Asset Protection Planning — This broad category of planning may involve one or more different strategies. Each of the techniques seeks to insulate assets from attack by creditors. Various trusts, FLPs, FLLCs and other entities may be considered for asset protection. Further, the choice of jurisdiction is important because certain domestic and foreign jurisdictions provide a favorable legal environment for asset protection. Those in high risk professions or those with high risk assets generally fit the profile for implementing asset protection strategies.
Bargain Sales — A bargain sale occurs when a donor sells property to a charity for less than its full fair market value of the property. The donor's tax deduction is limited to the "bargain" amount.
Business Succession Planning — This broad category of planning describes the process by which the owner of a closely held business determines who will take over the business and how and when the transition will take place. A business without a viable, clearly defined succession plan will be more likely to fail or be sold or liquidated. See Buy-Sell Agreements.
Buy-Sell Agreements — This type of contract is normally associated with the owners of a closely business who wish to provide for the purchase and sale of an owner's business interest in the event of disability or untimely death. Such agreements set forth the terms upon which an owner's share of the business will be redeemed by the business or purchased by the other owners. Buy-sells agreements may be funded with disability and life insurance or they may be unfunded. Unfunded agreements imply reliance on the cash flow of the business to fund the buy out. Providing liquidity for the estate of the business owner is often the reason for the formation and execution of a buy-sell agreement.
Corporate Recapitalization — Stock in a closely held company may represent a major portion of a business owner's estate. If there is only a single class of voting common stock, the business owner may find it difficult to transfer an equity stake in the company while still retaining voting control. A corporate recapitalization permits the creation of other classes of stock, including non-voting shares. The owner may sell or give away the non-voting shares without diluting his voting control. Because such shares cannot vote on corporate matters their value may be less than similar voting shares. Recapitalizations are available to S corporations as well as C corporations.
Crummey Powers — Most traditional life insurance trusts contain what are known as "Crummey Powers." Named after famous case, a Crummey Power grants the beneficiaries of the trust the right to withdraw cash or other contributions which are expected to be available to pay insurance premiums. A contribution to a trust subject to a Crummey Power may be classified as a gift of a "present interest" and therefore qualifying for the gift tax annual exclusion.
Dynasty Trust — A type of trust which may continue in trust for multiple generations. If properly structured, the trust assets will be available for many generations of beneficiaries outside of the estate tax system. Trust assets will also be protected from the claims of a beneficiary's creditors, whether that creditor be external to the family or internal as in the case of divorce. This type of irrevocable trust must be established in a jurisdiction that permits multi-generational trusts. Several states and foreign jurisdictions have repealed or softened traditional restrictions on the longevity of trusts such as the Rule Against Perpetuities.
Charitable Lead Annuity Trust (CLAT) — This type of trust distributes income to charity over the life of the donor or for a period of years. At the end of the trust term, the trust assets are either distributed to the grantor or to heirs. These trusts are used to either transfer assets to heirs with little or no gift tax or to make gifts if the grantor has already used significant charitable income tax deductions. CLATs have no minimum payout percentage.
Charitable Lead Unitrust (CLUT) — This trust operates very much like the CLAT. However, while the percentage payout remains fixed, the trust's distribution amount varies depending on the value of the trusts assets which are computed annually. Because of this, the CLUT cannot have a "zero" gift amount as there will always be some calculated remainder that passes to the heirs. CLUTs are often used for gifts to grandchildren or other "skip generations" because the generation skipping tax amount can be calculated when the trust is first established.
Charitable Life Estate — Donor gives his home to a charity but retains all rights and obligations of property ownership for his life. The gift generates an immediate charitable income tax deduction equal to the present value of the remainder interest in the property. At death, the property passes to the designated charity and is removed from the donor's estate.
Charitable Remainder Annuity Trust (CRAT) — A CRAT involves a single gift of property, normally appreciated assets, to a trust for the benefit of a charity but subject to the donor's right to receive an annuity payment from the trust for life or for a term of years. In addition to annuity income, the donor receives an immediate charitable income tax deduction equal to the present value of the gift to charity. The amount of the charitable deduction is based on the life expectancy of the donor or a term of years (no greater than twenty) and the prevailing interest rate environment. When the last income beneficiary dies or at the end of the term, the remainder passes to the charity.
