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Complex Planning

Complex Planning

 

INTRODUCTION

    Clients who need complex (or advanced) estate planning typically do so for one of two reasons (and often both reasons):  First, client can use advanced estate planning techniques to reduce or eliminate estate tax exposure.  Second, complex planning can effectively address the issues relating to the the succession of a family business.  Although complex estate planning can serve many other purposes, estate tax avoidance and business succession planning are the two most common goals clients look to achieve.  Each is addressed below.
 
Reduce or Eliminate Estate Tax Exposure.  The estate tax is a tax levied on one's "gross estate" (net worth including life insurance death benefits) of approximately 50%.  However, there is an exclusion to this tax which varies from year to year, and in 2009 it is $3.5 million.  As so, for every dollar someone is worth over $3.5 million, it will be taxed at approximately 50%.  A relatively simple AB trust for a married couple has provisions which result in an applicable exclusion of double that amount.  For example, whereas an indidual would be paying this 50% tax on every dollar over $3.5 million, the estate tax for a married couple would kick after $7 million.
 
     The purpose of complex estate planning with the objective of reducing or eliminating estate taxes is to remove certain assets from the equation which determins your "gross estate."  For example, an individual with $3 million of assets and $2 million of life insurance would have a gross estate of $5 million, and with an exclusion of $3.5 million, $1.5 million is subject to a 50% tax resulting in $750,000 of taxes payable.  But if this individual were to create an "Irrevocable Life Insurance Trust" to hold the life insurance policy, the IRS would not recognize the life insurance death benefits as part of the gross estate, and would thus lower this individuals gross estate to $3 million and completely eliminate estate taxes.
 
     In situations where the gross estate has not yet grown to the point of exceeding the estate tax exclusion amount, but assets in the estate are of a nature where dramatic appreciation is occuring or likely to occur, complex planning can allocate the appreciation to an entity or trust outside of the gross estate calculation, thus reducing or eliminating estate taxes.
 
Business Succession Planning.  The question all business owners will eventually have to ask themselves is, "Who will run the business when I am gone, and how will my beneficiaries benefit from the value or revenues of the business should they be unwilling or unable to manage it?"  Businesses typically have a life of their own, with many relationships, obligations, goals, and revenue of their own.  More often than not, there are outside investors or partners that have a contractual tie to the business.  Simply leaving the business to one's intended beneficiaries is never a good idea because it ignores all of the considerations above.
 
     The purpose of complex estate planning with the objective of business succession planning is to ensure that should the client so desire, the business continues to managed by those who are most willing or able, and that your intended beneficiaries benefit from the revenues and value of the business.
 
Complex Estate Planning Techniques.  Below are common advanced estate planning techniques which accomplish the reduction or elimination of estate taxes or a successful disposition of one's business interest.  These techniques can be implemented as stand-alone solutions or as interconnected strategies.
 
     Please do not hesitate to contact me at Bryan@EisenbiseLaw.com should you have any questions regarding complex estate planning issues and techniques.
 
 
 

IRREVOCABLE LIFE INSURANCE TRUSTS

    
     The primary objective of an Irrevocable Life Insurance Trust (or "ILIT")is to avoid inclusion of life insurance proceeds in the insured's taxable estate.  The Internal Revenue Code requires inclusion of life insurance death benefits in the estate of anyone who has "incidents of ownership," which includes anyone who either is a named beneficiary of the policy, or one who has the unfettered authority to access the policy and change the terms and/or beneficiaries of the policy.  So for an individual (or married couple) to own a life insurance on their own lives, the value of the death benefit will surely be included in their lives (and taxed at 50% if over the exclusion amount).
     What an ILIT accomplishes is the removal of "incidents of ownership," thus allowing the policy to exist without inclusion into the insured's estate.  This is the reason the ILIT is irrevocable--once you set the beneficiaries and distribution terms of the policy (through the trust), you must transfer the trust and give up any right to change the terms (or access the cash balance, if applicable).  For families with very predictible family situations, the restrictions incurred are minimally invasive, and the elimination of a 50% tax on the death benefits is well worth any convenience.
 
     However, there are some clients who have situations that may not be so predictable, or who may want to accomplish some investment or retirement goals with a life insurance policy, and as so, find the ILIT to be too restrictive, and in some situations, make the idea of an ILIT impractical.  As so, the relatively new concept of a "Flexible ILIT" has been introduced which, although requires a few more administrative tasks, includes provisions which result in the client being able to access any cash balance in the policy and change or even cancel the policy terms.  The Flexible ILIT is explained below.
     Please do not hesitate to contact me at Bryan@EisenbiseLaw.com should you have any questions regarding complex estate planning issues and techniques.
 
