Todd M. Villarrubia Attorney at Law, LL.M. in Taxation Board Certified Expert in Estate Planning

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1 Todd M. Villarrubia Attorney at Law, LL.M. in Taxation Board Certified Expert in Estate Planning 101 W. Robert E. Lee Blvd., Suite 404, New Orleans, LA Tel Fax

2 Annually Over Lifetime Transfer of wealth excluded from any gift tax $13,000 per individual ($26,000 gift splitting with spouse) per donee Direct payments to educational institutions and health care providers1 Irrevocable life insurance trusts (ILIT)2 Transfer of wealth through GST, estate, and gift tax exemptions Gift tax exemption of up to $5M per individual GST and estate tax exemptions of $5M per individual3 Generationskipping transfer trust (GST) Transfer of wealth utilizing discount strategies Family limited partnership (FLP) Family limited liability company (FLLC) Non-voting shares in family corporation (C or S corporation) Transfer of wealth utilizing freeze strategies (appreciation-only gifts) Grantor retained annuity trust (GRAT) Intentionally defective grantor trust (IDGT) Qualified personal residence trust (QPRT) Intra-family loan Statutory freeze partnership (FLP or FLLC)4 Transfer of wealth through taxable gifts Pay gift tax now rather than paying estate tax later Converting traditional IRA to Roth IRA5 1 To qualify for exclusion, gifts (a) of tuition must be made directly to the educational institution; and (b) for medical expenses must be made directly to the health care provider. 2 Often can be structured to use annual exclusion gifting. 3 In 2011, an estate is taxed at a top rate of 35% with a $5 million estate tax exemption and a $5 million GST tax exemption. 4 Can serve to both utilize discount and transfer wealth utilizing freeze strategies. 5 Paying the income tax in converting a traditional IRA to a Roth IRA is essentially a gift-tax-free gift.

3 Inter Vivos Gifts Annual Exclusion Gifts Unified Credit Gifts Dynasty Trust Grantor Retained Annuity Trust (GRAT) Intentionally Defective Grantor Trust (IDGT) Self-Cancelling Installment Note (SCIN) Private Annuity

4 Make full sense of the Unified Credit during lifetime Transfer highly-appreciating assets to a Grantor Retained Annuity Trust (GRAT) Sell highly-appreciating assets to an Intentionally Defective Grantor Trust (IDGT) Installment Note Self-Cancelling Installment Note (SCIN) Sell highly-appreciating assets to future generations in exchange for a private annuity

5 A type of trust which benefits multiple generations where none of the assets held by the trust are included in either the grantor s taxable estate or any of the beneficiaries taxable estates. Whenever a transfer is made by the grantor to a skip person (e.g. grandchild, great-grandchild, etc.) or a trust for their benefit (e.g. dynasty trust), a second level of tax is imposed on the transfer (in addition to gift tax). Notwithstanding this, a grantor is allowed a lifetime GST exemption on the first $5,000,000 of taxable transfers to skip persons. Thus, if the grantor allocates all or a portion of his/her GST exemption to the entire transfer, none of the transfer will be subject to GST tax either in the current year or future years.

6 Grantor/Parent Gift* Dynasty Trust Advantages Creditor protection Divorce protection Estate tax protection Direct decedent protection Spendthrift protection Consolidation of capital *Gift should take advantage of any remaining lifetime gift exclusion and lifetime GST exclusion No transfer tax paid. No transfer tax paid. No transfer tax paid. No transfer tax paid. Discretionary Distributions to Children for Life Discretionary Distributions to Grandchildren for Life Discretionary Distributions to Great-Grandchildren for Life Future Generations

7 Takes minimum advantage of the lifetime gift exclusion amount of $5,120,000 Takes maximum advantage of the one-time application of the $5,120,000 GSTT exemption Appreciation of assets will be estate tax free Provides a layer of asset protection from the beneficiaries creditors No transfer tax will be paid at the death of the grantor s descendants Provides flexibility Future trustees can be given the discretion to make distributions as appropriate, given the circumstances at the time the distributions are made Grantor can use the trust to positively affect future behavior

8 1. Value of estate is $10,000, After-tax growth rate of 4% Non-Dynasty Trust 3. One generation = 30 years 4. Federal Estate Tax = 35% Dynasty Trust Children s Inheritance $10,000,000 Children s Inheritance $10,000,000 Grandchildren s Inheritance $21,082,083 Grandchildren s Inheritance $32,433,975 Great-Grandchildren s Inheritance $44,445,424 Great-Grandchildren s Inheritance $105,196,274

9 $1 Million After-Tax Growth Value of Dynasty Trust After 120 Years Value of Property if No Trust 3.00% $34,710,987 $6,196, % $110,662,561 $19,753, % $348,911,561 $62,282, % $1,088,187,748 $194,248, % $3,357,788,383 $599,386, % $10,252,992,943 $1,830,223, % $30,987,015,749 $5,531,375, % $92,709,068,818 $16,549,148,216

