JOINT TRUST: ESTATE PLANNING IN A NEW ENVIRONMENT, THE

Martin, John H

Editors' Synopsis: This Article addresses different types of joint trusts and the tax issues associated with each trust. Its thesis is the joint trust offers a flexible approach to estate planning in an uncertain estate tax environment. The author provides prototype language for a Basic Joint Trust, a Disclaimer Joint Trust, two different Tax Plan Joint Trusts, and a Joint Trust for a second marriage. Each trust form is accompanied by a discussion of the applicable estate tax issues and the ideal client type for the trust.

I. INTRODUCTION

Few watershed events occur that dictate significant changes in the drafting of estate planning documents. There have been three such events over the past sixty years. The first, the adoption of the federal marital deduction in the Revenue Act of 1948,1 which restricted and dictated the pattern of gifts to surviving spouses.2 The second watershed event was the 1969 Tax Reform Act,3 which limited transfer tax deductions for partial gifts to charity to only a few arrangements.4 The third such event was the public revulsion to reports of archaic probate procedures,5 which led to the widespread use of the revocable living trust as the primary dispositive vehicle in an estate plan.6

Today, as the consequence of two developments, we stand at the crest of another watershed. Huge increases in the federal estate tax exclusion amount (and potential elimination of the tax) will change the basic design of estate planning documents.7 There has also been substantial clarification of difficult tax issues that previously inhibited the use of the joint revocable trust in common law states. The joint trust should experience a surge in popularity because it now offers the ability to respond with considerable confidence to a changing estate tax environment. Nevertheless, planners should consider carefully the remaining tax issues and draft joint trusts with precision.

As the name implies, the joint trust is a single trust into which two persons, usually a married couple, transfer their assets.8 Ideally, the assets are commingled; separate shares are not created. Both persons enjoy the benefits of the trust while both are living. They can amend or revoke the trust together or separately. At the death of one, the survivor receives beneficial enjoyment and full or partial control of all of the assets in the trust. The contingent or remainder beneficiaries typically are the children and more remote descendants of the settlors. In its common usage, the joint trust is nothing more than the trust version of the simple will that leaves everything to the surviving spouse, but if there is no surviving spouse, everything goes to the couple's descendants. In more sophisticated versions, the joint trust can be designed to accommodate complex tax and dispositive provisions.

The joint trust is not a new concept.9 Until now, however, the joint trust has had limited application. Commentators have agreed that the joint trust works well for couples whose combined wealth is less than the value of one estate tax applicable exclusion amount.10 But there have been serious questions about the estate tax treatment of a joint trust that seeks to shelter some or all of trust assets from inclusion in the survivor's gross estate. For this reason and other troubling tax questions, a joint trust typically has not been used for a married couple with combined assets worth more than several hundred thousand dollars.

Despite their prior limited application, joint trusts have an inherent and compelling appeal. Bank accounts, homes, and other investments often are held in joint names, making the common-law joint tenancy or tenancy by the entireties familiar to most couples.11 The concept that each is currently entitled to use and enjoy the assets and that the survivor will have everything after one spouse has died is a comfortable one.12 The joint trust mimics that familiar arrangement. The couple's assets are transferred to one trust, instead of being split to create a trust for each spouse. The value owned or controlled by each spouse does not require separate identification or monitoring,13 and the survivor can be given complete, or virtually complete, control after the first death. Current marital deduction tax planning, on the other hand, requires splitting assets between spouses, a step that is uncomfortable and disconcerting for many couples. At the present time, estate tax planning requires identification of separate ownership and allocation of assets to each spouse.15 Ongoing monitoring and rebalancing of ownership is necessary.

With an increasing estate tax exemption, more and more married couples will not need tax-oriented estate planning.17 They will not need to split their assets, and they will not need separate trusts. Each spouse will be able to leave everything to the survivor without fear of incurring an estate tax at the survivor's death. In short, these couples will be able to use a single joint trust.

All times are uncertain. Today, however, estate planners face complex uncertainty. The scheduled increases in the estate tax exclusion amount call for an increase from the 2004 exclusion of $1,500,000 to a total elimination of federal estate tax in 2010, with intermediate pauses at $2,000,000 and $3,500,000 exclusions.18 While the exclusion amount is scheduled to return to $1,000,000 in 2011,19 the exclusion amount probably will be pegged at a $3,000,000 to $5,000,000 per person exclusion.20

Even with an exclusion amount of $1,500,000, vast numbers of married couples no longer need planning that ties into the federal estate tax law. Realizing this fact, the planner hesitates, faced with many uncertainties, whether scheduled leaps in the exclusion amount will occur, whether a different, permanent exclusion amount will be adopted, whether a return to the $1,000,000 level will be effective, whether a couple's estates will grow in amounts that will exceed the then-available exclusion amount, and whether total repeal of the estate tax will occur.

Use of the joint trust cannot be fully embraced unless the joint trust has the ability to respond to this unpredictable future. Unfortunately, the joint trust itself has been unpredictable. Transfers to joint trusts present challenging gift tax problems.21 Planners have had the unpleasant realization that segregated shares may need to be created to avoid tax complications.22 Unintended taxable gifts to remainder beneficiaries may occur at the death of the first spouse to die,23 and the ability to create a shelter trust for the surviving spouse safely and effectively has been questioned.24

Fortunately, guidance is now available that enables the estate planner to chart a course for successful navigation of these troubled waters. This Article will address the tax issues presented by joint trusts and conclude that alternative forms of a joint trust can be drafted to address the uncertain future created by a confusing estate tax law and an unpredictable economy. Moreover, the Article will supply sample forms that demonstrate a proper application of legal conclusions in an actual trust agreement.

One planning alternative is the Basic Joint Trust, a trust for clients who do not have federal estate tax issues. Other alternatives permit the estate planner to use the simplicity of the joint trust format and also provide protection against potential federal estate tax. These other alternatives are (1) the Disclaimer Joint Trust, an approach that provides the surviving spouse with the option of diverting a portion of the joint trust to shelter it from taxation at the survivor's death, and (2) two forms of a Tax Plan Joint Trust, alternatives that anticipate estate tax consequences and provide a structure to minimize or eliminate estate tax.

