•an attempt to fix, at a low amount, the value of an asset in a taxpayer’s estate
Define Estate Freeze
•successors might not be adequately prepared to take over
•current owner may wish to retain control over some activities
•senior family members may want or need to retain income from business operations
Why are Estate Freezes often preferable to outright gifts?
In determining whether the transfer of an interest in a controlled corporation or partnership to (or for the benefit of) a member of the family of the transferor (a) is a gift and (b) the gift tax value of such gift, the value of certain retained rights with respect to an applicable retained interest held by the transferor or an applicable family member immediately after the transfer is generally deemed to be zero.
What is IRC Sec. 2701
•marketable transferred interests
•marketable retained interests
•interests in the same class of stock
•Retained preferred providing “qualified payments” (i.e., cumulative preferred dividends at a specified market rate)
When does Section 2701 does not apply*?
•retained rights to qualified payments are valued under normal valuation principles
•Qualified Payments are dividends payable under cumulative preferred stock, to the extent the payment is determined at a fixed rate.
What are the Exceptions to Sec. 2701: Qualified Payments*?
•The total common stock of the corporation may not be valued at less than 10 percent of the sum of
What is the Sec. 2701 Minimum Value Rule?
–the total value of all stock interests in the corporation plus
–the total indebtedness of the corporation to the transferor or an applicable family member
How is the Sec. 2701 Minimum Value Rule?
•effective estate reduction technique
•gift tax issues --present interest gifts can be achieved
•gift tax value of partnership interests is discounted
•facilitate income shifting
•more flexible than trusts or corporations with respect to distributions and allocations of income
•senior generation can maintain control
•asset protection is available
•virtually any business can be conducted in a family partnership
•avoid ancillary probate
What are the Advantages of Family Partnerships*?
•if the partnership is structured to restrict limited partners’ rights, a willing buyer would pay substantially less for the partnership interest
What are Marketability Discounts
•generally, no discount is available to the general partner
Is a Marketability Discount available to a General Partner?
–income shifted to the next generation will avoid inclusion in the donor’s estate
–lower family income taxes may result
What are the Advantages of Income Shifting with Partnerships
–the capital of the partnership must be a material income-producing factor
What are the Requirements of Income Shifting with Partnerships
•Exclusive Remedy to Creditors: The Charging Order
- –Creditor becomes entitled to the debtor’s distributions from the partnership until the debt is satisfied
•Fraudulent Transfer Laws may apply
What is Creditor Protection
•alternative to entity owned life insurance
What is a Family Life Insurance Partnership (FLIP)
–form a partnership under state law
–partnership applies for, owns, and is the beneficiary of life insurance
–policy premiums are paid for out of partnership assets
–at death of insured, partnership can continue or be terminated
How is a Family Life Insurance Partnership (FLIP) Structured
•heirs receive partnership interests as gifts, which can be designed to qualify for the $14,000 annual exclusion
•when the insured makes gifts to the partnership to pay premiums, these additional gifts qualify for the annual exclusion to the extent of each child’s or grandchild’s percentage ownership in the partnership.
What is the impact of a FLIPs on Gift Taxes
•unlike an ILIT, the insured can control and manage the partnership
•FLIPs can be funded –annually, or –by placing sufficient investment assets into the FLIP to make premium payments
What is the impact of FLIPs on Partnership Control*?
•the senior family member’s estate is potentially reduced by the amount of the gifts made to the FLIP
•only a portion of the death benefit will be included in the insured-partner’s gross estate –assuming the policy is not payable to the executor of the insured’s estate
What is the impact of FLIPs on Estate Taxes*?
•useful when the insured wants to retain maximum flexibility and control
•if insured feels that future access to the policy or changes in the dispositive scheme may be necessary, the FLIP is preferable to an ILIT
•the FLIP will be more favorable than an ILIT if the partnership will hold substantial other assets besides a life insurance policy.
How is a FLIP useful for Estate Planning?
•any sale in which at least one principal payment is received in a year other than the year of sale
•seller can use –installment reporting provisions, or –elect to use normal accounting and recognize all gain in the year of sale
What are Installment Sales
•taxable gain on sale is delayed and recognized gradually over time •election to treat gain currently can be advantageous
•freezes seller’s estate and shifts potential appreciation to junior family members
•buyer can defer some or all of the principal payments on the sale
What are the Advantages of Installment Sales
•Buyer gets immediate cost basis equal to purchase price
•Interest paid by buyer is potentially deductible for income tax purposes
•tax rules give target rates of interest on installment obligations
•imputed interest rules (IRC Sec. 483)
•original issue discount (OID) rules (IRC Secs. 1271-1274)
•Adverse income tax consequences if sold to a family member who re-sells within 2 years
What are the Income Taxation charactericstics of Installment Sales
•value of remaining payments included in estate
•remaining installments are treated as IRD –IRD items are not eligible for a step-up in basis under Section 1014
•Liquidity problems may result
What happens to Estate Tax when an Installment Sale seller dies prematurely
•seller has highly appreciated property
•seller wants to transfer future growth out of the estate
•seller wants to retain a security interest in the property
•seller can afford to finance buyer’s purchase
When are Installment Sales are useful?
•a sale of property in exchange for buyer’s agreement to make payments for the remainder of the seller’s life
•obligor cannot normally be in the business of providing commercial annuities
•value of payments considers mortality and is determined under Section 7520
What are Private Annuities
•no estate tax inclusion of any portion of the private annuity agreement •transfer tax advantages are lost if the annuity is not equal in value to the property transferred
- –gift taxes may result
- –valuation of property may be disputed
- –actuarial tables cannot be used to value the life annuity if there is less than a 50% chance that the seller will survive one year
What is the impact of Private Annuities on Transfer Taxes
•gain on sale is recognized at closing expectancy
•Not indicated normally unless gain is minimal or seller has substantial losses to offset
What are the Income Tax Considerations of Private Annuities
•since the value of a fixed annuity payment goes up when interest rates decline, a private annuity will be a more valuable estate reduction technique when interest rates are relatively low
What is the relationship between Private Annuities & Interest Rates*?
•No Gain recognition for transfers between grantor trusts or between grantor and trusts
•No gift if grantor pays income taxes on irrevocable grantor trust
•Adverse estate tax consequences only if the trust must reimburse grantor for income taxes
•Watch out for interpretations beyond the rulings
What is a Defective Trusts
•Completed gift of initial contribution
•Trust principal excluded from gross estate
•Income tax paid by grantor
•Sale to grantor trust ignored for income tax purposes
•Carryover or stepped-up basis?
What is th Nexte Tax Treatment of Sale to IDGT
•H buys policy on W’s life
•W buys policy on H’s life
•When an insured dies, the proceeds are not in the estate of the insured
- –Provides for survivor
- –Might have estate tax savings
•Does not change result of income tax free receipt of death benefits
What is Cross Ownership of Life Insurance