Basic
Sophisticated

A wealth owner can use a number of various types of trusts as well as other legal entities to accomplish more sophisticated wealth planning strategies. The transfer tax benefits from these strategies typically result from either "estate freezing", "valuation discounting", "beating the tables", or a combination thereof.

"Estate freezing" is the technique of fixing ("freezing") the value of particular assets in the wealth owner's gross estate at current levels, with the goal of shifting future appreciation, and often income from those assets, to the intended beneficiaries.

"Valuation discounting" is usually derived by placing assets into a legal entity (such as a Limited Partnership) and then transferring interests in that entity in lieu of transferring the assets themselves. For market reasons as well as legal constraints, those interests are valued (and taxes are computed on that value), at less than their pro rata share of the value of the underlying assets.

"Beating the Tables", as the phrase infers, is a game of chance. The "tables" are the actuarial tables used to determine the relative values of the various, separate interests in a trust. When the actual results are better than the actuarial predictions, under-valuation of the transferred interest may have occurred, having resulted in lower transfer taxes than there would have been with perfect investment return and lifespan foresight.

Some examples of strategies exploiting such transfer tax benefits follow:

1. Irrevocable Life Insurance Trust (ILIT). Life insurance is a very valuable wealth planning tool. It not only can provide for liquidity at death, but if the insured dies prior to his or her actuarial life expectancy, there can be tremendous financial gain. Without proper planning, however, the proceeds from a policy you own - or over which you are considered to have any of the broadly defined "incidents of ownership" - will be included in your estate. An ILIT then is an important device to remove these proceeds from your estate at little or no gift tax cost.

In its simplest form, the insured irrevocably transfers ownership of an insurance policy to the trustees of the trust. Better yet, money is transferred to the trust directly and a policy is then purchased by the trust itself. The trust terms can provide for the mandatory or discretionary distribution of income to the spouse, with the remainder to children or grandchildren. If structured properly, the estate tax consequences are simple. Nothing will be included in the insured's gross estate and, similarly, the proceeds will not be included in the non-insured spouse's gross estate. Liquidity is achieved in that the trustee is typically authorized to purchase assets from, or make a loan to, the insured's estate.

There are two distinct disadvantages to an ILIT, however, in that the insured gives up his or her policy and the freedom to control it, and also may incur gift tax liability. Additionally, there are typically further complications in operating such a trust.

2. Qualified Personal Residence Trust (QPRT). A QPRT is a trust to which a donor irrevocably transfers a personal residence, retains the term interest for a specific number of years for him- or herself, and then typically designates certain family members as remaindermen, (those who would receive the residence at the end of the term.) Although the home must be a "residence" of the donor, it need not be his or her primary residence. Therefore, a vacation home may qualify.

3. Grantor Retained Annuity Trust (GRAT). A GRAT is a split interest trust in which the grantor (wealth owner) irrevocably puts property into a trust and retains a right to an annuity from it for a term of years. At the end of the trust term, the trust ends and the property passes to the remainder beneficiaries. The grantor "beats the tables" if the actual income yield from the property exceeds the predicted yield built into the actuarial tables. Thus, such excess income, in effect, is added to the trust's corpus and generally passes to the remaindermen free of transfer tax. Of course, if the actual yield falls below that used in the tables, the amount of the gift, and any tax incurred on it, will be overstated. If the grantor does not survive the trust term, however, the trust assets, including all appreciation from the time of the transfer until death, will be included in the grantor's gross estate.

4. Family Limited Partnership (FLP). In a typical FLP, the wealth owner transfers property to a limited partnership in a tax-free exchange for a one percent general partnership interest and a 99% limited partnership interest. The wealth owner then retains the general partnership interest and subsequently gifts the limited partnership interests, for example, to children or grandchildren. By retaining the general partnership interest, he or she can retain control over the property transferred. Additionally, any associated liability which might be attached to the wealth owner by holding the general partnership interest can be limited through proper structuring of such. By transferring the limited partnership equity interests, the wealth owner can transfer the property, and all future appreciation and income attributable to it, at minimized gift tax cost. Highly appreciated assets are most appropriate for FLPs, although other assets, such as interests in closely held businesses and sometimes life insurance, can also fund FLPs.

