MEMORANDUM
PRIVILEGED AND CONFIDENTIAL — ATTORNEY-CLIENT COMMUNICATION
To: Jonathan R. Caldwell
From: Sylvia Hartwell, Partner (Tax), Calderwood & Harkness LLP
Date: August 1, 2023
Re: Generation-Skipping Transfer Tax Exemption Allocation Strategy — Caldwell Generational Estate Plan
Matter No.: 1034-00004
Billing Code: 78412-JRC
This memorandum is a privileged and confidential attorney-client communication prepared by Calderwood & Harkness LLP for the exclusive use of Jonathan R. Caldwell and is protected by the attorney-client privilege and work product doctrine. This memorandum should not be disclosed to third parties without prior written consent of Calderwood & Harkness LLP, except as necessary for the provision of tax return preparation services by Strathmore Corporation & Greaves LLP and estate planning coordination with Pemberton, Locke & Strauss LLP, as discussed herein. Any such disclosure should be accompanied by a Kovel letter or similar privilege-preservation arrangement.
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I. Executive Summary
The purpose of this memorandum is to analyze and recommend an optimal allocation strategy for Jonathan R. Caldwell's generation-skipping transfer tax ("GST") exemption across the various trust structures established as part of the comprehensive generational estate plan designed and implemented by Calderwood & Harkness LLP during the period of February through September 2023 (the "Caldwell Generational Estate Plan" or the "Plan"). This memorandum is intended to serve as the definitive planning document for GST exemption allocation decisions made in connection with the 2023 Form 709 (United States Gift and Generation-Skipping Transfer Tax Return) and to provide a forward-looking framework for post-ETIP allocation decisions anticipated to arise in 2025 and 2026 upon the termination of the grantor retained annuity trusts established as part of the Plan.
The key structures requiring GST analysis in connection with the Plan are as follows:
1. Caldwell Family Dynasty Trust — A Delaware-situs irrevocable trust established April 1, 2023, with an initial cash funding of $5,000,000, plus anticipated receipt of GRAT remainder interests upon expiration of three grantor retained annuity trusts;
2. Three Grantor Retained Annuity Trusts ("GRATs") — (a) Caldwell 2023 Securities GRAT ("GRAT A"), (b) Caldwell 2023 Realty GRAT ("GRAT B"), and (c) Caldwell 2023 Carried Interest GRAT ("GRAT C"), each structured as a zeroed-out GRAT under IRC § 2702 with remainder interests payable to the Caldwell Family Dynasty Trust;
3. Caldwell Revocable Trust Provisions — Specifically, the credit shelter trust and marital QTIP trust established under the Amended and Restated Caldwell Revocable Trust (effective April 1, 2023), which will be funded at Jonathan's death; and
4. Caldwell Family Insurance Trust ("ILIT") — An irrevocable life insurance trust established March 15, 2023, holding a $15,000,000 second-to-die universal life policy on the lives of Jonathan and Eleanor V. Caldwell.
Summary of Recommendations. Based on the analysis set forth in this memorandum, we recommend the following GST exemption allocation strategy:
• Allocate $5,000,000 of GST exemption to the Caldwell Family Dynasty Trust initial cash funding (April 1, 2023) to achieve an inclusion ratio of zero (0.000), ensuring that all future distributions from the dynasty trust to grandchildren and more remote descendants are entirely free of GST tax;
• Defer allocation of GST exemption to the GRAT remainder interests until the Estate Tax Inclusion Period ("ETIP") expires upon the termination of each GRAT's annuity term, as required by IRC § 2642(f);
• Evaluate the reverse QTIP election under IRC § 2652(a)(3) for the marital QTIP trust at the time of Jonathan's death, when complete information regarding remaining GST exemption and asset values will be available; and
• Preserve remaining GST exemption of $7,920,000 for post-ETIP allocations to GRAT remainder interests flowing into the dynasty trust, with contingency planning for trust severance if remainder values exceed available exemption.
2023 GST Exemption Amount. The GST exemption for 2023 is $12,920,000, which is the same as the basic exclusion amount applicable for lifetime gift tax purposes. Jonathan's prior taxable gifts total $6,750,000, which have consumed a corresponding amount of his lifetime gift tax exemption but may or may not have consumed any GST exemption. We have assumed, for purposes of this memorandum, that the prior gifts of $6,750,000 were transfers to non-skip persons (i.e., Jonathan's three adult children) and that GST exemption was not affirmatively allocated to those transfers. If this assumption is correct, the full $12,920,000 GST exemption is available for allocation in 2023 and in future years. We have requested confirmation from Martin J. Prescott, CPA, at Strathmore Corporation & Greaves LLP, who has prepared Jonathan's prior-year gift tax returns, and we will update this analysis if the assumption proves incorrect.
II. Overview of the Generation-Skipping Transfer Tax
II.A. Statutory Framework
The generation-skipping transfer tax ("GST tax") is imposed under Chapter 13 of the Internal Revenue Code, IRC §§ 2601 through 2664. The GST tax is designed to prevent wealthy individuals from avoiding the transfer tax system by transferring assets directly to grandchildren or more remote descendants, thereby "skipping" a generation of estate or gift tax. The GST tax operates as a backstop to the estate and gift tax regime, imposing a flat-rate tax on generation-skipping transfers at the highest marginal estate tax rate, currently 40%.
The Code defines three categories of generation-skipping transfers, each of which triggers the GST tax:
(1) Direct Skips (IRC § 2612(c)) — A transfer subject to the estate or gift tax made to a "skip person." A direct skip is the most straightforward type of GST event and occurs when property passes directly to a person (or a trust for the exclusive benefit of persons) assigned to a generation two or more generations below the transferor. Direct skips are taxed at the time of the transfer, and the GST tax is imposed on the transferor (or, in the case of a testamentary direct skip, on the estate).
(2) Taxable Distributions (IRC § 2612(b)) — A distribution from a trust to a skip person that is not a direct skip or a taxable termination. A taxable distribution occurs, for example, when a discretionary distribution is made from a trust with both skip and non-skip beneficiaries to a grandchild of the grantor. The GST tax on a taxable distribution is borne by the transferee (the recipient skip person).
