2021 Estate Planning Seminar: Advanced - The NSBA's Real Estate, Probate and Trust Law Section presents: Nebraska State ...
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The NSBA’s Real Estate, Probate and Trust Law Section presents:
2021 Estate Planning Seminar: Advanced
Friday, March 26, 2021
WEBCAST
John B. Atkins, Union Bank & Trust Company
Alex Wolf, Koley Jessen P.C., L.L.O.
Thank you to our Sponsors:
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AGENDA
The 2021 Estate Planning Seminar: Advanced webinar takes a deeper dive into several of the
more complex tools in estate planning. This webinar will provide an overview of Charitable
Remainder Trusts (CRTs), Charitable Lead Trusts (CLTs), and Intentionally Defective Grantor
Trust (IDGTs), including the risks associated with using them.
12:00 PM – 1:00 PM Charitable Remainder Trusts (CRTs) and Charitable Lead
Trusts (CLTs)
John B. Atkins, Union Bank & Trust
These two charitable vehicles are tools in the estate
planning toolbox but rarely the primary driver. This
webinar will address basic and fundamental features of
these conceptually simple concepts, but the speaker will
also include some features and risks associated with the
usage of either trust. This segment will try to give you
some helpful points about their usage. Many attendees
may find how different these trusts can be even though
the names suggest that they are trusts in reverse.
1:00 PM – 2:00 PM The ABCs of IDGTs
Alex Wolf, Koley Jessen, P.C., LLO
An Intentionally Defective Grantor Trust, or “IDGT,” can be
one of the most powerful estate planning tools available,
especially when planning for high net worth clients. This
presentation will provide a basic overview of IDGTs,
including how they work and when to use them, as well as
some practical planning tips and pitfalls that should be
kept in mind.This page intentionally left blank.
SPEAKER BIOS John B. Atkins John B. Atkins is Vice President and Senior Trust Officer at Union Bank & Trust Company working out of its Omaha office. He has been with Union Bank since March 2007. Prior to his career with Union Bank, John was an Employee Benefit Manager, and then a Personal Trust Officer, with the former Norwest Bank Nebraska, N.A. and Wells Fargo Bank, N.A beginning in 1975. John was also an Estate and Gift Tax Attorney for the Internal Revenue Service before becoming a trust officer. John received his BA from Hastings College in Economics and Business Administration in 1970 and his JD from Creighton University in 1973. In addition to his position as a trust officer, John is an active member of the Omaha Bar Association, Nebraska State Bar Association, the American Bar Association, and the Omaha Estate Planning Council. He has authored 8 articles published in the Estate Planning, Trust, and Employee Benefit fields in either the NEBRASKA LAWYER or the American Bar Association’s Real Property, Trust and Estate Committee’s PROBATE and PROPERTY magazine or the Journal. The most recent article was published in the NEBRASKA LAWYER in the March/April 2020 issue entitled “The Nebraska Uniform Directed Trust Act: A Trustee’s Perspective.” In 2017, John co-authored Chapter 18 of the Nebraska Probate Manual entitled “Creating and Administering Trusts”. On the legislative front, John prepared and presented to the NSBA’s Real Estate, Probate, and Trust Committee a proposed amendment to NRS 30-§ 3119.01 that brought the Conversion to Unitrust statute in line with other state laws regarding the Unitrust distribution amount as well as other modifications. See Laws 2010, LB760 § 1. In 2019, John also co-adapted the Uniform Directed Trust Act and worked with the NSBA’s Real Estate, Probate, and Trust Committee on a recommendation to the NSBA that it support this legislation that was passed by the unicameral and signed into law by the Governor effective January 1, 2021. John was a co-recipient of the NSBA’s George T. Turner award presented at the 2019 Nebraska State Bar Association’s annual meeting. Alex Wolf Alex Wolf is the President of Koley Jessen, P.C., LLO, and is a Shareholder in the firm’s Estate, Succession, and Tax Department. His practice focuses extensively on estate planning, business succession planning, and organizational/tax planning for high-net worth individuals, closely held businesses, and nonprofit entities. Alex holds a B.S. from the University of Nebraska at Lincoln and a J.D. from the University of Minnesota. In addition to being included for selection in the Chambers High Net Worth Guide for Private Wealth Law and The Best Lawyers in America© for Trust and Estates, he was named the 2021 Trust and Estates “Lawyer of the Year” in Omaha by Best Lawyers™, is a member of the Omaha Estate Planning Council, and has earned a Chartered Advisor in Philanthropy (CAP®) designation from The American College of Financial Services.
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2021 Estate Planning Seminar: Advanced
Charitable Remainder Trusts (CRTs) and
Charitable Lead Trusts (CLTs)
John B. Atkins
Friday, March 26, 2021
WebcastThis page intentionally left blank.
3/25/2021
Charitable Remainder Trusts
&
Charitable Lead Trusts
By: John B. Atkins, Esq.