II. THE BASIC JOINT TRUST

The Basic Joint Trust is intended for the married couple with assets well below the value of the federal estate tax exclusion amount or approaching that amount, but not likely to exceed it in the foreseeable future.25 The potential number of clients who meet this description is large.26 Skillful planning, however, still is required even for the nontax situation. While gift and estate tax consequences usually can be ignored for these clients, that assumption should not be made cavalierly. Couples with modest wealth often aspire to and sometimes do attain a wealthier position. They should not make transfers now that could have adverse gift or estate tax consequences at a later date.27 Likewise, the planner and the couple must be aware of and assess the effect that transfers into a joint trust could have on each spouse's property rights and protections against creditors.28

The desirable features of a Basic Joint Trust are the use of a single fund without the establishment of separate accounts for each spouse's assets, the presence of a mechanism to identify the portion of the fund each spouse controls, and the use of provisions that can serve as a platform for more sophisticated versions of the joint trust. The trust also should permit both spouses, and then the surviving spouse, to serve as trustee.29

A. Amendment and Revocation

In Form 1, the settlors, by mutual consent, may amend the joint trust in any respect.30 The requirement of joint action echoes a feature of a tenancy by the entireties. Each settlor, however, is given the unilateral authority to revoke the trust and acquire up to one-half of the assets. Thus, each spouse clearly has ownership and control of half the total value of the trust.

The unilateral right to revoke and acquire one-half the value of the trust serves several important functions. One function is to describe definite portions that each spouse controls without establishing segregated shares. This feature departs from the approach of many commentators who see the need to restrict each spouse to withdrawing the spouse's own contribution.32 If that restriction is imposed, however, it leads to the necessity of tracing contributions and creating segregated shares. With that, the joint trust becomes as complex as two individual trusts, and the goal of simplicity vanishes. The equal portions each spouse may acquire almost certainly will not represent actual contributions.33 Moreover, the spouse who contributes the greater amount cannot recover the excess above the value of one-half of the trust. But the other spouse's unilateral right to withdraw one-half of the trust makes the excess a completed gift34 that qualifies for the gift tax marital deduction.35

If a spouse partially revokes the trust, withdrawing less than the one-half of the value to which the spouse is entitled, the trustee is directed to distribute the same value to the other spouse. This maintains each spouse's share of the trust at the same percentage. While segregated shares are not maintained, the portion that each spouse controls remains constant. Form 1 illustrates the rights to amend and revoke given to the settlors of the Basic Joint Trust.

B. Distribution

In the Basic Joint Trust, the settlors together direct the distribution of income and principal while both are living. When the first settlor dies, that settlor may direct the allocation and distribution of up to one-half of all trust assets in any manner. This is a general power of appointment,37 and it serves several functions. First, by emphasizing the control each settlor possesses over one-half of the trust during the lifetimes of both, the general power provides a clear basis for including one-half of the trust value in the first decedent's federal gross estate.38 second, while inclusion presumably is irrelevant for estate tax purposes (because the assumption for the Basic Joint Trust is a total value well below one applicable exclusion amount), the consequence of the deceased settlor's general power of appointment is that it assures a new, fair market value basis for one-half the value of the trust.39 The general power held by the first spouse to die also permits the decedent to make a change in distribution even if the other spouse will not agree to amend the trust during the lifetimes of both.40

At the planning stage, the parties generally assume that the first settlor to die will not exercise the testamentary general power of appointment. Instead, the parties expect the default clause will operate, and the entire trust will continue for the sole benefit of the survivor. The survivor could serve as trustee and continue being a beneficiary.41 Even if the survivor is not serving as trustee, the powers to amend and revoke held by the survivor provide the grounds for estate tax inclusion42 and consequent basis adjustment at the survivor's death.43 Form 2 contains illustrative language to attain these results.44

III. THE DISCLAIMER JOINT TRUST

Given the uncertainties about the future amount of the estate tax exclusion amount, in many instances the planner cannot be sure that the married couple will be entirely free of estate tax concerns. It may turn out that higher asset values or a lower applicable exclusion amount will call for the use of a shelter arrangement at the first death.45 At the planning stage, however, the likelihood of this need may seem remote. The Disclaimer Joint Trust allows the estate planner to use the Basic Joint Trust format, but to hedge by including a safety net that can be unfurled if later circumstances disclose the need for a shelter arrangement. If the anticipated circumstances occur and the amount of the spouses' combined estate is less than the exclusion amount, no disclaimer is made and, as under the Basic Joint Trust, the surviving spouse enjoys full use of the trust assets with complete freedom to amend or revoke the trust. At the same time, the Disclaimer Joint Trust offers an opportunity for a second analysis at the first death. If a threat of a later estate tax liability appears, the survivor can disclaim46 part or all of the portion of the trust controlled by the first spouse to die.47 If a disclaimer is made, a splitting of assets results, and the disclaimed portion goes into a shelter trust48 to be held for the surviving spouse's benefit.49 Thus, the surviving spouse continues to be the beneficiary of all trust assets, but up to one-half the value of the trust is sheltered from estate tax inclusion at the surviving spouse's death.50

A. Amendment and Revocation

As with the Basic Joint Trust, settlors acting together (or the survivor alone if no disclaimer is made) may amend the Disclaimer Joint Trust. Acting unilaterally, either settlor may revoke and acquire up to one-half of the assets. But if there is a disclaimer, the survivor's right to amend or revoke is cut back. Neither the power to amend nor the power to revoke can be exercised over disclaimed assets.51 Form 3 expresses these rights and limitations.52

B. Distribution

While both spouses are alive, the distribution provisions are the same as those stated in the Basic Joint Trust.53 As with the basic form, the first spouse to die is given a testamentary general power to appoint up to onehalf of the trust assets.

