Specialized Estate Planning Techniques

KRH Website PictureThere are several areas of estate planning that provide unique opportunities to enhance tax and succession planning, while ensuring proper dissemination of net worth to appropriate individuals and/or entities.  Below are summaries of some of these specialized estate planning techniques:

INSURANCE

People should be aware that many estate planning situations involve the strategic use of insurance products.  Many attorneys and CPA’s often fail to see the connection between the dynamics of insurance and estate planning.  Individuals purchase millions of dollars worth of insurance each year for estate planning purposes, including liquidity, wealth replacement and business succession reasons.  Life insurance has relatively little market value during the life of the insured, therefore it is easy to get these policies isolated into an irrevocable life insurance trust.  Otherwise, the death benefit will be subject to the confiscatory estate tax.

DYNASTY TRUSTS

A Dynasty Trust is actually an irrevocable trust created by a trust agreement that may continue to create and operate trusts for many successive generations.  The trusts can continue passing assets from generation to generation without incurring transfer taxes.  Advantages of a Dynasty Trusts include estate tax-free compounding, creditor and divorce protection, per stirpital control, avoiding probate and potential income tax savings.

Most states have rules against holding property in trusts forever and limit the duration of the trust.  For example, Georgia allows trusts to continue for 90 years.  Fortunately, some states have abolished, enacted opt-out provisions or made other changes to their “rule against perpetuity” statutes allowing a person to create trusts to continue forever.  Currently, these states are Alaska, Arizona, Colorado, Delaware, Idaho, Illinois, Maine, Maryland, Missouri, Nebraska, New Jersey, Ohio, Rhode Island, South Dakota, Virginia and Wisconsin. In addition to these states, Wyoming and Utah both allow Dynasty Trusts to last for 1,000 years, Florida allows  Dynasty Trusts to last for 360 years and Washington allows Dynasty Trusts to last for 150 years.

Ironically, a person does not have to live in one of these states to take advantage of its laws. The Dynasty Trust language would name a special trustee that resides in the jurisdiction so desired to hold and manage the trust assets, thereby giving the trust sufficient nexus to the state in order to utilize its laws.

FAMILY LIMITED PARTNERSHIPS

Family Limited Partnership (“FLP”) is a business entity set up to hold assets such as stock, real estate, etc.  Actually, in certain circumstances, limited liability companies (LLC’s) or limited liability limited partnerships (LLLP’s) may be the entity of choice, but the planning technique is generally referred as an FLP.

Transferring assets to an FLP can result in gift tax and estate tax savings because the taxpayer now owns a limited partnership interest rather than the underlying assets.  Limited partners, under common law, state law and the partnership agreement cannot participate in management or generally force liquidation of the partnership; therefore, the value of the partnership interest in an arms-length transaction is affected by a lack of control discount.  There also may be restrictions on transferability and other reasons that the limited partnership interest is worth less than a proportionate share of the underlying assets that are inside the partnership.  Therefore, gifts of partnership interest have become very popular ways of diminishing the size and growth of our clients’ estates.

Other advantages of FLP’s are the power to monitor wealth transfers to heirs, simplification of a person’s annual gifting, keeping assets in the family, providing creditor protection, protecting family assets from failed marriages, flexibility in the partnership agreement (as opposed to the irrevocable, unamendable trust), and flexibility in the management of the FLP. However, there are many formalities that must be followed in setting up FLP’s.  For example, the IRS requires significant non-tax purposes for the FLP.  There are a myriad of guidelines that should be followed, such as one should not transfer “personal” assets, like a personal residence, to an FLP.  FLP’s are a great tool to pass a client’s wealth on to the heirs during their lifetime, while  minimizing gift and estate taxes.

DEFECTIVE GRANTOR TRUSTS

A Defective Grantor Trust (“DGT”) is a term used for a trust that effectively removes property from a grantor’s estate for estate tax purposes, but not for income tax purposes.  A DGT is often used as a “freeze” technique, particularly for clients with large holdings of S corp stock.

S corp stock cannot be transferred to limited partnerships because a partnership is not a permitted S corp shareholder.  Yet, one of our objectives is often to try to shift any future appreciation in the S corp to a dynasty trust that has been set up for future generations.  A DGT is a permitted S corp shareholder. The grantor sells his/her interest in the S corp to the DGT (with dynasty provisions) in exchange for an installment note.  Because a grantor is considered owner of the DGT for income tax purposes, this sale is ignored for IRS purposes (no gain recognized).  We have now moved this asset out of grantor’s estate, except for the monies paid to him/her resulting from the installment note.

