Duct Tape Estate Planning

When you head off
into the backwoods it’s always good to take duct tape (usually wrapped around
an old pencil stub). Use it to patch a tent, as a bug catcher, to close a
wound, and to fix almost anything. Similar creativity can be brought to your
estate planning. Standard techniques can be used in creative ways to better
meet whatever issues arise. We’re not speaking of new fangled exotica that are
soon to be on the IRS hit list, we’re speaking of common planning techniques
applied creatively (just like duct tape). Here are a few ideas:

o FLP/LLC:
Standard Use: Family
limited partnerships (FLPs) and limited liability companies (LLCs) are often
used to secure discounts for gift and estate tax purposes. You transfer real
estate, securities, etc. to an LLC and give gifts of small percentages. The
value of those gifts is invariably less than a pro rata percentage of the whole
(e.g., 10% of an LLC owning $750,000 of real estate is worth less than $75,000)
because a non-controlling interest is worth less than a pro rata amount. Tailored
Use: You invest in private
equity and other deals. If you die, or wish to make gifts, the process of
changing ownership of those assets is potentially costly and complex. Your
private equity deal may require an opinion of counsel, general partner approval
and more. Instead, if you make these types of investments using your FLP/LLC,
you might avoid these transfer difficulties if you later make gifts, or on
death when these interests are transferred to various trusts under your will.
You may not need to incur any additional costs or jump any extra hurdles if
your LLC, and not the underlying private equity deals, are transferred.
Caution: the accredited investor rules differ for a partnership and may have an
impact when you invest. Rule 501 requires greater than $5M net worth for a
partnership, in contrast to greater than $1M for an individual, to be an
accredited investor. Key:
The FLP/LLC is not only for discounts, it facilitates transfers and succession
of passive assets, while minimizing transfer costs.

o FLP/LLC:
Standard Use: Discounts
– see above. Tailored Use: The “transfer for value rule” can taint the proceeds of your
life insurance policy as being subject to income tax! This would be a
devastating tax result. This costly rule can apply if your insurance policy is,
for example, sold. There are a limited number of exceptions in the law that
have to be carefully followed to avoid this dilemma. If the purchaser of the
policy is a partner with the insured (i.e., you) this adverse tax result may be
avoided. You could set up an investment FLP/LLC for discount, asset protection
and other purposes, and then have your insurance trust (ILIT) invest as a
partner in the FLP/LLC. When the sale later occurs to your trust, the exception
may apply because the trust is your partner. Key: The FLP/LLC is not only discounts, it
can help you avoid the transfer for value rules thus preventing life insurance
proceeds from being subject to income tax.

o 1 Member LLC:
 Standard Use: A limited liability company (LLC) is used
to own a business or rental property so that a lawsuit against either won’t reach
your personal assets. If you’re the only member of the LLC, the entity is
ignored (disregarded) for tax purposes.  Tailored Use:  Adding a few
creative paragraphs in your LLC operating agreement (the document governing the
operation of your LLC) can create an inexpensive and effective disability and
succession plan. Name yourself as manager (the person to operate the LLC, which
you were doing as a member/owner, just now its formally addressed). Include
provisions governing what a manager can do. Name a successor manager in the
event you are disabled or die. These few steps provide a succession plan to
protect your investment in the event of your disability or death. Key: It’s not only asset protection planning,
its business succession planning.

o GRAT: Standard
Use: A grantor retained
annuity trust (GRAT) is a tax oriented trust to which you transfer assets,
receive an annuity for a set number of years, and at the end of which your
heirs (e.g. children) receive the assets. The benefit is a reduction in the
value of the assets for gift tax purposes. A typical GRAT scenario might be a
short 2-3 year GRAT funded with the most volatile securities in your portfolio,
or a private equity deal you hope will balloon in value. The goal is to remove
upside appreciation. However, if you’re a physician worried about malpractice,
perhaps a long 20 year term GRAT designed to give you an annual annuity might
be a better bet. With many short term GRATs much of principal is returned to
you via the annuity payments, back to the reach of your creditors. In a long
term GRAT the principal can be tied up in an irrevocable trust until after you
retire. The annual annuity payment are reachable by a claimant, but the
principal is in an irrevocable trust. Same technique, same governing legal
document, but completely different application. Key: It’s not only about gift tax
minimization, but asset protection as well.

o CLT:  Standard Use: Charitable lead trusts (CLTs) are a
great charitable and gift planning technique. You can gift a large sum to a
trust. A charity receives a periodic distribution for some number of years, say
6% of the value, paid annually for 20 years. The result is a dramatic reduction
of gift tax cost on a large transfer of assets that will be received by your
heirs (e.g. children) in 20 years. Great gift tax play. Tailored Use: Spin this by setting up a separate CLT
for each child and match the term  of each CLT to the number of years until each child reaches
retirement age, say 65. Key: You still have a gift tax benefit, but now you’ve effectively
given each child a retirement plan. If your heirs blow their inheritances,
these funds will be preserved for their later years.

o Pre-Nuptial
Agreement: Standard Use: Prenups are done to protect your assets if your new marriage
doesn’t succeed. Tailored Use: A prenup can also be used to supplement your asset protection
planning. Mandating separate accounts and assets, the preparation of married
filing separate tax returns from separate data (so that each of you and your
spouse have separate tax data to submit in the event of a suit or claim) even
if a joint return is filed; and more. Key: Prenups can do more than protect
assets from divorce, they can establish procedures and structure to backstop
your asset protection planning.

o QPRT: Standard
Use: A Qualified Personal
Residence Trust (QPRT) is a special trust used to transfer ownership of your
home to your heirs (e.g. children) at a discount from its current value. You
gift your house to a QPRT and reserve the right to live in the house for a
specified number of years, typically 5-10 years. After that time period the
heirs own the house. Often you’ll reserve the right to continue to lease the
house after that term at fair value. Tailored Use: While QPRTs are typically used by older
taxpayers to save estate tax, you might consider using a QPRT even if much
younger. You’re considering accepting a position on a board of directors and
are concerned about the potential liability. You transfer your house to a QPRT
for a 25 year term, lasting into your retirement. In the event of a later suit
or claim, absent a fraudulent conveyance, the house is owned by an irrevocable
trust with remainder beneficiaries having an interest in the trust’s property. Key: A QPRT can be more than just an estate
plan, it can be part of your asset protection plan to protect your house.