Showing posts with label Grantor Trusts. Show all posts
Showing posts with label Grantor Trusts. Show all posts

Tuesday, January 25, 2011

Irrevocable Life Insurance Trusts

Today's Advisor Forum call was excellent.  Bill Conway and Louis Shuntich discussed Irrevocable Life Insurance Trusts (ILITs) from a Advisor Team approach.  An ILIT is an irrevocable trust that holds life insurance.  An ILIT is used to make the death benefit escape estate tax.  Life insurance already escapes income tax.  Avoiding both tax systems makes life insurance a very attractive investment for the future of your family.

With the estate tax exemption climbing to $5 million, many taxpayers may believe that estate planning and estate tax planning in particular are no longer needed.  Wise families understand that taxes are just one of the many ways family wealth can be confiscated.  Other major risks, which can be far more devestating that taxes, include lawsuits, divorces, and market risk.  Appropriate life insurance in a well-designed irrevocable trust can address and eliminate these risks.

One rather dramatic planning idea that could be excellent for many families is to utilize the new $5 million gift tax exemption by making a large gift to an ILIT that purchases a single premium life insurance policy.  This could create a huge wealth transfer advantage for a family.  This is particular attractive considering the potential "claw-back" of gifts into the estate tax base at death if the estate tax exemption returns to $1 million in 2013.  This is because the "claw-back" would only bring back in the value of the gift at the time of gift, and not any appreciation on that gift.  If the gift is used to buy Life Insurance, then there is a huge leverage for the after tax wealth transfer.

Again, great seminar Bill & Lou!


Wednesday, November 24, 2010

Why should I want a “Grantor Trust” ?

A Grantor Trust is a Trust that is ignored for tax purposes.  Back when Federal Income Tax Rates were much higher, wealthy individuals would establish many trusts for their descendants to push income in to the lower brackets.  The trusts were designed to give the Grantor lots of power over the various trusts.  Congress decided to maintain the integrity of the Federal Income Tax System by implementing the Grantor Trust Rules.  If a Grantor retains certain powers over a trust, then the trust is ignored for income tax purposes.  This, in effect, keeps all of the income of the various trusts that "violate" the Grantor Trust rules combined back on the Grantor's income tax returns at the Grantor's marginal bracket.

Back when income tax rates were much higher, the Grantor Trust rules limited the usefulness of trusts.  In fact, a trust that violated the Grantor Trust rules was said to be a defective trust.  A trust that did not work.  If designed for income tax planning, that is correct, the trusts would no longer meet those goals.

Today, Income Tax Rates are lower.  Additionally, to further limit the utility of trusts to dilute the income tax base, the tax brackets for trusts are greatly compressed.  That is, a trust hits the highest income tax bracket at only around $11,000 of taxable income.  This compression of the brackets makes using trusts to manipulate income tax rates unattractive.  The Grantor Trust rules are actually no longer needed, but they remain in the law.

The Grantor Trust rules provide a distinct tax advantage from a gift and estate tax point of view.  If a gift is made to a properly drafted trust, that trust will keep the assets of the trust out of the Grantor's taxable estate.  At the same time, the trust will be ignored for income tax purposes. 

This dual tax status trust is essentially a vehicle to allow you to make a gift to your spouse, children or other beneficiaries that can grow income tax free.  Income tax-free compounding is a powerful tool for the transfer of wealth.

Remember the estate tax is scheduled to return on 01/01/11 with a $1 million exemption and a 55% highest rate.  The assets in a properly structured Grantor Trust not only grow income tax free during the grantor's life, but also will not be subject to an estate tax hit.

Grantor trusts is one more tool to help you Disinherit Uncle Sam.


Monday, October 18, 2010

Alaska Community Property Trusts

There is a planning strategy that could reduce income taxes for married couples.  The Alaska Community Property Trust permits married couples to transfer assets to a spouse at death, totally eliminating capital gains on all appreciated assets owned by the couple.

