How To "HEET" Up An Estate Plan - WealthCounsel (3 pages)

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How To "HEET" Up An Estate Plan

By Julius H. Giarmarco, Esq.

Under IRC Sections 2503(e) (concerning gift taxes) and 2611(b)(1) (concerning generation skipping
transfer ("GST") taxes) (hereafter the "IRC exclusion provisions") all "qualified transfers" for tuition or
medical expenses are excluded from both gift and GST taxes - if they are paid directly to the educational
institution or to the medical care provider. High net worth individuals commonly use IRC Section 2503(c)
as a wealth transfer strategy. By paying their grandchildren's and great-grandchildren's tuition and
medical bills, they are removing assets from their estate, both gift and GST tax free. Moreover, there are
no limitations as to the amount that can be paid for such expenses. However, this strategy only works
while the grandparents are alive.

For those grandparents who wish to pay for their descendants' education and medical bills while
transferring significant assets out of their estates, a health and education exclusion trust, or "HEET",
should be established. The grandparents can set up an inter vivos HEET using their $13,000 / $26,000
annual gift tax exclusion, their $1,000,000 / $2,000,000 gift tax exemption, or by naming the HEET as the
remainder beneficiary of a zeroed-out grantor retained annuity trust or a zeroed-out charitable lead
annuity trust (see below). Alternatively, a testamentary HEET can be established in the grandparent's Will
or Living Trust and funded at death. An inter vivos HEET can be an irrevocable life insurance trust ("ILIT")
drafted as a HEET. Assets used to fund a testamentary HEET (unless an ILIT is used) would be subject
to estate taxes, but not the GST tax. However, by creating and funding an inter vivos HEET, the after-tax
income and appreciation on the assets gifted to the HEET are removed from the grandparents' estate.

Generation-Skipping Tax

A key benefit of a HEET is that it gets around the onerous GST tax. The GST tax is 45% on the amount of
a grandparent's gift (inter vivos or testamentary) to grandchildren (or more remote descendants) that
exceeds (in 2009) $3,500,000, or $7,000,000 for married grandparents. To avoid the GST tax, the HEET
must pay the educational or medical expenses directly to the provider, and the HEET must have a charity
as a co-beneficiary. If the grandchildren (or more remote descendants) are the only beneficiaries of the
HEET, transfers to it would be subject to the GST tax. Thus, a HEET is best suited for grandparents who
have estates in excess of the $3,500,000 / $7,000,000 GST exemption and who have charitable goals.

A generation skipping transfer can occur in one of three ways: 1) a direct skip; 2) a taxable distribution;
and 3) a taxable termination. The GST tax is calculated by multiplying the highest estate tax rate by the
amount of the direct skip, taxable distribution, or taxable termination.

A transfer made directly to a skip person (i.e., grandchild), either during lifetime or at death, is a "direct
skip." A transfer made to a trust in which all beneficiaries are "skip persons" is also a direct skip.
However, because a HEET has a non-skip beneficiary (the charity), a transfer to a HEET is not a direct

Transfers to trusts that have both skip and non-skip persons as beneficiaries do not pay the GST tax
upon the funding of the trust. Instead, a GST tax is paid by the trustee when distributions are made to
beneficiaries who are skip persons. However, because of the IRC exclusion provisions, distributions
made from a HEET directly to providers of education and health care on behalf of a skip person are not
subject to GST tax.

A taxable termination occurs when a trust loses its last non-skip person and, therefore, only skip persons
remain as beneficiaries. Since a HEET will always have a non-skip person beneficiary - the charity - a
taxable termination will never occur, nor the GST tax consequent to it. But, the charity's interest must be
significant. Otherwise it will be ignored as being used "primarily to postpone or avoid" the GST tax. IRC
Section 2652(c)(2).

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