All in the Family

It is possible to pass along hard-earned wealth to your heirs, surrendering as little of it as possible to the estate-tax monster.


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If you own all or part of a business and have family to whom you’d like to leave it and other wealth, this article is for you. Your circumstances may be similar to those of Joe, the owner of Success Co. He is married to Mary, and they have three children: Jack and Jill, who work in the family business, and Jay, who is a teacher. All three children are married, and among them they have eight children of the own.

Joe worked hard for many years to build his company and, with it, his estate. He now wants to be able to live comfortably in retirement and gradually pass along his hard-earned wealth to his children, surrendering as little of it as possible to the estate-tax monster.

Joe and Mary’s net worth is $18.5 million, including Success Co., which has been professionally valued at $10.7 million; two homes worth $1.8 million; a 401(k) worth $900,000; and various investments (business real estate leased to the company and a stock/bond portfolio) worth $4.9 million. They also own a life insurance policy on Joe with a $1.3 million death benefit and a $200,000 cash surrender value (CSV).

If Joe and Mary both died today, the estate tax monster would gobble up about $3.4 million. And because they earn more than they spend each year, their potential estate tax burden will continue to rise every year that they live.

To beat this monster, we implemented several basic strategies in the couple’s estate plan, including using an intentionally defective trust (IDT) to transfer ownership of Success Co. to Jack and Jill without incurring income or capital gains taxes. First, we created 100 shares of voting stock and 10,000 shares of non-voting stock in the company. The voting shares were retained by Joe, and this allows him to maintain control of the company despite the fact that he no longer fully owns Success Co. The non-voting shares were sold to the IDT, but at a 
40 percent discount on their value, thanks to existing tax laws. This yielded savings on estate taxes of more than $1.7 million.

This was the appropriate strategy given Joe’s level of wealth, but one we would not have chosen for a less-well-to-do client like Scott. Scott’s company was valued at about $2.14 million, and his other assets also amounted to only about 20 percent of Joe’s. The major concern for Scott and his wife Sue is being able to maintain their lifestyle for as long as they live, so instead of using an IDT to transfer ownership of his company to their children, we used a strategy called a spousal access trust (SAT). This enables the couple to continue to receive income from the company for as long as they live, even though it will now be owned by the children.

Beyond these two strategies, we also implemented a family limited partnership (FLIP) to protect Joe and Scott’s other investments. Tax laws allow for a 35 percent discount on the value of so-called “limited partnership units” (LPUs) of various investments in a FLIP. In Joe’s case, 35 percent of $4.9 million in investments amounts to a discount of $1.7 million, reducing estate taxes by about $700,000.

Gifting programs also enable Joe and Mary to each gift $14,000 annually to each of their three children and eight grandchildren, for a total of $308,000 out of their estate each year. These gifts will make up the LPU portion of the FLIP and will be distributed each year to a dynasty trust (DT), a truly dynamic estate-tax-saver. We created three separate DTs for Joe and Mary’s children, so that each of them can enjoy that income for the duration of their lives before the trusts pass to their children. Separate trusts to receive the LPU gifts also were set up for each of Joe and Mary’s grandchildren to provide for their educations, down payments on homes, retirement, etc. What makes these trusts so dynamic? In effect, the assets in them pass from generation to generation but remain out of the grasp of the estate-tax monster. (What happens to the family wealth if one of the children gets divorced? All documents are drawn up in such a way that no assets pass to the ex-spouse.)

Other strategies we put into place to protect Joe’s wealth include a buy/sell agreement that is funded by insurance to cover the sale of Success Co. to Jack and Jill, and changes regarding life insurance. Joe dropped the existing $1.3 policy on his life and pocketed the $200,000 CSV, tax-free. A $3 million second-to-die policy on Joe and Mary was purchased through the IDT. Its proceeds also will be tax-free. Separate $2 million policies were purchased on each of Joe and Mary’s children through their DTs to help fund their lifestyles.

Not only did all of these strategies help eliminate taxes on Joe’s estate, but the additional life insurance will create a surplus of income, and his children and even grandchildren have a good start on their own estate plans.