1
1
13/25/2021
CRATs and CRUTs
Charitable Remainder Annuity Trust
CRAT •Fixed amount annually with not less than 5 percent
of initial fair market value of all property placed in
trust. Percentage not less than five percent nor
greater than 50 percent
•Cannot receive any additions after creation
CRUT Charitable Remainder UniTrust
•Fixed percentage with not less than 5 percent of
initial fair market value of property, valued annually
and amount recalculated. Percentage not less than
five percent nor greater than 50 percent
•May receive additions at any time
2
2
23/25/2021
Charitable Remainder Trust
CRT As Defined by Treasury Regulation 1.664-1(a)(1)(i)
A trust which provides for specified distribution at least annually to one of more
beneficiaries – at least one of which is not a charity – for life or for a term of
years (not to exceed 20) with the irrevocable remainder interest held for benefit
of, or paid over to, charity(s).
– A donor (grantor of trust) transfers property to an irrevocable trust;
– The trustee makes periodic payments of a fixed amount to beneficiary(s) –
monthly, quarterly or annually;
– The assets are ultimately distributed to charity(s) at the end of the term;
– CRT is not an IRC § 501(c)(3) charity but is regarded as a tax-exempt
entity;
– This designation is misleading as the CRT is a pass-through entity;
– Care is required; the CRT is subject to rules that apply to private
3 foundations.
3
33/25/2021
CRT—how long can it last?
The CLT is different
The rule recited on the previous page is from
the Treasury regulations:
• A period not to exceed 20 years
• For one or more lives
• But not for a combination of both such as one
person, or two, and then 20 years
• However, the later of one or two persons or 20
years is permissible
4
4
43/25/2021
CRT- Other rules of Interest
The CRAT is subject to a percentage test to
determine at the time of funding there is a less than
5% chance that the trust assets will be exhausted
before the trust ends; the ‘probability of exhaustion
test’. (See Rev. Rul. 77-374)
The test is only performed once.
The CRUT is not subject to the ‘5% probability or
exhaustion test’ because the distribution amount
fluctuates with the size of the trust assets.
5
5
53/25/2021
CRT- Other rules of Interest, page
2
For both trusts, the value of the charitable
remainder based upon the initial fair market
value of the property placed in the CRT must
be at least 10%. (See IRC § 664(d)(1)(D) for CRATs and IRC
§ 664(d)(2)(D for CRUTs).
6
6
63/25/2021
CRTs--Some practical
considerations
Failure of the trustee to comply with the terms of the
governing CRT by not distributing the periodic
payments will lead to disqualification of the CRT.
Even though in a CRT by not paying out the periodic
payments to the non-charitable beneficiary may lead
to a larger charitable distribution at the end of the
trust term (or so the argument goes).
(See Estate of Atkinson, 115 T.C. 26 (2000) and Bloomberg BNA Tax
Management Estates, Gifts and Trusts Journal, Richard L. Fox, Esq.
and Joshua D. Headley, Esq. 2017, page 5.
7
7
73/25/2021
Some practical considerations
A longer CRT term will lead to a smaller charitable deduction; a
shorter term, being logical, will lead to a greater charitable
deduction
When interest rates are low, an income interest is worth more
because you are assumed to be earning less. So a CRT is not
attractive as it increases the income interest at the expense of
the remainder interest, the charities.
If the income interest is worth less, the remainder after the
income interest must be worth more.
(See ‘Estate and Charitable Planning in a Low Interest Rate Environment’,
Lawrence P. Katzenstein, Leimbergservices.com, January 21, 2021)
8
8
83/25/2021
More practical considerations
A higher IRC § 7520 rate will provide a lower charitable
deduction in the CRT; the opposite for a CLT because you are
valuing the income interest.
The CRAT or CRUT can be inter vivos or testamentary
IRC § 7520 went into effect May 1, 1989. It describes the
valuation tables that must be used for computing the value of
certain income interests. These tables are used to compute the
charitable deduction for all life income gifts, retained life
estates, and lead trust gifts.
These tables are to be updated every ten years by law.
Currently, we are valuing income interests using the 2000 CM
Mortality tables.
9 The 2010 CM tables will not be effective until 2022.
9
93/25/2021
Gift and Estate Tax Consequences
Gift Tax Consequences
– If income from a CRT is payable to someone
other than the donor and donor’s spouse, it may
be subject to federal gift taxation
Estate Tax Consequences
– The value of the CRT is included in the trustor’s
gross estate.
– The value of interest passing to the charity is
deductible from the gross estate
10
10
103/25/2021
Marital Deduction with the CRT
There is IRC §§ 2056(b)(5), 2056(b)(6), 2056(b)(7),
and
IRC § 2056(b)(8) that provides a marital deduction
and a charitable deduction
Surviving spouse is the only non-charitable
beneficiary.
Interest of spouse can be a term, but not longer than
20 years, or for life.
There is no inclusion in the spouse’s estate upon the
conclusion of the CRT.
11
11
113/25/2021
Generation Skipping Transfer Tax (GSTT)
Grantor Creates CRT Assets Pass to Charities
GSTT will generally be applicable when assets avoid
estate tax inclusion from generation to generation.
For example, from grandparents to grandchildren, or
from grandparents to children in trust for life, no
general power of appointment, with the remainder to
grandchildren.
12
12
123/25/2021
Generational Skip - Example
Here’s an example of a generational skip: GM
A grandmother (GM) gifts $1,500,000 to a CRT
at 9.00 percent - $135,000 – of initial FMV $1,500,000
for 10 years with AFR at 5.8% (2001 or
2002). CRT
The beneficiaries were GM’s two daughters (D
1 and D 2) and her four grandchildren (GC
1, 2, 3, and 4).
