**MEMORANDUM**
PRIVILEGED AND CONFIDENTIAL — ATTORNEY-CLIENT COMMUNICATION / ATTORNEY WORK PRODUCT
TO: Jonathan R. Caldwell
FROM: Sylvia Hartwell, Specialist Partner (Tax), Calderwood & Harkness LLP
CC: Victoria Chambers, Responsible Partner; Monica Reyes, Lead Associate; Elliot Nguyen, Working Associate
DATE: March 28, 2023
RE: Marital Deduction Planning — Credit Shelter Trust and Marital QTIP Trust Design Under the Amended and Restated Caldwell Revocable Trust
MATTER NO.: 1034-00004
BILLING CODE: 78412-JRC
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I. PURPOSE AND EXECUTIVE SUMMARY
This memorandum analyzes the optimal marital deduction planning structure for the Amended and Restated Jonathan R. Caldwell Revocable Trust (originally established October 3, 2010; to be amended and restated effective April 1, 2023) (the "Revocable Trust") in the context of the comprehensive generational estate plan being implemented for Jonathan R. Caldwell ("Jonathan" or the "Grantor"). The analysis addresses the design, tax characteristics, funding mechanics, and coordination requirements of the two sub-trusts that will come into existence at Jonathan's death, as well as the interplay of those sub-trusts with the broader estate plan architecture.
Based on our analysis of the applicable provisions of the Internal Revenue Code, Treasury Regulations, relevant case law, and the specific facts of Jonathan's estate, we recommend a two-trust structure that will take effect at the first death:
1. Credit Shelter Trust (also referred to herein as the "Bypass Trust" or "Family Trust") — funded with assets equal to the then-available federal estate tax exemption amount (the "applicable exclusion amount" under IRC § 2010(c)), reduced by adjusted taxable gifts and specific bequests. This trust will be designed to be excluded from the surviving spouse's gross estate at the second death, thereby sheltering the trust principal and all post-death appreciation from federal estate tax at both deaths.
2. Marital QTIP Trust — funded with the balance of the Revocable Trust estate remaining after funding the Credit Shelter Trust. The Marital QTIP Trust will qualify for the unlimited marital deduction under IRC § 2056(b)(7), deferring all federal estate tax on the marital portion until the surviving spouse's subsequent death. The executor will elect qualified terminable interest property ("QTIP") treatment on the federal estate tax return (Form 706).
Eleanor V. Caldwell ("Eleanor"), Jonathan's spouse (date of birth September 22, 1958; age 64), will serve as the mandatory income beneficiary of both trusts. Eleanor will hold a general power of appointment over the Marital QTIP Trust, exercisable by will, but will not hold a general power of appointment over the Credit Shelter Trust. The Credit Shelter Trust distribution standard for principal invasions will be limited to an ascertainable standard — health, education, maintenance, and support ("HEMS") — to prevent inclusion in Eleanor's gross estate under IRC § 2041.
The two-trust design must be carefully coordinated with the other components of Jonathan's comprehensive estate plan, including: (a) the three Grantor Retained Annuity Trusts ("GRATs") — the Caldwell 2023 Securities GRAT ("GRAT A"), the Caldwell 2023 Realty GRAT ("GRAT B"), and the Caldwell 2023 Carried Interest GRAT ("GRAT C"); (b) the Caldwell Family Dynasty Trust (Delaware situs); (c) The Caldwell Family Foundation (a New York not-for-profit corporation); and (d) the Caldwell Family Insurance Trust ("ILIT"). Together, these components form an integrated architecture designed to minimize transfer taxes, preserve wealth across multiple generations, and provide for charitable giving consistent with the Caldwell family's philanthropic objectives.
This memorandum also addresses the following critical planning considerations:
• The portability election under IRC § 2010(c)(4) and the recommendation to file Form 706 at Jonathan's death regardless of whether any deceased spousal unused exclusion ("DSUE") amount is expected to be available;
• The impact of the scheduled 2025 sunset of the increased federal exemption amount under the Tax Cuts and Jobs Act of 2017 ("TCJA"), and the importance of formula funding clauses that automatically adapt to the exemption level in effect at the date of death;
• The reverse QTIP election under IRC § 2652(a)(3) for generation-skipping transfer ("GST") tax purposes;
• Second basis step-up planning under IRC § 1014 and the strategic allocation of assets between the Credit Shelter Trust and the Marital QTIP Trust at funding;
• Income tax considerations for both trusts after Jonathan's death, including the compressed trust income tax brackets, the net investment income tax under IRC § 1411, and New York state income tax implications; and
• The necessity of post-mortem planning flexibility, including disclaimer provisions, the Clayton QTIP election, and trust protector authority.
Summary Recommendation. We recommend adopting the credit shelter / QTIP split with fractional-share formula funding clauses; electing QTIP treatment on the Marital QTIP Trust assets on Form 706; preserving portability as a backstop by filing Form 706 in all events; and building in maximum flexibility for post-mortem planning through formula clauses, disclaimer provisions, the Clayton QTIP election, and the reverse QTIP election. The trust instrument should be drafted with sufficient flexibility to accommodate changes in the tax law, including the potential 2025 sunset, without requiring amendment.
This memorandum should be read in conjunction with the Estate Planning Strategy Memorandum, the GST Exemption Allocation Memorandum, the Dynasty Trust Situs Analysis, and the Federal Estate and Gift Tax Analysis prepared in connection with this matter.