Charitable Remainder Unitrust (CRUT) — A CRUT is similar to a CRAT, except that the donor's retained right to payments form the trust is based on the value of trust assets as they may vary over the years. Also, an individual or couple may make a one gift or a series of gifts to the trust. CRATs and CRUTs are often termed Charitable Remainder Trusts or "CRTs". All CRTs have a minimum payout percentage of 5%.
Donor Advised Fund (DAF) — A DAF is an arrangement under which a donor contributes funds to a Community Foundation or other sponsoring charity but retains the right to "advise" the charity as to the ultimate disposition of these funds over time. The sponsoring Community Foundation or charity is not bound to follow the donor's advice, but as a practical matter most do. DAFs are usually inexpensive to establish and operate.
Employee Stock Ownership Plans (ESOP) — Owners of closely held businesses often have no exit strategy. An ESOP can provide a ready market for the owner's stock and continuation of the business by employees. Establishing an ESOP is a complex transaction.
Family Limited Partnership (FLP) — An FLP is a limited partnership where most or all of the interests in the entity are held by the members of a family. Ownership interests of a limited partnership are either General Partner (GP) or Limited Partner (LP) interests. The holders of GP interests have the sole right and obligation to manage the entity, even though the GP interests may represent only a small percentage of the equity interests in the FLP. Holders of LP interests have an interest in the profits, losses and capital of the business, but no right to participate in management. Moreover, there may be significant restrictions on the transfer or sale of interests in the entity. Because the holders of LP interests may not participate in management, and because their interests may be subject to substantial restrictions on their sale or transfer, interests in FLPs are often valued at a significant discount from their pro rata share of the value of the entity's underlying assets. FLPs also have strong asset protection features, and therefore they are effective for family asset protection purposes.
Family Limited Liability Company (FLLC) — Much like the FLP, a FLLC is a type of business entity that provides for the centralized pooling and management of family assets. Owners of FLLC units are considered "members" and there is usually a single "managing member". FLLCs are a relatively new for of entity and there is less case law regarding their uses and nuances when compared to FLPs. However, many jurisdictions have passed favorable FLLC statutes and therefore the FLLC should be carefully considered in the proper jurisdiction.
Flip Charitable Remainder Unitrust (Flip CRT) — This type of CRT operates like a NIMCRUT when it is originally established, paying out only the income it earns at a set percentage. At some triggering event in the future, the FLIP CRT changes character and operates like a standard CRT (SCRUT) whereby it pays out a fixed percentage of its annual valuation. This type of CRT is often used when a gift that produces little current income (such as land) is transferred before it is sold. Upon sale, the proceeds are reinvested and the CRT begins paying its regular percentage.
Gifting — A simple way to transfer assets to beneficiaries. An individual may currently gift $11,000 of property to any other individual, annually ($12,000 beginning in 2006). Further, every individual can currently give away up to $1 million of assets during their lifetime without incurring gift taxes. Making gifts of property that is discounted in some way can be advantageous in transferring more than the statutory amount.
Grantor Retained Annuity Trust (GRAT ) — The GRAT transaction entails the transfer of assets to a trust whereby the grantor retains an income from the trust for a period of years and the remainder transfers to beneficiaries at the end of the trust term. The "remainder" is calculated using IRS tables and is considered a gift to the remainder beneficiaries. Therefore, many GRATs are structured to produce a "zero" gift and hope to take advantage of the possible arbitrage of the return of the assets in the GRAT compared to the IRS rates utilized to calculate the trust remainder. The disadvantage of the regular GRAT transaction is that if the grantor dies during the trust period, all of the assets in the GRAT are included back in the grantors estate.
