Let’s take a closer look at what happens to the IRA account. The IRA was $2 million at the time of her death. This is reduced by the excess accumulations tax of $148,831. If we assume the federal estate and state death taxes are divided proportionately between the IRA and the remainder of her estate, the death taxes attributable to the IRA are $742,827 and $168,493. In addition, the IRA creates an excess accumulations tax of $148,831 (based on a Sec. 7520 rate of 7.8 percent) and income taxes of $472,981. The income tax is payable in the tax year following the year of the decedent’s death (the result of the recalculation method for determining the IRA minimum distribution chosen by Mrs. Adams). The inefficiency of the IRA as an inheritance is demonstrated by the following table:

IRA balance at death		$2,000,000
Less excess accumulations tax	($148,831)
Federal estate tax	($742,827)
State death tax	($168,493)
Income tax on IRA		($472,981)
Total reduction		$1,533,132
Net value of IRA for heirs		$466,868
Percentage of IRA passing to heirs		23.3

Mrs. Adams' estate shrinks by just over 54 percent, but her IRA shrinks by more than 76 percent (with taxes fairly proportioned). What’s more, her IRA account balance will be subject to income taxes (compressed into the highest marginal bracket) in the year following the year of her death since she elected to recalculate life expectancy when determining her minimum required distribution.

At first glance, this result looks horrible. However, we need to remember that Mrs. Adams probably accumulated far more in her qualified plan account than she would have been able to accumulate in a taxable investment alternative. She probably took advantage of years of before-tax contributions and tax-deferred buildup in her qualified plan. Her family is probably better off in spite of the "triple tax." However, her heirs may not view the final result as a "victory."

General Guidelines Concerning Retirement Distribution and Estate Planning Choices. Although the estate planning implications for qualified retirement plans create some complex choices, there are several general rules to follow. The good news is that the standard choice of naming the surviving spouse as designated beneficiary and choosing a joint life payout will probably be the optimal choice in more than 90 percent of the cases.

In most retirement plans, a participant will be given annuity options. An annuity is a form of payout guaranteed for life or, in the case of a qualified joint and survivor annuity (QJSA), for the joint lives of a husband and wife. In other plans, the participant may have the choice of a lump-sum option or have an account balance that can be rolled over to an IRA. If income tax deferral is the goal, the rollover option generally provides the best alternative.

Generally, an individual must begin drawing from a pension plan or IRA no later than April 15th of the year following the tax year in which he or she attains age 70 1/2. The beneficiary designation for the account balance must also be made at this time. In advising your clients on how to take retirement plan distributions and selecting a beneficiary for their retirement plan, keep in mind the following general rules:

• Check the retirement provisions of the specific plan. Not all options are available in every plan.
• The financial needs of the participant, his or her spouse, and other heirs should be the primary concern.
• The income tax issues regarding the type of distribution option selected are more immediate and usually outweigh the estate planning issues. Thus, when in doubt, defer as long as possible or practical.
• The best choice for income tax deferral (annual recalculation of life expectancy) while the participant and/or his or her spouse are alive will create the worst income tax result after their deaths, since the remaining life expectancy will be zero after the second death. Thus as in the earlier example of Mrs. Adams, the income tax problem is immediate.
• A designated beneficiary should be selected. This will usually provide the longest income tax deferral. The participant’s spouse or other family members can be designated beneficiaries; the individual’s estate or trust cannot unless some special planning (discussed later) has been performed.
• Decisions about the retirement plan are extraordinarily complex (even in the context of the tax laws) and should not be made without appropriate professional advice. If you don’t stay on top of the subject, you may consider referring to a specialist.

Factors That Affect the Choice of Beneficiary. Most married individuals will designate their spouses as beneficiaries of their retirement plans. Many retirement plan participants will need to provide for the nonparticipant spouse from the retirement plan since the other family assets will be insufficient to provide a comfortable retirement. Furthermore, there may be no choice in many types of qualified retirement plans. The Retirement Equity Act (REA) stipulates in many instances that a married individual covered by a qualified pension plan must provide his or her spouse with a qualified joint and 50 percent survivor annuity. This survivor annuity can be avoided only with the nonparticipant spouse’s consent. The REA rules do not apply to IRAs, SEPs, or Sec. 403(b) plans. For qualified plans that permit rollovers to an IRA, the participant’s spouse must generally consent to a rollover. The IRS recently released Notice 97-10 providing much needed explanations of a plan participant’s spouse rights in a qualified plan and sample language for the waiver of a QJSA.

A married individual’s decision to consent to a distribution different from a QJSA will depend on several factors. First, the surviving spouse must have sufficient funds outside of the retirement plan to provide for the remainder of his or her retirement. Quite often, these funds could come from life insurance, a far superior vehicle for funding inheritances than the retirement plan account balance. "Pension maximization" employs the technique of choosing a larger single life payout from a retirement plan and using some of the extra cash to buy life insurance for the surviving spouse as a replacement fund.

Second, the participant could have another beneficiary who would be the appropriate choice from a personal and tax standpoint. For example, the plan participant may have children from a prior marriage that would be his or her first choice for designated beneficiary.

Third, the income and estate tax consequences of a retirement distribution choice must be carefully considered. The choice of the designated beneficiary has the following important tax consequences:

• The choice of designated beneficiary will affect the size of the minimum distribution if a joint and survivor option is selected.
• The income tax deferral available to the heirs depends on the selection of the designated beneficiary.
• The availability of the marital deduction and the ability to defer the excess accumulations tax until the second death depends on the selection of the spouse or the appropriate marital trust as the designated beneficiary.

Unique Tax-Deferral Options of Naming the Spouse as Designated Beneficiary

Income Tax Issues. Naming the spouse as designated beneficiary of the IRA offers income-tax-deferral options. First, the minimum distribution requirements at age 70 1/2 provide for a longer payout period if the joint life expectancy of the married couple is used. The required payout period is 16 years for one life at age 70 but much longer if two lives are used. For example, it is 26.2 years if the participant’s spouse is 10 years younger and a joint life payout is selected. Thus the income taxes on the account balance are spread over a longer period. In addition, if the surviving spouse is the designated beneficiary, he or she can roll over the account balance to his or her own IRA and delay distributions until he or she attains age 70 1/2. This gives more flexibility for deferral, particularly if the beneficiary-spouse is significantly younger. Better yet, the surviving spouse can name a new designated beneficiary of the rollover IRA (such as the couple’s child or children). This permits the family to further defer the income taxes since the minimum required distributions can be taken over a new joint-life payout.

Example: Suppose Mr. Jones, aged 68, is married to Mrs. Jones, aged 55, and has a large account balance in his IRA rollover. They have one child, Mitch, aged 35. If Mr. Jones dies this year and has designated Mrs. Jones as the beneficiary of the IRA, she can create her own IRA and roll over his account balance to her IRA. She will not have to take distributions from this IRA until she is age 70 1/2, or in about 16 years. She could then designate her child as sole beneficiary of the IRA and choose a joint-life payout. Her minimum required distributions would then be based on the joint life expectancy of herself and her child. However, the minimum distribution rules permit only a maximum 10-year differential between joint-life expectancies if the beneficiary is not the participant’s spouse. Thus a 26.2 year payout can be chosen. If Mrs. Jones dies before the balance is withdrawn and has not recalculated life expectancy, Mitch can spread the remaining payments over his actual life expectancy. Of course, this wonderful flexibility to defer income on the IRA presumes that the Jones family will not need sooner or larger distributions.

Estate Tax Issues. For estate tax purposes, the estate tax marital deduction will defer estate taxes until the second death (on any plan assets remaining at that time) if the designated beneficiary of the retirement plan is the surviving spouse. In addition, the estate of the participant can elect to defer the excess accumulations tax until the second death under these circumstances.

Marital Trust As Potential Beneficiary

Generally, a marital trust should be designated as the beneficiary only when the participant has an asset-protection goal. That is, the participant either (1) desires a trustee of the marital trust to control the management of the retirement plan account or (2) wants to preserve as much as possible of the principal of the retirement plan account for the next generation. For example, the participant may have children from a prior marriage. Using a marital trust as the designated beneficiary of the retirement plan will provide retirement income for the new spouse, but guarantee that the remaining retirement account balance will be distributed to the children at the surviving spouse’s death.

The use of the marital trust adds significant complexity and may remove flexibility. In a pure QTIP trust, the principal will be protected from unlimited invasion by the surviving spouse. Thus the participant will be able to name the remainder beneficiaries of the IRA and preserve as much principal as possible for these heirs. However, the surviving spouse will not be able to roll over the account to his or her IRA. The rollover potential is foreclosed unless the surviving spouse has sufficient control over the IRA to treat it as his or her IRA for rollover purposes. This type of control is not normally provided in a QTIP trust. In fact, such control is contrary to the asset-protection goal. For example, a recent private ruling (Ltr. 9608036) permitted rollover if the surviving spouse has a general power of appointment over the marital trust. Other private rulings (most recently, Ltrs. 9703036 and 9620038) have permitted rollover treatment when the IRA was payable to the estate, which could include testamentary trusts not qualifying for rollover, but the surviving spouse as executor had the power to allocate the IRA balance to an outright marital bequest. In either of these instances, the surviving spouse could invade the IRA at his or her discretion. Thus the participant had to forego the asset-protection goal to achieve the rollover potential.