Married couples who live in the ten Community Property states (Alaska, Arizona, California, Idaho, Louisiana, New Mexico, Nevada, Texas, Washington and Wisconsin) and hold their assets as community property receive a full "ste-up" in basis at the death of the first spouse for purposes of determining capital gains tax when the property is later sold.  Consequently, residents of community property states benefit from a significant capital gains tax savings by holding appreciated property as community property, an advantage unavailable to the rest of the nation, where only the assets of the deceased spouse would receive a step-up in basis (typically considered 1/2 of joint property).

Alaska, however, specifically allows non-Alaska residents who meet certain criteria to "borrow" the features of Alaska Community Property law and eliminate capital gains on their appreciated assets at the death of the first spouse.  It is now possible for you to transfer your appreciated property to a special trust drafted to take advantage of Alaska Community Property Trust features. 

Upon the first spousal death, the survivor of beneficiaries can then sell the property paying tax only on the gains above the date of death value.  If you read this, and are interested, please contact me.

Note: The rules for basis step up in 2010 are particular to 2010, this post does not address the 2010 issues.


Monday, March 1, 2010

Best States for Trusts

Interesting Article with a chart.

What is a Grantor Trust?

A Trust is a Grantor Trust if one or more of the Grantor Trust powers are retained by the Grantor.  The effect of being a Grantor Trust is that the trust will be disregarded for tax purposes.  Depending on the retained power (or combination of retained powers) the trust could be Grantor Trust for Income Tax purposes, but not a Grantor Trust for Estate Tax purposes. 

Some other advisors often mention to me that an irrevocable trust cannot be a grantor trust.  Or rather that only revocable trusts are Grantor Trusts.  This is incorrect.  A Trust is a Grantor Trust IF the Grantor retains certain powers over the trust. The Power to Revoke is one of powers that triggers Grantor Trust status. The Power to Revoke is not the only power that creates Grantor Trust status. A Grantor could create an Irrevocable Trust, and retain some other grantor trust power, and make the Irrevocable Trust be a Grantor Trust. Typically, we use one or more of the following three powers that make an Irrevocable Trust be a Grantor Trust for income tax purposes:

  1. Power to substitute assets of equal value,
  2. Power to add charitable beneficiaries, and/or
  3. Power to borrow trust assets with inadequate security.
Retaining one (or more) of these powers will make a trust a Grantor Trust, even if the trust is irrevocable.

Estate Planners typically use the term Grantor Trust only in regard to whether the trust is a Grantor Trust for Income Tax purposes.  For Estate Tax, we typically refer to a trust as either a "complete" or an "incomplete" gift trust.

By: Attorney Patrick D. Newton

Sunday, December 20, 2009

Qualified Personal Residence Trust (“QPRT”)

Qualified Personal Residence Trust (“QPRT”) – Would you like to remove the value of your home from your taxable estate without moving out?
A silver lining of the cooling real estate market is the opportunity to use a QPRT to transfer a “personal residence” (e.g. your primary residence of your vacation home) to beneficiaries while values are low. In a QPRT, the client transfers a home to an irrevocable trust, retaining the right to reside in a home rent free for a fixed term of years. The amount of the taxable gift made upon the initial transfer of a home is the value of the residence, discounted by the IRS-determined present value of a client’s retained interest. If the client survives the term of the trust, the value of the home, including all appreciation after the creation of the trust, will be removed from the client‘s taxable estate. After the trust term ends, a rental arrangement for the client’s continued use of the home can be structured, and rent payments from the client to the beneficiaries (which can be used to pay property taxes, insurance and other home expenses) can further reduce the client’s taxable estate. The trust can be extended and appropriate provisions included so that no income tax is payable by the beneficiaries on the rental income, thereby creating more tax savings.

Wednesday, February 25, 2009

Planning You Should Consider Now

These are difficult times. The "experts" now acknowledge that we are in a recession - and that we have been so for some time. Consumer confidence is low. As a result many of us are concerned, wondering what planning we should do now, if any.

For the vast majority of Americans, planning is not discretionary. These individuals continue to have - or perhaps for the first time have - personal concerns that they need to address now because these concerns are unrelated to the economy. In fact, some of these concerns may even be made worse by our current economic situation.