Specific provisions are included to govern the consequences of a disclaimer by the surviving spouse. These provisions direct any disclaimed portion into a Disclaimer Joint Trust that is parallel to the Continuing Trust for the survivor, with explicit exceptions. The exceptions prevent the survivor from changing the ultimate distribution of the Disclaimer Joint Trust assets and prohibit the survivor from invading the principal of the Disclaimer Joint Trust unless the power to invade is governed by an ascertainable standard.54 Form 4 employs an ascertainable standard.55 Thus, it permits the surviving spouse to serve as sole trustee and to have limited authority to invade principal for the survivor's benefit.

C. Validity of the Disclaimer

A crucial question is whether a disclaimer of the decedent's portion of a joint trust will have its intended consequences for federal transfer tax purposes. In general, a disclaimer must be made within nine months after the creation of the property interest56 and before the recipient has accepted the interest.57 Property that originated with the recipient, however, and that remained subject to the recipient's control cannot be disclaimed.58 The measurement of the nine-month period and determination of the source of the property are important issues in the joint trust context.

The treasury regulation that applies to joint tenancies with right of survivorship indicates the interest that passes to the survivor at the first death is a fifty percent interest in the jointly owned property and the nine-month disclaimer period runs from the first death.5 Clearly, the survivor tive for the joint trust situation. The regulation states that if the transferor to the joint account can regain the contributions unilaterally, the transfer into the joint holding is not a completed gift.61 This indicates a transfer to a joint trust is not a completed gift to the extent it can be reacquired through unilateral exercise of a power to revoke. The regulation also indicates that the survivor's interest in assets subject to control by the first to die is created at the first death. Thus, the survivor has nine months following the first spouse's death within which to disclaim, but the survivor "may not disclaim any portion of the account attributable to consideration furnished by" the survivor.62

An example in the regulations indicates a disclaimer cannot be made when the survivor furnished the funds and had not relinquished dominion and control over them.63 In contrast, a spouse who transfers the greater value to a joint trust relinquishes control over the excess above the one-half interest the spouse can reacquire. The relinquishment and completed gift occurs upon transfer into the trust, not at the later date of the first death. This clearly indicates the excess plus the balance of the joint trust attributable to the other spouse's contributions can be disclaimed if the contributor of the greater value is the surviving spouse. The ability to disclaim is also available if the contributor of the lesser value is the surviving spouse.

Because both spouses are entitled to income and to receive invasions of the principal of a joint trust, the question is whether the right to these benefits constitutes an acceptance that bars a disclaimer by the surviving spouse. Because a gift of a one-half interest is made to the survivor by the first decedent at death, the gift is made and is completed at the first death. Therefore, actions prior to that time should be irrelevant. There cannot be acceptance of a gift until the gift is made. This conclusion is confirmed by the regulation governing a true joint tenancy.64 Both joint tenants are entitled to use, possession, and enjoyment of the property. But, at the first death, the survivor may disclaim the fifty percent that passes from the first to die. Prior use and enjoyment is not a disabling acceptance.

D. Exclusion of Disclaimed Portion from Survivor's Estate

The transferor to a joint trust retains the right to income from the contribution. If the contribution is greater than one-half of the trust, and if the contributor becomes the survivor and disclaims a fifty percent interest, could the retention of income be grounds for including part of the disclaimed portion in the survivor's gross estate? The correct answer is clearly no. The ability to disclaim is predicated on the existence of a transfer to the disclaimant. The presence of control in the first decedent that is sufficient to constitute the first decedent as a transferor of property severs the prior connection to the survivor as an earlier transferor.65

This analysis indicates that the Disclaimer Joint Trust will work as advertised. If estate taxes, measured at the death of the first spouse to die, turn out to be a concern, the survivor may validly disclaim up to one-half of the interest the decedent spouse controlled. The disclaimed portion, while held for the disclaimant's lifetime benefit, will escape inclusion in the disclaimant's gross estate.

The Disclaimer Joint Trust is a hedge against the unexpected. The next section of this Article examines whether the joint trust can be used effectively by a married couple that clearly needs an estate-tax oriented approach.

IV. TAX PLAN JOINT TRUSTS

A Tax Plan Joint Trust involves the deliberate creation of a shelter trust at the first death.66 A formula in the joint trust stipulates that trust assets up to the current value of the applicable estate tax exclusion amount are allocated to the shelter trust. Any excess value is allocated to a share that qualifies for the estate tax marital deduction.

Recent private letter rulings state the Treasury's apparent position on key features of the Tax Plan Joint Trust and provide guidance for drafting.67 The rulings describe joint trusts that confer upon each spouse a general power to appoint all trust assets.68 The existence of the general power to appoint everything is crucial. It assures the inclusion of all trust assets in the estate of the first spouse to die, and it makes that spouse the transferor of all that flows from the allocation provisions that then take effect. If the first spouse to die contributed assets to the trust, the decedent's retained authority to alter or amend the trust dictates inclusion of the contributed portion under Code section 2038.69 The balance of the assets are includible under Code section 2041, based on possession of the general power of appointment.70 After the death of the first spouse to die, assets (up to the value of the entire trust) are allocated to a shelter trust in accordance with a formula clause. Because the first spouse to die is transferor of all trust assets, the surviving spouse is not a transferor to the shelter trust.71 Consequently, the surviving spouse has not retained an income interest or the ability to modify that might otherwise cause inclusion of the shelter trust in the surviving spouse's estate upon the survivor's death.72 Additionally, the surviving spouse has not made gifts to any remainder beneficiary whose rights are created at the first death.73

Notwithstanding the inclusion of all trust assets in the estate of the first spouse to die, the Internal Revenue Service denies a full basis adjustment in a Tax Plan Joint Trust under section 1014(e).74 In the rulings, the surviving spouse was determined to have made a gift to the decedent spouse of the survivor's contribution to the joint trust. This gift occurred at the decedent spouse's death. section 1014(e) was triggered because the decedent spouse acquired the survivor's contribution "by gift during the [one] year period ending on the date of the decedent's death" and the survivor then acquired the property from the decedent.