A QTIP trust as beneficiary of the IRA will qualify for the marital deduction if the requirements of Rev. Rul. 89-89, 1989-2 C.B. 231 are met. The trustee must be able to compel distribution of all income from the IRA, and the marital trust should receive the greater of the actual income or the minimum required IRA distribution. The annual distribution to the QTIP must be paid to the surviving spouse. Of course, the actual income earned by an IRA with a large account balance may be greater than the minimum required distribution under the normal IRA rules. Thus the QTIP requirement to distribute actual income may cause a larger required annual distribution and some income tax deferral may be lost if the QTIP trust is used as a beneficiary. In addition, the income tax deferral potential of a rollover is unavailable.

To some degree, the investment policy for the IRA could control the amount of annual income. For example, dividends, interest, or rent is normally allocated to income, while capital gains are normally allocated to principal. The IRA forms should be adapted to provide for the determination of principal and income.

If the surviving spouse is not a citizen of the United States, the qualified domestic trust rules must be followed, and the amount of the IRA distribution treated as principal must be determined to calculate the deferred estate tax applicable (see the next section of this chapter for a discussion of the deferred estate tax for a qualified domestic trust). In any event, significant additional compliance complexity and costs are associated with the selection of the marital trust as beneficiary if the beneficiary is a noncitizen.

Estate or Unified Credit Shelter/Bypass Trust Generally Not Recommended as Beneficiary

Naming the participant’s estate or unified credit shelter trust (UCST) as the designated beneficiary of the retirement plan account balance is generally not recommended because of adverse income tax treatment. The estate and any testamentary trust (including the UCST) created under the participant’s will cannot be designated beneficiaries for retirement plan purposes. Therefore the minimum required distributions at age 70 1/2 must be based solely on the participant’s life if his or her estate or testamentary trust is the named beneficiary. This causes the income tax to be incurred over a shorter period since payout cannot be made over the life expectancy of a surviving designated beneficiary. Depending on the age of the participant at his or her death or the type of distribution selected, the beneficiaries would take the remaining balance either (1) at least as fast as the participant was taking distributions, (2) in five installments beginning in the year following the year of the participant’s death, or (3) all in the year following the year of the participant’s death (if recalculation was chosen by the participant).

In addition, the UCST should generally be designed with a goal of maximum growth since it is a bypass trust and estate taxes are not imposed on this trust until the next generation. Funding the trust with retirement plan assets will shrink the growth by the income taxes that the UCST will incur on these retirement assets. Thus it is usually recommended that the UCST be funded with retirement plan assets only if there are no other estate assets available and only if the estate tax savings outweigh the adverse income tax consequences. One option may be to use the UCST as a disclaimer option if the surviving spouse and his or her advisers think this would be an appropriate postmortem choice.

Living Trust Can Be Designated Beneficiary

It is possible to designate a living trust, perhaps designed to use the marital deduction or unified credit, as beneficiary of the retirement plan assets. If the requirements of proposed Treas. Reg. Sec. 1.401(a)(9)-1 (Q&A D-5(a)) are met, a trust beneficiary can qualify as a designated beneficiary. Thus the beneficiary’s life expectancy can be used to determine the payout after the death of the participant. Of course, if the trust is a marital trust, the greater of the minimum distribution or the actual income must be paid to the spouse.

The proposed regulations give the following requirements for the living trust:

• The beneficiaries of the trust who are beneficiaries of the participant’s retirement benefits are identifiable from the trust document.
• The trust is a valid trust under state law.
• The trust is irrevocable at the later of the time it is designated as the beneficiary or the participant’s attainment of age 70 1/2.
• A copy of the trust is given to the plan administrator or custodian of the IRA.

Several private rulings have approved variations of this living trust beneficiary designation. Thus a living marital or UCST can be named as the designated beneficiary and the age of one of the trust beneficiaries can be used to determine the minimum distribution under a joint life payout option. One interesting question is whether the plan participant can change the beneficiary designation from the trust after reaching age 70 1/2. The living trust must be irrevocable at that time, but maybe the flexibility to change the beneficiary is not forgone.

Charitable Giving and Retirement Plan Benefits

A charity can be the beneficiary of a retirement plan, even though the plan account or an IRA is generally nonassignable. The charity makes an appropriate beneficiary if two circumstances coincide: First, the participant has a desire to benefit a charity. Second, the income and estate tax benefits from the charitable gift are important to the client.

The designation of a charity or a charitable remainder trust (CRT) solves several of the tax problems discussed above, and for this reason, it will probably be better to fund a charitable gift with retirement plan assets than with other family assets. If these tax problems are mitigated, the family, the charity, or both will receive greater net inheritances than if non-IRD assets are used to fund the charitable bequest.

If a charity or CRT is the named beneficiary, the following tax consequences occur:

• The estate receives a charitable deduction for the amount passing to charity.
• The charity or CRT is tax exempt, and the IRD may be avoided (or deferred if a CRT is the beneficiary). The excess-accumulations tax is not avoided.

Example: Suppose Mrs. Adams, from our previous example, would like to leave $2,000,000 to The American College. You will recall that her $6 million estate consisted of a $2 million IRA account balance and $4 million of non-IRD items. If she designates The American College as the beneficiary of her IRA and apportions all taxes and expenses to her residuary estate, The American College gets $2 million and her heirs receive $2,285,026. If she left the IRA to her children and made a bequest of $2 million of non-IRD items to The American College, the College would still receive its $2 million; however, her children would only receive $1,814,903. This result is far worse since the income tax on the IRA is not avoided. See chapter 14 for more details of this computation.

The use of a CRT solves a problem created by the recalculation method of determining the minimum required distribution. Suppose a participant named his or her surviving spouse as the beneficiary and elected a QJSA with recalculation. At the second death, the entire remaining balance is subject to estate taxes within 9 months and income taxes on the IRD in the year following the survivor’s death. By naming a testamentary CRT as the remainder beneficiary, the retirement assets will be payable to a tax-exempt trust. Thus the IRD is not immediately taxable.

If the married couple names their children as the CRT’s noncharitable annuity or unitrust payment recipients, the IRD can be spread over the lifetime(s) of the noncharitable beneficiaries, an alternative not available without the charitable donation. What’s more, an estate tax deduction is available for the remainder interest passing to charity.

Example: Suppose Mrs. Adams, from our previous example, did not want to deprive her children of the use of the IRA during their lifetimes, but still wanted to make a substantial gift to The American College. She could designate a testamentary charitable remainder trust (CRT) as the beneficiary of the IRA. Her children would receive an annual distribution equal to 6 percent of the annual value of the CRT’s principal, (payable at the end of the year) for the remainder of their lives. The American College would receive the balance of the principal at the death of the survivor of her children. In this scenario, her estate would receive a charitable deduction of $291,140, saving her estate $160,127 in state and federal death taxes. What’s more, the income taxes on the IRA would not have to be taken until her children received their annual payments form the CRT. The actuarial value of their payments would be $1,708,860, providing them with substantial funds for the remainder of their lives.

Where Can I Find Out More?

• HS 334 Fundamentals of Estate Planning II. The American College.
• "Estate Planning: The Cutting Edge," Workbook and tape. The American College. Phone (610) 526-1449.
• Kenneth A. Hansen. "Estate Planning for IRA and Qualified Plan Distributions," Taxation for Accountants, May 1996.
• Robert S. Schwartz. "Estate and Income Tax Planning for IRA and Qualified Plan Accounts," The Practical Tax Lawyer, summer 1995.

Estate Planning for Non-U.S. Citizens and Their Spouses
Ted Kurlowicz

What Was the Situation Before?

The federal estate tax is imposed on the entire taxable estate of a decedent who is a resident of the United States at the date of death. This is true even in a situation in which such individual was not a U.S. citizen at the date of death. Prior to the enactment of the Technical and Miscellaneous Revenue Act of 1988 (TAMRA) transfer to a resident-alien spouse would generally avoid estate tax because of the availability of the unlimited federal estate tax marital deduction and the unlimited federal gift tax marital deduction. The key point is that prior to the enactment of TAMRA, these deductions were equally available for transfers to spouses who were U.S. citizens and to resident aliens.

The legislative history of TAMRA makes clear that Congress was concerned about situations involving a non-U.S.-citizen surviving spouse returning to his or her homeland following the death of his or her spouse without ever paying federal estate tax on the marital property. Sec. 2056(d) was enacted as part of TAMRA to deny the federal estate tax marital deduction if the surviving spouse is not a U.S. citizen. The effective date of this provision was November 10, 1988. TAMRA also added Sec. 2056A that provided an estate tax deferral if assets transferred to a noncitizen surviving spouse were placed in a qualified domestic trust (QDOT). The Revenue Reconciliation Act of 1989 (RRA 89) made technical corrections to TAMRA with respect to the changes brought about on the estate and gift tax treatment of transfers to noncitizen spouses. The Revenue Reconciliation Act of 1990 (RRA 90) made further modifications. Finally, some proposed regulations were issued by the Treasury on December 31, 1992, to further explain the statutory changes. However, many items were unexplained or unclear, particularly with respect to security rules required for the collection of deferred estate taxes by a QDOT’s trustee.

What Is the Nature of the Change?

Final regulations were issued on August 21, 1995, on many of the issues formerly addressed in the proposed regulations mentioned above. Some new proposed and temporary regulations were issued at that time concerning some of the rules relating to the bond or security requirements for QDOTs. Final regulations on the security requirements were issued December 29, 1996.

