Wealth Transfer

As a basic premise, anything that you own at your death is included in the value of your taxable estate.  The estate tax is in addition to any amount of income tax that is due at your death.  Your taxable estate includes not only items that are disposed of in your will, but also items that pass by operation of law at your death, such as:

  • Items that are owned in joint tenancy by you with another individual (whether or not the other individual is a spouse) even though these items pass automatically to the survivor at the first death;
  • Items that contain a payable on death designation, such as many bank accounts; and
  • Items that contain a beneficiary designation, such as life insurance policies and investment accounts.

Currently, an individual has the ability to pass $5 million and a married couple has the ability to pass $10 million tax free to their children or to any other beneficiaries either during life (via the gift tax exemption) or at death (via the estate tax exemption).  However, this amount goes down to $1 million per individual and $2 million per couple on January 1, 2013 unless there is a change in the tax law.  The amount that you can transfer tax free is cumulative, so that if you transfer the maximum amount during your life using the gift tax exemption, you will not have the ability to transfer any property tax-free at death.  If the tax law doesn’t change, the time period between now and January 1, 2013 will provide a unique opportunity to protect wealth from future taxes.  In addition to the basic estate tax planning that should be built into your Last Wills or Revocable Living Trusts, there are many, many vehicles that we use to transfer assets out of your future taxable estate.  Discussed below are some of the more popular techniques.

Irrevocable Life Insurance Trusts

The first strategy that we usually consider is the use of an irrevocable life insurance trust, or ILIT.  Often, an ILIT will allow you to transfer existing life insurance to, or purchase new life insurance in, a trust structure without using any portion of your gift tax exemption.  Then, when the insurance pays out at death, the death benefit will not be included in your taxable estate.  Therefore, irrespective of the estate tax thresholds, an ILIT should be used to hold all significant life insurance policies.  ILITs can be drafted to range from very straightforward trusts to exceptionally sophisticated structures anticipating different premium payment options (such as premium financed payment arrangements) and multiple exit strategies (reinvestment of trust proceeds at death, put option exit strategies, dynasty arrangements, etc.).

Discounted Limited Partnership Structures

Another very popular strategy is using a family limited partnership, or FLP, structure.  This structure will allow you to place assets into a business entity (often a limited liability company, even though we still use the term FLP for both partnership and LLC structures) and then gift a portion of the ownership to members of subsequent generations or others.  Since the ownership you transfer does not give the recipients the ability to vote on the management of the company or the ability to sell their interests in it, the ownership will often qualify to receive a valuation discount for lack of control and lack of marketability.  It is typical to see discounts on properly structured FLP transactions from 30% to 45%.  We will often decide to use part or all of an individual’s $5 million gift tax exemption (or the $10 million exemption available to couples) in conjunction with this structure.  This is because we can often put the other strategies mentioned here in place without a significant use of your gift tax exemption.

Estate Freeze Transactions Using Installment Notes

A structure that is used both on its own as well as with an FLP structure when assets intended to be transferred are more than about $15 million utilizes a sale in return for an installment note to put an “estate freeze” into place.  If you have assets that you believe will appreciate, you can exchange those assets for an installment note.  Therefore, if you transfer assets that you expect to appreciate at an annualized rate of 8% for a note at an annual rate of 3%, the difference of 5% per year will escape estate taxation at your death because the growth happens outside your estate.  The typical structure to use in this type of transaction is known as an intentionally defective grantor trust (or “IDGT”).  Using this type of trust structure, which is valid for gift and estate tax purposes but transparent for income tax purposes, there is no trigger on the gain of the assets upon transfer and no recognition of taxable interest each year.  The “freeze” refers to the fact that instead of owning assets that will appreciate each year, you will die only with the value of the note in your estate, which is a static dollar amount.

The IDGT needs to be seeded with value before it is able to engage in the installment sale.  We do this by having you make a gift to the IDGT.  The gift is often 10% of the value of the note.  We usually utilize a portion of your lifetime gift tax exemption to make this gift so that it is tax free.

Grantor Retained Annuity Trusts

Grantor Retained Annuity Trusts, or GRATs, allow an individual to put assets into a trust and receive a fixed annuity amount for (usually) a term of years based on a rate of return determined when the GRAT is established.  At the end of the term, a remainder beneficiary (children, for instance) will receive whatever is left.  Therefore, if the assets actually generate a return that is higher than the rate of returned used in the GRAT, the beneficiaries get the difference.  If the assets generate a return that is lower than the rate of return used in the GRAT, the beneficiaries get nothing and the individual who funded the trust receives the assets back.  This deceptively simple structure can be used to transfer tremendous value at very little (or no) tax cost—especially in today’s low interest rate environment.

Personal Residence Trusts

A Personal Residence Trust (known as a QPRT or PRT depending on the design of the structure) is a strategy that will result in your home being outside of your future taxable estate.  As interest rates rise, this structure becomes increasingly attractive.   There are a number of practical considerations to take into account before implementing this structure.

As mentioned above, there are a myriad of additional techniques, from the mundane to the extremely sophisticated.  This is an incredibly interesting area of the law.  We will be happy to review with you the options that fit with your goals and assets.