The application of section 1014(e) to the Tax Plan Joint Trust may be challenged. It clearly rests on recognizing a gift from the surviving spouse to the first spouse to die at the instant of the first spouse's death. A gift that is triggered by the death of the donee possesses a certain mythical element. More critically, a relinquishment of dominion and control is difficult to see when the surviving spouse possessed control before the decedent's death and, at least in Private Letter Ruling 2001-01-021, continued to have significant authority over the funds after the decedent's death.77 Moreover, while the recent letter rulings expressly apply section 1014(e) to direct or indirect reacquisitions by the survivor, whether section 1014(e) applies to disallow a basis adjustment when the donor of the gift to the decedent becomes the beneficiary of an income interest or of a completely discretionary interest is unclear.78

Even if no gift occurs at the time of the first death under the current version of section 1014(e), a taxpayer victory may be short-lived. section 1014(e) was remedial in nature. Congress intended to prevent a potential estate beneficiary from making a gift to a dying donee in anticipation of receiving the donated property in return a short time later with a steppedup basis for income tax purposes.80 In the joint trust, the survivor does not part with control until the first death occurs, and the survivor also immediately receives benefits. section 1014(e) appears, at least facially, to be aimed at this type of transfer and reacquisition. A construction that attains the statute's intended objective seems proper. If this construction is not confirmed by the courts, corrective congressional action should be anticipated.

The recent private letter rulings do not focus expressly on a need to trace contributions to a joint trust. Nevertheless, the rulings clearly deny the basis adjustment for the portion attributable to the survivor's contribution. This consequence is not dependent on the amount of time from the contribution to the first death because the disabling gift from the survivor does not occur until the moment of the first death.

Under the logic of the recent rulings if the survivor turns out to be the contributor of most or all of the trust assets, only a small portion, if any, of such assets would be subject to a basis adjustment.81 Equally important in every situation is the need to determine the amount of each spouse's contribution and to monitor their respective shares throughout the time both spouses are living. This process will require the establishment of separate shares or the ability to keep clear and accurate records, a skill most clients do not demonstrate. Both consequences challenge the notion that this form of joint trust is a comfortable, simple estate plan for married couples with estate tax problems.

The high price of tracing contributions could be addressed, in theory, by always having the spouses make equal contributions. This would be easy if all pre-existing holdings were joint tenancies. Separate property, however, initially could be assigned or conveyed to both spouses as tenants-in-common. Each spouse could then make a contribution of the same value to the trust.82 Initial funding could be equal when done in this manner with the assistance of counsel. Later acquisitions, contributions, and withdrawals are unlikely to be so carefully choreographed and documented.

The arrangements described in Private Letter Rulings 2001-01-021 and 2002-10-051 might be called the Maximum Allocation Joint Trust. Their attractiveness is that the entire trust is available to be allocated to the shelter trust at the first death. In most cases, however, that maximum allocation is likely to be unnecessary. Perfectly acceptable estate tax planning can be achieved using the approach discussed previously and in the context of the Basic Joint Trust and the Disclaimer Joint Trust. This approach, which can be called the Equalizing Joint Trust, results in automatic equalization of estates upon the funding of the trust, but separate shares are neither needed nor created. If one spouse contributes more than the other, the gift occurs at funding.

Only if the donor who contributed the lesser amount dies within one year of funding is there a risk of a basis adjustment of less than one-half the total value of the trust. In all other circumstances, one-half of the trust assets will receive a basis step-up to fair market value at the death of the first spouse to die.83 But use of this approach does diminish the possibility that some taxpayer will overcome the barricade of section 1014(e) and that the victory will be permanent. In some instances, the planner may want to use the Maximum Allocation Joint Trust and provide for the possibility of a basis adjustment for all assets, or the planner may want to design a plan that will allocate the full exemption amount to a shelter trust. Form 5 might be used for the amendment, revocation, and spousal distribution provisions of a Maximum Allocation Joint Trust.84 Jn most cases, however, the yearning for simplicity will be compelling. When simplicity is an overarching goal, the Equalizing Joint Trust may be a good choice. Form 6 illustrates the amendment and revocation provisions of an Equalizing Joint Trust.85

A. Amendment and Revocation

Both settlors may amend the joint trust by agreement before the death of the first spouse. Each settlor is given the unilateral right to revoke and acquire up to one-half of the trust assets. After the first death, however, the survivor is limited to amending the survivor's own portion of the trust.86

B. Distribution

The Equalizing Joint Trust contains a formula that operates in default of exercise by the first spouse to die of his or her testamentary general power of appointment. The formula allocates the one-half of the trust assets controlled by the first spouse to die between a shelter trust (to absorb the estate tax applicable exclusion amount) and a marital trust (to absorb the balance, if any).87 The automatic allocation can be expressed as a pecuniary or fractional formula gift.88 The allocation also can be a primary gift to the shelter arrangement or a residual gift to the marital share. Form 7 includes a primary gift of a fractional, or percentage, formula to the shelter trust. The illustrated shelter trust employs ascertainable standards over invasion of principal, which permits the surviving spouse to be sole trustee without risk of inclusion of the trust in the survivor's estate.91 The survivor is the primary, but not the sole beneficiary, and in one illustrated alternative, is given a nongeneral testamentary power to appoint all assets that remain in the shelter trust at the survivor's death.92