The first rule to remember is that these new rules apply to transfers to the noncitizen spouse. Transfers from the noncitizen spouse to the citizen spouse are treated with the same exclusions, deductions, and credits available to transfers between spouses who are both citizens. The two sets of new regulations clarify and add compliance and drafting requirements for transfer to the noncitizen spouse, particularly with respect to transfers to a QDOT.

What Are the Gift Tax Changes?

The status of the donor is immaterial for this portion of the discussion. What is pertinent to the changes in the gift tax rules is that the donee is a noncitizen; the donor could be a citizen, a resident alien, or a nonresident alien.

No gift tax marital deduction is available for gifts to a noncitizen spouse. However, as the discussion below indicates, the new rules do borrow some of the traditional marital-deduction rules.

Super Annual-Exclusion Gifts. The gift tax annual exclusion is raised for transfers to a noncitizen spouse from $10,000 to $100,000. It gets complicated here since both the annual-exclusion and marital-deduction rules apply. The usual annual-exclusion rules requiring a present-interest gift apply to the transfer to the noncitizen spouse. The annual exclusion requires (1) an outright transfer in property, (2) a current income interest in a trust, or (3) that a "Crummey" withdrawal power over a transfer in a future interest trust be provided for the resident-alien spouse. Otherwise, no exclusion will apply to the gifts since neither the regular nor super gift tax annual exclusion is applicable and the donor spouse’s unified credit will be wasted. It appears from the regulations that gifts made between August 14, 1988, and June 29, 1989, must meet only the annual-exclusion and not the marital-deduction rules to qualify for this special $100,000 exclusion.

For lifetime gifts to a resident-alien spouse after June 29, 1989, the normal marital-deduction rules have to be followed for a gift to qualify for a super annual exclusion. However, the new regulations diverge somewhat from, and are not as broad as, the marital-deduction rules for gifts to a citizen spouse. The following types of transfers will qualify for the super annual exclusion: (1) outright transfers to the noncitizen spouse and (2) a life income interest in a trust coupled with a testamentary power of appointment (a power of appointment trust). The latter will qualify for the super annual exclusion to the extent of the actuarial value of the income interest. However, the regulations indicate that a gift to an inter vivos QTIP or estate trust will not qualify.

Qualified Plan Implications. The transfer of the qualified survivor annuity (the required default election under the qualified plan rules) from a qualified retirement plan will qualify for an unlimited marital deduction despite the general prohibition of these rules. Presumably, it makes no difference for tax revenue whether or not the nonparticipant surviving spouse is a citizen to avoid gift taxes on the creation of a survivor annuity.

Creation of a Joint Tenancy in Real Estate. There are special rules for the creation of joint tenancies or tenancies by the entireties where one spouse is not a citizen. The rules mysteriously refer to a now-repealed Code section (Sec. 2515) and the regulations thereunder. (Presumably, tax history is more significant to the IRS than it is to the rest of us.) Note that the joint tenancy rules discussed here apply to the gift tax treatment of the creation and termination of the property interest.

The creation of a joint tenancy with rights of survivorship or a tenancy by the entireties will result in a gift when one tenant contributes more than one-half the consideration. Normally, this is not an issue between spouses because of the unlimited marital deduction. However, there is no gift tax marital deduction when the donee spouse is a noncitizen. The creation of a joint tenancy in real property after August 13, 1988, that would otherwise be a gift is not treated as a gift if the donee spouse is a noncitizen. However, the gift is merely deferred until the property interest is severed or the donee spouse dies. The termination of a joint tenancy in real property created after August 13, 1988, may result in a gift if the donee resident-alien spouse gets too much of the proceeds on termination. A gift is made at the termination to the extent the donor spouse receives less than his or her proportionate share of the proceeds based on the portions of the initial purchase price provided by each.

Example: Suppose Dr. Dana, a citizen of the U.S., provided $150,000 to help purchase a $200,000 home in 1989. The home is a tenancy by the entireties with her husband, Mr. Dana, a resident alien, who provides the remainder of the purchase price. The home is sold in 1996 for $300,000, and the proceeds are divided equally. Dr. Dana makes a gift of $75,000 when the proceeds of the sale are divided equally since she should have received her proportionate share of $225,000 ($150,000/$200,000 multiplied by $300,000) when the home was sold. The gift on the termination of the joint tenancy should be eligible for the super annual exclusion since the transfer is an outright present interest in property when the joint tenancy in the home is terminated.

What Are the Estate Tax Changes?

The normal marital-deduction rules provide that transfers at death to a surviving spouse who is a U.S. citizen qualify for the unlimited estate tax marital deduction. The major change brought about by TAMRA generally disallows the marital deduction for transfers to a noncitizen surviving spouse. Although the new regulations are voluminous, this discussion will try to focus on the most important implications. Basically, there are a couple of possibilities to salvage the marital deduction, or at least to defer estate taxes where the surviving spouse is not a U.S. citizen. The surviving spouse could choose to become a citizen on a timely basis following the death of the spouse who leaves assets to such spouse, or the assets transferred to the surviving spouse by the decedent could be transferred to a qualified domestic trust (QDOT).

The Surviving Spouse Becomes a U.S. Citizen. The normal unlimited marital deduction rules will apply if the surviving spouse becomes a U.S. citizen on a timely basis. The new regulations clarify this procedure. The surviving spouse must become a citizen before the estate tax return is made and must have been a resident of the U.S. at all times after the deceased spouse’s date of death and before becoming a citizen. An early return is considered filed on the last date that the return is required to be filed (including extensions), and a late return filed at any time after the due date is considered filed on the date that it is actually filed.

It has been suggested that it may be practically impossible to attain citizenship within the 15 months (the normal due date of the estate tax return including extensions) following the decedent’s death. There are a couple of potential solutions. One solution would be to file late and apply for "reasonable cause" relief from late filing and payment penalties for the purposes of Sec. 6651, if the survivor decides to begin naturalization proceedings but it appears unlikely that the process can be completed on time. Another possibility is to qualify the transfers to the surviving noncitizen spouse for the estate tax deferral under the QDOT rules and then begin (or continue) the naturalization proceedings.

Estate Tax Deferral through the Use of a QDOT. An estate tax deferral was made possible by TAMRA for transfers to a QDOT for the benefit of a surviving noncitizen spouse. This estate tax deferral is not the same as (it is generally worse than) the traditional unlimited marital deduction and provides rules for a deferred estate tax to be paid by the decedent-spouse’s estate.

A QDOT can be established in one of two manners. First, it can be created by the transferor spouse as a testamentary marital trust contained in a will or funded at the death of the transferor spouse through the provisions of a living trust. Thus in this instance the QDOT is the traditional marital trust with the addition of the new QDOT drafting and administrative requirements. The other choice is for the QDOT to be created postmortem by the surviving noncitizen spouse or the executor of the deceased spouse’s estate.

Some of the requirements for a QDOT created by the transferor spouse as a testamentary transfer device differ from the requirements for a QDOT created postmortem solely to avoid the prohibition of the marital deduction. The QDOT created by the deceased spouse’s will must meet the usual rules for the marital- deduction trust contained in Sec. 2056. Thus a QTIP, power of appointment, or estate trust may be selected. Or, a charitable remainder trust, in which the surviving noncitizen spouse will be the only noncharitable beneficiary, will qualify as a QDOT. A QDOT created postmortem does not have to meet the normal marital- deduction rules. However, to be effective, the postmortem QDOT must be created prior to the time the return is due and the QDOT election must be made. All QDOTs must generally meet the following requirements:

• Initially, it was required to be a U.S. trust. The regulations now provide that the trust can be created in a foreign jurisdiction but must be maintained and governed by the laws of a U.S. state or the District of Columbia. (The QDOT is maintained in a state if the records, or copies thereof, are kept in the state). In the case of a foreign trust, the instrument must specify the U.S. state as the governing law of choice. This gives significant flexibility in choosing the most favorable state’s trust law.
• The trust must qualify as an ordinary trust under the rules of the regulations for entity tax classification.
• The QDOT must satisfy the trustee security rules.

If the QDOT created by the decedent does not qualify, it can be salvaged by a judicial reformation. The regulations provide that the property interest is treated as passing to the surviving spouse in a QDOT if the trust is reformed, either in accordance with the terms of the decedent’s will or trust agreement or pursuant to a judicial proceeding, to meet the requirements of a QDOT. A reformation made pursuant to the terms of the decedent’s will or trust instrument must be completed by the time prescribed (including extensions) for filing the decedent’s estate tax return. A reformation pursuant to a judicial proceeding is permitted under these rules if the reformation is commenced on or before the due date (determined with regard to extensions actually granted) for filing the estate tax return, regardless of the date that the return is actually filed.

Assignment of Property to a QDOT. The QDOT rules provide for the deferral of estate taxes for property left by the deceased spouse to the QDOT. However, what about transfers made to the surviving spouse that are not transferred to a marital trust? The new rules permit the surviving spouse to achieve the estate tax deferral by assigning or transferring such assets to a QDOT prior to filing the decedent’s estate tax return. If no other property, other than the property passing to the noncitizen, is transferred to the QDOT, the QDOT need not be in the form of a marital-deduction trust. However, it is important to note that the survivor will be considered the transferor of the property transferred or assigned to the QDOT for all tax purposes (other than qualifying for the QDOT). Thus care should be taken to avoid making completed gifts of the remainder interest in the QDOT or immediate gift taxes may result.