II. BACKGROUND — CLIENT PROFILE AND ESTATE CONTEXT
A. Jonathan R. Caldwell — Personal and Financial Overview
Jonathan R. Caldwell is a United States citizen and resident of New York. His personal details are as follows:
• Date of Birth: March 14, 1956 (age 67)
• Residence: 418 East 72nd Street, Apt. 14A, New York, NY 10021
• Social Security Number (last four): 4781
• Marital Status: Married to Eleanor V. Caldwell since 1985
• Citizenship: United States
Jonathan is the founder and former Managing Partner of Caldwell Ridgeline Capital LLC ("CRC"), a private equity firm headquartered at 280 Park Avenue, 35th Floor, New York, NY 10017, with approximately $2.1 billion in assets under management across multiple fund vintages. Jonathan retired from active management of CRC in 2019 but retains significant carried-interest positions and limited partner stakes in CRC Funds IV, V, and VI. These carried-interest and LP positions represent a substantial and illiquid component of his overall estate, currently estimated at approximately $38,000,000 in fair market value.
In addition to his interests in CRC, Jonathan holds a substantial commercial and residential real estate portfolio through Stonecrest Realty Holdings LLC ("Stonecrest"), a limited liability company organized under New York law with its principal office at 330 Madison Avenue, Suite 2401, New York, NY 10017. Stonecrest owns eleven commercial and residential properties located across New York, New Jersey, and Connecticut. The aggregate fair market value of Stonecrest is currently estimated at approximately $134,000,000, based on the most recent independent appraisals obtained from Pemberton Valuation Group LLC (dated January 15, 2023) and coordinated with Havensbrook Wealth Advisors LLC. The mortgages on the Stonecrest properties are non-recourse at the entity level and do not create personal liability for Jonathan; accordingly, the net estate approximately equals the gross estate for purposes of this analysis.
Jonathan's estimated gross estate, as of the date of this memorandum, is approximately $300,000,000, composed of the following asset categories:
All of Jonathan's property is separate property under New York law. Although Jonathan and Eleanor have been married since 1985, New York is not a community property state, and no transmutation agreements or other arrangements have been entered into that would alter the separate property characterization. This is relevant to the marital deduction analysis because the unlimited marital deduction under IRC § 2056 is available regardless of whether property is characterized as separate or community, but the characterization affects the ownership and funding analysis.
B. Eleanor V. Caldwell — Spouse
Eleanor V. Caldwell, Jonathan's spouse, is a United States citizen and resident of New York. Her personal details are as follows:
• Date of Birth: September 22, 1958 (age 64)
• Residence: 418 East 72nd Street, Apt. 14A, New York, NY 10021 (same as Jonathan)
• Marital Status: Married to Jonathan R. Caldwell since 1985
• Citizenship: United States
Eleanor was formerly a partner at the Whitmore-Langdon Gallery, a contemporary art gallery in Manhattan, which she co-founded and subsequently sold in 2017. Since the sale, Eleanor has been active in philanthropic pursuits, including her role as a founding board member of The Caldwell Family Foundation and her involvement with several New York-based arts and education nonprofits.
Eleanor holds separate assets of approximately $18,000,000, which are not part of this engagement. These separate assets are managed by Havensbrook Wealth Advisors LLC and are the subject of Eleanor's own estate plan, which is being developed by her independent counsel.
Independent Counsel. At Calderwood & Harkness's recommendation, Eleanor has retained independent legal counsel to ensure she receives separate and independent representation regarding the spousal consent provisions, marital trust design, general power of appointment, and other aspects of Jonathan's estate plan that affect her rights and interests. Eleanor's independent counsel is:
Rachel F. Dunlap, Esq. Pemberton, Locke & Strauss LLP 405 Lexington Avenue, 26th Floor New York, NY 10174
The retention of independent counsel for Eleanor is a best-practice measure that protects both Jonathan and Eleanor by ensuring that Eleanor's consent to the estate plan provisions — including the allocation of property between the Credit Shelter Trust (which bypasses her estate) and the Marital QTIP Trust (which is included in her estate) — is fully informed and independently advised. This practice also mitigates any potential future claims of undue influence or lack of informed consent.
C. Children and Grandchildren
Jonathan and Eleanor have three living children and four grandchildren:
1. Thomas R. Caldwell
• Date of Birth: June 7, 1985 (age 38)
• Residence: 55 Perry Street, Unit 3, New York, NY 10014
• Occupation: Vice President of Acquisitions, Meridian Crest Partners LLC
• Marital Status: Married to Dr. Sarah P. Caldwell (physician, NYU Langone)
• Children:
• Lucas T. Caldwell (date of birth: approximately 2020; age 3)
• Nora E. Caldwell (date of birth: approximately 2022; age 1)
Thomas is actively involved in the family's financial affairs and has been designated as successor trustee of both the Credit Shelter Trust and the Marital QTIP Trust, as well as the family trustee of the Caldwell Family Dynasty Trust. His professional background in private equity acquisitions provides him with relevant experience for these fiduciary roles.
2. Katherine C. Hartfield
• Date of Birth: November 19, 1987 (age 35)
• Residence: 210 Briarcliff Lane, Greenwich, CT 06830
• Occupation: Freelance interior designer
• Marital Status: Married to Dr. Andrew W. Hartfield (physician, Preswick Medical Center)
• Children:
• James W. Hartfield (date of birth: approximately 2015; age 8)
• Charlotte M. Hartfield (date of birth: approximately 2018; age 5)
Katherine has been designated as successor agent under Jonathan's health care proxy and has been included as a Crummey withdrawal beneficiary of the ILIT.
