1 best planning opportunities in todays low interest rate environment 2009 robert s. keebler, cpa,...

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Best Planning Opportunities in Today’s Low Interest Rate

Environment

© 2009 Robert S. Keebler, CPA, MST, DEP Virchow, Krause & Company, LLP All rights reserved

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Presented By:Robert S. Keebler, CPA MST, DEP

Virchow, Krause and Company, LLPPhone: (920) 739–3345

E-Mail: [email protected]

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Impending Change in U.S. Tax Policy

• We expect changes given Democratic party control of the Presidency, the House, and the Senate.

• Affluent taxpayers will most likely be affected to a greater extent under President-Elect Obama tax changes.– Expressed intention to maintain President Bush’s

tax cuts except for taxpayers earning over $250,000 per year.

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Impending Change in U.S. Tax Policy

• Likely effect of tax policy change – especially since President-Elect Obama will be in office:– Increases in the Income Tax– Increases in the Capital Gains Tax– Near certainty that the Estate Tax will not be

repealed in 2010

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Low Interest Rate Planning

• Due to low interest rates and a weak economy, today’s financial environment is advantageous for the transfer of property into a trust for one’s family.– Married couples with assets in excess of $7 million

and/or any individual with assets in excess of $3.5 million should take aggressive steps to take advantage of the low interest rate environment.

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Applicable Federal Rates 1985 to PresentRates for Intra-Family Transfers

0.00%2.00%4.00%6.00%8.00%

10.00%12.00%14.00%

Jan-

85

Jan-

87

Jan-

89

Jan-

91

Jan-

93

Jan-

95

Jan-

97

Jan-

99

Jan-

01

Jan-

03

Jan-

05

Jan-

07

Jan-

09

Short Term Mid Term Long Term

Lowest AFRs in recorded history

NO BETTER TIME THAN NOW

This may be a once in a lifetime opportunity for your clients, so do not let it pass them by. Talk to your local FEPG personnel to get a plan on how to present this information to your clients. Again, there is no better time than now, so do the right thing!© 2009 Virchow, Krause & Company, LLP. All rights reserved.

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CURRENT INTEREST RATES

January 2009Short-Term AFR 0.81%Mid-Term AFR 2.06%Long-Term AFR 3.57%IRC Sec. 7520 Rate 2.40%

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Low Interest Rate Planning• Determine a client’s living expense needs and isolate

“excess capital.”• Transfer out excess capital utilizing unified credit,

GRATs and sales to entities for the benefit of children, grandchildren and great grandchildren.– Also removes asset growth from estate– The most prevailing techniques that exist today are

dynasty trusts, defective trusts sales, and grantor retained annuity trusts.

– These strategies can be used in conjunction with the valuation adjustment strategy for an even more effective end result.

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GENERAL RECOMMENDATIONS• Make full use of the Unified Credit during lifetime

• Transfer highly-appreciating assets to a Grantor Retained Annuity Trust (GRAT)

• Sell highly-appreciating assets to an Intentionally Defective Grantor Trust (IDGT) Installment Note Self-Canceling Installment Note (SCIN)

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DYNASTY TRUST DISTRIBUTION UPON GRANTOR’S DEATH

Dynasty Trust

Discretionary Distributionsto Children for Life

Discretionary Distributionsto Grandchildren for Life

Discretionary Distributionsto Great-Grandchildren

for Life

Future Generations

No transfer tax paid.




Grantor / ParentGift*

Advantages• Creditor protection• Divorce protection• Estate tax protection• Direct descendent protection• Spendthrift protection• Consolidation of capital

* Gift should take advantage of any remaining Unified Credit / GST exclusion remaining.

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DYNASTY TRUSTADVANTAGES OF AVOIDING GST TAX*Wealth of Parents 10,000,000$ 10,000,000$ 10,000,000$ Estate Tax Rate 45% 45% 45%Estate Tax 4,500,000$ 4,500,000$ 4,500,000$

Wealth of Children 5,500,000$ -$ -$ Estate Tax Rate 45% 45% 45%Estate Tax 2,475,000$ -$ -$

Wealth of Grandchildren 3,025,000$ 5,500,000$ -$ Estate Tax Rate 45% 45% 45%Estate Tax 1,361,250$ 2,475,000$ -$

Wealth of Great-Grandchildren 1,663,750$ 3,025,000$ 5,500,000$

% of Original Wealth Passing to Great-Grandchildren 16.6375% 30.2500% 55.0000%

* For sake of simplicity, it is assumed that the marginal estate tax rate at each generation’s death is 45%.