D1 D2
The payments are:
25 percent to Daughter – D1 GC1 GC2 GC3 GC4
25 percent to Daughter – D2
This part – the grandchildren –
and
12.5 percent each to the grandchildren: is the generational skip
GC1, GC2, GC3, and GC4
13
13
133/25/2021
Tax Deduction on Funding CRT
Charitable income tax deduction is based on the
present value of charity’s right to receive trust assets
at some time currently or in the future:
Determining factors:
– Estimated length of time before charity receives distribution
– Annual percentage rate payable to income beneficiaries and
frequency of payments
– Current assumed rate of return on investments as
determined by IRC § 7520; what the government says the
trust will grow by.
– If charitable deduction exceeds a certain percentage of
donor’s adjusted gross income (AGI) for the year of the gift,
the excess portion may be carried over into future years
14
14
143/25/2021
Tax Consequences to the Grantor
The value of the charity’s interest is regarded as the
amount that constitutes the charitable deduction.
It is taken by the grantor on his or her 1040 for the
year of the creation and funding of the CRT
The grantor can deduct, in any one year, only a
certain percentage taken against the Adjusted Gross
Income (AGI)
The charitable deduction is limited by law, by
amount, to the type of property gifted and to whom
the charitable beneficiary
15
15
153/25/2021
CRTs or CLTs- Private Foundation Rules
The governing document should contain provisions
that prohibit the trustee from:
– Self dealing per IRC § 4941(d)
– Retaining excess business holdings IRC §
4943(c)
– Jeopardy investments IRC § 4944
– Follow the Prudent Investor Rules as set out in
the NUTC §§ 30-3883 to 30-3889
(See Charitable Gift Planning, Thomas J Ray, Jr, ABA section of Real
Property Probate and Trust Law, 2007, p 223, 505, 506)
16
16
163/25/2021
Income Tax Consequences - Example
5 shares Berkshire Hathaway @ $350,000 per share = $1,750,000
Can use the Best IRC § 7520 rate in the month of creation and
funding or either of the previous 2 months, in this case, December
2020 or January 2021 that were the same
The IRC § 7520 rate for February 2021 was 0.6%
The grantor is scheduled to receive 5% from a CRUT
Value of grantor’s interest at age 72 is $606,987
The charitable deduction amounted to $743,013 (mathematical to the
total value of the assets that funded the CRUT)
Passes the 5% probability of exhaustion test
Charity(s) to receive the remainder or whatever amount is left upon the
grantor’s death
Grantor, in this example, will have AGI of $300,000
Grantor is entitled to a charitable deduction of $90,000 ($300,000 X
30% as the gift was marketable securities) and $743,013 is carried
forward for up to five years after the year of funding
17
17
173/25/2021
Income Tax Consequences –
Continuing Example
If Grantor has AGI of $300,000 every year,
the carry over of the charitable deductions
from either the CRAT or the CRUT will last
for 7 tax years. Some deduction will be lost
The tax savings amount can be gifted to a
wealth replacement trust
18
18
183/25/2021
Wealth Replacement Trust
If the client likes the idea of a CRT and feels that it
should play a role in her estate plan, the children
may not be that enthused about having assets they
may have inherited end up in the hands of a charity
when they find out.
A solution? Assume the client is healthy and is going
to generate a reduction in income tax from the
charitable deduction, then the client can establish an
ILIT and fund it with the tax refund or tax savings.
This solution is not new.
19
19
193/25/2021
Income Tax Consequences –
Continuing Example
If Grantor has AGI of $300,000 every year,
the carry over of the charitable deductions
from either the CRAT or the CRUT will last
for 7 tax years. Some deduction will be lost
The tax savings amount can be gifted to a
wealth replacement trust
20
20
203/25/2021
Income Tax Consequences-
Variation
If the grantor in the previous slide wanted to look at a
CRAT rather than a CRUT (as the charitable
deduction was very attractive) but there was fear of a
protracted bear market that would cause her annuity
distributions to diminish.
The CRAT may flunk the ‘probability of exhaustion’
test under some of these scenarios.
A CRAT would pass the 5% test if the client was age
82 at least under the CM2000 mortality tables.
21
21
213/25/2021
CRT Income Tax Reporting Hierarchy;
CRT Income is categorized on a tiered basis
First Tier Ordinary Income for Current Year and Prior Years
Second Tier Capital Gains for Current Year and Prior Years
Third Tier Other Income for Current Year and Prior Years
Fourth Tier Distribution of Trust Corpus; if the CRT is designated as
beneficiary of an IRA or other qualified plan, the IRC §
691(c) deduction for the inclusion in the estate of the
IRA is treated as a 4th tier deduction. There is slim
chance that the CRT beneficiary will ever benefit from
the deduction as it is doubtful the beneficiary will only
receive tier 1 and 2 IRD. (See Planned Giving Design
Center, Chris Hoyt, Professor at UNKC School of Law,
entitled ‘IRAs and Qualified Retirement Plans, updated
September 2012 and PLR 199901023)
22
22
223/25/2021
CRT Income is categorized on a
tiered basis—continued, page 2
Treasury regulations create separate classes
and assign items of income to classes within
these categories based on the tax rate
applicable to each type of income within that
category.
The regulations retain the ‘worst-in-first-out’
(WIFO) characterization of distributions.