3. Olivia G. Caldwell
• Date of Birth: April 2, 1993 (age 30)
• Residence: 1240 North Dearborn Street, Apt. 807, Chicago, IL 60610
• Occupation: Associate at Linden & Fairchild LLP (environmental law practice)
• Marital Status: Unmarried; no children
Olivia has been included as a Crummey withdrawal beneficiary of the ILIT and is a remainder beneficiary of the Credit Shelter Trust and the Marital QTIP Trust.
Summary of Grandchildren. There are four grandchildren in total: James W. Hartfield (age 8), Charlotte M. Hartfield (age 5), Lucas T. Caldwell (age 3), and Nora E. Caldwell (age 1). The existence of grandchildren (and potential future grandchildren) is directly relevant to the generation-skipping transfer tax analysis and the coordination between the Credit Shelter Trust, the Dynasty Trust, and the GST exemption allocation strategy.
D. Existing Estate Documents
Jonathan's existing estate planning documents include the following:
• Original Caldwell Revocable Trust, established October 3, 2010. This trust was funded during Jonathan's lifetime with various assets and serves as the primary vehicle for the disposition of Jonathan's estate. The trust is currently revocable and amendable by Jonathan during his lifetime.
• Last Will and Testament, dated October 3, 2010, which serves as a pour-over will directing all probate assets into the Revocable Trust. This will is to be revoked and superseded by a new pour-over will to be executed on April 1, 2023.
The Revocable Trust is being amended and restated effective April 1, 2023, to incorporate the credit shelter / marital QTIP split structure analyzed in this memorandum, as well as to update fiduciary designations, administrative provisions, and other terms to reflect the comprehensive estate plan. The new pour-over will, also to be executed on April 1, 2023, will revoke the October 3, 2010 will and direct all probate assets into the Amended and Restated Revocable Trust.
E. Interplay with Other Plan Components
The Revocable Trust and the marital deduction planning structure analyzed in this memorandum constitute the central component of a broader estate plan architecture that includes several integrated vehicles. An understanding of each component and its relationship to the Revocable Trust is essential to the design of the Credit Shelter Trust and Marital QTIP Trust.
1. Caldwell 2023 Securities GRAT ("GRAT A")
GRAT A is a two-year grantor retained annuity trust to be funded on April 15, 2023, with $60,000,000 in publicly traded securities from Jonathan's liquid securities portfolio. The annuity payment is $32,195,122 per year, calculated based on the IRC § 7520 rate in effect at the time of funding (currently 5.0%) and designed to result in a gift value as close to zero as possible ("zeroed-out GRAT"). Upon termination, any appreciation in excess of the § 7520 hurdle rate passes to the Caldwell Family Dynasty Trust, free of gift and estate tax. If the GRAT assets fail to outperform the hurdle rate, the annuity payments return the contributed assets (plus the hurdle-rate return) to Jonathan, and no wealth transfer is achieved.
2. Caldwell 2023 Realty GRAT ("GRAT B")
GRAT B is a three-year grantor retained annuity trust to be funded on May 1, 2023, with membership interests in Stonecrest Realty Holdings LLC valued at $80,000,000 (representing approximately 59.7% of Stonecrest). The annuity payment is $29,375,859 per year, similarly designed as a zeroed-out GRAT based on the § 7520 rate. The Stonecrest interests will be valued for gift tax purposes taking into account applicable valuation discounts for lack of control and lack of marketability. The remainder interest passes to the Dynasty Trust upon termination.
3. Caldwell 2023 Carried Interest GRAT ("GRAT C")
GRAT C is a three-year grantor retained annuity trust to be funded on June 1, 2023, with Jonathan's carried-interest and limited partner positions in CRC Funds IV, V, and VI, valued at $38,000,000. The annuity payment is $13,953,759 per year. As with the other GRATs, this is designed as a zeroed-out GRAT. The carried-interest positions are inherently speculative and illiquid, and the GRAT structure provides an efficient mechanism to transfer any upside above the hurdle rate to the Dynasty Trust without gift tax cost.
Total GRAT-Funded Assets: $178,000,000 (pre-discount values). These assets are being removed from Jonathan's potential taxable estate during his lifetime through the GRAT mechanism. If the GRATs succeed (i.e., if the contributed assets appreciate above the § 7520 hurdle rate during the GRAT term), the excess appreciation will pass to the Dynasty Trust outside of Jonathan's and Eleanor's taxable estates.
4. Caldwell Family Dynasty Trust
The Caldwell Family Dynasty Trust (the "Dynasty Trust") is a Delaware-situs irrevocable trust established to benefit multiple generations of the Caldwell family in perpetuity under Delaware's perpetual trust statute (12 Del. C. § 3556). Northgate Trust Company of Delaware serves as the institutional co-trustee, and Thomas R. Caldwell serves as the family trustee. The Dynasty Trust has been initially funded with $5,000,000 in cash, which utilizes $5,000,000 of Jonathan's remaining $6,170,000 lifetime exemption. After this gift, Jonathan retains $1,170,000 in remaining lifetime gift/estate tax exemption. The Dynasty Trust will also receive the GRAT remainder interests upon termination of GRATs A, B, and C.
5. The Caldwell Family Foundation
The Caldwell Family Foundation is a New York not-for-profit corporation established for charitable purposes, initially funded with $10,000,000 ($5,000,000 contributed by Jonathan and $5,000,000 contributed by Eleanor). The Foundation has received its determination letter from the IRS (EIN 88-3021547; determination letter received July 14, 2023) and operates as a private foundation under IRC § 509(a). Jonathan's $5,000,000 contribution generated a charitable income tax deduction and reduced his gross estate by that amount. The Foundation's charitable mission and governance are outside the scope of this memorandum, but the contribution has already been reflected in the estate valuation analysis.