10 A type of trust that benefits the grantor s future generations (i.e. children) without the imposition of estate or gift tax. To the extent that the actual rate of return on the trust s assets exceeds the IRS s rate (a.k.a. IRC 7520 rate), the excess is transferred to the trust s beneficiaries free of any estate and/or gift tax. All income earned by the trust is taxed to grantor because the trust is defective for income tax purposes, thus allowing for a tax-free gift to the trust s beneficiaries. NOTE: The IRC 7520 rate for May 2012 is 1.60%

11 Payment of gift tax on present value of remainder interest transferred to children (should be at or near $0) Grantor (Lead Beneficiary) IRS Transfer of assets Annuity payments over a fixed term GRAT Children* (Remainder Beneficiaries) At end of term, any residual assets remaining in the trust pass to the children free of any gift tax * Instead of naming the children as outright remainder beneficiaries of the GRAT, a grantor trust could be used (thus producing a greater estate tax benefit)

12 Year Ten-Year Term 10% Growth Beginning Balance Taxable Income 10.00% Annuity Payment $795,680 Ending Balance 1 $10,000,000 $1,000,000 $ (795,680) $10,204,320 2 $10,204,320 $1,020,432 $ (795,680) $10,429,072 3 $10,429,072 $1,042,097 $ (795,680) $10,676,299 4 $10,676,299 $1,067,630 $ (795,680) $10,948,248 5 $10,948,248 $1,094,825 $ (795,680) $11,247,393 6 $11,247,393 $1,124,739 $ (795,680) $11,576,452 7 $11,576,452 $1,157,645 $ (795,680) $11,938,417 8 $11,938,417 $1,193,842 $ (795,680) $12,336,578 9 $12,336,578 $1,233,658 $ (795,680) $12,774, $12,774,556 $1,277,456 $ (795,680) $13,256,331 Benefit: $13,256,331 Transferred to Beneficiaries Tax-Free *Assuming a $7,000,000 (after valuation adjustments) initial contribution

13 Grantor Retained Annuity Trust Why GRAT Works Difference Between Rates of Return Year Beginning Balance Taxable Income Annuity Payment Ending Balance 2.40% $ 1,136,686 1 $ 10,000,000 $ 240,000 $ (1,136,686) $ 9,103,314 2 $ 9,103,314 $ 218,480 $ (1,136,686) $ 8,185,108 3 $ 8,185,108 $ 196,443 $ (1,136,686) $ 7,244,865 4 $ 7,244,864 $ 173,877 $ (1,136,686) $ 6,282,055 5 $ 6,282,055 $ 150,769 $ (1,136,686) $ 5,296,138 6 $ 5,296,138 $ 127,107 $ (1,136,686) $ 4,286,559 7 $ 4,286,559 $ 102,877 $ (1,136,686) $ 3,252,750 8 $ 3,252,751 $ 78,066 $ (1,136,686) $ 2,194,131 9 $ 2,194,131 $ 52,659 $ (1,136,686) $ 1,110, $ 1,110,104 $ 26,642 $ (1,136,686) $ 61 Year Beginning Balance Taxable Income Annuity Payment Ending Balance 10.00% $ 1,136,686 1 $ 10,000,000 $ 1,000,000 $ (1,136,686) $ 9,863,314 2 $ 9,863,314 $ 986,331 $ (1,136,686) $ 9,712,959 3 $ 9,712,959 $ 971,296 $ (1,136,686) $ 9,547,569 4 $ 9,547,569 $ 954,757 $ (1,136,686) $ 9,365,640 5 $ 9,365,640 $ 936,564 $ (1,136,686) $ 9,165,518 6 $ 9,164,518 $ 916,452 $ (1,136,686) $ 8,945,384 7 $ 8,945,384 $ 894,538 $ (1,136,686) $ 8,703,237 8 $ 8,703,237 $ 870,324 $ (1,136,686) $ 8,436,874 9 $ 8,436,874 $ 843,687 $ (1,136,686) $ 8,143, $ 8,143,876 $ 814,388 $ (1,136,686) $ 7,821,577 Benefit: $7,821,516 Additional Wealth Transferred to Beneficiaries Tax-Free (of which $1,640,473 is due to taxes paid to grantor) 13

