Beneficiary Defective Inheritors Trust

Transcription

1 Beneficiary Defective Inheritors Trust Creating New Planning Opportunities Orange County Estate Planning Council Presented by: Michael W Halloran AEP, CFP, ChFC, CLU Beneficiary Defective Inheritors Trust Creating New Planning Opportunities Special Thanks To: Richard A. Oshins Oshins & Associates, LLC 1645 Village Center Circle, Suite 170 Las Vegas, Nevada / Fax Robert G Alexander (Deceased) Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication, including attachments, was not written to be used and cannot be used for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein. If you would like a written opinion upon which you can rely for the purpose of avoiding penalties, please contact us. 2 1

2 Fact Patterns Fact Pattern #1 Protecting your property from the IRS and other potential claimants Fact Pattern #2 Planning with low cash flow assets Fact Pattern #3 Changing value conundrums Now you see; it now you don t 3 Strategies To Be Covered The Beneficiary Defective Inheritor s Trust ( BDIT ) The typical Inheritor s Trust Super-charging the Inheritor s Trust Note sales to trusts you control and enjoy Estate Planning With Disregarded Entities Defective trusts on steroids QPRT substitutes Changing Value Conundrums LLCs and FLPs create three sales opportunities Revisit old and find new clients 4 2

3 Strategy #1 THE BENEFICIARY DEFECTIVE INHERITOR S TRUST ( BDIT ) A Powerful New Wealth Planning Strategy With Significant Life Insurance Sales Potential 5 Primary Planning Choices of High-End Wealth Shifting Techniques GRATs Installment sales to IDGTs Both involve moving wealth to someone else A better alternative the BDIT The Beneficiary Defective Inheritor s Trust 6 3

4 Hypothetical Fact Pattern I own one-third (1/3) of a pass-through entity Value of 100% of the entity - $50 million Value of my one-third (1/3) interest after discounting $10 million 7 Major Causes of Wealth Erosion in the U.S. Bad Investments/management Taxes Divorces Lawsuits Beneficiary/family problems Bad economy Changes in the law 8 4

5 The Client s Wish List Save taxes Creditor and divorce protection Control over the plan - assets and income Full use and enjoyment of the plan assets The right to decide who else uses or gets the property Multi-generation/perpetuity 9 The Tax and Creditor Rights Impediments Income Tax grantor Trust Estate Tax grantor Trust Creditor rights self-settled trust Estate tax inclusion 10 5

6 Question #1 Can I set up a trust for my descendants which will avoid their: Transfer taxes, and Creditors, including divorcing spouses In perpetuity 11 The Typical Inheritor s Trust A trust set up and funded by someone else Generally as an accommodation 12 6

7 Transfer Tax Consequences Measured by the amount of the contribution Subsequent growth of the assets is irrelevant GSTT exempt forever 13 Key Concepts A trust created by someone else No gratuitous transfers by the beneficiaries Sales for FMV are OK 14 7

8 Question #2 What are the income tax consequences of a gift subject to a Crummey power of withdrawal? 15 Question #3 What are the gift tax implications if I pay income tax as a result of the grantor trust rules? 16 8

9 The Tax Burn Concept Estate depletion as a result of paying income tax on trust assets Less assets exposed to estate taxes Less assets exposed to creditors Over time the wealth compounding is more powerful than discounting Trust assets grow tax-free during the Grantor trust status 17 Question #4 If I make a sale to a trust that is income tax defective to me, do I recognize taxable gain or loss? 18 9

10 Question #5 If I own 100% of an entity and I make a gift of a 20% interest to each of my five (5) children, are the gifts of each 20% interest valued as a non-controlling interest? 19 The Ultimate Trust A Beneficiary Defective Inheritor s Trust Combining: A third-party settled trust with Grantor trust income tax status for the beneficiary Finessing the pipe dream 20 10

11 So What Makes A BDIT Work? Combines the planning opportunities of: #1 - Chapter 13 GSTT rules #2 - IRC 678 beneficiary income tax status #3 - Rev. Rul no additional gift on payment of income tax #4 - Rev. Rul non-recognition of sales to IDITs #5 - Rev. Rul no family attribution rules for purposes of discounting 21 BDIT Fact Pattern Mom sets up the trust Transfer tax protection for the beneficiaries Creditor protection for the beneficiaries In perpetuity Wealthy client is the grantor for income tax purposes Income tax planning 22 11

12 Variation Spousal Irrevocable Trust ( SIT ) Set up and seeded by the client s spouse Combines IRC 677(a) IRC 1041(a) Rev. Rul Spousal Inheritor s Trust Cont. Caveats Spouse is the owner of the trust income Subsequent divorce will not terminate grantor trust status IRC 672(e)(2) Spouse cannot be a beneficiary Solution give the spouse a SPA Support trust risk 24 12

13 Funded ILIT BDIT Spousal Irrevocable Trust variation 25 So What Is A BDIT? A dynasty trust set up for my descendants which avoids their Transfer taxes Creditors, including divorcing spouses A beneficiary controlled trust Allows gifts and sales to a trust that is income tax defective as to the beneficiary Crummey power of withdrawal 678 Wealth transfer leveraging with discounted entities 26 13