C. Evaluation and Contrast

The Maximum Allocation Joint Trust will create a shelter trust with a value up to the applicable exclusion amount available at the first spouse's death. Under that form, the entire value of the joint trust could be allocated to the shelter trust at the first death. In contrast, only one-half of the Disclaimer Joint Trust and only one-half of the Equalizing Joint Trust can be deflected into a shelter trust.93 The deflection could be substantially less than the available applicable exclusion amount. The contrast emphasizes the different roles assigned to these forms of joint trust. Either form of the Tax Plan Joint Trust is intended for and should be selected by a married couple that is likely to need estate tax planning. The Tax Plan Joint Trust is for the couple whose combined wealth now exceeds the likely exclusion amount or who anticipate substantial growth in asset values. Many couples desire to use to the fullest extent the exclusion amount available to the estate of the first spouse to die. The Maximum Allocation Joint Trust will accomplish that objective. The Equalizing Joint Trust also will achieve that objective when one-half of the joint trust is more than the applicable exclusion amount. Even if the one-half is less than the exclusion amount, there may be no estate tax at the second death because the survivor's one-half obviously is less than the exclusion available at the first death and may also be less at the second death. On the other hand, the Disclaimer Joint Trust should be selected when the need for estate tax planning is remote. The trust provides a safety net for the unexpected, and if the disclaimer must be employed, a shelter of up to one-half of the joint trust may be an adequate remedial device.94

The surviving spouse's control over the ultimate distribution of the shelter portion can be much greater under the Tax Plan Joint Trust (either form) than under the Disclaimer Joint Trust. With the Tax Plan Joint Trust, the survivor can hold a testamentary nongeneral power of appointment over the shelter trust.95 That power could have a narrow class of objects or could be exercisable in favor of almost anyone as long as it does not fall within the statutory definition of a general power.96 In contrast, the survivor who disclaims a portion of a joint trust may not be given the ability to designate the ultimate recipients of the disclaimed portion.97 If no disclaimer is made and no shelter trust created, the survivor has complete control over the entire joint trust. Thus, if estate tax consequences are a likely concern, one of the alternative Tax Plan Joint Trusts offers greater flexibility for future planning by the surviving spouse.98

Flexibility and control during the survivor's lifetime may also differ between the forms of joint trust. The survivor will have complete control over all of the assets in both a Basic Joint Trust and a Disclaimer Joint Trust if the anticipated circumstances occur and no disclaimer is made. Conversely, under the Tax Plan Joint Trust forms, the allocation to a shelter trust is automatic and required. Even if estate tax planning later proves unnecessary, the survivor must tolerate the existence and limitations of an irrevocable shelter trust.

In all of the joint trusts, except the Maximum Allocation Trust, the basis adjustment occurs at the death of the first spouse is limited to onehalf of the trust assets. This adjustment follows from inclusion of only one-half the trust in the estate of the first spouse to die. But in the Maximum Allocation Joint Trust, all of the trust assets are includible in the estate of the first spouse to die. Full inclusion provides the foundation for the argument that all assets should receive a basis step-up at the death of the first spouse to die.99

Those who use a joint trust are well advised to document the portions that each spouse contributes to the joint trust. The contributions are important if the first death occurs within one year of funding under the Basic, Disclaimer, or Equalizing Joint Trusts.100 In addition, the recent rulings suggest that the contributions are important under the Maximum Allocation Joint Trust regardless of when the first death occurs.101 Maintaining records of contributions for a one-year period, or even reconstructing them if the look-back is no more than one year, is not a significant burden. But the unlimited time frame for maintaining contribution records that appears necessary for the Maximum Allocation Joint Trust makes widespread use ofthat trust problematic.

V. VARIATIONS ON A THEME

Spouses will not always want to split assets equally. The spouse with inherited assets or the greater earning power may want to retain control over a disproportionately larger share of the couple's combined wealth. The joint trust can accommodate this desire. If the wife owns seventy-five percent of the wealth, the provision describing the power to revoke could grant her authority to acquire three-fourths of the trust value. Transfers into the trust by the wife that exceed the wife's control percentage would constitute partial gifts to the husband, and transfers into the trust by the wife that represent less than the wife's control would generate partial gifts to the wife from the husband. If each spouse has only the right to revoke and obtain his or her percentage, but no testamentary general power of appointment over the whole trust, the percentage represents the portion of the trust includible for estate tax purposes in the estate of the first spouse to die. If the husband dies first, only twenty-five percent of the trust would receive a new date-of-death cost basis.

A classic situation in which spouses may wish to control something other than equal percentages in the trust is a second marriage. The desire for control may apply not only to the lifetime right to revoke, but also may extend to assurance that the controlled portion ultimately will be distributed to the owner's children from a prior marriage. An owner's desire to provide for the second spouse may not extend to step-children.

Adjustments to the joint trust concept can accommodate the objectives of spouses in a second marriage. Each spouse can retain the right to revoke and acquire the percentage of total value that represents the spouse's prior ownership and trust contribution. Additionally, at the death of the first spouse to die, that spouse's percentage interest can be allocable to a share from which the survivor benefits but over which the survivor has no authority to amend or revoke. The survivor would retain control over, and the ability to change the distribution of, only the survivor's portion of the joint trust.

The Disclaimer Joint Trust is not an appropriate selection for spouses who want assurance that the assets belonging to the first decedent will be distributed in all events to that person's descendants. This trust form is inappropriate because of the high risk that the survivor will not disclaim. The standard form of the Basic Joint Trust also is not suitable for the second marriage when each spouse wants assurance that the survivor cannot divert assets of the first to die. The estate planner can adapt the forms to provide that the portion the first decedent controls is allocated automatically at the first death to a segregated, irrevocable portion. That irrevocable portion is held for the survivor's benefit. Income may be required to be distributed or may be distributable only in the trustee's discretion. If the latter option is selected, a trustee other than the spouse should be named. The survivor may or may not be permitted to receive invasions of the principal. The potential for invasions provides additional economic security for the survivor but also creates the risk that fewer assets will go to the first decedent's ultimate beneficiaries. Only the clients can decide on the proper balance between these competing interests. Form 8 illustrates a possible design for a joint trust for a second marriage when each spouse has a different pattern of distribution to take effect when both have died.102

Form 8 creates an Irrevocable Trust at the first spouse's death that holds that spouse's share. In essence, the Irrevocable Trust is a shelter trust that is not includible in the gross estate of the surviving spouse.103 If the combined wealth of the couple is or may be greater than the value of one estate tax applicable exclusion amount, a formula could be used to divide the portion owned by the first spouse to die between a shelter trust and a marital trust.104 Both of those portions could benefit the survivor economically but give the survivor no ability to modify the ultimate distribution provisions.

