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Society of Trust and Estate Practitioners September 9, 2014 Presented by Karl J. Feitelberg and Gary R. Lee Sterling Resources, LTD Solving the UNI Quagmire
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Society of Trust and Estate Practitioners September 9, 2014
Presented by
Karl J. Feitelberg and Gary R. Lee
Sterling Resources, LTD
Solving the UNI Quagmire
1. A Non-grantor Foreign Trust with a U.S. Beneficiary
accumulates income over time (UNI)
Non-Grantor Foreign Trust
2. In later years, the Trust makes a distribution to the U.S. Beneficiary in excess of current year
Distributable Net Income (DNI)
Solving the UNI Quagmire (Undistributed Net Income)
3. The U.S. taxes the distribution under the ‘Throwback Rules’ which are intended to impose the tax that would have been paid if the Trust had made distributions in the years the
income was earned…plus interest…capping the amount at 100% of the distribution
9/1/2014 SRL© 2014
1
Definitions
Foreign Trust – Court and Control Test U.S. court exercises primary supervision over trust administration U.S. persons control all substantial trust decisions Non-Grantor Foreign Trust Grantor retains right to revoke the trust, or Only permissible lifetime distributions are to the Grantor/Grantor’s spouse Distributable Net Income (DNI) In general, taxable income (includes capital gains for foreign trusts) Maximum amount deductible for distributions to Beneficiary Undistributed Net Income (UNI) Income retained by the trust from a year in which all current DNI was not distributed Accumulation Distribution When the trust has a UNI balance and distributions for the year exceed current DNI/accounting income
U.S. Trust
Grantor
Trust
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2
UNI
A/D
DNI
UNI
Distribution to Beneficiary retains its tax character
Accumulation Distribution to the Beneficiary UNI is taxed as ordinary income with
interest charges
Year X Distribute less than current year
DNI to Beneficiary
Year Y Distribute more than current
year DNI to Beneficiary when there is UNI in the Trust
DNI
Excess DNI not distributed is retained by the Trust as UNI
Distribution to Beneficiary retains its tax character
The UNI “Cycle”
9/1/2014 SRL© 2014
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Income/Estate Tax
Current Year Income
Original Gift to Trust
UNI
Ordinary Income/ Capital Gains
Non-Taxable
Ordinary Income plus
Interest Charge
Income Tax Upon Distribution
Inclusion in Taxable Estate
Depends on Terms of Trust
Assumed Taxable If Distributed
To Beneficiary and Retained Until Death
Foreign Non-Grantor Trust
9/1/2014 SRL© 2014
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The Case
Scenario An Italian grandfather established an offshore trust for the benefit of his heirs The grandfather died in 1991 at which time the trust became a Non-Grantor Foreign Trust The current beneficiary of the trust is the grandfather’s granddaughter The granddaughter moved to the U.S. prior to 1991 She is now 50 years old and is reviewing her distribution options The Trust The Trust had a balance of $10,000,000 in 1991 at the time of the grandfather’s death Currently, the Trust has a balance of approximately $30,000,000
9/1/2014 SRL© 2014
5
UNI Options
Alternative Planning Options Continue to Accumulate Current Income Distribute All Assets/Terminate the Foreign Trust Decant the Trust to a U.S. Trust * Domesticate the Foreign Trust to a U.S. Trust Distribute Current Income Annually to a U.S. Beneficiary/U.S. Trust Default Method for distributions to a U.S. Beneficiary/U.S. Trust