Example: Dr. Richards left all of his $2 million estate outright to his wife, Mrs. Richards, who is not a citizen of the United States. Mrs. Richards would like to inherit the wealth, but would like to defer the estate taxes on this transfer. She creates a QDOT and makes the election on a timely filed estate tax return for her husband’s estate. She transfers approximately $1.4 million of the inherited estate to the QDOT and leaves approximately $600,000 outside of the QDOT to be sheltered by her husband’s unified credit. How should the QDOT be designed? If a traditional QTIP is selected, she will receive all income from the QDOT and the remainder will go to their children. However, if the QDOT is irrevocable, she will have completed a gift of the remainder interest to the children when the property is transferred to the QDOT. Thus the actuarial value of the remainder (determined by her age and the Sec. 7520 rate) will be a taxable gift from her to her children. (Note: The new regulations exempt this type of transfer from the rules of Sec. 2702.) To avoid a taxable gift, she could retain the right to revoke or invade the principal of the QDOT and make the transfer of the remainder incomplete, and thus not a gift, until the time of her death.

What assets can be assigned to a QDOT? Virtually anything that passes to the surviving noncitizen spouse can be transferred or assigned. Certainly, outright bequests to the surviving will qualify for transfer to a QDOT. Life insurance benefits payable to the survivor, or joint property received by operation of law can also be transferred to the QDOT by the executor or the surviving spouse. In addition, the assignment rules permit the flexibility to be creative. The surviving spouse can choose to assign assets to a QDOT based on a pecuniary or other formula to mirror a traditional marital-deduction unified-credit-shelter trust arrangement. The regulations provide the details for such a formula assignment.

Example: Under the terms of Decedent’s will, the entire probate estate passes outright to Survivor. Prior to the date Decedent’s estate tax return is filed and before the date that the QDOT election must be made, the surviving noncitizen spouse establishes a QDOT and such survivor executes an irrevocable assignment to the QDOT equal to "that portion of the gross estate necessary to reduce the estate tax to zero, taking into account all available credits and deductions."

Assignment of Retirement Plan Assets. What about the assignment of retirement accounts and annuities? Retirement plan assets require special consideration. The retirement plan cannot be overlooked for the purposes of planning the client’s estate. The beneficiary designation should be formed in conjunction with, and with all the due care that goes into the preparation of, the wills and trusts. In many instances, it is even more important because the retirement plan assets may dwarf the size of the probate estate.

Individual retirement annuities are generally not assignable. However, the new regulations provide for the ability to defer taxes on retirement plan assets left to the noncitizen spouse irrespective of the nonassignability of such assets. In the case of a retirement plan, annuity, or other arrangement that is not assignable or transferable (or is treated as such), the property passing under the plan from the decedent is treated as meeting the requirements of the QDOT estate tax deferral rules if either of the following two requirements are met:

• First, the surviving noncitizen spouse could agree to pay the deferred estate tax on principal distributions from the IRA as they are received each year as part of the retirement plan or IRA distributions.
• Second, the principal portion of a distribution or an annuity payment could be rolled over to a QDOT to defer the estate tax.

These new rules for the assignment of the retirement plan assets or IRAs provide for significant complexity (in addition to the already complex minimum-distribution rules) and the regulations must be followed carefully. The regulations provide model forms for the assignment for both of the options discussed above.

In addition, the principal portion of retirement plan or IRA distributions must now be determined to meet either of these options. The principal portion of each nonassignable annuity or other payment is determined in accordance with the following formula:

        

The total present value of the annuity or other payment is the present value of the nonassignable annuity or other payment as of the date of the decedent’s death, determined in accordance with the interest rates and mortality data prescribed by Sec. 7520 (which generally provides valuation discount rates and mortality tables).

Example: At the time of Decedent’s death, Decedent is a participant in an employees’ pension plan described in Sec. 401(a). On Decedent’s death, Decedent’s spouse, Survivor, a noncitizen, becomes entitled to receive a survivor’s annuity of $72,000 per year, payable monthly, for life. At the time of Decedent’s death, Survivor is aged 60. Assume that under Sec. 7520, the appropriate discount rate to be used for valuing annuities in the case of this decedent is 7.4 percent. The annuity factor at 7.4 percent for a person aged 60 is 9.3865. The adjustment factor for monthly payments at 7.4 percent is 1.0335. Accordingly, the right to receive $72,000 a year on a monthly basis is equal to the right to receive $74,412 ($72,000 x 1.0335) on an annual basis.

The principal portion of each annuity payment received by Survivor is determined as follows: The first step is to determine the annuity factor for the number of years that would be required to exhaust a hypothetical fund that has a present value and a payout corresponding to Survivor’s interest in the payments under the plan:

Present value of survivor’s annuity:
$74,412 x 9.3865 = $698,468

Annuity factor for expected annuity term:
$698,468/$74,412 = 9.3865

The second step is to determine the number of years that would be required for Survivor’s annuity to exhaust a hypothetical fund of $698,468. The term-certain annuity factor of 9.3865 falls between the annuity factors for 16 and 17 years in the 7.4 percent term-certain annuity table. Accordingly, the expected annuity term is 17 years.

The third step is to determine the principal amount by dividing the expected term of 17 years into the present value of the hypothetical fund as follows:

Principal amount of annual payment:
$698,468/17 = $41,086

In the fourth step, the principal portion of each annuity payment is determined by dividing the principal amount of each annual payment by the annual annuity payment as follows:

Principal portion of each annuity payment:
$41,086/$74,412 = .55

Accordingly, 55 percent of each payment to Survivor is deemed to be a distribution of principal. A marital deduction is allowed for $698,468, the present value of the annuity as of Decedent’s date of death, if either (1) Survivor agrees to roll over the principal portion of each payment to a QDOT or (2) Survivor agrees to pay the tax due on the principal portion of each payment.

When and How Is Tax Imposed on a QDOT? Unfortunately, the QDOT is unlike a true marital-deduction transfer in that the tax ultimately paid will be based on the decedent-spouse’s estate tax bracket as if included in his or her estate at that time. A new system of deferred estate tax is applicable on various distributions from a QDOT. An estate tax is imposed on the occurrence of a taxable event. The following four events can trigger an estate tax on QDOT assets:

• Any distribution made prior to the surviving spouse’s death—other than (1) income to the surviving spouse or (2) a distribution to the surviving spouse on account of hardship—will trigger an estate tax.
• At the surviving spouse’s death the entire value of the property in the QDOT at that time will be subject to federal estate tax.
• An estate tax is imposed anytime the QDOT fails to meet any QDOT requirements.
• The payment of the deferred QDOT tax upon the first of the above triggering events (even if the U.S. trustee withholds such tax) is considered a taxable distribution that sets off yet another tax. In other words, the QDOT’s payment of the deferred estate tax on a distribution is itself a distribution (equal to the amount of the tax) subject to a further estate tax.

The regulations provide normal definitions of principal and income. However, only nonhardship definitions of principal trigger a tax. A distribution is treated as being made on account of hardship if the distribution is made to the spouse from the QDOT in response to an immediate and substantial financial need relating to the spouse’s health, maintenance, education, or support, or the health, maintenance, education, or support of any person that the surviving spouse is legally obligated to support. A distribution is not treated as a hardship if the amount distributed may be obtained from other sources that are reasonably available to the surviving spouse—for example, from the sale by the surviving spouse of personally owned, publicly traded stock or from the cashing in of a certificate of deposit owned by the surviving spouse. Fortunately, assets such as closely held business interests, real estate, and tangible personal property are not considered sources that are reasonably available to the surviving spouse.

Calculating the QDOT Tax. The tax payable on the occurrence of any of the four triggering taxable events discussed above is computed (in a cumulative manner similar to the tax on taxable gifts) as follows:

Step 1: State the amount of property involved in the taxable event.

Step 2: Add all previous taxable events.

Step 3: Compute the federal estate tax on the estate of first spouse to die if total of steps 1 and 2 above were included in decedent’s gross estate.

Step 4: Compute the federal estate tax on the estate of first spouse to die if only amount of previous taxable events were included in decedent’s gross estate.

Step 5: Subtract tax computed in step 4 from tax computed in step 3.

Result: Deferred estate tax imposed as result of current taxable event.

Example: Debra Decedent, a United States citizen, dies in 1996 as a resident of State X, with a gross estate of $2,000,000. Under Debra’s will, a pecuniary bequest of $700,000 passes to a QDOT for the benefit of Debra’s spouse, Donald, who is a resident but not a citizen of the United States. Debra’s estate pays $70,000 in death taxes to State X. Debra’s estate tax is computed as follows:

Gross estate                                              $2,000,000
Marital deduction                                          (700,000)

Taxable estate                                          $1,300,000
Gross tax                                                     $469,800
Less unified credit              $192,800
State death tax credit
limitation (lesser of $51,600
or $70,000 tax paid)          $ 51,600             (244,400)

Estate tax                                                      $225,400

Donald dies in 1997, at which time he is still a resident of the United States and the value of the QDOT’s assets is $800,000. Donald’s estate pays $40,000 in State X death taxes with respect to the inclusion of the QDOT in Donald’s gross estate for state death tax purposes. Assuming there were no taxable events during Donald’s lifetime with respect to the QDOT, the deferred estate tax is $ 304,800, computed as follows:

Debra’s actual taxable estate                      $1,300,000
QDOT property left at Donald’s death            800,000

Total                                                          $2,100,000

Gross tax                                                        829,800

Less unified credit                                          (192,800)

Pre-state death tax estate tax                       $ 637,000

(A) State death tax credit computation:

(1) State death tax paid by Donald’s
estate with respect to the QDOT
($40,000) plus state death
tax previously paid by Debra’s
estate ($70,000) = $110,000.