6. Caldwell Family Insurance Trust (ILIT)
The Caldwell Family Insurance Trust (the "ILIT") is an irrevocable trust that owns a $15,000,000 second-to-die universal life insurance policy issued by Beacon Life Assurance Company (Policy No. BLA-2023-77419). The annual premium is $187,500. Northgate Trust Company of Delaware serves as trustee. The policy insures the joint lives of Jonathan and Eleanor, with the death benefit payable upon the second death. The ILIT beneficiaries include Thomas R. Caldwell, Katherine C. Hartfield, and Olivia G. Caldwell, each of whom holds Crummey withdrawal rights to support the annual exclusion treatment of premium contributions. The ILIT proceeds ($15,000,000) are excluded from both Jonathan's and Eleanor's taxable estates because neither Jonathan nor Eleanor holds any incidents of ownership in the policy, and the trust is irrevocable and independently administered.
Relationship to the Revocable Trust. The Revocable Trust and the Credit Shelter / Marital QTIP structure govern the disposition of all assets remaining in Jonathan's estate at death — that is, assets that have not been previously transferred to the GRATs, the Dynasty Trust, the Foundation, or the ILIT during Jonathan's lifetime. The pour-over will (to be executed April 1, 2023, revoking the October 3, 2010 will) directs all probate assets into the Revocable Trust, ensuring that the Revocable Trust serves as the primary receptacle for Jonathan's estate and the vehicle through which the Credit Shelter Trust and Marital QTIP Trust are funded.
Assuming the GRATs perform as projected and successfully transfer excess appreciation to the Dynasty Trust, the assets passing through the Revocable Trust at Jonathan's death are estimated at approximately $225,000,000 to $240,000,000, depending on growth rates, GRAT performance, spending during Jonathan's lifetime, and other variables. This estimate is subject to significant uncertainty and will be refined as the plan is implemented and monitored over time.
III. FEDERAL ESTATE TAX EXEMPTION — CURRENT LAW AND 2025 SUNSET
The design of the Credit Shelter Trust and Marital QTIP Trust is fundamentally driven by the federal estate and gift tax exemption amount — the "applicable exclusion amount" under IRC § 2010(c) — available at the date of Jonathan's death. Because this amount is subject to legislative change, and because a major change is currently scheduled for January 1, 2026, a thorough understanding of the current exemption landscape and the potential sunset is essential to the design.
A. Current Exemption Amount (2023)
For the 2023 tax year, the federal estate and gift tax exemption is $12,920,000 per individual, as adjusted for inflation under IRC § 2010(c)(3)(B). This is the "basic exclusion amount" that each individual may transfer, either during lifetime or at death, free of federal estate and gift tax. The maximum federal estate tax rate is 40%.
Jonathan R. Caldwell's remaining exemption, before the current estate planning engagement, is computed as follows:
• 2023 basic exclusion amount: $12,920,000
• Less: prior taxable gifts (cumulative): ($6,750,000)
• Remaining exemption before current plan: $6,170,000
The $6,750,000 in prior taxable gifts reflects cumulative gifts made by Jonathan in prior years, including gifts to family members and prior trust funding that exceeded the annual gift tax exclusion amount.
Under the current estate plan, the following additional lifetime transfers will further reduce Jonathan's available exemption:
• Gift to the Caldwell Family Dynasty Trust: ($5,000,000)
• Remaining exemption after Dynasty Trust gift: $1,170,000
Additionally, the annual premium payments on the ILIT policy ($187,500 per year) will generate small incremental draws on Jonathan's exemption to the extent the premium contributions exceed the amount covered by the annual exclusion ($17,000 per beneficiary in 2023, or $51,000 for three Crummey beneficiaries, leaving approximately $136,500 per year in excess of the annual exclusion). Over time, these annual draws will further reduce the available exemption.
At the time of Jonathan's death, the applicable exclusion amount available for Credit Shelter Trust funding will be the then-current exemption (as adjusted for inflation) less all lifetime adjusted taxable gifts, including the gifts described above and any future gifts made between now and the date of death.
B. Scheduled 2025 Sunset Under the Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act of 2017 ("TCJA"), Pub. L. No. 115-97, 131 Stat. 2054, approximately doubled the federal estate and gift tax exemption from approximately $5,490,000 (in 2017) to its current level. The TCJA achieved this increase by adding a temporary provision that effectively doubled the "basic exclusion amount" for taxable years beginning after December 31, 2017, and before January 1, 2026.
Under current law, the increased exemption is scheduled to sunset after December 31, 2025. Unless Congress enacts legislation extending the increased exemption, it will revert to its pre-TCJA level (approximately $5,000,000, as adjusted for inflation from the 2010 base year). Based on current inflation projections, the post-sunset exemption is expected to be in the range of approximately $6,000,000 to $7,000,000 beginning January 1, 2026.
The scheduled sunset has significant implications for the Credit Shelter Trust design:
• If Jonathan dies before January 1, 2026, and the exemption remains at its current level, the Credit Shelter Trust can be funded with up to $12,920,000 (less prior gifts), potentially sheltering a substantial amount from estate tax at both deaths.
• If Jonathan survives beyond December 31, 2025, and the exemption reverts, the Credit Shelter Trust will be funded with a significantly smaller amount — potentially as little as $0 to $1,000,000, depending on the post-sunset exemption level and Jonathan's cumulative lifetime gifts. In this scenario, virtually all of the Revocable Trust estate will pass to the Marital QTIP Trust, deferring estate tax to Eleanor's death.
