Welcome to the Council of Metro Detroit

Welcome to the Council of Metro Detroit
Financial and Estate Planning Council of Metro Detroit Presented by: Mike Halloran

Michael W. Halloran, AEP®, CLU®, CFP®, ChFC®
THE BENEFICIARY DEFECTIVE INHERITOR’S TRUST (“BDIT”) “A Powerful New Wealth Planning Strategy” Michael W. Halloran, AEP®, CLU®, CFP®, ChFC® ©2010 Richard A. Oshins and Robert G. Alexander

A Special Acknowledgement
The Beneficiary Defective Trust, the original version of the BDIT, was created by attorney Richard A. Oshins in the 1970’s. In the ensuring years, under his tutelage, the concept has gained prominence in estate and asset protection planning among top attorneys around the nation dealing with high-net-worth individuals and families. Grateful acknowledgement is given to his origination and further development of the BDIT and related strategies. ©2010 Richard A. Oshins and Robert G. Alexander

©2010 Richard A. Oshins and Robert G. Alexander
Topics Primary high-end wealth shifting strategies The BDIT Concept Benefits Tax Creditor protection Client does not give up control Modern wealth design Enhancing the value of gifts and bequests ©2010 Richard A. Oshins and Robert G. Alexander

Topics – cont. The squeeze, freeze and burn Enhanced IDITs for estate tax depletion planning Funded ILIT – the BDIT can buy life insurance on The client/beneficiary Others with an insurable interest Life insurance correlation with the BDIT ©2010 Richard A. Oshins and Robert G. Alexander

Topics – cont. Clients with business or investment opportunities Planning with pass-through entities Doctors and business owners with equipment leasing Buy-sell strategies ©2010 Richard A. Oshins and Robert G. Alexander

Topics – cont. Advanced asset protection strategies Self-settled trusts Income tax strategies Estate planning for professional athletes and entertainers Other planning opportunities ©2010 Richard A. Oshins and Robert G. Alexander

Primary Planning Choices for High-End Wealth Shifting
GRAT – IRC §2702 Gift to trust in exchange for an annuity substantially equal in value to the transferred property IDIT – Note Sale Non-controlling interest sold to an income tax defective trust in exchange for an installment note Generally interest only with a balloon payment ILIT ©2010 Richard A. Oshins and Robert G. Alexander

Primary Planning Choices for High-End Wealth Shifting
These techniques involve moving wealth to trusts created for someone else: Wealth depletion concerns – no direct access Control concerns Loss of control IRS exposure with too much retained control A better alternative – the BDIT “The Beneficiary Defective Inheritor’s Trust” ©2010 Richard A. Oshins and Robert G. Alexander

Major Causes of Wealth Erosion in the U.S.
Bad Investments/management Taxes Divorces Lawsuits Beneficiary/family problems Bad economy Changes in the law ©2010 Richard A. Oshins and Robert G. Alexander

The Client’s “Wish” List
Save taxes Creditor and divorce protection Control over the plan - assets and income Full use and enjoyment of the plan assets The right to decide who else uses or gets the property And when and how they get the property Multi-generation/perpetuity The ability to re-write the plan as needed ©2010 Richard A. Oshins and Robert G. Alexander

Fundamental Facts of Wealth Planning
Trusts enhance gifts and bequests Inheriting in trust is better than inheriting outright Trusts offer many significant advantages that cannot exists for assets owned outright Assets received and retained in trust are more valuable to the inheritor than assets received outright ©2010 Richard A. Oshins and Robert G. Alexander

Fundamental Facts of Wealth Planning - cont. -
A trust shelters inherited assets from the beneficiary’s Taxes Transfer taxes Income taxes Would be claimants Creditors Divorcing spouses ©2010 Richard A. Oshins and Robert G. Alexander

The Ultimate Creditor and Creditor Protection Vehicle
A discretionary trust with “. . . the distribution discretion held by an independent trustee is the ultimate in creditor and divorce claims protection – even in a state that restricts so called ‘spendthrift’ trusts – since the beneficiary himself has no enforceable rights against the trust.” (Emphasis supplied) Frederick R. Keydel “Trustee Selection, Succession, and Removal: Ways to Blend Expertise with Family Control,” 23 U.Miami Inst. On Est. Plan., Ch 4 (1989) at §409.1 ©2010 Richard A. Oshins and Robert G. Alexander

Overlooked Benefit – Particularly in Today’s Volatile Economic World
Trusts enable the beneficiary to borrow for business or investment purposes without exposing trust-owned assets to risk Lending institutions typically require personal guarantees of business owners and their spouses ©2010 Richard A. Oshins and Robert G. Alexander

The Tax and Creditor Rights Impediments
Income Tax – grantor trust Estate Tax – grantor trust Creditor rights – self-settled trust Estate tax inclusion Creditor rights can create serious income and wealth transfer tax issues! Also, watch distribution standards and who is (are) the trustees ©2010 Richard A. Oshins and Robert G. Alexander

The BDIT Solution Anyone other than the client him/herself can set up and fund the trust Key Concept: The trust must be set up and funded by someone else The beneficiary cannot make “gifts” to the trust ©2010 Richard A. Oshins and Robert G. Alexander