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DYNASTY TRUSTADVANTAGES

Takes maximum advantage of the applicable exclusion amount Currently at $1,000,000

Takes maximum advantage of the one-time application of the $2,000,000 GSTT exemption

Appreciation of assets will be estate tax-free Provides a layer of asset protection from the beneficiaries’ creditors No transfer tax will be paid at the death of the grantor’s descendants Provides flexibility

Future trustees can be given the discretion to make distributions as

appropriate, given the circumstances that exist at the time the distributions are made

Grantor can use the trust to positively affect future behavior

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GRANTOR RETAINED ANNUITY TRUST

(GRAT)

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Grantor / Parent GRATGift of Assets

For gift tax purposes, the initial gift is based upon a calculation of the present value of the annuity stream.

All growth in excess of the IRC §7520 rate inures to the beneficiaries, effectively freezing growth of assets to the IRC §7520 rate. The IRC Section 7520 rate for January 2009 is 2.4%.

GRANTOR RETAINED ANNUITY TRUST STEP ONE: GIFT OF ASSETS

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Grantor / Parent IRSGift Tax Payment

The amount of the taxable gift is the value of the property transferred to the trust minus the present value of the annuity interest that the grantor retains.

In valuing the lead interest, the IRS assumes that the trust assets produce a return equal to the IRC §7520 rate, effectively freezing growth of assets to the IRC §7520 rate.

GRANTOR RETAINED ANNUITY TRUST STEP TWO: PAYMENT OF GIFT TAX

Most likely will equal zero

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Grantor / Parent GRATAnnuity Payments

GRANTOR RETAINED ANNUITY TRUST STEP THREE: ANNUITY PAYMENTS

The GRAT must provide for payment of an annuity to the grantor not less frequently than annually.

As cash flow may be insufficient to satisfy the GRAT annuity payments, in-kind distributions may have to be made to the grantor to satisfy the annuity payments. However, thesein-kind distributions could be contributed to new GRATs to avoid estate inclusion of the in-kind distributions.

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Children

GRAT

At conclusionof GRAT term, remaining assets are transferred to children.

At this point, no further tax is imposed.

GRANTOR RETAINED ANNUITY TRUST STEP FOUR: PAYMENT TO BENEFICIARIES

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GRANTOR RETAINED ANNUITY TRUSTEXAMPLE*

TEN-YEAR TERM – 10% GROWTH

Benefit: $11,065,678 Transferred to Beneficiaries Tax-Free

YearBeginning

BalanceTaxable Income

Annuity Payment Ending Balance

10.00% $ 933,134 1 10,000,000$ 1,000,000$ (933,134)$ 10,066,866$ 2 10,066,866$ 1,006,687$ (933,134)$ 10,140,419$ 3 10,140,419$ 1,014,042$ (933,134)$ 10,221,328$ 4 10,221,328$ 1,022,133$ (933,134)$ 10,310,327$ 5 10,310,327$ 1,031,033$ (933,134)$ 10,408,226$ 6 10,408,226$ 1,040,823$ (933,134)$ 10,515,915$ 7 10,515,915$ 1,051,592$ (933,134)$ 10,634,373$ 8 10,634,373$ 1,063,437$ (933,134)$ 10,764,677$ 9 10,764,677$ 1,076,468$ (933,134)$ 10,908,011$ 10 10,908,011$ 1,090,801$ (933,134)$ 11,065,678$

* Assuming a $7,000,000 (after valuation adjustments) initial contribution

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GRANTOR RETAINED ANNUITY TRUSTWHY GRAT WORKS – Difference Between Rates of Return

Benefit: $4,692,065 Additional Wealth Transferred to Beneficiaries Tax-Free (of which $536,867 is due to

taxes paid to grantor)

YearBeginning



5.60% $ 1,333,048 1 10,000,000$ 560,000$ (1,333,048)$ 9,226,952$ 2 9,226,952$ 516,709$ (1,333,048)$ 8,410,613$ 3 8,410,613$ 470,994$ (1,333,048)$ 7,548,560$ 4 7,548,560$ 422,719$ (1,333,048)$ 6,638,231$ 5 6,638,231$ 371,741$ (1,333,048)$ 5,676,924$ 6 5,676,924$ 317,908$ (1,333,048)$ 4,661,784$ 7 4,661,784$ 261,060$ (1,333,048)$ 3,589,796$ 8 3,589,796$ 201,029$ (1,333,048)$ 2,457,776$ 9 2,457,776$ 137,635$ (1,333,048)$ 1,262,364$ 10 1,262,364$ 70,692$ (1,333,048)$ 8$