VI. CONCLUDING THOUGHTS

The joint trust has the capacity to meet the estate planning requirements of clients and attorneys in the new transfer tax environment. The vast majority of married couples will no longer face estate taxation. These couples are freed from the traditional asset splitting and separate documentation, and they can use a relatively basic joint trust. For many couples, however, the prospect of incurring estate tax is uncertain. A joint trust that features a disclaimer mechanism as a protective device is available to them. The joint trust can also be employed by the married couple who will quite certainly need to use two applicable exclusion amounts. The joint trust also is adaptable to disproportionate ownership patterns and to second marriages. In both of these situations, each spouse can be assured that the desired pattern of distribution will be attained. The broad range of joint trust designs permits the planner to achieve tax objectives, and in a relatively simple manner, to conform to the desire of most couples to treat their assets as common property available to both and to the survivor.

Form 1

BASIC JOINT TRUST RIGHTS TO AMEND AND REVOKE

Amendment. Subject to the retained rights in the section below entitled "Revocation," settlors acting together and the surviving settlor alone may amend this agreement in any respect. An amendment must be in writing.

Revocation. While both settlors are living, either settlor may revoke this agreement and acquire up to one-half of the total trust estate. This power may be exercised in whole or in part at any time and without the consent of trustee, the other settlor, or anyone else, but the revocation must be in writing. If a settlor revokes in part while both settlors living and withdraws less than one-half of the trust assets, trustee also shall distribute the same value to the other settlor. After the death of the first to die, the surviving settlor may revoke this agreement and acquire all assets then held in the trust. In making distribution following a revocation or upon the death of a settlor, trustee may allocate assets disproportionately among the portions.

Form 2

BASIC JOINT TRUST

Distribution for Settlors105

For Both Settlors. While both settlors are living, trustee shall pay the net income and distribute principal as settlors together direct. If one or both of settlors is disabled, trustee may apply income and principal as necessary or advisable for the support and care of the disabled settlor(s).

Allocation at First Death. When the first of settlors dies, trustee shall distribute the portion of the trust fund that the first settlor to die could revoke as that settlor appoints by will, by specific reference to this power, to or among any person or entity including the deceased settlor's estate. If the power of appointment is not exercised or to the extent it is not effectively exercised, trustee shall allocate that portion to the Continuing Trust, as described below. Trustee also shall allocate to the Continuing Trust the portion that the survivor could revoke.

Continuing Trust

For Surviving Settlor. After the death of the first settlor to die, trustee shall pay the net income to or for the benefit of the surviving settlor, at least annually. In addition, trustee may distribute principal as necessary or advisable to provide for the survivor's comfort, welfare, and best interests.106

Distribution at Survivor's Death. Upon the death of the surviving settlor and after payment of all charges, trustee shall distribute the balance of the trust fund as provided below.107

Form 3

DISCLAIMER JOINT TRUST RIGHTS TO AMEND AND REVOKE

Amendment. Subject to the retained rights in the section below entitled "Revocation," settlors acting together and, subject to the section entitled "Effect of Disclaimer," the surviving settlor alone may amend this agreement in any respect. An amendment must be in writing.

Revocation. While both settlors are living, either settlor may revoke this agreement and acquire up to one-half of the total trust estate. This power may be exercised in whole or in part at any time and without the consent of trustee, the other settlor, or anyone else, but the revocation must be in writing. If a settlor revokes in part while both settlors are living and withdraws less than one-half of the trust assets, trustee also shall distribute the same value to the other settlor. After the death of the first to die, the surviving settlor, subject to the section below entitled "Effect of Disclaimer," may revoke this agreement and acquire all assets then held in the trust. In making distribution following a revocation or upon the death of a settlor, trustee may allocate assets disproportionately among the portions.

Form 4

DISCLAIMER JOINT TRUST

Distribution for Settlors

For Both Settlors. While both settlors are living, trustee shall pay the net income and distribute principal as settlors together direct. If one or both of settlors is disabled, trustee may apply income and principal as necessary or advisable for the support and care of the disabled settlor(s).

Allocation at First Death. When the first of settlors dies, trustee shall distribute the portion of the trust fund that the first settlor to die could revoke as that settlor appoints by will, by specific reference to this power,108 to or among any person or entity including the deceased settlor's estate. If the power of appointment is not exercised or to the extent it is not effectively exercised, trustee shall allocate that portion to the Continuing Trust, as described below. Trustee also shall allocate to the Continuing Trust the portion that the survivor could revoke.

Effect of Disclaimer. If the surviving settlor disclaims any part or all of the portion that passes to the Continuing Trust because the power to appoint is not exercised or effectively exercised, trustee shall set aside the assets representing the disclaimed portion as a Disclaimer Trust. The Disclaimer Trust shall be administered on the same terms and conditions as those which apply to the Continuing Trust, except the surviving settlor shall not have any power to amend, revoke, or appoint the Disclaimer Trust nor, if serving as a trustee, exercise any discretion (unless governed by an ascertainable standard relating to health, education, support, or maintenance) with respect to it nor exercise any incidents of ownership over insurance owned by the Disclaimer Trust on his or her life.109

Continuing Trust

For Surviving Settlor. After the death of the first settlor to die, trustee shall pay the net income to the surviving settlor. In addition, trustee may distribute principal as necessary or advisable to provide for the survivor's health, education, support, and maintenance in the survivor's accustomed manner of living.110

Distribution at Survivor's Death. Upon the death of the surviving settlor and after payment of all charges, trustee shall distribute the balance of the trust fund as provided below.111

Form 5

MAXIMUM ALLOCATION JOINT TRUST

Amendment and Revocation

Amendment. While both settlors are living, but subject to the retained rights in the section below entitled "Revocation," either settlor may amend this agreement in any respect. An amendment must be in writing and must be delivered to the other settlor at least 90 days before the effective date of the amendment."2 Notice may not be given by a settlor's will. After the death of the first to die, the surviving settlor may amend only the Marital Trust.