Question #1 Can I set up a trust for my descendants which will avoid their: Transfer taxes, and Creditors, including divorcing spouses In perpetuity Chapter 13 GSTT rules ©2010 Richard A. Oshins and Robert G. Alexander

The Typical Inheritor’s Trust
A trust set up and funded by someone else Generally as an accommodation ©2010 Richard A. Oshins and Robert G. Alexander

Transfer Tax Consequences
Measured by the amount of the contribution Subsequent growth of the assets is irrelevant GSTT exempt forever ©2010 Richard A. Oshins and Robert G. Alexander

Question #2 What are the income tax consequences of a gift subject to a Crummey power of withdrawal? IRC §§ 678 and 671 Beneficiary income tax status Trust income is taxes to the beneficiary Remember – the income tax provisions and the estate/gift tax provisions of the IRC are not interpreted in paria materia! ©2010 Richard A. Oshins and Robert G. Alexander

Tax Consequences of an Income tax Defective Trust Including a BDIT
Rev. Rul Non-recognition of gain of sales The “tax burn” ©2010 Richard A. Oshins and Robert G. Alexander

The “Tax Burn” Concept Estate depletion as a result of paying income tax on trust assets Less assets exposed to estate taxes Less assets exposed to creditors Trust assets grow income tax-free during the “Grantor” trust status Over time the wealth compounding is more powerful than discounting ©2010 Richard A. Oshins and Robert G. Alexander

The Tax Burn - Illustration
©2010 Richard A. Oshins and Robert G. Alexander

Question #3 What are the gift tax implications if I pay income tax as a result of the grantor trust rules? Rev. Rule No additional gift on payment of income tax ©2010 Richard A. Oshins and Robert G. Alexander

Question #4 If I make a sale to a trust that is income tax defective to me, do I recognize taxable gain or loss? Rev. Rul Non-recognition of gain/loss on sales/exchanges with an IDIT ©2010 Richard A. Oshins and Robert G. Alexander

Question #5 If I own 100% of an entity and I make a gift of a 20% interest to each of my five (5) children, are the gifts of each 20% interest valued as a non-controlling interest? Rev. Rul No family attribution rules for purposes of discounting ©2010 Richard A. Oshins and Robert G. Alexander

So What Makes A BDIT Work?
Combines the planning opportunities of: #1 - Chapter 13 – GSTT rules #2 - IRC § 678– beneficiary income tax status #3 - Rev. Rul – no additional gift on payment of income tax #4 - Rev. Rul – non-recognition of sales to IDITs #5 - Rev. Rul – no family attribution rules for purposes of discounting ©2010 Richard A. Oshins and Robert G. Alexander

The Ultimate Trust A Beneficiary Defective Inheritor’s Trust
Combining: A third-party settled trust with Grantor trust income tax status for the beneficiary Finessing the “pipe dream” ©2010 Richard A. Oshins and Robert G. Alexander

BDIT Fact Pattern Mom sets up the trust for the benefit of her son and his children Transfer tax protection for the beneficiaries Creditor protection for the beneficiaries In perpetuity Wealthy client (the son) is the grantor for income tax purposes Income tax planning for the son ©2010 Richard A. Oshins and Robert G. Alexander

BDIT Fact Pattern – cont.
Client’s parent sets up the BDIT funding it with a gift of $5,000 Parent uses independent funds Parent is the settlor of the trust for transfer tax purposes and for creditor rights purposes Client (and only the client) is given a Crummey withdrawal power over the entire gift The withdrawal right is allowed to lapse ©2010 Richard A. Oshins and Robert G. Alexander

BDIT Fact Pattern – cont.
Son owns one-third (1/3) of a pass-through entity Value of 100% of the entity - $50 million Value of son’s one-third (1/3) interest after discounting $10 million Son sells discountable interests in the entity to the trusts for installment notes Son’s sale to the trust is for “full and adequate consideration” ©2010 Richard A. Oshins and Robert G. Alexander

A Beneficiary Defective Inheritor’s Trust
The trust is defective to the client for income tax purposes Power of withdrawal – IRC §678(a) Transactions between the client and the trust are ignored for income tax purposes Rev. Rul ©2010 Richard A. Oshins and Robert G. Alexander

Variation Spousal Irrevocable Trust (“SIT”)
Set up and seeded by the client’s spouse Combines IRC §677(a) – income tax grantor trust rules IRC §1041(a) – no tax on transfers between spouses Rev. Rul ©2010 Richard A. Oshins and Robert G. Alexander

Spousal Inheritor’s Trust – Cont.
Caveats Settler spouse is the “owner” of the trust income Subsequent divorce will not terminate grantor trust status IRC §672(e)(2) The settler spouse cannot be a beneficiary Solution – give the beneficiary spouse a SPA Support trust risk ©2010 Richard A. Oshins and Robert G. Alexander

