Wealth transfer opportunities: A silver lining in today’s economy  Part two of two

Wealth transfer opportunities: A silver lining in today’s economy Part two of two

Wealth transfer opportunities: A silver lining in today’s economy
Using trusts to transfer wealth
Part two of two

by Richard Kohan
Partner, Private Company Services/Personal Financial Services

The use of trusts offers asset protection for children as well as many other ways to reduce taxes while providing for and protecting your family members or others and, at the same time, allowing you to set initial parameters regarding the management of those assets.

There are several types of trusts. For effective gift planning purposes in the current low value/low interest environment, we will focus here on two types of irrevocable trusts—grantor trusts and non-grantor trusts. This can be confusing, since both are funded by a grantor (the person establishing the trust) and both are irrevocable, meaning the terms cannot be changed and any assets held by the trust should be excluded from the estate of the person funding the trust (assuming the terms are drafted correctly). Both are subject to gift tax upon funding (although the planning techniques discussed below are designed to reduce or eliminate actual gift tax). The difference is that a grantor trust is set up so that the person funding the trust is responsible for income taxes on the earnings of the trust (a benefit for wealth transfer planning) and a non-grantor trust is responsible for income taxes on its earnings.

Sophisticated versions of these trusts can generate impressive wealth tax savings, particularly when values and interest rates are low. Some of these include:

Grantor retained annuity trust (GRAT)s. With a GRAT, the grantor transfers highly appreciating property into a trust while retaining an annuity stream for a stated period of years. At the expiration of the term, the property remaining in the trust is transferred to the beneficiaries. Because the grantor retains an annuity stream GRATs particularly appeal to people who are cautious about giving away wealth now.

The transfer of assets to the GRAT creates a taxable gift equal to the fair market value of the assets less the actuarially determined present value of the retained annuity stream. To the extent that the amount actually transferred as the remainder interest exceeds the value calculated for gift tax purposes, the excess is transferred gift tax-free. At the end of the GRAT term, the remainder interest that passes to heirs is completely out of the grantor’s estate. Because the present value of the remainder interest is calculated based on the interest rate at the time the trust is established, GRATs can be especially effective during periods of low interest rates.

Intentionally defective irrevocable trust (IDIT)s. Because an IDIT is considered a grantor trust for income tax purposes, the grantor pays the tax on income within the IDIT, increasing the after-tax trust value to the ultimate beneficiaries (as with a GRAT). However, an IDIT is structured so that its assets will not be included in the grantors estate for federal estate tax purposes. This split feature gives rise to various planning opportunities, such as a sale to an IDIT, which are particularly attractive when values and interest rates are low.

iditgrat1With a sale to an IDIT, the grantor makes a cash gift to the trust and also sells assets (e.g., closely-held stock) at fair market value to the trust in return for a promissory note bearing interest at the Applicable Federal Rate. (A cash gift to a new trust can be avoided if the family structure already includes a grantor trust with assets that can support the required promissory note.) As with a GRAT, appreciation (and cash flow) of the property sold, in excess of the interest rate charged on the note (or the GRAT Internal Revenue Code section 7520 rate), passes to heirs free of transfer tax. The grantor does not recognize gain or loss in connection with the sale of property to the trust in exchange for a note (or funding of GRAT). The grantor is not taxed on the interest the grantor receives on the note (or the GRAT annuity payments). The grantor indirectly retains an element of cash flow from assets sold to the trust. And, the grantor’s payment of the trust’s income tax liability is not considered to be an additional gift to the trust beneficiaries.

Dynasty trust. These are irrevocable trusts designed to pass assets through multiple generations at a reduced transfer tax cost. They have a perpetual existence and assets owned by the trust should not be includible in anyone’s estate until the trust is terminated. Grantor trust rules allow the settlor to pay the income taxes on behalf of the trust during his/her life, which further benefits future generations by allowing trust assets to grow tax-free. Further, dynasty trusts may provide creditor protection and may not be subject to marital claims. Kohan points out that an IDIT is a great trust to set up as a dynasty trust.

Want to know more about current wealth transfer opportunities?
Please contact:

Richard Kohan
Partner, Private Company Services/Personal Financial Services
[email protected]

Or visit www.pwc.com/pcs to locate the PricewaterhouseCoopers contact nearest you.

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One thought on - Wealth transfer opportunities: A silver lining in today’s economy Part two of two

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