In addition, for anyone who may be subject to federal or state estate tax in the future, unusual circumstances have created a "perfect planning storm" that will not last long. This post addresses some of the planning needs unrelated to the economy and discusses strategies that create the biggest planning opportunities today.

Planning Needs Unrelated to the Economy

Many planning needs are unrelated to the economy. They include:
  • Disability and retirement planning;
  • Special needs planning;
  • Beneficiary protection planning (for example, protection from divorce, creditors and/or perhaps the beneficiaries themselves); and
  • Second marriage and "blended family" protection.
These planning needs are often more critical for those with fewer assets than for those with more wealth.
Disability Planning
According to the Family Caregiver Alliance and recent MetLife Mature Market Study, of those Americans currently age 65 and older:
  • 43% will need nursing home care;
  • 25% will spend more than a year in a nursing home;
  • 9% will spend more than 5 years in a nursing home; and
  • The average stay in a nursing home is more than 2.5 years.
Nursing home costs are increasing much faster than the inflation rate would imply. Thus, many of us quite appropriately are very worried about how we will pay for that kind of care if we need it.
Planning Tip: Careful consideration of how to pay for long-term care is critical for most individuals.
Also of concern to many people is who will provide long-term care and whether those caregivers will care for us in the way we desire. For many, there is a strong desire to stay at home as long as possible. For others, the companionship found in an assisted living facility makes that choice preferable. Still others need care that cannot be provided at home or only at a prohibitive cost. And, not surprisingly, these goals often change over time and with changing circumstances.
Planning Tip: A trust that sets forth your current, carefully thought-out disability objectives is the best way to ensure that your planning meets your personal goals and objectives.
Special Needs Planning
Special needs planning is another area unrelated to the economy. According to the 2002 U.S. census:
  • 51.2 million people reported having a disability;
  • 13-16% of families have a child with special needs;
  • Autism occurs every 1 in 150 births and between 1 and 1.5 million Americans have an Autism spectrum disorder.
Failure to properly plan for a person with special needs can have disastrous consequences, especially if the person is receiving government benefits.
Planning Tip: A Special Needs Trust that incorporates specific care provisions is a critical component of the planning necessary for a special needs person who needs ongoing support.
Planning Tip: Insurance on the lives of the parents or grandparents of a special needs person frequently funds the ongoing care of that special needs beneficiary.
Beneficiary Protection Planning
Protecting an inheritance from being lost in a divorce or to a beneficiary's creditors is a serious concern of many individuals. Many from the older generation fear that their children and grandchildren lack strong financial decision-making skills - and the potential for creditor attack or for beneficiary dissipation of an inheritance is greater during difficult economic times.
Also, divorce rates exceed 50% nationally. Many individuals express concern over their children and grandchildren divorcing - they don't want the assets they worked so hard to accumulate winding up in the hands of a former daughter-in-law, son-in law, etc. Since divorce rates increase in difficult economic times, this planning is even more important now than in better economic times.
Blended Family Planning
A higher divorce rate also leads to more second and subsequent marriages - each with a higher statistical probability of ending in another divorce. With blended families (in other words with potentially his, her, and their kids), it is critical that each parent's planning protect his or her children in the event that parent predeceases the subsequent spouse. Failure of blended-family parents to do this type of planning practically guarantees that somebody's kids will be disinherited or a messy probate will result.
Planning Tip: Carefully drafted estate plans protect beneficiaries from divorce, creditors and themselves. Such plans can also provide for children from prior marriages, which is often the only way to ensure that these beneficiaries actually receive any inheritance.
The "Perfect Storm" for Taxable Estate Tax Planning
Certainty as to the Federal Estate Tax