14 Grantor Retained Annuity Trust Why GRAT Works Valuation Adjustments Year Beginning Balance Taxable Income Annuity Payment Ending Balance 10.00% $ 1,136,686 1 $ 10,000,000 $ 1,000,000 $ (1,136,686) $ 9,863,314 2 $ 9,863,314 $ 986,331 $ (1,136,686) $ 9,712,959 3 $ 9,712,959 $ 971,296 $ (1,136,686) $ 9,547,569 4 $ 9,547,569 $ 954,757 $ (1,136,686) $ 9,365,640 5 $ 9,365,640 $ 936,564 $ (1,136,686) $ 9,165,518 6 $ 9,165,518 $ 916,552 $ (1,136,686) $ 8,945,384 7 $ 8,945,384 $ 894,538 $ (1,136,686) $ 8,703,236 8 $ 8,703,237 $ 870,324 $ (1,136,686) $ 8,436,875 9 $ 8,436,874 $ 843,687 $ (1,136,686) $ 8,143, $ 8,143,876 $ 814,388 $ (1,136,686) $ 7,821,578 Year Beginning Balance Taxable Income Annuity Payment Ending Balance 10.00% $ 795,680 1 $ 10,000,000 $ 1,000,000 $ (795,680) $ 10,204,320 2 $ 10,204,320 $ 1,020,432 $ (795,680) $ 10,429,072 3 $ 10,429,072 $ 1,042,907 $ (795,680) $ 10,676,299 4 $ 10,676,299 $ 1,067,630 $ (795,680) $ 10,948,249 5 $ 10,948,248 $ 1,094,825 $ (795,680) $ 11,247,393 6 $ 11,247,393 $ 1,124,739 $ (795,680) $ 11,576,452 7 $ 11,576,452 $ 1,157,645 $ (795,680) $ 11,938,417 8 $ 11,938,417 $ 1,193,842 $ (795,680) $ 12,336,579 9 $ 12,336,578 $ 1,233,658 $ (795,680) $ 12,774, $ 12,774,556 $ 1,277,456 $ (795,680) $ 13,256,331 Benefit: $5,434,754 Additional Wealth Transferred to Beneficiaries Tax-Free 14

15 Grantor Retained Annuity Trust Why GRAT Works Payment of Taxes by Grantor Year Beginning Balance Taxable Income Annuity Payment Less: Ending Balance 10.00% $ 795, % 1 $ 10,000,000 $ 1,000,000 $ (795,680) $ (81,728) $ 10,122,592 2 $ 10,122,592 $ 1,012,259 $ (795,680) $ (86,632) $ 10,252,540 3 $ 10,252,539 $ 1,025,254 $ (795,680) $ (91,830) $ 10,390,283 4 $ 10,390,284 $ 1,039,028 $ (795,680) $ (97,339) $ 10,536,293 5 $ 10,536,292 $ 1,053,629 $ (795,680) $ (103,180) $ 10,691,062 6 $ 10,691,062 $ 1,069,106 $ (795,680) $ (109,370) $ 10,855,118 7 $ 10,855,117 $ 1,085,512 $ (795,680) $ (115,933) $ 11,029,016 8 $ 11,029,016 $ 1,102,902 $ (795,680) $ (122,889) $ 11,213,349 9 $ 11,213,349 $ 1,121,335 $ (795,680) $ (130,262) $ 11,408, $ 11,408,742 $ 1,140,874 $ (795,680) $ (138,078) $ 11,615,858 Year Beginning Balance Taxable Income Annuity Payment Less: Ending Balance 10.00% $ 795, % 1 $ 10,000,000 $ 1,000,000 $ (795,680) $ - $ 10,204,320 2 $ 10,204,320 $ 1,020,432 $ (795,680) $ - $ 10,429,072 3 $ 10,429,072 $ 1,042,907 $ (795,680) $ - $ 10,676,299 4 $ 10,676,299 $ 1,067,630 $ (795,680) $ - $ 10,948,249 5 $ 10,948,248 $ 1,094,825 $ (795,680) $ - $ 11,247,393 6 $ 11,247,393 $ 1,124,739 $ (795,680) $ - $ 11,576,452 7 $ 11,576,452 $ 1,157,645 $ (795,680) $ - $ 11,938,417 8 $ 11,938,417 $ 1,193,842 $ (795,680) $ - $ 12,336,579 9 $ 12,336,578 $ 1,233,658 $ (795,680) $ - $ 12,774, $ 12,774,556 $ 1,277,456 $ (795,680) $ - $ 13,256,331 Benefit: $1,640,473 Additional Wealth Transferred to Beneficiaries Tax-Free 15

16 Grantor Retained Annuity Trust Why GRAT Works Summary Total Wealth Transferred $ 13,256,331 Reasons for Total Wealth Transferred Differential Between Rates of Return $ 6,181,043 Valuation Adjustment 5,434,754 Income Taxes Paid by Grantor 1,640,473 Rounding Adjustment 61 Total Wealth Transferred $ 13,256,331 16

17 Grantor Retained Annuity Trust Why GRAT Works Payment of trust income taxes by the grantor Valuation adjustments on assets transferred Difference between actual rate of return and IRC 7520 rate 17