• If Congress extends the increased exemption or enacts other changes, the Credit Shelter Trust will be funded according to whatever exemption amount is in effect at the date of death.
The critical planning implication is the importance of formula funding clauses that reference the "applicable exclusion amount" at the date of death, rather than fixed dollar amounts. A formula clause ensures that the Credit Shelter Trust is automatically funded with the maximum tax-free amount, whatever it may be, without requiring amendment to the trust instrument. This approach provides the plan with built-in adaptability to any legislative outcome.
C. Anti-Clawback Regulation
A related concern that has been addressed by the Treasury Department involves the potential "clawback" of gifts made during the increased exemption period if the exemption subsequently decreases. Specifically, there was concern that a taxpayer who made large gifts during the TCJA period (when the exemption was $12.92M or higher) could face estate tax on those gifts at death if the exemption had reverted to a lower level, effectively "clawing back" the benefit of the higher exemption.
The Treasury Department's final anti-clawback regulation, codified at Treas. Reg. § 20.2010-1(c), addresses this concern by providing that the estate tax computation at death will use the higher of the basic exclusion amount in effect at the date of death or the basic exclusion amount that was effectively used to offset gifts during the taxpayer's lifetime. In other words, gifts made during the increased exemption period will not be "clawed back" if the exemption later decreases.
For Jonathan's estate, this means:
• Jonathan's prior gifts of $6,750,000 are protected by the anti-clawback regulation. These gifts were made (or deemed made) during the increased exemption period and will not generate additional estate tax at death even if the exemption reverts to a lower level.
• The $5,000,000 gift to the Dynasty Trust, also made during the increased exemption period, is similarly protected.
• However, the anti-clawback regulation does not increase the exemption available at death for the Credit Shelter Trust. The Credit Shelter Trust will be funded with the then-applicable exemption amount, net of lifetime gifts, at the date of death. If the exemption has reverted, the available amount for the Credit Shelter Trust will be reduced accordingly.
The anti-clawback regulation thus protects Jonathan's lifetime gifts but does not preserve the higher exemption for the testamentary Credit Shelter Trust. This distinction underscores the importance of the formula funding approach and the complementary role of the GRAT and Dynasty Trust structures in transferring wealth outside the taxable estate during Jonathan's lifetime, when the higher exemption is available.
IV. CREDIT SHELTER TRUST DESIGN
The Credit Shelter Trust (also referred to as the "Bypass Trust" or "Family Trust") is the cornerstone of the marital deduction planning structure. Its primary purpose is to shelter an amount equal to the available federal estate tax exemption from estate tax at both Jonathan's death and Eleanor's subsequent death. By designing the Credit Shelter Trust to be excluded from Eleanor's gross estate, the trust achieves a permanent estate tax savings on the funded amount plus all post-death appreciation.
A. Funding Mechanism — Formula Clause
The Credit Shelter Trust will be funded using a formula clause equal to the maximum amount that can pass free of federal estate tax at Jonathan's death — that is, an amount equal to the "applicable exclusion amount" under IRC § 2010(c), reduced by adjusted taxable gifts made during Jonathan's lifetime and any specific bequests that do not qualify for the marital or charitable deductions.
The formula clause operates as follows: at Jonathan's death, the Revocable Trust estate is divided into two shares — the Credit Shelter Share and the Marital Share. The Credit Shelter Share is defined by formula as the largest amount that can pass free of federal estate tax (taking into account the unified credit, adjusted taxable gifts, and any other available deductions or credits), and the Marital Share is the balance. This approach ensures that the Credit Shelter Trust is always funded with exactly the optimal amount, regardless of the exemption level in effect at the date of death.
Pecuniary vs. Fractional-Share Funding. There are two principal methods of implementing the formula clause:
• Pecuniary Formula. The Credit Shelter Trust is funded with a fixed dollar amount (as determined by the formula), and the Marital Trust receives the residue. The advantage of the pecuniary approach is simplicity of administration — the Credit Shelter Trust receives specific assets valued at the formula amount, and the Marital Trust receives everything else. The disadvantage is that the distribution of assets to satisfy a pecuniary amount is treated as a sale or exchange for income tax purposes (under Kenan v. Commissioner, 114 F.2d 217 (2d Cir. 1940), and Rev. Rul. 60-87, 1960-1 C.B. 286), potentially triggering recognition of capital gain on appreciated assets used to fund the pecuniary share. This income tax cost can be significant for an estate with substantial built-in gain.
• Fractional-Share Formula. The Credit Shelter Trust is funded with a fractional share of the Revocable Trust estate, with the numerator determined by the formula amount and the denominator determined by the total value of the Revocable Trust estate. Both trusts share proportionately in post-death appreciation and depreciation. The advantage of the fractional-share approach is that no gain is recognized upon funding (because each trust receives an undivided fractional interest in each asset, rather than a specific dollar amount satisfied with appreciated property). The disadvantage is greater administrative complexity, as each trust must track its fractional interest in each asset.
Recommendation. We recommend the fractional-share formula for the Caldwell plan. Given the magnitude of the estate and the substantial unrealized appreciation in the Stonecrest and CRC interests, the income tax cost of recognizing gain on pecuniary funding distributions could be significant — potentially several million dollars in capital gains tax. The fractional-share approach avoids this entirely. While the administrative complexity is greater, the Revocable Trust will have professional fiduciary and advisory support (from Northgate Trust Company of Delaware, Havensbrook Wealth Advisors LLC, and Strathmore Corporation & Greaves LLP) sufficient to manage the fractional-share accounting.