The prospect for a repeal of the federal estate tax in the foreseeable future is essentially zero and, in half the U.S. jurisdictions, there is also a state estate tax (which can apply if you own property in that state or move there). Nobody knows whether the Congress and President will agree to a new federal estate tax exemption amount (the amount an individual, with planning, can pass free of federal estate tax). Despite rumors from Capitol Hill, we also do not know what that new amount might be - especially in light of the federal spending developments of the past few months. If that spending leads to greatly increased inflation, many more individuals may face being subject to the federal estate tax. Because of the virtual certainty that we will continue to have an estate tax, many individuals must plan if they wish to avoid paying it.
As the U.S. Supreme Court said:
Anyone may so arrange his affairs that his taxes shall be as low as possible; he
is not bound to choose that pattern which will best pay the Treasury; there is
not even a patriotic duty to increase one's taxes. Therefore, if what was done
here was what was intended by [the statute], it is of no consequence that it was
all an elaborate scheme to get rid of [estate] taxes, as it certainly was.
For those who may be subject to federal or state estate tax, we are in a "perfect storm" that creates exceptional planning opportunities not likely to be seen again for many years. The factors that have come together to create this "perfect storm" are (a) reduced asset values; and (b) historically low interest rates.
Reduced Asset Values
Reduced values for stocks, real estate, businesses, etc., mean that individuals can transfer these assets for less today than they could have just a few months ago.
For example, if a particular stock you own declined from $100 per share to $80, now you can transfer 162.5 shares with a $13,000 annual gift tax exclusion (it went up from $12,000 on January 1, 2009) instead of 130 shares had it remained at $100. Married couples can give twice that amount, or $26,000 per person, per year. Typically, clients transfer this amount to children, grandchildren and other close family members.
In addition, reduced real estate and business values mean that you can transfer a larger percentage of these assets free of federal gift tax by taking advantage of your $1 million lifetime exemption from federal gift tax.
Planning Tip: At a minimum, if you are subject to federal or state estate tax, you should take advantage of the annual gift tax exclusion ($13,000 per person as of January 1, 2009) to transfer assets with reduced values to children, grandchildren and others. Ideally, you should make these gifts in trust to provide the beneficiaries protection from divorce, creditors, predators, and themselves.
Historically Low Interest Rates
The other piece to the "perfect storm" is today's historically low interest rates. The January 2009 Applicable Federal Rates (AFRs) - the "safe harbor" interest rates provided by the government for, among other things, loans among family members - are as follows:
  • Short-term (not over 3 years): 0.81%
  • Mid-term (over 3 but not over 9 years): 2.06%
  • Long-term (over 9 years): 3.57%
February Rates are even lower. Due to a number of reasons, these low interest rates make many estate planning strategies even more attractive, including:
  • Strategies that involve the use of loans at current interest rates; and
  • Strategies that assume (as required by the IRS) that the assets you transfer will grow at current interest rates.
For transfers made in January 2009, this rate is 2.4%.
I encourage you to contact your advisors to determine if one or more of these strategies is appropriate for you under the circumstances.
Despite these difficult economic times, there are many reasons why you should plan or update your planning now rather than wait until we have more economic certainty. Furthermore, in the current economic and political climate it is impossible to know which of us will be subject to federal (or state) estate tax in the future. We do know, however, that the federal estate tax is not going away. If you may be subject to estate tax, the current "perfect storm" creates a unique opportunity for the planning team to help you meet your goals and objectives.
To comply with the U.S. Treasury regulations, I hereby inform you that (i) any U.S. federal tax advice contained in this blog was not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (ii) each taxpayer should seek advice from their tax advisor based on the taxpayer's particular circumstances.

