In This Issue
Foreclosures of Reverse Mortgages:
Inadvertent Tax Liability To Estate Beneficiaries
Ginger Skinner
Skinner Law, PC
Portland, OR
People with debt-free homes will occasionally obtain a reverse mortgage on
their homes. The reverse mortgage allows the homeowners to continue living in
their own home, while increasing their cash ow due to the payments received
from the mortgage company. However, complications arise if the person dies
with a reverse mortgage on a home, especially if the balance due on the reverse
mortgage is higher than the fair market value of the home at the time of death
or, in current slang, underwater.
The general rule is that debt, including tax debt, is the responsibility of
the decedent’s estate. Children or other heirs of the decedent are not liable
for any of the decedent’s debt. However, it is possible for estate beneciaries
to inadvertently become liable for additional taxes if a decedent’s residence
is subject to an underwater reverse mortgage that is then foreclosed and the
mortgage company discharges the remaining debt. This is a result of the unique
conduit taxation nature of an estate. As a reminder, from a tax perspective, an
estate is sometimes referred to as a “pass-through” entity. Each beneciary, not
the decedent’s estate, pays income tax on his or her distributed share of income.
If a taxpayer, including an estate, is relieved of a nonrecourse liability in
connection with the disposition of encumbered property, the debt relief is
included in the taxpayer’s amount realized for the purpose of computing gain
or loss realized in the property transaction. See Treas. Reg. § 1.1001-2. If the
taxpayer was instead relieved of a recourse liability, the amount of the forgiven
debt is included in the taxpayer’s gross income. See IRC § 61(a)(12); IRC § 108(a).
Reverse mortgages are generally nonrecourse debt. This is because the
Federal Housing Administration (FHA) as part of its Home Equity Conversion
Mortgage program insures most reverse mortgages. Therefore, if a reverse
mortgage is obtained when the real estate market is high and the market
subsequently crashes after most of the equity has been stripped from the home,
the borrower (or the borrower’s estate) will not be personally liable for the
deciency, if the mortgage was through the FHA program.
Applying this general rule to a reverse mortgage situation might look like this
example. Imagine a situation where the decedent’s home sells for $200,000 at a
foreclosure auction. The outstanding loan balance was $300,000. The amount
realized includes the sale proceeds ($200,000) and the amount of the discharge
of liability ($100,000). Therefore, the amount realized by the borrower’s estate
is $300,000.
Oregon Estate Planning
and Administration
Section Newsletter
Volume XXXII, No. 3
September 2015
estateplanning.osbar.org
Published by the
Estate Planning
and Administration
Section of the
Oregon State Bar
1 Foreclosures of Reverse
Mortgages: Inadvertent Tax
Liability To Estate Beneciaries
2 529 Plans: Beware Transfer Tax
Consequences on Change of
Beneciary
4 Federal and Oregon Income Tax
Planning for Trusts
8 Events Calendar
Estate Planning and Administration Section September 2015
Page 2
The same home was appraised at $200,000 as of the date
of the decedent’s death. Therefore, the basis of the home is
$200,000 because the basis of the home is adjusted to the fair
market value of the home at the date of the decedent’s death.
IRC § 1014(a)(1).
The gain realized is the amount realized ($300,000), less
the basis in the home ($200,000). As a result, the gain realized
is $100,000. The capital gain is either taxed to the borrower’s
estate or passed through to the beneciaries, depending on
whether distributions are made to the beneciaries during the
tax year in which the estate realizes the capital gain.
If the estate terminates and is fully distributed to the
beneciaries during the tax year in which the gain was
realized, then each beneciary’s share of the capital gain is
reported on that beneciary’s personal income tax return
without any corresponding distributed assets to pay the
resulting increase in personal income taxes.
If the estate does not make any distributions to the
beneciaries during the tax year in which the gain was
realized, then the capital gain is taxed directly to the estate. If
the estate is unable to pay taxes on the capital gain, then the
executor may be able to approach the IRS and ask to settle
the outstanding debt. If this approach is contemplated, the
beneciaries should be advised to disclaim their interests in
the home to avoid any distribution of the capital gain to the
beneciaries.
In conclusion, any time your client is dealing with an estate
that has a reverse mortgage, you should exercise an abundance
of caution and make sure you have all of the information
prior to advising that client. Be sure you are the rst to know
whether an estate is insolvent and if a mortgage company will
discharge nonrecourse debt as a result of a foreclosure.
529 Plans: Beware Transfer Tax
Consequences on Change of
Beneficiary
Brent Berselli
Holland & Knight LLP
Portland, Oregon
Education savings plans under Section 529 (“529 plans”)
of the Internal Revenue Code (“IRC”) are well-known
vehicles for funding qualied higher education expenses. 529
plans offer a unique combination of gift, estate, and income
tax benets to the account owner and beneciary, which are
discussed briey below. This article addresses the potential
unintended transfer tax consequences when
an account
owner changes the beneciary of a 529 plan to one in a
lower generation.
A) Transfer Tax and Income Tax
Consequences of 529 Plans
1) Gift Tax: Contributions to 529 plans are considered
completed, present interest gifts to the beneciary.
1
Therefore, contributions are eligible for the annual
gift tax exclusion under IRC Section 2503(b) and
the generation-skipping transfer tax exclusion under
IRC Section 2642(c). Donors may make a lump-sum
contribution to a 529 plan in an amount equal to ve
times the federal annual exclusion ($70,000 single or
$140,000 if married) per recipient, provided that the
donor les a gift tax return and makes the appropriate
election.
2
The contribution is treated as being made
ratably over ve years, which exhausts the donor’s
eligibility to make additional annual exclusion gifts
to the same beneciary over that time period. In other
words, a donor may contribute $70,000 (or $140,000 if
married and electing to gift-split) to a 529 account for
a beneciary, but the donor may not make additional
gifts to the same beneciary over the next ve years
(whether through additional contributions to the 529
plan or otherwise) without transfer tax consequences.
Advisors should caution plan owners that the ve-year
election is not automatic, and the donor must le a gift
tax return. If a married couple elects to gift-split and
ratably spread the maximum $140,000 contribution
over ve years, each spouse must le a separate gift
tax return.
2) Estate Tax: Contributions to 529 plans are generally not
included in the donor’s gross estate for federal estate tax
purposes.
3
Since contributions are treated as completed
gifts, the plan value is included in the beneciary’s gross
estate.
4
An exception occurs where the donor, prior to
death, elected to spread a lump-sum contribution over
ve years pursuant to Prop Treas Reg § 1.529-5(b)(i). In
such event, the portion of the contribution allocated to
the years after the donor’s death is included in his or her
gross estate.
3) Income Tax: Investments within 529 plans grow tax-
free until distribution.
5
Plan earnings avoid income tax
upon distribution provided the funds distributed pay
“qualied higher education expenses”
6
to an “eligible
1 IRC § 529(c)(2)(A)(i).
2 Prop Treas Reg § 1.529-5(b)(i).
3 See IRC § 529(c)(4)(A); Prop Treas Reg § 1.529-5(d)(1).
4 See IRC § 529(c)(4)(A); Prop Treas Reg § 1.529-5(d)(1).
5 See IRC § 529(a).
6 “Qualied higher education expenses” include tuition, fees,
room and board, books, supplies, computer technology and
equipment, education software, and internet access.