So What Is A BDIT? A dynasty trust set up for my descendants which avoids their Transfer taxes Creditors, including divorcing spouses A beneficiary “controlled” trust Allows gifts and sales to a trust that is income tax defective as to the beneficiary Crummey power of withdrawal – § 678 Wealth transfer leveraging with discounted entities ©2010 Richard A. Oshins and Robert G. Alexander

BDIT Design Established and initially funded by a third party Fully discretionary distribution standards Controlled trusteeship Family trustee Independent trustee The “use” concept Broad SPA – a “re-write” power Perpetual Beneficiary has the functional equivalence of outright ownership of the trust assets ©2010 Richard A. Oshins and Robert G. Alexander

Guarantees Guarantees as “seed” money Must be legitimate Better than trust assets Often made by beneficiaries Need not be for the full amount of the note ©2010 Richard A. Oshins and Robert G. Alexander

Is a Gratuitous Guarantee a Gift?
Unsettled Cases seem to say no We pay for the guarantee Get an appraisal Avoids risk of gift to the trust by the guarantor Income tax-free if the guarantor is the spouse or an income tax defective trust ©2010 Richard A. Oshins and Robert G. Alexander

Seeding the Trusts Gifts to Trust
$1,667 $1,667 $1,666 Trust A Trust B Trust C FBO Client and Katie FBO Client and Bob FBO Client and Sue Client – Power of Withdrawal $5,000 ©2010 Richard A. Oshins and Robert G. Alexander

Transfer Tax Creditor rights
Who is the Grantor? Transfer Tax Creditor rights Owner for Income Tax Purposes - IRC § 678(a) Caveat: Client has a Power of Withdrawal over all gifts to BDIT Caveat: Client never makes a gratuitous transfer to BDIT ©2010 Richard A. Oshins and Robert G. Alexander

Tax-Free Sale to BDIT Assets Installment Notes
BDITs Trust A Trust B Trust C Wealthy client sells discountable income producing assets for an Installment Note ©2010 Richard A. Oshins and Robert G. Alexander

Note Sale to a BDIT with a Guarantee
Parent “mom” Gift Subject to Power of Withdrawal BDIT Note Sale Guarantee H W Fee Family Trustee Beneficiary I/T Grantor Seller ©2010 Richard A. Oshins and Robert G. Alexander

BDIT Tax Results Estate freeze Installment notes in the estate Post-transfer appreciation shifted Estate squeeze Discounted assets removed from the transfer tax system Income “tax burn” – the beneficiary pays the tax on the income generate by the trust IRC §678 Crummey power of withdrawal ©2010 Richard A. Oshins and Robert G. Alexander

BDIT Non-tax Results The client/beneficiary is in control of the BDIT Assets are creditor protected for the client/beneficiary and his/her family Assets are available after the “tax burn” Client/beneficiary has a “re-write” power with a SPA Protects against potential family conflicts Protects against inadvertent gifts to the trust ©2010 Richard A. Oshins and Robert G. Alexander

Safe Transaction – Valuation Disparity
Gift Tax/Chapter 14 SPA protects against an inadvertent gift The gift is incomplete Reg. § (b) EstateTax/GSTT Report the sale ©2010 Richard A. Oshins and Robert G. Alexander

IRS Reporting of Sale to Trust
Timely file from 709 gift tax return Non-completed gift Treas. Reg. § (c) - 1(f)(4) If IRS does not challenge the valuation ©2010 Richard A. Oshins and Robert G. Alexander

IRS Reporting of Sale to Trust - cont. -
If the IRS successfully challenges the valuation It is an incomplete gift Treas. Reg. § (b) Allocation pro-rata between exempt and non-exempt trusts for GSTT purposes The BDIT is safer than alternative strategies ©2010 Richard A. Oshins and Robert G. Alexander

BDIT Non-tax Results -Cont.
Opportunity shifting Business and investment opportunities Giving free advice or managing trust assets Quintessential life insurance trust Life insurance on a beneficiary who is also a trustee Decision must be made by an independent trustee Beneficiary cannot have a SPA over life insurance ©2010 Richard A. Oshins and Robert G. Alexander

Benefits of This Strategy
The entity/assets are moved out of the client’s estate on a discounted basis The transaction results in a leveraged estate freeze There is no income tax on the sales or the guarantee All of the assets in the BDIT are still available to and controlled by the Inheritor/beneficiary ©2010 Richard A. Oshins and Robert G. Alexander

Benefits - Continued The Inheritor/beneficiary has a SPOA – a rewrite power The taxable estate of the inheritor is depleted by valuation discounts as well as payment of incomes taxes on the trust income – the “tax burn” The Inheritor and his/her family have creditor and divorce protection in perpetuity ©2010 Richard A. Oshins and Robert G. Alexander

Benefits - Continued The Inheritor and his/her family have GSTT and estate exemption in perpetuity The SPOA prevents a gift tax on transactions with the trust Otherwise resistant clients will move forward with planning ©2010 Richard A. Oshins and Robert G. Alexander

Why Wouldn’t Everyone Do A BDIT?
Misconception – The BDIT is only for the ultra wealthy Planning alternatives involve giving to someone else BDIT includes the virtues of alternative estate planning techniques BDIT benefits – substantial and forever ©2010 Richard A. Oshins and Robert G. Alexander