The gift tax cost is minimized because of the availability of substantial discounts in valuing the gifted limited partnership interests. Valuation discounts are allowed because of the minority status of limited partners, the lack of marketability of limited partnership interests, or a combination of these two. These discounts, in conjunction with the Annual Gift Tax Exclusion and "gift-splitting" provisions, can be used to maximize annual gifts. Accordingly, the FLP is a useful tool to arrange a wealth owner's property so as to depress its value for gift tax purposes.

Due to relatively recent changes in entity formation law in most states, many professional advisors extensively use Limited Liability Companies (LLCs), in lieu of Limited Partnerships, to serve this purpose. Thus, this structure is commonly known as a Family Limited Liability Company (FLLC). Note well, however, that these entities, both FLPs and FLLCs, are being giving close scrutiny by the IRS. As such, their design, implementation and operation must be afforded heightened consideration.

5. Intentionally Defective Grantor Trust (IDGT). An IDGT - sometimes know as an Intentionally Defective Irrevocable Trust (IDIT) - is an irrevocable trust which is treated as owned by the grantor (wealth owner) for income tax purposes, but not for gift, estate, or generation-skipping transfer (GST) tax purposes. The trust is "defective" in that a "defect" is put into the trust agreement (for example, the grantor retains the right to reacquire trust property by substituting other property of equivalent value) which causes the trust to be taxed as a "grantor trust" even though a completed gift has occurred for transfer tax purposes.

6. Charitable Giving Techniques. Gifts to qualified charities are exempt from gift tax, are removed from the donor's estate and may qualify for current income tax deductions. In addition to lifetime gifts, charitable gifts can also be structured to occur at death. Although these tax benefits alone can sometimes drive the following gift vehicles, they are particularly successful for those clients with existing charitable intent:

a. Charitable Remainder Trust (CRT). A CRT is an irrevocable trust where a stream of payments is paid to one or more intended beneficiaries (which may include the donor), typically for a term of years. At the end of the term of years, the remainder is paid to one or more designated, qualified charities. There are several tax benefits to a CRT. First, an income tax deduction is one obvious tax benefit. Second, another benefit may result from actually "beating" the actuarial valuation of these split interests. Third, a tax advantage typically results by funding the trust with highly appreciated assets. As no capital gains will be incurred by the generally income tax-exempt trust, the "full pre-tax" value of the assets will support the payments to the non-charitable beneficiaries.

These trusts, however, must meet rigid qualifications as either a Charitable Remainder Annuity Trust (CRAT) - paying out a set annuity for the term - or as a Charitable Remainder UniTrust (CRUT) - paying out a percentage of the value of the trust assets each year. One can also structure the terms of the non-charitable interests in order to affect the timing and amount of payments to them, which may provide for increased benefits in later years when more desired. A CRT may also be used in conjunction with an Irrevocable Life Insurance Trust to actually replace the wealth which will eventually end up in the hands of the designated charity or charities.

b. Charitable Lead Trust (CLT). A Charitable Lead Trust is the reverse of the Charitable Remainder Trust. A CLT provides for a gift of payments from property to a charity for a term of years, after which the property either reverts to the donor or passes to a non-charitable beneficiary designated by the donor. By varying the term and the amounts of payments to the charity, the donor can reduce the transfer taxes, even while eventually putting the property into the hands of his or her intended beneficiaries. Future appreciation will escape transfer tax as well. Note, however, that a CLT is practical only for a donor whose family can forego payments from the transferred property during the period of the charity's interest.

c. Other Charitable Transfers. Some other tools available to the charitably inclined wealth owner include the following:

1. Outright Gifts - particularly of appreciated property,
2. Gifts of Remainder Interests in a Residence or Farm,
3. Establishment of a Private Foundation,
4. Gifts to Donor Advised Funds and Pooled Income Funds, and
5. Charitable Gift Annuities.