Checkout out the Section’s New Website
estateplanning.osbar.org
Estate Planning and Administration Section September 2015
Page 3
educational institution.”
7
Nonqualied distributions
are (1) subject to a 10% penalty, and (2) taxed at the
beneciary’s marginal income tax rate.
8
B) Transfer Tax Consequences on Change of Beneciary
1) Transfers to Same or Higher Generation: 529 account
owners maintain control of the plan by determining
when distributions are made and retaining the ability
to change the beneciary or rollover the account
balance to a new account. Beneciary changes can
often occur with no adverse transfer tax consequences.
Changing to a new beneciary who: (1) is a member
of the same family
9
as the previous beneciary, and
(2) is assigned to the same or higher generation for
generation-skipping transfer tax purposes as the old
beneciary is not treated as a new taxable gift.
10
2) Transfers to a Lower Generation: Plan owners and
their advisors must exercise caution in selecting a
new beneciary who is one generation or more below
the current beneciary. If the new beneciary is in a
lower generation (i.e., changing the beneciary from
a child to grandchild), the transfer is treated as a new
taxable gift. The IRC does not specify the donor of the
new gift. The Service has not issued nal Treasury
Regulations on point, but Section 1.529-5(b)(3) of the
1998 Treasury Proposed Regulations states that the
change in beneciary is considered a taxable gift from
the previous beneciary to the new beneciary.
11
If the
new beneciary is more than a generation below the
current beneciary, the transfer will also be subject to
generation-skipping
transfer tax.
The ve-year election is available to the current
beneciary, and he or she may qualify up to $70,000
(or $140,000 if married) of the deemed gift for annual
exclusion treatment. However, if the current plan balance
7Nearly all colleges, universities, community colleges, and law,
medical, or business schools qualify as “eligible educational
institutions.”
8 See Prop Treas Reg § 1.529-2(e).
9 A member of the family of a beneciary is a dened term
under IRC § 529(e)(2) and Prop Treas Reg § 1.529-1(c). IRS
Publication 970 lists the following as “members of the family”
of the beneciary: son, daughter, stepchild, foster child,
adopted child, or a descendant of any of them; brother, sister,
stepbrother, or stepsister; father or mother or ancestor of
either; stepfather or stepmother; son or daughter of a brother
or sister; brother or sister of father or mother; son-in-law,
daughter-in-law, father-in-law, mother-in-law, brother-in-law,
or sister-in-law; the spouse of any individual listed above;
or rst cousin. Available at http://www.irs.gov/publications/
p970/ch08.html#en_US_2014_ publink1000178578.
10 See Prop Treas Reg § 1.529-5(b)(3)(i).
11 See IRC § 529(c)(5)(B); Prop Treas Reg § 1-529-5(b)(3)(ii).
exceeds ve times the applicable annual exclusion
amount, the excess amount may be subject
to gift tax.
The Service’s rationale for treating the current
beneciary as the donor of the new gift stems from the
fact that 529 plan contributions are considered completed
gifts. Therefore, the current beneciary is deemed to be
the owner of the funds in the account, and the current
beneciary is the donor with respect to the transfer to
the new beneciary. This is true notwithstanding the fact
that the current beneciary has no authority to change the
beneciary or distribute funds. The current beneciary
may not even be aware of the existence of the 529 plan.
Commentators have periodically raised concerns about
this approach, but the Service has yet to issue nal
Regulations. In Announcement 2008-17, issued on March
3, 2008, the Service requested public comment on the
transfer tax consequences of such a change of beneciary
to a lower generation. As stated in Announcement 2008-17:
In order to assign the tax liability to the party who
has control over the account and is responsible for the
change of any beneciary, the forthcoming notice of
proposed rulemaking will provide that a change of
[Designated Beneciary] that results in the imposition
of any tax will be treated as a deemed distribution
to the [Account Owner] followed by a new gift.
Therefore, the [Account Owner] will be liable for
any gift or GST tax imposed on the change of the
[Designated Beneciary], and the [Account Owner]
must le gift and GST tax returns if required.
Announcement 2008-17 has not resulted in new Proposed
Regulations, and the current treatment under Section 1.529-
5(b)(3) of the 1998 Treasury Proposed Regulations remains
a concern.
C) Conclusion
Because the Service has not issued nal Treasury
Regulations, the transfer tax consequences of a change
in beneciary to a lower generation are not entirely clear.
However, the plan owner and his or her advisors must
carefully consider the possibility that the Service could
assess a gift tax liability against the current beneciary.
For this reason, practitioners should exercise caution and
may wish to prospectively le a gift tax return in the year
following the transfer to qualify up to $70,000 (or $140,000
if married) of the deemed gift from the current beneciary
to the new beneciary for annual exclusion treatment.
Welcome Back
Michele Wasson of Stoel Rives LLP has returned
to serve once again as an editor for the Estate Planning
and Administration Section Newsletter. Michele has many
volunteer positions and we are honored that she is willing to
rejoin us. We look forward to Michele’s insight and clarity
as an editor.
Estate Planning and Administration Section September 2015
Page 4
Federal and Oregon Income Tax
Planning for Trusts
Ed Morrow, J.D., LL.M., CFP®
1
Senior Wealth Specialist,
Key Private Bank Family Wealth Advisory Services
Most Americans are patriotic and proud to pay taxes
as a necessary price of living in such a great country.
Oregonians are equally proud of their state. But most
would feel just as proud paying half as much. This article
will focus on how higher income Oregon residents can
legitimately avoid or lower the federal and/or Oregon
income tax burden using both incomplete and completed
gift trusts. These techniques are most useful to those who
anticipate being in the highest income tax brackets and,
due to sharply increased applicable exclusion amounts and
dozens of recent private letter rulings from the IRS, are
more appealing than ever.
2
Some of these techniques have
the side effect of avoiding Oregon estate tax as well, though
that is not the focus of this article.
3
At 9.9%, Oregon has one of the highest state income tax
rates in the country – behind only California, Hawaii, or
residents of New York City, which has both a state and city
income tax.
4
For long-term capital gains tax rates, this state
burden may be over a third of the overall tax and places
Oregon residents among the highest payers of capital gains
tax on the planet. The savings can be tremendous – nearly
$99,000 for every million dollars of capital gains avoided.
5
First, we’ll very briey summarize how trusts are taxed
at the federal level. Then we’ll explain Oregon’s trust
1 The author is a member of the Ohio rather than Oregon bar, but
is an alumnus of Lewis and Clark Law School.
2 Federal tax rules for trusts are primarily found in Subchapter J
of the Internal Revenue Code, IRC §§ 641-692. The top federal
income tax bracket of 39.6% (20% for long-term capital gains
and qualied dividends) as of 2013 starts at $400,000 taxable
income for singles and $450,000 for married ling jointly,
which annually adjust upwards for ination; in 2015 these
start at $413,201 and $464,851 respectively. The additional
Medicare surtax on net investment income of 3.8%, which
acts in many ways like an income tax, starts at $200,000
and $250,000 modied AGI respectively, not adjusted for
ination.
