DEED OF TRUST
GENERAL EXPLANATION

As you know from reading through your Deed of Trust document, the tax planning complexities which Congress has thrust upon us in the estate planning area are quite severe and very difficult, if not impossible, to easily comprehend. It is the purpose of this Memo to attempt to give a general explanation of the provisions found in the Deed of Trust as an aid to you in reading through and understanding your Deed of Trust.

The tax planning provisions in the trust have been designed to offer as many post-death planning capabilities to your executor and trustees as possible. These planning capabilities can be taken advantage of by your fiduciary, or ignored completely. However, if we do not build in the capability of these planning possibilities, then your estate may end up paying more taxes to the IRS than otherwise would be required.

Before getting into a specific explanation of each of the provisions in the Deed of Trust, it will be helpful to go through a general outline of the two major taxes which will impact on your estate and Deed of Trust. The two taxes are the federal death tax and the federal generation skipping transfer tax. From a general concept standpoint, these two taxes should be considered as operating independently of each other, but from a tax planning and drafting standpoint, how we deal with one of these taxes may adversely impact the other tax.

From a death tax standpoint, each person is entitled to two big deductions (or deduction equivalent). Each person is currently entitled to give $1,500,000 (increasing over the years to 2009) worth of property tax free to any recipient, and in addition each person is entitled to give an unlimited amount to a surviving spouse on a tax free basis. Thus, for example, if your Wills were simple Wills which left everything to the surviving spouse, and then only when the two of you have passed away would anything go to the children, the first estate would be completely tax free since everything that passes to a surviving spouse is not taxed. However, when the second spouse passed away, his or her estate would be entitled to give $1,500,000 (increasing over the years to 2009) tax free to the children, and the balance would be subject to death taxes. Thus, we would only be passing $1,500,000 (increasing over the years to 2009) to the children/grandchildren on a tax-free basis. However, if we go back to the first estate and restructure the disposition of the spouse's assets who is first to die, then we can increase the $1,500,000 (increasing over the years to 2009) amount going to the children tax free to $3,000,000 by taking advantage of the $1,500,000 (increasing over the years to 2009) exemption for the first spouse as well as the second spouse. This is accomplished in the first estate by having the first $1,500,000 (increasing over the years to 2009) worth of property go into a "tax savings trust" which is designed to provide financial security for the surviving spouse but which is also designed so as not to be taxed in the second estate. This way, the trust utilizes the $1,500,000 (increasing over the years to 2009) exemption for the first estate so that the funding of the trust is done on a nontaxable basis, and the trust is designed to bypass taxation in the second estate. Thereafter, when the second spouse dies, that spouse is also entitled to give another $1,500,000 (increasing over the years to 2009) away tax free to the children/grandchildren. Therefore, by properly structuring the first estate, we can get $3,000,000 or more out to the children/grandchildren on a tax-free basis. (And, since we don't know which of the spouses will pass away first, we have provided similar documents for each spouse so that this tax saving trust can be established in the first estate regardless of who might pass away first.)

For death tax purposes, we have disposed of the first $1,500,000 (increasing over the years to 2009) worth of property in the first estate, but what do we do with the balance of property owned by the first spouse to die? There are basically three choices: one, an outright bequest to the surviving spouse; two, a bequest in trust where the spouse has unlimited withdrawal rights; and three, a distribution to a trust where the spouse has income rights only and no ability to withdraw principal, although principal can be distributed in the trustee's discretion. Basically, there is no practical difference between alternatives one and two, except that the marital deduction bequest is made in the trust format. The third alternative allows us to get some generation skipping transfer tax advantages, with the corresponding disadvantage of being more restrictive for the surviving spouse.

And this very nicely leads us into the second major tax with which we are concerned in planning an estate: the generation skipping transfer tax. The generation skipping transfer tax has its genesis in the IRS belief that each person should give his or her property to the next generation in line and so on from generation to generation so that inherited property is taxed at each and every generation from a death tax standpoint. To the extent that a distribution is made, for example, to a grandchild, then the intervening generation (the children) have been skipped and the IRS believes that it has been deprived of the death taxes which it would have received on that intervening generation. To counteract this, the IRS and Congress promulgated the generation skipping transfer tax which in theory is designed to go back and recapture the death taxes which would have been paid by the skipped/intervening generation. However, it is impossible to know at what tax bracket that intervening generation would have paid its death taxes so the IRS imposes a flat tax of fifty-five percent (55%), that being the maximum rate of federal death taxes. In its infinite wisdom, IRS and Congress have recognized that a 55% flat tax can produce confiscatory results, and accordingly a $1,500,000 exemption amount is allowed to each spouse. In other words, $1,500,000 can be given to the grandchildren (for example) without incurring any generation skipping transfer taxes. This $1,500,000 exemption is available to each spouse such that a total of $3,000,000 is available on an exemption basis for the generation skipping transfer tax. It should be kept in mind, however, that this $1,500,000 exemption has nothing to do with the $1,500,000 exemption amount which we talked about in connection with the death taxes. The allocation of the $1,500,000 generation skipping transfer tax exemption amount is not determined by how the $1,500,000 death tax exemption amount is allocated, and vice versa.

