By Jill Roamer, J.D.
The VAPT (Veterans asset protection trust) is a powerful tool that can protect assets while enabling the grantor to qualify for needs-based pension benefits. There are two sub-trusts within the VAPT – one is a grantor sub-trust and the other is a non-grantor sub-trust. Why is it structured this way? The VA has a direct line of communication with the IRS. The VA routinely checks the tax returns of pension recipients, to get income information. Because of this, it is best to avoid any “phantom income” from a grantor trust being reported on the grantor’s tax return. This additional reported income may jeopardize eligibility for benefits.

The solution in the VAPT is to have only the residence held in the grantor sub-trust. One can design the VAPT so that the residence cannot be rented out and so there should never be any income reported on the grantor’s tax return. In addition, if the home is sold, the proceeds must be held according to the provisions of the non-grantor sub-trust.

Everything besides the home is held according to the non-grantor sub-trust so that any income generated by assets will not be an issue for benefits eligibility. The non-grantor trust income is reported under an EIN for the trust. So, this is why there is a non-grantor sub-trust in the VAPT – to protect benefits eligibility.  However, how do we still preserve the important tax benefits or estate inclusion and basis adjustment in the VAPT non-grantor sub-trust? Very carefully.

A limited power of appointment (LPOA) is a handy tool to cause estate inclusion and a basis adjustment under IRC § 2038(a)(1) and IRC § 1014(b)(9), respectively. The former states:

“(a) In general- The value of the gross estate shall include the value of all property—

(1) Transfers after June 22, 1936

To the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money’s worth), by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power (in whatever capacity exercisable) by the decedent alone or by the decedent in conjunction with any other person (without regard to when or from what source the decedent acquired such power), to alter, amend, revoke, or terminate, or where any such power is relinquished during the 3 year period ending on the date of the decedent’s death.”

The latter states:

“(9) In the case of decedents dying after December 31, 1953, property acquired from the decedent by reason of death, form of ownership, or other conditions (including property acquired through the exercise or non-exercise of a power of appointment), if by reason thereof the property is required to be included in determining the value of the decedent’s gross estate under chapter 11 of subtitle B or under the Internal Revenue Code of 1939. In such case, if the property is acquired before the death of the decedent, the basis shall be the amount determined under subsection (a) reduced by the amount allowed to the taxpayer as deductions in computing taxable income under this subtitle or prior income tax laws for exhaustion, wear and tear, obsolescence, amortization, and depletion on such property before the death of the decedent. Such basis shall be applicable to the property commencing on the death of the decedent. This paragraph shall not apply to—

(A) annuities described in section 72;

(B) property to which paragraph (5) would apply if the property had been acquired by bequest; and

(C) property described in any other paragraph of this subsection.”

However, the LPOA does not always provide for grantor trust status. For example, if income cannot be accumulated with principal (that is, the grantor or other lifetime beneficiary has a mandatory income interest), and if the LPOA can only be exercised by will, then grantor trust status is not achieved. This is the exception we rely on in the non-grantor sub-trust in the VAPT to allow the LPOA to provide estate inclusion and basis adjustment, without causing grantor trust status. And this is accomplished via IRC § 674(b)(3):

“(b) Exceptions for certain powers – Subsection (a) shall not apply to the following powers regardless of by whom held: . . .

(3) Power exercisable only by will

A power exercisable only by will, other than a power in the grantor to appoint by will the income of the trust where the income is accumulated for such disposition by the grantor or may be so accumulated in the discretion of the grantor or a nonadverse party, or both, without the approval or consent of any adverse party.”

So, the LPOA in the EC Veterans Asset Protection Trust® will cause estate inclusion, thereby qualifying for the basis adjustment at death. If grantor trust status is desired, as with the grantor residence sub-trust within the VAPT, one of the grantor trust powers will ensure grantor trust status. However, as to the non-grantor sub-trust, the LPOA and the other provisions of the trust are designed to not cause grantor trust status for income tax purposes.