Do you have a family? A wife? Kids? Grandkids? Also, do you own all or part of a business? Then this article is for you. This is the estateplanning story of a real-life column reader from the Midwest. Joe (grandpa) is married to Mary. They have three kids: Jack and Jill work in Joe's business (Success Co.) and Jay is a schoolteacher. Interesting. Jill (the youngest child) is the clear leader.

All the kids are married. There are eight grandchildren (and I was told the production facilities are closed).

Joe and Mary are worth $18.5 million, including Success Co. (professionally valued at $10.7 million), two homes worth $1.8 million, a 401(k) worth $0.9 million, various investments, worth $4.9 million (including business real estate leased to Success Co. and a stock/bond portfolio). Finally, there is a $1.3 million (death benefit) life insurance policy on Joe with a $200,000 cash surrender value.

Grandpa and grandma’s estate plan

If Joe and Mary both got hit by the proverbial bus today, the estate tax monster would gobble about $3.4 million. What’s more, because Joe and Mary earn (every year) more than they spend, their potential estate tax burden will continue to rise.

Following are the basic strategies we used to beat up the estate tax monster:

An Intentionally Defective Trust (IDT) used to transfer Success Co. to Jack and Jill tax-free (no income tax, no capital gains tax).
Before the transfer (really a sale) to the IDT, we created voting stock (100 shares) and non-voting stock (10,000 shares), a tax-free transaction. Only the non-voting shares were sold to the IDT.

The tax law allows a 40 percent discount on the non-voting shares, yielding estate tax savings of over $1.7 million. Joe kept the voting stock and control of Success Co.

Important exception

About 60 percent of this column’s business owner readers, such as, for example, Scott are not well-to-do like Joe. The facts are almost the same or similar to Joe's, but the various assets owned, including Scott’s Success Inc., are only about 20 percent of the numbers shown for Joe, (i.e., Success Inc. is only worth about $2.14 million).

A major issue for the Scotts of the world, is to make sure that Scott and his bride can maintain their lifestyle if they live to a ripe old age. In such cases, instead of an IDT, we use a strategy called a Spousal Access Trust (SAT). Why? An SAT removes Success Inc., from Scott’s estate (the kids now own it), but Scott and Sue continue to get the income from Success Inc. for as long as they live. 

Lifestyle issue solved

Family limited partnership (FLIP) used to protect the investments.

The tax law allows a 35 percent discount of $1.7 million (35 percent X $4.9 million) for the so-called “limited partnership units”, (LPU) reducing the estate tax by about $0.7 million.

Gifting programs

Joe and Mary can gift $14,000 to each donee (here we have his three kids and eight grandkids) every year for a total of $308,000 per year (11 donees @ $14,000 = $154,000; $154,000 X 2 = $308,000). WOW!

The start of an estate plan for the kids

Dynasty Trust (DT): The gifts in our gifting program above will be the LPU portion of the FLIP. The gifts will be made each year to a DT, a truly dynamic estate tax saver. A separate DT trust will be created for each of the three kids. Each kid can enjoy the income from their trust for life and when he or she goes to heaven, their kids (Joe’s grandkids) will enjoy the income; and then the same for each future generation.

Why is the DT so dynamic? The assets in the trust, in effect, pass from generation to generation, but are free from the grasp of the estate tax monster.

What if one (or more) of the kids gets divorced? The documents are drawn in such a way that if one of the kids (or grandkids) gets divorced, the ex-spouse will not get any of the family wealth.

What about the grandkids? A separate trust is set up for each grandkid to receive the LPU gifts described above. Each trust will provide for the child’s education, down payment on a home and ultimately, retirement — all at appropriate ages.

Other considerations

A buy/sell agreement concerning Success Co., covering Jack and Jill, was created.

Life insurance: The buy/sell agreement is insurance-funded. The $1.3 million policy on Joe’s life was dropped with Joe pocketing the $200,000 CSV (tax-free). A $3 million second-to-die policy on Joe and Mary was purchased in the IDT (proceeds will be tax-free). Each (of the three) DT bought a $2 million policy on each kid to help fund the lifestyle of their kids (the grandkids of Joe and Mary).

And finally, Joe and Mary's plan not only eliminated the estate tax, but because of the new life insurance, will create a surplus.

And yes, the kids (and even the grandkids) have a good start on their estate plans.

Want to learn more about how to kill the estate tax monster. Browse my website: www.taxsecretsofthewealthy.com. Any questions, call me, Irv, at 847-674-5295 or email me ([email protected]).