(2) Limit for state death tax credit = $106,800.

(B) State death tax credit allowable              (106,800)

Net tax                                             $530,200

Less tax that would have been
  imposed on Debra’s taxable estate
  of $1,300,000                                  225,400

Deferred estate tax on Debra’s estate          $304,800

New Security Requirements for QDOTs. Congress was concerned about the ability to collect the QDOT tax. The law generally requires that at least one trustee must be an individual who is a U.S. citizen or a domestic corporation. In addition, Congress directed the Treasury to make regulations to provide for the collection of the QDOT tax when a taxable event occurs. For the purposes of the security requirements, the new regulations create a distinction between large (over $2 million) QDOTs and small ($2 million or less) QDOTS.

A small QDOT simply needs to meet the requirement of a U.S. trustee. Thus the trustee could generally be any individual or entity residing in the U.S.

For a large QDOT, special security arrangements were deemed necessary since the potential deferred estate taxes would be larger. Alternative requirements for QDOTs with assets in excess of $2 million (determined without regard to indebtedness encumbering the assets) are as follows:

• The QDOT must require that at least one trustee be a U.S. bank or a U.S. branch of a foreign bank (provided a U.S. trustee with a tax home in the U.S. serves as cotrustee),
• The QDOT must require an individual U.S. trustee that will post a bond in favor of the IRS equal to 65 percent of value the trust assets, or
• The QDOT must require that the U.S. trustee furnish an irrevocable letter of credit issued by a U.S. bank, or a U. S. branch of a foreign bank, or by a foreign bank and confirmed by a U.S. bank in an amount equal to 65 percent of the fair market value of the trust assets.
• The IRS will consider alternative security arrangements to ensure the collection of tax if proposed by the trustee and a request for a private letter ruling is made (for example, a major law firm with substantial assets as trustee for the QDOT).

Of course, there are many special rules for computing the value of the QDOT assets to determine its status as a large or small QDOT. These rules provide additional annual compliance burdens and the regulations must be followed carefully. The following are key issues for determining the large or small status of a QDOT:

• Indebtedness can be ignored. The fair market value of the assets passing, treated, or deemed to have passed to the QDOT (or in the form of a QDOT) is determined without reduction for any indebtedness with respect to the assets in the QDOT.
• Principal residences can be excluded. The value of the surviving spouse’s home and one additional residence that is personal (that is, not rented) can be excluded up to a combined value of $600,000, including related furnishings.
• Foreign property limitation: The trust instrument must require that no more than 35 percent of the fair market value of the trust assets, determined annually on the last day of the taxable year of the trust (or on the last day of the calendar year if the QDOT does not have a taxable year), may consist of real property located outside of the United States, or the trust must meet the bank trustee, bond, or security requirements required for large QDOTs.

Miscellaneous Compliance Issues. The complexity and compliance requirements for QDOTs added by the regulations is astonishing and cannot be given full treatment here. However, the following key issues should be examined by the client’s advisers if a QDOT will be used:

• The QDOT election is irrevocable and must be made timely.
• Annual reporting statements may be required to determine the value of the QDOT and the foreign property limitation.
• A QDOT must be drafted to meet all of the new rules, including the security arrangements.
• Tax returns must be filed for events triggering a deferred estate tax. The due date for payment of the deferred estate tax imposed on distributions during the noncitizen spouse’s lifetime is April 15th of the year following the distribution. An extension of not more than 6 months may be obtained for filing Form 706-QDT. Other filings are required for hardship distributions.
• Each trustee (and not solely the U.S. trustee(s)) of a QDOT is personally liable for the amount of the estate tax imposed in the case of any taxable event. In the case of multiple QDOTs with respect to the same decedent, each trustee of a QDOT is personally liable for the amount of the deferred estate tax imposed on any taxable event with respect to that trustee’s QDOT, but is not personally liable for tax imposed with respect to taxable events involving QDOTs of which that person is not a trustee.
• For multiple QDOTs, a designated return filer can be named. The designated filer must be a U.S. trustee.
• Watch out for the retirement plan or IRA. Additional information statements must be filed with the return to select the alternate approach to receive QDOT deferral for these assets.

When Do These Changes Affect Clients?

The date for the new regulations governing the gift tax treatment of lifetime interspousal gifts to noncitizen spouses is effective for gifts made after August 22, 1995, although the denial of the marital deduction and the availability of the super annual-exclusion gift generally go back to the effective date of TAMRA.

The date for the new regulations (except for the new security requirements) governing the estate tax treatment of transfers to surviving noncitizen spouses is also effective for decedent’s dying after August 22, 1995. The denial of the marital deduction and the availability of the QDOT also generally go back to the effective date of TAMRA.

The effective date for the new security requirements is for QDOT elections made after December 9, 1996.

What Should Be Done?

Perhaps the most obvious conclusion that can be formed from the discussion of the new rules discussed above is that the QDOT approach will add incredible complexity and compliance requirements for marital transfers to the noncitizen spouse. Understanding the implications should lead to the following conclusions:

• Avoid the QDOT approach whenever possible.
• If a QDOT must be used, attempt to qualify as a small QDOT to reduce the expense of the security requirements.

How Do You Avoid the Funding of a QDOT? First, the surviving spouse could avoid the QDOT approach entirely by obtaining citizenship, which of course would have to be obtained on a timely basis. Even if the citizenship is obtained later, the QDOT can be avoided afterward and all QDOT distributions made prior to becoming a citizen will be treated as gifts by the surviving spouse. Such gifts can be sheltered by the surviving spouse’s unified credit and the deferred estate tax will no longer apply to withdrawal of principal from the marital trust.

Second, if obtaining citizenship is impractical or undesirable, all other estate reduction techniques should be examined. Maximum use should be made of $100,000 super annual-exclusion gifts to the noncitizen spouse. If the estate is not that large, a combination of the use of the unified credit and lifetime super annual-exclusion gifts to the noncitizen spouse could be effective.

Example: Mrs. Remington is married to Mr. Remington, who is not a citizen of the United States. She has an estate of approximately $1.2 million and her husband has insignificant wealth. She creates a will to leave an optimal marital formula to take maximum advantage of her unified credit. Her will creates a unified credit shelter trust (UCST) and QDOT. The UCST provides her husband with all income and the power for a trustee to invade for his support if he survives. She begins a pattern of $100,000 super annual-exclusion gifts to her husband. If she lives 6 more years, she will have transferred enough to her husband to fund a full unified credit transfer in his estate. In addition, she will have removed much of the excess over her unified credit-equivalent from her estate. This will reduce the funding of the QDOT that might be created by her will. If Mr. Remington is well-advised, he will use some of the annual gifts to buy life insurance on his wife’s life. The life insurance will provide additional flexibility. For example, it would provide the liquidity to pay taxes at the death of his wife. If Mr. Remington and his advisers decide that they should avoid the QDOT approach, they can choose not to make the QDOT election. If her estate exceeds $600,000, this will result in some first-death taxes. The life insurance proceeds provide ability to freeze her estate tax costs by avoiding the future deferred estate taxes on the QDOT.

Third, the hardship exemption from QDOT tax should be investigated. This could allow the surviving noncitizen spouse to consume principal without tax. Of course, it will require the survivor to have insufficient non-QDOT funds for support. However, business interests held by the family will not have to be liquidated to qualify for hardship treatment.

Finally, life insurance can be used to effectively mitigate or avoid the QDOT tax. An inter vivos irrevocable life insurance trust (ILIT) would prevent the proceeds from enhancing either spouse’s gross estate. The noncitizen spouse could own the policy covering the life of the citizen spouse. Or, the couple’s children could own the policy. If survivorship (second to die) coverage is used, the impact of the QDOT can be mitigated at the second death.

Where Can I Find Out More?

• HS 334 Fundamentals of Estate Planning II. The American College.
• Treas. Reg. Secs. 20.2056A-1 to 13.
• IAFP Success Forum, Wealth Transfer Planning for Non-U.S. Citizens and Their Spouses. Audio tape and workbook. Phone (800) 241-7785.

Character-Building Trust (Family Goals Trust)
Constance J. Fontaine

How Does This Affect Clients?

The wealthy have concerns that their self-earned wealth will be the ruination of their children’s and grandchildren’s characters.

Creative estate planning can be developed to provide incentives for lineal descendants through the use of carefully drafted trusts that are centered on the settlor’s values. Such provisions are appropriate for irrevocable life insurance trusts as well as many other situations. (Also see chapter 11, "Human Behavior Perspectives.")

Common Scenario. You are "well off" financially, perhaps downright wealthy, and are respected within your community. The family values you embrace are founded on love, caring, recognition, and respect. Perpetuation of these qualities through generations to follow would be the greatest gift and finest legacy you could leave. Yet you recognize that respect has to be earned—it can’t be gifted and it can’t be bought. To get where you are today you worked tirelessly, struggled for years, sacrificed many things, and did without. From your perspective your efforts broadened your shoulders and made you appreciate what you have and what you have achieved. In essence you believe that taking the rough road made you learn to manage life and money. It gave you confidence, values, standards, self-esteem. You love your children and grandchildren and can afford to lavish them with all sorts of money and privileges that were unavailable to you at their ages.