Planning For The Mid-range Client
The client with a: $5 million business $1 million home $2 million other assets The dilemma: Tax and creditor exposure Cannot afford to give the wealth away! ©2010 Richard A. Oshins and Robert G. Alexander

Planning For The Mid-range Client
GRAT and IDIT Prohibition against transfers with retained rights BDIT “Fair and adequate consideration” exception Really the “only option” ©2010 Richard A. Oshins and Robert G. Alexander

THE BDIT vs. OTHER STRATEGIES

The BDIT vs. Note Sales to IDITs
Wealth shifting benefits Retained interest often creates continued Sec exposure No need to retain anything Control No economic risk Management Use and enjoyment Rewrite power Tax burn ©2010 Richard A. Oshins and Robert G. Alexander

The BDIT vs. Note Sales to IDITS
Safety Gift tax Step transaction Pierre vs. Comm’r ©2010 Richard A. Oshins and Robert G. Alexander

The BDIT vs. APTs Greater creditor protection Not a self-settled trust Transfer tax savings Control Use and enjoyment determined by the client APTs continuing costs ©2010 Richard A. Oshins and Robert G. Alexander

The BDIT and Other Estate Planning Vehicles
Revocable trusts – avoid probate Gifting Charitable planning Business succession planning ©2010 Richard A. Oshins and Robert G. Alexander

The BDIT and Other Estate Planning Vehicles - Cont. -
Pre-marital agreements Unmarried, co-habiting partners Traditional Non-traditional Planning for physicians Planning for athletes and entertainers Combined with charitable planning ©2010 Richard A. Oshins and Robert G. Alexander

TOPICS Advantages of trusts Designing trusts from the viewpoint of the competent inheritor Opportunity shifting Hypothetical fact pattern The BDIT solution – freeze, squeeze, and burn BDIT/life insurance compatibility ©2010 Richard A. Oshins and Robert G. Alexander

Key Concept Trusts Enhance Gifts and Bequests
Assets received and retained in trust are much more valuable to the inheritor/donee than assets received outright The foundational concept of modern wealth planning: “Own everything in trust forever…” ©2010 Richard A. Oshins and Robert G. Alexander

A Trust “Shelters” Inherited Assets From the Beneficiaries’…
Taxes Transfer taxes Income taxes Potential claimants Creditors Divorcing spouses Government/agencies Others ©2010 Richard A. Oshins and Robert G. Alexander

Transfer Taxes “In fact, we haven’t got an estate tax, what we have, you pay an estate tax if you want to; if you don’t want to, you don’t have to.” Statement of Prof. A. James Casner “Estate and Gift Taxes: Hearings Before the House Ways and Means Comm.,” 94th Cong., 2d Sess., pt. 2, 1335 (March 15-23, 1976) ©2010 Richard A. Oshins and Robert G. Alexander

Transfer Taxes – Cont. “The perpetual generation-skipping trust may have been the ultimate estate-planning scheme for those who had the foresight to establish one.” “…it appears possible to create … a perpetual trust, permanently eliminating future transfer taxes.” “For an intervening generation now the beneficiary of a generation-skipping trust, estate planning is no problem, because the trust is already the best possible built-in estate plan.” George Cooper “A Voluntary Tax? New Perspectives on Sophisticated Estate Tax Avoidance,” The Brookings Institution, Washington D.C. (1979), P 57,58 ©2010 Richard A. Oshins and Robert G. Alexander

Power of Compound Growth
Assumptions $1 million contributed to trust Trust lasts 120 years 45% transfer tax imposed on non-dynastic trust assets every 30 years ©2010 Richard A. Oshins and Robert G. Alexander

Power of Compound Growth Chart
____________________________________________________ Value Value of Trust of Property Annual After if no Growth 120 Years Trust _____________________________________________________ 4% $ 110,662,561 $ 10,126,316 5% 348,911,986 31,927,627 6% 1,088,187,748 99,575,980 7% 3,357,788, ,258,623 8% 10,252,992, ,212,935 ©2010 Richard A. Oshins and Robert G. Alexander

Observations Chart only illustrates estate tax depletion Ignores impact of Divorce Lawsuits Reduced propensity to spend trust assets State income tax savings ©2010 Richard A. Oshins and Robert G. Alexander

INCOME TAXES Reduced planning importance due to Compressed rates Reduced exemption Kiddie tax Defective trust accelerates growth during “owners” lifetime ©2010 Richard A. Oshins and Robert G. Alexander

The Ultimate Creditor and Creditor Protection Vehicle
A discretionary trust with “. . . the distribution discretion held by an independent trustee is the ultimate in creditor and divorce claims protection – even in a state that restricts so called ‘spendthrift’ trusts – since the beneficiary himself has no enforceable rights against the trust.” (Emphasis supplied) Frederick R. Keydel “Trustee Selection, Succession, and Removal: Ways to Blend Expertise with Family Control,” 23 U.Miami Inst. On Est. Plan., Ch 4 (1989) at §409.1 ©2010 Richard A. Oshins and Robert G. Alexander