Revocation. While both settlors are living, either settlor may revoke this trust agreement and acquire up to one-half of the total value of the trust. This power may be exercised in whole or in part at any time and without the consent of trustee, the other settlor, or anyone else, but the revocation must be in writing. If a settlor revokes in part while both settlors are living and withdraws less than one-half of the trust assets, trustee also shall distribute the same value to the other settlor. After the death of the first to die, the surviving settlor may revoke only the Marital Trust. In making distribution following a revocation or upon the death of a settlor, trustee may allocate assets disproportionately among the portions.

Distribution

For Both Settlors. While both settlors are living, trustee shall pay the net income and distribute principal as settlors together direct. If one or both of settlors is disabled, trustee may apply income and principal as necessary or advisable for the support and care of the disabled settlor(s).

Distribution at First Death. When the first of settlors dies, trustee shall distribute the remaining trust fund as that settlor appoints by will, by specific reference to this power, to or among any person or entity including the deceased settlor's estate. If the power of appointment is not exercised or to the extent it is not effectively exercised, trustee shall allocate and administer the trust assets under the terms of this agreement.

Allocation Instructions. If Chapter 11 of the Internal Revenue Code of 1986, as amended, applies at the death of the first settlor to die, trustee shall allocate to the Shelter Trust a percentage interest in the balance of the assets constituting the entire trust estate. The interest allocated shall be the largest percentage that can pass free of federal estate tax by reason of the federal applicable exclusion amount, the federal credit or deduction for transfer taxes paid to a state and all deductions allowed on the federal estate tax return (other than the marital deduction and charitable deduction). If Chapter 11 does not apply at the death of the first settlor to die, trustee shall allocate all assets to the Shelter Trust.

Trustee shall allocate to the Marital Trust the remaining percentage interest of the trust estate.

The percentage interests shall be based on finally determined federal estate tax values and the valuation date selected for federal estate tax purposes. The percentage allocated to each portion shall be applied for distribution purposes to the distributed assets valued at their fair market values at the date or dates of distribution, and the percentage shall be adjusted to reflect any partial distributions and the payment of charges from the trust estate.

Shelter Trust

Distributions. Trustee shall administer the Shelter Trust as follows:

(a) Income. Trustee shall pay the net income to the surviving settlor, at least annually.

(b) Invasion of Principal for Surviving Settlor. Trustee may pay principal to the surviving settlor from time to time (even to the exhaustion of the trust) as necessary to provide for the survivor's health, education, support, and maintenance in the survivor's accustomed manner of living.

(c) Invasion for Descendants. Trustee may pay principal to benefit one or more of settlors' descendants (if it will not impair the surviving settlor's security) when, in trustee's discretion, payment is necessary in order to provide for health, education, support, and maintenance of each.

Intent. The economic welfare of the surviving settlor is primary and that of the other beneficiaries is secondary. Therefore, if there is a conflict between the interests of the surviving settlor and other beneficiaries, trustee shall favor the survivor.

Drafting Note: The following two sections are alternatives for allocating and distributing the balance of the Shelter Trust at the survivor's death.

[Alternate 1] Termination; Testamentary Power of Appointment. Upon the death of the surviving settlor, trustee shall distribute the Shelter Trust as the survivor appoints by will. This power of appointment may be exercised in favor of one or more of settlors' descendants, spouses of settlors' descendants, and charitable organizations transfers to which are deductible under Internal Revenue Code sections 170(c), 2055(a), and 2522(a). If this power of appointment is not exercised or to the extent it is not effectively exercised, then upon the death of the surviving settlor, trustee shall divide and distribute the remaining trust assets as provided below.

or

[Alternate 2] Termination. Upon the death of the surviving settlor, trustee shall divide and distribute the Shelter Trust as provided below.

Marital Trust

Income. Trustee shall pay the net income to the surviving settlor, at least annually, or more frequently if requested by the surviving spouse.

Principal. Trustee may distribute principal as necessary or advisable to provide for the surviving settlor's comfort, welfare, and best interests.

Form 6

EQUALIZING JOINT TRUST RIGHTS TO AMEND AND REVOKE

Amendment. Subject to the retained rights in the section below entitled "Revocation," settlors acting together may amend this trust agreement in any respect. After one settlor has died, the surviving settlor may amend only the Continuing Trust. An amendment must be in writing.

Revocation. While both settlors are living, either settlor may revoke this agreement and acquire up to one-half of the total trust estate. This power may be exercised in whole or in part at any time and without the consent of trustee, the other settlor, or anyone else, but the revocation must be in writing. If a settlor revokes in part while both settlors are living and withdraws less than one-half of the trust assets, trustee also shall distribute the same value to the other settlor. After the death of the first to die, the surviving settlor may revoke only the Continuing Trust and acquire all assets then held in that trust. In making distribution following a revocation or upon the death of a settlor, trustee may allocate assets disproportionally among the portions.

Form 7

EQUALIZING JOINT TRUST

Distribution for Settlors

For Both Settlors. While both settlors are living, trustee shall pay the net income and distribute principal as settlors together direct. If one or both of settlors is disabled, trustee may apply income and principal as necessary or advisable for the support and care of the disabled settlor(s).

Allocation at First Death. When the first of settlors dies, trustee shall distribute the portion of the trust fund that the first settlor to die could revoke ("First Decedent's Portion") as that settlor appoints by will, by specific reference to this power, to or among any person or entity including the deceased settlor's estate. If the power of appointment is not exercised or to the extent it is not effectively exercised, trustee shall allocate that portion under the following terms of this agreement. Trustee shall allocate to the Continuing Trust the portion that the survivor could revoke.