However, you begin to notice that there might already be some telltale signs that the kids are "spoiled," lazy, and take the good life for granted. Your concerns: Will they squander the wealth? Will they "waste" their lives and live off their inheritances? Will your money undermine their personal growth and chances for success? Your wish is that they live up to their individual potentials. You don’t want your achievements to be a cause of their inability to lead constructive, respected lives in their own right. The quandary is how to instill a work ethic, promote self-reliance, develop a sense of responsibility, reinforce love, and continue to provide assistance to your lineal descendants. The answer may be found in a "character-building" or "personal philosophies" trust.

What Should Be Done?

A carefully and creatively drafted character-building trust can be fashioned to help develop the settlor’s most treasured personal characteristics and family values in his or her lineal descendants. The underpinnings of this kind of trust are quite different from the typical garden variety trust that is premised on the avoidance of gift and estate taxes and that mandates distributions of income and corpus at predetermined beneficiary ages. The character-building trust will not necessarily pay out income at certain specified intervals, nor will it dole out corpus to lineal descendant beneficiaries upon the attainment of chronological ages. Rather, this trust will make distributions of income and corpus when the benefi-ciaries have "earned" them in accordance with the personal philosophies of the one who originally earned them.

For instance, if the settlor considers education to be a primary source for gainful employment and self-worth, distributions could be related to academic achievements—a college degree, a graduate degree, etc. Of course, if the prerequisites for distribution are too narrow, that is, the college degrees must be from certain educational institutions or within certain fields of study, the limitations may discourage the intended beneficiaries from trying to meet the goals the settlor originally wanted them to achieve. Therefore the trust terms could provide latitude. If a beneficiary is not academically inclined, the trust could provide for distributions for the completion of a vocational or trade-oriented program. Perhaps the beneficiary is not a good academic student but is artistically or musically accomplished. In that case, satisfactory progression or completion of art or music school could meet the desired incentives expectation.

Maybe the settlor has determined that employment or some form of money-earning endeavor is the foundation for success. The reasoning here is that the settlor had to work hard to get where he or she is and therefore so should the kids. The harder the beneficiaries work, the more likely it is they will make it on their own. In this case, the trust might provide that every dollar earned in a year is matched with trust money. Limitations could be placed in the trust instructions. For example, earned dollars aren’t matched by trust dollars until the beneficiary has earned a certain level of income. Conversely, there could be a limit on the amount of matching to discourage greed. Inflation and the possibility of changes in the economy and personal lives should be kept in mind, however, at the time of drafting.

Trust directions can also anticipate beneficiaries who aspire to government careers or to lives of public service as well as those who wish to give time and effort to philanthropic causes. The possibilities are endless and thought provoking. Clearly the creation of a values-oriented trust can be time consuming and may require a fair amount of ingenuity—the guidance and caring of others usually does.

The character-building trust does not have to (and probably would not be intended to) preclude beneficiaries from receiving any trust benefits unless they have jumped through exacting hoops. The trust terms can make provisions for emergency situations, hardships, and extraordinary or changing circumstances. The trust (and the settlor) is likely to be viewed in a positive light when it allows for some flexibility and discretion. Since the wealthy settlor probably stumbled several times on the road to his or her own success and fortune, the trust directions can provide for flexibility so that the beneficiaries won’t be denied distributions entirely because of a mistake or two. After all, one of the values of the trust that the settlor wishes to convey is kindness.

The thrust of a personal goals type of trust is to encourage the beneficiaries to develop qualities and values that will serve them well throughout their lives, years after the settlor is available to provide guidance. If a trust that strives for the development of values is too rigid, it may thwart the very purpose for which it was originally created. To avoid the appearance of being too much like a carrot on the end of a stick, the trust directions could grant distributions at specified age intervals when desired accomplishments (a college degree, full-time employment, etc.) have been achieved. Should trust conditions and desired qualities in the beneficiaries not be met, the trust instructions could call for corpus to pass to charity or to the next generation and so forth. Understanding the settlor’s intentions, concepts, and reasoning may be enhanced by the settlor gathering the family together for a discussion of the trust contents.

The selection of a financial adviser and attorney must be done with care. This is clearly a more customized and people-focused trust document than a conventional trust that is mostly money oriented. Computer software doesn’t contain provisions for this kind of finely tailored instrument. A good balance may be achieved if there is an independent, institutional trustee and also a family or close family friend cotrustee. The corporate trustee has the tax and investment expertise while the individual trustee provides the personal family insights. A trust that encourages children and grandchildren to reach their potentials and establish sound values is an excellent way of being remembered and a fine family tradition to pass on.

Estate and Gift Tax Implications. The character-building trust will have some estate and/or gift tax implications since it involves a transfer of property. However, the estate and/or gift tax implications cannot be discussed without addressing the specific circumstances of the transfer or terms of the trust. For example, an inter vivos trust may or may not be a completed gift when it is created, depending on the types of powers retained by the grantor. A completed gift to an inter vivos trust may be included back in the grantor’s estate at the time of his or her death under Secs. 2036 or 2038 if the grantor retains the right to sprinkle benefits or change beneficiaries. A testamentary trust will invariably invoke the estate tax system. Due to this complexity, please do not attempt to create a character-building trust without appropriate legal and tax advice.

Where Can I Find Out More?

• See chapter 11, "Human Behavior Perspectives."
• GS 816 Advanced Estate Planning II. The American College.

Keeping a Living Will Alive
Constance J. Fontaine

Generally speaking, both law and custom accept a competent individual’s right to refuse life-prolonging medical treatment. However, the area of health care decisions regarding incapacitated and incompetent patients is where the conflict, uncertainty, and difficult issues prevail. The importance of formally expressing medical treatment wishes while competent—before a possible future state of incompetence—cannot be overemphasized. Life-prolonging measures may be withdrawn or withheld if there is reliable evidence that, under the existing circumstances, the patient did not want treatment.

An advance health care directive (commonly but misleadingly called a living will) is a document establishing a declarant’s instructions for medical treatment at such time he or she is terminally ill and is incapable of communicating medical choices. The long and short of it is that in the majority of cases the declarant is trying to avoid being sustained by artificial life support when there is no hope of recovery. An advance medical directive is in most situations a declarant’s attempt to provide for a dignified death. It may be an attempt to alleviate the fear of being held hostage by medical technology. It may be an attempt to avoid becoming the cause of a financial drain on the family coffers. Perhaps, above all, it may be an attempt to spare the family the anguish, disagreements, confusion, and guilt that abound with decisions related to medical issues surrounding the terminally ill.

Ninety percent of Americans say they do not want heroic measures to prolong their lives when there’s no real hope of recovery. Out of the 90 percent only 15 percent have executed a document saying so.¹ Why?

• Procrastination ("I’ll do it soon." "I’ll let the family handle it if it ever comes to that.")
• Denial ("The likelihood of this happening to me. . . ." "I’m too young to worry about this now.")
• Reluctance to discuss incompetence or terminal condition with family, friends, or doctor ("Bringing this up will just upset my family.")
• Expense concerns ("I’ll have to get a lawyer." "It will be expensive.")
• Lack of knowledge ("I don’t know how to go about creating one." "I don’t know where to go or what to say.")
• Viewed as worthless effort ("Nobody pays any attention to these things anyway.")

1. Alfred Lewis. "How Living Wills Could Save Billions," Business and Health,  page 68, September 1994.

One problem area with advance health care directives is the distinction between the discontinuation of life-sustaining medical treatment and the omission of treatment in the first place. Society, and therefore family members and medical providers, seems to find it more morally and psychologically troublesome to stop treatment already commenced than to simply not consider the treatment in the first place. Perhaps this is because the discontinuation of treatment involves affirmative action, whereas failing to begin treatment is passive. Maybe the distinction rests with the attitude that the withdrawal of life support is perceived as euthanasia or as "killing" someone. Legally, however, there is a clear distinction between the removal of life-support treatment and affirmative euthanasia where a health care provider, such as a physician, actively assists the patient, at the patient’s behest, to die. Currently, no state legalizes active euthanasia. In the last few years, however, the cases involving Dr. Jack Kevorkian have made the issues surrounding the terminally ill and those who are chronically in pain the subject of heated debates in the news, courts, and legislative bodies.

The medical, ethical, legal, religious, financial, emotional, and moral questions swirling around the subject of a person’s right to die appear to be infinite. It involves a balancing of a person’s right to medical self-determination about life when death is imminent, the medical oath to preserve life, and public policy to protect citizenry, allowing what inherently has a sense of being humane and compassionate while simultaneously seeming inhumane and disturbing. Congress and Uniform Laws Commissioners are striving to achieve more uniformity, "clarity," and acceptance concerning medical treatment decisions for those unable to express their wishes. The Patient Self-Determination Act is a federal law requiring health care providers participating in medicare and medicaid programs to inform and educate patients about their right to refuse medical treatment. In other words, medical personnel must tell patients of the right to execute, in accordance with state law, an advance medical directive to provide guidance in case of incapacity.

Another problem is the fact that although all states recognize at least some type of advance medical directive—be it in the form of a health care proxy, living will, or durable medical power of attorney—there are many discrepancies among them. Living wills become operative if a person is suffering from a "terminal condition" or is in a "persistent vegetative state." The way one state defines terminal condition may be different from another state. What constitutes a persistent vegetative state may vary from jurisdiction to jurisdiction. Some state statutes provide suggested forms but allow flexibility while other states require the use of a particular form. States also differ in their standards in determining the validity of advance medical directives, such as the number of witnesses, notarization, and so forth. In an attempt to alleviate jurisdictional discrepancy problems, many states have reciprocity agreements. (See figures 2–1 and 2–2 at the end of this section: "Reciprocity Provisions in Living Will Statutes" and "Reciprocity Provisions in Statutes Authorizing Health Care Agents.")