* Treated as a distribution for UNI purposes
ACCUMULATE UNI
DISTRIBUTE UNI
“FREEZE” UNI
9/1/2014 SRL© 2014
6
Current Income Retained by Trust
UNI Increases over time
Accumulation Distribution Taxes/interest could equal 100%
of the distribution
Estate Tax May not apply
Net to Heirs Reduced over time
Accumulate UNI
Continue to Accumulate UNI
Taxes and Interest Due Upon Ultimate
Distribution
Taxes and Interest Capped at 100% of
the Distribution
Accumulation Distribution
Accumulation Distribution
9/1/2014 SRL© 2014
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NON-UNI INVESTMENT ACCOUNT Balance BOY Earnings Taxes Net Investment Account Earnings CURRENT DISTRIBUTION FROM TRUST Income Taxes Net Current Distribution ACCUMULATION DISTRIBUTION Accumulation Distribution Tax on Accumulation Distribution Interest on Accumulation Distribution Net Accumulation Distribution CAPITAL DISTRIBUTION TOTAL AVAILABLE FUNDS ESTATE TAX Assets Included in Taxable Estate Estate Tax Rate Estate Tax Due NET TO HEIRS
2050 0 0 0 0 8,300,000 3,500,000 4,800,000 157,800,000 68,500,000 89,300,000 0 10,000,000 14,800,000 - 40% - 14,800,000
2015 0 0 0 0 0 0 0 0 0 0 0 0 0 - 40% - 0
Accumulate UNI
*
*
Assumes distribution outside taxable estate
*
9/1/2014 SRL© 2014
8
Current Income Remaining assets reinvested by
U.S. Beneficiary/U.S. Trust
Accumulation Distribution UNI taxed with interest upon
distribution
Estate Tax Assets held in Beneficiary
account subject to estate tax
Net to Heirs Reduced, but larger than
“Accumulate” option
Distribute UNI
If held by Beneficiary at death, account balance included in taxable estate further reducing net to heirs
Investment account growth is reduced
Tax and Interest on UNI paid immediately reduces
investment account
Accumulation Distribution
9/1/2014 SRL© 2014
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NON-UNI INVESTMENT ACCOUNT Balance BOY Earnings Taxes Net Investment Account Earnings CURRENT DISTRIBUTION FROM TRUST Income Taxes Net Current Distribution ACCUMULATION DISTRIBUTION Accumulation Distribution Tax on Accumulation Distribution Interest on Accumulation Distribution Net Accumulation Distribution CAPITAL DISTRIBUTION TOTAL AVAILABLE FUNDS ESTATE TAX Assets Included in Taxable Estate Estate Tax Rate Estate Tax Due NET TO HEIRS
2050 53,700,000 2,600.000 1,000,000 55,300,000 0 0 0 0 0 0 0 0 55,300,000 55,300,000 40% 22,100,000 33,200,000
2015 0 0 0 0 1,500,000 600,000 900,000 20,900,000 7,900,000 4,700,000 8,300,000 10,000,000 19,200,000 - 40% - 0
Distribute UNI
9/1/2014 SRL© 2014
10
Current Income Current income taxed;
reinvested outside UNI umbrella
UNI Tax is “Frozen” since current
income is distributed annually
Accumulation Distribution Taxed with interest when
ultimately distributed
Estate Tax Assets held in Beneficiary
account subject to estate tax
Net to Heirs Enhanced over other options
“Freeze” UNI
Net after-tax income accumulated outside of the
UNI environment
Accumulation Distribution
“Frozen”
Tax and Interest on UNI Could reach 100% of the
“Frozen” UNI amount
Accumulation Distribution
Accumulation Distribution
9/1/2014 SRL© 2014
11
INVESTMENT ACCOUNT Balance BOY Earnings Taxes Net Investment Account Earnings CURRENT DISTRIBUTION FROM TRUST Income Taxes Net Current Distribution ACCUMULATION DISTRIBUTION Accumulation Distribution Tax on Accumulation Distribution Interest on Accumulation Distribution Net Accumulation Distribution CAPITAL DISTRIBUTION TOTAL AVAILABLE FUNDS ESTATE TAX Assets Included in Taxable Estate Estate Tax Rate Estate Tax Due NET TO HEIRS
“Freeze” UNI