(See Ray, supra, page 257, slide 16, and Treas. Reg, §§ 1.664-
1(d)(1)(iv) (a) and (b) and 1.664-1(d)(2))
23
23
233/25/2021
CRUTs - Variations
SCRUT – Standard Fixed Percentage CRUT
NI CRUT
NIM CRUT Income Exception CRUTs
Flip CRUT
24
24
243/25/2021
NICRUT
Net Income (or Net Income Only)
Trustee pays lesser of net income or stated percentage.
Donor does not need current income but may need assets in
the future to generate income.
For example, a highly compensated executive inherits stocks
paying low or no dividends. His or her current retirement plan
accumulation forecasts do not reflect sufficient balances at
normal retirement.
25
25
253/25/2021
NIMCRUT
Net Income Makeup
Trustee pays income beneficiary only net income if
less than fixed percentage.
May pay income in excess of fixed percentage if total
income paid in prior years was less than amount
required by fixed percentage.
Net income in current year must be sufficient in
amount to make up for prior year deficiencies.
26
26
263/25/2021
NIMCRUT - Example
$1,000,000 CRUT @ 6 Percent $60,000.00
Trust Assets Dividends
$250,000 Merck $8441.00
$250,000 Apple $1530.00
$250,000 Pepsi $7,410.00
$250,000 Altria $4,210.00
$21,591.00
Fees are ½ to Income, ½ to Principal -5,500.00
Net Income $16,091.00
Carry-over: NICRUT – none
27 NIMCRUT Carry-over - $43,909.00
27
273/25/2021
Net income of 7% Unitrust with Make-up
A Trust can make-up past deficiencies by paying out excess
income earned in the current year. This concept is somewhat
analogous to the cumulative dividend feature on preferred
stock, and is referred to as a Net Income with Make-Up Unitrust
Year Trust Unitrust Trust Actual Annual Amt of Excess
Value Amt Income Payment Deficit Make-Up Income
1 1,000,000 70,000 70,000 70,000 0 0 0
2 1,010,000 70,700 60,600 60,600 10,100 0 0
3 1,010,000 70,700 82,416 72,114 0 10,100 20,200
4 1,030,200 72,114 82,416 72,114 0 0 30,502
5 1,040,502 72,835 41,620 41,620 31,215 0 30,502
6 1,100,100 77,007 124,860 108,222 0 31,215 47,140
28 Source: Tax Ecomonics of Charitable Giving: Toce, Abbin, Pace & Vorsatz; Warren, Gorham & Lamont, 2004
28
283/25/2021
Flip Unitrust
CRUTs can flip payment from NICRUT or NIMCRUT
to a standard fixed percentage CRUT
Triggered upon occurrence of specific date or event
Not subject to someone’s discretion or within control
of trustee or some other person
Some examples:
– CRT funded with house and flips when house sells
– CRT funded with unmarketable securities
– Trust to flip when a daughter is 18 and enrolled in college
– Trust flips on retirement at 65
– Marriage, divorce, or death of a non-charitable beneficiary
29
29
293/25/2021
IRC § 1042 Exchange; Employer Stock
Gifted to a CRT
Grantor & Closely Company ESOP
Held Shareholder Sells Shares to ESOP Buys Shares for
§1042 exchange
Cash
Privately owned shares; not previously received from a 401(a) ESOP.
ESOP must be at least a 30 percent owner of company after purchase.
Selling shareholder uses the basis in company stock sold to ESOP as
basis for marketable shares purchased.
Purchase period is three months before date of sale of stock to ESOP
and twelve months after sale.
Grantor funds CRT with stock purchased with proceeds from sale of
stock to ESOP.
Been in the Code since 1986; no abuse apparent.
30
30
303/25/2021
IRAs & CRUTs
IRA Owner as a CRT Income to IRA Owner as
Creates Grantor of CRUT for Life and
Grantor
CRUT then to Grantor’s Spouse for
Life
Trustor is receiving IRA distributions during life.
Trustor creates a CRUT for his or her life and then his or her spouse’s
life.
CR(A) or (U)T generates an income tax charitable deduction to offset
tax consequence of IRA distributions.
Trustor names CRT as beneficiary of his or her IRA
Upon IRA owner’s death, trustee of CRT receives lump sum of IRA
assets
Trustee of CRUT calculates higher annuity payout to spouse for
remainder of his or her life.
For Internal Use Only
31
31
313/25/2021
CRT and the SECURE Act
The SECURE Act removed the stretch IRA for beneficiaries of
inherited IRAs
A grantor can name a testamentary CRT as a designated
beneficiary of the IRA
The CRT is drafted to distribute to the beneficiary, for example,
the basic or minimum 5% of the assets
Assuming the CRT is qualified, the IRA is paid in a lump sum
distribution to the CRT
The beneficiary receives distributions for life
The SECURE Act 10 year payout limit is expanded
The IRA RMDs are treated as tier one income and it may take
15 or more years to payout the IRA to the beneficiary
32
32
323/25/2021
CRTs AND Unrelated Business
Taxable Income (UBTI)
Pay particular attention to the type of assets selected
to fund the CRT; a complicated aspect of CRT
administration.
UBTI can create a 100% tax rate on such income
payable at the CRT level. Expect an audit. (See Planned
Giving Design Center, Dan Rice, ‘Bashing UBTI to Bits’, May 12, 2016
for a method to deal with this topic)
CRTs funded with developmental real estate,
operating business, REITs, master limited
partnerships, an LLC that used debt-financing to
acquire its assets including for profit businesses.