Discounted Value of Assets 10,000,000$ GRAT Payout Percentage 13.33048%

YearBeginning



10.00% $ 1,333,048 1 10,000,000$ 1,000,000$ (1,333,048)$ 9,666,952$ 2 9,666,952$ 966,695$ (1,333,048)$ 9,300,599$ 3 9,300,599$ 930,060$ (1,333,048)$ 8,897,611$ 4 8,897,611$ 889,761$ (1,333,048)$ 8,454,324$ 5 8,454,324$ 845,432$ (1,333,048)$ 7,966,709$ 6 7,966,709$ 796,671$ (1,333,048)$ 7,430,332$ 7 7,430,332$ 743,033$ (1,333,048)$ 6,840,317$ 8 6,840,317$ 684,032$ (1,333,048)$ 6,191,300$ 9 6,191,300$ 619,130$ (1,333,048)$ 5,477,382$

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GRANTOR RETAINED ANNUITY TRUSTWHY GRAT WORKS – Valuation Adjustments

Benefit: $6,373,605 Additional Wealth Transferred to Beneficiaries Tax-Free

YearBeginning



10.00% $ 1,333,048 1 10,000,000$ 1,000,000$ (1,333,048)$ 9,666,952$ 2 9,666,952$ 966,695$ (1,333,048)$ 9,300,599$ 3 9,300,599$ 930,060$ (1,333,048)$ 8,897,611$ 4 8,897,611$ 889,761$ (1,333,048)$ 8,454,324$ 5 8,454,324$ 845,432$ (1,333,048)$ 7,966,709$ 6 7,966,709$ 796,671$ (1,333,048)$ 7,430,332$ 7 7,430,332$ 743,033$ (1,333,048)$ 6,840,317$ 8 6,840,317$ 684,032$ (1,333,048)$ 6,191,300$ 9 6,191,300$ 619,130$ (1,333,048)$ 5,477,382$ 10 5,477,382$ 547,738$ (1,333,048)$ 4,692,073$

YearBeginning



10.00% $ 933,134 1 10,000,000$ 1,000,000$ (933,134)$ 10,066,866$ 2 10,066,866$ 1,006,687$ (933,134)$ 10,140,419$ 3 10,140,419$ 1,014,042$ (933,134)$ 10,221,328$ 4 10,221,328$ 1,022,133$ (933,134)$ 10,310,327$ 5 10,310,327$ 1,031,033$ (933,134)$ 10,408,226$ 6 10,408,226$ 1,040,823$ (933,134)$ 10,515,915$ 7 10,515,915$ 1,051,592$ (933,134)$ 10,634,373$ 8 10,634,373$ 1,063,437$ (933,134)$ 10,764,677$ 9 10,764,677$ 1,076,468$ (933,134)$ 10,908,011$ 10 10,908,011$ 1,090,801$ (933,134)$ 11,065,678$

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GRANTOR RETAINED ANNUITY TRUSTWHY GRAT WORKS – Payment of Taxes by Grantor

Benefit: $536,867 Additional Wealth Transferred to Beneficiaries Tax-Free

YearBeginning


Annuity Payment Less: Taxes @ Ending Balance

10.00% $ 933,134 40.00%1 10,000,000$ 1,000,000$ (933,134)$ (26,747)$ 10,040,120$ 2 10,040,120$ 1,004,012$ (933,134)$ (28,351)$ 10,082,647$ 3 10,082,647$ 1,008,265$ (933,134)$ (30,052)$ 10,127,726$ 4 10,127,726$ 1,012,773$ (933,134)$ (31,856)$ 10,175,509$ 5 10,175,509$ 1,017,551$ (933,134)$ (33,767)$ 10,226,159$ 6 10,226,159$ 1,022,616$ (933,134)$ (35,793)$ 10,279,849$ 7 10,279,849$ 1,027,985$ (933,134)$ (37,941)$ 10,336,759$ 8 10,336,759$ 1,033,676$ (933,134)$ (40,217)$ 10,397,085$ 9 10,397,085$ 1,039,708$ (933,134)$ (42,630)$ 10,461,030$ 10 10,461,030$ 1,046,103$ (933,134)$ (45,188)$ 10,528,811$

YearBeginning



10.00% $ 933,134 40.00%1 10,000,000$ 1,000,000$ (933,134)$ -$ 10,066,866$ 2 10,066,866$ 1,006,687$ (933,134)$ -$ 10,140,419$ 3 10,140,419$ 1,014,042$ (933,134)$ -$ 10,221,328$ 4 10,221,328$ 1,022,133$ (933,134)$ -$ 10,310,327$ 5 10,310,327$ 1,031,033$ (933,134)$ -$ 10,408,226$ 6 10,408,226$ 1,040,823$ (933,134)$ -$ 10,515,915$ 7 10,515,915$ 1,051,592$ (933,134)$ -$ 10,634,373$ 8 10,634,373$ 1,063,437$ (933,134)$ -$ 10,764,677$ 9 10,764,677$ 1,076,468$ (933,134)$ -$ 10,908,011$ 10 10,908,011$ 1,090,801$ (933,134)$ -$ 11,065,678$