2015 0 0 0 0 1,500,000 600,000 900,000 0 0 0 0 0 900,000 - 40% - 0
2050 57,000,000 2,900,000 1,100,000 58,800,000 1,500,000 600,000 900,000 20,900,000 9,100,000 11,800,000 0 10,000,000 69,700,000 59,700,000 40% 23,900,000 45,800,000
* Assumes distribution outside taxable estate
9/1/2014 SRL© 2014
12
Prior Year 1
$ Distribution
Prior Year 2
$ Distribution
Prior Year 3
$ Distribution
Sum of Prior 3 Years Distributions Times 1.25
Divided by 3
Average Distribution Increased by 25%
Treated as a Distribution of Current Income
without UNI Charges
|
Balance of Distribution Taxed as an Accumulation Distribution
The Default Method – A Hybrid “Freeze” Approach
The “Cost” of the Election All income taxed at ordinary rates Once elected, can not be changed
9/1/2014 SRL© 2014
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Summary – Highlighted Concerns
Current Income Retained by Trust
UNI Increases over time
Accumulation Distribution Taxes/interest could equal 100%
of the distribution
Estate Tax May not apply
Net to Heirs Reduced over time
Current Income Remaining assets reinvested by
U.S. Beneficiary/U.S. Trust
Accumulation Distribution UNI taxed with interest upon
distribution
Estate Tax Assets held in Beneficiary
account subject to estate tax
Net to Heirs Reduced, but larger than
“Accumulate” option
Current Income Current income taxed;
reinvested outside UNI umbrella
UNI Tax is “Frozen” since income is
distributed annually
Accumulation Distribution Taxed with interest when
ultimately distributed
Estate Tax Assets held in Beneficiary
account subject to estate tax
Net to Heirs Enhanced over other options
Accumulate UNI Distribute UNI “Freeze” UNI
9/1/2014 SRL© 2014
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The Spreadsheet Analysis
Approached by an attorney with a UNI issue who wondered if life insurance might offer a solution given the tax-free build up of cash value and income tax-free receipt of death benefit… …however, life insurance proceeds received inside a foreign trust do not escape UNI treatment for subsequent trust distributions We took a different approach, accepting the UNI toll charge and using life insurance to recreate the trust corpus in a more tax advantageous environment, making this the generation to “solve the problem” The goal of the analysis was to compare UNI distribution alternatives to see which was stronger in terms of maximizing the net amount passed to heirs under three scenarios No Life Insurance $30,000,000 Life Insurance on the Beneficiary’s life (current Trust balance) $99,000,000 Life Insurance on the Beneficiary’s life (premium based on Trust net cash flow)
9/1/2014 SRL© 2014
15
-
20,000,000
40,000,000
60,000,000
80,000,000
100,000,000
120,000,000
140,000,000
160,000,000
180,000,000
200,000,000
220,000,000
Net to Heirs - Death at Age 85 1991 Trust for a Beneficiary Insurance Age 50
No Insurance
30.9m Insurance
99.0m Insurance *
9/1/2014 SRL© 2014
16
Accumulate Distribute Decant Domesticate Income to Bene Income to Trust Default to Bene Default to Trust MEC
No Insurance 14,800,000 33,200,000 53,500,000 69,700,000 45,800,000 69,700,000 38,000,000 63,400,000 -
DB - Trust Bal
DB - Net Income
-
20,000,000
40,000,000
60,000,000
80,000,000
100,000,000
120,000,000
140,000,000
160,000,000
180,000,000
200,000,000
220,000,000
Net to Heirs - Death at Age 85 1991 Trust for a Beneficiary Insurance Age 50
No Insurance
30.9m Insurance
99.0m Insurance *
9/1/2014 SRL© 2014
17
Accumulate Distribute Decant Domesticate Income to Bene Income to Trust Default to Bene Default to Trust MEC
