Beyind the Living Trust 

Living trusts continue to enjoy unprecedented popularity for a variety of reasons, particularly probate avoidance. Many people fail to appreciate, however, that for those with taxable estates (see Exemption Chart), estate planning should not end with the garden variety living trust. This article reviews advanced estate planning techniques which take you beyond the living trust.

Qualified Personal Residence Trusts (QPRT).

A QPRT is an irrevocable trust that may hold only a personal residence (either a primary residence or vacation home). The QPRT lasts for a term of years that selected by the grantor. During the trust term, the grantor has the right to continue to use the property. Because the value of this retained right is subtracted from the value of the gift to the QPRT, and because the value of the gift (remainder interest) is frozen at current values and does not include future appreciation, substantial estate and gift tax savings are possible.

Life Insurance Trusts.

A life insurance trust is an irrevocable trust designed to own a policy of life insurance on the individual or couple creating the trust. The policy could be either an existing policy or a new policy purchased by the trust with cash gifts made by the trustor or trustors. The policy might be a single life or so-called "second to die" policy on a husband and wife. Life insurance owned individually is subject to death taxes. Life insurance owned by a properly structured irrevocable trust is excluded from the taxable estate (except for an existing policy if the original policy owner dies within 3 years after the transfer to the trust -- see annual exclusion and generation-skipping tax exemption, as well as create liquidity for estate taxes and administration expenses on a dollar-for-dollar basis.

Generation-Skipping Trusts.

Your current plan may provide for distribution of your estate outright to your children if they are adults, or in trusts to be distributed when they attain adulthood. If so, you should consider modifying your current plan to retain your children's shares in trust for life with the trust passing to your grandchildren at the death of your children. Reasons for creating "generation-skipping trusts" include:

(1) assets in the trust, including appreciation on trust assets during your children's lifetimes, will not be included in the death tax estates of your children, thus saving estate taxes;

(2) the trust protects from attack by a spouse in the event a child gets a divorce; and

(3) trust assets will be protected from a child's creditors in the event of a lawsuit, bankruptcy, failed business, or other financial difficulties the child might encounter.

Taking the concept of a generation-skipping trust to the extreme, the grantor might consider forming the trust under the laws of a state (eg. Alaska, Delaware, Idaho, South Dakota), that has abolished the "Rule Against Perpetuities" so that the trust can (in theory) run forever without ever being subjected to transfer taxes again. This is sometimes called a "Dynasty Trust."

Family Limited Partnerships.

Family limited partnerships enable one to make lifetime gifts of fractional interests in assets on a value-adjusted (discounted) basis. For example, if you own a business, vineyard, rental real estate, etc., you can transfer those assets to a limited partnership in which you or a closely held corporation become the general partner, and you and your family members become limited partners. By making gifts of limited partnership interests to your children, grandchildren, or to irrevocable trusts for their benefit, you are able to transfer the value of the assets at a fraction of their underlying value, thereby leveraging your annual exclusion and estate tax exemption amounts. The valuation adjustments are based on concepts of minority interest discount and lack of marketability and are a function of the restrictions placed in the partnership agreement.

Charitable Trust Planning.

Whether or not you are charitably inclined, if you own highly appreciated assets (such as real estate) which produce a small return relative to fair market value, the charitable remainder trust ("CRT") can be an attractive planning technique. Here's how it works: you transfer assets to a trust, reserving the income stream defined either as a fixed annual amount (annuity trust) or as a percentage of the value of the trust assets determined annually (unitrust). At your death, whatever is left in the CRT (the "remainder interest") passes to a charity of your choice.

Not only do you receive a charitable income tax deduction upon creating the CRT, but the CRT can sell the assets transferred by you free of capital gains tax. As a result, the full value of the assets, without reduction for capital gains taxes, is invested, thereby producing a larger income stream than would have been possible if you had sold the assets, paid the tax, and invested the difference. Of course, as a result of transferring assets to the CRT, the principal at death will not pass to your heirs. Therefore, CRT's are often coupled with an irrevocable insurance trust, with the insurance policy replacing the asset transferred to the CRT.

Other charitable planning techniques include outright gifts to charities, charitable lead trusts, and the creation of private charitable foundations. For high-asset clients who are charitably motivated, the private foundation can be personally rewarding as well as economically rewarding from a tax planning point of view. Gifting Programs.

One of the simplest and most often overlooked ways to reduce a taxable estate is to take advantage of the gift tax annual exclusion. An individual may make as many gifts as he or she likes, up to $10,000 (adjusted for inflation beginning in 1999) per donee per year, without paying a gift tax and without consuming any of his or her estate and gift tax exemption amount (see Exemption Chart). Such gifts do not have to be in the form of cash, but could include securities, mutual funds, partial interests in land, shares of stock in a family business, or interests in a family limited partnership. Gifts to minor children or grandchildren, can include custodial accounts under the California Uniform Transfers to Minors Act or an irrevocable trust. In addition, few people know that a special gift tax provision makes it possible to make unlimited gifts to children or grandchildren for education or medical needs by payment directly to the school or medical provider.

Asset Protection Trusts.

High-asset clients with potential liability exposure can combine family limited partnerships, irrevocable trusts, and tax-neutral off-shore (eg. Cook Islands) trusts or on-shore (eg. Alaska, Delaware) trusts to set aside a "nest egg" in case of a catastrophic lawsuit. Because of fraudulent conveyance laws, such planning must be done before you have knowledge of a claim.

Business Succession Planning.

Statistics show that only a small percentage of family businesses pass successfully from one generation to the next. Death taxes and the failure to plan for the transfer of control are the major culprits. Business succession planning often involves a combination of several techniques discussed above, as well as use of the Family Business Exclusion, buy-sell agreements, split-dollar life insurance, deferred compensation plans, stock recapitalizations, qualified and non-qualified stock option plans, Employee Stock Ownership Plans (ESOPs), and re-structuring the form of entity, such as moving from a sole proprietorship or general partnership form of business to a Limited Liability Company (LLC), limited partnership, or corporation.

Conclusion.

Even if you have already established a basic estate plan, you should consider updating and reviewing your plan to determine if some of these techniques are appropriate for you. If you have not completed your estate plan, the foregoing techniques are important adjuncts to a basic plan consisting of a revocable living trust or will and durable powers of attorney.