 
 

THE "FLEXIBLE" IRREVOCABLE LIFE INSURANCE TRUSTS (FLEX-ILIT)

     For sake of conversation, the basic concept between a traditional ILIT and a Flex-ILIT are identical, and therefore a review of such principles is not merited.  For a discussion on the principles and purpose of a traditional ILIT, pleas review the above section.
 
     As state earlier, the Flex-ILIT allows access to the cash balance of any life insurance policy held by the ILIT, and also allows the insured to make changes to the terms of the policy and trust.  What the Flex-ILIT offers is a chance to essentially "have your cake and eat it too."  Such is accomplished through the implementation of various provisions and characteristics of the trust:
  • Rather than "gifting" money to the trust to pay the premiums, the insured would "loan" the money to the trust in exchange for promissory notes which do not require payment unless asked, so whenever access to the funds are needed, the insured simply calls in the notes.  It is essential that a well-versed attorney draft the trust to allow such transactions.
  • The client can appoint a "Trust Protector," which is an individual who does not have a fiduciary duty to the beneficiaries, and, at the request of the client, can exercise previously-granted authority to alter the terms of the trust or policy, even if it involves the detriment to one of the beneficiaries.
  • Legal precedent recently set allows the client to retain the right to "fire" the trustee of the trust, and appoint another without being considered an "incident of ownership."
  • For a married couple, in some situations, one spouse can appoint the other spouse as a lifetime beneficiary of the trust and mandate that any cash value accumulated in the policy be distributed to the non-insured, and non-participating spouse, and under the unlimited martial gift exclusion, the beneficiary spouse can gift that money back to the client spouse tax-free.
     The main disadvantages of a Flexible ILIT center around the lack of absolute power the client has.  Most of the benefits mentioned above are not reserved powers under the trust (they cannot be without being considered "incidents of ownership.")  And as so, the success of a properly-drafted ILIT depends on the trustworthiness of the trustee and other agents you appoint.  Furthermore, a Flexible ILIT tends to have a bit more administrative tasks up front, but compared to the benefits of flexibility and accessibility, it is most often preferable to a traditional ILIT.
 
     Please do not hesitate to contact me at Bryan@EisenbiseLaw.com should you have any questions regarding complex estate planning issues and techniques.
 
 
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STRETCH IRA TRUSTS ("IRA TRUSTS")

     IRAs are not typically thought of as a wealth transfer device, but rather purely a retirement vehicle.  With IRAs comprising most of one's total net worth.  Adding a secondary purpose to one's IRA is something that needs to be considered.
 
     The Stretch IRA Trust begins with the concept of "stretching" one's IRA.  After complying with certain provisions in the Internal Revenue Code, creators can continue to grow their IRA accounts and defer taxes for decades after death and thus, grow a modest retirement account into a fortune. However, based on the creator's life expectancy, their beneficiaries will have to take a small taxable distribution each year, but the vast majority of the account grows without any IRS intervnetion.
 
     Although stretching an IRA sounds like a good idea, upon death the beneficiary can "cash out" the IRA for personal or selfish reasons, incurring significant taxes on penalities on this "found" money.  Furthermore, this beneficial, mult-generational, tax-deferred growth can prematurely terminate by reasons of divorce, bankruptcy, legal judgment, creditors, etc.  Although the concept of stretching an IRA logically results in mult-generational tax-deferred growth, in practice, it is easily subject to frustration.  Enter The Stretch IRA Trust.
 
     Up until a few years ago, the Internal Revenue Code did not allow anything other than an individual to be the beneficiary of an IRA that is being stretched.  However, now, trusts with very specific provisions are allowed to act as such beneficiaries.  With an IRA Trust as the beneficiary of an IRA, the benefits of stretching still are available, along with the protection a trust provides--beneficiaries will not be able to prematurely liquidate the acccount or lose it to divorce or to creditors.  Furthermore, the flexibility of distribution provisions also allow the trust, to a certain extent, to accumulate IRA distributions, and distribute them to the ultimate beneficiary per terms the creator chooses.
 
    Please do not hesitate to contact me at Bryan@EisenbiseLaw.com should you have any questions regarding complex estate planning issues and techniques.
 
 
 

CHARITABLE REMAINDER TRUSTS (AND WEALTH REPLACEMENT TRUSTS)

     In essence, a Charitable Remainder Trust (CRT) is an Irrevocable trust to which the creators will donate an asset (or multiple assets).  The CRT then makes payments of income (per IRS tables) back to the creators (or other beneficiary), and the remaining assets in the trust at the death of the creators is then distributed to a qualifying .  In this, its simplest form, the CRT provides an income tax deduction for the original contribution, no gift taxes for the original contribution, an income opportunity, and an overall reduction of one's gross estate by the amount of the value of the donated asset.
 