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GRANTOR RETAINED ANNUITY TRUSTWHY GRAT WORKS – Summary

Total Wealth Transferred 11,065,678$

Reasons for Total Wealth TransferredDifferential Between Rates of Return 4,155,198$ Valuation Adjustment 6,373,605 Income Taxes Paid by Grantor 536,867 Rounding Adjustment 8


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GRANTOR RETAINED ANNUITY TRUSTWHY GRAT WORKS

Difference between actual rate of return and IRC §7520 rate

Payment of trust income taxes by the

grantor

Valuation adjustments on assets transferred

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GRANTOR RETAINED ANNUITY TRUSTADDITIONAL GRAT FEATURE – 20% Increasing Payment

Benefit: $872,333 Additional Wealth Transferred to Beneficiaries Tax-Free

Under Treas. Reg. §25.2702-3(b)(1)(ii)(B), the annual GRAT payment may increase by up to 20% over the annuity payment from the previous year. Accordingly, by “back-end loading” the GRAT payments, more wealth is left to future generations.

YearBeginning



10.00% $ 933,134 1 10,000,000$ 1,000,000$ (933,134)$ 10,066,866$ 2 10,066,866$ 1,006,687$ (933,134)$ 10,140,419$ 3 10,140,419$ 1,014,042$ (933,134)$ 10,221,328$ 4 10,221,328$ 1,022,133$ (933,134)$ 10,310,327$ 5 10,310,327$ 1,031,033$ (933,134)$ 10,408,226$ 6 10,408,226$ 1,040,823$ (933,134)$ 10,515,915$ 7 10,515,915$ 1,051,592$ (933,134)$ 10,634,373$ 8 10,634,373$ 1,063,437$ (933,134)$ 10,764,677$ 9 10,764,677$ 1,076,468$ (933,134)$ 10,908,011$ 10 10,908,011$ 1,090,801$ (933,134)$ 11,065,678$

YearBeginning



10.00%1 10,000,000$ 1,000,000$ (389,089)$ 10,610,911$ 2 10,610,911$ 1,061,091$ (466,907)$ 11,205,094$ 3 11,205,094$ 1,120,509$ (560,289)$ 11,765,315$ 4 11,765,315$ 1,176,532$ (672,346)$ 12,269,500$ 5 12,269,500$ 1,226,950$ (806,816)$ 12,689,634$ 6 12,689,634$ 1,268,963$ (968,179)$ 12,990,419$ 7 12,990,419$ 1,299,042$ (1,161,815)$ 13,127,646$ 8 13,127,646$ 1,312,765$ (1,394,178)$ 13,046,233$ 9 13,046,233$ 1,304,623$ (1,673,013)$ 12,677,843$ 10 12,677,843$ 1,267,784$ (2,007,616)$ 11,938,011$

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GRANTOR RETAINED ANNUITY TRUSTADVANTAGES

Annuity payments provide income stream to the grantor

Ability to make gifts of substantial amounts of property tax-free

Grantor pays income tax on trust income, leaving more assets in the GRAT for

remainder beneficiaries Reduces the taxable estate of the grantor Valuation adjustments increase effectiveness

of sale for estate tax purposes

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GRANTOR RETAINED ANNUITY TRUSTDISADVANTAGES If the grantor dies before the end of the GRAT

term, the assets in the GRAT are included in the grantor’s estate The remainder beneficiaries will have the same

basis in the property transferred to the GRAT as the grantor had at the time the property was transferred (no step-up in basis) Risk that rate of return will not exceed interest

rate resulting in no assets being transferred to remainder beneficiaries

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SALE TO AN INTENTIONALLY DEFECTIVE GRANTOR TRUST

(IDGT)

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Gift approximately 10% of total value that needs to be transferred to trust. This transfer will be a taxable gift that may require gift tax to be paid. The assets transferred, and the earnings on the assets transferred, will pay for future installment payments.

Grantor / Parent IDGTGift

SALE TO AN IDGTSTEP ONE: GIFT OF ASSETS

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SALE TO AN IDGTSTEP TWO: SALE OF ASSETS

The remaining assets are transferred to the IDGT in exchange for an installment note payable.

Note Payable

Grantor / Parent IDGTSale

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Annual installment payments are made from the IDGT to the seller/grantor. These may include interest and principal or just interest with a balloon payment due at the end of the term.