Allocation Instructions. If Chapter 11 of the Internal Revenue Code of 1986, as amended, applies at the death of the first settlor to die, trustee shall allocate to the Shelter Trust a percentage interest in the First Decedent's Portion. The interest allocated shall be the largest percentage which can pass free of federal estate tax by reason of the federal applicable exclusion amount, the federal credit or deduction for transfer taxes paid to a state, and all deductions allowed on the federal estate tax return (other than the marital deduction and charitable deduction). If Chapter 11 does not apply at the death of the first settlor to die, trustee shall allocate the First Decedent's Portion to the Continuing Trust."3

Trustee shall allocate [to the Marital Trust] or [to the Continuing Trust] the remaining percentage interest of the First Decedent's Portion.

The percentage interests shall be based on finally determined federal estate tax values and the valuation date selected for federal estate tax purposes. The percentage allocated to each portion shall be applied for distribution purposes to the distributed assets valued at their fair market values at the date or dates of distribution, and the percentage shall be adjusted to reflect any partial distributions and the payment of charges from the trust estate.115

Shelter Trust

Distributions. Trustee shall administer the Shelter Trust as follows:

(a) Income. Trustee shall pay the net income to the surviving settlor, at least annually.

(b) Invasion of Principal for Surviving Settlor. Trustee may pay principal to the surviving settlor from time to time (even to the exhaustion of the trust) as necessary to provide for the survivor's health, education, support, and maintenance in the survivor's accustomed manner of living.

(c) Invasion for Descendants. Trustee may pay principal to benefit one or more of settlors' descendants (if it will not impair the surviving settlor's security) when, in trustee's discretion, payment is necessary in order to provide for health, education, support, and maintenance of each.

Intent. The economic welfare of the surviving settlor is primary and that of the other beneficiaries is secondary. Therefore, if there is a conflict between the interests of the surviving settlor and other beneficiaries, trustee shall favor the survivor.

Drafting Note: The following two sections are alternatives for allocating the Shelter Trust at the survivor's death."6

[Alternate 1] Termination; Testamentary Power of Appointment. Upon the death of the surviving settlor, trustee shall distribute the Shelter Trust as the survivor appoints by will. This power of appointment may be exercised in favor of one or more of settlors' descendants, spouses of settlors' descendants, and charitable organizations transfers to which are deductible under Internal Revenue Code section 170(c), 2055(a), and 2522(a). 11'this power of appointment is not exercised or to the extent it is not effectively exercised, then upon the death of the surviving settlor, trustee shall divide and distribute the remaining trust assets as provided below.117

or

[Alternate 2] Termination. Upon the death of the surviving settlor, trustee shall divide and distribute the Shelter Trust as provided below."8

Marital Trust119

Income. Trustee shall pay the net income to the surviving settlor.

Principal. Trustee may distribute principal to the surviving settlor to provide for the survivor's health, education, support, and maintenance in the survivor's accustomed manner of living.

Termination. Upon the death of the surviving settlor, Trustee should divide and distribute the Marital Trust as provided below.120

Continuing Trust

For Surviving Settlor. After the death of the first settlor to die, trustee shall pay the net income to the surviving settler, at least annually. In addition, trustee may distribute principal as necessary or advisable to provide for the survivor's comfort, welfare, and best interests.121

Distribution at Survivor's Death. Upon the death of the surviving settlor and after payment of all charges, trustee shall distribute the balance of the trust fund as provided below.

Form 8

JOINT TRUST FOR A secOND MARRIAGE

Amendment and Revocation

Amendment. Subject to the retained rights in the section below entitled "Revocation," settlors acting together may amend this agreement in any respect. The surviving settlor may amend only that portion which the survivor could obtain if the trust were revoked. An amendment must be in writing.

Revocation. While both settlors are living, either settlor may revoke this trust agreement. Upon revocation, trustee shall distribute one-fourth of the total trust to husband and three-fourths of the total trust to wife. This power may be exercised in whole or in part at any time and without the consent of trustee, the other settlor, or anyone else, but the revocation must be in writing. If a settlor revokes in part while both settlors are living and withdraws less than the maximum value he or she could acquire, trustee also shall distribute an amount to the other settlor so that the withdrawals are in the same proportions as the settlors are entitled to obtain through revocation. After the death of the first to die, the portion that the first to die could have acquired through revocation immediately before death is irrevocable. The surviving settlor thereafter may revoke this agreement and acquire only the assets held in the other portion of the trust.

Distribution for Settlors

For Both Settlors. While both settlors are living, trustee shall pay the net income and distribute principal as settlors together direct. If one or both of settlors is disabled, trustee may apply income and principal as necessary or advisable for the support and care of the disabled settlor(s).

Allocation at First Death. When the first of settlors dies, trustee shall distribute the portion of the trust fund that the first settlor to die could revoke as that settlor appoints by will, by specific reference to this power, to or among any person or entity including the deceased settlor's estate. If the power of appointment is not exercised or to the extent it is not effectively exercised, trustee shall continue that portion in trust as the Irrevocable Trust under the terms stated below. Trustee shall allocate to the Continuing Trust the portion that the survivor could revoke.

Irrevocable Trust and Continuing Trust

For Surviving Settlor. After the death of the first settlor to die, trustee shall pay the net income of both the Irrevocable Trust and Continuing Trust to the surviving settlor, at least annually. In addition, trustee may distribute principal from either as necessary or advisable to provide for the survivor's health, education, support and maintenance in the survivor's accustomed manner of living.

Distribution at Survivor's Death. Upon the death of the surviving settlor and after payment of all charges, trustee shall distribute the trust that represents the portion contributed by husband as follows: [State allocation provisions desired for husband's portion.]

Trustee shall distribute the trust that represents the portion contributed by wife as follows: [State allocation provisions desired for wife's portion.]

John H. Martin*

* Partner, Warner Norcross & Judd, LLP, Muskegon, Michigan; Fellow and Michigan State Chair, American College of Trust and Estate Counsel.

Copyright American Bar Association, Real Property, Probate and Trust Law Section Summer 2004
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