Without advanced estate planning strategies, much of the significant assets you have accumulated may end up with the IRS and state taxing authorities.
Our firm regularly assists affluent families with such sophisticated planning strategies as Family Limited Partnerships or Limited Liability Companies, Personal Residence Trusts, Irrevocable Life Insurance Trusts, Grantor Retained Trusts, Sales to Intentionally Defective Grantor Trusts, and a wide range of charitable gifting techniques to reduce federal estate taxes, gift taxes and generation skipping transfer taxes.
Family Limited Partnerships
A Family Limited Partnership (FLP) is a form of a limited partnership among members of a family. The main advantages of forming and funding an FLP involve estate and gift tax savings and asset protection. An FLP also allows you to retain control over the transferred assets while enjoying these advantages.
Once the FLP is established and your assets are transferred to it, you can make gifts of limited partnership interests to your children or other beneficiaries. This accomplishes several different estate planning objectives simultaneously.
First, the value of each limited partnership interest which you give away decreases the value of your taxable estate and, consequently, any tax which your heirs would have to pay upon your death. The gifts are made using the annual gift tax exclusion, so you do not have to pay any gift tax on the transfer.
Second, the value of the partnership interests transferred to your beneficiaries is far less than the corresponding value of the assets in the partnership. Since limited partners do not have the ability to direct or control the day-to-day operation of the partnership, a minority discount can be applied to reduce the value of the limited partnership interests which you are gifting. Furthermore, because the partnership is a closely-held entity and not publicly-traded, a discount can be applied based upon the lack of marketability of the limited partnership interest. This allows you to leverage the FLP as a vehicle to transfer more wealth to your beneficiaries, while retaining control of the underlying assets. Lastly, a properly-structured FLP can have creditor protection characteristics since the general partners are not obligated to distribute earnings of the partnership.
Qualified Personal Residence Trusts
Our homes are often our most valuable assets and hence one of the largest components of our taxable estate. A Qualified Personal Residence Trust or a QPRT (pronounced “cue-pert” allows you to give away your house or vacation home at a great discount, freeze its value for estate tax purposes, and still continue to live in it. Here is how it works: You transfer the title to your house to the QPRT (usually for the benefit of your family members), reserving the right to live in the house for a specified number of years. If you live to the end of the specified period, the house (as well as any appreciation in its value since the transfer) passes to your children or other beneficiaries free of any additional estate or gift taxes. After the end of the specified period, you may continue to live in the home but you must pay rent to your family or designated beneficiary in order to avoid inclusion of the residence in your estate. This is may be an added benefit as it serves to further reduce the value of your taxable estate, though the rent income does have income tax consequences for your family. If you die before the end of the period, the full value of the house will be included in your estate for estate tax purposes, though in most cases you are no worse off than you would have been had you not established a QPRT. An added benefit of the QPRT is that it also serves as an excellent asset/creditor protection vehicle since you no longer technically own the property once the trust is established and your residence is transferred to the QPRT.
Irrevocable Life Insurance Trusts
There is a common misconception that life insurance proceeds are not subject to Federal Estate Taxes. While the proceeds are received by your loved ones free of any income taxes, they are countable as part of your taxable estate and therefore your loved ones can lose about half of its value to estate taxes.
An Irrevocable Life Insurance Trust is created specifically for the purpose of owning your life insurance policy. A properly established and administered trust holds the policy outside of your estate and keeps the proceeds from being taxable to your estate. The proceeds from the insurance policy can then be used to provide your estate with the liquidity to pay estate taxes, pay off debts, pay final expenses and provide income to a surviving spouse or children.
The ILIT will be the policy owner and beneficiary. Once your trust is established, you use your annual gift tax exclusion to make cash gifts to your trust. Your beneficiaries forgo the present gift (in lieu of the future proceeds) and the trustee uses the remaining gift to pay the premium on the life insurance policy.
There are many options available when setting up an ILIT. For example, ILITs can be structured to provide income to a surviving spouse with the remainder going to your children from a previous marriage. You can also provide for distribution of a limited amount of the insurance proceeds over a period of time to a financially irresponsible child.
Grantor Retained Trusts
A Grantor Retained Annuity Trust (GRAT) is an irrevocable trust to which you contribute assets. You retain the right to receive annuity payments for a specified period of time based on an assumed discount rate determined by the IRS. At the end of the term, assets in the trust pass to other beneficiaries. The GRAT provides gift and estate tax savings if the return on the assets placed in the GRAT exceeds the assumed discount rate. Grantor Retained Unitrusts (GRUTs), where distributions are based on a percentage of assets instead of an annuity, and Grantor Retained Interest Trusts (GRITs), where you retain an income interest, are similar techniques.
Intentionally Defective Grantor Trusts
Alternatively, you may want to sell assets to an Intentionally Defective Grantor Trust (IDGT), an irrevocable trust you establish that is excluded from the your estate for federal estate tax purposes, yet owned by you for income tax purposes. The sale can be in exchange for a promissory note. Similar to a GRAT, the sale of the promissory note provides gift and estate tax savings if the return on the IDGT exceeds the interest rate on the note.
Charitable Planning Documents
If you are charitably inclined and seeking to minimize taxes while enhancing the amounts going to your loved ones, you may want to consider charitable planning. Documents associated with charitable planning include Charitable Remainder Trusts (CRATs and CRUTs), Charitable Lead Trusts (CLATs and CLUTs), and Private Foundations.
Our firm is dedicated to helping clients make educated, informed decisions about their assets and will work with you and your team of financial advisors and CPAs to implement a highly sophisticated estate plan.
For more, please click on the "ARTICLES" tab to read the article I co-authored on advanced estate planning techniques published in the Journal of Financial Planning in October 2008 entitled Many Estate Planning Strategies Provide Benefits in Low-Interest-Rate Environment.