Upgrade your estate plan with the OBIT and the 412(e)(3)
By Nick Paleveda MBA J.D. LL.M
National Pension Partners
Upgrading the estate plan by replacing the RLT with the OBIT and the ILIT with the 412(e)(3) can help client's save immediately on income taxes and, in the future, capital gains taxes. The adjustment clause can help them minimize estate taxes on the first death.
The OBIT, the FLP and the ILIT have been the cornerstone of many advanced estate plans. Wait a minute, I've never heard of an OBIT.
Now is the time to look at optimal basis income trust (OBIT). Ed Murrow, J.D. LL.M at Keybank keyed me in on this planning technique. The problem today is most assets will receive a "step-up" in basis at death. Well, we assume (especially during the Carter years) that all assets have increased in value. In fact, many have not, and some have gone down. The OBIT allows the surviving spouse a limited power of appointment over assets which have not appreciated and a general power of appointment over the other assets. This will allow the survivor to basically pick and choose the appreciated assets to pass through the estate — and receive a step up — and the other assets to remain with a carryover basis. Most revocable living trusts (RLTs) do not have these provisions as they came into play with portability in 2010. Bottom line: it's time for an upgrade.
Concerned about the value of the family limited partnership (FLP) assets? You should be. The IRS routinely argues for higher valuations and now will receive 40 percent of the increase. One way to "upgrade" the FLP is to insert an adjustment clause. The adjustment clause may be found in Wandry v. Commissioner, a tax court case in 2012. The clause "adjusts" the value to minimize the tax at the first death.
The irrevocable life insurance trust (ILIT) has been a hallmark tool to pay estate taxes, but why not "upgrade" to a 412(e)(3) trust? This will allow the premiums to be income tax-deductible. The death benefit will be in the estate, but with $10,500,000 sheltered by a married couple, the income tax deduction may be very attractive. The 412(e)(3) does require the participants to be engaged in an "active trade or business" under 162 and 212, and many FLPs are engaged in an "active trade or business" (but be careful: some are not). Now the life insurance premiums are deducted from the income tax and Obamacare tax.
Upgrading the estate plan by replacing the RLT with the OBIT and the ILIT with the 412(e)(3) can help client's save immediately on income taxes and, in the future, capital gains taxes. The adjustment clause can help them minimize estate taxes on the first death. During your annual review, there are new planning opportunities.