(3) Taxable Terminations (IRC § 2612(a)) — A termination of an interest in a trust, by death, lapse of time, release of a power, or otherwise, if after such termination only skip persons hold interests in the trust (or no person holds an interest in the trust and no distribution from the trust may be made to a non-skip person). The GST tax on a taxable termination is borne by the trust itself.
The concept of "skip person" is defined under IRC § 2613 and is central to the operation of the GST tax. A "skip person" is an individual assigned to a generation two or more generations below the generation assignment of the transferor. For purposes of the Caldwell Generational Estate Plan, the generation assignments are as follows:
• Jonathan R. Caldwell (transferor) — Generation 1.
• Non-skip persons (Generation 2 — one generation below Jonathan):
• Thomas R. Caldwell (son, age 38)
• Katherine C. Hartfield (née Caldwell) (daughter, age 35)
• Olivia G. Caldwell (daughter, age 30)
• Dr. Sarah P. Caldwell (spouse of Thomas) — assigned to the same generation as Thomas under IRC § 2651(c)(1)
• Dr. Andrew W. Hartfield (spouse of Katherine) — assigned to the same generation as Katherine under IRC § 2651(c)(1)
• Skip persons (Generation 3 — two generations below Jonathan):
• James W. Hartfield (grandson, age 8, child of Katherine and Andrew)
• Charlotte M. Hartfield (granddaughter, age 5, child of Katherine and Andrew)
• Lucas T. Caldwell (grandson, age 3, child of Thomas and Sarah)
• Nora E. Caldwell (granddaughter, age 1, child of Thomas and Sarah)
• Any future-born issue of Thomas, Katherine, or Olivia
• More remote descendants (Generation 4 and beyond) — Any future-born great-grandchildren or more remote descendants are also skip persons.
A trust is a skip person only if (a) all interests in the trust are held by skip persons or (b) no person holds an interest in the trust and no future distribution from the trust may be made to a non-skip person. Because the Caldwell Family Dynasty Trust names Thomas, Katherine, and Olivia (all non-skip persons) as current beneficiaries alongside the grandchildren and more remote descendants, the dynasty trust itself is not a skip person. However, distributions from the dynasty trust to grandchildren or more remote descendants will constitute taxable distributions or, upon the death of the last non-skip beneficiary, taxable terminations — both of which are generation-skipping transfers subject to the GST tax unless the trust has a zero inclusion ratio.
II.B. GST Exemption
Each individual is allowed a lifetime GST exemption under IRC § 2631. The GST exemption amount is equal to the basic exclusion amount under IRC § 2010(c), which for 2023 is $12,920,000 (as adjusted for inflation under IRC § 2631(c)). The GST exemption is the primary mechanism by which transferors can shelter transfers to grandchildren and more remote descendants from the GST tax.
The GST exemption is allocated to transfers (whether inter vivos or testamentary), and the allocation determines the "inclusion ratio" of a trust, which in turn determines the effective rate of GST tax applicable to generation-skipping transfers from that trust. The mechanics are as follows:
Applicable Fraction. The applicable fraction for a trust is determined under IRC § 2642(a)(2) as:
Applicable Fraction = Amount of GST Exemption Allocated to the Trust ÷ Value of Property Transferred to the Trust
Inclusion Ratio. The inclusion ratio is determined under IRC § 2642(a)(1) as:
Inclusion Ratio = 1 – Applicable Fraction
Applicable Rate. The applicable rate of GST tax is the product of the maximum federal estate tax rate (currently 40%) and the inclusion ratio:
Applicable Rate = Maximum Estate Tax Rate × Inclusion Ratio
The strategic objective for trusts intended to benefit multiple generations — such as the Caldwell Family Dynasty Trust — is to achieve an inclusion ratio of zero (0.000), which results in an applicable rate of zero and renders all generation-skipping transfers from the trust entirely free of GST tax, regardless of the amount transferred or the number of generations that benefit. A trust with an inclusion ratio of zero is commonly referred to as "fully GST-exempt," while a trust with an inclusion ratio of one (1.000) is "fully GST-non-exempt."
It is worth noting the current elevated exemption amount is the product of the Tax Cuts and Jobs Act of 2017 (P.L. 115-97), which approximately doubled the basic exclusion amount from its pre-2018 level. Under the sunset provision of the Act, the current elevated exemption amount is scheduled to revert to approximately $5,000,000 (indexed for inflation from 2010, estimated to be approximately $7,000,000) after December 31, 2025, unless Congress enacts legislation to extend or make permanent the current amount. This sunset presents a significant planning consideration, particularly for allocations that cannot be made until 2026 or later, as discussed in Section IV.E below.
II.C. Relationship Between Gift Tax Exemption and GST Exemption
It is important to distinguish between the gift tax exemption and the GST exemption. Although both are currently set at the same dollar amount ($12,920,000 for 2023), they are consumed independently and serve different purposes. The gift tax exemption (technically, the "applicable exclusion amount" under IRC § 2505 and § 2010(c)) shelters lifetime gifts from the gift tax. The GST exemption shelters generation-skipping transfers from the GST tax. A transfer may consume one exemption without consuming the other, depending on the nature of the transfer and the identity of the recipient.
Jonathan R. Caldwell has made prior taxable gifts totaling $6,750,000. These gifts consumed $6,750,000 of his lifetime gift tax exemption, leaving $6,170,000 of gift tax exemption available prior to the implementation of the Plan. With the $5,000,000 cash gift to the dynasty trust in 2023, an additional $5,000,000 of gift tax exemption is consumed, leaving $1,170,000 of gift tax exemption after the dynasty trust funding (before accounting for the ILIT premium not covered by annual exclusion, which further reduces available gift tax exemption by $136,500 to approximately $1,033,500).