Grantor Deemed Owned Trust (GDOT) — This type of trust has several unique properties that make it a very powerful estate planning tool. First, when assets are transferred to the trust either by gift or by sale, they are removed from the estate of the grantor. Second, the assets in the GDOT remain income taxable to the grantor of the trust. While this may not seem like a positive attribute, the grantor's recognition and payment of the income taxes essentially allows the assets in the GDOT to grow free of income taxes outside of the estate. This can greatly increase the ultimate value of the assets transferred to the trust.
IRA Maximizer — This strategy is for those individuals who have significant balance in their IRA (or other qualified plan) and who do not need the funds to live on. Normally, the IRA invests all or some of its assets in a newly formed family limited partnership (flp) and the flp invests all or some of its assets in a restricted management account (rma). The result of the transaction is that there will be a reduction in appraised value of the account because of the illiquid nature of the rma and the flp. By structuring the transaction properly, the IRA owner may reduce income taxes on required minimum distributions and estate taxes because of the reduction in apprised value.
Irrevocable Life Insurance Trust (ILIT) — In many estate plans, it is best to own life insurance outside of the taxable estate. The ILIT is the most common and flexible form of trust to accomplish this function. The ILIT will be the owner and beneficiary of one or more life insurance policies and will obligated to pay the premiums, collect the proceeds at death and distribute the funds to beneficiaries per the provisions of the trust. This is a good way to engage professional management in the management and oversight of the trust funds. ILITs may be established as Dynasty Trusts, if so desired.
Leveraged Bonus Plan (LBP) — An individually-owned executive benefits program funded by life insurance, LBP is a deductible alternative to traditional executive benefit arrangements and is not subject to the new section 409A provisions. In addition, LBP represents a cost savings opportunity for companies while using leverage to extend benefits to participants.
Limited Liability Company/Charitable Remainder Trust (LLC/CRT) — In this strategy a gift of appreciated property is made to an LLC. The LLC then gifts the property to a CRT in exchange for the income interest. The LLC is then sold to a Grantor Deemed Owned Trust (GDOT) in exchange for a note. Because of the fact that the LLC only owns the income stream due from the CRT, and the LLC has restrictions on marketability and liquidity, the "discount" available for the sale to the GDOT should be substantial.
Limited Partnership owned Life Insurance — An alternative to owning life insurance in an irrevocable life insurance trust (ILIT), families often use a Limited Partnership. This is normally done as one step in a transaction whereby the limited partnership units will be sold or otherwise transferred out of the estate of the insured. Further, there are usually other assets contributed to the partnership that will fund the insurance premiums. Done properly, the life insurance death benefit can remain outside of the estate of the insured while some degree of controlled through the control granted by retaining the General Partner interest.
Long Term Care Insurance (LTC) — This type of insurance is meant to protect families from the catastrophic costs of care due to a prolonged illness. Coverage is usually provided as a "per day" cost and many policies feature various riders that protect against inflation. Coverage applies not only for nursing home and rehabilitation facilities but for home health care costs as well. Policies can be structured so that they are paid for over a lifetime or for a period of years. Some policies refund the premiums that have been paid at the death of the insured. LTC is income tax deductible to C Corporations and owners of those corporations may "discriminate" as to which employees are covered.
Net Income with Makeup Unitrust (NIMCRUT) — This is a special type of charitable remainder unitrust (see above) wherein the trust distributes the "net income" that the trust assets earn within the trust. If the trust does not earn enough income to pay the stated income percentage payout, the trust creates an "IOU" account that it can pay at a later date when the assets earn more income. These trusts are often used when a donor has other income currently but would like income later such as during their retirement. Trust assets can be managed to produce income or not.
Preferred Limited Partnership (LP) — This type of LP creates two different classes of limited partner. LP units are allocated between "common" and "preferred" classes. The common interests are generally entitled to receive any of the growth associated with the underlying assets of the LP. The preferred receive a stated percentage income return, e.g. 5%. Because of the possible disparity of return between the two types of units often have different values when appraised. This allows the General Partner of the LP to make different decisions as to the ultimate disposition of the two types of interests. This type of LP can provide substantial planning leverage for the appropriate estate.
