Estate Planning: Beyond the Basics
MORELLO LAW GROUP
PROFESSIONAL CORPORATION
ATTORNEYS AND COUNSELORS AT LAW
ESTATE PLANNING: BEYOND THE BASICS
At Morello Law Group, P.C., we take pride in preparing essential estate planning services, professionally and efficiently, for any client in need of an estate plan. However, sometimes certain circumstances such as your asset level, family situation, or otherwise, calls for more complex planning. We can help you protect your family, your estate, and ensure that you wishes are seamlessly carried out after your death with some advanced estate and tax planning strategies.
Our advanced estate and tax planning practice focuses on asset protection for you and your family, efficient wealth transfer to your beneficiaries and charitable endeavors, and estate tax reduction techniques.
Asset protection planning is a complex area. To begin with, we must understand the scope of your specific issues, concerns and assets. Then we discuss a multitude of relevant options to consider in addressing these, and other, relevant issues. These options vary widely based on the nature and size of your assets, your tolerance for risk, tax considerations, transaction costs/administrative burden and, of course, requirements for legal compliance. Asset protection plans can vary greatly and can include, on the simple end, increased insurance coverage or, on the more complex end, a Domestic Asset Protection Trust or other trust.
The wealth transfer process focuses on how to preserve and plan for wealth transfer between generations or individuals. First and foremost, we need to understand your goals and objectives. Only with that solid foundation can we help advise on the multitude of complex issues that are involved. We will then discuss your wishes, charitable intentions, and susceptibility to advance estate planning techniques to develop proposed options that fit your unique situations and ultimate wishes.
LEVELS OF ESTATE PLANNING
Basic Estate Planning.
We cannot understate the benefits of at least having a basic, but comprehensive, estate plan in place. If you are reading this information, it is likely that you already have this planning in place and, as such, it will not be discussed here in detail. However, if you or someone you know does not currently have an estate plan in place, please contact our office and we can provide additional information tailored specifically to basic estate planning.
In-depth (Intermediate) Estate Planning.
So you have a Basic Estate Plan in place? Is it doing everything you need it to in order to address your particular situation?
Some advance estate planning techniques, while beneficial, can get complicated and cumbersome to administer. This level is different. Before investigating advanced strategies that could come with additional reporting requirements, cause you to give up a certain level of control over your own assets, or otherwise, we will first take a deeper look at your planning and see if you can benefit from any of these intermediate planning options:
A. Business Trusts
We often recommended that you complete a separate business trust agreement (“Business Trust”) to hold and manage any privately held business interests you own. A Business Trust is a revocable trust designed to hold your ownership interest in any business entity(ies), either now or at your death. Business interests in particular require careful planning in order to address the additional considerations unique to these types of assets, and a Business Trust is an excellent way to provide for the continued management of such interests after your death and to structure the ultimate distribution of these interests to your beneficiaries. Your Business Trust ensures that your business interests avoid probate, it identifies your selected Trustee(s) and gives such individual broad powers to quickly and effectively take charge of your business interests, and it holds such business interests in a separate trust where they will not be comingled with your other personal assets.
B. Dynasty Trusts
The phrase “Dynasty Trust” is simply a way of describing how long your assets are held in trust and who receives those trust assets when they are eventually distributed out. A Dynasty Trust leaves your assets to your children and their descendants, and holds assets for generation after generation. No beneficiary(ies) has/have the right to demand that all assets be distributed out to them. The assets can be distributed out under the Trustee’s discretion for the health, education, maintenance, support, and welfare of the beneficiary(ies), and trust income will usually be distributed out due to more favorable tax treatment.
The three (3) most popular reasons for creating Dynasty Trusts are to: (i) establish a legacy for all of your descendants in perpetuity; (ii) to avoid federal Estate, Gift, and Generation Skipping Transfer (GST) Taxes at the time of your death and in the future; and (iii) to provide asset protection over the trust assets from creditor claims (divorce, professional malpractice, creditor problems) of trust beneficiaries.