SALE TO AN IDGTSTEP THREE: INSTALLMENT PAYMENTS

Installment Payment(s)

Grantor / Parent IDGT

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SALE TO AN IDGT EXAMPLE*

TEN-YEAR TERM – 10% GROWTH


Year Beginning Balance Taxable Income Annual Ending Balance10.00% Payment

1 10,000,000$ 1,000,000$ (340,200)$ 10,659,800$ 2 10,659,800$ 1,065,980$ (340,200)$ 11,385,580$ 3 11,385,580$ 1,138,558$ (340,200)$ 12,183,938$ 4 12,183,938$ 1,218,394$ (340,200)$ 13,062,132$ 5 13,062,132$ 1,306,213$ (340,200)$ 14,028,145$ 6 14,028,145$ 1,402,814$ (340,200)$ 15,090,759$ 7 15,090,759$ 1,509,076$ (340,200)$ 16,259,635$ 8 16,259,635$ 1,625,964$ (340,200)$ 17,545,399$ 9 17,545,399$ 1,754,540$ (340,200)$ 18,959,739$ 10 18,959,739$ 1,895,974$ (7,340,200)$ 13,515,513$

* Assuming a $7,000,000 (after valuation adjustments) interest only, balloon payment feature installment note with a 4.86% annual interest rate (long-term AFR)

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SALE TO AN IDGTWHY SALE TO AN IDGT WORKS – Difference Between Rates of Return

Benefit: $8,191,836 Additional Wealth Transferred to Beneficiaries Tax-Free (of which $5,297,500 is due to

taxes paid to grantor)

YearBeginning


Installment Payment Ending Balance

4.86% $ 486,000 1 10,000,000$ 486,000$ (486,000)$ 10,000,000$ 2 10,000,000$ 486,000$ (486,000)$ 10,000,000$ 3 10,000,000$ 486,000$ (486,000)$ 10,000,000$ 4 10,000,000$ 486,000$ (486,000)$ 10,000,000$ 5 10,000,000$ 486,000$ (486,000)$ 10,000,000$ 6 10,000,000$ 486,000$ (486,000)$ 10,000,000$ 7 10,000,000$ 486,000$ (486,000)$ 10,000,000$ 8 10,000,000$ 486,000$ (486,000)$ 10,000,000$ 9 10,000,000$ 486,000$ (486,000)$ 10,000,000$ 10 10,000,000$ 486,000$ (10,486,000)$ -$

YearBeginning



10.00% $ 486,000 1 10,000,000$ 1,000,000$ (486,000)$ 10,514,000$ 2 10,514,000$ 1,051,400$ (486,000)$ 11,079,400$ 3 11,079,400$ 1,107,940$ (486,000)$ 11,701,340$ 4 11,701,340$ 1,170,134$ (486,000)$ 12,385,474$ 5 12,385,474$ 1,238,547$ (486,000)$ 13,138,021$ 6 13,138,021$ 1,313,802$ (486,000)$ 13,965,824$ 7 13,965,824$ 1,396,582$ (486,000)$ 14,876,406$ 8 14,876,406$ 1,487,641$ (486,000)$ 15,878,046$ 9 15,878,046$ 1,587,805$ (486,000)$ 16,979,851$ 10 16,979,851$ 1,697,985$ (10,486,000)$ 8,191,836$

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YearBeginning



10.00% $ 486,000 1 10,000,000$ 1,000,000$ (486,000)$ 10,514,000$ 2 10,514,000$ 1,051,400$ (486,000)$ 11,079,400$ 3 11,079,400$ 1,107,940$ (486,000)$ 11,701,340$ 4 11,701,340$ 1,170,134$ (486,000)$ 12,385,474$ 5 12,385,474$ 1,238,547$ (486,000)$ 13,138,021$ 6 13,138,021$ 1,313,802$ (486,000)$ 13,965,824$ 7 13,965,824$ 1,396,582$ (486,000)$ 14,876,406$ 8 14,876,406$ 1,487,641$ (486,000)$ 15,878,046$ 9 15,878,046$ 1,587,805$ (486,000)$ 16,979,851$ 10 16,979,851$ 1,697,985$ (10,486,000)$ 8,191,836$