18 Grantor Retained Annuity Trust Additional GRAT Feature 20% Increasing Payment Under Treas. Reg (b)(1)(ii)(B), the annual GRAT payment may increase by up to 20% over the annuity payment from the previous year. Accordingly, by back-end loading the GRAT payments, more wealth is left to future generations. Year Beginning Balance Taxable Income Annuity Payment Ending Balance 10.00% $ 795,680 1 $ 10,000,000 $ 1,000,000 $ (795,680) $ 10,204,320 2 $ 10,204,320 $ 1,020,432 $ (795,680) $ 10,429,072 3 $ 10,429,072 $ 1,042,907 $ (795,680) $ 10,676,299 4 $ 10,676,299 $ 1,067,630 $ (795,680) $ 10,948,249 5 $ 10,948,248 $ 1,094,825 $ (795,680) $ 11,247,393 6 $ 11,247,393 $ 1,124,739 $ (795,680) $ 11,576,452 7 $ 11,576,452 $ 1,157,645 $ (795,680) $ 11,938,417 8 $ 11,938,417 $ 1,193,842 $ (795,680) $ 12,336,579 9 $ 12,336,578 $ 1,233,658 $ (795,680) $ 12,774, $ 12,774,556 $ 1,277,456 $ (795,680) $ 13,256,331 Year Beginning Balance Taxable Income Annuity Payment Ending Balance 10.00% 1 $ 10,000,000 $ 1,000,000 $ (317,164) $ 10,682,836 2 $ 10,682,836 $ 1,068,284 $ (380,596) $ 11,370,524 3 $ 11,370,523 $ 1,137,052 $ (456,715) $ 12,050,860 4 $ 12,050,860 $ 1,205,086 $ (548,058) $ 12,707,888 5 $ 12,707,887 $ 1,270,789 $ (657,670) $ 13,321,006 6 $ 13,321,005 $ 1,332,101 $ (789,204) $ 13,863,902 7 $ 13,863,901 $ 1,386,390 $ (947,045) $ 14,303,246 8 $ 14,303,245 $ 1,430,325 $ (1,136,454) $ 14,597,116 9 $ 14,597,115 $ 1,459,712 $ (1,363,744) $ 14,693, $ 14,693,081 $ 1,469,308 $ (1,636,495) $ 14,525,894 Benefit: $1,269,563 Additional Wealth Transferred to Beneficiaries Tax-Free 18

19 Annuity payments provide income stream to the grantor Ability to make gifts of substantial amounts of property tax-free Grantor pays income tax on trust income, leaving more assets in the GRAT for remainder beneficiaries Reduces the taxable estate of the grantor Valuation adjustments increase effectiveness of sale for estate tax purposes

20 If the grantor dies before the end of the GRAT term, the assets in the GRAT are included in the grantor s estate The remainder beneficiaries will have the same basis in the property transferred to the GRAT as the grantor had at the time the property was transferred (no step-up in basis) Risk that rate of return will not exceed interest rate resulting in no assets being transferred to remainder beneficiaries

21

22 Donor can maintain control and management of investment assets (by retaining the voting membership interests.) Creates otherwise unavailable minority and marketability discounts for estate and gift tax purposes. Protects investment assets from creditors or ex-spouses of members because charging order is sole remedy of creditors.

23 FLLC Governed by Operating Agreement Receive Voting Interests & Non-Voting Interests Contributes Assets Parents (Members & Managers) Gift/Sell Non-Voting Interests ILIT (Member)

24 FLLC Governed by Operating Agreement Income retained in FLLC or allocated among members based on percentage interests. Parents/Managers Gifts are easily made; reduce parent s estate; and may qualify for valuation discounts. ILIT

25 An IDGT is a type of trust where all income earned by the trust is taxed to the grantor because the trust is defective for income tax purposes, thus allowing for a tax-free gift to the trust s beneficiaries.

26 NON-GRANTOR TRUST GRANTOR TRUST Year Beginning Balance Taxable Income 7% Less: Taxes at 40% Ending Balance Year Beginning Balance 1 $10,000,000 $700,000 $(280,000) $10,420,000 1 $10,000,00 0 Taxable Income 7% Less: Taxes at 40% Ending Balance $700,000 $ - $10,700, ,420, ,400 (291,760) 10,857, ,700, ,000-11,449, ,857, ,035 (304,014) 11,313, ,449, ,430-12,250, ,313, ,956 (316,783) 11,788, ,250, ,530-13,107, ,788, ,218 (330,087) 12,283, ,107, ,557-14,025, ,283, ,878 (343,951) 12,799, ,025, ,786-15,007, ,799, ,992 (358,397) 13,337, ,007,304 1,050,511-16,057, ,337, ,624 (373,450) 13,897, ,057,815 1,124,047-17,181, ,897, ,836 (389,135) 14,481, ,181,862 1,202,730-18,384, ,481,364 1,013,695 (405,478) 15,089, ,384,592 1,286,921-19,671,514