C. Special Needs Trusts
Most individuals’ primary concern when contemplating their Estate Plan is to ensure that their loved ones will be “taken care of.” When one of those loved ones is a disabled child,
their concerns are intensified. Questions abound such as: Where will the child live? Who will take care of the child’s special needs? Is there enough money available to meet these needs? The typical estate planning tools address some of these concerns, however, meeting the financial needs of a disabled child is not so simple.
Even if the disabled child inherits as little as a few thousand dollars, he or she may no longer qualify for much-needed governmental benefits. Conversely, failing to provide any assets for a disabled child means that a child may not have the means to pay for the many items that the government does not provide for, such as over-the-counter medications, toiletry items, visits to relatives, or miscellaneous entertainment expenses. Proactive Estate Planning can avoid this unpleasant outcome. Establishing a special needs trust for the disabled beneficiary allows the deceased parent to continue supporting his or her child, improving and supplementing his or her quality of life without supplanting any needs-based assistance that he or she may be receiving.
D. Gun Trusts
Any individual who desires to plan for the ownership, and ultimate distribution, of firearms would benefit from having a specialized trust to handle the unique issues related to these particular assets. A Morello Law Group “Gun Trust” is an all-encompassing document specifically designed to both: (a) simplify the acquisition and ownership of all firearms, including any long guns, hand guns, and/or Title II Firearms regulated by the National Firearms Act (“NFA”); and (b) to provide the provisions and direction necessary to ensure the proper ownership, use, and smooth transition of any firearm.
E. Domestic Asset Protection Trusts
For many individuals, a basic estate plan does not provide sufficient asset protection features. As of March 2017, individuals who reside in the State of Michigan are now able to create a Michigan Domestic Asset Protection Trust or “DAPT” according to the requirements of the Qualified Dispositions in Trust Act. This allows individuals to establish a trust that will govern the use or potential use of the trust’s assets for themselves and their family during their lifetime and beyond while protecting the assets from creditor claims and reducing potential tax liabilities.
Advanced Wealth Transfer Planning.
At this level, we will evaluate your current planning and identify proposed solutions to ensure that more of your wealth is effectively transferred to your intended beneficiaries. Typically, this involves advanced estate tax planning techniques for individuals who have potentially taxable estates at, or near, the applicable estate tax exclusion amount ($11.7 Million per person for 2021).
These techniques can reduce your estate tax liability and maximize the amount of your wealth that can pass to your beneficiaries; and it is best to get started now. For example, there are numerous strategies that leverage your annual gift tax exclusion and if you do not use this annual exclusion each year you lose it. For individuals with taxable estates, even the simplest annual gifting program can result in significant tax savings. As illustrated below, by simply giving assets each year, a married couple can transfer wealth now (tax free) and effectively save $12,000.00 in estate tax liability, per recipient, every year.
And this is only the beginning. Not only will any growth on these assets occur outside of your taxable estate, additional techniques such as intentionally defective grantor trusts, valuation discounts, and retained interest can further increase the tax savings. Gifts can also take the form of life insurance premiums increasing the value of gifts through growth of the policy and higher death benefits, and trusts can be used to control distribution of gifts while ensuring that all growth on these assets occurs free of estate tax. In order to maximize the value of this planning, we will be looking at specific types of trusts (orange in the diagram above) in addition to, or in combination with, other value reducing techniques (green boxes in the diagram above) to find synergies and maximize the value that this planning can provide. Some of these techniques include, but are not limited to the following:
A. Irrevocable Living Insurance Trusts (ILITs)
One way to take full advantage of the annual gift tax exclusion amount, in addition to other benefits, is to use an Irrevocable Life Insurance Trust or “ILIT”. An ILIT is an irrevocable trust formed to hold life insurance where the insurance policy and/or premiums paid into the trust will qualify, at least in part, for the annual gift tax exclusion. However, in order to ensure that the value in life insurance is removed from your estate, and therefore excluded from federal estate taxation, you must transfer all incidents of ownership in the life insurance policy to the ILIT, meaning you no longer own the assets and retain no power to control the management of the assets.