3 Which, to generalize, starts at 10% on taxable estates over the
$1 million exemption and increases to 16%, also one of the
highest rates in the nation. See Oregon Tax Form OR706 and
instructions at http://www.oregon.gov/dor/bus/docs/form-
or706_104-001_2013.pdf.
4 ORS 316.037 (reaching the 9.9% at only $125,000 of income,
lower than most state’s top brackets; California tops out at
13.3%, Hawaii is 11%, and New York state and New York
City are 8.82% and 3.4% respectively). See state income tax
map and charts updated at www.taxfoundation.org.
5 Savings may be slightly less due to itemized deductions of tax
paid, exemptions, etc.
income tax scheme and the importance of being classied
as a “resident” or “non-resident” trust. Then, we’ll address
“source income” and situations involving real estate,
income, and businesses with Oregon situs, when Oregon
may tax even non-residents and non-resident trusts. More
importantly, we’ll discuss how this may often be avoided.
Next, we’ll revisit the two federal tax options available and
distinguish between completed gift and incomplete gift
trusts. Lastly, we’ll explore when these same trusts may
actually save federal income tax in many situations as well,
despite the common wisdom that trusts pay higher rates of
income tax.
Federal Trust Income Tax Scheme
Many trusts, including all revocable trusts and even
many irrevocable ones, are “grantor trusts” for income
tax purposes, meaning they are not considered separate
taxpayers and all gains, income, losses, and deductions of
the trust are attributable to the grantor.
6
This article will assume a familiarity with basic federal
duciary income tax principles and for the remainder of
this article “trusts” will refer to standard non-charitable,
irrevocable non-grantor trusts unless specied otherwise
– thereby excluding grantor trusts, charitable remainder
trusts, and trusteed qualied plans and IRAs.
7
Trusts and estates have similarities to pass-through
entities, but are taxed quite differently from entities taxed
as S corporations and partnerships – usually, capital gains
are trapped and taxed to the trust and other income is taxed
to the beneciaries to the extent distributed and to the trust
to the extent not distributed. That is a highly simplied
summing up of a complex subject.
8
Federal trust income tax rates hit the higher income tax
brackets at much lower levels to the extent that income is
trapped in trust and not passed out to beneciaries on a K-1.
The top 39.6% federal income tax bracket is reached at only
$12,300 for tax year 2015. There is no 35% bracket.
9
The
3.8% net investment income tax is triggered by investment
income over this same low threshold.
10
Oregon’s Trust Income Tax Scheme – Differentiating
Oregon Resident and Non-Resident Trusts
The Oregon duciary income tax has the same top tax
rate as the individual income tax: 9.9%.
11
Avoiding Oregon
6 See IRC §§ 671-679, especially § 671, for general rules.
7 Hence subject to the remainder of IRC Subchapter J, §§ 641-
692, not IRC §§ 671-679 subpart E grantor trust rules.
8 If you want the gory detail, see A Fiduciary Income Tax Primer
by Philip N. Jones in the Oregon Bar’s Estate Planning
Newsletter, October 2014 special issue report.
9 IRC § 1; for ination-adjusted brackets see Rev Proc 2014-61
at http://www.irs.gov/pub/irs-drop/rp-14-61.pdf.
10 IRC § 1411(a)(2).
11 ORS 316.037; ORS 316.282; OAR 150-316.282(3), (4).
Estate Planning and Administration Section September 2015
Page 5
trust income tax is essentially a two-step process: avoid
being a resident trust, and avoid source income. Let’s
take the rst step. Oregon tax law differentiates between
resident trusts and non-resident trusts.
12
The same tax form
is used for both.
13
Oregon’s denition of a resident trust is
extremely taxpayer-friendly and much narrower than many
states’:
“[A] ‘resident trust’ means a trust, other than a qualied
funeral trust, of which the duciary is a resident of Oregon
or the administration of which is carried on in Oregon. In
the case of a duciary that is a corporate duciary engaged
in interstate trust administration, the residence and place of
administration of a trust both refer to the place where the
majority of duciary decisions are made in administering
the tr ust.”
14
Thus, unlike many states, the “residency” of an Oregon
trust is not triggered by the in-state residency of the settlor
and/or beneciaries, but rather by where it is administered.
Oregon has rather liberal (compared with, e.g., California)
allowances for corporate trustees who may have ofces
and administration in several states. Thus, if the primary
administration of a trust is done out of state but only
incidental functions are performed in Oregon, the trust
is still not a resident trust. Permitted functions include
“preparing tax returns, executing investment trades as
directed by account ofcers and portfolio managers,
preparing and mailing trust accountings, and issuing
disbursements from trust accounts as directed by account
ofcers.”
15
Non-resident trusts are simply dened as those that are
not resident trusts.
16
Thus, to form a non-resident trust,
Oregon residents merely have to nd a trustee or trustees out
of state that will not administer the trust beyond performing
incidental functions in Oregon. This precludes naming an
Oregon resident as co-trustee.
17
Trustees with ofces in
multiple states have an edge because there can still be local
contact and incidental functions and meetings in Oregon
while the primary administration is done elsewhere. This
scheme creates a signicant disincentive, to both Oregon
residents and non-residents alike, against using Oregon
duciaries.
Dividing the traditional functions of the trustee, such as
naming an out-of-state trustee yet appointing a distribution
or investment advisor or committee to direct the trustee
12 OAR 150-316.282(1).
13 The duciary income tax return and instructions are at
http://www.oregon.gov/dor/BUS/docs/form-41-fiduciary-
income_101-041_2014.pdf.
14 ORS 316.282(1)(d) (also mirrored and reinforced in OAR 150-
316.282(3)).
15 OAR 150-316.282(5) (including several examples).
16 ORS 316.302.
17 OAR 150-316.282(5), example 3.
to make distributions or investments, is becoming more
common, and muddies the waters of this analysis. The
administrative code and statute refers only to “trustee,” not
to the broader term “duciary.” The Oregon Department
of Revenue’s examples do not cover such innovative trust
designs. Because such advisors may be duciaries as well,
it is unclear whether Oregon would treat them in the same
manner as a co-trustee if any are Oregon residents, or
whether their actions would merely factor into the analysis
in determining the extent of signicant duciary decisions
in Oregon.
18
Advisors are by default duciaries unless
the document provides otherwise.
19
Presumably the tax
department and court would follow any declaration under
the document that an advisor is not a duciary even when
they outwardly appear to be.
Powers of appointment, however, are typically non-
duciary in nature and such powers should not be considered
duciary or administrative regardless of the state law
presumption, though it may be prudent to reafrm that such
power holders are not duciaries in the trust document.
The importance of these distinctions and the pitfalls and
opportunities they open up are discussed later.
The taxable income of an Oregon resident trust is
simply its federal taxable income, modied by certain
duciary adjustments.
20
The federal taxable income for a
trust excludes many important deductions that differ from
individuals’, which will be important in the latter part of
this article.
Although this article primarily discusses inter vivos
planning, the concepts herein also apply to the administration
of the trust after the death of the rst spouse. This provides a
signicant tax incentive for Oregonians to name out-of-state
trustees for trusts, including garden-variety “AB” trusts.
