"5 by 5" power in trust?

I can't think of a good reason. In the past we'd sometimes have people renounce powers that would keep the property in their estates, and the renunciation would (at least arguably) allow the property to pass to others without further estate tax. The law has been changed since and renouncing a power will generally be considered a taxable transfer, if it exceeds the "5 and 5" parameters. In your case I don't see any benefit at all. The property in question should not be taxed in your mother's estate in any case, so renouncing the power won't avoid anything.

So it will increase her taxable estate by that much. I don't see why she can't execute a document simply saying that she does not exercise the power of withdrawal unless she does it explicitly - but I'd have to see exactly how the trust is drafted, and know what state you are in to look into the laws on the subject.

I've never heard about the automatic transfer on death - it's probably in the trust rather than some general legal proposition. As far as the adverse tax consequences, assuming the automatic transfer is made and she is in a very high estate tax bracket, her exposure is half of the amount transferred because her estate tax might be increased by that amount. That's the only thing I can think of.

I'm not aware of any general adverse consequences either way, though it depends on the precise documents involved and the facts in each situation.

It's in Internal Revenue Code §2041(b)(2) -

Stu

You are delving into some of the more arcane areas of estate tax here. What these provisions are specifically addressing is the creation of a power of appointment. Estate taxation of powers of appointment is covered by Code section 2041. Where things start getting confusing are with lapses of powers of appointment. The "5 and 5" (or "5 by 5" or "5x5" there are all sorts of ways of referring to this) power is a specific exception that is provided for in Code section

2041(b)(2). And, you have heard correctly. In the year of your mother's death, she will be treated as having access to the greater of 5% or $5,000 of the trust. This amount will be included in her estate and will be subject to estate taxation.

--Chris

wrote:

You could try asking her attorney, with your mother's permission, to explain the answers to your questions or to educate you. And for background, Revenue Ruling 67-241 and Private Letter Ruling 200022035 may contain the information which is the basis of her attorney's concerns. Although these IRS documents do not appear to include a reference to including the amounts that could be withdrawn in the year of death in the estate, the fact that the person who had that right of withdrawal is deemed the owner until the rights lapse at the end of the year probably is the basis of the attorney's concern. Therefore, these documents appear to be consistent with the information the attorney is reported to be stating. I assume from your "(Ouch!)", that in the year of her death the transfer of 5% of the trusts principal to her estate has an impact and is therefore undesireable with respect to estate taxes. Otherwise, it shouldn't matter to her or her attorney with respect to her death. It also appears that these IRS documents imply that there are current tax liabilities with regard to income, etc. received by the trust with regard to your mother's interests regardless of who, if anyone, is receiving income distributions from the trust or whether she exercises her corpus withdrawal rights in any year. Again, her attorney may need to be consulted. The information provided by the OP is inadequate to determine issues involving those distributions and obligations. Hope this helps.

See Section 2041 and Regulations 20.2401-1 and 20.2401-3 to start. But they are just a starting place. There are quite a few cases, rulings, etc. in this area.

-- Drew Edmundson, CPA Cary, NC

Thanks to all who responded. Good information, all. Thanks especially for the citations to the code, regs and rulings. I will follow through on them, for my edification. FYI, we already spent a couple hours with her estate attorney (of several years) on a slew of questions, including this one. Frankly, the attorney seemed a little loopy -- we suspect he was on antidepressant drugs, by his own admission -- and his answers tended to be "non-responsive" or dismissive (like his "no-brainer" comment). I did not think of all of my concerns until after our meeting. But we have already decided to find another estate planning attorney. Of course, that will take time. In the meantime, I wanted some confirmation that I was not completely in "left field" with my questions about this "no-brainer" (not!). Your responses have helped us to evaluate the current attorney and confirm our feeling that we need a new one. This will be one of the "test" questions that we will use to evaluate the next attorney. Thanks again.

Ok, after reading what others have written I went back to take a look. I didn't remember all the nuances of this off the top of my head. If your mother has the ability to withdraw principal without a standard and without the consent of another trustee, her estate will be taxed as if she had the value of what she could have taken. So if your father's trust has $2,000,000,

5% of that is $100,000, which will be taxed in your mother's estate (estate tax). Normally if someone has that kind of a power it will be taxed in her estate even if she renounces it. But if the value is less than $5,000 or 5% of the amount in the trust (whichever is more), then it's not included in her estate. That's why the lawyer suggested renouncing it now - it will reduce your mother's taxable estate.

Whether or not it's transferred, the tax law treats her as the owner of that money under those circumstances. There is another option. Does the trust provide for a successor trustee for your father? Does it allow your mother to appoint another trustee along with her? If so, it might (it's allowed to, anyway) permit the independent trustee to agree to any distributions to your mother out of principal without regard to any ascertainable standard (health, education, etc.). In that case your mother can renounce the 5/5 power, because the trustee (assuming he's trustworthy) has the power to invade principal for her anyway - and it won't be taxed in her estate unless she actually receives it. Stu

This is one of the things I caution people and families about when considering trusts - the likelihood that because of the trust, the beneficiary/family will be using (and paying for) a variety of advisors over the trust's lifetime. While there certainly are instances where the benefits justify the time and costs, my experience is that the use of trusts exceeds the need by a nice margin.

-HW "Skip" Weldon Columbia, SC

In my experience trusts can be simpler and cheaper than not having them. If families have issues they need to talk to a lawyer about, they would probably have those issues whether they had a trust or not - it just makes them more aware that they need guidance before they do something they will later regret. Stu