The primary advantage to holding life insurance in an ILIT is that assets transferred to your ILIT, including any associated increased value and death benefits, are excluded from your estate for estate tax purposes. Additionally, ILITs have the added benefit of protecting the transferred asset from subsequent claims of creditors, avoiding the probate process, and providing critical liquidity to pay estate taxes and fees immediately at your death (e.g. the life insurance proceeds can be used by your beneficiaries to pay any outstanding federal estate tax bill or expenses, allowing all of your other assets within your estate to pay out, taxfree).
B. Irrevocable Gifting Trusts
Lifetime gifts can be made to each of your beneficiaries, either outright to a beneficiary or through an irrevocable trust. An irrevocable trust, with an associated gifting program to support the trust, is a great option and accomplishes several objectives. Lifetime gifting through an irrevocable trust provides a mechanism to utilize your annual gift tax exemption, retain assets for your beneficiaries under the distribution terms and provisions that you specify, and any additional growth or appreciation of these on the assets would occur outside of your taxable estate further reducing your exposure to estate taxation at death. Additionally, funds held in an Irrevocable Trust prior to distribution have an added benefit in that they are not subject to claims from you or your beneficiaries’ creditors. Such trusts may also be set up with “dynasty” provisions that will ensure that trust funds are available for generations to come.
C. Closely-Held Businesses / Valuation Discounts
Another way to minimize potential estate tax is through the use of a closely-held business entity, such as a new Family Limited Liability Company or “FLLC” or recapitalization of an existing business entity. The broad concept of an FLLC is that an individual can create a closely held company that holds the assets of the founder, and structure the entity to have both voting and non-voting ownership interests. Then, when a founder transfers an interest in the company to a relative, either through an inter vivos gift or at death, the value of the transferred ownership interests can be discounted for estate tax purposes. The amount of discount allowed for the ownership interest, typically due to non-marketability of closely held business interests, lack of voting rights, and/or gift a minority ownership stake, effectively avoids estate taxation. These discounts vary, and no discount can be guaranteed, but they typically range between 25% – 35%. Additionally, the gifted ownership interests can be structured so that significant financial interests of the FLLC are given to family members while the initial founder still retains control of the company and its assets by retaining all of the voting interests.
D. Intentionally Defective Grantor Trusts (IDGTs)
An Intentionally Defective Grantor Trust or “IDGT” is an irrevocable trust, the assets of which are not includable in the your estate, but the income of which is treated as being taxable to you individually, and not to the IDGT. Relevant IRC provisions direct that when you retain certain rights or powers, then you will be treated as the owner of the trust property for income tax purposes, and as a result will be responsible for payment of the income tax earned by the trust. This is a benefit in that the payment of such income tax is not treated as an additional gift by you. In effect, you are then able to further reduce your taxable estate and also maximize the value of the assets held for your beneficiaries. In addition, you can sell assets to an IDGT and, because the IDGT is a disregarded entity for income tax purposes, you will not realize any capital gain as a result of such transfer.
E. Spousal Lifetime Access Trusts (SLATs)
A Spousal Lifetime Access Trust or “SLAT” is an irrevocable trust set up by one spouse for the benefit of the other spouse. The two most popular reasons for creating a SLAT are to: (i) ensure that one’s spouse has access to certain money for his or her lifetime; and (ii) to avoid federal Estate, Gift, and Generation Skipping Transfer (GST) Taxes. By gifting away in assets in the trust now, potentially up to your total estate tax exemption amount, you may pass those assets to your beneficiaries tax-free, and free from your beneficiaries’ creditors, regardless of where the tax exemption amount(s) and tax rates are ultimately set by the federal government. In addition, all of the growth from those assets (i.e. any interest that is earned) will be removed from your estates, thereby allowing the growth to also pass estate tax-free. This option is particularly beneficial to utilize now, especially if the estate tax exemption amount is ever reduced in the future.