(See IRC § 512(a)(1) and Ray, page 142, et. seq. from slide 16)
33
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333/25/2021
Charitable Lead Trusts
CRTs---persons paid first, charitable
beneficiaries the remainder
CLTs---charities paid first, non-charities
receive remainder
But these planning tools are quite different
34
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343/25/2021
Charitable Lead Trusts-Other differences
Unlike CRTs, CLTs do not have minimum
percentage or maximum percentage
payments. No 5% to 50% payment
requirement.
CLUTs cannot have FLIP provisions.
Unlike CRTs, CLTs are not limited to a
maximum of 20 years. The term limit would
actually be the state’s rule against
perpetuities.
35
35
353/25/2021
Charitable Lead Trusts-
more differences, page 1
The CLT can be either a ‘grantor’ trust or a ‘non-
grantor’ trust.
If the donor is selling a business, a substantial gift
can be made to a CLT and the grantor can use the
charitable deduction.
The penalty, or problem, caused by using the
charitable deduction is that it converts the CLT into a
grantor trust that will cause the grantor to include
the income generated by the CLT on her 1040 for
the remaining life of the CLT from the point of
36 creation and beyond.
36
363/25/2021
Charitable Lead Trusts-
more differences, page 2
If the CLT grantor wants/needs the charitable
deduction, the CLT is no longer a pure irrevocable
trust and a separate taxpaying entity
If the grantor of the CLT makes a substantial gift to
the CLT that is treated as a non-grantor CLT, the
charities must be those as described in IRC §§
2055(a) and 2522(a).
(See PG Calc, ‘Charitable Lead Trusts: No Time Like the Present, Bill
Laskin, 2021, PG Calc Webinar)
37
37
373/25/2021
Charitable Lead Trusts-
more differences, page 3
If the grantor does use the charitable deduction upon creation
and funding of the CLT, she will not be able to benefit from
future charitable distributions even if the CLT distributes more
than was claimed as a charitable deduction by the CLT creator.
38
38
383/25/2021
A zeroed-out charitable lead
annuity trust
There is an overall planning possibility: A ‘zeroed-out
charitable lead annuity trust’.
The CLT is initially charitable with the remainder to
children. This is different than a zeroed out GRAT.
The % distribution has been historically significantly
less because the trustee is not paying a person but
charity(s).
As the § 7520 rate is low, the valuation of the lead
annuity interest is high.
(See Charitable Lead Annuity Trusts: Planning Opportunities in Today’s
Low-Interest-Rate Environment, Bradley A. Ridlehoover, McGuireWoods,
39 February 11, 2021; and Katzenstein, supra, pages 7-11, slide 16)
39
393/25/2021
A zeroed-out charitable lead annuity trust—
more commentary, page 1
Here is a scenario:
CLT creator wants to donate $100,000 per year to
her medical school for 20 years
The gift to the CLAT is $1,879,360
The § 7520 rate is 0.06%
The CLT payout rate is 5.321%
The gift over to the children at the time of funding is
Zero—a zeroed-out CLAT
If the trustee generates a net annual return of 5%,
the CLT may be valued at $1,679,906 in the 20th
40
year. No taxable transfer to the children at the end.
40
403/25/2021
A zeroed-out charitable lead
annuity trust—more commentary, page 2
The following chart shows the Terms of Years and
the Annuity Payout Rates if the § 7520 rate is 0.06%:
Terms of Years Annuity Payout Rate
15 6.991%
20 5.321%
25 4.319%
30 3.652%
(The next 2 slides are generated by TigerTables software prepared by
Larry Katzenstein, quoted earlier in this outline, with ThompsonCoburn of
St. Louis)
41
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413/25/2021
A Zeroed-Out Charitable Lead Annuity Trust —
Charitable Lead Annuity Trust for a Term of Years,
page 1
42
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423/25/2021
A Zeroed-Out Charitable Lead Annuity Trust —
Charitable Lead Annuity Trust for a Term of Years,
Economic Analysis
43
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433/25/2021
CONTACT INFORMATION
John B. Atkins, Union Bank & Trust
Email: john.atkins@ubt.com
Toll free number: 1-888-239-5135
44
44
442021 Estate Planning Seminar: Advanced
The ABCs of IDGTs
Alex Wolf
Friday, March 26, 2021
WebcastThis page intentionally left blank.
The ABCs of IDGTs
ALEXANDER J. WOLF
NEBRASKA STATE BAR ASSOCIATION - 2021 ESTATE PLANNING SEMINAR
MARCH 26, 2021
1Alex draws on his small-town Midwestern values while working with
high net worth individuals, business owners, and nonprofit entities as
they seek to build and preserve a legacy. Alex provides sophisticated,
yet practical, legal advice in a manner that is easy to understand and
implement.