27 ASSUMPTIONS FMV of Assets Sold to IDGT $ 1,111,100 Gift to Trust $111,100 Interest Rate (Mid-Term AFR) 2.33% Terms (Years) 9 Payment Structure Payment Period Timing of Payments Year Beginning Balance Growth 10.00% $111,100 Down Payment with Gift, Balance Interest-Only w/balloon Payment Installment Payment Annually End of Period Ending Balance 1 $ 1,000,000 $ 100,000 $ (23,300) $ 1,076,700 2 $ 1,076,700 $ 107,670 $ (23,300) $ 1,161,070 3 $ 1,161,070 $ 116,107 $ (23,300) $ 1,253,877 4 $ 1,253,877 $ 125,388 $ (23,300) $ 1,355,965 5 $ 1,355,965 $ 135,596 $ (23,300) $ 1,468,261 6 $ 1,468,261 $ 146,826 $ (23,300) $ 1,591,787 7 $ 1,591,787 $ 159,179 $ (23,300) $ 1,727,666 8 $ 1,727,666 $ 172,767 $ (23,300) $ 1,877,133 9 $ 1,877,133 $ 187,713 $(1,023,300) $ 1,041,546 Amount passing to beneficiaries free of estate and gift tax And income tax on trust income is paid by grantor as additional gift without gift tax

28 No mortality risk with IDGT. Can allocate GST exemption to seed gift. Mid-Term AFR is less than Section 7520 rate. Back-loading (i.e., interest only with balloon payment vs. level annuity payment.) Not a statutory technique. Possibility of unintended gift tax, which may be mitigated by using a defined value clause.

29

30 A type of transaction whereby a grantor sells a highlyappreciating asset to an IDGT in exchange for an installment note. Note, however, that the grantor should make an initial gift (at least 10% of the total transfer value) to the trust so that it has sufficient capital to make its payments to the grantor. To the extent that the growth rate on the assets sold to the IDGT is greater than the interest rate on the installment note taken back by the grantor, the excess is passed on to the trust beneficiaries free of any gift, estate and/or GST tax. No capital gains tax is due on the installment sale to the trust because the trust is defective for income tax purposes. Interest income on installment note is not taxable to the grantor because the trust is defective for income tax purposes.

31 Grantor/ Insured 1. Gifts $5M of LLC Non-Voting Interests 2. Sells $45M of LLC Non-Voting Interests (No Capital Gain Tax) 3. $45M Note to Grantor Balloon Payment in 9 Years IDGT 5. Excess Cash Flow/Premiums 6. Death Proceeds (Income and Estate Tax Free/Leverages GST Exemption) Life Insurance Company 4. $1,098,000 annual interest (Interest Rate 2.44%) Advantages: Value of loan proceeds frozen at 2.44% for nine years (assumed mid-term AFR). Grantor s estate further reduced by the income taxes paid on behalf of the trust. The trust property escapes estate taxation for as long as permitted under state law. Possible valuation discounts for non-voting interests.

32 Grantor Gift & sale of highly-appreciating assets Installment note(s) IDGT Discretionary distributions of income and principal during the lifetime of the trust s beneficiaries Assets outside of the taxable estates of beneficiaries Children, Grandchildren, Great-Grandchildren & Future Generations

33 Sale to an IDGT Example* Ten-Year Term 10% Growth Year Beginning Balance Taxable Income Annual Ending Balance 10.00% Payment 1 $ 10,000,000 $ 1,000,000 $ (256,200) $ 10,743,800 2 $ 10,743,800 $ 1,074,380 $ (256,200) $ 11,561,980 3 $ 11,561,980 $ 1,156,198 $ (256,200) $ 12,461,978 4 $ 12,461,978 $ 1,246,198 $ (256,200) $ 13,451,976 5 $ 13,451,976 $ 1,345,198 $ (256,200) $ 14,540,973 6 $ 14,540,973 $ 1,454,097 $ (256,200) $ 15,738,871 7 $ 15,738,871 $ 1,573,887 $ (256,200) $ 17,056,558 8 $ 17,056,558 $ 1,705,656 $ (256,200) $ 18,506,014 9 $ 18,506,014 $ 1,850,601 $ (256,200) $ 20,100, $ 20,100,415 $ 2,010,041 $ (7,256,200) $ 14,854,256 Benefit: $14,854,256 Transferred to Beneficiaries Tax-Free * Assuming a $7,000,000 (after valuation adjustments) interest only, balloon payment feature installment note with a 3.66% annual interest rate (long-term AFR) 33

34 Sale to an IDGT Why Sale to an IDGT Works Difference Between Rates of Return Year Beginning Balance Taxable Income Installment Payment Ending Balance 3.66% $ 366,000 1 $ 10,000,000 $ 366,000 $ (366,000) $ 10,000,000 2 $ 10,000,000 $ 366,000 $ (366,000) $ 10,000,000 3 $ 10,000,000 $ 366,000 $ (366,000) $ 10,000,000 4 $ 10,000,000 $ 366,000 $ (366,000) $ 10,000,000 5 $ 10,000,000 $ 366,000 $ (366,000) $ 10,000,000 6 $ 10,000,000 $ 366,000 $ (366,000) $ 10,000,000 7 $ 10,000,000 $ 366,000 $ (366,000) $ 10,000,000 8 $ 10,000,000 $ 366,000 $ (366,000) $ 10,000,000 9 $ 10,000,000 $ 366,000 $ (366,000) $ 10,000, $ 10,000,000 $ 366,000 $ (10,366,000) $ - Year Beginning Balance Taxable Income Annuity Payment Ending Balance 10.00% $ 366,000 1 $ 10,000,000 $ 1,000,000 $ (366,000) $ 10,634,000 2 $ 10,634,000 $ 1,063,400 $ (366,000) $ 11,331,400 3 $ 11,331,400 $ 1,133,140 $ (366,000) $ 12,098,540 4 $ 12,098,540 $ 1,209,854 $ (366,000) $ 12,942,394 5 $ 12,942,394 $ 1,294,239 $ (366,000) $ 13,870,633 6 $ 13,870,633 $ 1,387,063 $ (366,000) $ 14,891,697 7 $ 14,891,697 $ 1,489,170 $ (366,000) $ 16,014,866 8 $ 16,014,866 $ 1,601,487 $ (366,000) $ 17,250,353 9 $ 17,250,353 $ 1,725,035 $ (366,000) $ 18,609, $ 18,609,388 $ 1,860,939 $ (10,366,000) $ 10,104,327 Benefit: $10,104,327 Additional Wealth Transferred to Beneficiaries Tax-Free (of which $5,971,931 is due to taxes paid by grantor) 34