B. Assets Available for Credit Shelter Funding
At Jonathan's death, the assets remaining in the Revocable Trust — and therefore available for allocation between the Credit Shelter Trust and the Marital QTIP Trust — will include:
• Remaining Liquid Securities. The portion of Jonathan's $112,000,000 liquid securities portfolio that has not been transferred to GRAT A. GRAT A is funded with $60,000,000, leaving approximately $52,000,000 in liquid securities in the Revocable Trust (subject to investment performance and spending during Jonathan's lifetime).
• Remaining Stonecrest Membership Interests. Approximately 40.3% of Stonecrest Realty Holdings LLC — the portion not contributed to GRAT B. GRAT B is funded with membership interests representing approximately 59.7% of Stonecrest ($80,000,000 of $134,000,000). The remaining 40.3% interest, representing approximately $54,000,000 in value, remains in the Revocable Trust.
• Art & Collectibles. Jonathan's art and collectibles, valued at approximately $9,000,000, remain in the Revocable Trust and are not part of any GRAT or other transfer vehicle.
• Other Assets. Cash, personal property, and miscellaneous assets valued at approximately $7,000,000 remain in the Revocable Trust.
• GRAT Annuity Payments. During the GRAT terms, the annuity payments from GRATs A, B, and C are returned to Jonathan (or his estate, if he dies during the GRAT term). These annuity payments — totaling approximately $32.2M/year from GRAT A, $29.4M/year from GRAT B, and $14.0M/year from GRAT C — will flow back into Jonathan's hands and ultimately into the Revocable Trust, to the extent not spent or reinvested.
Assets Not Passing Through the Revocable Trust. The following assets are not part of the Revocable Trust estate and will not be available for Credit Shelter Trust or Marital QTIP Trust funding:
• GRAT remainder interests that successfully pass to the Dynasty Trust upon GRAT termination are excluded from Jonathan's taxable estate.
• The ILIT death benefit ($15,000,000) is excluded from both Jonathan's and Eleanor's taxable estates because neither holds any incidents of ownership in the policy.
• The Foundation contributions ($10,000,000) have already been made and are not part of the estate.
Estimated Post-Plan Assets. Based on current projections, the assets passing through the Revocable Trust at Jonathan's death are estimated at approximately $225,000,000 to $240,000,000, assuming the GRATs perform as projected, Jonathan does not make additional transfers during his lifetime, and investment returns and spending are within expected ranges. This estimate is, of course, highly sensitive to market conditions, investment performance, the duration of Jonathan's life, and other variables.
C. Beneficiaries and Distribution Standards
The Credit Shelter Trust beneficiaries and distribution provisions are designed to provide for Eleanor during her lifetime while ensuring that the trust is excluded from her gross estate at her subsequent death. The key provisions are as follows:
• Mandatory Income Beneficiary. Eleanor V. Caldwell is the mandatory income beneficiary of the Credit Shelter Trust. She is entitled to receive all net income of the trust, payable at least quarterly. This mandatory income distribution ensures that Eleanor has access to the income generated by the Credit Shelter Trust assets throughout her lifetime and also carries out distributable net income ("DNI") for income tax purposes, avoiding the compressed trust income tax brackets on distributed income.
• Discretionary Principal Distributions. The trustee is authorized to distribute principal to Eleanor for her health, education, maintenance, and support (the "HEMS" standard). The HEMS standard is an ascertainable standard under IRC § 2041(b)(1)(A) and Treas. Reg. § 20.2041-1(c)(2), which means that Eleanor's power to receive principal distributions under this standard does not constitute a general power of appointment and does not cause inclusion of the Credit Shelter Trust in Eleanor's gross estate. The HEMS standard has been construed by the IRS and the courts to permit distributions for the beneficiary's accustomed standard of living, medical expenses, educational expenses, and other needs consistent with the beneficiary's station in life.
• Remainder Beneficiaries. Upon Eleanor's death, the remaining principal and undistributed income of the Credit Shelter Trust pass to Jonathan and Eleanor's three children — Thomas R. Caldwell, Katherine C. Hartfield, and Olivia G. Caldwell — per stirpes. Alternatively, the trust instrument will grant the trustee discretion to direct the Credit Shelter Trust remainder to the Caldwell Family Dynasty Trust, to the extent consistent with GST planning objectives. This pour-over mechanism allows the Credit Shelter Trust assets to be merged into the Dynasty Trust at Eleanor's death, achieving perpetual multi-generational trust protection under Delaware's perpetual trust statute.
It is important to emphasize that Eleanor does not hold a general power of appointment over the Credit Shelter Trust. This is the critical distinction between the Credit Shelter Trust and the Marital QTIP Trust. The absence of a general power of appointment, combined with the HEMS distribution standard, ensures that the Credit Shelter Trust is excluded from Eleanor's gross estate under IRC § 2041.
D. Trustee Designation
The trustee designations for the Credit Shelter Trust are as follows:
• During Jonathan's Lifetime (Revocable Trust Phase). Jonathan R. Caldwell serves as the sole trustee of the Revocable Trust during his lifetime. The Revocable Trust is fully revocable and amendable by Jonathan, and he retains complete control over trust assets.
• Upon Jonathan's Death (Trust Becomes Irrevocable and Splits). Upon Jonathan's death, the Revocable Trust becomes irrevocable and divides into the Credit Shelter Trust and the Marital QTIP Trust. Eleanor V. Caldwell will serve as the initial trustee of the Credit Shelter Trust.
