The Remainder Purchase Marital Trust

“The Remainder Purchase Marital Trust,” that is the subject of today’s ACTEC Trust and Estate Talk.

Transcript/Show Notes

This is Margaret Van Houten, ACTEC Fellow from Des Moines, Iowa. What is an RPM Trust and what are its advantages and considerations? To give us more information on this topic, you will be hearing today from ACTEC Fellow, Stacy Eastland of Houston. Welcome, Stacy.

Overview

Thank you, Margaret. Well, the Remainder Purchase Marital Trust is sometimes referred to as the RPM Trust. It involves a transfer of assets to a trust in which the donor’s spouse has an income interest or annuity interest for a specified term or life. The remainder of the RPM Trust passes to a separate trust, the Remainder Trust, which could be a generation-skipping trust. The transfer to the trust is gift taxfree because, first of all, the spouse’s income or annuity interest in the RPM Trust qualifies for the gift tax marital deduction, and the Remainder Trust pays the donor the actuarial value of the remainder interest when the RPM Trust is created. The RPM Trust assets are not included in either the donor’s estate, because the donor has no retained interest in the trust, or the spouse’s estate because the spouse does not have a general power of appointment and there’s no QTIP election at her subsequent or his subsequent death. This technique has been extensively described by David Handler.

It is important that the spouse beneficiary only has a straight income or annuity interest in the RPM Trust. If she or he has a right to receive distributions under an ascertainable or discretionary standard, her interest would be hard to value, and it’d be very difficult to effectuate the technique. Many think that this should be subject to the terminable interest rule when they first look at it, but it’s not subject to the terminable interest rule because there’s an exception to the terminable interest rule if you have a purchase for the remainder interest for adequate and full consideration. Thus, in order to not run afoul of the terminable interest rule, it is crucial that full consideration be paid for the remainder interest of the RPM Trust. Generally, at times when the interest rates are high, it is more advantageous to provide an income interest for the donor spouse, and in times when we have low interest rates, it is more advantageous to provide for the annuity for the donor spouse. The remainderman trust, unless it’s very clear that it’s an old and cold trust, should be created by someone other than the grantor in order not to run afoul of the terminable interest rule.

Advantages to a Remainder Purchase Marital Trust (RMP Trust)

What are the advantages? Well, it has all of the tax advantages of creating a grantor trust. The second advantage is that the near-term death of a grantor or the grantor’s spouse generally does not affect the technique like the death of a grantor of a GRAT (Grantor Retained Annuity Trust). The appreciation of the assets, the third advantage, will be out of the grantor’s estate and the spouse of the grantor’s estate. The fourth advantage is that the grantor and the grantor’s spouse will have available, for their consumption needs, the consideration paid by the remainderman trust. In other words, they could get back some of the assets that were formally in the GST trust and the distributions paid to the beneficial provisions of the RPM Trust.

Fifth advantage. There’s more flexibility in the design of the structure in comparison to a GRAT. Why is that? Section 2702 does not apply to the technique, and it’s easier to do leveraged GST (Generation-Skipping Trust) planning in comparison to a GRAT. In other words, it’s difficult, generally speaking, to have a generation-skipping trust be the remainderman of a GRAT. This is because of the ETIP rules; but since Section 2702 does not apply, you can have the remainder interests going to a GST trust. The joint purchase rule of Section 2702 is not applicable because the donor’s spouse has not paid any consideration for her term interest. It’s important, under the regulations Section 2702–4 (c), that she not be a beneficiary of the generation-skipping trust. So, you have to have a generation-skipping trust when it’s created where the donor’s spouse did not have an interest. Okay—if Section 2702 does not apply, there’s tremendous flexibility in designing the trust in comparison to a classic GRAT. For instance, you could pay the annuity amount with loan amounts or note amounts. You can’t do that with a GRAT. You could have significant appreciation on the annuity amounts where you can’t, above the 20 percent threshold, where you cannot do that with a GRAT. This trust, if you want to, you could have a one-year term, which would be very valuable if you use certain options strategies inside the RPM Trust.

Sixth advantage. The technique could also serve as a Qualified Personal Residence Trust (QPRT) substitute and could be a very good vehicle for planning for art. Now art is a very difficult asset to plan for and there are certain problems with QPRT Trust that discourage their use. These problems do not exist for the RPM Trust. Suppose we had an RPM Trust in which it is only an income-only trust for the life of the grantor spouse or a set number of years. Let’s assume, for this example, it’s for the grantor spouse’s life. Suppose the donor put in an amount of cash that’s equal to the actuarial value of an income interest for his or her spouse and the remainder trust could be funded with cash and near cash that’s easy to value. In other words, the donor puts in cash and the remainder trust puts in cash. If that happened, perhaps what could happen is that the donor would sell after he’s created this trust, would sell the personal residence for some cash and a note and sell his art for some cash and a note. As long as his wife is living, he does not have to get a divorce from that wife, or in the other case does not have to get a divorce from the husband, and Section 2036 will not apply. He can continue to enjoy the art hanging on his wall without all the complications of the lease that are sometimes used in these art techniques.

The other advantage with respect to a QPRT is you could have unlimited homes in such an arrangement. The two residents limit would not apply. If you sold the home, you would not have to convert it to an annuity like you would with the QPRT. It’s crucial that we have a defined value allocation formula in the sale because otherwise we could have a gift tax, which would make the technique not work.

RPM Trust Considerations

Considerations or other considerations – well, the obvious one, the first consideration is that it requires a spouse beneficiary. The second consideration is that the RPM Trust cannot have a divorce clause, but it could be an advantageous technique to use  in pre-divorce planning. The third consideration is that the remainderman must pay full consideration, and when you have different assets, perhaps the best way to do that is to have all the assets in a partnership or limited liability company so you have apples to apples. The step transaction could apply, and this is why it’s critical that the remainderman trust should be created several years ago before this technique is used.

Fifth consideration. There’s a need for substance with respect to the purchase by the remainder trust. A GRAT, of course, can be the remainder interest that could have a very low value. Some worry that you should not do that with this technique. It should have some substance because all of the cases that have said that this works, the remainder interest did have some substance. It’s crucial that the remainder and term interests in the RPM Trust be transferred simultaneously. Otherwise, if you create a trust for the spouse and later on the consideration comes from the remainder trust, you could have a real problem. It could be a taxable gift. So how do you make sure that it’s done simultaneously? Some of us suggested make the RPM Trust revocable and then when the consideration arrives, then you elect to make it irrevocable. The interest on the note received by the selling spouse will be taxable income of that selling spouse, but it should be offset by a corresponding deduction to the spouse who created the grantor trust.

Eighth consideration — this should be obvious. The RPM transaction will only be a profitable transaction to the remainderman trust if the assets subject to the remainder purchase grow faster than what the consideration utilized by the remainder trust would have otherwise increased.

Thank you, Margaret.

Well, thank you Stacy for helping us understand more about the Remainder Purchase Marital Trust.

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