One of the things to keep in mind is that the $1,500,000 exemption for generation skipping transfer tax purposes can be given outright to the beneficiary or it can be allocated to a trust for the benefit of such beneficiaries. If it goes into a trust vehicle, one of the important aspects of the generation skipping transfer tax is that "once exempt, always exempt". Thus, if we put the $1,500,000 exemption amount in a segregated trust, and that trust grew to $5,000,000 over the ensuing years before being distributed to the grandchildren, et cetera, then the $5,000,000 would be exempt when paid to the grandchildren.

Although the purpose of this memo is not to explain the generation skipping transfer tax in every detail, one additional nuance needs to be disclosed. When the first spouse dies, this may fix the level of generations for some of the trusts set up in the first estate such that if there is a distribution to a grandchild while the parent/child is living, this will be deemed a distribution subject to the generation skipping transfer tax. This "fixing of the generations" rule will apply to the $1,500,000 tax savings trust which we talked about in connection with the death taxes. This rule will also apply to the third alternative which we talked about in connection with the marital deduction bequest for death tax purposes if a special generation skipping transfer tax election is made. This rule, will not, however, apply to the first two alternatives for the marital deduction bequest which we discussed above. This is one of the examples where there is some crossover between what we do for the death tax and what we do for the generation skipping transfer tax.

In connection with the generation skipping transfer tax, one of the planning possibilities for the "once exempt, always exempt" rule, is to place the exemption amounts in a segregated trust and invest that trust for growth. The balance of the inheritance which is not exempt from the generation skipping transfer tax is placed in a separate trust and invested for income. In addition, we can provide for the payment of certain expenses to be made from the nonexempt trust. In this manner, we can not only have a balanced portfolio when we take the aggregate investments of the two trusts, but we can maximize the total tax-free inheritance of the grandchildren, etc.

The first level of estate planning always deals with the death taxes. As discussed above, we will end up with two trusts: a tax savings trust and a marital deduction trust. In the Deed of Trust, the tax savings trust is known as Trust B and the marital deduction trust is known as Trust A. In order to deal with the generation skipping transfer tax, however, each of these trusts will potentially be divided into two separate trusts, thus potentially creating a total of four trusts. The "-0" designation in the trust name indicates that it is exempt from the generation skipping transfer tax and the "-1" designation in the trust name indicates that it is fully subject to the generation skipping transfer tax. Recognizing that the administration of four separate trusts may be inconvenient if not expensive from an administration standpoint for the expected generation skipping transfer tax savings many years hence, the trustees are given the authority to undo this and to revert back to the two original trusts (the tax savings trust and the marital deduction trust) dealing with just the death taxes and completely ignore the generation skipping transfer tax implications.

Now that we have covered the basic tax planning theories, the rest of the Memo will direct itself to explaining the specific provisions in the Deed of Trust to show you how they accomplish these basic planning points. The explanation of each provision in the Deed of Trust will have the same caption as in the original Deed of Trust document.

FIRST: DISPOSITIVE PROVISIONS FOR MY BENEFIT. Although it is anticipated that your Deed of Trust will be funded at the time of your death by and through your Will, it is possible to fund the Deed of Trust during your lifetime. For example, you may become disabled in which case your Power of Attorney holder (under the terms of the Power of Attorney which we drafted for you) can either administer your property pursuant to the Power of Attorney or transfer the property to your Deed of Trust and administer it there for your benefit. It is these objectives which are accomplished by Article First. In addition, Article First allows any other person to put property into your trust with you receiving the income from it but without it being taxed in your estate.

SECOND: MARITAL DEDUCTION TRUST. The initial paragraph of Article Second sets out the formula whereby we determine how much property should go into the marital deduction trust. In our discussions, we have always talked in terms of the first $1,500,000 (increasing over the years to 2009) going into the tax savings trust and the balance going into the marital deduction trust. One would have expected, therefore, to see the tax savings trust being funded first, with the balance going over to the marital deduction trust. In point in fact, the formula is worded just the reverse, and by doing so we have created an additional post-death planning capability. From a tax standpoint it may not be advisable to fully utilize the marital deduction in the first estate. In this case, the surviving spouse would file a "disclaimer" to effectively disclaim any interest in the marital deduction trust, or portion of it. If this happens, the disclaimed property will pass to the tax savings trust where the surviving spouse will continue to have an income interest, but without the property being taxed in the second estate. If we had funded the trusts in the reverse order, the disclaimed property would have passed to the children or grandchildren and there would be no reserved income interest to the surviving spouse.