YearBeginning



10.00% $ 340,200 1 10,000,000$ 1,000,000$ (340,200)$ 10,659,800$ 2 10,659,800$ 1,065,980$ (340,200)$ 11,385,580$ 3 11,385,580$ 1,138,558$ (340,200)$ 12,183,938$ 4 12,183,938$ 1,218,394$ (340,200)$ 13,062,132$ 5 13,062,132$ 1,306,213$ (340,200)$ 14,028,145$ 6 14,028,145$ 1,402,814$ (340,200)$ 15,090,759$ 7 15,090,759$ 1,509,076$ (340,200)$ 16,259,635$ 8 16,259,635$ 1,625,964$ (340,200)$ 17,545,399$ 9 17,545,399$ 1,754,540$ (340,200)$ 18,959,739$ 10 18,959,739$ 1,895,974$ (7,340,200)$ 13,515,513$

SALE TO AN IDGTWHY SALE TO AN IDGT WORKS – Valuation Adjustments

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YearBeginning



10.00% $ 340,200 40.00%1 10,000,000$ 1,000,000$ (340,200)$ (263,920)$ 10,395,880$ 2 10,395,880$ 1,039,588$ (340,200)$ (279,755)$ 10,815,513$ 3 10,815,513$ 1,081,551$ (340,200)$ (296,541)$ 11,260,324$ 4 11,260,324$ 1,126,032$ (340,200)$ (314,333)$ 11,731,823$ 5 11,731,823$ 1,173,182$ (340,200)$ (333,193)$ 12,231,612$ 6 12,231,612$ 1,223,161$ (340,200)$ (353,184)$ 12,761,389$ 7 12,761,389$ 1,276,139$ (340,200)$ (374,376)$ 13,322,952$ 8 13,322,952$ 1,332,295$ (340,200)$ (396,838)$ 13,918,210$ 9 13,918,210$ 1,391,821$ (340,200)$ (420,648)$ 14,549,182$ 10 14,549,182$ 1,454,918$ (7,340,200)$ (445,887)$ 8,218,013$

YearBeginning



10.00% $ 340,200 40.00%1 10,000,000$ 1,000,000$ (340,200)$ -$ 10,659,800$ 2 10,659,800$ 1,065,980$ (340,200)$ -$ 11,385,580$ 3 11,385,580$ 1,138,558$ (340,200)$ -$ 12,183,938$ 4 12,183,938$ 1,218,394$ (340,200)$ -$ 13,062,132$ 5 13,062,132$ 1,306,213$ (340,200)$ -$ 14,028,145$ 6 14,028,145$ 1,402,814$ (340,200)$ -$ 15,090,759$ 7 15,090,759$ 1,509,076$ (340,200)$ -$ 16,259,635$ 8 16,259,635$ 1,625,964$ (340,200)$ -$ 17,545,399$ 9 17,545,399$ 1,754,540$ (340,200)$ -$ 18,959,739$ 10 18,959,739$ 1,895,974$ (7,340,200)$ -$ 13,515,513$

SALE TO AN IDGTWHY SALE TO AN IDGT WORKS – Payment of Taxes by Grantor

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SALE TO AN IDGTWHY SALE TO AN IDGT WORKS – Summary


Reasons for Total Wealth TransferredDifferential Between Rates of Return 2,894,336$ Valuation Adjustment 5,323,677$ Income Taxes Paid by Grantor 5,297,500$


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SALE TO AN IDGTWHY A SALE TO AN IDGT WORKS

Difference between actual rate of return and AFR

Payment of trust income taxes by the grantor

Valuation adjustments on assets sold

Back end-loading of installment payments

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• Trust income is taxed to the seller/grantor

• Trust assets sold are not in seller/grantor’s estate for estate tax purposes

• Payments of income tax on behalf of the trust should not be an additional gift to the trust

SALE TO AN IDGT INTENTIONALLY DEFECTIVE GRANTOR TRUST

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• Freezes value of appreciation on assets sold in the seller/grantor’s taxable estate at the low interest rate on the installment note payable

• No capital gains tax due on installment sale • Interest income on installment note is not

taxable to the seller/grantor• Grantor pays income tax on trust income,

leaving more assets in the IDGT for remainder beneficiaries

• Valuation adjustments increase effectiveness of sale for estate tax purposes

SALE TO AN IDGT ADVANTAGES

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SALE TO AN IDGT DISADVANTAGES

• Estate inclusion of note if seller/grantor dies during term of installment note

• No step-up in basis at seller/grantor’s death• Trust income taxable to seller/grantor during his/her life

could cause a cash flow problem if there is not sufficient income earned by the seller/grantor

• Possible gift and estate tax exposure if insufficient assets are used to fund the trust• Possible taxable gift for amount of loan• Possible taxable estate inclusion under Karmazin (retained life estate)

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SALE TO AN IDGT USING A SELF-CANCELING

INSTALLMENT NOTE (SCIN)

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• Transaction similar to an ordinary installment sale to an IDGT

