United States: Advanced Estate Planning Techniques

Introduction

Below we have described what we call advanced estate planning techniques that clients may wish to consider once they have basic estate planning documents in place. The descriptions below are not intended to be a discussion of all the technical requirements for each technique, but rather, a general description of the technique and how it works. If you would like to explore the use of any of the techniques described below, a member of the trusts and estates department would be happy to discuss the technique with you in detail and to prepare an analysis of how the particular technique would operate in your overall plan.

Qualified Personal Residence Trusts ("QPRT")

QPRTs are an estate planning technique specifically permitted under the Internal Revenue Code and Regulations. To use this technique, the grantor creates a trust to which he or she transfers a residence. Under the terms of the trust, the grantor may use the residence contributed to the trust for the trust term (the trust term chosen is designed to be shorter than the life expectancy of the grantor). The trust terminates at the end of the trust term and the residence passes either outright to the grantor's children or, as we generally suggest, in further trust. After the termination of the trust, the grantor may continue to have the use of the residence but he or she is required to pay fair market rent in order to do so.

Why QPRTs Work

QPRTs are effective because they allow the grantor to transfer a residence for less than its full value. This is possible because, for gift tax purposes, the value of the gift to the trust is equal to the full value of the residence less the value of the right, retained by the grantor, to use the residence during the trust term. In addition, the expectation is that the residence will appreciate faster than the interest rate prescribed by the Internal Revenue Service and the Regulations to determine the value of the interest retained by the grantor and the interest transferred. As long as the grantor survives the trust term, both the value of the residence and all future appreciation are removed from the grantor's estate.

Having the residence pass to a trust at the end of the QPRT presents an opportunity for additional estate planning benefits. If the continuing trust is structured as a grantor trust, under current law, the rent paid by the grantor is not treated as income to the trust. The end result is that the rental payments made by the grantor for the continued use of the residence pass to the lower generation free of tax. There has been some discussion recently in Congress of changing the grantor trust rules.

Caveats

If the Grantor does not survive the trust term, the value of the residence on the date of the grantor's death will be included as part of his or her estate for estate tax purposes. If the grantor paid gift taxes in connection with the transaction, the grantor's estate will receive a credit for gift taxes attributable to the transaction.

The grantor should be financially able to pay the rent for the residence, if the Grantor wishes to continue to occupy the residence after the initial trust term. If the rent is not paid, the benefits of the transaction may be lost or reduced.

The trust takes the owner's basis in the residence so, the capital gains taxes that will be paid on the sale of the residence after the grantor's death should be considered in determining the overall tax savings to be obtained by the transaction.

The Grantor will need to consider generation-skipping tax issues if the beneficiaries of the continuing trust may be grandchildren of the Grantor.

Grantor Retained Annuity Trusts ("GRAT")

Like the QPRT, GRATs are specifically permitted under the Internal Revenue Code and Regulations. To use this technique, the grantor creates a trust to which he or she transfers an asset or several assets, such as stock, partnership interests, interests in real estate, etc. Under the terms of the trust, the grantor retains the right to annuity payments (fixed payments determined based on the value of the assets transferred to the trust on the date of transfer) for the trust term. At the end of the trust term, the trust terminates and the trust assets are distributed either outright to the beneficiaries or to a continuing trust.

Why GRATs Work

As with the QPRT, GRATs are effective because they allow the grantor to transfer assets for less than the full value of the asset. This is possible because the value of the gift to the trust is equal to the full value of the asset transferred less the value of the annuity payments required to be paid to the grantor under the terms of the trust. In addition, the expectation is that the assets will appreciate faster than the interest rate prescribed by the Internal Revenue Code and Regulations to determine the annuity payments.

GRATs can be structured in such a way as to allow the initial gift to the GRAT to be valued at almost zero and, currently, can have very short terms. GRATs are particularly effective when the assets contributed appreciate in value rapidly.

Caveats

If the grantor does not survive the term of the GRAT, the value of the assets held in the GRAT will be included as part of the grantor's estate for estate tax purposes.

At the end of the GRAT term, the grantor will no longer have the benefit of the income from the assets transferred nor will he or she have the annuity income. The grantor must be comfortable with the level of his or her assets after the transfer.

Family Limited Partnership ("FLP") or Limited Liability Company ("LLC")

A FLP or LLC is not in and of itself an estate planning technique, but either may be used in estate planning under the right circumstances. Generally, the senior generation contributes assets to an FLP or LLC in return for limited partnership interests or limited liability company interests. The senior generation may then gift limited partnership interests or limited liability company interests, to the lower generation either outright or in trust.

Why FLPs or LLCs Work

FLPs or LLCs work if discounts are available when valuing the transferred interests. Two discounts are generally applied: (1) a lack of control discount and (2) lack of marketability discount. The concept of the discount for lack of control is that the owners of the interests do not have any control over the underlying assets of the partnership and so the value of the interest held by the partner or member is less than the value of the partner or member's share of the underlying assets, if the FLP or LLC were liquidated. The concept of the lack of marketability discount is that the limited interests are not readily marketable, as is a publically traded stock, so the true value of the limited interest is adjusted for lack of liquidity.