However, the prior taxable gifts of $6,750,000 may or may not have consumed any of Jonathan's GST exemption. GST exemption is consumed only if it is affirmatively allocated (or automatically allocated under the rules discussed in Section VII below) to a transfer to a trust with skip-person beneficiaries or to a direct skip to a skip person. If the prior gifts of $6,750,000 were made to Jonathan's three children — who are non-skip persons — then no GST exemption was consumed by those gifts, and the full $12,920,000 GST exemption is available in 2023. This is the working assumption of this memorandum, and we have requested confirmation from Martin J. Prescott, CPA, at Strathmore Corporation & Greaves LLP, who prepared Jonathan's prior-year Forms 709, to verify that no GST exemption was affirmatively or automatically allocated to those prior transfers.
If it is determined that some portion of GST exemption was previously allocated, the analysis and recommendations in this memorandum will need to be updated accordingly.
III. GST Exemption Allocation to the Caldwell Family Dynasty Trust
III.A. Initial Funding — $5,000,000 Cash Gift (April 1, 2023)
On April 1, 2023, Jonathan R. Caldwell established the Caldwell Family Dynasty Trust (the "Dynasty Trust") as an irrevocable trust with situs in Delaware. The Dynasty Trust was created pursuant to the Caldwell Family Dynasty Trust Agreement dated April 1, 2023, and is governed by the laws of the State of Delaware. The selection of Delaware situs was made deliberately to take advantage of Delaware's favorable trust laws, including the absence of a rule against perpetuities (12 Del. C. § 3556), which permits the Dynasty Trust to continue in perpetuity for the benefit of Jonathan's descendants.
The institutional co-trustee of the Dynasty Trust is Northgate Trust Company of Delaware, with Philip A. Rossiter, Senior Vice President, Trust Administration, serving as the primary point of contact. Thomas R. Caldwell serves as the family co-trustee. The administrative trustee provisions and distribution standards are set forth in the trust agreement and are not the subject of this memorandum, though they bear on GST planning to the extent they define the class of beneficiaries and the circumstances under which distributions may be made to skip persons.
The Dynasty Trust was initially funded with $5,000,000 in cash, constituting a completed gift for federal gift tax purposes. Jonathan retained no interest in the trust (no retained annuity, no reversionary interest, no power to alter, amend, or revoke), and accordingly the transfer is not subject to estate tax inclusion under IRC §§ 2036, 2037, or 2038. The trust is a "grantor trust" for income tax purposes under IRC § 671 et seq. (by reason of Jonathan's power to substitute assets of equivalent value under IRC § 675(4)(C)), but this classification has no bearing on the GST analysis, which is determined under the transfer tax provisions of Subtitle B of the Code.
The beneficiaries of the Dynasty Trust include both non-skip persons (Thomas R. Caldwell, Katherine C. Hartfield, and Olivia G. Caldwell) and skip persons (all four current grandchildren — James W. Hartfield, Charlotte M. Hartfield, Lucas T. Caldwell, and Nora E. Caldwell — and all future-born issue, per stirpes). Because non-skip persons hold current interests in the Dynasty Trust, the trust itself is not a "skip person" under IRC § 2613(a)(2). However, distributions from the Dynasty Trust to grandchildren or more remote descendants will constitute taxable distributions under IRC § 2612(b), and upon the death of the last non-skip beneficiary holding an interest in the trust, a taxable termination under IRC § 2612(a) may occur. Both types of generation-skipping transfers are subject to GST tax at the applicable rate, which is determined by the trust's inclusion ratio.
III.B. Recommended Allocation
We recommend that Jonathan R. Caldwell affirmatively allocate $5,000,000 of his GST exemption to the initial $5,000,000 cash funding of the Dynasty Trust on his 2023 Form 709. This allocation will be reported on Schedule D (Computation of Generation-Skipping Transfer Tax) of the return and will be coordinated with Strathmore Corporation & Greaves LLP.
The allocation produces the following result:
Applicable Fraction = GST Exemption Allocated ÷ Value of Property Transferred
= $5,000,000 ÷ $5,000,000
= 1.000
Inclusion Ratio = 1 – Applicable Fraction
= 1 – 1.000
= 0.000 (fully GST-exempt)
The effect of achieving a zero inclusion ratio is that all generation-skipping transfers from the Dynasty Trust — whether taxable distributions to grandchildren, taxable distributions to more remote descendants, or taxable terminations — will be subject to GST tax at an applicable rate of zero (40% × 0.000 = 0%). In practical terms, this means that distributions from the Dynasty Trust to grandchildren and more remote descendants will be entirely free of GST tax, in perpetuity, for as long as the trust remains in existence under Delaware law. This is the fundamental objective of the Dynasty Trust and the reason for its Delaware situs.
It is critically important that the Dynasty Trust's zero inclusion ratio be maintained. The inclusion ratio can be disrupted if additional property is contributed to the trust without a corresponding allocation of GST exemption, because the applicable fraction is recomputed to take into account both the previously allocated exemption and the newly contributed property. This consideration is directly relevant to the anticipated receipt of GRAT remainder interests, as discussed in Section IV below.
After this allocation, Jonathan's remaining GST exemption will be:
$12,920,000 – $5,000,000 = $7,920,000 (available for future allocations, including GRAT remainder interests after ETIP expiration)
III.C. Timing of Allocation and Form 709 Reporting
The allocation of GST exemption to the Dynasty Trust initial funding will be reported on Schedule D (Computation of Generation-Skipping Transfer Tax) of Jonathan R. Caldwell's 2023 Form 709. Under IRC § 2632(a), an allocation of GST exemption to a direct skip, and under IRC § 2632(b), a lifetime allocation of GST exemption to any trust, is made on a timely filed gift tax return for the calendar year in which the transfer occurs. The filing deadline for the 2023 Form 709 is April 15, 2024, with an automatic extension to October 15, 2024, if properly requested.
We recommend making an affirmative allocation on the 2023 Form 709 rather than relying on the automatic allocation rules under IRC § 2632(c). Although the Dynasty Trust likely qualifies as a "GST trust" for purposes of the automatic allocation rules (discussed in Section VII below), affirmative allocation provides several important advantages:
• Certainty and precision. An affirmative allocation eliminates any question as to whether the automatic rules applied, in what amount, and as of what date.
• Control over the amount allocated. The automatic rules may allocate more or less exemption than desired, particularly if multiple GST trusts exist and the order of automatic allocation is uncertain.
