Remainder Purchase Marital Trust Strategy
A couple of months ago I wrote about the possible use of spousal lifetime access trusts (SLATs) as a way for a married couple to exploit the recent $5 million increase in their respective federal gift tax exemption amount, while still retaining access to the cash flow generated by those transferred assets. Yet another technique for a wealthy married couple to consider to shift wealth at a low transfer tax ‘cost,’ again making use of their temporarily increased federal gift tax exemption while retaining access to some of the income from some of the transferred assets, is a remainder purchase marital trust (or RPM Trust.) A RPM Trust is intended to use the federal gift tax marital deduction for a gift in trust for the benefit of a spouse (who must be a U.S. citizen), yet satisfy the valuation rules of IRC 2702 as a qualified interest.
Three Transactions: To implement this planning strategy, the donor spouse (hereafter the donor) engages in three separate, but simultaneous, transactions.
- First, the donor creates and funds an irrevocable trust for the benefit of his or her spouse. This RPM Trust gives to the donee spouse a life income interest or a term of year’s interest in the RPM Trust as an annuity. This transfer utilizes the donor spouse’s federal gift tax marital deduction. [IRC 2523(b)(1).] However, the transfer by the donor is neither intended to be a qualified terminable interest property (QTIP) trust nor is the trust corpus otherwise includible in the donee spouse’s taxable estate on death due to the absence of any general power of appointment over the RPM Trust’s assets. Consequently, the donor retains the remainder interest in the RPM Trust, albeit for a brief moment in time.
- Second, the donor creates and funds another irrevocable trust that is a generation skipping transfer tax exempt trust (the GST Exempt Trust) that is established for the benefit of the donor’s descendants, usually children and grandchildren. A seed gift is made by the donor to this GST Exempt Trust using the donor’s increased federal gift tax and GST exemption amounts. The donor retains no other interest in this GST Exempt Trust, although the Trust could be initially structured as a grantor trust for income tax reporting purposes with the donor retaining one of the powers intentionally used to cause the GST Exempt Trust to be treated as a grantor trust, e.g. the donor retains a power to substitute property of equivalent value with the GST Exempt Trust under IRC 675(4)(C).
- Third, the donor immediately sells the remainder interest in the RPM Trust to the GST Exempt Trust, either for cash or for a promissory note, for the fair market value of that reminder interest which is calculated using the prevailing IRC 7520 rate and Treasury’s Life Expectancy Tables with regard to the value of the donor’s remainder interest in the RPM Trust.
Tax Consequences: The transfer tax consequences of these separate transactions can be summarized as follows:
- The donor will not have used any of the donor’s federal gift tax exemption amount other than the seed gift to the GST Exempt Trust.
- The donor’s gift to the donee spouse in the RPM Trust of the income or annuity interest for life, or a term of years qualifies for the federal gift tax marital deduction under IRC 2523(b)(1) because the donee spouse does not retain any interest in, or control over, the RPM Trust- he/she just receives the income or the annuity interest for life, or a term of years.
- The assets held in the name of the RPM Trust, upon the expiration of the RPM Trust (the donee’s death or the elapse of the specific term of years), pass to the GST Exempt Trust not by gift or by bequest, or the exercise of a power of appointment by the donee spouse, but by virtue of the GST Exempt Trust’s purchase of the remainder interest in the RPM Trust from the donor.
- The donor will not face any estate tax inclusion since the donor sold his/her remainder interest in the RPM Trust for its fair market value calculated using the IRS’s Tables and the applicable federal rate of interest. Thus, the donor has retained no interest in the property transferred to the RPM Trust under either IRC 2036(a) or IRC 2038; the donor’s remainder interest was sold in exchange for a promissory Note, or its cash equivalent.
- The consideration received by the donor for his/her sale of the remainder interest in the RPM Trust will be included in his/her taxable estate. However, this could be a ‘frozen’ asset if a promissory note is given by the GST Exempt Trust for its purchase of the donor’s remainder interest in the RPM Trust, or a self-cancelling installment note (SCIN) could be used.
- If the donee spouse dies during the term of the RPM Trust, only the remaining present value of his/her income or annuity interest in the RPM Trust is included in the donee spouse’s taxable estate.
- In all events, the GST Tax Exempt Trust receives all of the property of the RPM Trust upon the expiration of the RPM Trust’s term.