35 Sale to an IDGT Why Sale to an IDGT Works Valuation Adjustments Year Beginning Balance Taxable Income Installment Payment Ending Balance 10.00% $ 366,000 1 $ 10,000,000 $ 1,000,000 $ (366,000) $ 10,634,000 2 $ 10,634,000 $ 1,063,400 $ (366,000) $ 11,331,400 3 $ 11,331,400 $ 1,133,140 $ (366,000) $ 12,098,540 4 $ 12,098,540 $ 1,209,854 $ (366,000) $ 12,942,394 5 $ 12,942,394 $ 1,294,239 $ (366,000) $ 13,870,633 6 $ 13,870,633 $ 1,387,063 $ (366,000) $ 14,891,697 7 $ 14,891,697 $ 1,489,170 $ (366,000) $ 16,014,866 8 $ 16,014,866 $ 1,601,487 $ (366,000) $ 17,250,353 9 $ 17,250,353 $ 1,725,035 $ (366,000) $ 18,609, $ 18,609,388 $ 1,860,939 $ (10,366,000) $ 10,104,327 Year Beginning Balance Taxable Income Annuity Payment Ending Balance 10.00% $ 256,200 1 $ 10,000,000 $ 1,000,000 $ (256,200) $ 10,743,800 2 $ 10,743,800 $ 1,074,380 $ (256,200) $ 11,561,980 3 $ 11,561,980 $ 1,156,198 $ (256,200) $ 12,461,978 4 $ 12,461,978 $ 1,246,198 $ (256,200) $ 13,451,976 5 $ 13,451,976 $ 1,345,198 $ (256,200) $ 14,540,973 6 $ 14,540,973 $ 1,454,097 $ (256,200) $ 15,738,871 7 $ 15,738,871 $ 1,573,887 $ (256,200) $ 17,056,558 8 $ 17,056,558 $ 1,705,656 $ (256,200) $ 18,506,014 9 $ 18,506,014 $ 1,850,601 $ (256,200) $ 20,100, $ 20,100,415 $ 2,010,041 $ 7,256,200 $ 14,854,256 Benefit: $4,749,929 Additional Wealth Transferred to Beneficiaries Tax-Free 35

36 Sale to an IDGT Why Sale to an IDGT Works Payment of Taxes by Grantor Year Beginning Balance Taxable Income Annuity Payment Less: Ending Balance 10.00% $ 256, % 1 $ 10,000,000 $ 1,000,000 $ (256,200) $ (297,520) $ 10,446,280 2 $ 10,446,280 $ 1,044,628 $ (256,200) $ (315,371) $ 10,919,337 3 $ 10,919,337 $ 1,091,934 $ (256,200) $ (334,293) $ 11,420,777 4 $ 11,420,777 $ 1,142,078 $ (256,200) $ (354,351) $ 11,952,304 5 $ 11,952,304 $ 1,195,230 $ (256,200) $ (375,612) $ 12,515,722 6 $ 12,515,722 $ 1,251,572 $ (256,200) $ (398,149) $ 13,112,945 7 $ 13,112,945 $ 1,311,295 $ (256,200) $ (422,038) $ 13,746,002 8 $ 13,746,002 $ 1,374,600 $ (256,200) $ (447,360) $ 14,417,042 9 $ 14,417,042 $ 1,441,704 $ (256,200) $ (474,202) $ 15,128, $ 15,128,344 $ 1,512,834 $ (7,256,200) $ (502,654) $ 8,882,325 Year Beginning Balance Taxable Income Annuity Payment Less: Ending Balance 10.00% $ 256, % 1 $ 10,000,000 $ 1,000,000 $ (256,200) $ - $ 10,743,800 2 $ 10,743,800 $ 1,074,380 $ (256,200) $ - $ 11,561,980 3 $ 11,561,980 $ 1,156,198 $ (256,200) $ - $ 12,461,978 4 $ 12,461,978 $ 1,246,198 $ (256,200) $ - $ 13,451,976 5 $ 13,451,976 $ 1,345,198 $ (256,200) $ - $ 14,540,973 6 $ 14,540,973 $ 1,454,097 $ (256,200) $ - $ 15,738,871 7 $ 15,738,871 $ 1,573,887 $ (256,200) $ - $ 17,056,558 8 $ 17,056,558 $ 1,705,656 $ (256,200) $ - $ 18,506,014 9 $ 18,506,014 $ 1,850,601 $ (256,200) $ - $ 20,100, $ 20,100,415 $ 2,010,041 $ (7,256,200) $ - $ 14,854,256 Benefit: $5,971,931 Additional Wealth Transferred to Beneficiaries Tax-Free 36