Areas of Practice:
• Estates & Trusts
• Business Succession Planning
• Wealth Transfer Planning
Alexander J. Wolf • Asset Protection Planning
President and Managing
• Nonprofit Organizations and Charitable Planning
Shareholder
alexander.wolf@koleyjessen.com • Taxation
Education:
• J.D., University of Minnesota, 2006, cum laude
• B.S., University of Nebraska - Lincoln, 2003, highest distinction
Omaha
Recognition:
402.343.3862
• Recognized for Private Wealth Law by Chambers High Net Worth Guide,
2018-2020
• Best Lawyers in America (Woodward/White, Inc.), Trust and Estates
2018-2021; Trusts and Estates “Lawyer of the Year” in Omaha, 2021
• “AV” Rating, Preeminent, Martindale-Hubbell
• Midlands Business Journal “40 Under 40” honoree, 2018
2Agenda
• IDGT Overview
• Benefits
• Sample Case
• Practice Pointers
3Overview of the IDGT
• Intentionally Defective Grantor Trust
• Irrevocable wealth transfer trust
• Intentionally set up as “grantor trust”
• IDGT income flows through to grantor who pays tax
• Transactions between grantor and IDGT do not trigger
tax consequences
4Overview of the IDGT
• Achieving Grantor Trust Status
• IRC §§ 673 – 677
• Favored Provisions:
• Power of Substitution
• Income to Grantor’s Spouse
• Power to Pay Life Insurance Premiums
• Power to Add Beneficiaries
5Overview of the IDGT
• Power of Substitution
• IRC § 675(4)(C) - “Swap power”
• Assets must be of equivalent value
• Allows grantor to take back trust assets, often in
exchange for a promissory note
• Provides tremendous flexibility
• Grantor can reacquire income-producing asset
• Provides basis planning opportunity (i.e., a step-up at death)
• Should require confirmation by independent trustee
6Overview of the IDGT
• Power to Add Beneficiaries
• IRC § 674
• Adding to the class of permissible beneficiaries (e.g.,
charity)
• Should not be held by grantor
7Overview of the IDGT
• Income for Benefit of Grantor’s Spouse
• IRC § 677(a)(1)
• Income distributable to grantor’s spouse without
consent of adverse party
• Distribution of principal irrelevant
• Beware of a surprise termination
8Overview of the IDGT
• Power to Pay Life Insurance Premiums
• IRC § 677(a)(3)
• Using income to pay premiums on grantor or grantor’s
spouse
• Caution – may require actual payment, and may only
result in partial grantor status
9Benefits of IDGTs
• Typical Wealth Transfer Planning Objectives
• Minimize impact of “transfer taxes” at death
• Provide protection for beneficiaries
• Preserve:
• Control
• Flexibility
• Cash flow (if necessary)
10Benefits of IDGTs
• Five IDGT “super powers”
1) “Locking-in” lifetime exemption amount
2) Income tax payments ≈ tax-free gift
3) Leveraging valuation discounts
4) Sales to IDGT and interest rate “arbitrage”
5) Dynastic planning (GST exemption)
11Benefits of IDGTs
1) “Locking-In” Lifetime Exemption Amount
• Federal Estate Tax
• Tax on the right to transfer property at death (40% tax rate)
• No tax on property left to charity or spouse
• Exclusion in 2021 - $11.7M
• Federal Gift Tax
• Tax on gratuitous lifetime transfers (40% tax rate)
• Lifetime exemption in 2021 - $11.7M
• Usage of lifetime exemption reduces exclusion available at death
12The Federal Estate Tax
$14,000,000
*Biden*Projected
Administration proposal
Exclusion
Amounts
$12,000,000
Exclusion Amount
45% rate
$10,000,000
$8,000,000
$6,000,000
$4,000,000 $3.5M exclusion
$2,000,000
$0
Year
Exclusion Amount Estate Tax Rate
13Use of Lifetime Exemption Illustrated No Gift Pre-
Biden
Grantor Gift Pre-
Biden $20M
Taxable
$8.3M Estate
Income-Producing Taxable
Cash ($8.3M)
Assets ($11.7M)
Included for Estate Tax Estate
Purposes
Excluded for Estate
Tax Purposes ($7.4M) Tax
$11.7M $12.6M to
heirs
IDGT Not
Taxed
($3.7M) Tax ~$3.7M
$16.3M to difference!