Caveats

FLPs and LLCs have come under intense scrutiny by the Internal Revenue Service in recent years. The Internal Revenue Service has taken the position that, in order for the various discounts to apply, the FLP or LLC must have been formed for a business reason. For this reason, a FLP formed solely to hold non-business property (e.g. marketable securities or cash) may very well be challenged by the IRS.

It is also problematic for the senior generation to retain control over the FLP and LLC. The Internal Revenue Service has aggressively argued that the control by the senior generation results in the transferred interest remaining subject to estate tax in the estate of the senior generation member.

Sales to Grantor Trusts

A sale to a grantor trust is, as its name suggests, a sale of assets to a trust. When using this technique, the grantor creates a trust to which he or she makes a gift. The terms of the trust are such that the grantor is treated as the owner of the trust for income tax purposes (the reason this is an advantage is explained below). The grantor then engages in a sale transaction with the trust. He or she sells assets to the grantor trust for fair market value as of the date of the sale in return for a note in the amount of the sale price. During the term of the note, the trust makes payments on the note and if the grantor dies during the term of the note, the outstanding balance on the note is included in the grantor's gross estate for estate tax purposes.

Why Sales to Grantor Trusts Work

The interest rate charged on the note will be the minimum allowable Applicable Federal Rate. The expectation is that the assets sold to the trust will outperform the interest rate on the note; hence appreciation on the assets sold is removed from the grantor's estate. There are no income tax consequences to the grantor on the sale because the trust is a grantor trust and, as such, for income tax purposes, the grantor is treated as both the buyer and the seller.

Caveats

The assets do not receive a step up in basis on sale to the trust so the overall tax savings obtained from the transaction needs to be evaluated in light of the capital gains taxes that would be incurred on the sale of the asset by the trust.

Even though the transaction is a sale transaction, a gift tax return should be filed, so that the statute of limitations will begin to run with respect to the valuation of the assets sold remain a possibility.

It is important to make sure that the trust has sufficient assets and cash flow to make payments on the note. The valuation issues mentioned above will be exacerbated if the trust makes payments on the note by returning a portion of the assets sold.

Dynasty Trusts

Dynasty trusts are basically trusts designed to hold assets for multiple generations of a family. They make use of the exemption to the Generation Skipping Transfer Tax available under the Internal Revenue Code. To provide some background, Section 2601 of the Internal Revenue Code imposes a tax on Generation Skipping Transfers. While there is a complex set of rules for determining if a transfer is a Generation Skipping Transfer simply put, as the name implies, such transfers are basically transfers that bypass the generation immediately following the grantor's generation in favor of beneficiaries in a lower generation. The Generation Skipping Transfer Tax is designed capture the tax that would have been paid in the "skipped" generation.

Under the Internal Revenue Code an exemption to the Generation Skipping Transfer Tax is allowed, in other words, you may pass a certain amount of wealth to a lower generation without incurring a Generation Skipping Transfer Tax. The current exemption matches the Federal Estate and Gift Tax Exemption, $5,120,000. As with the current Federal Estate and Gift Tax Exemption, if Congress does not act the exemption will be reduced to $1,000,000 on January 1, 2013.

Dynasty Trusts are generally established in a jurisdiction that does not have a rule against perpetuities. The rule against perpetuities is an ancient doctrine that requires all interests in property to vest within a certain period (often a life in being plus twenty-one (21) years). In other words, the trusts must terminate within the defined period. Some jurisdictions, such as Delaware, do not have a rule against perpetuities and so trusts can extend over multiple generations. Therefore, Delaware has become a favored jurisdiction for the creation of these trusts.

A Dynasty Trust can have many different purposes and the provisions will varry but in general, the grantor creates a trust and transfers assets to the trust. The grantor then allocates all or a portion of his or her Generation Skipping Transfer Tax Exemption to the trust. The assets held in the trust remain in trust to benefit multiple generations.

It is important to understand that the Generation Skipping Transfer Tax Exemption is not in addition to the Estate and Gift Tax Exemption. In order for a transfer to be free of estate, gift and Generation Skipping Transfer Tax the grantor will need to allocate both Generation Skipping Transfer Tax Exemption and Estate and Gift Tax Exemption.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
James T. Ausili
 
In association with
Related Video
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert
Email Address
Company Name
Password
Confirm Password
Mondaq Topics -- Select your Interests
Accounting and Audit
Anti-trust/Competition Law
Consumer Protection
Corporate/Commercial Law
Criminal Law
Employment and HR
Energy and Natural Resources
Environment
Family and Matrimonial
Finance and Banking
Food, Drugs, Healthcare, Life Sciences
Government, Public Sector
Immigration
Insolvency/Bankruptcy, Re-structuring
Insurance
Intellectual Property
International Law
Litigation, Mediation & Arbitration
Media, Telecoms, IT, Entertainment
Privacy
Real Estate and Construction
Strategy
Tax
Transport
Wealth Management
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.