     The real value of CRTs, however, become apparent when they are implemented as a part of larger strategies.  Consider the following techniques highlighting the power of the Charitable Remainder Trust:
  • One can contribute liquid assets to a CRT and create a stream of income for himself, or for another for a period of years (or for a lifetime), and once those income goals are met, the remainder is dontated to a charity of his choice.  An income tax deduction is available upon the initial contribution, income goals are accomplished, and charitable intent is also satisfied.  And to the extent the income did not accumulate in the estate, the entire amount of the contribution is not included in the gross estate.
  • If one has a highly-appreciated asset of which asset's value is not needed elsewhere, this individual can create a CRT, contribute the asset to the CRT, and have the CRT sell the property.  The individual gets a charitable contribution deduction for donating it to the CRT, the CRT can now hold the cash value of the asset without any reduction for capital gains taxes per the law relating to CRTs.  Rather than pay that cash out to the creator or anyone else under allowable income payments, such income is diverted to fund a life insurance policy that has a death benefit equal to the value of the original contribution (or more if possible).  With that life insurance policy held in an ILIT (now called a "Wealth Replacement Trust"), the creator effectively created an income tax deduction, totally avoided capital gains taxes, reduced his gross estate (thus drastically reducing estate taxes), and passed the equivalent value of the asset onto his heirs tax-free.  And to the extent the income payment are sufficient to fund a policy worth more than the original asset, the creator can create additional money out of nothing.
  • Rather than leave the contributed asset to any charity, the creator can establish his own charitable foundation, and name that as the remainder interest holder of the trust.  Not only does this allow the creator to use his own assets for his own charitable purposes.  He can also draw a salary as a director of the charity, and also hire family members as employess, and thus reduce his gross estate even more by transferring his own assets as salary.  If a charitable foundation is too complicated for the client, the named charity can also be a "Donor Advised Fund," which allows near-autonomous decision-making authority over the specific allocation of contributions without the cost and procedural upkeep of a charitable foundation.
     Income tax deductions, capital gains avoidance, income, wealth replacement, estate tax reduction (or elimination), and charitable opportunities all make Charitable Remainder Trusts a very powerful and often-used estate planning techniqe.
 
     Please do not hesitate to contact me at Bryan@EisenbiseLaw.com should you have any questions regarding complex estate planning issues and techniques.
    
 

PRIVATE CHARITABLE FOUNDATIONS

     Charitable giving comprises a large part of estate planning for a few reasons.  Most visible would be the tax benefits--primarily estate tax benefits.  Charitable contributions are deductible in determining one's gross estate (amount to which the estate tax is levied), thus reducing or eliminating the need for one's family to liquidate other assets and pay such to the IRS.  For charitable contributions before death, there is an income tax benefit as well.  A less visible (and more intrinsic) motive for charitable giving is charitable intent--gifting to charity to benefit a segment of society or other purpose.  The use of a charitable foundation can drastically enhance both of the reasons mentioned above.
 
     First, should the creator be integrating charitable giving into their estate planning for estate tax purposes, they presumably have a substantial amount of net worth and will likely be looking at other alternatives to reduce their gross estate to use in conjunction with the charitable giving.  Employing children or other beneficiaries as directors of your charitable foundation is one of the many methods by which a charitable foundation can transfer assets to beneficiaries free of estate taxes.  Furthermore, appreciation of assets held by a chartiable foundation are not counted in the creator's gross estate.  And last, capital gains, income, and other potential taxable events are all free of any taxes if realized within a charitable foundation, thus keeping assets within your family without gross estate inclusion.
 
     Second, when incorporating charitable giving into an estate plan, clients need to select which charitable purpose they would like to support.  And once a charitable purpose is chosen, the appropriate charity then is decided upon.  By creating a charitable foundation, clients can enjoy all of the benefits of a charitable contribution, while having complete control over how those charitable funds are used.  Many estate planning techniques involve a remainder interest contribution to a charitable organization, and if the client has also created their own charitable organization, direction of the funds can be kept close to home, along with all of the benefits mentioned above.
 
     Please do not hesitate to contact me at Bryan@EisenbiseLaw.com should you have any questions regarding complex estate planning issues and techniques.
 
 
 

FAMILY LIMITED PARTNERSHIPS

     Family Limited Partnerships (FLPs) are an advanced estate planning technique for business owners, and for other valid business interests.  FLPs were abused quite a bit in the 1990's by families and individuals who sought to utilize an FLP for non-business assets such as investments and personal residences, but Internal Revenue Service regulations have curtailed this.
 