heirs
14Benefits of IDGTs
2) Income tax payments ≈ tax-free gift
• Grantor’s payment of income taxes:
• Allows IDGT assets to grow unencumbered by income tax
• Further minimizes grantor’s “taxable” estate
• Is not considered an additional gift for gift tax purposes
(Rev. Rul. 2004-64, 2004-2 CB 7)
• Transactions between grantor and trust do not trigger
income tax consequences
15Income Tax Benefit Illustrated
Grantor
Cash
$450k
Taxes on IDGT income
Included for Estate
Tax Purposes
IRS / NEDOR
Excluded for Estate
Tax Purposes
IDGT
Cashflow
$1.0M Income-Producing
Assets
16Benefits of IDGTs
3) Leveraging valuation discounts
• Discount for lack of marketability and lack of control
• Applicable to closely-held businesses
• Recapitalize company to create voting and nonvoting
interests
• E.g., 1,000 voting interests / 99,000 nonvoting interests
• Generates lack of control discount for nonvoting interests
• Allows control to remain with owner of voting interests and
value to be transferred with nonvoting interests
17Leveraging Discounts Illustrated
Results compared assuming
current estate tax rules
Grantor No With
discounts discounts
$8.4M
Income-Producing Assets Taxable $5.4M
Cash ($8.3M)
Voting stock NV stock (99%) Estate Taxable
Included for Estate Tax
Purposes
(1%) ($117k) ($11.58M) Estate
Excluded for Estate
Tax Purposes 25% discount – ($2.9M)
$11.6M
Not $14.6M
IDGT
Taxed Not
Taxed
Exemption usage only ($3.4M) Tax
$8.7M (leaving ~$3.0M $16.4M to
remaining) ($2.2M) Tax
heirs $17.8M to
heirs
18Benefits of IDGTs
4) Sales to IDGT and interest rate “arbitrage”
• Sale of appreciating / income-producing assets to IDGT
• Exchange for promissory note with low/fixed interest rate
• IDGT assets produce cash-flow to pay off note
• Remaining assets available for IDGT beneficiaries
• Estate “freeze” technique
• No income tax consequences for sale or interest
payments
• Can involve valuation discounts for further leverage
19Sale to IDGT Illustrated
Grantor
Promissory Note - $8.7M
Payments on Promissory Note
Income-Producing Assets Cash ($8.3M)
($7.3M)
Voting stock NV stock (99%)
Included for Estate Tax
(1%) ($117k) ($11.58M NAV)
Purposes
Excluded for Estate
Tax Purposes Sale for FMV Step 1 – Seed gift ($1M)
IDGT
Cashflow from stock
20Sale to IDGT Illustrated
Practical Impact of “Estate Freeze”
Net Value of IDGT*
(i.e., in the form of
appreciated assets) is
not included in
Grantor’s estate.
Instead, it remains in
Business Interests the IDGT and is held
for the benefit the
(or proceeds from their beneficiaries
IDGT sale)
“Net”
Value The tax-free cash/in-
kind payments
Grantor’s Cash Payments received by Grantor
“Estate” from the IDGT over
Received the course of the loan
are Grantor’s to use
Promissory Note Receivable during lifetime, and
will be included in
Grantor’s estate
following death for
estate tax purposes**
Date of Year 9
Year 9
Sale * - Assumes the assets transferred appreciate at a rate greater than the interest paid under the promissory note
** - No estate tax will result if remaining assets are left to foundation/charity
21Benefits of IDGTs
5) Dynastic Planning (GST-Exempt)
• Federal GST Tax – Tax on transfers to persons two or
more generations below transferor
• Utilize $11.7M GST exemption to “shelter” for all time
• Maintain assets in continuing trust to maintain benefit
• Leveraging GST on Sale to IDGT
22Sample Case
• Client
• Single business owner
• 3 children
• Large S corp – est. $75M enterprise value
23Sample Case
• Year One
• Recapitalized corp - 1,000 voting / 99,000 nonvoting
• Formed dynasty trust IDGT for lineal descendants
• Included power to add future spouse as beneficiary
24Sample Case
• Year One (continued)
• Client gifted $1M of cash into IDGT
• Client sold 20% of nonvoting stock to IDGT
• Undiscounted value ~$15M
• Sale was valued at $10.5M after:
• 30% combined discount for lack of marketability and lack of
control
• IDGT paid $1M of cash as down payment, issued $9.5M
promissory note for balance
25Sample Case
• Year Two
• Business marketed for sale
• Business sold for $100M
• Proceeds allocated as follows:
• IDGT
• $20M – Original proceeds as 20% owner of stock
• ($9.5M) – Repaid to client for purchase of stock
• $10.5M – Amount actually left in IDGT
• Client
• $80M – Original proceeds as 80% owner of stock
• +$9.5M – Repayment from IDGT for purchase of stock
• $89.5M – Amount actually allocated to client
26Sample Case
• Income tax implications
• Client had relatively low basis in the stock
• Client pays cap gains tax for himself and IDGT
Client IDGT
Starting Cash $89,500,000 $10,500,000
Tax Due ($24,000,000) $0
Ending Cash $65,500,000 $10,500,000
27Sample Case
• Results
• $10.5M captured in IDGT
• Client used only $1M of gift / estate / GST exemption
• Client will continue to pay income tax for IDGT for
decades, allowing IDGT assets to grow unencumbered
by income tax
• Tax savings
• $3.8M of immediate estate tax savings
• + 40% of all future growth / appreciation of IDGT assets
(assuming 3 doubles = $84M x 40% = $33M savings)
28Practice Pointers – Flexibility is Key
• Power of substitution
• Allows grantor to take back assets at any time
• Can regain control over IDGT assets and their income
• Opportunity for basis “step-up”
• Powers of appointment
• Allow someone other than grantor (including spouse
potentially) to change IDGT terms
• Changes can be typically only be made among descendants,
spouses/widows/widowers of descendants, and/or charities
29Practice Pointers – Flexibility is Key
• Spousal interest (SLAT)
• Spouse as sole or co-beneficiary
• Distributions of income / principal available to spouse
• Distributions to spouse could “indirectly” benefit
grantor
30Practice Pointers – Dual Legacy Trusts
Husband Wife
Gift / Sale Gift / Sale
Husband’s Wife’s Legacy
Legacy Trust Trust
• Set of two IDGTs, one created by Husband and one created by Wife, with assets gifted / sold by
each of them to their respective Trust
• Husband and Wife could potentially be beneficiary of each other’s Trust