14 BDIT Design Established and initially funded by a third party Fully discretionary distribution standards Controlled trusteeship Family trustee Independent trustee The use concept Broad SPA a re-write power Perpetual Beneficiary has the functional equivalence of outright ownership of the trust assets 27 Seeding the Trusts Gifts to Trust $5,000 $5,000 $5,000 Trust A Trust B Trust C FBO Client and Katie FBO Client and Bob FBO Client and Sue Client Power of Withdrawal $15,

15 Who is the Grantor? Owner for Income Tax Purposes - IRC 678(a) Transfer Tax Creditor rights Caveat: Client has a Power of Withdrawal over all gifts to BDIT Caveat: Client never makes a gratuitous transfer to BDIT 29 Tax-Free Sale to BDIT BDITs Assets Installment Notes Trust A Trust B Trust C Wealthy client sells discountable income producing assets for an Installment Note 30 15

16 Note Sale to a BDIT with a Guarantee Parent mom Gift Subject to Power of Withdrawal H Note Sale BDIT Guarantee Fee W 1. Family Trustee 2. Beneficiary 3. I/T Grantor 4. Seller 31 BDIT Tax Results Estate freeze Installment notes in the estate Post-transfer appreciation shifted Estate squeeze Discounted assets removed from the transfer tax system Income tax burn the beneficiary pays the tax on the income generate by the trust IRC 678 Crummey power of withdrawal 32 16

17 BDIT Non-tax Results The client/beneficiary is in control of the BDIT Assets are creditor protected for the client/beneficiary and his/her family Assets are available after the tax burn Client/beneficiary has a re-write power with a SPA Protects against potential family conflicts Protects against inadvertent gifts to the trust 33 BDIT Non-tax Results -Cont. Opportunity shifting Business and investment opportunities Giving free advice or managing trust assets Quintessential life insurance trust Life insurance on a beneficiary who is also a trustee Decision must be made by an independent trustee Beneficiary cannot have a SPA over life insurance 34 17

18 Benefits of This Strategy The entity/assets are moved out of the client s estate on a discounted basis The transaction results in a leveraged estate freeze There is no income tax on the sales or the guarantee All of the assets in the BDIT are still available to and controlled by the Inheritor/beneficiary 35 Benefits - Continued The Inheritor/beneficiary has a SPOA a rewrite power The taxable estate of the inheritor is depleted by valuation discounts as well as payment of incomes taxes on the trust income the tax burn The Inheritor and his/her family have creditor and divorce protection in perpetuity 36 18

19 Benefits - Continued The Inheritor and his/her family have GSTT and estate exemption in perpetuity The SPOA prevents a gift tax on transactions with the trust Otherwise resistant clients will move forward with planning 37 Guarantees Guarantees as seed money Must be legitimate Better than trust assets Often made by beneficiaries Need not be for full amount of the note 38 19

20 Is a Gratuitous Guarantee a Gift? Unsettled Cases seem to say no We pay for the guarantee Get appraisal Avoids risk of gift to trust by guarantor Income tax-free - if spouse or defective trust 39 Ancillary Considerations Economic Risk Estate Depletion Exposure Toggling Reimbursement Clauses Forum shopping to avoid self-settled trust BDIT resolves dilemma SIT exposure Basis Monitoring 40 20

21 ENHANED PLANNING OPPORTUNITIES WITH BDITs Significant Life Insurance Sales Potential 41 Life Insurance - ILIT BDIT is also a funded ILIT So is the SIT variation Insurance on the life of a beneficiary who is also a trustee Decisions made by independent trustee No power of appointment 42 21

22 Life Insurance Correlation with a BDIT Life insurance has two component parts Death benefit Inside buildup Asset class QRP and NIMCRUT alternative 43 Life Insurance Correlation with BDIT Cont. Early Death Negligible Tax Burn Win on the Mortality Bet Later Death Greater estate tax depletion Tax-free build-up more dramatic 44 22

23 Cash Value Life Insurance - CVLI Tax exempt access to the investment fund Can access fund on a temporary basis and pay back E.g. - college Survivorship feature Early death win on mortality bet No administrative and legal costs Fully discriminatory 45 Major Comparisons Deferral v. Tax exempt access to income Access to funds on a temporary basis Survivorship Feature Risk of early death for QRPs and NIMCRUTs Decedent's Receipt QRP-IRD NIMCRUT none CVLI in trust tax-free 46 23

24 Life Insurance in a Beneficiary Defective Inheritor s Trust Adjustments beneficiary controlled Special Trustee Not subject to power of appointment Accessing Inside Build-up Two-step process Wrap Trust - there may be serious tax problems 47 Accessing Policy Cash Values Loan money to the beneficiary No income tax consequence Purchase other assets from the beneficiary Non-recognition of gain Distributions to the beneficiary Worst alternative Assets no longer protected 48 24

25 Accessing Policy Cash Values Cont. MEC Income tax issues Estate tax inclusion issues Back-end loaded policies Other planning issues 49 Other Planning Opportunities With a BDIT Tax and asset protected forever Advanced wealth shifting opportunities Family income tax planning Valuation/discount planning Structured gifts and loans New businesses seed money Investment opportunities 50 25

26 Planning Opportunities Cont. Grantor trust income tax planning Sales of hot assets IRC 751 Structuring buy-sell arrangements State income tax planning Multi-jurisdictional asset protection planning Private retirement plan 51 Planning Opportunities Cont. Advanced Life Insurance Planning Access to cash values No transfer for value problems Super-charge the insurance funding Super-charge life insurance partnership planning Premium financing techniques Split dollar arrangements 52 26