F. Grantor Retained Trusts (GRITs, GRATs, GRUTs)
Another type of trust that can reduce estate taxes is a Grantor Retained Income Trust or “GRIT,” a Grantor Retained Annuity Trust or “GRAT,” and a Grantor Retained Unitrust or “GRUT”. These trusts typically work by creating an irrevocable trust, funding is with certain assets now, and directing the trustee to pay you a retained interest (income stream, annuity payment, or unitrust interest) from the trust for a specified number of years or allow you to retain possession of the trust’s property. When your interest terminates, the property in the trust is distributed to your beneficiaries. When you put assets into the trust, you will have made what is called a gift of a “future interest,” since your beneficiaries do not receive this gift immediately. The value of the gift of this future interest is the excess of the value of the property you initially transferred over the value of the retained interest that you kept. The value of your retained interest in a GRAT can be found by multiplying the principal by the present value of an annuity factor for the number of years the trust will operate.
Like other advance strategies, GRITs, GRATs, and GRUTs work better if established early on. With sufficient time, it may be possible to structure your retained interest to be equal, or close, to the value of the initial transfer. This would allow you to structure a transfer now, above and beyond the annual gift tax exclusion, with little or no impact on your ultimate estate tax exemption amount.
G. Qualified Personal Residence Trusts (QPRTs)
A Qualified Personal Residence Trust or “QPRT” is another trust that is helpful in reducing estate taxes. A QPRT functions in a similar way as a GRIT/GRAT/GRUT (e.g. your retained interest for a period of time reduces the taxable value of your ultimate gift), with a few exceptions. First, a QPRT will hold your personal residence, but you retain the right to use the residence for a specified number of years. After the fixed term ends, the property passes to the beneficiaries named in the QPRT.
If you want to continue using the residence after the fixed term expires, you can lease it from your beneficiary(ies) at fair market rental rates. This would effectively provide additional value to your beneficiary(ies) and save more in estate taxes by removing these payments from your estate. While the rent would be taxable income to the beneficiary(ies), the net effect is that you will transfer assets (i.e., rent) to you beneficiary(ies) at potentially lower income tax rates. However, if the trust is a “Grantor” trust for income tax purposes (such as an IDGT), the rent will not be taxable income to the children (nor to the Grantor). By combining these strategies, these rent payments would essentially be tax-free gifts to your beneficiary(ies).
Charitable / Charitable Remainder Giving.
For clients who are charitably inclined, estate tax liability can be further reduced by gifts to, or trusts for the benefit of, charitable entities. In addition to estate tax savings, utilizing charitable trusts can also minimize and eliminate income taxes in certain situations. Charitable Remainder Annuity Trusts (CRATs), Charitable Remainder UniTrusts (CRUTs), and others could be used for these purposes.
For example, when a CRAT is established, a gift of cash or property is made to the irrevocable trust. The donor (and/or another non-charitable beneficiary) retains an annuity (fixed payments of principal and interest) from the trust for a specified number of years or for the life or lives of the non-charitable beneficiaries. At the end of the term, the qualified charity specified in the trust document receives the property in the trust and any appreciation.
Most gifts made to a charitable remainder annuity trust qualify for income and gift tax charitable deductions (or in some cases an estate tax charitable deduction). A charitable deduction is permitted for the remainder interest gift only if the trust meets certain criteria. The grantor will receive an income tax deduction for the present value of the remainder interest that will ultimately pass to the qualified charity. Government regulations determine this amount, which is essentially calculated by subtracting the present value of the annuity from the fair market value of the property and/or cash placed in the trust. The balance is the amount that the grantor can deduct when the grantor contributes the property to the trust.
PLANNING PROCESS
When considering how to preserve and plan for wealth transfers between generations or individuals, we first and foremost need to understand the clients’ goals and objectives. Only with that solid foundation can we help advise on the multitude of complex issues that are involved. Proposing any advanced techniques that may work from a tax perspective, but simply don’t feel right to the client, leaves clients cold and their most fundamental concerns unanswered.
Once the client and attorney have agreed upon the options to pursue, we implement the plan by drafting the appropriate documents, setting up the entities and transferring the assets. Again, this can be a simple or complex process, depending on a variety of factors including tax considerations.
If any of this information is of interest to you or someone you know, please contact Morello Law Group, P.C. at 248-347-2950 to schedule an appointment with an attorney from our advanced estate planning practice. One of our attorneys will be able to spend time to understand your situation, needs and wants, and work with you to develop the best plan for you and your family. We look forward to speaking with you and assisting you with these very important matters.