Premium Finance — When purchasing life insurance, many families face the possibility of making taxable gifts because the amount of the premium exceeds the amount of annual gifting available to the insured. Using the option of premium financing may alleviate this problem. Funds are provided by a third party lender who pays the premium. The insured usually pays only the interest on the borrowed funds while the principal of the loan accumulates and is often repaid from the insurance proceeds at the insured's death. While complicated, premium financing can be an interesting solution for funding large policies.
Principal Protected Notes (PPN) — A PPN is a type of investment which is a hybrid between a fixed income obligation and a stock market index fund. PPNs generally guarantee a return of the investor's principal at some time in the future plus a promise of some percentage of one of the various stock market indexes. While many PPNs are freely traded, some are structured privately and may be highly illiquid. Because of the lack of liquidity of the private PPN, appraisals often discount the value of these investments significantly.
Private Annuity — A private annuity is a form of installment obligation between a seller and a buyer of property. Private annuities are calculated based on mortality tables and current mandated interest rate factors. The advantage of the private annuity transaction is that if a seller of the property dies before their published life expectancy, the obligation to pay is canceled and the transaction terminates. The disadvantages of the private annuity are that payments are generally higher than a normal installment note transaction and if the seller lives past their life expectancy, the payments must continue.
Private Foundation — A private foundation is a specific type of charity that is established and operated usually by one family. The entity can be a trust or a corporation and the family may have 100% control of the board, make all of the investment decisions and all charitable grants. Private foundations must distribute 5% of its assets annually. There are also strict guidelines as to what type of investments may be owned and there are special limitations as to the amount of charitable income tax deductions are available for contributions.
Qualified Personal Residence Trust (QPRT) — This technique involves transferring a residence by gift to a trust for a period of years. Normally, a gift tax return is filed for the year that the QPRT is funded. At the end of the trust period, the residence becomes the property of the beneficiaries of the trust. Because the gift is made currently and vests in the beneficiary at a later date, there is a discount on the value of the transfer which is calculated utilizing IRS tables. One risk of the QPRT is if the transferor dies during the QPRT term, the house reverts to the estate of the transferor. After the QPRT terminates, the transferor should pay rent to the transferees as in any other commercial transaction.
Remainder Sales — This type of sale of a remainder interest in a marital trust involves the grantor's transfer of property to an irrevocable trust for the benefit of the grantor's spouse, who receives an income interest or an annuity payment from the trust for life, and the grantor's simultaneous sale of the remainder interest in the trust to the remainder beneficiaries for its fair market value. The transfer will qualify for the gift tax marital deduction, but the trust property will not be subject to estate tax at the spouse's death. As a result, the trust property passes to the grantor's children completely free of gift and estate taxes.
Restricted Management Account (RMA) — Formed in partnership with a commercial bank or trust company, an RMA is meant to provide long term investment management for a portion of a family's assets. The RMA typically operates for a fixed period of time (often five years) and the bank or trust company has full management control of the contributed assets. During the RMA period, the assets are totally unavailable to the family. The investor will create an investment policy statement which provides guidance for the trust company regarding the types of assets to be considered as well as the risk tolerance of the investor. Because of the lack of liquidity of the RMA, they are often discounted when they are valued by appraisers.
Revocable Living Trust (RLT) — A foundational document of most estate plans, the RLT is a trust that is established by an individual for the purpose of holding and managing the assets of the individual. The trust is a non-entity for income tax purposes. That is, the grantor of the trust is still responsible to report and pay the income tax due on any trust assets. RLTs are also effective in the event of a disability or incompetence of the grantor, in that they name a successor trustee who can step in to the shoes of the grantor without a court proceeding. RLTs are often established in order for the grantor's estate to avoid probate. Further, a properly drafted RLT can be utilized to take advantage of the estate exemption in order to minimize estate taxes.
Sale for Installment Note — This transaction is normally coupled with other techniques to improve the results. Often a family will use an FLP or FLLP and sell interests that have been appraised at a reduced value because of lack of liquidity and marketability. The buyer is often a trust for the beneficiaries, which purchases the discounted assets for the installment note. Whilethe note is in the estate of the seller, it is usually of less value than the assets that have been sold. The note can be structured to be paid as "interest only" or it may be amortized.