This does not mean just any trust company or out-of-
state trustee should be used. You don’t want to name a
California resident as trustee to simply exchange a 9.9%
tax for a 13.3% tax. However, many states have no income
tax, most notably our neighbor to the north, Washington,
18 OAR 150-316.282(5).
19 ORS 130.735(1) (“An adviser shall exercise all authority
granted under the trust instrument as a duciary unless the
trust instrument provides otherwise.”). Restatement (Third)
of Trusts § 64(2) (2003) also incorporates this presumption:
“The terms of a trust may grant a third party a power with
respect to termination or modication of the trust; such
a third-party power is presumed to be held in a duciary
capacity.” Of course, in many situations, practitioners are
going to use Delaware, Ohio, Nevada, or other state DAPT
law rather than Oregon law, but these states have similar
provisions. See Ohio Rev Code §§ 5815.25, 5808.08; Delaware
tit 12, § 3313(a).
20 ORS 316.282(2) (also mirrored and reinforced in OAR 150-
316.282(6)).
Estate Planning and Administration Section September 2015
Page 6
but also Alaska, Texas, Nevada, Florida, and others. Many
other trust-friendly states, such as Ohio or Delaware, have
an income tax for their own residents, but would not impose
a state income tax unless there is a current beneciary
residing in the state.21
Understanding Oregon Source Income – When It Can
and Cannot Be Avoided
Once we have successfully created a non-resident trust
for Oregon income tax purposes, we next need to resolve
when and how non-residents and non-resident trusts may
still be taxed. This brings us to the third part of this article
discussing “source” income. Taxpayers selling an asset
or block of assets for a large gain are often dealing with
depreciated real estate and business entities in state. These
present special issues. The best overview dening Oregon
source income can be quoted right from the Department of
Revenue’s own instructions:
“Examples of Oregon source income are: wages or other
compensation for services performed in Oregon; income or
loss from business activities in Oregon, including rents, S
corporations, and partnerships; gain or loss from the sales
of real or tangible personal property located in Oregon;
income from intangible personal property if the property
has acquired Oregon business situs.”
22
Even an out-of-state resident will typically pay Oregon
income tax on Oregon source income, not just a non-resident
trust. Thus, a non-resident beneciary of a trust (even a
non-resident trust) is taxed by Oregon in the same manner
as if the beneciary had received the income directly if
the income resulted from the ownership or disposition of
tangible property (real or personal) in Oregon, or from the
operation of a trade or business in Oregon.
23
This article will ignore wages and compensation and
focus on sales of intangible personal property, which is
the most likely corpus of a trust, the most likely candidate
for large capital gain triggering events, and often the
most desirable candidate for tax avoidance. It is also the
part of the source income concept that is most difcult to
understand.
C corporations, for example, are not pass-through
entities, so the more complex pass-through entity tax rules
do not apply to them. As hinted at by the lack of mention in
the Oregon tax return instructions noted above, a Florida or
Ohio resident isn’t necessarily going to pay Oregon income
tax on Precision Castparts stock (a C corporation) when it is
21 For example, see Ohio Department of Taxation Information
Release TRUST 2003-02 - Trust Residency — February
2003, http://www.tax.ohio.gov/ohio_individual/individual/
information_releases/trust200302.aspx.
22 Form 41, Oregon Fiduciary Income Tax Return and
Instructions at 6, http://www.oregon.gov/dor/BUS/docs/form-
41-duciary-income_101-041_2014.pdf.
23 OAR 150-316.282(7); ORS 316.127; OAR 150-316.127-(D)
sold, or pay Oregon income tax on dividends received, but
any C corporation has its own separate taxes to deal with.
However, most closely held businesses (even large ones)
prefer to avoid the double tax system of C corporations,
which can be much more onerous overall, especially upon
sale, distribution, or termination.
So, let’s assume for the remainder of this section that
we are dealing with a pass-through entity: an LLC, a
partnership, or an S corporation. The ongoing income of
an Oregon pass-through entity with ongoing operations or
real estate in Oregon is clearly taxed.
24
However, the sale
of the stock (or membership interest) of such entities is not
necessarily taxed in Oregon if the owners are out of state.
Income from the sale of intangibles is traditionally allocated
to the state of the taxpayer’s domicile through the doctrine of
mobilia sequuntur personam.
25
This is generally conrmed
through Oregon’s adoption of the Uniform Division of
Income for Tax Purposes Act (“UDITPA”):
26
“Capital gains
and losses from sales of intangible personal property are
allocable to this state if the taxpayer’s commercial domicile
is in this state.” More specically, this is conrmed in
Oregon’s administrative rules interpreting the statute:
“Intangible property. The gain from the sale, exchange, or
other disposition of intangible personal property, including
stocks, bonds, and other securities is not taxable unless the
intangible personal property has acquired a business situs
in Oregon.”
27
Thus, the sale of S corporation stock, even if the
business has real estate or operations in Oregon, is not
Oregon source income, unless the stock itself has acquired
a business situs in the state.
28
This might occur if the stock
is pledged for indebtedness used in carrying on business in
the state, or if the stock itself is not a mere investment but
used to further the business of the owner, or if the owner is
in the business of buying and selling such stock.
29
There is
a history of complex litigation when the stock is a corporate
subsidiary, but for most individuals or non-resident trusts
24 OAR 150-316.127-(D)(1).
25 “movables follow the person”
26 UDITPA § 6(c), http://www.uniformlaws.org/shared/docs/
uditpa/uditpa66.pdf. More material on uniformity projects
and discussion of state income tax law can be found at the
Multistate Tax Commission’s website at www.mtc.gov.
27 OAR 150-316.127-(D)(2)(b).
28 OAR 150-316.127-(D)(2)(c).
29 OAR 150-316.127-(D)(1).
The article
Federal and Oregon Income Tax
Planning for Trusts
by Ed Morrow was also published,
in nearly identical form, by the Oregon State Bar
Taxation Section in their Summer 2015 issue. For
those readers who have already enjoyed this article, we
apologize for the duplication.
Estate Planning and Administration Section September 2015
Page 7
the stock is going to be a mere investment, not used to
further the business of the owner.
30
Neither is the sale of an LLC or LP interest going to
necessarily be Oregon source income, but the analysis is
more complex. For instance, a general partnership interest,
whether as part of a limited partnership or not, is Oregon
source income,
31
but the limited partnership interest is
probably not:
“Limited Partnership Interests. In general, a non-
resident’s gain or loss from the sale, exchange, or disposition
of a limited partnership interest is not attributable to a
business carried on in Oregon and is not Oregon source
income.”
32
For Oregon source income taxation rules, member-
managed LLCs are taxed like partnerships (source), and
manager-managed LLCs are taxed like limited partnerships
(not source, as cited above).
33
Curiously, limited liability
partnerships (LLPs) are taxed for this purpose like general
partnerships.