Creditor and Divorce Protection
Asset Protection Maxim Divorces – Trust better than pre-nuptial agreement Use even if taxes were not a consideration ©2010 Richard A. Oshins and Robert G. Alexander

Overlooked Benefit – Particularly In Today’s Volatile Economic World
Enables beneficiary to borrow for business or investment purposes without exposing trust owned assets to risk Lending institution typically requires personal guarantees of business owners and their spouses ©2010 Richard A. Oshins and Robert G. Alexander

Why We Use Dynastic Trusts Even If There Is No Estate Tax
Predator protection State Income Tax Income shifting There will be a gift tax Enables younger beneficiaries to participate in family wealth earlier Compare to a GRAT ©2010 Richard A. Oshins and Robert G. Alexander

Receiving Assets in Trust Enhances the Gift or Inheritance
Transfers from someone other than beneficiary If beneficiary makes the transfer it is a self-settled trust Taxes Creditors Conclusion - Transfers in trust are more valuable to recipients ©2010 Richard A. Oshins and Robert G. Alexander

Beneficiary Controlled Trusts
Beneficiaries will like “in trust” inheritances only if: They are placed in control of the trust They understand benefits of receiving property in trust They understand the BCT concept ©2010 Richard A. Oshins and Robert G. Alexander

Traditional Trusts Typical Characteristics
Pays out income Principal may be invaded for “HEMS” – “support trust” Distributes assets at specified ages Beneficiary not in control ©2010 Richard A. Oshins and Robert G. Alexander

Modern Trust Design Fully Discretionary Perpetual “Use” Concept Broad SPA’s – “Re-write power” Controlled Trusteeship at Proper Time Family Trustee Independent Trustee ©2010 Richard A. Oshins and Robert G. Alexander

Trusts Protect Assets From Creditors and Predators
Trust must be set up by someone other than the beneficiary him/herself Third party settled trust Makes sense even if there was no transfer tax Modern theory of comprehensive wealth planning: “Own everything in trust forever…” ©2010 Richard A. Oshins and Robert G. Alexander

Beneficiary Controlled Trust “BCT”
Goal – To maximize the benefits that an “in trust” inheritance can provide Family Trustee Controls Investments Controls Identity of the Independent Trustee ©2010 Richard A. Oshins and Robert G. Alexander

Beneficiary Controlled Trust “BCT”
Independent Trustee Controls all non-tax sensitive decisions Individual or institution who meets the criteria of IRC § 672(c) “Independence” does not require a confrontational relationship ©2010 Richard A. Oshins and Robert G. Alexander

Opportunity Shifting Referrals of favorable business or investment opportunities Giving free advice or managing assets Inheritor’s Trust as recipient BDIT often preferable ©2010 Richard A. Oshins and Robert G. Alexander

Basic Inheritor’s Trust Opportunity Shifting
Income Tax Options Traditional Trust IDGT BDIT SIT Combination Tax Burn ©2010 Richard A. Oshins and Robert G. Alexander

Putting the BDIT on Steroids Hypothetical Fact Pattern
Client owns 1/3 of a pass-through entity Value of entity $50 million Valuation discounts assume 40% ©2010 Richard A. Oshins and Robert G. Alexander

The BDIT Strategy Client’s parent sets up BDIT funding it with $5,000 Client is given power of withdrawal Client sells his 1/3 interest in the entity to the trust for a $10 million note ©2010 Richard A. Oshins and Robert G. Alexander

Variation – Spousal Irrevocable Trust
Client’s spouse is the Settlor IRC §677(a) IRC §1041(a) ©2010 Richard A. Oshins and Robert G. Alexander

Parent is Settlor Client’s parent sets up BDIT funding it with $5,000 Parent uses independent funds Parent is Settlor for transfer tax and creditor right purposes Sale by the beneficiary is for “full and adequate consideration” ©2010 Richard A. Oshins and Robert G. Alexander

Beneficiary Defective Trust
Trust is defective to the client/inheritor for income tax purposes Power of withdrawal IRC § 678(a) Transactions between client and trust ignored Rev. Rul ©2010 Richard A. Oshins and Robert G. Alexander

Seeding the Trusts Gifts to Trust
$1,667 $1,667 $1,666 Trust A Trust B Trust C FBO Client and Katie FBO Client and Bob FBO Client and Sue Client – Power of Withdrawal $5,000 ©2010 Richard A. Oshins and Robert G. Alexander

Transfer Tax Creditor rights
Who is the Grantor? Transfer Tax Creditor rights Owner for Income Tax Purposes - IRC § 678(a) Caveat: Client has a Power of Withdrawal over all gifts to BDIT Caveat: Client never makes a gratuitous transfer to BDIT ©2010 Richard A. Oshins and Robert G. Alexander

Tax-Free Sale to BDIT Assets Installment Notes
BDITs Trust A Trust B Trust C Wealthy client sells discountable income producing assets for an Installment Note ©2010 Richard A. Oshins and Robert G. Alexander