• Documentary record. An affirmative allocation creates a clear audit trail on the face of the gift tax return, facilitating future planning and coordination.
• Avoidance of unintended allocation. If the automatic rules were to apply, they might also allocate GST exemption to the ILIT (discussed in Section V), which is not desired.
Calderwood & Harkness LLP (Sylvia Hartwell and Elliot Nguyen, Senior Associate) is preparing the draft Form 709 and Schedule D for Jonathan R. Caldwell for the 2023 tax year. The draft will be transmitted to Martin J. Prescott, CPA, at Strathmore Corporation & Greaves LLP, for review, finalization, reconciliation with prior-year returns, and filing on Jonathan's behalf. We anticipate transmitting the draft by December 15, 2023, and scheduling a joint conference call with Mr. Prescott in January 2024 to resolve any open items.
IV. ETIP Rules and GRAT Remainder Interests
IV.A. The Estate Tax Inclusion Period (ETIP) — § 2642(f)
The Estate Tax Inclusion Period ("ETIP") is one of the most critical concepts in GST exemption allocation planning and has direct bearing on the treatment of the three GRATs established as part of the Caldwell Generational Estate Plan.
Under IRC § 2642(f)(1), any allocation of GST exemption to property transferred in a transfer subject to an estate tax inclusion period shall not be made before the close of the ETIP. An allocation made during an open ETIP is void and has no effect. The ETIP is defined in IRC § 2642(f)(3) as the period during which, should the transferor die, the value of the transferred property (or any portion thereof) would be includable in the transferor's gross estate under Subtitle B of the Code, other than by reason of IRC § 2035 (transfers within three years of death).
For a grantor retained annuity trust, the ETIP arises because the grantor retains a qualified annuity interest under IRC § 2702. If the grantor dies during the annuity term, the value of the GRAT corpus is includable in the grantor's gross estate under IRC § 2036(a)(1), which provides for inclusion of property transferred by the decedent if the decedent retained the right to income from the property or the right to designate who shall possess or enjoy the property. The retained annuity interest constitutes a right to income or enjoyment for purposes of § 2036(a)(1). Therefore, the ETIP for a GRAT is co-extensive with the annuity term: the ETIP begins on the date the GRAT is funded and closes on the date the annuity term expires (assuming the grantor survives the term).
The practical consequence of the ETIP rule is that GST exemption cannot be allocated to the remainder interest of a GRAT until the GRAT's annuity term expires. This is true even if the GRAT is a "zeroed-out" GRAT with a taxable gift of zero, because the ETIP rule operates independently of the gift tax valuation of the transfer. The ETIP rule ensures that GST exemption is not "wasted" by allocating it to property that might be pulled back into the grantor's estate if the grantor dies during the annuity term.
IV.B. Application to Each GRAT
The Caldwell Generational Estate Plan includes three zeroed-out GRATs, each funded with different asset classes and having different annuity terms. The ETIP analysis for each GRAT is as follows:
GRAT A — Caldwell 2023 Securities GRAT
• Funding Date: April 15, 2023
• Assets Contributed: Publicly traded securities with a fair market value of $60,000,000
• Annuity Term: 2 years
• Annual Annuity Payment: $32,195,122 (each of two payments, structured to return the entire initial funding plus the § 7520 hurdle rate, resulting in a taxable gift of approximately $0)
• ETIP Close Date: April 15, 2025
• Conclusion: No GST exemption may be allocated to the GRAT A remainder interest before April 15, 2025.
GRAT B — Caldwell 2023 Realty GRAT
• Funding Date: May 1, 2023
• Assets Contributed: Membership interests in Stonecrest Holdings LLC, a family-owned real estate holding company. Pre-discount fair market value of underlying real estate: $80,000,000. Post-discount value (reflecting lack of control and lack of marketability discounts): $60,000,000.
• Annuity Term: 3 years
• Annual Annuity Payment: $29,375,859 (each of three payments)
• ETIP Close Date: May 1, 2026
• Conclusion: No GST exemption may be allocated to the GRAT B remainder interest before May 1, 2026.
GRAT C — Caldwell 2023 Carried Interest GRAT
• Funding Date: June 1, 2023
• Assets Contributed: Limited partnership interests and carried interests in Caldwell Ridgeline Capital LP. Pre-discount fair market value: $38,000,000. Post-discount value (reflecting lack of control and lack of marketability discounts): $25,300,000.
• Annuity Term: 3 years
• Annual Annuity Payment: $13,953,759 (each of three payments)
• ETIP Close Date: June 1, 2026
• Conclusion: No GST exemption may be allocated to the GRAT C remainder interest before June 1, 2026.
IV.C. Consequences of the ETIP Rule
The ETIP rule has several important consequences for the Caldwell Generational Estate Plan:
First, because each GRAT is structured as a zeroed-out GRAT under IRC § 2702 — meaning that the present value of the retained annuity interest equals the value of the property transferred, resulting in a taxable gift of approximately zero — there is no reportable taxable gift to which GST exemption could be allocated even apart from the ETIP restriction. The combination of a zero taxable gift and an open ETIP means that no GST exemption allocation can or should be made at the time of GRAT funding.
Second, the ETIP precludes not only affirmative allocation of GST exemption but also automatic allocation under IRC § 2632(c). Section 2632(c)(4) provides that the automatic allocation rules do not apply to any transfer during an ETIP. This reinforces the conclusion that no action is required (or permitted) with respect to GST exemption allocation to the GRATs at the time of funding.
Third, the allocation of GST exemption must wait until the ETIP closes — that is, until the expiration of each GRAT's annuity term, assuming Jonathan R. Caldwell survives the term. At the close of the ETIP, the remainder interest in each GRAT (i.e., the excess appreciation above the § 7520 hurdle rate) will transfer to the Caldwell Family Dynasty Trust, as designated in each GRAT agreement. At that point, the value of the remainder interest flowing into the Dynasty Trust will be known, and GST exemption can and should be allocated to that transfer.
