Make sure you check out Part I before reading below…
The Bigger Picture
In addition to the SCIN-specific issues, the complaint touches on a number of themes of which every estate-planning adviser – and every client – should be aware.
The Facts Matter
An adviser should assume that the IRS will scrutinize the estate plan closely, especially in the case of a large estate or a prominent client.
The adviser should prepare for such an exam contemporaneously with the implementation of the plan, not later. This may be especially important in the case of a client’s premature or unexpected death.
The Technique and Execution Matter
An adviser should recognize that certain techniques, including the use of SCINs, are likely to attract the attention of the IRS.
Whenever a “risky” technique is employed as part of an estate plan, it must be prudently and properly executed if it is to withstand IRS scrutiny.
As a general rule, transfers between family members will be subject to greater scrutiny, and could be challenged as not being bona fide and not being conducted at arm’s-length. Failing to have separate counsel for the parties to the transaction will only exacerbate the matter. The estate plan as a whole could be deemed to be a testamentary device deployed purely to avoid tax liability.
Educate the Client
The client must be presented with alternatives, each of which may accomplish his or her testamentary goals. It is not the adviser’s role to make the necessary “business” decisions.
Assess the Risks
For each alternative, the client must also be informed of the attendant risks, the likelihood of their being realized, and the economic consequences thereof. Without this information, how can the client be expected to make any decision?
According to the complaint, nowhere in DT’s presentation was there a comprehensive list of the relevant and material risks. Rather, it is alleged that DT assured the decedent that its estate plan hedged all risk, maximized the transfer of wealth, and minimized taxes.
One Tool May Not Suffice
In light of the strict scrutiny that a particular decedent’s estate is likely to receive (for example, because of the size of the estate), it may behoove the estate planner to use more conservative and more reliable estate planning techniques.
If more “aggressive” techniques are to be used, the planner should consider not making them the centerpiece of the estate plan. The planner should also consult with subject matter experts, including other legal counsel, doctors, actuaries and others, in connection with the formulation and implementation of such an estate plan.
Too Good to be True
A proposal that purports to eliminate all economic risk to the taxpayer’s estate is the sort of estate plan that the IRS routinely rejects as having no economic substance.
DT’s SCIN-GRAT “circular” transaction eliminated the risk incumbent in the SCIN transactions. Only if the transaction involves an appropriate degree of economic risk will it be found to be a bona fide transfer. Without such risk, the IRS is bound to scrutinize a transaction, like the SCIN, and challenge it as strictly a tax avoidance device.
Substance Over Form
In the case of the decedent’s estate, the IRS concluded that the transfers of stock
in exchange for the SCINs should be viewed as gifts because the SCINs lacked the indicia of genuine debt in that there was no requirement of repayment of principal, there was no reasonable expectation that the debt would be repaid, and DT’s use of the §7520 mortality tables to set the terms of the SCINs was unfounded.
The arrangement was nothing more than a device to transfer the stock to family members at a substantially lower value than the fair market value of the stock.
Although an estate may vigorously maintain that a decedent intended to enforce and collect on a note, it is difficult to support such an assertion without the kind of proof that is demonstrated by the actual receipt of payments.
Know the Law and Apply It
The client will reasonably assume that the adviser is – and the adviser must actually be – intimately familiar with the applicable statutes, regulations, administrative and judicial pronouncements.
In recommending any estate planning technique, the adviser must be able to anticipate the IRS’s reaction and arguments, and he or she must plan for them accordingly.
According to the complaint, the existing authority made clear that the absence of periodic payments of principal in connection with all of the SCINs and, in particular, no requirement of the payment of any risk premium until the end of their term, made them susceptible to being challenged as not being bona fide transactions. DT should have known, it continues, that the IRS generally challenges estate plans that provide purported “win/win” scenarios.
It is not unusual for an estate planner, acting on behalf of a client’s estate, to defend its planning and the implementation thereof to the IRS. In doing so, however, the planner must walk a very fine line and must be completely transparent with respect to its client.
For example, the complaint alleges that DT’s provision of services to the decedent’s estate subsequent to his death was not only intended to defend its plan to the IRS, but also to conceal the defects in that plan from the executors of the client’s estate.
“How Do We Kosher This Pig?”
A former colleague would sometimes put this question to me when confronted with an IRS examination of a transaction or plan that we had not structured, but that we were retained to defend. Too often, there was little we could do to reverse what had already been done, and it was too late to do what should have been done earlier.
This question also highlighted the importance of planning thoroughly and in advance of engaging in any transaction. The best time to prepare for an audit is before the subject of the audit has even occurred.