No Insurance 14,800,000 33,200,000 53,500,000 69,700,000 45,800,000 69,700,000 38,000,000 63,400,000 -
DB - Trust Bal
DB - Net Income
Accumulate Distribute ‘Freeze’
-
20,000,000
40,000,000
60,000,000
80,000,000
100,000,000
120,000,000
140,000,000
160,000,000
180,000,000
200,000,000
220,000,000
Net to Heirs - Death at Age 85 1991 Trust for a Beneficiary Insurance Age 50
No Insurance
30.9m Insurance
99.0m Insurance *
9/1/2014 SRL© 2014
18
Taxable in the Estate
Not subject to Estate Tax
Taxable in the Estate
Not subject to Estate Tax
Taxable in the Estate
Not subject to Estate Tax
Accumulate Distribute Decant Domesticate Income to Bene Income to Trust Default to Bene Default to Trust MEC
No Insurance 14,800,000 33,200,000 53,500,000 69,700,000 45,800,000 69,700,000 38,000,000 63,400,000 -
DB - Trust Bal
DB - Net Income
Accumulate Distribute ‘Freeze’
-
20,000,000
40,000,000
60,000,000
80,000,000
100,000,000
120,000,000
140,000,000
160,000,000
180,000,000
200,000,000
220,000,000
Net to Heirs - Death at Age 85 1991 Trust for a Beneficiary Insurance Age 50
No Insurance
30.9m Insurance
99.0m Insurance *
9/1/2014 SRL© 2014
19
Income to Trust Domesticate Default
to Trust
Accumulate Distribute Decant Domesticate Income to Bene Income to Trust Default to Bene Default to Trust MEC
No Insurance 14,800,000 33,200,000 53,500,000 69,700,000 45,800,000 69,700,000 38,000,000 63,400,000 -
DB - Trust Bal
DB - Net Income
Accumulate Distribute ‘Freeze’
-
20,000,000
40,000,000
60,000,000
80,000,000
100,000,000
120,000,000
140,000,000
160,000,000
180,000,000
200,000,000
220,000,000
Net to Heirs - Death at Age 85 1991 Trust for a Beneficiary Insurance Age 50
No Insurance
30.9m Insurance
99.0m Insurance *
Income to Trust Domesticate Default
to Trust
Accumulate Distribute Decant Domesticate Income to Bene Income to Trust Default to Bene Default to Trust MEC
No Insurance 14,800,000 33,200,000 53,500,000 69,700,000 45,800,000 69,700,000 38,000,000 63,400,000 -
DB - Trust Bal 37,800,000 52,900,000 71,100,000 87,300,000 65,600,000 87,300,000 57,700,000 81,000,000
DB - Net Income
9/1/2014 SRL© 2014
20 Accumulate Distribute ‘Freeze’
-
20,000,000
40,000,000
60,000,000
80,000,000
100,000,000
120,000,000
140,000,000
160,000,000
180,000,000
200,000,000
220,000,000
Net to Heirs - Death at Age 85 1991 Trust for a Beneficiary Insurance Age 50
No Insurance
30.9m Insurance
99.0m Insurance *
Income to Trust Domesticate Default to
Trust
MEC
Accumulate Distribute Decant Domesticate Income to Bene Income to Trust Default to Bene Default to Trust MEC
No Insurance 14,800,000 33,200,000 53,500,000 69,700,000 45,800,000 69,700,000 38,000,000 63,400,000 -
DB - Trust Bal 37,800,000 52,900,000 71,100,000 87,300,000 65,600,000 87,300,000 57,700,000 81,000,000
DB - Net Income 88,400,000 84,500,000 109,800,000 126,100,000 109,000,000 126,100,000 96,500,000 119,700,000 202,400,000
9/1/2014 SRL© 2014
21 Accumulate Distribute ‘Freeze’
* (202m net)
Premature Death Lack of investment time
Fewer premium payments Impact of UNI rules Consistent pattern
Base Case Death at Age 85
-
20,000,000
40,000,000
60,000,000
80,000,000
100,000,000
120,000,000
140,000,000
160,000,000
180,000,000
200,000,000
220,000,000
Accumulate Distribute Decant Domesticate Inc to Bene Inc to Trust Default to Bene Default to Trust MEC
Net to Heirs - Death at Age 85 1991 Trust for a Beneficiary Insurance Age 50
No Insurance
30.9m Insurance
99.0m Insurance
-
20,000,000
40,000,000
60,000,000
80,000,000
100,000,000
120,000,000
140,000,000
160,000,000
180,000,000
200,000,000
220,000,000
Accumulate Distribute Decant Domesticate Inc to Bene Inc to Trust Default to Bene Default to Trust MEC