We have used a self-canceling installment note (“SCIN”) with an installment sale to a DGT.  This is obviously attractive since any remaining value of the installment note will go to zero if the grantor dies before the note has been completely paid.

GRAT’s, CRT’s & QPRT’s

Grantor Retained Annuity Trusts (“GRAT”), Charitable Remainder Trusts (“CRT”) and Qualified Personal Residence Trusts (“QPRT”) are irrevocable trusts where the grantor transfers an asset to the trust in exchange for an annual payment (or use of the underlying property in the case of a personal residence trust) for a specified term of years (or for life in the case of a charitable trust).  Upon the expiration of the term the trust terminates and the assets pass to the named beneficiaries or charities.  Due to the current low interest and tax rate environment, techniques involving GRAT’s can be more attractive, while generally CRT’s and QPRT’s are not as popular, but they all are still used in particular situations.

On the other hand, CRT’s may be more popular for their income tax advantages.  Assets are first contributed to the CRT and then sold.  Generally, 100% of the proceeds are then available for alternate investments.  The CRT is a device that can be used to alleviate income taxes on the sale of capital assets because CRT’s are generally not subject to income taxes. Presently, the low interest rate environment maximizes the amount of charitable deduction that is available for gifts to CRT’s today (versus several years ago.  However, the capital gains rates have generally been reduced to 15% making the avoidance of these lower rates less attractive.

A popular variety of the GRAT planning technique is the “Walton” GRAT.  This is a very short term GRAT used to remove appreciating property out of an estate with zero or minimal gift tax consequences.  The Walton GRAT sets up the payment to the grantor over a short period of time where the GRAT will exhaust most of the corpus within the trust.  Since, according to the IRS tables, the value returned to the grantor represents the entire value of the trust, the gift element (the remainder interest) is worth nothing for gift tax purposes.  However, the appreciation in the property that has occurred over that period of time is removed from the grantor’s estate.  A Walton GRAT is particularly useful if the value of the asset placed in the GRAT is a discounted asset, such as a limited partnership interest.  A limited partnership can make distributions to the GRAT during its term and allow payments back to the grantor, while having the limited partnership interest flow to dynasty trusts at the end of the GRAT’s term.

These are merely a few of the examples of the types of unique estate planning techniques available to estate planning clients.  It is important that clients, attorneys, accountants, trust officers, insurance agents and financial advisors become familiar with these techniques so they can be watchful and vigilant for opportunities where they may be appropriate.

For more information regarding this or any other estate planning concern, please visit the Hoffman & Associates website at www.hoffmanestatelaw.com, call us at 404-255-7400 or send us an email.

 

In accordance with IRS Circular 230, this article is not to be considered a “covered opinion” or other written tax advice and should not be relied upon for IRS audit, tax dispute, or any other purpose. The information contained herein is provided “as is” for general guidance on matters of interest only. Hoffman & Associates, Attorneys-at-Law, LLC is not herein engaged in rendering legal, accounting, tax, or other professional advice and services. Before making any decision or taking any action, you should consult a competent professional advisor.

Generation Skipping Transfer Tax Notice for 2010

Many of our clients gift life insurance premiums to their life insurance trusts on an annual basis. Prior to passage of the 2010 Tax Relief Act, there was uncertainty and risk around these gifts with regard to allocation of generation skipping transfer tax exemption. As a result, our advice to clients was to treat the money given to the life insurance trust in 2010 as a loan. However, with the passage of the 2010 Tax Relief Act on December 17, 2010, it now appears that you can allocate generation skipping transfer tax exemption to gifts to pay premiums made to life insurance trusts. Therefore, as of this week, we do not recommend clients treat the money as loans to the life insurance trust. Instead, we recommend treating those transfers as gifts as usual and applying the generation skipping transfer tax exemption on a timely filed 2010 Gift Tax Return, which must be filed no later than September 17, 2011. This negates the necessity of all the paperwork associated with documenting a loan, such as the promissory note.

Governor signs Senate Bill 461

Governor Perdue signed Senate Bill 461 on May 28, 2010, making the provisions thereof retroactive to January 1, 2010.  As discussed, the law allows married Georgia residents to utilize the entire step up in basis provided under the current estate tax laws without modification to current documents.

If you have any questions about this law or how it affects your estate plan, please give us a call.

Georgia Senate Bill 461 and Funding of the Marital Trusts

As a previous article stated, the Federal Estate Tax purported repeal and the new carryover basis rules could cause problems for older Wills of married persons where the Will is drafted to maximize the Federal Estate Tax Exclusion.  The Georgia legislature is in the process of passing a bill that would all the language of the older Wills to fully fund the marital trusts for the benefit of spouse until Congress settles whether or not there will be a federal estate tax.  This bill allows married Georgia residents to utilize the entire step up in basis provided under the current estate tax laws and will become effective when Governor Perdue signs it.  To view a text of Senate Bill 461, click here.