• Successor Trustee. Thomas R. Caldwell is designated as the successor trustee, to serve if Eleanor is unable or unwilling to serve as trustee, or upon Eleanor's death.
• Institutional Co-Trustee. Northgate Trust Company of Delaware may serve as institutional co-trustee if Eleanor or Thomas declines to serve or is unable to serve. The trust instrument will also provide the option for the serving individual trustee to appoint Northgate (or another qualified institutional trustee) as co-trustee at any time, providing flexibility to bring in professional fiduciary support as needed.
The designation of Eleanor as trustee of the Credit Shelter Trust is appropriate because her distribution authority is limited to the HEMS standard, which is an ascertainable standard that does not create a general power of appointment. If Eleanor served as trustee and held broader discretionary authority over distributions to herself, there would be a risk of inclusion under IRC § 2041. The HEMS limitation eliminates this risk.
E. Tax Characteristics of the Credit Shelter Trust
The Credit Shelter Trust is designed to achieve the following estate and gift tax results:
• Excluded from Eleanor's Gross Estate. Because Eleanor does not hold a general power of appointment over the Credit Shelter Trust, and because her right to principal distributions is limited to the ascertainable HEMS standard, the Credit Shelter Trust is not included in Eleanor's gross estate under IRC § 2041 or any other provision. The entire value of the Credit Shelter Trust at Eleanor's death — including all post-death appreciation — passes to the remainder beneficiaries (the children or the Dynasty Trust) free of estate tax.
• One-Time Use of Exemption. The Credit Shelter Trust utilizes Jonathan's available exemption amount at his death, permanently sheltering that amount from the federal estate tax system. The trust assets and all appreciation thereon are never again subject to estate tax (assuming the trust is properly administered and Eleanor does not acquire incidents of ownership or a general power of appointment).
• No Additional Estate Tax at Second Death. Unlike the Marital QTIP Trust (which defers estate tax to Eleanor's death), the Credit Shelter Trust permanently eliminates estate tax on the funded amount. This is the primary advantage of the Credit Shelter Trust over reliance on portability alone.
The magnitude of the estate tax savings depends on the exemption amount available at Jonathan's death and the appreciation of the Credit Shelter Trust assets between the two deaths:
• If the exemption at Jonathan's death is $12,920,000 or higher, the Credit Shelter Trust could hold a substantial amount. For example, if the trust is funded with $12,920,000 (less lifetime gifts) and the assets appreciate at 6% annually over a 10-year period (assuming Eleanor survives Jonathan by 10 years), the trust would grow to approximately $20–$22 million, all of which bypasses Eleanor's estate. At a 40% estate tax rate, the estate tax savings attributable to the Credit Shelter Trust would be approximately $8–$9 million.
• If the exemption reverts to approximately $6–7 million (post-sunset), the Credit Shelter Trust holds less, and the tax savings are correspondingly smaller. In this scenario, more assets pass to the Marital QTIP Trust, deferring tax to Eleanor's death.
F. Income Tax Considerations
The Credit Shelter Trust will be a separate taxpayer for federal income tax purposes after Jonathan's death. (During Jonathan's lifetime, the Revocable Trust is a grantor trust, and all income is reported on Jonathan's individual income tax return.) The trust will be required to file its own Form 1041 (U.S. Income Tax Return for Estates and Trusts) annually.
The compressed trust income tax brackets present a significant planning consideration. For 2023, trusts reach the maximum marginal federal income tax rate of 37% at taxable income of only $14,450, compared to $578,125 for married individuals filing jointly. This means that undistributed trust income is taxed at much higher effective rates than income distributed to individual beneficiaries.
However, this concern is largely mitigated by the Credit Shelter Trust's mandatory income distribution provision. Because Eleanor is entitled to all net income of the Credit Shelter Trust, payable at least quarterly, the trust will distribute all of its income to Eleanor. These distributions carry out distributable net income ("DNI") under IRC §§ 651–652 (or §§ 661–662, depending on the trust's classification as a simple or complex trust), and the income is taxed at Eleanor's individual rates rather than the compressed trust rates. To the extent the trust has income in excess of the mandatory income distribution (e.g., capital gains that are not included in DNI under the trust instrument or applicable state law), the compressed trust brackets may apply.
New York State Income Tax. The Credit Shelter Trust may be subject to New York state income tax if it holds assets that generate New York source income (such as the Stonecrest real estate interests, which generate rental income from New York properties) or if the trust is administered in New York. New York taxes resident trusts — defined as trusts created by a New York domiciliary — on all income, subject to certain exceptions for trusts that have no New York trustees, no New York assets, and no New York source income. The Credit Shelter Trust will need to be carefully analyzed for New York income tax purposes, and consideration should be given to situs planning (e.g., appointing a Delaware trustee and avoiding New York administration) to minimize New York income tax exposure.
V. MARITAL QTIP TRUST DESIGN
The Marital QTIP Trust is the second component of the two-trust structure. Its primary purpose is to qualify for the unlimited marital deduction under IRC § 2056, thereby deferring all federal estate tax on the marital portion of the estate until Eleanor's subsequent death. The Marital QTIP Trust will hold the balance of the Revocable Trust estate after funding the Credit Shelter Trust — which, given the magnitude of Jonathan's estate relative to the available exemption, will be the vast majority of the estate.
A. Funding Mechanism
The Marital QTIP Trust is funded with the balance of the Revocable Trust estate remaining after the Credit Shelter Trust has been funded with the formula amount. Because the Credit Shelter Trust is funded first (by formula), the Marital QTIP Trust functions as the residuary share.