• Cancellation-at-death feature added to note• Premium must be paid, either in the form of

additional principal or increased interest rate to compensate for the cancellation-at-death feature

• OBJECTIVE: Reduction of estate tax if premature death occurs

SALE TO AN IDGT USING A SCIN

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• Hedge SCIN – A SCIN designed to hedge against the possibility of death during a bet-to-live strategy (taxable gifts, GRAT, etc…)

• Bridge SCINSM – A SCIN designed to take advantage of the increases in the Unified Credit

• Mortality SCIN – A SCIN designed for those who have a high likelihood of dying within a short period of time

SALE TO AN IDGT USING A SCINTHREE TYPES OF SCINs

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*AssumptionsTerm of Note 10 AFR 4.86%Payment Frequency AnnuallyType of Note Interest Only with Balloon Payment

SALE TO AN IDGT USING A SCINSAMPLE OF SCIN RISK PREMIUMS*

AgeSCIN Risk Premium AFR

Total Interest

Rate Age 1 Age 2SCIN Risk Premium AFR

Total Interest

Rate53 0.990% 4.860% 5.850% 53 53 0.085% 4.860% 4.945%58 1.515% 4.860% 6.375% 58 58 0.189% 4.860% 5.049%63 2.267% 4.860% 7.127% 63 63 0.401% 4.860% 5.261%68 3.404% 4.860% 8.264% 68 68 0.834% 4.860% 5.694%73 5.146% 4.860% 10.006% 73 73 1.701% 4.860% 6.561%78 7.849% 4.860% 12.709% 78 78 3.383% 4.860% 8.243%

SINGLE LIFE JOINT LIFE

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Year Beginning Balance Growth Annual Ending Balance10.00% Payment

1 10,000,000$ 1,000,000$ (889,630)$ 10,110,370$ 2 10,110,370$ 1,011,037$ (889,630)$ 10,231,777$ 3 10,231,777$ 1,023,178$ (889,630)$ 10,365,325$ 4 10,365,325$ 1,036,532$ (889,630)$ 10,512,227$ 5 10,512,227$ 1,051,223$ (889,630)$ 10,673,820$ 6 10,673,820$ 1,067,382$ (889,630)$ 10,851,572$ 7 10,851,572$ 1,085,157$ (889,630)$ 11,047,099$ 8 11,047,099$ 1,104,710$ (889,630)$ 11,262,179$ 9 11,262,179$ 1,126,218$ (889,630)$ 11,498,767$ 10 11,498,767$ 1,149,877$ (7,889,630)$ 4,759,014$

SALE TO AN IDGT USING A SCINEXAMPLE*

TEN-YEAR TERM – 10% GROWTH / 78 YEAR-OLD SELLER

* Assuming a $7,000,000 (after valuation adjustments) interest only, balloon payment feature installment note with a 12.709% annual interest rate (4.86% long-term AFR + 7.849% risk premium )

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• Future appreciation above the note interest rate, including the risk premium, is removed from the seller/grantor’s estate

• Asset not included in seller/grantor’s estate in case of premature death during SCIN term• Value of assets transferred out greatly exceeds value of payments coming back into the estate of the seller/grantor if he/she passes away prematurely • No gain or loss on sale• Trust income taxable to seller/grantor allows for greater appreciation to inure to future generations, thereby creating an additional tax-free gift• Valuation adjustments increase effectiveness of sale for estate tax purposes

SALE TO AN IDGT USING A SCINADVANTAGES

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• Complex calculation of risk premium • Possible gift tax exposure if SCIN risk premium is inadequate• Possible gift tax exposure if insufficient assets are used to fund the trust• Possible taxable estate inclusion under Karmazin (retained life estate)• No step-up in basis at seller/grantor’s death• Possible acceleration of capital gain at seller/grantor’s death• Trust income taxable to seller/grantor during his/her life could cause a cash flow problem if there is not sufficient income earned by the seller/grantor• Possible upstream transfer to seller/grantor if he/she survives term of note (or lives a significant portion of the term and/or is relatively old)

SALE TO AN IDGT USING A SCINDISADVANTAGES

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SALE TO AN IDGT USING A SCIN WHY A SALE TO AN IDGT USING A SCIN WORKS

Difference between actual rate of return and risk-adjusted AFR

Payment of trust income taxes by the grantor

Valuation adjustments on assets sold

Back end-loading of installment payments

Cancellation-at-death feature

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Planning Tools Which May Be Eliminated Under a New

Administration• Dynasty Trusts• Valuation Adjustment Planning

– Utilizing GRATs and IDGTs• Low Interest Rate Planning

– Utilizing Gifting, Unified Credit, GRATs and IDGTs

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Dynasty Trusts• Tax law currently allows a taxpayer to create a trust

that will exist in perpetuity.– One of the most powerful estate planning strategies

available today may be disallowed under a new administration.