34
This leaves ample opportunity for proactive pre-sale
planning through changing the management structure of
an LLC through its Articles of Organization, changing
to an S corporation structure (usually not recommended
for other reasons), or using tax-free reorganizations from
general partnerships or LLPs to manager-managed LLCs
to minimize Oregon income tax upon sale. There is no
statute, rule, or case law as to how soon before sale that
30 “Nonbusiness capital gains and losses from sales of intangible
personal property (i.e., stocks, bonds) are allocable to the
taxpayer’s state of commercial domicile.” Gregory E. Stern,
State Taxation of Mergers and Acquisitions, 783-4th Tax
Mgmt Portfolios (BNA) at A-7 (2010)
(citing the UDITPA).
This of course, leads to the question of whether the stock
is integrally part of the owner’s own business or the owner
is in the business of buying and selling corporations. “For
example, the taxpayer in W.R. Grace & Co. v. Commr. of
Revenue (‘Grace’) purchased a majority stock interest in
the Miller Brewing Company and later sold its interest at a
substantial gain. Grace was a Connecticut corporation doing
business in Massachusetts. Massachusetts treated the gain
as business income and required its inclusion in Grace’s
apportionment formula. Grace contended that the gain was
nonbusiness income fully allocable to its state of commercial
domicile, New York. The state court agreed that Grace was
not in the business of buying and selling securities, but found
ample evidence that Grace’s business included the purchase
and sale of operating subsidiaries. The court did not view the
fact that Grace was unable to acquire full control of Miller as
stripping the holding of its business character. Finding that
ownership of Miller was an ‘integral component’ of Grace’s
total operations (i.e., unitary), the court concluded that gain
from the sale of the interest was apportionable business
income.” Id. at A-30 (footnotes omitted).
31 OAR 150-316.127-(D)(2)(d).
32 OAR 150-316.127-(D)(2)(e).
33 OAR 150-316.127-(D)(2)(f).
34 OAR 150-316.127-(D)(2)(g).
such reorganizations must be done. Ideally this should be
done in the tax year before sale, even though there is no
good argument against the immediate effectiveness of such
changes.
An Example of Savings
Let’s start with a basic example that we will go back
to throughout this article: John Doe makes over $500,000
annual taxable income (39.6% bracket, plus 3.8% or 0.9%
Medicare surtax, thus 23.8% federal capital gains rate and
9.9% Oregon marginal tax rate). John is married and both
he and his spouse are Oregon residents. He has $11 million
in assets he anticipates selling soon for a capital gain of
$10 million – this might be a sale of depreciated real estate,
a sale of closely held or publicly traded stock or limited
partnership, or perhaps even a forced recognition of gain,
like one of the recent corporate inversions such as Burger
King or Medtronic, or Kinder Morgan’s reorganization of
its publicly traded limited partnerships. John would like
to explore options that might avoid roughly $990,000 of
Oregon income tax. Let’s assume that John is not in the
business of buying and selling such assets, but the assets are
held for investment. Is he out of luck getting around Oregon
income tax if the asset is a business? Not necessarily. It
depends on the type of business, the structure of the deal,
and whether an IRC § 338(h)(10) election is made.
Let’s examine the Oregon tax savings opportunities
based on whether John’s assets are C corporation stock,
LLC (member-managed), LLC (manager-managed), LP,
LLP, or general partnership. The design of the irrevocable
trust will be discussed in the next section.
C corporation, publicly traded stocks/bonds
– John
conveys these to a non-resident trust. The trust sells the
asset. No Oregon income tax.
LLC (member-managed)
– John conveys these to a non-
resident trust. The trust sells the asset. Oregon income tax
is apportioned accordingly, up to $990,000. However, John
and his partners may change the management structure of
the LLC to a manager-managed LLC to avoid this result.
LLC (manager-managed, by someone other than John
who is a non-resident)
– otherwise same as above, except
that $990,000 is saved.
LP
(whether or not publicly traded LP)
– no source
income; $990,000 is saved. Notably, there is no aggregation
of limited and general partnership interests where someone
may own both.
35
This may lead some to prefer the LP
to the LLC model where the owner may want to retain
management rights.
LLP
or GP
– all source income to extent apportionable,
up to $990,000 tax. However, John and his partners may
35 OAR 150-316.127-(D)(2)(d), (e).
Estate Planning and Administration Section September 2015
Page 8
change the partnership to a manager managed LLC, LP, or
S corporation to avoid this outcome.
If the sale is potentially source income, then an enquiry
into the nature of the operations may matter – how much
of the property/sales/operations are in Oregon?
36
Structure
of the sale – Asset Deal vs. Stock Deal and IRC § 338(h)
(10) Elections
Finally, the structure of the deal matters – is John
selling stock or LLC interests in a “stock deal,” or is the
rm selling in an “asset deal,” whereby the buyers are
36 ORS 317.365. [repealed]
purchasing all the assets of the company? Most buyers
prefer to buy the assets of a company rather than stock,
so they can depreciate assets with a new FMV basis,
and avoid latent liabilities of the selling entity. However,
certain contractual obligations and benets may require a
stock deal to properly transfer. All the reasons pro and con
vary depending on the nature of the business, contracts,
depreciable assets, and whether it’s an S or a C corporation,
etc. – many issues beyond the scope of this article. Some
buyers may be amenable to structuring a buyout as a stock
deal and some may not even consider it, but sometimes it is
simply a matter of negotiation.
Let’s bypass that debate and summarize the “asset
deal” for Oregon income tax purposes – if all gains pass
through to the owner of an LLC/LP/S corporation in an
asset deal, then we are left with the conclusions noted
above. It is harder to avoid Oregon source income, and
any Oregon income apportioned to the business will pass
through and be taxed to a non-resident or a non-resident
trust. For a small to mid-size business with operations
and employees only in Oregon, that’s probably 100%.
There would typically be no Oregon income tax avoided
by transferring such assets to a non-resident trust prior to
an “asset sale,” unless a signicant percentage could be
apportioned elsewhere, as with a truly interstate business.
If it is a “stock deal,” the analysis is quite different and,
as noted above, the gain can be avoided. Here we refer
to “stock deal” broadly to include sale of membership or
partnership interests.
There is a hybrid of the two types of deals, however,
where the parties elect to treat a stock deal, which might be
preferred for state law/contractual reasons, as an asset deal
for tax purposes, pursuant to § 338(h)(10) of the Internal
Revenue Code. Like an asset deal, this would likely lead
to Oregon source income. Thus, when we speak of stock
deals that can effectively avoid Oregon source income
categorization, we are speaking more specically of stock
deals wherein the IRC § 338(h)(10) election is not made.
Importance of IRC § 754 to Buyers; Differentiating LP/
LLC from S Corporations “Stock Deals”
As mentioned above, buyers receive a new cost basis for
their outside basis in the stock or LLC membership interest,
but that may not necessarily change the inside basis,
which is more relevant to ongoing taxation of operations.
Inside basis determines the amortization of goodwill or
depreciation of a building or equipment. However, an LLC
or LP taxed as a partnership under federal tax law may
elect to adjust its inside basis upwards to more accurately
reect the sale price.
