I’d Like Some Cake, Please

Carole and Bill Nelson, our hypothetical clients, have just learned that Carole’s grandmother has passed away leaving a small ranch to Carole and her sister, Janet Figneuton, outright, free and clear. The ranch is leased to neighboring ranchers as pasture and Janet and Carole will be absentee landlords. They don’t plan to actually operate the ranch as a going concern, but will continue as landlords employing a ranch or property manager to run the place, handling the day to day concerns.


But, Bill and Carole, and now Janet and her husband Charlie are worried that upon the death of one or both of the sisters, there could be a big mess. Spouses, children, spouses of children and possibly others will become unwitting partners with each other. What does that look like? It doesn’t look pretty. Everyone will have different interests and goals. Some may want to convert the ranch to cash, some may want to preserve it forever for the family’s recreational use, some may want to break off their own parcels and become cowboys on their own. 


The ranch will add about $2,500,000 each to Janet’s and Carole’s estate for transfer tax calculations if they were to die today. Currently, the property provides an annual income stream  of about $200,000 per year which will now be divided between the sisters.


 The primary concern of both families, the Nelsons and the Figneutons, is to solidify their own goals for the family’s use of the ranch, and to reduce their taxable estates while not losing the income stream. Can this be done? It can with some creative and careful design work.


Carole can create a trust for her own benefit, transferring her undivided ½ interest to the trust and retaining the right to the income for life.  This is possible in a state that permits a “self settled trust,” one in which the trust creator is also the beneficiary and often the trustee.  In Carole’s home state, Colorado, that is a yet unresolved question, although there is an old case that seems to permit it.


It can also work in a state that doesn’t permit a self settled trust if the income distribution to Carole is wholly discretionary with the trustee and that trustee is not Carole. By using an adverse, or even an independent trustee as those concepts are defined by the Tax Code, and with Carole having no right to demand a distribution of any type, the trust is not self settled. Of course, if the trustee is not required to make a distribution to Carole, Carole risks a trustee that will do just that.  There are other strategies and techniques that can be applied depending on what the sisters decide they want to accomplish. (And it is also worth noting that the law of each state may be different in terms of what it will allow and not allow regarding this concept. No planning attorney will undertake this without some careful research.) 


Janet will create her own trust that basically does the same thing, but carefully drafted to avoid any “reciprocal trust issues.” While that is a subject for another article, it is worth noting that with wholly discretionary trustees, the reciprocal trust doctrine loses some of its steam.


You can’t have your cake and eat it too, but this planning strategy comes tantalizingly close. It is an advanced planning design and certainly won’t fit everyone’s comfort zone. But Bill and Carole along with Janet and Charlie are giving it some serious thought.