Monday, December 29, 2008

Understanding the Significance of Trusts

In the right circumstances, trusts can provide significant advantages to those who utilize them, particularly in protecting trust assets from the creditors of beneficiaries. Admittedly this can be a complex topic, but you see its implications in the headlines every day. Today’s post attempts to simplify the subject and explain the general protection trusts provide for their creator (the “trustmaker”) as well as the trust beneficiaries. Given the numerous types of trusts, I will only explore the most common varieties of Trusts. I encourage you to seek the counsel of your wealth planning team if you have questions about the application of these concepts to your specific situation, or if you have questions about specific types of trusts.

Revocable vs. Irrevocable Trusts

There are two basic types of trusts: revocable trusts and irrevocable trusts. Perhaps the most common type of trust is revocable trusts (aka revocable living trusts, inter vivos trusts or living trusts). As their name implies, revocable trusts are fully revocable at the request of the trust maker. Thus, assets transferred (or “funded”) to a revocable trust remain within the control of the trust maker; the trust maker (or trust makers if it is a joint revocable trust) can simply revoke the trust and have the assets returned. Alternatively, irrevocable trusts, as their name implies, are not revocable by the trust maker(s).

Revocable Living Trusts

As is discussed more below, revocable trusts do not provide asset protection for the trust maker(s). However, revocable trusts can be advantageous to the extent the trust maker(s) transfer property to the trust during lifetime.

Planning Tip: Revocable trusts can be excellent vehicles for disability planning, privacy, and probate avoidance. However, a revocable trust controls only that property affirmatively transferred to the trust. Absent such transfer, a revocable trust may not control disposition of property as the trust maker intends. Also, with revocable trusts and wills, it is important to coordinate property passing pursuant to contract (for example, by beneficiary designation for retirement plans and life insurance).

Asset Protection for the Trust Maker

The goal of asset protection planning is to insulate assets that would otherwise be subject to the claims of creditors. Typically, a creditor can reach any assets owned by a debtor. Conversely, a creditor cannot reach assets not owned by the debtor. This is where trusts come into play.

Planning Tip: The right types of trusts can insulate assets from creditors because the trust owns the assets, not the debtor.

As a general rule, if a trust maker creates an irrevocable trust and is a beneficiary of the trust, assets transferred to the trust are not protected from the trust maker’s creditors. This general rule applies whether or not the transfer was done to defraud an existing creditor or creditors. Until fairly recently, the only way to remain a beneficiary of a trust and get protection against creditors for the trust assets was to establish the trust outside the United States in a favorable jurisdiction. This can be an expensive proposition. However, the laws of a handful of states (including Alaska, Delaware, Nevada, Rhode Island, South Dakota, and Utah) now permit what are commonly known as domestic asset protection trusts. Under the laws of these few states, a trust maker can transfer assets to an irrevocable trust and the trust maker can be a trust beneficiary, yet trust assets can be protected from the trust maker’s creditors to the extent distributions can only be made within the discretion of an independent trustee. Note that this will not work when the transfer was done to defraud or hinder a creditor or creditors. In that case, the trust will not protect the assets from those creditors.

Planning Tip: A handful of states permit what are commonly known as domestic asset protection trusts.

Given this insulation, asset protection planning often involves transferring assets to one or more types of irrevocable trusts. As long as the transfer is not done to defraud creditors, the courts will typically respect the transfers and the trust assets can be protected from creditors.

Planning Tip: If you are concerned about personal asset protection but are unwilling to give up a beneficial interest to protect your assets from creditors, consider a domestic asset protection trust or even a trust established under the laws of a foreign country.

Asset Protection for Trust Beneficiaries

A revocable trust provides no asset protection for the trust maker during his or her life. Upon the death of the trust maker, however, or upon the death of the first spouse to die if it is a joint trust, the trust becomes irrevocable as to the deceased trust maker’s property and can provide asset protection for the beneficiaries, with two important caveats. First, the assets must remain in the trust to provide ongoing asset protection. In other words, once the trustee distributes the assets to a beneficiary, those assets are no longer protected and can be attached by that beneficiary’s creditors. If the beneficiary is married, the distributed assets may also be subject to the spouse’s creditor(s), or they may be available to the former spouse upon divorce.

Planning Tip: Trusts for the lifetime of the beneficiaries provide prolonged asset protection for the trust assets. Lifetime trusts also permit your financial advisor to continue to invest the trust assets as you instruct, which can help ensure that trust returns are sufficient to meet your planning objectives.

The second caveat follows logically from the first: the more rights the beneficiary has with respect to compelling trust distributions, the less asset protection the trust provides. Generally, a creditor “steps into the shoes” of the debtor and can exercise any rights of the debtor. Thus, if a beneficiary has the right to compel a distribution from a trust, so too can a creditor compel a
distribution from that trust.