37 Sale to an IDGT Why Sale to an IDGT Works Summary Total Wealth Transferred $ 14,854,256 Reasons for Total Wealth Transferred Differential Between Rates of Return $ 4,132,396 Valuation Adjustment $ 4,749,929 Income Taxes Paid by Grantor $ 5,971,931 Total Wealth Transferred $ 14,854,256 37

38 Sale to an IDGT Why Sale to an IDGT Works Back end-loading of installment payments Payment of trust income taxes by the grantor Valuation adjustments on assets sold Difference between actual rate of return and AFR 38

39 Trust income is taxed to the seller/grantor Trust assets sold are not in seller/grantor s estate for estate tax purposes Payments of income tax on behalf of the trust should not be an additional gift to the trust

40 Freezes value of appreciation on assets sold in the seller/grantor s taxable estate at the low interest rate on the installment note payable No capital gains tax due on installment sale Interest income on installment note is not taxable to the seller/grantor Grantor pays income tax on trust income, leaving more assets in the IDGT for remainder beneficiaries Valuation adjustments increase effectiveness of sale for estate tax purposes

41 Estate inclusion of note if seller/grantor dies during term of installment note No step-up in basis at seller/grantor s death Trust income taxable to seller/grantor during his/her life could cause a cash flow problem if there is not sufficient income earned by the seller/grantor Possible gift and estate tax exposure if insufficient assets are used to fund the trust Possible taxable gift for amount of loan Possible taxable estate inclusion under Karmazin (retained life estate)

42

43 Transaction similar to an ordinary installment sale to an IDGT Cancellation at death feature added to note Premium must be paid, either in the form of additional principal or increased interest rate to compensate for the cancellation-at-death feature OBJECTIVE: Reduction of estate tax if premature death occurs

44 Sale to an IDGT Using a SCIN Sample of SCIN Risk Premiums* SINGLE LIFE Total Interest Rate Age 1 Age 2 JOINT LIFE *Assumptions Term of Note 10 AFR 3.66% Payment Frequency Annually Type of Note Interest Only with Balloon Payment Total Interest Rate Age SCIN Risk Premium AFR SCIN Risk Premium AFR % 3.660% 4.532% % 3.660% 4.320% % 3.660% 5.010% % 3.660% 3.811% % 3.660% 5.708% % 3.660% 3.988% % 3.660% 6.850% % 3.660% 4.393% % 3.660% 8.785% % 3.660% 5.315% % 3.660% % % 3.660% 7.174% 44

45 Sale to an IDGT Using a SCIN Example* Ten-Year Term 10% Growth/78 Year-Old Seller Year Beginning Balance Growth Annual Ending Balance 10.00% Payment 1 $ 10,000,000 $ 1,000,000 $ (832,230) $ 10,167,770 2 $ 10,167,770 $ 1,016,777 $ (832,230) $ 10,352,317 3 $ 10,352,317 $ 1,035,232 $ (832,230) $ 10,555,319 4 $ 10,555,319 $ 1,055,532 $ (832,230) $ 10,778,621 5 $ 10,778,621 $ 1,077,862 $ (832,230) $ 11,024,253 6 $ 11,024,253 $ 1,102,425 $ (832,230) $ 11,294,448 7 $ 11,294,448 $ 1,129,445 $ (832,230) $ 11,591,663 8 $ 11,591,663 $ 1,159,166 $ (832,230) $ 11,918,599 9 $ 11,918,599 $ 1,191,860 $ (832,230) $ 12,278, $ 12,278,229 $ 1,227,823 $ (7,832,230) $ 5,673,822 Benefit: $5,673,822 Transferred to Beneficiaries Tax-Free * Assuming a $7,000,000 (after valuation adjustments) interest only, balloon payment feature installment note with a % annual interest rate (3.66% long-term AFR % risk premium ) 45

46 Future appreciation above the note interest rate, including the risk premium, is removed from the seller/grantor s estate Asset not included in seller/grantor s estate in case of premature death during SCIN term Value of assets transferred out greatly exceeds value of payments coming back into the estate of the seller/grantor if he/she passes away prematurely No gain or loss on sale Trust income taxable to seller/grantor allows for greater appreciation to inure to future generations, thereby creating an additional tax-free gift Valuation adjustments increase effectiveness of sale for estate tax purposes

