringing this article to my attention.

Trusts as Eligible Shareholders of an S Corporation

It is a common estate planning practice for small business owners to transfer ownership of their business interests into their revocable living trusts. These transfers can be made during the business owner's lifetime or with a "transfer on death" (TOD) designation. 

This estate planning technique has many benefits, a major one being the avoidance of probate of the business interest at death, but only if the terms of the trust provide the necessary protections, AKA ensuring the trust is an eligible shareholder of an S corporation. 

The are certain factors to consider in these instances. So long as the business owner is living, "his or her revocable trust is treated as a 'grantor trust' for income tax purposes, and as such, is an eligible S corporation shareholder." Upon the death of the business owner, the trust will remain an eligible shareholder for a period of two years. After the two year period, the trust will be required to distribute stock outright to an eligible shareholder, unless the stock is to remain in the trust, in which case the trust must qualify as a qualified subchapter S trust (QSST) or an electing small business trust (ESBT). 

In order for the trust to qualify as a QSST, the trust "must require that all of the net income be distributed to a single beneficiary." To qualify as an ESBT, "the Trustee may have discretion to accumulate income, and there may be multiple beneficiaries."

For more information on the tax benefits of QSST and ESBT trusts: 

See Rebecca C. Bowen, Trusts as Eligible Shareholders of an S Corporation, Thompson McMullan P.C.: Commentary, March 17, 2022. 

Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.

Planning: 2022 Planning Guide

Below is information about a 2022 planning guide put together by the Advanced Planning Group. 

Indeed, the bulk of 2021 was spent under the specter of seemingly inevitable changes: in May of 2021, the Administration released its wish list of tax proposals, then the House released a draft bill in September that proposed serious changes—some even retroactive—to income tax, capital gains, and corporate tax rates, as well as wide-ranging changes to the estate and gift tax regime, retirement planning, and international corporate taxation. Yet, despite the House passing legislation in November to make significant tax changes, we are now into 2022 without any changes to the tax landscape passed into law, other than some moderate inflation adjustments. This doesn’t mean that tax changes are not still possible sometime this year.

 

The purpose of this guide is to summarize some key aspects of tax laws affecting ultra-high net worth (UHNW) individuals and families and is organized into three sections:

 

– Income tax planning

– Retirement planning, and

– Estate planning.

 

The first of these sections deals primarily with income tax planning and lists updated figures for applicable rates and brackets, as well as a discussion of key concepts in income tax planning. The second section discusses retirement planning, including an outline of the tax rules for IRAs, Roth IRAs, and required minimum distribution rules, before concluding with a discussion of Social Security and Medicare benefits.

 

Finally, the section on estate planning outlines key concepts and changes to the gift and estate taxes in 2022.

See Planning: 2022 Planning Guide, UBS (2022). 

Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.

He Got $300,000 From Credit-Card Rewards. The IRS Said It Was Taxable Income.

The IRS went after Konstantin Anikeev, an experimental physicist, after he exploited the difference between unlimited 5% rewards and lower fees on gift cards and money orders, a concept Anikeev learned about from personal-finance websites. 

Anikeev used American Express cards, the government's view that credit-card rewards aren't income, and his own willingness to spend time buying gift cards and money orders. Anikeev stated, "If one has a theory, one can test it experimentally. Some are easier to test. . .[o]thers require a Large Hadron Collider or something like that. But this one was a bit more accessible." 

Mr. Anikeev's $6.4 million in credit-card charges led to an Internal Revenue Service audit "and a finding that he and his wife had more than $310,000 in income that should have been taxed." 

Judge Joseph Goeke affirmed the IRS practice, which says that credit-card rewards are usually nontaxable income. For example, buying a sweater for $100 and getting a 5% reward is really a $95 purchase, as opposed to $5 of income. However, the judge did offer the IRS avenues for tougher enforcement. 

Anikeev took the government to court and received a split ruling from Judge Goeke, who ruled that rewards earned on purchases of Visa gift cards aren't taxable because the cards are products. Anikeev even brought a tub of gift cards to court as a demonstration, and according to his lawyer, Jeffrey Sklarz, "[The government] sort of picked a fight with the wrong person. . .They should have picked someone who was a hot mess."

See Richard Rubin, He Got $300,000 From Credit-Card Rewards. The IRS Said It Was Taxable Income., Wall Street Journal, March 7, 2021. 

Special thanks to David S. Luber (Florida Probate Attorney) for bringing this article to my attention.

CLE: Estate Planning With Specialty Assets: Carried Interest, SPACS, and QOZ Funds

On Thursday, January 20, 2022 at from 12:00–1:30 PM Eastern, The American Law Institute (ALI) and The American College of Trust and Estate Counsel (ACTEC) are cosponsoring a CLE entitled, Estate Planning With Specialty Assets: Carried Interest, SPACS, and QOZ Funds. 

Below is more information on the CLE: 

Why You Should Attend

Wealth transfer structures can be complicated and have many moving parts. In recent years, new investment opportunities have emerged with the promise and potential for explosive growth and significant tax benefits. Such specialty assets, including interests in special purpose acquisition companies (SPACs), qualified opportunity zone (QOZ) funds, and private investment funds, are increasingly on clients’ radars as good vehicles for wealth transfer. While these assets can provide unique opportunities for leverage, they also come with nuanced pitfalls and risks within the realms of estate, gift, and income taxation. Join us for this 90 minute webcast to learn how seemingly small variations in different structures can result in quite different solutions. Gain a better understanding of the facts and circumstances of the various options and learn ways to create customized plan structures for each of your clients. 

What You Will Learn

The faculty, all Fellows of The American College of Trust and Estate Counsel and highly-experienced estate and tax planning practitioners, will take a deep dive into the lightly chartered waters of estate planning with specialty assets. They will particularly focus on: 

Carried interests in private investment funds

Various categories of interests in SPACs

Interests in QOZ funds

Preferred partnership structures

 Questions submitted during the program will be answered live by the faculty. All registrants will receive a set of downloadable course materials to accompany the program. 

Who Should Attend

Estate planners and other related professionals, particularly those with wealthy clients, will benefit from this CLE on estate planning with specialty assets offered by ALI CLE and ACTEC. 

Register two or more and SAVE! Register as a group for this program and save up to 35% (click here for more details). Click "Register as a Group" to register at these savings. (Offer valid on new registrations in the same delivery format only; discounts may not be combined.)