Fourth, the value for GST exemption allocation purposes will be the fair market value of the property at the close of the ETIP (i.e., the fair market value of the assets actually transferred to the Dynasty Trust at the termination of each GRAT), not the value at the time the GRAT was funded. This is a critical distinction: the "cost" of GST-exempting the GRAT remainder interest is measured by the fair market value of the assets at termination, which may be substantially greater than zero (the taxable gift value at funding) if the GRAT assets outperform the § 7520 hurdle rate. The entire planning premise of the GRAT structure is that assets will appreciate at a rate exceeding the hurdle rate, generating excess appreciation that transfers to the Dynasty Trust without gift tax. However, this excess appreciation will require GST exemption allocation if the Dynasty Trust's zero inclusion ratio is to be maintained.
IV.D. Projected GST Exemption Needs Post-ETIP
The estate plan projects that the GRATs will outperform the 5.0% § 7520 hurdle rate (applicable for April, May, and June 2023 GRAT fundings) by approximately 4% per annum on average, generating an estimated $35,000,000 to $50,000,000 in aggregate excess appreciation that will transfer to the Dynasty Trust upon expiration of the three GRAT annuity terms. The specific projections for each GRAT are as follows:
GRAT A Remainder (Due April 2025): The value of the GRAT A remainder interest will depend on the two-year performance of the $60,000,000 portfolio of publicly traded securities, net of two annuity payments of $32,195,122 each. At an assumed 9% annual return, the projected remainder value is approximately $5,000,000 to $8,000,000. At higher return assumptions, the remainder could be significantly larger.
GRAT B Remainder (Due May 2026): The value of the GRAT B remainder interest will depend on the three-year performance of the $60,000,000 (post-discount) Stonecrest membership interests, net of three annuity payments of $29,375,859 each. The real estate portfolio has historically appreciated at rates substantially above the hurdle rate, and projected remainder values range from $15,000,000 to $25,000,000 depending on assumptions.
GRAT C Remainder (Due June 2026): The value of the GRAT C remainder interest will depend on the three-year performance of the $25,300,000 (post-discount) Caldwell Ridgeline Capital LP interests, including carried interest, net of three annuity payments of $13,953,759 each. The venture capital and private equity exposure in this GRAT creates significant upside potential, with projected remainder values of $15,000,000 to $20,000,000 at favorable return assumptions.
In aggregate, if $35,000,000 to $50,000,000 in GRAT remainder assets flow into the Dynasty Trust, and only $7,920,000 of GST exemption remains after the initial $5,000,000 allocation to the Dynasty Trust's cash funding, the Dynasty Trust's inclusion ratio would increase above zero upon receipt of the GRAT remainder interests. Specifically, the applicable fraction for the Dynasty Trust would be recomputed under the formula in IRC § 2642(d) as follows:
New Applicable Fraction = (Old Applicable Fraction × Old Trust Value + New GST Exemption Allocated) ÷ (Old Trust Value + New Property Added)
If, for example, $40,000,000 in GRAT remainder assets are added to a Dynasty Trust with a then-existing value of $5,500,000 (original $5,000,000 plus growth), and $7,920,000 of GST exemption is allocated to the new contributions, the recomputed applicable fraction would be:
= (1.000 × $5,500,000 + $7,920,000) ÷ ($5,500,000 + $40,000,000)
= $13,420,000 ÷ $45,500,000
= approximately 0.295
Resulting inclusion ratio = 1 – 0.295 = approximately 0.705
An inclusion ratio of 0.705 would subject 70.5% of any subsequent generation-skipping transfer from the Dynasty Trust to GST tax at 40%, yielding an effective rate of approximately 28.2%. This outcome would significantly undermine the planning objectives of the Dynasty Trust and must be addressed through careful allocation strategy and, if necessary, trust severance.
IV.E. Strategies to Address GST Exemption Shortfall
Given the projected mismatch between available GST exemption ($7,920,000) and projected GRAT remainder values ($35,000,000 to $50,000,000), several strategies should be considered:
Separate Share Rule / Qualified Severance. Under IRC § 2642(a)(3) and Treasury Regulation § 26.2642-6, a trust may be severed into two or more trusts in a "qualified severance" that results in each resulting trust having a defined inclusion ratio. Specifically, upon receipt of GRAT remainder interests, the Dynasty Trust can be severed into (a) a GST-exempt share, to which all available GST exemption is allocated, resulting in an inclusion ratio of zero, and (b) a GST-non-exempt share, which receives the balance of the GRAT remainder property and has an inclusion ratio of one (1.000). Each share would be administered as a separate trust for GST purposes. The qualified severance must be made on a "fractional basis" as defined in the regulations and must be reported on a timely filed Form 706 or Form 709, as applicable. This is the primary recommended strategy for addressing the GST exemption shortfall.
Allocation of Eleanor's GST Exemption. Eleanor V. Caldwell holds her own GST exemption of $12,920,000 (2023). However, Eleanor is not the grantor of the GRATs or the Dynasty Trust, and under the GST tax framework, only the transferor's exemption can be allocated to a transfer made by that transferor. Eleanor's GST exemption cannot be allocated to Jonathan's transfers. Her exemption may, however, be relevant to the marital QTIP trust at her subsequent death (discussed in Section VI) and to any separate trusts she may create for grandchildren under her own estate plan.
2025 Sunset Risk. The scheduled sunset of the elevated exemption amount after December 31, 2025 presents a significant risk to the post-ETIP allocation strategy. If the GST exemption reverts to approximately $7,000,000 (indexed from the pre-2018 base), the available exemption for allocation at GRAT B and GRAT C termination (May and June 2026) could be significantly less than currently anticipated. Under the anti-clawback regulations (Treas. Reg. § 20.2010-1(c)), exemption already allocated is protected, but future allocations would be limited to the then-available amount. This underscores the importance of (a) allocating exemption promptly upon ETIP expiration, (b) monitoring legislative developments closely, and (c) considering whether any acceleration of GRAT terminations or other restructuring is feasible if sunset appears imminent and unavoidable.
