KISS or Make Up?
Worth Magazine, February-March 2013
When it comes to legal strategies for gift and estate planning, should you keep it simple—or resort to more complicated approaches?
Not too long ago, a prospective client came to my office to discuss some elaborate planning techniques he had read about in a financial magazine—not this one—that promised to eliminate all his taxes. I asked whether he had deployed some simpler techniques often utilized in his line of work. He had not. I explained that I believe in the “KISS” method of planning—keep it simple, stupid. Thinking I was calling him stupid, he rose from his chair and stormed out of my office. A sad ending to a short relationship.
People often overlook easy solutions to their legal problems that work as well or almost as well as more expensive and complicated ones. Which make more sense for you—off-the-rack strategies or custom-made ones? From an income, gift and estate tax planning stand-point the answer is…both. For example, vanilla techniques such as GRATs, irrevocable life insurance trusts and family limited partnerships can often accomplish gift and estate objectives at a relatively minimal cost. Other situations require more elaborate planning.
Most of my clients are savvy companies, executives and investors who come to me because they have the basic strategies in place, but have complicated problems. This week alone I worked on finding the most tax efficient way to spin off a subsidiary, maximizing the use of foreign tax credits against future foreign dividends, determining how best to utilize losses from some business activities against the profits of others, and the best way to buy out a partner and arbitrage the IRS—all matters that required custom solutions.
Sometimes you can get the result you want by combining multiple strategies. For example, some people will utilize their unused lifetime estate and gift tax exclusion by simply gifting cash and/or securities to their children or grandchildren. The shift will remove the gifted amount from the person’s estate. Easy enough.
But what if a single per-son owns a substantial real estate portfolio or business assets likely to appreciate substantially over his lifetime? This is where complexity can help. One option is to con-tribute these properties and business assets to a family limited partnership. Then, after waiting a reasonable period of time (about a week), some or all of the partnership interests could be sold at a discount from the value of the underlying assets (because of their lack of marketability and control rights) to a trust for the benefit of future children or grandchildren. The trust would be funded with cash or securities equal to the giver’s remaining lifetime exclusion amount. The amount contributed to the trust doesn’t generate any gift or estate tax to him and, because of the type of trust utilized, the sale does not result in any gain to him. Instead of the trust paying only cash for the limited partnership interests purchased, it pays some cash and also gives an interest-only, 20-year note paying interest at the lowest rate permitted under the tax laws (now about 2.4 percent per annum). The leverage of the note permits the purchase of a much greater amount of discounted limited partnership interests.
This strategy allows for the removal from the estate of the amount of the difference be-tween the purchase price paid by the trust for the partnership interests and the actual value of the underlying assets purchased. It also removes from the estate any future increases in value of the purchased partnership interests. The interest paid on the note from the trust is included in the estate, but the interest is neither taxable to the recipient nor deductible by the trust or its beneficiaries, while gain on the sale of any of the underlying properties allocated to the trust is taxable to the grantor and not to the beneficiaries. The payment of the income tax by the grantor on this gain is really an additional gift to the beneficiaries, but it isn’t taxed that way, creating an additional estate tax benefit.
I love KISS. But sometimes simplicity isn’t enough.