There are several uniform acts that help to bring about a degree of consensus among the states. The Uniform Durable Power of Attorney Act contains a checklist of the types of transactions that are widely accepted and that may be authorized in a power of attorney. The Uniform Statutory Form Power of Attorney Act provides a simple, universally accepted durable power of attorney form. The Uniform Health Care Decisions Act was approved by the Uniform Law Commissioners in 1993. The drafters recognized a need to provide for advance health care directives that can be either a power of attorney for health care or an "individual instruction" (terminology the drafters considered to be more appropriate than "living will") since these issues are typically addressed by separate statutes in most states. The act includes a combined durable power of attorney for health care and individual instruction form that can be modified by the declarant. Another benefit of the Uniform Health Care Decisions Act is the minimization of requirements for executing advance directives.² While most states require witnesses or acknowledgment in addition to the declarant’s signature, the act provides that an individual instruction may be oral or in writing and that a medical power of attorney merely be written and signed.

2. David M. English. "The Health-Care Decisions Act Represents a Major Advance,"  Trusts and Estates, May 1994, pages 32-38.

What Should Be Done?

Reliance on federal legislation and uniform acts in most cases isn’t going to be enough. Presently, the best protection of an individual’s right to health care self-determination is by executing an advance medical directive such as a living will type of document and a durable power of attorney for health care or health care proxy. There are several ways to achieve acceptance of and reliance on these documents as well as convince family members and relevant medical providers of the declarant’s intentions.

The declarant’s wishes should be documented in writing, and the instrument should be dated and witnessed. Notarization may be required by the particular state, but, even if not required, notarization serves to validate the declarant’s intent.

Any and all health care documents must comply with applicable state law, and therefore state law must be consulted. This is not as onerous as it sounds. There are numerous sources for achieving compliance including the local or state bar association, which may provide information, and also certain organizations, such as Choice In Dying, that will furnish information that is state specific for a nominal cost, if any. (Choice In Dying is a nonprofit patients’ rights organization that is based in New York. It produces state-specific advance directives and other materials and services relating to end-of-life medical care. Call Choice In Dying for information. (212) 366-5540.) Of course, an attorney who is knowledgeable in this area of the law can be consulted. Additionally, if the declarant has more than one medical decision-making document, each instrument can acknowledge the existence of the other.

The individual should openly express his or her feelings with respect to health care decisions with loved ones, close friends, doctors, and a lawyer. Specifically, those individuals who may be consulted about the declarant’s health care should know what the declarant wanted. Although the document may state the declarant’s wishes, hearing the wishes gives added meaning (and comfort).

Documents should be as specific and as flexible as possible. Clearly all situations and medical treatments can’t be anticipated and considered. The benefit of having both a durable power of attorney for health care and an advance medical directive regarding artificial life support and the prolongation of life is that the power of attorney can be drafted to grant broad powers to the agent or proxy for decision-making situations that are not specifically addressed. To the extent possible, however, the more medical conditions and treatments delineated in the document, the less uncertainty for all concerned. General, overly broad descriptions of mental and physical conditions should be avoided. For instance, phrases such as "no heroic measures" or "no life-prolonging procedures if there’s no hope of recovery" don’t provide any real decision-making guidance to medical personnel and family. These types of phrases with no elaboration are too vague to be helpful. In this case the declarant’s wishes need to be verbally expanded: "Should it be determined that I am terminally ill with irreversible brain damage resulting in family and friends being unrecognizable to me, and/or the inability to breathe on my own, or swallow, I would (or would not) want the following measures to be taken—(1) a respirator, (2) gastric feeding tube," and so forth.

Keep the advance medical directive where it can be easily located. Studies have shown that in 40 percent of the instances in which declarants have executed advance medical directives, the documents can’t be found when needed. To solve this problem, Choice In Dying has developed an automated advance directive registry to provide document availability at any time.³ The legal staff at Choice In Dying reviews submitted documents for state law compliance. Once compliance is determined, a copy of the advance directive is entered into the registry database. Thereafter, a copy can be obtained and faxed within minutes of a request.

3. Joan R. Rose and Debra Porter. "News Beat," Medical Economics, July 10, 1995,  page 24.

Last, reviewing and updating the advance medical directive is important. Although a periodic review every 2 to 3 years is advisable, the interval between reviews should not exceed 5 years. Updating in most cases merely constitutes signing or initialing, dating, and notarizing the update.

Once a person has taken the steps to execute a living will type of document, efforts to ensure its viability are not burdensome. The declarant’s objectives are usually twofold—peace of body and peace of mind—and by putting this document in place, both objectives may be achieved.

Where Can I Find Out More?

• GS 816 Advanced Estate Planning II. The American College.
• Choice In Dying, Inc., 200 Varick Street, New York, N.Y. 10014 (1-[212]-366-5540)
• Joseph E. Beltran. The Living Will and Other Life-and-Death Medical Choices. 1994.
• Carolyn Brown, et al. (Nancy R. Hull, ed.) Decide for Yourself: Life Support, Living Will, Power of Attorney for Health Care. 1993.
• Norman L. Cantor. Advance Directives and the Pursuit of Death with Dignity. 1993.
• David J. Doukas and William Reichel. Planning for Uncertainty: A Guide to Living Wills and Other Advance Directives for Health Care. 1993.
• Living Wills and Powers of Attorney. (E-Z Legal Guide Ser.) 1995.
• Take Control of Your Own Health Care Decisions: A State-by-State Guide to Preparing Your Living Will and Appointing Your Health Care Agent, with Forms. Regional Edition: Midwest & Great Lakes Edition. 1995.
• Francis Collin, Jr., Esq., et al. Durable Powers of Attorney and Health Care Directives. 3d ed. 1995.

 

© 1996 Choice In Dying, Inc.
200 Varick Street, 10th Floor    New York, NY    10014-4810     (212) 366-5540

*Figures 2-1 and 2-2 are reprinted with the permission of Choice In Dying, Inc.

*While Nevada's medical power of attorney statute makes no mention of reciprocity, its living will statute explicitly recognizes living will documents executed in other states.   The state's living will law permits individuals to appoint health care agents to make decisions regarding life-sustaining treatment.

© 1996 Choice In Dying, Inc.
200 Varick Street, 10th Floor    New York, NY    10014-4810     (212) 366-5540

Organ Donation in Estate Planning
Constance J. Fontaine

What Was the Situation Before?

A generation ago organ donation was unusual and uncommon. Medical technology and expertise weren’t as sophisticated as they are today. The capabilities just weren’t there to the extent that they are now.

What Is the Nature of the Change?

Organ donation is increasingly being brought to public attention partly through advertisements on television encouraging donation and also through the news media, which has brought the Nicholas Green story to the world. Nicholas was the California child gunned down while vacationing with his parents in Italy in 1994. His parents donated his organs and seven Italian citizens were the organ recipients. Organ donation in Italy has significantly increased as a result of the Green family’s caring gesture. Nicholas’s parents claim to find comfort in the fact that others continue to live because of their son. Other success stories having name recognition include actor Larry Hagman of television’s "Dallas" J.R. Ewing fame. After being on a donation waiting list for six weeks, Mr. Hagman received a new liver and a new lease on life. Since his successful liver transplant, he has given a great deal of time and effort to furthering the organ donation cause. Several years ago Pennsylvania’s then governor Robert Casey was the recipient of a "new" liver and heart in a successful double transplant operation.

Most individuals have a desire to make a contribution to society in some recognizable way—to "make a difference." Although many are in a better position than others to help mankind, organ and tissue donations are not limited to the wealthy, the people who have time, or even those who are medically healthy. Practically every person is capable of improving the lives of others—and society as a whole—through organ and tissue donations. No one may be in a better position than the estate planner to introduce the thought processes relating to organ donation.

What Could Be Done?

The most common topics that come to mind with estate planning are wills, trusts, various insurance needs, retirement plans, and durable powers of attorney. While many clients are reluctant to discuss their financial and personal family situations freely, getting them to address plans for incapacity, personal care, terminal illness, and organ donation is in most cases an even greater impasse. First, let’s review the following documents used to address personal and physical care issues, including organ donations.

Medical Durable Power of Attorney. The durable power of attorney for health care is an instrument that appoints another individual, usually a close family member or friend, to make health-related decisions for the declarant when the declarant is no longer capable (as determined by the physician and/or spouse or children of the declarant) of making his or her own decisions. In most situations, the document spells out specific instructions concerning the decisions to be made under varying circumstances. In essence, the declarant is taking the precaution of making his or her own decisions in advance should a loss of decision-making capacity prevent him or her from doing so later. States often have example forms that can be used. A successor attorney-in-fact should also be named in the document in case the original agent is, for one reason or another, unable to act on behalf of the declarant. (For an example, see Texas Durable Power of Attorney for Health Care at the end of this chapter.)

Health Care Proxy. A health care proxy is a written document that appoints a named agent or surrogate to make decisions relating to the declarant’s health care. This particular instrument typically is not specific regarding decisions to be made and instead merely names someone to act on the declarant’s behalf. Some states, however, require that the declarant’s wishes about certain issues be communicated to the proxy either orally or in writing. For example, under state law the proxy may need to know the declarant’s wishes concerning artificial feeding and hydration by tube feeding. As with the medical durable power of attorney, a successor agent should be designated in the proxy instrument. Since both a durable power of attorney for health care and a health care proxy name an agent to act for the creator of the instrument and serve essentially the same basic purpose, an individual would need only one of these documents—having both would be redundant. (For an example, see New York Health Care Proxy at the end of this chapter.)