The dispositive provisions for the marital deduction trust are contained on page two in Part A. Basically, all of the income must be paid to the surviving spouse, and principal will be disposed of either by the surviving spouse or disposed of in the trustee's discretion.

The remaining parts of Article Third deal with a number of tax elections available to the trustees in connection with this trust and have been included here as an outline and reminder of these planning possibilities for the trustee.

THIRD: RESIDUARY TRUST B. The tax savings trust is Trust B, and accordingly you can anticipate that $1,500,000 (increasing over the years to 2009) will go into Trust B. Trust B is held for the benefit of the surviving spouse during his or her lifetime with the income either being paid outright to the spouse. Principal is distributed in the trustee discretion on a "need" basis. In addition, the surviving spouse is given an ability to withdraw principal on a "want" basis as opposed to a "need" basis. This power of withdrawal is outlined in paragraph A(3). This power of withdrawal entitles the spouse to withdraw up to five percent (5%) of the trust principal each year on a noncumulative basis.

Parts B and C of Article Third deal with what happens to the trust once both spouses have passed away. Essentially, because of the provisions of Part C of Article Second, the trusts will come together into a single trust (or two trusts if the generation skipping transfer tax division is being made) and will be administered for the benefit of the children/ grandchildren in accordance with the designated terms of trust in the Deed of Trust. The surviving spouse is given the ability in Part B of Article Third to change the dispositive provisions but not the beneficiaries.

Parts D and F deal with the division of the trusts into the two separate generation skipping transfer tax subtrusts. Part E deals with the disclaimer planning issue which was discussed above. Parts G, H and I are other tax or contingency planning provisions.

FOURTH: SURVIVAL PROVISION. Under state law, if two spouses die simultaneously in an accident, certain presumptions will be applied as to who survived whom with respect to what property. Generally these presumptions are not advantageous to you from a tax planning standpoint. The law, however, allows us to reverse those presumptions and this is what Article Fourth does for you. If you die in quick succession, Part B will equalize your taxable estates to take advantage of each estate's lower marginal tax brackets.

FIFTH: OPTIONAL TERMINATION OF TRUSTS. If the trust principal declines to such a level that it is administratively inconvenient or expensive to administer the trust, this provision allows the trustees to terminate that trust and to distribute the trust corpus to the beneficiaries then entitled to the income.

SIXTH: MINORITY AND DISABILITY PROVISION. Since grandchildren or great-grandchildren may be potential beneficiaries under the Deed of Trust, we have included a provision to allow the trustee to hold back any minor's inheritance until they are old enough to take care of it. Similarly, to the extent a beneficiary is mentally incompetent, the trustees can hold back any distributions to the incompetent person.

SEVENTH: PROTECTIVE PROVISIONS. This provision provides that no creditor of a beneficiary can foreclose upon or seize any trust assets. Not until funds are in fact paid to a beneficiary, can that beneficiary's creditors grab it. In addition, a beneficiary cannot sell his or her interest in the trust.

EIGHTH: NON-ACCRUAL OF INCOME. Generally, when income comes into the trust it comes in on a monthly basis and is paid out on a quarterly or other convenient basis, such that if a beneficiary passes away there may be some income which has been received but not yet distributed to the income beneficiary. This paragraph provides that the undistributed income gets paid to the next beneficiary in line. Not only is this administratively more convenient to the trustee, but it also means that the accumulated income will not be taxed in the estate of the deceased beneficiary.

NINTH: PAYMENT OF DEATH TAXES. Life insurance proceeds may be paid to the trust, or advance distributions may be made from the estate to the trust, before the death taxes have in fact been paid by the estate. In this instance, this provision allows the trustee to utilize trust assets for the payment of death taxes. The priority of the various trusts from which the taxes are to be paid is designated in order to accomplish the best combined death tax and generation skipping transfer tax result. In addition, there are certain property items which should not be used to pay taxes, and these are listed in this provision as a reminder to the trustee.

TENTH: INSURANCE POLICIES. To the extent that life insurance is owned or paid to the trust, the insurance company often requires the trust to contain these provisions, and accordingly they have been included. Even though you may not currently intend to provide the trust with ownership of life insurance or to designate it as a beneficiary on your life insurance, this may happen in the future, and accordingly these provisions have been included.