Self Canceling Installment Note (SCIN) — Like other installment notes, the SCIN originates when assets are sold. As the name implies the SCIN obligation is canceled when the obligation is fully paid or at the death of the seller. Because of the self-canceling feature of the SCIN, the seller receives a "premium" amount that is higher than a normal installment obligation. The premium is reflected in one of two ways; either more principal is added to the balance or a higher (than current federal tables) interest rate is applied to the obligation. SCINs may be effective in circumstances where the seller is not expected to live to their IRS computed life expectancy.
Single Premium Immediate Annuity/Life Arbitrage (SPIA/Life) — There is sometimes an opportunity to find an economic difference between what a commercial annuity will pay an individual for a SPIA and what an insurance company will charge the same individual for an amount of life insurance. To accomplish this, the annuity must be "underwritten" and the commercial annuity company must determine that the annuitant has a shorter life expectancy than the life insurance company believes. This disparity causes the SPIA payments to be more than adequate to fund a life insurance policy greater than the annuity deposit. Hence, the arbitrage. While this does not occur often, it is important to examine the opportunity in the proper circumstances.
Supporting Organization (SO) — SOs are similar to private foundations but are actually public charities that can be established by private families. Because they are technically public charities, the higher charitable income tax deduction rules for public charities apply. Unlike private foundations, however, SOs require that a private family may not have absolute control of the board. That is, if the board is to have 5 members, the family can only have a maximum of 2 of those members. SOs are not required to pay excise taxes, nor are they required to distribute 5% of their assets annually. Instead, they must distribute 85% of their income.
Systematic Annuity Withdrawal — Often families ignore the funds that clients have in commercial annuities. Since funds are accumulating on a tax-deferred basis, this is often a logical approach. However, since annuities remain in the estate of the owner and are therefore subject to estate tax and income in respect of a decedent tax, it is often advisable to begin a systematic program of annuity withdrawal. Frequently the after-tax proceeds of the withdrawal can be utilized to subsidize lifestyle or to purchase life insurance to replace the dollars that would be lost to the double taxation of the annuity.
Testamentary Charitable Lead Annuity Trust (TCLAT) — A TCLAT is established at the death of the grantor. It pays a fixed annuity percentage to charity for a period of time, at which point the remaining assets are transferred to the grantor's beneficiaries. Most TCLATs are structured to create a "zero" transfer tax and are often used to eliminate estate tax that would be due from the grantor's estate.
Walton GRAT — In a typical GRAT assets are transferred to a trust and the grantor of the trust receives an income stream for a period of years. What is left in the trust at the end of its term is transferred to beneficiaries, normally the grantor's heirs. The normal structure of a GRAT is meant to use "leverage" to reduce or eliminate the taxable gift to the heirs form the GRAT. This type of normal GRAT causes all of the GRAT assets to be included in the grantor's estate if the grantor dies during the GRAT period. The Walton GRAT provides an exception to this rule, thereby allowing GRAT payments to continue after death and the GRAT assets not reverting to the grantor.
412(i) Plan — A type of defined benefit pension plan permitted by the referenced section of the Code. Such plans are structured to permit the plan to investment in either life insurance and/or commercial annuities. Normally these products are designed to produce a low guaranteed rate of return which causes the annual contribution and, therefore, the income tax deduction to the participants in the plan, to be relatively high. 412(i) may be appropriate for an older business owner who has few employees.
529 Plan — A type of plan for payment of educational expenses permitted by the referenced section of the Internal Revenue Code. An individual may establish a 529 plan investment account for himself or another person (normally children or grandchildren). Investment returns grow on a tax free basis and, if utilized for post high school educational purposes, remain tax free when distributed from the plan. While funds contributed to a plan are generally removed from the plan owner's estate for estate tax purposes, the owner or grantor of the plan may still take them back at any time, subject to a 10% penalty on the earnings.
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