Individual Instruction/Advance Health Care Directive/Living Will. Although medical powers of attorney are sometimes referred to as advance medical directives, in most circumstances an advance medical directive is a more accurate reference to what is generically called a "living will." This instrument states more specifically the declarant’s wishes regarding limitations on medical treatment upon the occurrence of a coma, persistent vegetative state, or terminal condition where there is no medical expectation of recovery. In most cases an advance medical directive is a declarant’s statement that he or she does not want to be kept alive by machines or other artificial support when there’s no hope of recovery. In most cases it’s created as a "pull the plug" directive, but it may be used as a directive for medical providers to prolong life in spite of low medical expectations for recovery. For instance, under the Uniform Health Care Decisions Act there is a Choice Not to Prolong Life as well as a Choice to Prolong Life.⁴ Additional credibility that this document represents the declarant’s rational, clear-thinking views on the matters at hand is achieved with a video in which the declarant expresses his or her health care wishes about prolonging life. (For an example, see Florida Living Will at the end of this chapter.

4. Uniform Health Care Decisions Act ("UHCDA") 1993 Sec. 4(a) and (b).

The Uniform Health Care Decisions Act was approved by the Uniform Law Commissioners in August 1993 for the purpose of facilitating the use of advance health care and surrogate decision-making directives, including powers of attorney for health care.⁵ The act has provisions on executing and revoking advance medical directives as well as an optional statutory form. A space is provided on the form where a declarant can express a desire for anatomical gifting. The hope is that the use of a statutory form supported by statutory terms will reinforce the acceptance of a donor’s intentions by third parties.

5. 9 U.L.A. (Pt. I(1994 Supp.)).

Although individuals may be willing to execute medical treatment documents while alive, they may not care about having control over their bodies, other than funeral and burial matters, after death, or they may simply be uncomfortable thinking about their remains at death. A 1993 Gallup survey found that one-third of survey respondents were somewhat uncomfortable thinking about their deaths.⁶ Because of the estate planner’s role in the client’s life, he or she is in a good position to bring up and elicit the client’s feelings about organ donation. The planner must, of course, remain conscious of the client’s personal religious and cultural sensitivities. If the client doesn’t want to think about it, or doesn’t care one way or another, at least the planner can impart that much to family members if they are approached about donating the deceased client’s organs and tissues. Although the planner may be rebuffed by the client with respect to this topic, bringing the subject up is sometimes all it takes to nudge the client into discussing his or her feelings about organ donation with family members.

6. "The American Public's Attitudes Toward Organ Donation and Transplantation."Survey prepared by the Gallup Organization, Inc., for the Partnership  for Organ Donation (Feb. 1993).

Are documents necessary for organ and tissue donations? Clearly, an individual can express a desire for anatomical contributions in a medical power of attorney, to the agent of a health care proxy, and even in a living will type of medical directive. Generally a will should not contain organ donation provisions. Time is of the essence with organ and tissue transplantation. Gifts could become unusable and wasted when wills are not readily located by family members. (Specifically, hearts, livers, kidneys, pancreases, and lungs are considered to be organs; bone, bone marrow, skin, veins, corneas, and eyes are categorized as tissues.)

A model organ donation act called the Uniform Anatomical Gift Act (UAGA) 1987 (supersedes the Uniform Anatomical Gift Act as amended in 1980) is the force behind all 50 states and Washington D.C. partially or completely enacting some type of organ and tissue donation statute.⁷ The UAGA requirements are that (1) the donor must be at least 18 years old, (2) donation may be made for the purposes of medical research, transplantation, and therapy, and (3) donation may be made to a hospital, physician, procurement organization, educational institution, or another specified person.

7. Fred H. Cate, "Human Organ Transplantation: The Role of Law." Journal of Corporation Law, Fall 1994, 71, 24.

In addition to instructions in general medical directive document(s), a contributor should sign an organ donor card and/or complete a simple Organ Donor Declaration form. (For an example, see Organ Donor Declaration.) Copies of the donor card or form should be given to relevant family members and the donor’s doctor. (For an example, see the PA Department of Health Voluntary Uniform Anatomical Donor Card.) The donor card does not have to be witnessed, and, like other health care instruments, it can be modified and revoked at any time either orally or in writing. Since these documents are recognized in every state as legal documents, relocations and vacations do not affect the intent of the gifts. Most jurisdictions include information about organ, tissue, and body donations with applications for drivers’ licenses and renewals. (For an example, see the Pennsylvania Voluntary Uniform Anatomical Donor Card at the end of this chapter.) Many states also provide for the notation of anatomical gifts on drivers’ licenses. In fact, most states require drivers to check off whether they do or do not want to be an organ donor at the time they register for their driver’s license.

In spite of properly executed organ donation documents, however, hospitals and medical providers universally require the written permission of the deceased’s available next-of-kin. Unfortunately, more than 50 percent of eligible family members refuse to make anatomical donations on behalf of their recently deceased relatives. This reluctance resulted in the deaths of approximately 3,100 Americans from a list of approximately 42,000 desperately waiting for organs.⁸ There are estimates that for certain organs, one-third of those on waiting lists will die waiting.

8. Peter MacPherson. "A Pitch for Organ Donations." Hospitals and Health Networks, vol. 70, no. 4, page 76, February 20, 1996 (according to a study published in the Annuals of Internal Medicine, July 1995).

Members of the National Coalition on Donation, based in Richmond, Virginia, have come to the conclusion that encouraging families to talk about organ donation prior to the death of a loved one will increase donations. The coalition’s impression is that once families discuss their wishes about anatomical gifts, surviving family members will know what the deceased wanted and won’t be in a quandary when the time arrives. Enter the estate planner . . . .

Is it fair for family members in their time of grief to have to make an emotional and perhaps wrenching decision when there are no earlier words of guidance from the deceased?

Does it cost to make donations? No, there is no expense to family or the deceased’s estate for the donation of organs and tissue. Costs resulting from donations are covered by the nearest regional Organ Procurement Organization (OPO). OPOs are organizations that procure and coordinate organ donations within their established regions. OPOs also maintain priority lists of recipients. More specifically, an OPO arranges for the surgery necessary to retrieve donated organs, oversees tissue typing, keeps lists for matching those in need of transplants with available donations, and makes arrangements for donation transport.⁹ There are about 70 OPOs in the U.S.

9. Gloria S. Neuwirth. "Guidelines for Clients Contemplating Organ Donation." Estate Planning, vol. 23, no. 8, October 1996.

Will organ donation interfere with funeral arrangements? No. Organ donation involves ordinary surgical procedure. Open casket services are not affected by anatomical gifts nor are funeral services delayed.

Do the benefits of transplantation outweigh the costs? There is no doubt that transplantation is expensive. However, as organ donation becomes more common and medical techniques become more advanced, the long-run benefits are certain to outweigh the initial expense. For example, kidney transplants are becoming increasingly successful and are more cost-efficient than long-term kidney dialysis. That’s the objective value. Subjectively, there is no monetary amount that can be placed on the benefit to the recipient and his or her family.

What about religious considerations? If a potential donor has religious concerns about making anatomical gifts, he or she should discuss them with the appropriate members of the clergy. Today all major religions in the U.S. accept and endorse anatomical gifting.

Can donations be limited? Yes. A person can provide for the donation of any or all needed body organs and tissues or for only a certain, specific organ. An entire body may be gifted for medical research. Donations are not necessarily affected by the age of the donor.

If someone makes the decision to provide for anatomical donation before death, he or she is making an additional gift to family members—relief from having to make the decision at a time when they are already under stress when approached by the OPO and/or hospital staff members. The previously mentioned Gallup survey determined that 87 percent of Americans had a positive attitude about organ donation.¹⁰ Although 69 percent stated a desired to actually become a donor at death, only half of them shared that desire with family members.

10."The American Public's Attitude Toward Organ Donation and Transplantation." Survey prepared by the Gallup Organization, Inc., for the Partnership for the Organ Donation (Feb. 1993).

By bringing the subject of organ and tissue donation to the foreground with clients, the estate planner may be assisting clients in following through with an intention that heretofore had not been formally addressed. The result may provide emotional relief for surviving family members who can act one way or another according to a deceased family member’s wishes. The discrepancy between the need for and the availability of organs may be narrowed. The quality of recipients’ lives may be enhanced, and people’s lives may be saved. Medical knowledge may be advanced and medical costs overall reduced. Society can make a difference and can benefit from it.

Where Can I Find Out More?

• HS 323 Individual Life Insurance. The American College.
• Coalition on Donation, 1100 Boulders Parkway, Suite 500, Richmond, VA 23225
• Uniform Anatomical Gift Act of 1987, 8A U.L.A.
• Uniform Determination of Death Act, 12 U.L.A. 414 (Supp. 1994)
• National Organ Transplant Act, Pub. L. No. 98-507, 98 Stat. 2339
• Brigid McMenamin. "Why People Die Waiting for Transplants." Forbes, vol. 157, no. 5, pages 140–148.
• United Network for Organ Sharing (UNOS)
• "The American Public’s Attitudes Toward Organ Donation and Transplantation." Survey prepared by Gallup Organization, Inc., for the Partnership for Organ Donation (Feb. 1993).
• Bethany Spielman, ed. Organ and Tissue Donation: Ethical, Legal, and Policy Issues. 1996.

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Chapter 2b