Estate Freeze Trust
What Is An Estate Freeze Trust?
If you are blessed to have an estate large enough to be concerned about estate taxes even after other typical planning techniques such as Shelter Trusts, ILITs and aggressive annual gifting have been exhausted, then it may be worthwhile to engage in sophisticated "freeze" techniques. The specialized trusts used in conjunction with such freezes, if they work as planned, are tailored to push future growth in value outside your taxable estate. The most optimal assets for these trusts are those expected to appreciate greatly in the future. Business owners sometimes use these trusts to combine their interest in minimizing taxes with incrementally transferring control of the business to children.
Grantor-Retained Trusts (GRATs, GRUTs, and GRITs)
An irrevocable grantor-retained annuity trust (GRAT) is one way to transfer assets from your estate at a discount, freezing the value retained by your estate. The IRS discounts the GRAT below its actual value provided that two requirements are met:
You must receive an annuity payment from the GRAT for a fixed number of years based upon IRS tables. The payments reduce the value of the gift to the heirs for tax purposes, because the heirs do not have immediate full use of the GRAT assets. The longer the retained-annuity period, the lower the value of the remainder interest in your estate. If you die before the end of the GRAT period, its assets, including growth, revert to and are includable in your estate. If you outlive the termination date, the GRAT's assets are excluded from your estate. One drawback of the "successful" GRAT (where you outlive its terms) is that the heirs receive a "carryover" basis. In other words, with no stepped-up basis on appreciated assets your beneficiaries may eventually have to pay capital gains taxes.
An irrevocable grantor-retained unitrust (GRUT) is similar to a GRAT. The difference is that with GRUTs, assets placed in the trust are reappraised each year, and the amount of the income received by you is adjusted accordingly. This might seem like a bother and it certainly leads to further annual accounting fees, but it helps ensure that if inflation takes off the income you receive from the trust will increase. That could be important if you require the income-but it also may shield less of the assets from estate taxes.
A grantor-retained income trusts (GRIT) directs that you receive the income generated by the trust assets, if any, for some preset period of time rather than an annual fixed dollar amount, as in a GRAT. GRITs have become less effective freeze tools over the years due to strict disallowance of family members as beneficiaries. The only type of GRIT exempt from these limitations is the qualified personal residence trust (QPRT), which is now the most popular form of GRIT.
What is an Installment Sale?
Installment sales are often the simplest tools used to transfer family businesses, removing the business from your estate and providing you with income. Upon the sale however, you must pay a capital gain.
An installment sale to an irrevocable Intentionally Defective Grantor Trusts (IDGTs), exploits inconsistencies between income-tax rules and estate-tax rules. They allow you, as grantor, to shift an asset out of your estate for estate-tax purposes while continuing to act as owner for income-tax purposes. By paying the income taxes, you shift even more assets from your estate. In contrast to GRATs and GRUTs and a regular the installment sale, the IDGT approach does not trigger a capital gains tax upon the transfer of appreciated assets and may result in a step-up in basis upon your death, eliminating capital gains to your heirs as well.
IDGTs are typically used to freeze the value of a family business or real estate and involve part sale (usually about 90 percent of its value) and part gift (the remaining 10 percent). The sale portion of the transaction usually involves the use of a self-liquidating installment note over a number of years leading to a balloon payment on the due date. The IDGT strategy often includes life insurance purchase by an interest-only note with payment of the principal becoming obligatory only upon your death.
Since sophisticated estate freeze techniques involving trusts require considerable bookkeeping along with significant or total loss of control over the asset that funds the trust and the IDGT in particular tends to attracts IRS scrutiny, their use is appropriate only for large estates where estate taxes will have to be paid.
If you live in the Chicago or Lake County area, and need an experienced Trust attorney, please contact Matlin and Associates.
Types of Trusts We Establish:
- Estate Planning
- Probate & Trust Administration