The Marital QTIP Trust qualifies for the unlimited marital deduction under IRC § 2056(b)(7), which provides that "qualified terminable interest property" passing from a decedent to the surviving spouse is treated as passing to the surviving spouse for marital deduction purposes, provided that (a) the surviving spouse is entitled to all income from the property for life, payable at least annually, (b) no person has a power to appoint any part of the property to any person other than the surviving spouse during the surviving spouse's lifetime, and (c) the executor makes a timely election on the estate tax return (Form 706).
The QTIP election will be made by the executor on Form 706 (United States Estate (and Generation-Skipping Transfer) Tax Return), filed within nine months of Jonathan's death (or within the extended filing period, if applicable). The election is irrevocable once made and may be made with respect to all or a portion of the property passing to the QTIP trust.
A "reverse QTIP" election under IRC § 2652(a)(3) is also available and will be considered for GST tax allocation purposes. The reverse QTIP election is discussed separately in Section VIII below.
B. QTIP Requirements
To qualify for the marital deduction under IRC § 2056(b)(7), the Marital QTIP Trust must satisfy three statutory requirements:
1. All Income to Surviving Spouse. Eleanor must be entitled to all income of the Marital QTIP Trust, payable at least annually. IRC § 2056(b)(7)(B)(ii)(I). The trust instrument must not grant anyone the power to accumulate income or divert income to any person other than Eleanor during her lifetime. Consistent with this requirement, the trust instrument provides that Eleanor is entitled to receive all net income of the Marital QTIP Trust, payable at least quarterly (which exceeds the statutory minimum of annual payment).
2. No Power to Appoint to Others During Eleanor's Lifetime. No person (including any trustee) may have a power to appoint any part of the trust property to any person other than Eleanor during her lifetime. IRC § 2056(b)(7)(B)(ii)(II). The trust instrument must be carefully drafted to ensure that no such power exists. Discretionary principal distribution authority in favor of Eleanor is permissible, but distributions to any other person during Eleanor's lifetime would disqualify the trust.
3. Executor Election. The executor must elect QTIP treatment on the estate tax return (Form 706). The election is made on Schedule M of Form 706 and is irrevocable once the return is filed. The election may be made with respect to all or a specific fractional or percentage share of the qualifying property.
The trust instrument has been drafted to satisfy each of these requirements. Particular care has been taken to ensure that no provision inadvertently grants a power to appoint property to anyone other than Eleanor during her lifetime, which would disqualify the trust.
C. General Power of Appointment
The trust instrument grants Eleanor V. Caldwell a general power of appointment over the Marital QTIP Trust, exercisable by will. This is an intentional and important design choice with the following implications:
• Inclusion in Eleanor's Estate. The general power of appointment causes the Marital QTIP Trust to be included in Eleanor's gross estate under IRC § 2041(a)(2), independent of the QTIP inclusion under IRC § 2044. This ensures that the assets receive a second basis step-up under IRC § 1014 at Eleanor's death (discussed in Section X).
• Flexibility for Eleanor. The general power of appointment gives Eleanor the ultimate ability to control the disposition of the Marital QTIP Trust assets at her death. Eleanor may exercise the power to direct the assets to anyone she chooses — including the Caldwell children, grandchildren, trusts, or charitable organizations — or she may allow the power to lapse, in which case the default remainder provision governs.
• Coordination with Eleanor's Estate Plan. The exercise or non-exercise of the general power of appointment will be coordinated with Eleanor's own estate plan, as developed by her independent counsel at Pemberton, Locke & Strauss LLP. Eleanor's estate plan should take into account the Marital QTIP Trust assets that will be included in her gross estate.
Eleanor's independent counsel, Rachel F. Dunlap at Pemberton, Locke & Strauss LLP, has reviewed the general power of appointment provision and confirmed, in correspondence dated March 22, 2023, that Eleanor understands the implications of holding the general power — specifically, that the exercise of the power determines who receives the Marital QTIP Trust assets at her death, and that the trust assets will be included in her gross estate regardless of whether she exercises the power.
D. Beneficiaries and Distribution Standards
The Marital QTIP Trust beneficiaries and distribution provisions are as follows:
• Mandatory Income Beneficiary. Eleanor V. Caldwell is the mandatory income beneficiary. She is entitled to receive all net income of the Marital QTIP Trust, payable at least quarterly. This satisfies the QTIP requirement that the surviving spouse be entitled to all income for life.
• Discretionary Principal Distributions. The trustee is authorized to distribute principal to Eleanor for her health, education, maintenance, and support (the HEMS standard). In addition, if an independent trustee (defined as a trustee who is not a beneficiary and is not related or subordinate to a beneficiary within the meaning of IRC § 672(c)) is serving, the independent trustee may make broader discretionary distributions to Eleanor beyond the HEMS standard. This dual-standard approach provides maximum flexibility: Eleanor, as trustee, can make HEMS distributions to herself without adverse tax consequences, and if an independent trustee is appointed, the trustee can exercise broader discretion.
• Remainder — Exercise of General Power. Upon Eleanor's death, the Marital QTIP Trust assets pass pursuant to Eleanor's exercise of her general power of appointment, if any.
• Remainder — Default of Exercise. In default of Eleanor's exercise of the general power of appointment, the remaining principal and undistributed income of the Marital QTIP Trust pass to Thomas R. Caldwell, Katherine C. Hartfield, and Olivia G. Caldwell, per stirpes.