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.

Procrastination: What Are The Consequences?

Currently, there are approximately 70% of Americans without a Will.  Without this basic estate planning document, your loved ones may pay the highest possible taxes upon your death, lose some of the assets you have earned during your lifetime, and will have to handle a much more complex administration of your estate.

By way of example, consider these famous deaths: Elvis Presley died suddenly at the age of 42 with an estate worth an estimated $10 million.  Of that amount, his daughter only received $3 million, as the other 70% was spent on estate taxes, administration costs and legal fees.  With a proper estate plan, Elvis’ daughter certainly would have received more than a mere third of her father’s wealth.

Famous for their chewing gum, the Wrigley family is another great example of a missed opportunity.  Both of William Wrigley’s parents died in 1977.  Their death gave Mr. Wrigley controlling interest in the Wrigley company, but it also left a significant estate tax burden due to the IRS.  The Wrigley’s had to sell their 80% stake in the Chicago Cubs for $20.5 million in 1981 to satisfy this debt.

Finally, Steve McNair, the famous NFL MVP, died in 2009 with an estate estimated to be worth $19 million but without even a simple will.  In attempts to settle his estate, his wife tried to sell his interest in a Nashville restaurant, his ranching and farming business as well as his Nashville home.  Not only did his murder shroud any hope of a amicable resolution of his estate, but the lack of any planning whatsoever left his wife and his children in a heated legal battle over the estate assets.

Although the most basic tenet of estate planning is a Will, the estate plan may and should encompass other aspects of your financial situation for when you pass.  Estate planning is thoughtful foresight that protects your family, provides for their future, and makes your wishes known.  If you pass without a Will in place, your assets will be distributed in accordance with State law in a process known as intestate succession.

Under the intestate succession laws in Georgia, a personal representative of the deceased is appointed by the Probate Court in order to marshal the assets, pay the debts and then distribute anything left over to the heirs.  Heirs are the closest relatives of the deceased, including the spouse, if living, and the children, including adopted and those born out of wedlock.  Stepchildren are not heirs.  Heirs of other degrees are determined if necessary.  A determination of the heirs is made by the Court, while your estate pays court fees, lawyer fees and other costs associated with probate handled by the Court and state law, rather than pursuant to your directions set forth in a Will. The Court and personal representative (which may or may not be a family member) may charge hefty fees (sometimes 5-15% of the value of the estate) to administer your estate.  Above all, this process takes time.  The probate of an estate handled by the court may take months longer than if you had clear, specific instructions regarding the distribution of your estate in a Will.

Having a Will does not avoid the probate process; rather, a Will is followed by the Court to determine who receives what property, who is appointed guardian of any minor children and who will be responsible for carrying out the wishes contained in the Will.

In order to ease the administrative burden on your family at your death and to save time and money on court costs and fees, you should plan accordingly now by contacting professionals who can help, such as an estate planning attorney, a financial planner, a CPA, and an insurance agent.  All can work together to help you prepare a plan that fits your family’s needs.  An exhaustive plan put in place by each of these professionals can also ensure you are taking advantage of any and all tax savings’ tools available to you.

Consider the following goals when thinking about your estate plan:

  • Determining who receives what share of your assets.
  • Deciding who will manage your estate and be responsible for distribution of the assets.
  • Selecting a guardian for your children.
  • If you own or control a business, providing for a smooth transition of management into the hands of persons who will effectively manage the business.
  • Arranging your affairs so that the chance for disputes among your heirs is minimized.
  • Making sure that your heirs can live with the estate plan. A plan that cannot respond to changes in the economy, or to unanticipated events, can burden the family.
  • For individuals with charitable wishes, making sure that your vision will be fulfilled.

With these overall goals in mind, it is important to move forward in developing an estate plan that fits your family’s needs.  At Hoffman & Associates, we define a basic estate plan as having the following essential components:

For individuals and families who are of higher net-worth, additional planning techniques may be introduced in order to reduce the estate taxes due upon death and take advantage of other tax savings strategies during your life.  Some of these techniques include:

 

For more information regarding estate planning, business law or tax controversy and  compliance, please visit the Hoffman & Associates website at www.hoffmanestatelaw.com or call us at 404-255-7400.

 

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.

SELF-CANCELING INSTALLMENT NOTE (SCIN)

The Self-Canceling Installment Note (“SCIN”) is a planning technique usually used in a sale of an asset to either a trust or directly from an older family member to a member or members of a younger generation.  Basically, the older generation sells the asset in exchange for an installment note with a term shorter than the seller’s life expectancy, which is found in Internal Revenue Service (IRS) Tables.  The SCIN is a valuable tool because, if the seller dies before the term of the note, the remaining balance is completely canceled and is not included in the seller’s estate.

The SCIN is best structured as requiring interest-only annual payments until a balloon principal payment is due at the end of the term.  By deferring the principal payment until the end of the term, the amount canceled upon death will include the entire principal amount of the promissory note.

