Some well known planners, such as Stacy Eastland, are recommending consideration of the BDOT for families with significant wealth to plan with the existing $11.2 million exemption.  Most of you are aware of the Beneficiary Defective Inheritor’s Trust (BDIT), which is funded with only $5,000, and provides that all of that $5,000 may be withdrawn when the trust is created.  The problem with the BDIT is engaging in a transaction of significant size with the beneficiary where the trust is funded with only $5,000.

With the BDOT,  the beneficiary of the third-party-created trust is given the unilateral power to withdraw all of the net taxable income of the trust from all of the assets of the trust.  This makes the BDOT a grantor trust with respect to the beneficiary.

These planners argue that the beneficiary can grow the BDOT  without estate inclusion by not withdrawing income from the trust up to the lapse protection (the “5 and 5” protection of IRC Sections 2514(e)(2) and 2041(b)(2)).  If the trust has income in excess of 5% in any year the trust loses the lapse protection at least with respect to the excess.  Accordingly, the beneficiary should withdraw this excess amount.  Additionally, use of hanging powers could mitigate transfer tax concerns.

The main risk with this technique are creditor rights issues.  If a creditor potentially can get to the trust, estate inclusion results.  Accordingly, state law should be reviewed.

Regardless of state law creditor rights issues, a creditor issue will exist if the BDOT enters into a leveraged sale with the beneficiary for less than adequate and full consideration.  Of course, such a sale would raise inclusion issues under Code Section 2036 or 2038.   Accordingly, care should be exercised in determining the selling price, and use of a value adjustment clause should be seriously considered.

For a family willing to take on some planning risk, the BDOT offers the ability for a family of multigenerational wealth to adequately fund a BDOT at the parent level, so that children with significant wealth can transfer that wealth on a leveraged basis to future generations.

Spent several days in San Antonio at the TexFed Tax Institute.  Most of the discussion was about the Tax Cuts and Jobs Act (“TCJA”) after two years.   The main takeaway was how poorly written the law is.  If you recall the law was put together in about three weeks.  While the lowering of the corporate tax rate, has made us more competitive with other countries on the top line, the loopholes and limitations have not resulted in a significant rise in business activity in the United States.

Exciting opportunities created, such as opportunity zones, were drafted without consideration that real estate investment is typically made in pass through entities.  Two versions of regulations later, they still haven’t gotten it right.

Perhaps the worst provision of the TCJA is the elimination of the carryback of NOLs and the limitation of interest deduction to EBITDA now and just EBIT is a couple of years.  This was done because TCJA had to be done via reconciliation, and Congress had to find ways to keep the deficit hit to no more than $1,500,000,000,000 (which is absurd).  The problem is that these provisions will be devastating to distressed companies in the next downturn.  This will be like throwing gasoline on a fire.

Tax laws should be written deliberately with committees formed to develop underlying goals, and careful drafting to ensure consistency.  TCJA is ripe with inconsistencies and confusion.

Hopefully, all of these issues will be cleaned up over the next couple of years.  Or better yet, maybe we tear this one up and start over.

Recently watched a show on Jack Nicklaus, and his ability to hit 1 irons.  There was a segment with current tour pros attempting to hit 1 irons, and it didn’t go well.

I thought I would give it a try.

Trevino said God couldn’t hit a one iron, but Jack and I can.  One was a draw and one was a fade.  Can you tell?

It is happening with more and more frequency…someone knocks on the door and announces him or her self as the child of the man answering the door.  DNA and the rise of and the like have created this potentially awkward moment over and over again.   In many cases it is a beautiful moment.  I have read cases, where strong bonds have been formed between the man and the child.  I have even read about cases, where the mother and the man have married or are living together.  But what are the legal ramifications to the donor.  Typically, he went to a sperm bank or infertility clinic, and didn’t want to be found out.

State law on the issue varies.  About two-thirds of states (including Texas) have adopted the Uniform Parentage Act (UPA). The UPA establishes that any male who provides sperm under the guidance of a physician for purposes of artificial insemination is not the father unless he is legally married to the recipient. Therefore, if there is no legal marriage, the male who provided the sperm is not legally obligated to perform fatherly duties such as paying child support. However, most states adopting the UPA have not been willing to extend protection to the donor in cases where the insemination process does not involve a physician.

In many cases, the donor is known, and in those cases, an agreement should be put in place so the parties intentions are clear.  Without an agreement (and perhaps even with one if the donor become active in the child’s life) a court will typically rule based on the best interest of the child, and that could mean child support payments.

I have been involved in many premarital agreement situations where the parties got upset and decided the negotiations were hurting their relationship, so they decide to drop it.  In Texas, there is an option, however, for the person of means to pursue that can be done without the knowledge or consent of their fiancee.

The moneyed fiancee can create a limited partnership and contribute the assets he or she wants protected to it.  This should maintain the separate property character of the assets contributed to the partnership during the marriage as long as the assets remain in the partnership.  Distributions from the partnership are thought to be community property, and the moneyed finacee should be aware that some assets, such as royalty payments, are separate property and contributing them to the partnership could convert those payments to community property.

The moneyed finacee also should be aware of the Jensen rule, and pay him or herself reasonable compensation for his labor and services rendered to the partnership to avoid a claim for community reimbursement.

