Estate Planning: Mechanisms for Large Lifetime Non-Cash Gifts

Making lifetime taxable gifts is an invaluable estate planning strategy for a high net worth family. These strategies can range from utilizing the annual exclusion strategically to more complicated strategies involving GRATs, Intentionally Defective Grantor Trusts, installment sales, and plenty of other context-dependent alternatives. For a high net worth family, the advantages of these strategies will almost always outweigh the disadvantages because their cumulative net worths far exceed the unified credit amount and because losing the use of the cash that might be necessary in paying gift tax for a certain period of time will likely not have a meaningful effect on their financial condition. In the current market, the rate of return available for that cash is not so high as to make the loss of that liquidity a very important consideration. The other potential disadvantage to consider is the fact that testamentary gifts have a stepped-up income tax basis whereas lifetime gifts retain the donor's basis. For a high net worth family with responsible children, there would seem to be no foreseeable problems with regard to mismanagement of any lifetime gifts by their children or any problems with regard to dis-incentivizing their children to work because they are all for the most part successful, motivated, and responsible from the information that has been provided to us.

The best option for the X family to make gifts in one of the following manners. I provide a brief explanation of each option and the mechanics and advantages of each. The ideal option, though, is the intentionally defective grantor trust with the appropriate and optimal allocation of lifetime gift and GST exemption. This option is best because it will keep all future appreciation out of the estate, thereby saving a ton of money at death. It is even possible to fully fund the childrens’ inheritance during the parents' lifetime. The intentionally defective grantor trust is the best option because it has the best risk profile legally and economically speaking and allows the most flexibility and efficiency (especially in terms of GST planning).

a. GRAT -

A GRAT is an irrevocable trust to which a donor contributes assets (can be company stock, cash, or any number of other financial interests) but retains the right to receive an annuity for a specified term. The remainder of the trust property passes to the remainder beneficiaries chosen by the donor (in this, case, the children). As long as some very specific IRS (§2702) and Treasury regulations are strictly adhered to, the GRAT would let the parents transfer property (such as their Company stock) at a negligible gift tax cost because that gift tax cost is calculated by the FMV of the property transferred to the GRAT minus the present value of the retained annuity payment right. Structured properly, the trust instrument makes this amount is as close to zero as possible. A critical consideration here beyond the drafting of the instrument is how long of a term we choose for the parents'' GRAT; if the parents' don't survive the specified term, the result will not quite be punitive, but will return us back to the status quo estate tax circumstances. A 5-year term seems reasonable, but we'll need to have some slightly more sensitive conversations with the parents about their health should we choose to go this route. Because of the strict rules related to a GRAT and possible complications that could be caused by company stock, the GRAT might not be the most flexible or best option here. For instance, if the Company goes public and the Board decides to issue a dividend, that dividend cannot accrue to the trust without jeopardizing its status. A GRAT works best when the trust term is structured to capture the immense upturn in value in the company (company's) stock and exceed the §7520 rate. Usually, we would only fund a GRAT with a single asset instead of a mix of assets (or create multiple GRATs holding each asset). Also, GST cannot be allocated to the GRAT at the time of its creation, so the beneficiaries shouldn't be grandchildren.

b. Installment Sale -

The installment sale option is a strategy by which parentswould transfer title to their property in exchange for a promissory note that stipulates a payment schedule over a certain length of time. Regarding the company stock interest, timing would be important in the execution of this option because a sale of a marketable security cannot be reported on an installment basis (losing the tax benefit of the entire scheme).

Like the GRAT option, if the seller dies before the note is paid, the note will be included in the seller's estate and taxed accordingly at its FMV. Valuation of the property appropriately is extremely important in order to avoid unintended gift tax consequences and having the IRS re-characterize the transaction in a most unpleasant and most unfavorable way. There is also the possibility that other trust assets would be liable on the promissory note involved if the primary asset (Company stock) declines in value.

c. IDGT -

The Intentionally Defective Grantor Trust strategy, which I would recommend, combines all of the benefits of the aforementioned options while retaining more flexibility in estate planning. An Intentionally Defective Grantor trusts involves some aspects of the installment sale strategy, but will allows the parents'' to sell their property to the trust without any negative income tax implications (regardless of whether grantor is a beneficiary himself/herself or receives any benefit from it). Of course, just as in the installment sale explanation above, the installment note involved would have to be regarded by the IRS as having the indicia of genuine debt. The IDGT should hold some assets other than the purchased property in order to have a source for note payments other than income from the purchased property to avoid complications. In order to maximally take advantage of the possible upside in their company stock, their basic QTIP plan should include the creation of multiple separate QSTTs for the children. The children should be appropriately advised of the requirement that they elect for those trusts to qualify as QSTTs.