Recommendation. Upon expiration of GRAT A's ETIP on April 15, 2025, we recommend that Jonathan allocate his remaining GST exemption (then $7,920,000, subject to any interim adjustments) to the GRAT A remainder share entering the Dynasty Trust. If the GRAT A remainder value exceeds the available GST exemption, a qualified severance of the Dynasty Trust should be executed to create a GST-exempt share and a GST-non-exempt share, with the GST-exempt share receiving the maximum amount that can be fully sheltered by the available exemption. The same analysis should be repeated for GRATs B and C upon their termination in May and June 2026, using the then-available exemption amount and accounting for any changes in the law.
V. GST Treatment of the Caldwell Family Insurance Trust (ILIT)
V.A. Current Structure
The Caldwell Family Insurance Trust (the "ILIT") was established on March 15, 2023, as an irrevocable trust with Jonathan R. Caldwell as grantor and Northgate Trust Company of Delaware as trustee. The ILIT was created as part of the Caldwell Generational Estate Plan to hold life insurance for the purpose of providing liquidity at the deaths of Jonathan and Eleanor to cover anticipated estate tax liabilities.
The ILIT holds a $15,000,000 second-to-die universal life insurance policy issued by Beacon Life Assurance Company (Policy No. BLA-2023-77419) on the joint lives of Jonathan R. Caldwell and Eleanor V. Caldwell. The death benefit is payable upon the second death (i.e., upon the death of the survivor of Jonathan and Eleanor), which is when the estate tax liability is anticipated to arise.
The annual premium for the policy is $187,500. Jonathan makes annual premium payments to the ILIT, which the trustee uses to pay the premium. To qualify the premium payments for the federal gift tax annual exclusion under IRC § 2503(b), the ILIT includes Crummey withdrawal powers for the following beneficiaries:
• Thomas R. Caldwell — $5,000 annual withdrawal right (lapses after 30 days)
• Katherine C. Hartfield — $5,000 annual withdrawal right (lapses after 30 days)
• Olivia G. Caldwell — $5,000 annual withdrawal right (lapses after 30 days)
The three Crummey beneficiaries are each entitled to withdraw up to $5,000 per year upon receipt of notice that a contribution has been made to the ILIT. Each withdrawal right is limited to $5,000 to ensure that the lapse of the withdrawal right does not constitute a taxable transfer by the Crummey beneficiary under the "five-or-five" safe harbor of IRC § 2514(e). The 2023 annual exclusion amount is $17,000 per donee. With three Crummey beneficiaries, the total annual exclusion coverage is $51,000 (3 × $17,000). The remaining premium of $136,500 ($187,500 – $51,000) is not covered by the annual exclusion and consumes Jonathan's lifetime gift tax exemption.
V.B. GST Analysis
The GST analysis of the ILIT requires consideration of both the nature of the current beneficiaries and the identity of the remainder or contingent beneficiaries under the ILIT trust agreement.
Crummey Withdrawal Powers. Each of the three Crummey beneficiaries — Thomas, Katherine, and Olivia — is a non-skip person (Generation 2). The annual exclusion gifts subject to the Crummey withdrawal powers are therefore not direct skips. The Crummey withdrawal right creates a present interest in the non-skip beneficiary, and the transfer is treated as a gift to that non-skip person. No GST event occurs upon the making of the annual premium contribution or the lapse of the withdrawal right.
Remainder and Contingent Beneficiaries. However, the ILIT trust agreement may include grandchildren (James, Charlotte, Lucas, and Nora) as contingent or remainder beneficiaries. If the ILIT terms provide that, upon the death of the survivor of Jonathan and Eleanor (when the death benefit is paid), the trust corpus (including the $15,000,000 insurance proceeds) may be distributed to or held in trust for grandchildren or more remote descendants, then the ILIT is a trust with potential skip-person beneficiaries. In that event, distributions from the ILIT to grandchildren would constitute taxable distributions subject to GST tax, and the ILIT's inclusion ratio would be relevant.
Automatic Allocation Under § 2632(c). Annual contributions to the ILIT may be treated as "indirect skips" subject to automatic GST exemption allocation under IRC § 2632(c) if the ILIT is a "GST trust" as defined in IRC § 2632(c)(3)(B). A GST trust is generally any trust that could have a generation-skipping transfer, unless one of the narrow statutory exceptions applies (e.g., the trust instrument provides that the trust must terminate and distribute to non-skip persons before the transferor reaches age 46, etc.). If the ILIT includes grandchildren as beneficiaries — even contingent beneficiaries — the ILIT is likely a GST trust, and automatic allocation would cause GST exemption to be allocated to each annual premium contribution ($187,500 per year), consuming $187,500 of GST exemption annually without any affirmative action by Jonathan.
This automatic allocation is undesirable for several reasons. The ILIT death benefit of $15,000,000 is designed primarily for estate tax liquidity upon the second death. The ILIT trust terms should be structured — and we believe they are structured, based on our review of the trust agreement prepared by Monica Reyes of our office — so that distributions flow first to non-skip beneficiaries (Thomas, Katherine, and Olivia) for the purpose of funding estate tax obligations. The multi-generational wealth accumulation objectives of the Plan are served by the Dynasty Trust, not the ILIT. Preserving GST exemption for allocation to the Dynasty Trust (where the exemption will shelter potentially tens of millions of dollars in GRAT remainder interests from GST tax) is a significantly higher priority than sheltering the ILIT from GST tax.
Recommendation. We recommend that Jonathan R. Caldwell elect out of automatic GST exemption allocation to the ILIT on his 2023 Form 709, pursuant to IRC § 2632(c)(5)(A)(i) and Treasury Regulation § 26.2632-1(b)(2). The election-out statement will be included on the 2023 Form 709 and will specify the Caldwell Family Insurance Trust by its full name and taxpayer identification number. The election out will apply to the 2023 contribution and to all future contributions, unless affirmatively revoked on a subsequent Form 709.
Alternative Approach. If a more detailed review of the ILIT trust agreement reveals that distributions to grandchildren are a primary (rather than contingent) feature of the trust, a limited allocation of GST exemption to the ILIT may be appropriate. We recommend that Monica Reyes review the ILIT trust agreement provisions specifically with respect to the identity of beneficiaries, the standards governing distributions to skip persons, and the trust's termination provisions, and provide a memorandum addressing whether any modification to the election-out recommendation is warranted.
