Trusts, Partnerships Help Wealthy Take Sting Out of Taxes

By AMANDA BRONSTAD

Staff Reporter

Since it’s been well established that you’re not going to take it with you, a considerable amount of effort has been put into maintaining accumulated wealth for the next generation.

Children, among other benefits, can provide a vehicle for the retention of wealth through a series of maneuvers to shield it from the burden of estate and gift taxes.

But without early planning, say money managers, tax planners and insurance consultants, children could end up paying enough taxes to cut once vast estates by half.

“Your family will pay a lot of money to the IRS within a nine-month period after your death,” said Len Brisco, an advisor at Merrill Lynch’s private wealth center in L.A., which serves clients with $10 million or more in assets. “To the extent you can lower that amount during your lifetime, you should do that. The easiest example is to gift money to your children.”

Here are some ways in which rich parents reduce their tax bill:

Trusts

There is truth behind the phrase “Trust Fund Babies.” When money is passed directly from one generation to another, it is subject to gift or inheritance taxes. By allotting the money to trusts, parents avoid those taxes.

One form of trust, or account, is set up under the Uniform Trust for Minor’s Act, or UTMA. These non-taxable entities are typically set up shortly after a child’s birth with after-tax dollars.

Another example is a charitable lead trust, which allows the wealthy to give an allowance to their children, written off as donations rather than income. “A parent can put money into a trust, and each year, the trust has to pay out its income to a charity,” Brisco said. “At the conclusion of the trust, say in 10 years, the kids get to keep whatever remains.”

A similar product is a charitable remainder trust, where the child receives a percentage income of the trust’s income. The remainder goes to charity.

A grantor retained annuity trust, or GRAT, typically lasts three to five years and allows a business owner to put money or stock into the trust. The children receive appreciation on the principal, tax free.

“Say you have Cisco Systems stock,” said Andrew Katzenstein, a partner at Katten Muchin Zavis Rosenman. “You might put that into a GRAT with the assumption it’ll go up and you’ll get paid back the current value, plus interest, when it concludes in three years. If your children are the beneficiaries, they keep everything over and above.”

Another trust is a qualified personal residence trust, which allows parents give their home or vacation home to their children as a gift without paying inheritance or estate taxes after they die.

Exclusions, Exemptions and Credits

The standard $3,000 exemption most parents claim on their tax returns amount to very little for the ultra rich. “If you make $50 million a year, $3,000 is a rounding error,” Brisco said.

Many parents start by giving up to $11,000 per year (recently upped from $10,000) to their children, the maximum allowed without incurring a gift tax.

For those with greater resources, there is the unified credit, which allows parents to pass along up to $1 million during their lifetimes to their child, without paying gift or estate taxes.

“Each year you can give $11,000 without dipping into your lifetime $1 million credit,” Brisco said. “Say you own a company and want to gift your son $50,000 worth of stock in the company. Eleven thousand dollars of that is part of the annual gifting amount. The other $39,000 would apply to the $1 million lifetime exemption.”

An option for grandparents is the generation-skipping tax exemption, or GSTE. Under this exemption, up to $1 million of their estate can be passed to grandchildren without having to pay taxes. If the money were to flow through the children and then the grandchildren, it would incur taxes at each transfer, said Jeffrey Forer, a partner at Weinstock Manion Reisman Shore & Neumann Corp. Without the GSTE, a $1 million gift could end up being $150,000 after taxes, he said.

Often in cases where parents are divorced or were never married, one can use gifts for tuitions or medical expenses without incurring taxes.

Family Limited Partnerships

Family limited partnerships, where parents are general partners and the children are limited partners, can be especially useful for family businesses.

Partnerships allow business owners to transfer stock in their company to their children, while obtaining a 30 percent discount on gift taxes. The federal government gives the discount because, under a partnership, the children have no control over the assets and the stock is not marketable publicly, he said.

Whether the same discount can be applied to public stock is a fuzzy issue.

“Public stock is threading the needle a bit, but it can work,” Forer said. “You have to be creative and understand there’s always a risk the IRS will say you’re being a bit piggish and challenge it. But as long as the client understands that, that’s fine.”

Insurance Policies

Wealthy parents will often take out life insurance policies naming a trust as the beneficiary so their kids don’t have to pay estate and inheritance tax on the payout, said Marvin Mandelbaum, owner and president of Mandelbaum Insurance Services in Beverly Hills.

Parents also use a single premium life insurance policy or a “second-to-die” insurance policy to cover inheritance taxes. The second-to-die policy pays out only on the death of the surviving parent, which triggers the passage of the estate to the next generation.