Note Sale to a BDIT with a Guarantee
Parent “mom” Gift Subject to Power of Withdrawal BDIT Note Sale Guarantee H W Fee Family Trustee Beneficiary I/T Grantor Seller ©2010 Richard A. Oshins and Robert G. Alexander

Results - Tax Freeze, Squeeze and Burn Estate Freeze Installment Notes in the beneficiary’s estate Post-transfer appreciated shifted Estate Thaw Discounted assets are removed from the transfer tax system forever Tax Burn – client beneficiary pays the income tax on trust income ©2010 Richard A. Oshins and Robert G. Alexander

Results – Non-Tax Client/inheritor is in control of the BCT Hot assets are creditor protected for client and family Assets available after “tax burn” Re-write power Protects against potential family conflicts Protects against inadvertent gift tax ©2010 Richard A. Oshins and Robert G. Alexander

Is a “Gratuitous” Guarantee a Gift?
Unsettled Cases seem to say “no” We pay for the guarantee Get appraisal Avoids risk of gift to trust by guarantor Income tax-free - if spouse or defective trust ©2010 Richard A. Oshins and Robert G. Alexander

Ancillary Considerations
Economic Risk – Estate Depletion Exposure Toggling Reimbursement Clauses Forum shopping to avoid self-settled trust BDIT resolves dilemma SIT exposure Basis Monitoring ©2010 Richard A. Oshins and Robert G. Alexander

Life Insurance - ILIT BDIT is also a funded ILIT So is the SIT variation Insurance on the life of a beneficiary who is also a trustee Decisions made by independent trustee No power of appointment ©2010 Richard A. Oshins and Robert G. Alexander

Life Insurance Correlation with a BDIT
Life insurance has two component parts Death benefit Inside buildup Asset class QRP and NIMCRUT alternative ©2010 Richard A. Oshins and Robert G. Alexander

Life Insurance Correlation with BDIT – Cont.
Early Death Negligible Tax Burn Win on the Mortality Bet Later Death Greater estate tax depletion Tax-free build-up more dramatic ©2010 Richard A. Oshins and Robert G. Alexander

EXHIBIT F Increasing: income tax deferred cash value – available for use and outside the estate Decreasing: need for estate tax liquidity during “burn” (& net amount at risk outside estate) Decreasing Net Amount at Risk Increasing Cash Value Estate accessible Estate tax free “Tax burn” Insurance + A FIXED component of an investment portfolio outside the estate Now Future Derived from “Life Insurance as an Asset Class” by Richard M. Weber, MBA, CLU and Christopher Hause, FSA, MAAA © 2009 Ethical Edge Insurance Solutions, LLC. For further information contact ©2010 Richard A. Oshins and Robert G. Alexander

Planning Alternatives
Primary Retirement Planning Alternatives Goal – tax exempt or tax deferred wealth accumulation Vehicles Qualified Retirement Plans (“QRPs”) NIMCRUTs Cash Value Life Insurance (“CVLI”) ©2010 Richard A. Oshins and Robert G. Alexander

QRP’s Tax deferral – not exemption Tax at ordinary income rates Often converts capital gain into ordinary income IRD Non-alienation prohibits transfers to escape the estate tax ©2010 Richard A. Oshins and Robert G. Alexander

QRP’s - Cont. Too Soon-Too Late – Too Much-Too Little Contributions Distributions Administrative and Legal Costs Government Regulations IRS Department of Labor Legislative Changes Non-discriminatory ©2010 Richard A. Oshins and Robert G. Alexander

NIMCRUTs Tax-deferral-not exemption Four-tier Rule – worst first 10% Rule Eliminates younger clients Reduces potential accumulation period Goes to charity at death Early death risk Administrative and legal costs Fully discriminatory ©2010 Richard A. Oshins and Robert G. Alexander

Cash Value Life Insurance - CVLI
Tax exempt access to the investment fund Can access fund on a temporary basis and pay back E.g. - college Survivorship feature Early death – win on mortality bet No administrative and legal costs Fully discriminatory ©2010 Richard A. Oshins and Robert G. Alexander

Major Comparisons Deferral v. Tax exempt access to income Access to funds on a temporary basis Survivorship Feature Risk of early death for QRPs and NIMCRUTs Decedent's Receipt QRP-IRD NIMCRUT – none CVLI in trust – tax-free ©2010 Richard A. Oshins and Robert G. Alexander

Life Insurance in a Beneficiary Defective Inheritor’s Trust
Adjustments – beneficiary controlled Special Trustee Not subject to power of appointment Accessing Inside Build-up Two-step process Wrap Trust™ - there may be serious tax problems ©2010 Richard A. Oshins and Robert G. Alexander

Accessing Policy Cash Values
Loan money to the beneficiary No income tax consequence Purchase other assets from the beneficiary Non-recognition of gain Distributions to the beneficiary Worst alternative Assets no longer protected ©2010 Richard A. Oshins and Robert G. Alexander

Accessing Policy Cash Values – Cont.
MEC Income tax issues Estate tax inclusion issues Back-end loaded policies Other planning issues ©2010 Richard A. Oshins and Robert G. Alexander