37
Most estate planning attorneys are
familiar with this election in the context of the death of
a partner, but it is also applicable to sales and exchanges
37 See IRC §§ 743(b), 754.
Events Calendar
Central Oregon Estate Planning Council
Quarterly Meetings
When:
September 29, 2015 / November 10, 2015
Where:
5:30 – 7:30 pm at Awbrey
Glen Golf Course, Bend
Register:
Contact Cheryl Puddy, Associate
Program Ofcer, The Oregon
Community Foundation
(541) 382-1170, CPuddy@oregoncf.org
60th Annual Estate Planning Seminar
Sponsored by The Seattle Estate Planning Council and
UW School of Law – Graduate School of Taxation
When:
November 2-3, 2015
Where:
Washington State Convention
Center, Seattle, WA
Register:
http://depts.washington.edu/uwconf/wordpress/
estateplanning/registration/
Basic Estate Planning and
Administration CLE
When:
November 20, 2015
Where:
Oregon Convention Center,
Portland, Oregon
Register:
https://www.osbar.org/cle
The Editors want to include announcements of upcoming
events that may be of interest to our readers. If you know
of an event, please send basic information to Sheryl S.
McConnell at [email protected] for inclusion in the
next issue of the Newsletter.
Estate Planning and Administration Section September 2015
Page 9
during lifetime. What this means is that “stock deal” buyers
of partnership and membership interests (LLC/LPs taxed
as such) can get most of the same benets as an “asset
deal” with a IRC § 754 election, which is not available to
corporations or LLCs taxed as S corporations. Thus, buyers
of LLC/LPs should be much more amenable to “stock
deals” than S corporation buyers, who often insist on asset
deals or IRC § 338(h)(10) elections for the aforementioned
reasons.
Special Issues for S Corporations and Non-Grantor
Trusts
In addition to the messy Oregon tax issues for businesses,
transferring an S corporation to a non-grantor trust has
the added complications of a forcing an Electing Small
Business Trust (“ESBT”) election, and possibly adding a
3.8% surtax, whereas this tax is more easily avoided in the
hands of an “active” investor in the business (or his/her
grantor trust or a QSST wherein the beneciary is active
in the business). Whether ESBTs can be “active” business
investors and avoid the 3.8% surtax on business income is a
complicated issue, even with a high-prole recent taxpayer
victory in Tax Court.
38
Protecting the Trustee from Having to Diversify While
Avoiding Residency Status
Typically, when corporate trustees take custody
of or manage special assets there needs to be special
accommodations. This is because the Prudent Investor
Act would otherwise require a trustee to diversify assets
and neither the settlor nor the trustee may want the trustee
to have to actively manage such closely held assets prior
to sale. This requirement can be waived in a number of
ways. Notably, an investment advisor or committee might
be named to direct the trustee to hold or sell the stock,
LLC interest, or other asset. Sometimes the settlor or
immediate family is the investment advisor, at least for
traditional domestic asset protection trusts. However, if
the settlor/family were Oregon residents fully managing
the investments, this could lead to a nding that duciary
decisions are made in Oregon or that the advisor is a quasi-
trustee and lead to a nding that the trust is an Oregon
resident trust.
39
Thus, this design should be avoided. The
practitioner should use other methods, such as restricting
sale and waiving the duty to diversify and gifting non-
voting stock or LLC/LP interests, or should ensure that
38 Frank Aragona Trust v. Commissioner, 142 TC 9 (2014), http://
www.ustaxcourt.gov/InOpHistoric/FrankAragonaTrustDiv.
Morrison.TC.WPD.pdf.
39 OAR 150-316.282(5).
another out-of-state resident has this role, such as an out-
of-state LLC.
Structuring the Trust as an Incomplete or Completed
Gift Non-Grantor Trust
So, in our example, let’s say John has assets that would
otherwise be able to avoid Oregon source income upon sale
if he were to change residency or if assets were in a non-
resident trust. The next step, of course, is creating a trust
that meets his estate planning and non-tax goals, which
are a non-grantor trust for income tax purposes and a non-
resident trust for Oregon tax purposes.
There are two basic trust designs that can be used: a
trust structured as an incomplete gift, or one structured as
a completed gift. The latter would count against the donor’s
$14,000 annual gift tax exclusion and $5.43 million gift tax
exclusion and, if beyond that, be subject to a 40% gift tax.
40
The former only causes a taxable gift to the extent that later
distributions are made to individuals other than the settlor/
spouse.
Let’s tackle the more complicated rst: the incomplete
gift, non-grantor trust. These types of trusts are colloquially
known as DING trusts (Delaware Incomplete Gift Non-
Grantor Trusts), based on the original private letter rulings
that used Delaware trusts, and subsequently written
articles.
41
PLRs with such structures have also used
Alaska and Nevada law, and there is no reason that laws of
other states, such as Ohio or Wyoming, might not also be
appropriate, but Delaware’s law is still probably the most
commonly used.
The design of these trusts are slightly more complicated
than most due to the conicting goals of 1) making the gift
incomplete, 2) making the trust a non-grantor trust, and 3)
enabling the settlor to have access to the trust as a potential
appointee or beneciary. Either goal by itself is rather easy
for any experienced practitioner to accomplish – all three
at once requires some agility.
This article will not go through the DING design in
depth, but at its basic level, after the dozens of PLRs
released in the last two years, it is a trust with several
40 The available exclusion amount accounts for prior taxable
gifts, adjusts annually for ination, and could be up to double
with the Deceased Spousal Unused Exclusion, gifts split with
a spouse, or a jointly settled trust with a spouse.
41 See, e.g., PLRs 200148028 (Aug. 27, 2001), 200247013 (Aug.
14, 2002), 200502014 (Sept. 17, 2004), 200612002 (Nov.
23, 2005), 200637025 (June 5, 2006), 200647001 (Aug. 7,
2006), 200715005 (Jan. 3, 2007), 200729025 (Apr. 10, 2007),
200731019 (May 1, 2007).
Estate Planning and Administration Section September 2015
Page 10
unique features to enable the above characteristics.
42
The
rst three below refer to the how distributions are made.
The settlor retains a lifetime and testamentary limited
power of appointment solely exercisable by him-/herself
– this may only be permitted in some states, such as
Delaware, without compromising asset protection. It is
designed to make the gift incomplete yet be curtailed
enough so as not to cause the trust to become a grantor
trust. Lifetime distributions to appointees are limited to
a standard such as health, education, maintenance, and
support to prevent grantor trust status, or possibly limited
to charitable beneciaries (this latter idea is not in the
PLRs, but could work equally well).
There is a distribution committee composed of adverse
parties (beneciaries) – this is necessary to enable
distributions back to the settlor and/or spouse without
triggering grantor trust treatment. The committee structure
is necessary to prevent adverse estate/gift tax effects to the
power holders or grantor trust status as to power holders.
There is a veto/consent power unless the distribution
committee unanimously overrules the settlor – this is
designed to make the gift incomplete.
The trust is established in a state that permits self-settled
trusts (aka domestic asset protection trusts) and would not
otherwise tax the trust or beneciaries. This is designed to
prevent grantor trust status and ensure asset protection.
43
Without getting into gritty detail, the dozens of rulings
on these types of trusts point to a design whereby, for many
taxpayers and situations, we have the perfect tax design, yet
the settlor keeps enough control and exibility not to offend
other non-tax estate planning goals.