47 Complex calculation of risk premium Possible gift tax exposure if SCIN risk premium is inadequate Possible gift tax exposure if insufficient assets are used to fund the trust Possible taxable estate inclusion under Karmazin (retained life estate) No step-up in basis at seller/grantor s death Possible acceleration of capital gain at seller/grantor s death cause a cash flow problem if there is there is not sufficient income earned by the seller/grantor Possible upstream transfer to seller/grantor if he/she survives term of note (or lives a significant portion of the term and/or is relatively old)

48 Sale to an IDGT Using a SCIN Why a Sale to an IDGT Using a SCIN Works Back end-loading of installment payments Payment of trust income taxes by the grantor Valuation adjustments on assets sold Cancellation-at-death feature Difference between actual rate of return and risk-adjusted AFR 48

49 Make part gift/ part note sale transfers $5M Asset: 30% Discount Assumes a Male, age 65 Preferred Non smoker with business generating 6% income. Loan Interest was calculated based on Feb Mid Term AFR rate of 2.33% Grantor Pays trust income taxes $116,500 Loan Interest Grantor Trust $428,571 Asset Income $312,071 Premiums $5,488,190 Death benefit $428,571 Life Insurance

50 Make outright gift of discounted asset Grantor $5M Asset Grantor Trust $428,571 Asset Income Income From Asset Funds premium and/or interest Actual transfer: $7.1M Asset with 30% discount = $5M Gift the asset or sell the asset to trust or Make part gift/ part sale of asset Assumes a Male, age 65 Preferred Non smoker for $5,488,190 death benefit with a premium for $312,071 with a crediting rate of 5.2%. 6% Income from asset of $428,571. Feb Mid-term AFR used to calculate interest payment.

51 ASSUMPTIONS FMV of Assets Sold to IDGT $ 10,000,000 Interest Rate (Long-Term AFR) 3.53% Term (Years) 10 Payment Structure Interest-Only w/balloon Payment Payment Period Annually Timing of Payments End of Period Year Beginning Balance Growth 10.00% Installment Payment Ending Balance 1 $ 10,000,000 $ 1,000,000 $ (353,000) $ 10,647,000 2 $ 10,647,000 $ 1,064,700 $ (353,000) $ 11,358,700 3 $ 11,358,700 $ 1,135,870 $ (353,000) $ 12,141,570 4 $ 12,141,570 $ 1,214,157 $ (353,000) $ 13,002,727 5 $ 13,002,727 $ 1,300,273 $ (353,000) $ 13,950,000 6 $ 13,950,000 $ 1,395,000 $ (353,000) $ 14,992,000 7 $ 14,992,000 $ 1,499,200 $ (353,000) $ 16,138,200 8 $ 16,138,200 $ 1,613,820 $ (353,000) $ 17,399,020 9 $ 17,399,020 $ 1,739,902 $ (353,000) $ 18,785, $ 18,785,922 $ 1,878,592 $ (10,353,000) $ 10,311,514 Amount passing to beneficiaries free of estate and gift tax

52 Investor Profile for Case Study Married Couple $30 million combined estate, invested as follows: a) 60% globally diversified* stocks b) 40% intermediate-term municipal bonds Spend $400,000 (inflation-indexed), after tax, each year Time Horizon: 20 years

53 Scenarios tested a) No family limited partnership ( FLP ); no lifetime transfers ( no planning ); b) Fund FLP with $15 million, FLP interests valued initially at $10 million for transfer tax purposes (i.e., 33% valuation discount*); no lifetime transfers ( discount only ); c) Same as B, except transfer FLP interests in 2011 to an irrevocable nongrantor trust ( taxable trust ); d) Same as C, except transfer FLP interests in 2011 to an irrevocable grantor trust ( grantor trust ); e) Same as D, except general partner invests the FLP entirely in globally diversified** stocks ( 100/0 ). In 20 years, any balance remaining in the couple s portfolio above the available applicable exclusions (i.e., $5 million per spouse, indexed for inflation) is subject to a 35 percent estate tax

54 Range of Beneficiaries Wealth 20 th year, after 35% estate tax $5 million (real) exclusion per spouse $Millions (nominal) 10,000 Simulated Trials Median benefit = $32.5 million (nominal)* Probability 5% 10% 50% 90% 95%

55 Range of Beneficiaries Wealth 20 th year, after 35% estate tax $5 million (real) exclusion per spouse $Millions (real) 10,000 Simulated Trials Median benefit = $17.8 million (real)* Probability 5% 10% 50% 90% 95%

56 Range of Beneficiaries Wealth 20 th year, after 55% estate tax $1 million (nominal) exclusion per spouse $Millions (real) 10,000 Simulated Trials Median benefit = $52.0 million (nominal)* Probability 5% 10% 50% 90% 95%

57 Thank You! Todd M. Villarrubia Attorney at Law, LL.M. in Taxation Board Certified Expert in Estate Planning LIKE US ON FACEBOOK!

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