Shrink your estate without losing value Featured

7:00pm EDT February 28, 2007

After spending your life building a successful company and a level of wealth, the last thing you want to happen upon your death is for the government to take all of your money.

“There is a way to limit or eliminate altogether estate and gift taxes and allow for estate tax-free future asset growth,” says Chris T. Christensen, president and CEO of The Advanced Strategies Group, Inc. in Southfield.

Smart Business talked to Christensen about a strategy that enables business owners to shrink their estate without losing value for their heirs.

How can clients allow for estate tax-free future asset growth?

This is accomplished by using an installment sale to a grantor trust that allows the transfer of assets to heirs without gift, estate or capital gain taxes and also allows the appreciation of assets to accrue to the heirs, not to the owner of the estate. This planning strategy works by creating an irrevocable trust for the benefit of the next generations of family members. The trust is designed so that the grantor is taxed on the trust’s income but the trust’s assets are not taxed in the grantor’s estate.

The trust can also be designed as a generation-skipping trust so that any assets remaining inside the trust at a child’s death pass estate tax-free to the grandchildren and maybe even the great-grandchildren. This arrangement also protects the trust’s beneficiaries from lawsuits, including divorces.

How can a client start an installment sale plan?

The grantor makes a gift to the trust as ‘seed money,’ which should be at least 11.11 percent of the value of the assets to be sold to the trust. This gift will consume part or all of the grantor’s $1 million ($2 million if married) lifetime gift-tax exemption. This gift can be made using cash or the same property to be sold to the trust.

The grantor subsequently sells assets to the trust, which will return more profit than the cost of the interest on the note given in payment. Usually, there is no down payment, interest is payable annually, and there is a balloon payment that would be due at the end of a set term lasting nine years or longer. The assets sold to the trust — which must generate income for interest payments — may qualify for valuation discounts for lack of marketability and control. For example, nonvoting interests in an LLC or a Subchapter S Corporation are good assets to sell to a grantor trust. The interest rate on the note is fixed for the entire term at the lowest rate allowed by the IRS.

Is this technique of an installment sale the most efficient method of transferring wealth?

It is one of the most efficient methods for transferring large amounts of wealth because the tax benefits are very significant. The grantor does not recognize a gain on the sale because the grantor and the trust are treated as one in the same person for income tax purposes. The grantor is not separately taxed on the interest payments received. Instead, the grantor is taxed on all of the trust’s income. Moreover, if the trust makes interest payments using some of the assets purchased instead of cash, the grantor recognizes no income and is instead taxed on all of the income from the property of the trust.

In fact, the grantor is making tax-free gifts to the beneficiaries by paying the trust’s income tax. If the total return on the assets sold to the trust exceeds the interest rate on the note, the excess is transferred tax-free to the beneficiaries. The transfer tax benefits are enhanced by the grantor’s payment of the trust’s income taxes. Basically, the trust grows income tax-free. These excess trust assets can be reinvested however the grantor decides, including acquiring life insurance on the grantor and/or their spouse’s life. If the trust is designed as a generation-skipping trust, the assets inside the trust can escape estate taxes in the estate of the children, grandchildren and perhaps great-grandchildren.

Any final thoughts?

Selling assets on the installment method to a grantor trust allows for the income tax-free transfer of appreciating property outside the estate and enables making tax-free gifts in the form of income tax payments on trust income. These tax advantages — plus the asset protection afforded to beneficiaries— make the sale to a grantor trust an outstanding wealth transfer technique.

CHRIS T. CHRISTENSEN is president and CEO of The Advanced Strategies Group, Inc. Reach him at (248) 359-2480 or CChristensen@AdvancedStrategiesGroup.com.