Planning Tip: The more rights a beneficiary has to compel distributions from a trust, the less protection that trust provides for that beneficiary.
Therefore, where asset protection is a significant concern, it is important that the trust maker not give the beneficiary the right to automatic distributions. A creditor will simply salivate in anticipation of each distribution. Instead, consider discretionary distributions by an independent trustee.

Planning Tip: Consider a professional fiduciary to make distributions from an asset protection trust. Trusts that give beneficiaries no rights to compel a distribution, but rather give complete discretion to an independent trustee, provide the highest degree of asset protection.

Lastly, with divorce rates at or exceeding 50% nationally, the likelihood of divorce is quite high. By keeping assets in trust, the trust maker can ensure that the trust assets do not go to a former son-in-law or daughter-in-law, or their bloodline.

Irrevocable Life Insurance Trusts

With the exception of domestic asset protection trusts discussed above, a transfer to an irrevocable trust can protect the assets from creditors only if the trust maker is not a beneficiary of the trust. One of the most common types of irrevocable trust is the irrevocable life insurance trust, also known as a wealth replacement trust. Under the laws of many states, creditors can access the cash value of life insurance. But even if state law protects the cash value from creditors, at death, the death proceeds of life insurance owned by you are includible in your gross estate for estate tax purposes. Insureds can avoid both of these adverse results by having an irrevocable life insurance trust own the insurance policy and also be its beneficiary. The dispositive provisions of this trust typically mirror the provisions of the trust maker’s revocable living trust or will. And while this trust is irrevocable, as with any irrevocable trust, the trust terms can grant an independent trust protector significant flexibility to modify the terms of the trust to account for unanticipated future developments.

Planning Tip: In addition to providing asset protection for the insurance or other assets held in trust, irrevocable life insurance trusts can eliminate estate tax and protect beneficiaries in the event of divorce.

If the trust maker is concerned about accessing the cash value of the insurance during lifetime, the trust can give the trustee the power to make loans to the trust maker during lifetime or the power to make distributions to the trust maker’s spouse during the spouse’s lifetime. Even with these provisions, the life insurance proceeds will not be included in the trust maker’s estate for estate tax purposes.

Planning Tip: With a properly drafted trust, the trust maker can access cash value through policy loans.

Irrevocable life insurance trusts can be individual trusts (which typically own an individual policy on the trust maker’s life) or they can be joint trusts created by a husband and wife (which typically own a survivorship policy on both lives).

Planning Tip: Since federal estate tax is typically not due until the death of the second spouse to die, trust makers often use a joint trust owning a survivorship policy for estate tax liquidity purposes. However, a joint trust limits the trust makers’ access to the cash value during lifetime. In these circumstances, consider an individual trust with the non-maker spouse as beneficiary.

Monday, December 1, 2008

Happy Holidays

It is December 1, 2008. This is generally the most hectic month of the year for estate tax professionals as we attempt to help clients complete their gifting by December 31.'

Most large gifting by NC residents however is being postponed to January, when the repeal of the NC Gift tax goes into effect.

I fully expect January to be full of Grantor Retained Annuity Trust (GRAT) formations and larger installment note sales to Intentionally Defective Trusts (IDIT).

A GRAT is a type of Gift Trust. The Grantor gives property to the trust and reserves the right to an annuity from the property over a specified term. At the end of the term (if the Grantor is still living), the GRAT beneficiaries receive whatever is left. If designed properly, the GRAT can be a means to gift more to your family than you otherwise could with annual exclusion gifting alone.

An installment note sale to an Intentionally Defective Trust is an estate freeze technique in which the Grantor essentially exchanges an asset with growth potential for an asset without growth potential. An installment note only grows by the interest on the note.

Neither of these techniques work well if the assets do not appreciate. The two transactions are essentially competing techniques to accomplish the same thing: move all future growth to your family without gift and estate taxes.

If you want to know more about how these techniques may fit in your planning, please let me know.