To recap the issue, as most Wills are currently drafted, a formula is used to maximize the federal estate tax allowance that is in existence at the time of a person’s death.  If a married individual dies in 2010, his entire estate would pour over to the Credit Shelter Trust under his will, leaving no assets to fund the Marital Trust which is necessary to maximize the spousal step up in basis).

If you are unsure of how your Will works or have questions about the funding of trusts under your Will, please give us a call.

Federal Estate Tax Laws that may affect your Will

As a result of the 2001 tax legislation, the Federal Estate Tax has purportedly been repealed for 2010.  While Congress is still debating the issue, as it stands now if a person were to die in 2010 there might be no federal estate tax on their estate.  Additionally, step up in basis of assets to the date of death value is virtually eliminated.  There is an exception to the step up in basis in that a spouse can elect to step up the basis in $3,000,000 worth of assets and other individuals can elect to have $1,300,000 of assets stepped up in basis.  All other assets will be inherited with a carryover basis from the time the decedent acquired the property.

As a result of this new carryover basis rule, there could be an issue with capturing the basis increase in $3,000,000 of assets passing to spouse under a Will.  In order to qualify for the step up in basis on the $3,000,000, the property must be held in what is known as a qualified terminable interest property trust.  As most Wills are currently drafted, a formula is used to maximize the federal estate tax allowance that is in existence at the time of a persons death.  While no one anticipated that Congress would actually allow a total repeal of the federal estate tax law, we are currently faced with that issue.  There is talk that if Congress reinstates the federal estate tax they will make it retroactive back to January 1, 2010.  However, some may challenge this as unconstitutional and we do not know if they would be successful.

Therefore, we want to inform everyone that under the current law, if a formula is used in your Will to maximize the funding of the Credit Shelter Trust, all of your assets will go to that under your Will.  What this means is that your surviving spouse may lose the right to get a step up in basis on $3,000,000 worth of assets as no assets from your estate will go to the QTIP Marital Trust.  Some argue that your family could go to court and argue that your intent was not to have all assets pass to the Credit Shelter Trust and that the court may “revise” the Will to accomplish your intent to fully maximize all benefits affordable to your spouse.  Unfortunately, we cannot advise whether this argument would be successful.

Of course, if the federal estate tax is reinstated and made retroactive, there is no issue.  However, if it is not retroactive, and if you pass away during a “total repeal” period (2010), your spouse and family may lose out on the benefits of a step up in tax basis.

Therefore, it is advisable that you contact an attorney to execute a Codicil to your Will to assure assets that pass to your spouse will be allowed to fully utilize the step up in basis rule.

Federal Estate Tax Laws that may affect your Will in a Second Marriage

As a result of the 2001 tax legislation, the Federal Estate Tax has been repealed for 2010.  While Congress is still debating the issue, as it stands now if a person were to die in 2010 there might be no federal estate tax on their estate.

There could be an issue with providing assets for some spouses under a Will, particularly if it is a second marriage.  Typically, a Will is drafted utilizing a formula to maximize the federal estate tax allowance that is in existence at the time of your death.  While no one in the legal and accounting communities anticipated that Congress would actually allow 2010 to arrive with a total repeal of the federal estate tax law, we are currently faced with that issue.  There is talk that if Congress reinstates the federal estate tax they will make it retroactive back to January 1, 2010.  However, some may challenge this as unconstitutional, and we do not know if they would be successful.

Therefore, under the current law, if the typical formula is used in your Will to maximize federal estate tax allowances, all of your assets will go to the Family Trust, also known as the Credit Shelter Trust.  What this means is that if your spouse is not named as a beneficiary under the Family Trust, they will not get any benefit from your estate as the Marital Trust created for the benefit of the spouse will not receive any assets from your estate.

In some instances in second marriages, a person’s Will provides for spouse under a Marital Trust and for children from a previous marriage under the Family Trust.  Therefore, under the current tax law this is detrimental to the surviving spouse, as all assets will go to the children from the previous marriage.  If this is not your intent, it is advisable that you contact an attorney to execute a short Codicil to your Will to assure assets will pass to a spouse in a second marriage.

Of course, if the federal estate tax is reinstated and made retroactive, there is no issue.  However, if it is not retroactive, if you pass away during a “total repeal” period (2010), your spouse will lose out on the benefits of your estate.