Net to Heirs - Death at Age 70 1991 Trust for a Beneficiary Insurance Age 50
No Insurance
30.9m Insurance
99.0m Insurance *
9/1/2014 SRL© 2014
22
Longevity The gaps close
Additional investment time Additional premiums
Consistent pattern
Base Case Death at Age 85
-
20,000,000
40,000,000
60,000,000
80,000,000
100,000,000
120,000,000
140,000,000
160,000,000
180,000,000
200,000,000
220,000,000
Accumulate Distribute Decant Domesticate Inc to Bene Inc to Trust Default to Bene Default to Trust MEC
Net to Heirs - Death at Age 85 1991 Trust for a Beneficiary Insurance Age 50
No Insurance
30.9m Insurance
99.0m Insurance
-
20,000,000
40,000,000
60,000,000
80,000,000
100,000,000
120,000,000
140,000,000
160,000,000
180,000,000
200,000,000
220,000,000
Accumulate Distribute Decant Domesticate Inc to Bene Inc to Trust Default to Bene Default to Trust MEC
Net to Heirs - Death at Age 100 1991 Trust for a Beneficiary Insurance Age 50
No Insurance
30.9m Insurance
99.0m Insurance *
9/1/2014 SRL© 2014
23
Base Case $250,000 Annual
Distribution to Beneficiary
Base Case Maximize
Distribution to Heirs
-
20,000,000
40,000,000
60,000,000
80,000,000
100,000,000
120,000,000
140,000,000
160,000,000
180,000,000
200,000,000
220,000,000
Accumulate Distribute Decant Domesticate Inc to Bene Inc to Trust Default to Bene Default to Trust MEC
Net to Heirs - Death at Age 85 1991 Trust for a Beneficiary Insurance Age 50
No Insurance
30.9m Insurance
99.0m Insurance
(40,000,000)
(20,000,000)
-
20,000,000
40,000,000
60,000,000
80,000,000
100,000,000
120,000,000
140,000,000
160,000,000
180,000,000
200,000,000
220,000,000
Accumulate Distribute Decant Domesticate Inc to Bene Inc to Trust Default to Bene Default to Trust MEC
Net to Heirs - Death at Age 85 1991 Trust for a Beneficiary Insurance Age 50
No Insurance
30.9m Insurance
99.0m Insurance *
9/1/2014 SRL© 2014
24
“The” Solution to the UNI Quagmire…
Alternative Approaches Monitor Income Distributions Manage trust accounting income through use of a trust owned LLC Alternate between Foreign and U.S. Beneficiary distributions Distribute Capital Gain Property at Basis Subsequent taxation upon sale by Beneficiary Continue Trust in Place with Distributions of Income “Forever” Rule Against Perpetuities may force an ultimate distribution No early access to corpus for business/investment reasons Use Life Insurance to Replicate the Trust Corpus in a More Advantageous Tax Environment To maximize net to heirs To include an annual distribution to the current beneficiary
9/1/2014 SRL© 2014
25
-
20,000,000
40,000,000
60,000,000
80,000,000
100,000,000
120,000,000
140,000,000
160,000,000
180,000,000
200,000,000
220,000,000
Net to Heirs - Death at Age 85 1991 Trust for a Beneficiary Insurance Age 50
No Insurance
30.9m Insurance
99.0m Insurance *
Accumulate Distribute Decant Domesticate Income to Bene Income to Trust Default to Bene Default to Trust MEC
No Insurance 14,800,000 33,200,000 53,500,000 69,700,000 45,800,000 69,700,000 38,000,000 63,400,000 -
DB - Trust Bal 37,800,000 52,900,000 71,100,000 87,300,000 65,600,000 87,300,000 57,700,000 81,000,000
DB - Net Income 88,400,000 84,500,000 109,800,000 126,100,000 109,000,000 126,100,000 96,500,000 119,700,000 202,400,000
* (202m net) 9/1/2014
SRL© 2014 26
Sterling Resources, Ltd 175 Derby Street, Suite 33
Hingham, MA 02043 781-749-1533
Karl J. Feitelberg Gary R. Lee 617-645-3598 617-692-0279
Society of Trust and Estate Practitioners September 9, 2014
Presented by
Karl J. Feitelberg and Gary R. Lee
Sterling Resources, LTD
Solving the UNI Quagmire