     The primary characteristic of the FLP is the concept of "discounting."  Discounting essentially is the process of reducing the fair market value of an asset that is currently part of your gross estate, to thus reduce your potential estate tax exposure.  Furthermore, discounting shares of a company or asset as you gift them to beneficiaries, allows the giftor to gift a more significant portion amount of the asset due to its value having already been decreased through discounting. 
 
     Discounting through an FLP works like this:  The creator establishes a Family Limited Partnership (comparable to a standard limited partnership), which holds ownership of the business or business asset.  The creator retains the general partnerhip share, along with all management, decision-making, and income rights.  It is important to remember that throughout the lifetime of a FLP, the creator never has to give up any income, management, or decision-making rights--they will always remain in control.  The creator then gifts limited partnership shares to beneficiaries.  These limited shares have no voting rights, no decision-making rights, no management rights, and if the creator so chooses...no income rights either.
 
     The above explanation does not uncover any inherent benefit of the FLP, but after applying the concept of discounting, it becomes prevalent:  The creator may initially intend to gift a 1/10th share of a business asset to a beneficiary.  Normally this would be a 1/10th value of the asset, but with the asset held in an FLP, the creator can assume the 1/10th share of the asset (or containing partnership) is worth much less than 1/10th of the value.  Under widely accepted discounting strategies, the 1/10th interest is worth less due to the lack of any decision-making authority over that asset.  Furthermore, the value can be discounted even more due to the lack of any income rights of the 1/10th share.  Additional discounts that can be applied include lack of marketability, minority interest, lack of management authority, restrictions on transfer, etc.  By the time all of the discounts are applied, the 1/10th ownership share of the partnership can have (hypothetically) a value somewhere near 1/20th of the total ownership.  By discounting, the creator can transfer a much larger percentage of the company to the beneficiaries and still remain under the annual gift tax exclusion, while retaining all of the management, income, and decision rights.
 
     Furthermore, the retained partnership shares of the creator, although worth substantially more than the limited shares, can also be discounted due to lack of complete ownership, lack of marketability, and other discounts.  After a lifetime of management and ownership rights, the creator enjoys a much smaller gross estate on death, and if properly planned, minimal gift taxes during life.  And if the beneficiaries are to also be the future owners / managers of the business, the FLP can be a very effective way of transferring ownership under the tax radar.
 
     FLPs can drastically reduce estate and gift tax exposure, while providing for very effective business succession planning.  The primary caveat to consider, however, is that the FLP can only be used for "legitimate business interests," and the IRS has been known to unravel FLPs where the asset(s) was / were not business interests.  Widely held is the invalidity of an FLP used to hold personal investments or a personal residence.  FLPs are good for family businesses, including investment or rental properties.
 
      Please do not hesitate to contact me at Bryan@EisenbiseLaw.com should you have any questions regarding complex estate planning issues and techniques.
 
 
 

QUALIFIED PERSONAL RESIDENCE TRUSTS

      A Qualified Personal Residence Trust (QPRT) effectively holds title to the creator's personal residence, while the creator maintains control over the property and the right to reside. This transfer involves an agreement about how long the owner may continue to reside in the house even though the residence has been transferred to the trust. The creator may continue to reside at the residence for a term of years specified in the qualified personal residence trust. During the grantor's stay he or she is not required to pay rent but is responsible for related expenses (e.g., maintenance and estate fees) and may claim associated income tax deductions. If the grantor wishes to extend his or her stay past the predetermined term of years the creator will have to pay fair market rent.  The only caveat to this is that the beneficiary will now own the home, and it is ultimately the beneficiary's decision whether to lease the property, but if prior agreements are made, children typically support their parents planning--especially if there is rental income for them.  Rental income is also a way to further reduce one's gross estate.
 
     Since the gift is not transferred to the beneficiary immediately (but rather after the term of years), its value is not equal to the value of the residence at the time the QPRT is created. The value of the gift is based on the value of the future right to own the residence at the end of the specified term, which may make the gift value as much as 25-50% lower than the actual retail price of the house at the time of the transfer.  And with a gift tax equal to the estate tax, the net taxes payable to the IRS will be much less through a QPRT rather than through inheritance.
 
     Another advantage of the QPRT is the asset protection characteristics:  With the QPRT holding title to the house, the value of the property is not the creator's tp lose or encumber.  As so, any debt or judgment levied against the creator will not extend into the QPRT.  However, should the creator choose to lease back the house after the specified term of years, the house is subject to the creditors and judgments of the beneficiaries, similar to any rental property.
 
      Please do not hesitate to contact me at Bryan@EisenbiseLaw.com should you have any questions regarding complex estate planning issues and techniques.
 
 

 

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