Of course, the IRS would not allow this transaction without a modification of the terms of the note to make it an arms-length transaction between the parties.   So, either the principal amount or the interest rate must be increased to make this a bona fide transaction.  The older the seller is, the greater the mortality risk premium will be.  However, with long-term interest rates being at historical lows right now, the time has never been better for an estate-freezing transaction using a SCIN.

For example, using October’s rates, a 55-year-old person could sell assets using a 28-year SCIN with a balloon payment and an interest rate of only 2.695%.   If the seller died before the end of the term, the value of the entire principal amount would be transferred to the trust without incurring any estate tax.

These low rates make a SCIN not only a good idea for clients looking to freeze some of the value of their estates, but there is also opportunity for clients who have already entered into DGT sales (see other articles on website that describe DGT sales as a popular estate planning/freezing technique) to refinance with a SCIN, possibly at lower rates and the self-canceling feature.

 

For more information regarding estate planning, business law or tax controversy and compliance, please visit the Hoffman & Associates website at www.hoffmanestatelaw.com or call us at 404-255-7400.

 

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.

The SCIN: An Attractive Estate Planning Opportunity In 2012

2012 presents unique opportunities to do estate planning.  The reasons may be familiar to you by now:   lifetime gift and estate tax exemptions are $5 million (without Congressional action, it will go to $1 million in 2013), valuation discounts for family owned entities remain viable, and property values and interest rates at all time lows.  The catch:   There’s a limited time to capitalize on these opportunities.

This article will focus on one estate planning tool, the Self Canceling Installment Note (“SCIN”) whose benefit is magnified under 2012’s low interest rate environment. 

What is a SCIN?

SCINs are a planning technique used in a sale of an asset to either a trust or directly from an older family member to members of a younger generation.  Basically, the older generation sells the asset in exchange for an installment note with a term shorter than the seller’s life expectancy.  Life expectancies are found in IRS tables.   The installment note contains a provision by which the remaining balance is completely canceled upon the seller’s death.

What is the benefit of the SCIN?

What makes a SCIN a valuable tool is the fact that if the seller dies before the term of the note, the remaining balance is completely canceled and this canceled amount is not included in the seller’s taxable estate.   

The SCIN is especially beneficial if only annual interest payments are made until the end of the term, when a balloon principal payment is due.  By deferring the principal payment until the end of the term, the amount cancelled upon death can include the entire principal amount of the promissory note.

To illustrate, assume a client sells a small business worth $10 million to a trust for her children in return for a promissory note with annual interest payments and a balloon payment at the end of the term.  This simple sale would itself be beneficial for estate tax purposes.  If the business  appreciated to $20 million before client’s death, all $10 million of appreciation would be outside the client’s taxable estate, perhaps saving $3.5 million in estate taxes.    However, $10 million remaining principal balance on the note would remain in the taxpayer’s taxable estate, subject to a 35% tax rate.  If the client had used a SCIN rather than a simple promissory note,   the $10 million principal payment would cancel, leaving the trust with a windfall.  For estate tax purposes, this means that the entire $20 million asset escapes estate tax.

Is there any downside to a SCIN?

The IRS would not allow this transaction unless it is equivalent to an arms-length transaction between unrelated parties.   So in return for the self cancelling feature of the note,  a “mortality risk premium” is charged to the payor – typically an increased interest rate.  The older the seller is, the greater the mortality risk premium will be.    

This mortality risk premium is the downside of the SCIN transaction.  If the seller outlives the term of the SCIN, the trust will have paid the mortality risk premium interest rate to the seller for absolutely no benefit.[1] 

What makes 2012 an unusually good time to use a SCIN?

What makes the SCIN extremely attractive now is the historically low interest rate environment.  The SCIN interest rate is the base AFR rate which the IRS requires for all promissory notes, plus the mortality risk premium.  

Today, both the AFR rates and mortality risk premiums are very low.   Long term AFR rates for 2012 have hovered around 2.75%.  The largest the mortality rate premium has been for a 55-year-old male since January 2010 was only .58 percent.  The SCIN rate for a 70 year old in March 2012 was only 3.07 percent.    Thus, a 55 year old can do a SCIN at an interest rate of around 3.47%.  A 70 year old can do a SCIN for a rate of around 5.96%.  In both cases, the SCIN interest rates are below historical average prime rate of interest for third party loans.    Under these circumstances the downside risk of a SCIN is very small when compared to the huge estate tax benefit that could result. 

If you need help with your estate plan or want additional information, please contact us at (404) 255-7400.


[1] This downside risk can be mitigated by combining the SCIN strategy with a GRAT strategy.  The SCIN strategy only works if the seller passes away during the term of the SCIN. The GRAT strategy only works if the seller survives the term of the GRAT.  By combining the two, mortality risk can be greatly reduced if not eliminated.