Other Planning Opportunities With a BDIT
Tax and asset protected forever Advanced “wealth shifting” opportunities Family income tax planning Valuation/discount planning Structured gifts and loans New businesses – seed money Investment opportunities ©2010 Richard A. Oshins and Robert G. Alexander

Planning Opportunities – Cont.
Grantor trust income tax planning Sales of “hot” assets – IRC§ 751 Structuring buy-sell arrangements State income tax planning Multi-jurisdictional asset protection planning Private retirement plan ©2010 Richard A. Oshins and Robert G. Alexander

Planning Opportunities – Cont.
Advanced Life Insurance Planning Access to cash values No transfer for value problems Super-charge the insurance funding Super-charge life insurance partnership planning Premium financing techniques Split dollar arrangements ©2010 Richard A. Oshins and Robert G. Alexander

Physicians/Equipment Leasing
The doctors purchase $3 million worth of equipment in an LLC Each doctor sell his/her 1/3 interest in the LLC to a BDIT for a note Rev. Rul Discount ©2010 Richard A. Oshins and Robert G. Alexander

Physicians/Equipment Leasing - cont. -
Equipment is leased to the medical practice Cash flow from the equipment leasing business Pays the note Buys CVLI For retirement-pension substitute As an asset class For family protection For buy-sell purposes ©2010 Richard A. Oshins and Robert G. Alexander

Buy-sell Planning Newco is owned 50/50 by A and B A’s parent set up A’s BDIT which buys A’s entity interest from A B’s parent sets up B’s BDIT which buys B’s entity interest from B ©2010 Richard A. Oshins and Robert G. Alexander

Buy-sell Planning cont’d
A’s BDIT B’s BDIT Owns A’s interest Buys Life Insurance on B’s Life Owns B’s interest Buys Life Insurance on A’s Life ©2010 Richard A. Oshins and Robert G. Alexander

Estate Planning for Professional Athletes and Entertainers
Split between shiftable and non-assignable A BDIT is wonderful for income opportunities which can be assigned Athlete/entertainer pays the income tax on all income ©2010 Richard A. Oshins and Robert G. Alexander

Estate Planning for Professional Athletes and Entertainers – cont.
Income tax and current expenditures deplete non-assignable wealth BDIT grows income tax-free Divorce and creditor protected Better than a marital property agreement Cash value life insurance as a pension substitute or in addition to those provided by the sport Death benefit protects the family ©2010 Richard A. Oshins and Robert G. Alexander

Premium Financing Strategies
Premium Financing strategies to Consider Private loan arrangements Bank loan arrangements Private split-dollar arrangements Special thanks to Northwestern Mutual Life insurance Company in the preparation of slides Used by permission, with modifications ©2010 Richard A. Oshins and Robert G. Alexander

Large life insurance need Large premiums Often a 6 or 7 figure premium Insufficient gift tax capacity However - No gifts allowed with the BDIT! Background Background on the use of life insurance in estate planning. --Used to provide liquidity to help pay estate taxes. --Other uses are based on non-tax objectives including equalizing inheritances, replacing wealth, etc. To keep the death benefit out of the insured’s taxable estate, an irrevocable trust usually owns the policy (commonly referred to as an ILIT). Premiums for the trust-owned life insurance are often paid by the trustee with money given by the insured. The gifts qualify for annual exclusion treatment through Crummey withdrawal provisions in the ILIT. However, many clients can’t or don’t want to make cash gifts to an ILIT. Some don’t have annual exclusion gifts available to cover the policy’s premium because: --They are using annual exclusion gifts to transfer other property or --The premiums substantially exceed available annual exclusion gifts ©2010 Richard A. Oshins and Robert G. Alexander

Background Client has cash flow or other assets available but must deal with gift tax limits However - No gifts allowed with the BDIT! or Client wants flexibility Client does not have sufficient cash flow or other assets available and wants to avoid selling assets Other clients have annual exclusion gifts available, but want flexibility to get the money back that was used for premiums. --Cash flow --Financial instability --Planning uncertainty Finally, clients lack liquidity (business owners, hedge fund shareholders, etc.) to pay premiums. Premium financing gives these clients options. ©2010 Richard A. Oshins and Robert G. Alexander

Critical Planning Points With the BDIT!
Private premium financing arrangements The arrangement must accrue interest at the AFR and pay the accrued interest with the principal at the end of the term so that there is no deemed gift to the BDIT Private split-dollar arrangements The arrangement must be a contributory arrangement The BDIT, from its own funds, must contribute the economic benefit portion of the premium Therefore, initially the BDIT must be independently funded with sufficient assets to make these payments ©2010 Richard A. Oshins and Robert G. Alexander

Premium Financing Overview
Personal (“private”) loans Regular bank loans pay interest in cash accrue interest Current trends: interest rates, estate taxes Planning flexibility  lend, don’t give Non-equity split dollar Exit strategies Concept is simple-use someone else’s money to buy life insurance. --Lenders charge interest --Loans must be repaid ©2010 Richard A. Oshins and Robert G. Alexander