In many respects, such trusts, because they have very real
tax differences, and arguably stronger powers and controls
emboldening adverse parties, are much stronger from
an asset protection perspective than ordinary self-settled
asset protection trusts, which are typically incomplete gift,
grantor trusts. Indeed, DINGs are not even “self-settled.”
42 See various presentations by the author on this subject for
more detail, such as those available at www.nbi-sems.com
or w ww.mylaw.com. Recent PLRs include: PLRs 201310002
(Nov. 7, 2012) to 201410006 (Oct. 21, 2013), PLRs 201410001
to 201410010 (Oct. 21, 2013), PLR 201426014 (Feb. 24,
2014), PLR 201426014 (Jun. 27, 2014), PLRs 201427010 to
201427015 (Feb. 24, 2014), PLRs 201430003 to 201430007
(Feb. 7, 2014), PLRs 201436008 (Dec. 27, 2013) to 201436032
(Dec. 30, 2013), and PLRs 201440008 to 201440012 (Dec.
31, 2013) PLR 201510001 to 201510008, PLR 201438010-14*
(this PLR does not concern an ING trust but has overlapping
similar issues and has a similar distribution committee).
43 Treas Reg § 1.677(a)-1(d) (if a settlor’s creditors can reach a
trust, this triggers grantor trust status).
The many differences for state, tax, and bankruptcy law
are beyond this article.
How does this trust function? The management and
reporting is like any trust, but the distribution provisions
are unique. The distribution committee uses a jointly held
limited power of appointment to appoint cash or property
during the settlor’s lifetime, in lieu of a traditional trustee
spray power or direction from the settlor. In addition, the
settlor retains a limited power. Together, there is ample
exibility to make distributions – indeed, more exibility
than most trusts that are typically more limited in the
trustee’s ability to distribute assets.
While most trusts permit the trustee to distribute
current income and principal in a given year, they do not
have to. Many ILITs, for instance, have a clause preventing
distributions until the settlor/insured dies, particularly if
the goal of the trust is to provide a set amount of liquidity
at death for a loan covenant, buy-sell, estate equalization,
or estate tax. Does John or his family need the funds
this year? Next year? Not for another ve years, when
John and Jane will be retired and living in Florida? A
trust does not need to have any beneciaries entitled to
current distributions of income or principal to be a valid
trust; a beneciary that can be ascertained now or in the
future is adequate.
44
Beneciaries might become current
beneciaries at a later date, sometimes referred to as a
“springing executory interest.”
45
Trust protectors might be
able to add beneciaries, but practitioners should be careful
since this power in itself may cause grantor trust status if
not carefully curtailed.
46
Here, the settlor and/or spouse or
children would only be entitled to funds during the settlor’s
lifetime as a result of a committee of adverse parties’
lifetime limited power of appointment, rather than via the
trustee. This is necessary to prevent grantor trust status.
Oregon income tax thus can be avoided to the extent
income is trapped in the trust and is not distributed via
a power of appointment from distributable net income to
Oregon resident beneciaries in that tax year. Importantly,
Oregon does
not
have throwback rules similar to California
and New York that might otherwise try to tax income
accumulated and taxed to the trust in prior tax years, nor
does it have a specic rule regarding incomplete gift trusts
44 ORS 130.155(2).
45 For a discussion on shifting and springing executory interests
and how they might be used to ward off IRS tax liens and
consideration of trust assets in the event of a divorce even
better than wholly discretionary trusts, contact the author for
a separate CLE outline.
46 If the trust protector is non-adverse, IRC § 677 would
probably cause such a power to create a grantor trust if the
settlor and/or spouse could be added as beneciary later.
Some attorneys refer to this as a “hybrid-DAPT.”
Estate Planning and Administration Section September 2015
Page 11
as New York recently passed.
47
Oregon does still have a
reference to the old throwback rule on the books, but unlike
New York or California, there is no modication to adapt
to federal changes made years ago that make the rules
primarily apply only to foreign trusts.
48
To illustrate the tremendous importance of the lack of a
throwback rule, let’s say John’s trust sells the $10 million
of assets in 2015. It would incur and pay approximately
$2.38 million in federal capital gains tax (23.8%), make
no further distributions in 2015, and avoid the $990,000
in Oregon tax assuming it is not otherwise an Oregon
resident trust, as discussed above.
49
In 2015, there is a
“clean slate” as to 2015 income. If in mid-2016, to take an
extreme case, the trust makes $10,000 in dividends and
interest before distributing the entire amount of the trust
to Oregon beneciaries, then the only amount on the K-1
for the beneciaries subject to Oregon tax is the $10,000 of
2015 income.
If distributions were made in 2015, the year of the large
capital gains, recall the general rule above for non-grantor
trusts: capital gains are generally trapped in trust, unless
one of the three exceptions to this general rule applies.
50
Also, if either John or Jane were to have a “springing
executory interest,” becoming a traditional current
beneciary later, this would trigger grantor trust status even
before that event because income might be accumulated
and distributed to them later (and, therefore, trigger Oregon
taxation directly).
51
This may also be true if a non-adverse
party such as a trustee or trust protector could add them as
full beneciaries later.
DINGs require distribution committees of adverse
parties (typically, children) to permit trustee distributions
to the settlor and/or spouse. Such adverse party consent
negates grantor trust status. Because their children are
47
NY Tax Law § 612(b)(41) (new law signed March 31, 2014),
http://www.assembly.state.ny.us/leg/?default_d=&bn=S0635
9&ter m=2013&Sum mar y =Y&Actions=Y&Memo=Y&Text =Y.
48 OAR 150-316.737 (referencing IRC § 665 accumulation
distributions, which are now dened to primarily apply to
foreign trusts per IRC § 665(c)).
49 This is assuming there is not an alternative Oregon “source”
trigger.
50 For an extensive discussion of how the trustee and family
can manipulate this, or use beneciary grantor trust status to
alternatively shift, trap, or toggle income, see The Optimal
Basis Increase and Income Tax Efciency Trust, a white
paper by Edwin P. Morrow III (Dec. 1, 2014), http://ssrn.
com/abstract=2436964, that incorporates several published
articles therein. A very early version of this paper was
presented to the Portland Estate Planning Council on March
13, 2013.
51 IRC § 677(a).
adverse parties, the existence of this power would not
trigger grantor trust status in itself under IRC § 677.
At rst glance, this kind of arrangement reminds one of
the oft-cited warnings against large lifetime gifts borne out
from Shakespeare’s King Lear. But King Lear never used
a DING trust. Had he done so, he would have avoided a lot
of grief. Here, John keeps just enough control via lifetime
and testamentary powers of appointment to make the gift
incomplete and keep the ultimate beneciaries in line,
but not so much control as to cause grantor trust status.
Retaining a veto/consent power and lifetime limited powers
of appointment and allowing the children to act without
settlor consent only unanimously gives just as much, if
not more, access to the trust than if John and Jane were
named beneciaries – as long as at least one of the children
is a Cordelia rather than a greedy Goneril or Regan.
52
In
most families, John and Jane should not fear the King Lear
effect. In my experience, most people trust their children
far more than their attorney, nancial advisor, or bank trust
department anyway.