VI. Reverse QTIP Election and the Marital Trust
VI.A. Structure of the Credit Shelter Trust and Marital QTIP Trust
Under the Amended and Restated Caldwell Revocable Trust, effective April 1, 2023 (originally dated October 3, 2010, and previously amended November 15, 2016), the following dispositive provisions take effect upon Jonathan's death:
(a) Credit Shelter Trust. A credit shelter trust (also referred to as a "bypass trust" or "family trust") is funded with an amount equal to the then-applicable federal estate tax exemption amount. The credit shelter trust is designed to use Jonathan's remaining applicable exclusion amount so that the funded amount passes free of estate tax at Jonathan's death and is excluded from Eleanor's gross estate at her subsequent death. Eleanor is the income beneficiary of the credit shelter trust and may receive discretionary distributions of principal for her health, education, maintenance, and support. Upon Eleanor's death, the remaining assets in the credit shelter trust are distributed to Jonathan's descendants per stirpes.
(b) Marital QTIP Trust. The balance of the revocable trust estate, after funding of the credit shelter trust, passes to a marital trust qualifying for the qualified terminable interest property (QTIP) election under IRC § 2056(b)(7). Eleanor is the income beneficiary of the marital QTIP trust, entitled to all income for life, and holds a limited power of appointment over the trust corpus exercisable by will in favor of Jonathan's descendants. Upon Eleanor's death, absent the exercise of the power of appointment, the remaining marital trust assets are distributed to Jonathan's descendants per stirpes.
The marital QTIP trust qualifies for the estate tax marital deduction under IRC § 2056(b)(7), meaning that the value of the marital trust is deducted from Jonathan's gross estate and no estate tax is due on that portion at Jonathan's death. However, the marital trust property is included in Eleanor's gross estate under IRC § 2044 at her subsequent death, ensuring that the property is eventually subject to estate tax at one generation.
VI.B. GST Exemption Allocation to Credit Shelter Trust
At Jonathan's death, the credit shelter trust will be funded with the then-available estate tax exemption amount. If the current exemption amount of $12,920,000 remains in effect, the credit shelter trust will receive up to $12,920,000 (reduced by any post-mortem adjustments). If the 2025 sunset occurs and the exemption reverts to approximately $7,000,000, the credit shelter trust funding will be correspondingly reduced.
Jonathan's executor may allocate remaining GST exemption to the credit shelter trust on Jonathan's estate tax return (Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return). The goal would be to achieve an inclusion ratio of zero for the credit shelter trust, so that all distributions from the credit shelter trust to grandchildren and more remote descendants — whether during Eleanor's lifetime (unlikely, given the trust's focus on supporting Eleanor) or after Eleanor's death (when the trust distributes to descendants per stirpes) — are free of GST tax.
The credit shelter trust is not included in Eleanor's gross estate, and therefore its GST status is permanent: once the inclusion ratio is set at zero, it remains at zero regardless of what happens at Eleanor's subsequent death or thereafter. This makes the credit shelter trust an efficient vehicle for GST exemption allocation, as the exemption is "locked in" permanently.
The amount of GST exemption available for allocation to the credit shelter trust at Jonathan's death will depend on (a) the total exemption amount in effect at that time, (b) prior allocations made during Jonathan's lifetime (including the $5,000,000 allocation to the Dynasty Trust in 2023 and any post-ETIP allocations to GRAT remainder interests), and (c) any automatic allocations that may have occurred. The executor's allocation decision should be made in the context of the overall estate plan and in coordination with the reverse QTIP election analysis for the marital trust.
VI.C. Reverse QTIP Election — § 2652(a)(3)
The reverse QTIP election is a specialized GST planning tool authorized by IRC § 2652(a)(3). Under general principles, the "transferor" for GST purposes is the individual with respect to whom the property was most recently subject to estate or gift tax. For QTIP property, this creates a complexity: at Jonathan's death, the QTIP election treats the marital trust property as a transfer from Jonathan for estate tax purposes (qualifying for the marital deduction), but at Eleanor's death, the QTIP property is included in Eleanor's gross estate under IRC § 2044, which would ordinarily make Eleanor the GST transferor. Eleanor's GST exemption would then need to be allocated to the marital trust to achieve GST-exempt status.
The reverse QTIP election under § 2652(a)(3) allows the executor to elect to treat Jonathan — rather than Eleanor — as the transferor of the QTIP trust for GST purposes, notwithstanding the inclusion of the QTIP property in Eleanor's estate. If the reverse QTIP election is made, Jonathan's GST exemption can be allocated to the marital QTIP trust on Jonathan's Form 706, sheltering the trust from GST tax using Jonathan's exemption rather than Eleanor's.
Without the reverse QTIP election, Eleanor would be treated as the GST transferor of the QTIP property upon her death (since the QTIP property is included in her gross estate under § 2044). In that case, Eleanor's GST exemption would need to be allocated to the marital trust at her death to achieve a zero inclusion ratio.
Analysis of Whether to Elect Reverse QTIP. The decision whether to make the reverse QTIP election depends on several factors that cannot be fully evaluated until the time of Jonathan's death:
(1) Available GST Exemption at Jonathan's Death. If Jonathan has significant unused GST exemption at death — for example, if the GRAT remainder values are smaller than projected, or if the exemption amount has been increased by legislative action — a reverse QTIP election could shelter the marital trust from GST tax using Jonathan's exemption, preserving Eleanor's GST exemption for her own planning.
(2) Eleanor's GST Exemption. If Jonathan's GST exemption is largely consumed by allocations to the Dynasty Trust and GRAT remainder interests, it may be preferable to rely on Eleanor's own GST exemption ($12,920,000 in 2023, subject to future adjustment) to shelter the QTIP trust at her subsequent death. Eleanor's exemption is entirely unused (assuming no prior allocations) and may be sufficient to cover the marital trust.