While not as effective as a well-drafted premarital agreement, the use of a  limited partnership offers the moneyed finacee a way to provide significant protection if things don’t work out for better or worse.

March of Dimes was created to deal with polio, and was left without a mission once a vaccine was developed.  So with a nationwide infrastructure in place, it decided to change its mission from polio to premature children.  Today, if a 501(c)(3) wants to broaden or change its mission it doesn’t need to file a new 1023 and seek a new determination letter.  Instead, all it needs to do was notify the IRS on its annual 990.  On the state level, it will need to amend its Articles of Formation to reflect the new purposes of the organization.

Use of donated funds is a bit more complicated.  If funds already raised are restricted, it will not be able to use those funds for the new charitable purpose.  It would be better to raise new donations for the new purpose and segregate them from existing funds.

The bottom line is a charity can change and evolve.  It doesn’t have to start over.

Recently, the Alaska Supreme Court in Toni 1 v. Wacker put a nail in the coffin of domestic asset protection trusts as effective creditor protection for out of state donors.   After a Montana state court issued a series of judgments against Donald Tangwall and his family, the family members transferred two pieces of property to the “Toni 1 Trust,” a trust allegedly created under Alaska law. A Montana state court and an Alaska bankruptcy court found that the transfers were made to avoid the judgments and were therefore fraudulent. Tangwall, the trustee of the Trust, then filed suit, arguing that Alaska state courts have exclusive jurisdiction over such fraudulent transfer actions under AS 34.40.110(k). The Alaska Supreme Court concluded this statute could not unilaterally deprive other state and federal courts of jurisdiction, therefore it affirmed dismissal of Tangwall’s complaint.

Planners have long wondered if the full faith and credit clause of the US Constitution would prevail over state laws in DAPT states.  The answer is “yes” in Alaska.  It likely is “yes” anywhere else in the United States.

You can still do a DAPT for estate planning reasons, and they do provide asset protection as a trust in the state of the donor’s residence would.  You just can’t avoid a judgement in the donor’s state of residence by fraudulently transferring assets to a DAPT created in another state.

You can still create a foreign trust which isn’t subject to the constrains of the US Constitution, but foreign trusts raise another set of issues.

When in comes to asset protection planning, do it when the skies are clear and have other reasons for doing it.

Proposed regulations were issued in November under Code Section 2010 addressing the possibility of “clawback” when the temporary high exemption amount reverts to pre TCJA levels (adjusted for inflation).  The good news is that the proposed regulations state that clawback will not occur if one fully uses his or her exemption amount prior to sunset.  The bad news is that the proposed regulations did not address the issue of what happens if you only gift the temporary exemption increase during the period when the temporary high exemption is in effect.

The consensus at Heckerling was that if you only gift the exemption increase you will not have any remaining exemption left after sunset, other than annual increases for inflation.  So it is “use it or lose it.”

Here in Texas and other community property states, we can offer you ways to fully utilize the temporary high exemption amount without losing income on gifted assets and obtain some asset protection in the process.   The time to act is now, however, since it is very possible that the current political environment could result in a termination of the temporary high exemption amount as early as 2021.

In theory conservation easements are simple- a landowner grants a perpetual easement on a portion of his land for a charitable purpose and gets an income tax deduction for the reduction in value to the land encumbered by the easement.   Many wealthy landowners have successfully done conservation easements.  However, they have been highly abused over the years with inflated appraisals and syndication of the concept.

Recently, the Tax Court in Pine Mountain Preserve channeled Meatloaf’s famous song, and held that two out of the three conservation easements claimed were bad.  The issue here wasn’t inflated appraisals but rather improper reservations of future residential development of sixteen homes on the easement property without specifying where this potential residential development could be done.  This meant that the easement was not granted “in perpetuity” as required by Section 170(h)(2)(C) the Internal Revenue Code.

Bottom line is this- if you are going to consider a conservation easement, apply the KISS principle.  The statute is straightforward, keep the deal simple and get a highly qualified appraiser that follows best practices.

Proposed regulations on Qualified Opportunity Funds (QOF) were released at the end of October.  The regulations are complex, and a complete analysis is beyond the scope of a blog post.  However, there are some interesting provisions to note:

  1.  There was some confusion over whether the deferred gain had to be recognized 12/31/2026 if the property is not sold.  The answer is “yes.”
  2. Investment in a QOF can be directly in a Qualified Business Zone Property (QBZP) or indirectly in a corporation or flow through entity.  The rules are different for each.  Most interestingly, indirect investment cannot be in a so-called “sin business” such as golf course (I didn’t know golf was a sin), massage parlors, hot tubs, sun tanning and gambling, but the sin business prohibition does not apply to direct investment in a QBZP.
  3. If a QOF sells its interest in a QBZ, it can elect to defer again if the sales proceeds are reinvested in another QOF within 180 days.
  4. If you own a QOF via a partnership interest (or other flow through entity) and the partnership elects not to defer capital gain, you can elect to defer your distributive share of the capital gain by investing in another QOF within 180 days.

Comments are being submitted on these proposed regs.  We will continue to monitor this new investment opportunity.

About Grady Dickens

I created this blog to comment on items of current interest regarding trusts, estate planning, charitable planning and tax law, and share my knowledge and over thirty years of experience as an attorney practicing in Dallas, Texas.