Lifetime Strategies for Protecting Your Business and Family Wealth

These goals need not be at odds with each other, however. There are ways to maintain control of the family business or other assets and generate an income stream, while keeping a lid on your estate tax bill. In the 1980s, Congress allowed everyone to pass on $600,000 transfer tax-free, and up to  $1,000,000 – including the $600,000—to a skip generation. Back then, that tax exemption may have been more than enough to cover your net worth. But since that time, the exemption has remained fixed, while your family’s net worth has probably climbed. Now, a big chunk of your assets could be swallowed by federal estate tax rates that start at 37 percent on the first dollar over $600,000, and rise to 55 percent on amounts over $3 million.

If your assets already exceed $1.2 million in value (husband or wife)—or if you expect they will someday – it makes sense to start preparing your estate plan now. You may want to consider some of the following strategies as you map out your future.

CREDIT SHELTER TRUST

This trust serves as the core of most estate plans for married couples.

Used correctly, a credit shelter trust can double the amount you and your spouse leave to your children free of estate taxes -–from $600,000 to $1.2 million. Suppose husband and wife each have $600,000 in assets, and each sets up a credit shelter trust. At his death, his $600,000 would go to his trust, instead of going directly to his wife. She could draw income from the trust during her lifetime, and dip into the principal under certain circumstances.  Later when she dies, the trust assets would pass to the kids, along with her $600,000, with no estate tax liability. Since both spouses have credit shelter trusts, the scenario would be reversed if she died first. For this arrangement to work, however, each spouse should have at least $600,000 in his or her own name (or half the aggregate estate if that amount is less than $600,000). That’s because jointly owned assets won’t pass into the trust.

GENERATION SKIPPING TRUST

While setting up a credit shelter trust, you might also want a generation-skipping trust which can provide income for your children and a big tax break later on for your grandchildren. When you die, your children’s inheritance goes into this trust, which can retain the investment income or pay it out to your children or grandchildren. The principal is ultimately passed on to your grandchildren and the tax laws levy no transfer taxes on these trusts funded with any amount up to $1 million. In providing this for your grandchildren, however, make sure you aren’t compromising the long-range security of your children.

GIFT GIVING

A basic building block of any estate plan is making lifetime gifts of cash or other assets to your children, grandchildren, or others. By giving away assets during your lifetime, you can begin to provide for your family while shrinking the size of your estate – which can result in lower estate taxes upon your death. Under the tax laws, lifetime gifts are added up with the property that passes through your estate at death. Aggregate amounts over $600,000 – the “exemption” – are then subject to the estate and gift tax. Additionally, the Internal Revenue Code allows you to give away up to $10,000 ($20,000 if your spouse joins you) each year to as many people as you desire, without denting the $600,000 exemption, or paying any gift tax. Over a five-year period, a couple making the maximum joint gifts to their four kids — $80,000 per year – could reduce the size of their estate by $400,000.

BUSINESS GIFTS

Giving gifts of stock in a family business to your children is usually advantageous for businesses that are not highly appreciated, but are expected to grow over time. For example, if you gift your $1 million business today, you’ll owe gift taxes on $400,000 (the amount over your $600,000 lifetime exemption). If, instead, you wait ten years when it’s value has doubled to $2 million, you’ll face gift taxes on $1.4 million. Gifts of family business shares can be made into a family income trust for the benefit of the next generation, or outright to your children whom you expect to eventually take over the company.

As the owner of a closely held business, you may be able to take certain valuation discounts – and save on transfer taxes – when making gifts of minority interest of your business. The minority discount is a recognition that a minority interest may be worth less because of the lack of control inherent in minority ownership.

Suppose a husband-wife business team annually transfer shares in their business to their two children for a 25-year period. By applying a 25% minority discount, for example, they jointly give them $53,000 worth of stock per year free of gift taxes – the discounted equivalent of their joint maximum annual exemption of $40,000 to both children – which grows at seven percent yearly. During their lifetimes, the parents would have transferred over $10 million out of their estates, an estate tax savings of about $5.5 million.

FAMILY LIMITED PARTNERSHIP

A family limited partnership can help you gradually shift ownership of your business (or other assets) to your children while allowing you to retain control until you are ready to retire. By properly designing the parents’ partnership interest, it is possible to pass a large portion of the growth in value of the business to the next generation.

GRANTOR RETAINED

ANNUITY TRUST

This kind of trust, also known as a GRAT, lets you remove assets from your estate without giving up the income they generate. When you set up a GRAT, you keep the annuity interest – the right to receive income from the trust property for the length of time you specify. You could place income-producing investments and real estate into the trust. When the trust period ends, the property passes to your heirs. Since they are annuities, GRATs pay you a fixed dollar amount each year. For instance, the trust could pay you $4,000 annually.

Be cautious, however. If you take more income from the trust than you can use during your lifetime, you will wind up putting that unspent money back into your taxable estate and possibly paying estate taxes on it. Your gift tax is based on the present value of the remainder interest going to your heirs. Therefore, you will be transferring the assets at a discounted rate. That means a lower gift tax bill for you. Since GRATs are irrevocable, you can’t take the assets back later if you decide you need them. So be sure you can afford to lose control of these assets before placing them in the trust.

GRANTOR RETAINED UNITRUST

The Grantor Retained Unitrust (GRUT) is a cousin of the GRAT. It too, holds income producing assets, which throws off income to the grantor of the trust for a set period, at which point the assets pass to the beneficiaries. A GRUT, however, pays a fixed percentage of the trust’s value each year, instead of a set dollar amount.

CHARITABLE REMAINDER TRUST

If you have highly appreciated assets – like a closely held business, stocks or real estate – and a charitable inclination, you might consider transferring them to a GRAT or GRUT, but the beneficiary is a charity instead of your children. You get a lifetime annuity or unitrust interest from the trust assets – either a set dollar figure each year, or a fixed percentage of the assets not less than five percent. At your death, the assets go to the charity you named when you set up the trust. If the trust is properly drafted, you can take a charitable income tax deduction when you first place the assets in the trust. You can’t deduct the full value however, because the charity won’t receive the principal for years.

 Another tax advantage: the potential for the trust to sell the stock or other trust assets without paying the 28% capital gains tax. If you sold it outright instead of gifting it to the trust, you would be writing the IRS a check for 28% of your profit upon sale. One way you can replace the donated assets and provide for your children is to purchase life insurance on behalf of your children with the income stream thrown off by the trust.

PERSONAL RESIDENCE TRUST

Suppose you want to pass on your home, currently worth  $500,000, to your children. You also plan to retire in ten years and move out of state. Rather than give them the house when you retire and incurring hefty gift taxes on its appreciated value, you can, in effect, give it to them now. By placing your home into a qualified personal residence trust, you remove it from your estate – thereby avoiding future estate taxation. You live in the house during the ten years, then ownership passes to your children. Since your kids must wait a decade to receive the property, the IRS discounts the value of the gift they are getting. Thus, the $500,000 house is transferred at a gift tax cost of much less. These trusts have their drawbacks, however. If you die before the trust expires, the house is kicked back into your taxable estate at its full value. If you move or sell the house before the end of the trust term, you may also lose the tax advantages if the house is not replaced.

Used correctly, these various techniques may help you meet your goals of reducing the size of your taxable estate, retaining income, and—in some instances – keeping control of your assets. Contact an estate planning professional to get a better idea of how you may help preserve your family’s assets as they continue to grow.  RT

The above article was prepared by CIGNA registered representative Richard B. Weinerman, Southfield, Mich., in conjunction with CIGNA Financial Advisors, Inc.