(3) Relative Ages and Life Expectancies. Jonathan was born on March 14, 1956 (age 67), and Eleanor was born on September 22, 1958 (age 64). If Jonathan predeceases Eleanor by a significant number of years, the marital trust may appreciate substantially during the intervening period. A reverse QTIP election allows Jonathan's exemption to be "locked in" at the value of the marital trust at his death, which may be significantly less than the value at Eleanor's subsequent death.
(4) Projected Asset Growth. If the marital trust is expected to grow substantially between Jonathan's death and Eleanor's death, it may be more efficient to allocate Jonathan's GST exemption to the marital trust at Jonathan's death (via the reverse QTIP election) rather than relying on Eleanor's exemption at her later death, when the trust's value may have increased beyond her available exemption.
(5) Potential Changes to Exemption Amounts. If legislative action reduces the exemption amount before Eleanor's death, Eleanor's available GST exemption at her death may be less than currently anticipated, making the reverse QTIP election (using Jonathan's exemption at his death, when the exemption may still be at the elevated level) more attractive.
Recommendation. We recommend deferring the final decision on the reverse QTIP election to the time of Jonathan's death, when the executor will have full information regarding (a) the amount of Jonathan's remaining GST exemption, (b) the value of the marital trust, (c) the applicable exemption amount then in effect, (d) Eleanor's health and life expectancy, and (e) the then-current legislative landscape. To facilitate this future decision, we will include detailed instructions regarding the reverse QTIP election in the estate plan closing letter to Jonathan (dated September 29, 2023) and in the executor guidance memorandum that will be prepared as part of the Plan documentation. These materials will explain the mechanics of the election, the factors bearing on the decision, and the applicable deadlines for making the election on Form 706.
VI.D. Eleanor's Independent GST Exemption
Eleanor V. Caldwell holds her own GST exemption of $12,920,000 for 2023. Eleanor is not the grantor of the Dynasty Trust, the three GRATs, or the ILIT. She is a co-grantor (with Jonathan) only of The Caldwell Family Foundation, which is a charitable entity organized under IRC § 501(c)(3) and does not generate GST implications, as transfers to charitable entities are not subject to the GST tax.
Eleanor's GST exemption is available for allocation to:
(a) The QTIP trust property, if no reverse QTIP election is made by Jonathan's executor, treating Eleanor as the transferor at her death under the general rule of IRC § 2652(a)(1); or
(b) Any separate trusts Eleanor may create for grandchildren or more remote descendants under her own estate plan.
Eleanor holds separate assets of approximately $18,000,000, which are not part of the Calderwood & Harkness engagement for the Caldwell Generational Estate Plan. Eleanor's own estate plan is administered by Pemberton, Locke & Strauss LLP, with Rachel F. Dunlap serving as lead counsel. We recommend that Jonathan's GST allocation strategy be coordinated with Eleanor's independent estate planning to ensure that the combined GST exemptions of Jonathan and Eleanor ($25,840,000 in aggregate for 2023) are deployed in the most efficient manner possible, taking into account the various trusts and structures in both estate plans. We have communicated this recommendation to Jonathan and propose scheduling a joint coordination meeting with Ms. Dunlap in the fourth quarter of 2023.
VII. Automatic Allocation Rules and Elections
VII.A. Automatic Allocation to Direct Skips — § 2632(a)
Under IRC § 2632(a), GST exemption is automatically allocated to any direct skip — that is, a transfer subject to gift or estate tax made directly to a skip person — to the extent of the transferor's available GST exemption, unless the transferor elects out on a timely filed Form 709.
No direct skips are contemplated in the current Caldwell Generational Estate Plan. All transfers made during 2023 flow through trusts that include non-skip beneficiaries: the Dynasty Trust names the three children as beneficiaries, the GRATs designate the Dynasty Trust as remainder beneficiary, and the ILIT includes the three children as Crummey beneficiaries. Therefore, the automatic allocation rule for direct skips does not apply to any transfer made in connection with the Plan, and no election out is necessary under this provision.
VII.B. Automatic Allocation to Indirect Skips — § 2632(c)
Under IRC § 2632(c), enacted as part of the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA"), transfers to "GST trusts" are treated as indirect skips and automatically receive an allocation of the transferor's GST exemption. The purpose of this rule is to prevent inadvertent loss of the GST exemption in situations where a transferor makes a gift to a trust with skip-person beneficiaries but fails to affirmatively allocate GST exemption on the gift tax return.
A "GST trust" is defined in IRC § 2632(c)(3)(B) as any trust that could have a generation-skipping transfer with respect to the transferor, unless one or more of six statutory exceptions applies. The exceptions are narrowly drawn and generally cover trusts that are designed to terminate and distribute entirely to non-skip persons within specified timeframes. Most trusts with any skip-person beneficiaries — including trusts for descendants per stirpes where grandchildren are contingent or remainder beneficiaries — will qualify as GST trusts and be subject to automatic allocation.
The application of the automatic allocation rule to each of the trusts in the Caldwell Generational Estate Plan is as follows:
Dynasty Trust: The Dynasty Trust names grandchildren and more remote descendants as beneficiaries and is therefore likely a GST trust. If the automatic allocation rules applied, they would allocate GST exemption to the $5,000,000 initial funding automatically. However, as discussed in Section III.C above, we recommend making an affirmative allocation rather than relying on the automatic rules, to ensure precision and control. The affirmative allocation supersedes the automatic allocation and achieves the same result with greater certainty.
ILIT: The ILIT may qualify as a GST trust if grandchildren are named as contingent or remainder beneficiaries. If the automatic allocation rules applied, they would allocate $187,500 of GST exemption to each annual premium contribution, which is undesirable for the reasons discussed in Section V.B above. We recommend electing out of automatic allocation to the ILIT (see Section VII.C below).
GRATs: The automatic allocation rules do not apply during the ETIP. IRC § 2632(c)(4) expressly provides that the deemed allocation rules of § 2632(c) shall not apply to any indirect skip to which § 2642(f) (the ETIP rules) applies. Because each GRAT has an open ETIP, the automatic allocation rules are inapplicable to the GRAT fundings. This reinforces the ETIP analysis set forth in Section IV above.
VII.C. Election Out of Automatic Allocation