– Taxpayer can transfer up to $7 million into a trust in the current year and the assets of the trust will never be subject to federal estate tax at any point in the future.

• The income from the trust could be distributed to children, grandchildren, and future generations on an estate tax-free basis.

– Wisconsin, South Dakota, Delaware and a few other states currently have no rule against perpetuities, thus allowing the establishment of dynasty trusts.

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Dynasty Trusts• Type of trust which benefits multiple generations where none of

the assets held by the trust are included in either the grantor’s taxable estate or any of the beneficiaries’ taxable estates.– However, under the tax law, whenever a transfer is made by the

grantor to a “skip person” (e.g., grandchild, great-grandchild, etc.) or a trust for their benefit (e.g., dynasty trust), a second level of tax is imposed on the transfer (in addition to gift tax).

– This is known as the generation-skipping transfer (GST) tax.– Notwithstanding, a grantor is allowed a lifetime GST exemption on

the first $2,000,000 of taxable transfers to “skip persons”.– Thus, if the grantor allocates all or a portion of his/her GST

exemption to the entire transfer, none of the transfer will be subject to GST tax either in the current year or future years.

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Dynasty Trust

Discretionary Distributionsto Children for Life

Discretionary Distributionsto Grandchildren for Life

Discretionary Distributionsto Great-Grandchildren

for Life

Future Generations





Joe SmithGift*

Advantages• Creditor protection• Divorce protection• Estate tax protection• Direct descendent protection• Spendthrift protection• Consolidation of capital

* Gift should take advantage of any remaining lifetime gift exclusion and lifetime GST exclusion

Dynasty Trust - Overview

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Wealth of Parents 1,000,000$ 1,000,000$ 1,000,000$ Estate Tax Rate 45% 45% 45%Estate Tax 450,000$ 450,000$ 450,000$

Wealth of Children 550,000$ -$ -$ Estate Tax Rate 45% 45% 45%Estate Tax 247,500$ -$ -$

Wealth of Grandchildren 302,500$ 550,000$ -$ Estate Tax Rate 45% 45% 45%Estate Tax 136,125$ 247,500$ -$

Wealth of Great-Grandchildren 166,375$ 302,500$ 550,000$

% of Original Wealth Passing to Great-Grandchildren 16.6375% 30.2500% 55.0000%

Dynasty Trust - Example

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Valuation Adjustment Planning• Discounts for minority interests and

marketability are provided for in the Code.• Not uncommon to see 25-40% combined

discounts when the correct conditions are present.

• These discounts could be on the “chopping block” for a new administration.

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Valuation Adjustment Planning - Example

• Mike and Molly are husband and wife. They own MM Co., which is valued at $150 million. MM Co. is controlled 50% by Mike and 50% by Molly.– For estate tax purposes, when applicable discount

are used, MM Co. would have a value of only $100 million (i.e., $150,000,000 * 33.33% discount = $50,000,000).

• $50,000,000 effectively removed from Mike and Molly’s taxable estates

• Note - this is a simplified example

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Valuation Adjustment Planning

• A client with an estate in excess of $7 million should be “locking in” discounts today.

• Sell and/or gift property to trusts including:– Grantor Retained Annuity Trusts (GRATs) and– Intentionally Defective Grantor Trusts (IDGTs)

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• This written communication, if it contains tax advice, is not intended to be issued as a “reliance opinion”, as defined under Section 10.35 of Circular 230, so as to avoid any of the penalties that could be assessed under the Internal Revenue Code or its applicable Treasury Regulations. Accordingly, any information contained herein cannot be relied upon for purposes of avoiding any of the penalties imposed by the Internal Revenue Code or its applicable Treasury Regulations.

• In addition to the above, it is understood by all recipients that this written communication cannot be used to promote and/or market any tax arrangement, plan and/or strategy that may exist in this document.

• To the extent that this written communication does present any tax arrangement, plan and/or strategy, it is further understood by all recipients that the confidentiality of the tax aspects of this written communication cannot be limited or restricted by the preparer with regard to the distribution of this document by the recipient. However, it should be noted that this confidentiality restriction in no way releases Virchow, Krause & Company, LLP or its preparer from its duty of confidentiality imposed by the AICPA Code of Professional Conduct or state codes of professional conduct.

• Finally, it is understood by all recipients that neither Virchow, Krause & Company, LLP nor its preparer have agreed to any refund of fees and /or contingent fee arrangement associated with the tax results of any arrangement, plan and/or strategy that my be contained within this written communication.

Disclaimer

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