• Assets held in trust are not subject to the claims of beneficiaries’ creditors, whether related (e.g.,
ex-spouses) or unrelated
• Trusts must not be “reciprocal” in nature (i.e., cannot be mirror images of each other)
31Practice Pointers – The “BCT”
• The BCT - Beneficiary Controlled Trust
• Beneficiary’s share placed into lifetime trust
• Beneficiary can elect to serve as trustee
• Trustee can make distributions for health, education, maintenance
support
• Beneficiary has 5% annual withdrawal right over principal
• Beneficiary has ability to direct disposition at death
• Could avoid estate tax at Beneficiary’s death (unless desirable for
basis step-up)
• Trust is protected from Beneficiary’s creditors – both third party
creditors and “related” creditors (i.e., serves as “stealth prenup”)
32Practice Pointers – Managing the Tax
• Controlling the client’s income tax burden
• Tax reimbursement clause (if permitted)
• Spousal distributions
• Control income tax generation through investment of
IDGT assets
• Power of substitution
• Turn off grantor trust status of IDGT
33Practice Pointers – Life Insurance
• IDGT can hold life insurance
• On grantor’s life
• Power of substitution does not cause estate inclusion
(Rev. Rul. 2011-28, 2011-49 IRB 830)
• On beneficiary’s life
• Insured bene cannot serve as Trustee, or at least, as a
Trustee with control over policy
• Insured bene cannot have power of appointment over policy
• Death benefit is GST exempt
34Practice Pointers – Timing
• Timing is critical if client considering liquidation
• Planning should be done as far in advance of sale as
possible
• As soon as client expresses interest in eventual sale of
business, wealth transfer planning effort should begin
• Adequate time between wealth transfer planning effort
and business sale reduces risk
• Once letter of intent is signed, planning opportunity is
lost
35Practice Pointers – Timing
• Sale to IDGT process:
• Determine tax and non-tax objectives
• Recapitalize company into voting/nonvoting interests
• Form IDGT
• Obtain appraisal of nonvoting interests
• Gift / sell nonvoting interests to IDGT
• Gift tax return
• Usually will take 2-3 months to design and implement
36Practice Pointers – Gifts
• Gift considerations
• Follow 10% seed gift rule of thumb
• Consider asset utilized for seed gift
• Cash – there is no dispute about the value of a dollar
• Business Interests – can start statute of limitations on gift tax return
even if sale is not reported
• What if client has used all gift tax exemption?
• Personal guaranty by IDGT beneficiary can be used (PLR
9515039)
• Beneficiary should receive guaranty fee
37Practice Pointers - Gifts
• Gifts of Business Interests
• Consider using “defined value clause” to transfer assets
• See Wandry, T.C. Memo 2012-88 - upheld a defined value clause which
transferred to taxpayer’s family members a fixed dollar amount of LLC
interests, as such interests were finally valued for gift tax purposes
• Consider having Trustee sign “acceptance” that incorporates
refusal to accept / disclaimer of any transferred assets that are
in excess of desired gift amount
• Provides argument that there was no acceptance of “excess” gift value
– acceptance is fundamental element of a gift
38Practice Pointers – Sale Considerations
• Arms-length transaction
• Prepare written purchase agreement
• Limit term of note to no more than 20 years to avoid
the appearance of retained equity interest
• Accrue interest at AFR or higher
• Secure promissory note with pledge of purchased
business interests and written pledge agreement
• Perfect the security interest
• Coordinate timely payments on promissory note
39Practice Pointers – Sale Considerations
• Respect the formalities of the transaction
• Entity consent minutes authorizing transfer
• Comply with buy-sell / shareholder agreement
restrictions on transfers
• Ensure IDGT is party to buy-sell / shareholder agreement
• Issue new stock certs or other indicia of entity ownership
• Update entity ownership records
• Actually transfer cash gift from grantor account to IDGT
account and back following sale
40Practice Pointers – Sale Considerations
• Value adjustment clause – adjusts purchase price
paid for fixed number of interests
• See King, 545 F.2d 700 (10th Cir. 1976)
• Defined value clause – adjusts number of interests
transferred to reflect fixed dollar amount
• See Wandry, T.C. Memo 2012-88
• Value allocation clause – allocates any gift among
taxable and nontaxable donees
• See McCord, Christiansen, Petter and Hendrix
41Practice Pointers – Gift Tax Returns
• File timely return by 4/15 of year following the gift
• Be careful with descriptions
• Allocate GST exemption to gift using formula
allocation clause
• Determine whether to report sale on gift tax return
• Arguments for reporting
• Arguments against reporting
42Practice Pointers - Privilege
• Maintain attorney-client privilege
• “Intermediary doctrine” covers privilege where working
with agent of client to implement planning
• See Baylor, 130 F. Supp. 3d at 330 (“In considering whether a client’s
communication with his or her lawyer through an agent is privileged
under the intermediary doctrine, the ‘critical factor’ is ‘that the
communication be made in confidence for the purpose of obtaining
legal advice from the lawyer.’”)
• Engagement agreement should specifically name
agent(s) and authorize communications with them
43Thank You!
Presentation Disclaimer: This presentation should not be considered as legal, tax, business, or financial advice. This presentation is intended
for educational and informational purposes only. It is provided with the understanding that while the authors are practicing attorneys, neither
they nor Koley Jessen has been engaged by the attendee/reader to render legal advice or other professional services. If legal advice or other
44
expert assistance is needed by the attendee/reader, the services of a competent professional should be sought.You can also read