Therefore, with a modicum of creativity, we can use a
DING to legitimately avoid Oregon taxation of trust income
except to the extent a current year’s income is distributed
52 To sum up the play, the King gave away the kingdom to two
ungrateful daughters rather than the caring one and regretted it.
Oregon Estate Planning and
Administration Section Newsletter
Editorial Board
Janice Hatton Timothy R. Strader
Philip N. Jones Vanessa Usui
John D. Sorlie Michele Wasson
Questions, Comments, Suggestions
About This Newsletter?
Contact: Sheryl S. McConnell,
Editor-in-Chief
(503) 857-6860 [email protected]
Disclaimer
The articles and notes in the Oregon State Bar Estate
Planning and Administration Section Newsletter may
contain analysis and opinions that do not necessarily
reflect the analysis and opinions of the Newsletter Editor-
in-Chief, the Editorial Board, the Estate Planning Section
Board or the membership of the Estate Planning Section.
It is the responsibility of each practitioner to perform
their own research and analysis and to reach their own
opinions.
Estate Planning and Administration Section September 2015
Page 12
via K-1 to an Oregon resident beneciary. A domestic asset
protection trust statute is recommended for such DINGs to
avoid grantor trust status, since any potential for creditor
access to ordinary self-settled trusts would lead to a nding
of grantor trust status. Washington State, though it has no
income tax, is not a good candidate for such a trust’s situs
due to its lack of clear creditor protection through a DAPT
statute.
53
However, while there are dozens of DING PLRs on the
books now, some practitioners may be nervous about drafting
such trusts. After all, if the tax law were obvious, some
would argue, there would not be so many people seeking
PLRs! While many attorneys are comfortable drafting such
trusts based on the reasoning and statutes/regulations cited in
the PLRs, some may not be. Are there other options?
Completed Gift Non-Grantor Trusts
With $5.43 million of federal exclusion, potentially
double for married couples, some clients may not care about
using up some of their estate/gift exclusion. Using completed
gift trusts may have the double benet of leveraging the gift
and estate tax exclusion, removing growth from the federal
estate tax base and potentially saving up to 16% in Oregon
estate tax as well.
To create a completed gift non-grantor trust, you simply
use a DING without the features that make the gift
incomplete (or alternatively, remove or add provisions in
a standard irrevocable grantor trust that make the trust a
grantor trust). This would mean removing settlor limited
powers of appointment, veto powers, powers of substitution,
and the like and keeping the adverse party distribution
structure for any distributions to the settlor and/or spouse
to avoid grantor trust status.
S
ome practitioners would feel more comfortable with
completed gift trusts as being less “cutting edge” or
susceptible to an adverse ruling. And, they would certainly
have additional state and/or federal estate tax benets in
many cases. However, completed gift trusts would potentially
be wasteful of exclusion to the extent funds were eventually
returned to the settlor/spouse’s estate tax base, and it would of
course be limited to the amount of exclusion available. There
may be ways to leverage such amounts, such as Crummey
powers, GRAT pourovers, and the like, but these are beyond
the scope of this article. Sufce it to say that both incomplete
gift trusts and completed gift trusts may be useful to clients.
For those mere single-digit millionaires
with estates well
53 See Ohio Rev Code § 5805.06(B)(3) (discussed in greater
detail in 2013 OSBA Annual Conference on Wealth Transfer
Planning CLE material, with comparisons between DAPTs
and Power Trusts).
under $10.86 million, the
completed gift trust option is
more viable, and has many other uses.
54
When Non-Grantor Trusts Are More Efficient for
Federal Income Tax Regardless of State
Although trusts reach the highest 39.6% bracket and
3.8% surtax bracket at only $12,300, if settlors are otherwise
in that same bracket (or perhaps merely close), there
are features that make non-grantor trust taxation more
attractive. Despite the Supreme Court’s decision in Knight,
there is still the opportunity for trustees to avail themselves
of better above the line deductions than individuals.
55
For those charitably minded, there is even more benet.
Deductions for gifts to charity from a trust’s gross income
are not limited to U.S. domestic charities, they are not
subject to any AGI limitation, and they are not subject to
Pease limitations.
56
Furthermore, they are eligible for a
one-year look back. Imagine if we could make a donation
in December of 2015 and make it count against our 2014
income! Furthermore, they can be limited to coming from
higher income rate categories provided the provision has an
economic effect.
57
More importantly, there is a far superior opportunity
to shift income to beneciaries in lower tax brackets. For
example, if a distribution is made carrying out capital gains
or qualied dividends to a beneciary in one of the lower
tax brackets, their federal tax rate on this income is 0%.
This threshold is higher than many people think, e.g., for
a married beneciary ling jointly, this bracket is up to
$74,900 taxable income (which is after deductions, so this
may be a much higher AGI or gross income). Thus, if the
trust makes distributions of $28,000 to three children in
such lower brackets, the $84,000 passes gift tax free due to
the annual exclusion (assuming the settlor and spouse gift
split), and shifts $84,000 to children in a 0% tax bracket.
In practical effect, there is a tax deduction for annual
exclusion gifts to the kids.
There are even greater advantages that may be had
using a charitable remainder trust as an appointee of trust
distributions because it can defer income much more
efciently than individual contributions to charitable trusts.
Non-grantor trusts can also be used to achieve installment
sale treatment for a sale of certain assets, provided the non-
grantor trust does not in turn sell the same asset for at
least two years.
58
However, there are signicant traps for
54 E.g., see Edwin P. Morrow III, The Upstream Optimal Basis
Increase Trust, CCH Estate Planning Review, May 2014.
55 IRC § 67(e).
56 Pease limitations do not apply to non-grantor trusts and
estates. IRC § 68(e).
57 For a more extensive discussion, see other DING/OBIT CLE
materials from author cited herein.
58 IRC §453
Estate Planning and Administration Section September 2015
Page 13
the unwary for depreciable or amortizable assets and pass
through entities that are beyond the scope of this article.
Conclusion
To summarize, establishing a non-grantor, non-resident
trust in the manner contemplated in the rst part of this
article can legitimately avoid 9.9% Oregon income taxes
on traditional portfolio income, including capital gains
and including sales of closely held C corporations, income
from pass-through entities owning out-of-state property or
out-of-state businesses, or proceeds of pure ‘stock sales’ of
S corporations, LLCs, and LPs, provided they are manager-
managed.
The use of either completed or incomplete gift non-
grantor trusts as discussed above has signicant asset
protection, family management, and even federal income
tax benets for taxpayers with income above the highest
income tax bracket. For anyone not in the highest two federal
tax brackets, income trapped in trust at the highest income
tax bracket (starting at only $12,300 of taxable income) is
too high a price to pay to make any trust strategy avoiding
Oregon income tax worthwhile. The clients for whom such
a strategy is most useful are those wealthy enough to have
signicant annual income above the highest federal tax
bracket – over half a million dollars – or who anticipate
future income to be well over that due to anticipated
capital gains or other windfall. Oregonians in this category
typically have a second residence in Washington, Florida, or
elsewhere, so perhaps such techniques can entice them from
changing their domicile completely.