Advantages of the Planning Strategy: The advantages of this sale remainder interest strategy are that the donor does not need to survive any term to achieve the transfer tax benefits, unlike a grantor retained annuity trust (GRAT.) The GST Tax Exempt Trust only needs to pay the present value of the RPM Trust’s remainder interest retained by the donor, in contrast to the larger payments that are normally associated with the traditional sale by a grantor to an intentionally defective grantor’s trust (IDGT) in exchange for an installment note, i.e. an IDGT installment sale strategy. The donor can apply his/her GST exemption amount when the seed gift transfer is made to the GST Exempt Trust, unlike with a GRAT where the GST exemption can only be applied after the estate tax inclusion period (ETIP) ends. [Treas. Reg. 26.2632-1(c)(3)(ii).] The donee spouse’s income or annuity interest in the RPM Trust, and the remainder interest purchased by the GST Tax Exempt Trust use IRC 7520 actuarial tables to value those respective interests in that Trust. The donee spouse possesses the right under the RPM Trust to compel that Trust’s property be converted to income producing property, especially if illiquid assets are initially used to fund the RPM Trust and the donee spouse later becomes dependent upon income or an annuity paid from the RPM Trust to the donee spouse.
No IRS Guidance: Treasury has not yet formally ruled on this sale of remainder interest in a marital deduction trust strategy, although it did provide a negative opinion on the sale of a remainder interest in a GRAT. In PLR 200107015 (Feb. 16, 2001) the Treasury ruled unfavorably on the sale of a GRAT remainder interest as it pertained to GST taxes. Treasury noted in that PLR: “The series of transactions proposed in the ruling request have the effect of circumventing the rules of Section 2642(e) using the same type of leveraging that prompted Congress to enact section 2642(e).” However, this private letter ruling was based on Congress’ perceived tax policy with regard to the generation skipping transfer tax at that time and not expressly on IRC 2523(b)(1).
Example of this Planning Technique: An example of how this planning technique works to shift wealth at a relatively low transfer tax cost by using a donor’s larger gift tax exemption follows. Assume the following facts: Wife is age 65 years. The current IRC 7520 rate is 3.4%. Husband makes a $3,317,000 gift of marketable securities to a GST Tax Exempt Trust that he creates, using a part of his ‘new’ $5.0 million federal gift tax and GST exemption amounts available to him. Husband then transfers $5.0 million in assets to an RPM Trust for Wife’s benefit; Wife will receive all of the income from the RPM Trust for 15 years, or until her death, if sooner. Wife’s interest in the RPM Trust is protected by the federal gift tax marital deduction. [IRC 2532(b)(1).]
Husband immediately sells his remainder interest in the RPM Trust (the right to receive the remaining RPM Trust assets after the 15-year income-only term or Wife’s death) to the GST Exempt Trust for $3,317,000. [Treasury’s Life Estate and Remainder Interest Tables, Appendix A-17, supply the fraction that the life estate interest of an individual age 65 years, which is 0.67970, with a remainder interest then being 0.32030 in the same assets subject to that life estate interest.] The value of Husband’s remainder interest in the RPM Trust using the IRC 7520 valuation tables is thus $3,317,000.
Because the GST Tax Exempt Trust purchased Husband’s remainder interest in the RPM Trust, Wife’s 15-year income interest qualifies for the federal gift tax marital deduction under IRC 2523(b)(1). Thus, no federal gift tax is due as a result of the $5.0 million Husband transferred to the RPM Trust for Wife’s benefit for the next 15 years. Husband reports the gift of $3,317,000 to the GST Exempt Trust which may, or may not, be set up as a grantor trust for income tax reporting purposes. Husband either receives from the GST Exempt Trust the $3,317,000 (that he just gave to that Trust) if he feels the need to have continued access to those assets, or Husband will take an interest only, balloon promissory note or SCIN back from the GST Exempt Trust for its purchase of Husband’s remainder interest in the RPM Trust if an estate ‘freeze’ is the reason behind adopting this planning strategy.
Conclusion: As noted earlier, Treasury has yet to rule on the sale of a remainder interest in a marital deduction trust. But this planning technique shows just how effective the additional $5.0+ federal gift tax and GST exemption amounts can be used to shift wealth over a long period of time while the married couple retains some use and enjoyment of the transferred assets.
Source: Allen and Jensen, “Sweating the Small Stuff: Pre-and Post- Liquidity Event Planning for Business Owners”, Estate Planning Course Materials Journal (August, 2018) published by the American Law Institute Continuing Legal Education.
George F. Bearup
Senior Trust Advisor
Before joining Greenleaf Trust in 2016, George Bearup practiced law in Michigan for over four decades, gaining prominence in trusts and estate planning. A longstanding Fellow of the nationally recognized American College of Trusts and Estates Council (ACTEC), he has been included on Best Lawyers in America for over 30 years, and the Michigan Super Lawyer list for more than a decade. George is a frequent author and speaker for the Institute of Continuing Legal Education, as well as a chapter author and former co-editor of the ICLE publication, Michigan Revocable Grantor Trusts (2d and 3d editions). His articles have been published in Michigan Bar Journal and Michigan Probate and Estate Planning Journal. George earned a B.A. from the University of Michigan magna cum laude, and a J.D. from Northwestern University School of Law, after graduating with honors.