An estimated $30 billion to $40 billion in wealth is set to transfer from baby boomers to their heirs or favorite charities. This includes wealth tied up in a family business. As you plan for the future of your business, you may earmark the proceeds from the sale of the business to support your lifestyle, your family or a preferred charity for years to come. But it’s also important to consider the potentially significant toll taxes could take. Fortunately, tools and strategies exist to help ease the impact.
One such tool is a trust – a fiduciary relationship in which you as the grantor give a trustee the right to hold title to assets for the benefit of your beneficiary. While there are many types of trusts, here are four that are commonly used in business planning.
This irrevocable trust enables you to enjoy the proceeds from the sale of your business, then potentially pass significant wealth to beneficiaries with little or no gift tax. To create a GRAT, the grantor transfers assets into the trust and receives annuity payments over a fixed number of years. These annuity payments are calculated so that the grantor is treated as having made little or no taxable gift to the GRAT beneficiaries because, relative to present value, the grantor will receive back everything put in. Appreciation in the trust assets in excess of the IRS assumed rate of return eventually passes to the beneficiaries gift-tax free.
For a GRAT to be effective, two conditions must be met: First, the assets in the GRAT must grow faster than the IRS’s assumed rate of return so there is something to pass along. Second, you must outlive the term of the GRAT. If not, assets will revert back to your estate. However, creating a series of short-term GRATs can mitigate some of the mortality risk.
In some cases, the IRS has held that trusts established after signing letters of intent violated the Anticipatory Assignment of Income Doctrine that was adjudicated by the Supreme Court in 1930 to limit tax evasion. Consult your tax, legal and financial professionals regarding the date you intend to sell your business and any estate planning or wealth transfer you wish to do around the sale.
An IDGT creates a complete transfer of assets to a trust for transfer-tax purposes, but an incomplete (defective) transfer for income tax purposes. Assets, such as a business, are transferred by a completed gift or a fair market value sale (or installment sale), in which both are disregarded for income tax purposes in regard to the estate.
As a result, you will no longer retain any powers that would cause estate tax inclusion, and the future value of the transferred assets is removed from your estate. Although the trust is irrevocable, it is treated as a grantor trust for income tax purposes because the grantor retains other powers. This means the grantor, though not a beneficiary, is taxed on all the trust’s income, even though you would not be entitled to any trust distributions.
Some states’ income taxes can reach significant percentage levels. This is where the establishment of an ING trust may help. To date, ING trusts have been used for nearly 20 years and have received more than 70 private letter rulings from the IRS that the trust structure is valid.
The trust is effective due to its designation as a taxpayer for income tax purposes. Therefore, the trust and trustee must be domiciled in a no-income-tax state. When business ownership is transferred to the ING trust, the transfer is not a taxable event. When the trust later sells the company, the income will be attributed to the trust, a resident of a no-income-tax state. While the proceeds and earned investment income remain in the trust, they will receive the benefits of tax savings. When the trust is requested to distribute funds, income tax is then paid to the home state.
If you would like the proceeds of selling a business to benefit a favorite charity, yet also desire to receive income from the proceeds, a CRT is an option. It is, however, an irrevocable trust so once established, terms cannot be changed nor assets moved.
To establish a CRT, you would transfer business shares or proceeds from a sale to the trust. You would name yourself or another beneficiary as recipient of the income from the trust. When the terms of the trust end, the chosen nonprofit group receives the remainder. You also will receive an income tax deduction equal to the estimated present value of the remainder interest. The charity selected must be approved tax exempt by the Internal Revenue Service. The trustee is also required to maintain tax records.
A trust in the future of your business may invigorate your trust in the future, too. Just be sure to consult with professionals to determine what works best for your personal and professional situation.
This article is general in nature and provided for informational purposes only. Raymond James and your Raymond James financial advisor do not provide tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.