Private Financing: How It Works
Loans TRUST Premiums Client(s) Life Insurance Policy Ins. Co. Gifts (= interest) Overview of a private financing arrangement: --The client/insured lends money to the ILIT to pay some or all of the policy’s premiums. -- The client/insured typically gives money to the ILIT each year to help pay the loan interest. --To avoid estate inclusion for the client/insured, the loans are not secured by the policy. --The loan can be repaid before or after the insured’s death. Interest

Private Financing: Why Do It?
Low gifts interest < premium Generally lower interest rate than bank loan Gift tax efficient—gifts other than cash can be made However: No gifts allowed with the BDIT! Flexibility How the client benefits: --Reduces the client/insured’s gift from the premiums to the loan interest amount. --Interest rate is typically less charged by a bank. --Based on the Applicable Federal Rate (AFR) provided by the IRS. --Depends on whether the loan is designed as a term or demand loan --Saves annual exclusion and lifetime exemption gifts for other purposes. --Avoids complexity and cost of a bank financed arrangement. --Provides flexibility to handle changing financial, personal, and estate planning circumstances. ©2010 Richard A. Oshins and Robert G. Alexander

Private Financing: Risks & Drawbacks
Does it make financial sense over the long term? Interest rates vary unless a lump sum is loaned The cost of an increasing death benefit vs. the cost of a static death benefit Issues to consider: --Client/insured must have the money to pay the premiums. --Interest rate environment -- Policy must be provide enough death benefit to meet planning objectives. --How will the ILIT repay the loans? ©2010 Richard A. Oshins and Robert G. Alexander

Bank Financing: How It Works
Lender Interest Loans TRUST Premiums Life Insurance Policy Ins. Co. Overview of a bank premium financing arrangement: --The bank lends annually to the ILIT. --The trust uses the borrowed funds to pay premiums on a policy insuring the life of the client/ grantor of the ILIT. --The policy is assigned to the bank as collateral. The bank often requires additional collateral and/or a guarantee from the client/grantor. --The client/grantor typically gives money to the ILIT each year to pay the loan interest. --The ILIT pays the interest to the bank. The payment is not deductible by the ILIT. --The ILIT repays the bank according to the terms of the loan. Gifts (= interest) Client(s)

Bank Financing: Why Do It?
Lower out of pocket cost interest < premium Gift tax efficient However – No gifts allowed with the BDIT! Other people’s money Minimize the need to sell performing assets How the client benefits: --The loan interest is lower than the annual premium. This lowers the client’s annual gift. --The client avoids the opportunity, transaction and tax costs of liquidating another asset or redirects cash that would otherwise have been used to pay premiums. ©2010 Richard A. Oshins and Robert G. Alexander

Bank Financing: Risks & Drawbacks
Does it make financial sense? Interest rate uncertainty Lender uncertainty Additional time and expenses Collateral requirements in addition to policy Is grantor’s personal guarantee a gift? Issues to consider: --Positive arbitrage exists when the assets that would have been used to pay premiums return a higher rate than the interest cost charged by bank. --The bank’s interest rates usually are tied to LIBOR. --Bank may not commit to lending indefinitely or may call loan unexpectedly. --If loans are to be repaid with death benefit, the amount of death benefit paid to the ILIT is decreased. --Possible gift tax consequences of a personal guarantee. ©2010 Richard A. Oshins and Robert G. Alexander

Non-Equity Split Dollar: How It Works
Prem. Payments TRUST Premiums Client(s) Life Insurance Policy Ins. Co. Gifts (= term cost) Overview of a private split dollar arrangement (aka “nonequity split dollar”): --Client/insured pays premiums for ILIT-owned policy and is entitled to an amount equal to the policy’s cash value. -- ILIT is entitled to some, but not necessarily all, of death benefit paid by the policy. --Client/insured gives the ILIT an amount equal to the cost of the death benefit it controls. ILIT pays this amount to client/insured. This is based on term rates provided by the government (Table 2001) or the insurer. --To avoid estate inclusion for the client/insured, the arrangement is unsecured. --When the arrangement is terminated, the ILIT is buying the client’s interest in the policy. The purchase price is its cash value. Term cost

Non-Equity Split Dollar: Why Do It?
Term cost < premium Term cost < interest Gift tax efficient However – No gifts allowed with a BDIT! How the client benefits: -- Reduces the client/insured’s gift from the premiums to the term cost. --Term costs are typically less than interest costs making this financing arrangement less expensive than loans. However term costs increase with age. ©2010 Richard A. Oshins and Robert G. Alexander

Non Equity Split Dollar Risks & Drawbacks
Failure to terminate plan before: CV significantly > premiums Term cost gets too big (leverage is lost) Works best for younger insureds Issues to consider: --Since term costs increase with age the cost of maintaining this arrangement also increases with age. --As the policy’s cash value increases so does the amount to which the client/insured is entitled. --Because client/insured’s interest in the arrangement will not be secured by, or necessarily paid from, the proceeds of the policy, the arrangement does not technically meet the definition of split dollar under Treasury regulations. This leaves some question as to the tax treatment of the arrangement. ©2010 Richard A. Oshins and Robert G. Alexander

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