The Alphabet Soup Of Estate Planning

Guest article by Todd C. Ganos, JD, LLM (Taxation), CFP®:

A/B, GST, APT, QTIP, GRAT, IDGT, DING, NING, BDIT, NIMCRUT, . . M . . O . . U . . S . . E.  These are just some of the types of trusts that wealthy and high-income families use to help reduce estate and income taxes as well as provide for asset protection.

We all know that the Internal Revenue Code is complex, and state-level tax rules are just as complex. In some cases, though, this complexity has created opportunities for tax reduction, and these trusts are the tools by which that tax reduction might be realized.

Certain types of trusts – such as generation-skipping transfer trusts or simply “GST” trusts – have been around for decades. GST trusts “skip over” the Internal Revenue Service’s ability to estate tax a family’s wealth as it passes down the generations. For families who are exposed to the estate tax, a 40 percent tax at each generation seems punitive. GST trusts can eliminate it. However, trusts follow state property law and most states require a trust to terminate after a certain number of years. As such, in time, the IRS would regain its ability to estate tax the family’s assets. The good news is that a handful of states allow trusts to remain in effect permanently or at least for a substantial period of time. In such cases, a family’s wealth would sidestep the estate tax permanently or at least for many generations. To take advantage of this, a trustee in one of those states must administer the trust.

The potential tax benefits of other types of trusts have come into focus more recently. Periodically, attorneys – on the behalf of clients – will submit a trust strategy to the IRS before implementing it to see whether anticipated tax benefits are valid. Recent rulings by the IRS have affirmed the validity of certain types of trusts that can potentially reduce or defer state-level income tax. For example, consider a family who lives in a high income tax state and who has a large position in a particular stock. The family learns that the company will be bought out with an all-cash offer. The family anticipates a large capital gain on the sale, which they can’t avoid. Knowing that Nevada imposes no income tax on trusts, the family might transfer the stock to a Nevada Incomplete-Gift Non-Grantor (NING) Trust prior to the sale and sidestep state-level income tax. The family would defer income tax payable to their own state until they take a distribution from the NING trust. However, if the family became a resident of a different state – perhaps a lower or no income tax state – and then took a distribution, the family would only pay state-level income tax (if any) to the new state of residency.

Beyond tax savings, there is asset protection. We know that we live in a litigious society. Wealth and high-income families use certain types of trusts to protect themselves from opportunistic plaintiffs. As with tax planning, key to implementing these asset protection strategies is having a trustee in a favorable jurisdiction. Alaska, Delaware, Nevada, South Dakota, and New Hampshire are five states that have enacted laws that are “trust friendly.” They impose no income tax on trusts and they have strong asset protection laws. Delaware and Nevada are the most favored among the five.

So, what might all of this alphabet soup of estate planning mean to your IRA? For individuals with larger IRA accounts, there is the Qualified Terminable-Interest Property (QTIP) Trust. While its name is not sexy, its tax result can be.

Normally, distributions from a retirement plan – whether an IRA, 401k, or another plan – are income taxed at the recipient’s ordinary income rate. For individuals in the highest marginal income tax brackets, the tax imposed seems almost punitive. Might there be a way for a family to reduce the ultimate tax burden on retirement plan assets and maximize the after-tax proceeds it receives? Yes.

Every owner of a retirement plan account designates a beneficiary who will receive the account’s remaining assets should the owner die. For a number of complex tax reasons, one would not normally designate a trust as the beneficiary of one’s retirement plan. In this strategy, there will be an exception. In this strategy, a QTIP trust will be used. It will be a stand-alone trust whose only function is to be the beneficiary of a retirement plan account. With a QTIP trust, the surviving spouse receives income for life and – upon the death of the surviving spouse – the remaining assets pass to children (or whomever).

However, rather than going the “income for life” route, one year after the retirement plan owner dies, the surviving spouse sells her interest in the QTIP trust – not the IRA, the trust – to a qualified charitable organization at a slight discount. (The discount is done for a specific tax reasons.) Because the surviving spouse is selling her interest in the trust – and not the IRA – it is a sale of a “capital asset” and proceeds of such a sale are income taxed as capital gains and NOT at the surviving spouse’s ordinary income rate.  The net result can be as much as 17 percent greater after-tax wealth to the family and a handsome donation to the family’s favorite charity.

Proper use of trusts – even in conjunction with IRAs – can yield very attractive tax results. You can never be too educated in all the possibilities trusts offer. Perhaps it is time to do some more research.

 

Todd Ganos is a professional trustee and the principal of Integrated Wealth Counsel, LLC, whose divisions provide family office, wealth management, trustee, and trust protector services.  He is also a contributor to Forbes magazine online and focuses on the management and preservation of family wealth. Todd can be reached at 866-898-1860.

Share