ELEVENTH: POWERS OF TRUSTEE. The provisions under this Article Eleventh drag on for about three pages and are exhaustive in their list of powers given to the trustee. From a practical standpoint, this may be wasted paper since only in five to ten percent (5-10%) of the cases are these powers useful. However, in that minority of situations, having these powers in the trust will save the trustee the time and expense of preparing a special petition to the Orphan's Court to receive approval for what he or she wishes to do. These powers also contain some tax planning provisions which allow the trustees to make certain tax elections if deemed advisable. It should be noted that these powers are not mandatory, but are optional in the discretion of the trustee.

Note should also be taken of paragraph - since this is the provision which allows the trustees to undo the tax planning which we have built into the Deed of Trust concerning the generation skipping transfer taxes with the "-0" and "-1" sub-trusts.

TWELFTH: REDEMPTION OF UNITED STATES TREASURY BONDS. There are certain U.S. Treasury Bonds which are redeemable at par value in payment of federal estate taxes. It used to be that you could buy these bonds at very steep discounts if you knew that you were terminally ill, and then upon your death your heirs could cash them in at par value and make a significant return on the investment. However, we are now nearing the maturity dates on these bonds and they are no longer being issued by the federal government. Nonetheless the provision has been included. Paragraphs A and B deal with the separate situations of the first spouses's death and the second spouse's death.

THIRTEENTH: BUSINESS INTEREST. This provision sets forth a number of optional powers for the Trustee to the extent that there is any closely held business interest owned by the trust. The powers are designed to eliminate the red tape and potential conflicts of interest so that the Trustee can act quickly and decisively as and when action is needed. Without this type of provision, then court approval, which would be expensive from both a dollar and time standpoint, might be necessary, or the Trustee might be required to liquidate the closely held business investment.

FOURTEENTH: ADDITIONS. This paragraph simply allows anybody to give property to the trust.

FIFTEENTH: APPOINTMENT OF INTER VIVOS TRUSTEES. This provision designates the trustees to serve during your lifetime. In addition, there are some other tax planning provisions included such as the authority to hire investment advisors, the authority to appoint additional co-trustees, and the exclusion of a trustee from participating in any discretionary decisions relating to distributions to that trustee.

SIXTEENTH: APPOINTMENT OF ADDITIONAL CO-TRUSTEE. This provision appoints the surviving spouse as the additional co-trustee upon the first spouse's death. The spouse is added as a trustee at the time of death in order to avoid certain potential adverse tax consequences if that spouse had been the first to die. In addition, the trust settlor is designated as a co-trustee if the trust has been funded by any other person.

SEVENTEENTH: COMPENSATION OF FIDUCIARY. This provision allows any bank or trust company to be paid fees per their standard schedule of charges. A bank or trust company will not serve as a trustee unless this provision is included. Even though you may not have designated a bank or trust company as a co-trustee, your designated co-trustees are given the authority to appoint additional co-trustees and they may elect to appoint a bank or trust company.

EIGHTEENTH: SUBSTITUTION OF TRUSTEE. This provision allows a trustee to be removed and replaced. In addition, it allows a trustee to resign and be replaced.

NINETEENTH: PRIVILEGES AND IMMUNITIES. Paragraph A provides that majority vote on the trustees can control (as opposed to state law which requires unanimity). The remaining provisions are designed to eliminate some of the administrative red tape matters in a trust administration as well as a "forgiveness of sins" provision which provides that trustees are not liable for acts or omissions of other trustees and are only responsible for their own acts if they intentionally intended to produce the bad result.

TWENTIETH: BOND WAIVED. Generally, a trustee must have a "faithful performance bond" unless the trust document provides otherwise. Bonds such as this are an added expense and an administrative hassle to the trust.

TWENTY-FIRST: AFTER ADOPTED AND BORN CHILDREN. To the extent that additional children or grandchildren are born after the execution of this trust, they are automatically included.

TWENTY-SECOND: RIGHT TO REVOKE AND AMEND. This gives you the ability to change the trust at any time or times and in any manner that you see fit. The only exception comes about if property is added to this trust by some other person and you are the beneficiary.

TWENTY-THIRD: SITUS. This provision provides that Pennsylvania law will control in the interpretation of the trust.

TWENTY-FOURTH: DEFINITIONS. Defines "education" and "health" purposes.

^©All rights reserved by Andrew H. Dohan, Esquire, Lentz, Cantor & Massey, Ltd., Chester County Commons, 460 East King Road, Malvern, PA 19355.