CEO Musings: Lifetime Gifting Part 2: How do I Gift to Maximize Tax Savings, Preserve, Control and Protect Assets
by Mike Hoffman, Esq., CPA
In estate planning there is an old adage, “if you don’t need it, gift it away.” Some assets are much more attractive for gifting purposes than others. When gifting to or on behalf of loved ones, those who would inherit your assets eventually, anyway, it is desirable to use “hard to value” assets. These typically include closely held business interests or real estate. These categories of assets are hard to value, since appraisals will contain a significant degree of subjectivity, unlike cash or publicly traded securities.
When valuing these “hard to value” assets, one must take into account the realities of fair market value. While a piece of property may be worth $100, an undivided half interest in that same property, standing alone, is likely worth substantially less than $50. This discrepancy occurs because of valuation discounts, such as lack of control and lack of marketability. There are a myriad of other types of discounts that can be taken into consideration, but appraisers generally focus on these two.
Since the early 1990s, estate planners have used limited partnerships and limited liability companies to gift large portions of taxpayers’ estates while the taxpayers are still alive.
By placing “hard to value” assets into a holding company structure, such as a family limited partnership or a limited liability company, we can isolate the control of the holding company into a very small percentage of its ownership. For instance, the holding company could have 1% voting interest and a 99% non-voting interest.
If the liquidation value of the assets placed in the holding company was $100, the owner could gift or sell her 99% non-voting interest to her children or a trust for her children, and the value would likely be approximately $65 after taking into consideration the appropriate valuation discounts for lack of marketability and lack of control. The family matriarch retains control over the assets in the holding company because of her retention of the 1% voting interest. But 99% of the holding company and 99% of future appreciation attributable to that ownership have been removed from the matriarch’s estate.
When the time comes, the family matriarch can transfer the voting interest to the family member who should be the likely successor in managing the assets of the holding company yet enable all the children to share equally in the economic ownership of the underlying assets. It is an important concept in estate planning to maintain flexibility when it comes to succession planning and the management of properties and businesses.
Using Trusts for Gifting
There is a reason that most estate planning attorneys are referred to as trust and estate attorneys. A lot of that has to do with the understanding and use of the power of trusts.
It is more common today to create trusts that last for the lifetime of the beneficiary, as opposed to terminating or distributing assets from trusts when beneficiaries achieve random birthdays, such as a third at age 25, a third at age 30 and final distribution at age 35. This latter concept of terminating a trust based on birthdates is what I refer to as 19th century planning and generally indicates that documents are very old and need re-drafting. The draftsman is definitely “old school” and not particularly expert in the area of trusts.
A trust can be set up for the lifetime of a beneficiary, and in many jurisdictions, including Georgia, can run out for over ten or more generations. That’s ten generations of death tax avoidance and ten generations of asset protection from divorce and judgement creditors. This concept of cascading trusts for each ensuing generation is what we refer to as “dynasty trusts.” Families want to ensure that assets stay within the family or bloodline for hundreds of years. While there are some formalities for these trusts that must be adhered to with the existence of separate entities, these are more than offset by the continuing benefits of income tax flexibility and probate avoidance in future years and generations.
Most importantly, when most people think of trusts, it brings to mind a corporate trustee, such as a bank or trust company; however, the reality is that the vast majority of trusts are controlled by individuals and, in many cases, a beneficiary is also the trustee. In fact, beneficiary-controlled trusts (BCTs) are quite common, although the drafting must be very intricate.
Of course, trusts that will have ownership and custody of assets for such a long period of time must be created with a great deal of flexibility, so that fiduciaries and beneficiaries can react to changing laws and circumstances in the future. Whether a trust is created by a trust agreement (because it is needed right now to own assets) or the trusts are created by one’s Last Will & Testament, the power of trusts should not be overlooked or underestimated.