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Note: Nothing on this blog should be construed as legal advice. Rather, it is a discussion of various mechanisms that might achieve a particular end from a non-lawyer source. This is merely for comparative purposes, not advisory. This advice should not be relied on as expert knowledge in any way.

Estate Planning: The Benefits of Lifetime Trusts

The primary advantages of using lifetime trusts in estate planning for a very wealthy family are the estate tax efficiencies, the assistance in managing money for the children, income tax flexibility, and creditor protection. While their concern about being paternalistic is a common one, we can create the trusts such that the requirements are not overbearing in that sense while still retaining the positive features that would normally lead one to use such a strategy.

First, there are important estate tax efficiencies that are gained from utilizing lifetime trusts because of GST allocation problems and the avoidable problem of having to calculate taxes by aggregating personal net worth of the children with the inherited amount from the estate. Using trusts to assign certain assets directly to grandchildren (which might be a good idea in Jonathan’s case because he looks like he won’t be needing money from his parents in his lifetime) without subjecting those assets to a second round of estate taxation is very valuable.

Second, the practical consideration of managing the money in the estate after the survivor’s death is not one to be overlooked. A trustee is a professional subject to standards of prudent investing who can be trusted to make sound financial decisions for beneficiaries. Here, there doesn’t seem to be any overwhelming concern because of the relative success and responsibility-level of each of the children. In fact, Jonathan seems like he might do much better than a professional investor, and the girls might certainly perform or exceed that type of performance. However, the paternalism concerns can be balanced here by providing for mandatory (or completely discretionary) distributions or requiring a certain amount of the trust corpus to be wholly distributed by a certain age (or any permutation thereof). Trusts are incredibly flexible and can be adapted to almost any circumstance. For instance, if Sabrina wanted to take money out for a down payment on her first house, she could request it from the trustee who would almost certainly not unreasonably withhold (as long as the trust instrument was written to provide for such a contingency).

Third, the paternalism concerns also should be balanced by the desire to protect assets from creditors; this could be relevant in the case of divorce, professional liability (malpractice liability risk for Beth), and any kind of freak accident. Also, in the unfortunate case where one of the children suffers from a debilitating illness or disability and needs assistance form government agencies, a trust can help beneficiaries from losing access to those benefits.

Fourth, the use of a lifetime trust provides a significant amount of income tax flexibility by not forcing the beneficiaries to be responsible for a huge tax bill on a lump sum inheritance or on income generated by assets they inherit.

Of course, the avoidance of probate and the flexibility of a trust instrument (especially with a decanting provision) are critical benefits with which I am sure you are already well acquainted.

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Note: I am not a lawyer yet, and nothing on this blog should be construed as legal advice; it is merely policy analysis of certain aspects of estate planning.

"Disrupting" Real Estate Agents

Recently read this Gawker article about how real estate agents in over-saturated markets can just absolutely gouge renters and can even scuttle sales by taking just enough commission on both sides of the deal to make it less palatable for everyone involved.

This is a particularly bad problem in New York, which the article discusses in some detail. However, the problem is even worse in close proximity to popular colleges with huge student populations that can't quite fit into school-run or school-sponsored housing or dormitories. For instance, when I rented my house in Cambridge last year, I did absolutely all of the leg work, negotiation (for what little of it there was), and even found the place. All the realtor did was post a largely inaccurate and poorly crafted advertisement on Craigslist that I came across after a couple hours of searching. I called that agent, and had to hound her on the phone in order to get a call back and get her to show me the place at a mutually convenient time. She was late to the showing, which lasted all of 10 minutes, and took forever to get the paperwork together once I told her we were ready to move on the place. (By the way, all of that paperwork is completely standard and cookie-cutter and just needs to be filled out for maybe 10 minutes tops).

For all of my troubles, my four roommates and I had the pleasure of paying her a grand total of about $20,000. This total was comprised of: First month's rent, last month's rent, security deposit, and a $5,000 broker's fee (equivalent to one month's rent). So, for her 30 minutes of work, or let's say an hour to be generous...she was compensated $5,000. And, if we factor in some of her costs like the costs in attracting that client (the owner of the house) to allow her to rent it out, some of her fixed costs, and what she probably had to give to her broker as a cut, she probably still made out like a bandit. She made somewhere above $1,500 per hour for basically doing the easiest thing in the world.

There needs to be a way for renters in crowded markets like this to change the game by either going straight through the landlord (facilitated by some kind of sublet or leasing database). This money shouldn't be going to any middleman. It should discount the real estate, or be more profit for the landlord. Anything else (other than maybe a database posting fee) is just pure inefficiency waiting to be capitalized on by someone entrepreneurial enough to take the plunge and do it.