Trust Strategies for Business Owners and Multigenerational Families

Speaker 1 – 00:00
We’re going to take a deep dive on a well structured irrevocable trust with a sound trustee and good trust
document in place.
Speaker 2 – 00:06
The three that we’re going to cover today are a little bit more complex, all set up for different reasons. The one
we’re going to cover today is a charitable remainder trust.
Speaker 1 – 00:13
Someone that’s very charitably inclined wants to leave a legacy to charity and be as tax efficient as possible.
However, they still want an income stream from this asset to help support them.
Speaker 2 – 00:23
While they’re living GSTs. So generation skipping trust. And these are primarily for grandchildren. If you don’t set
this up, it gets taxed to 40% of them. It goes to the adult children’s estate, it gets taxed 40% again, almost cutting
your wealth in half. GST would either be provisioned in some of those trusts or it could be a separate trust by itself.
Intentionally defective grantor trust. And this one’s really unique one, especially for a business owner. You
ultimately want your business to go to your kids and you want them to avoid paying this big hit of.
Speaker 1 – 00:54
Estate tax benefit is you’re using money that’s inside of your estate to pay that tax to get more money into the trust
that’s outside of your estate.
Speaker 2 – 01:01
We want to get so intimately in the know of your goals, your family, your situation, and educate you on how these
work. We believe clients need to understand if you don’t.
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Speaker 1 – 01:16
We are in the process in America of seeing the greatest wealth transfer that has ever occurred between
generations. And statistically speaking, 70% of wealth is gone by the first generation and over 90% of wealth is
gone by the second generation. So those are big problems. And one of the ways to solve for that is to have a well
structured irrevocable trust with a sound trustee and good trust document in place. And we’re going to take a deep
dive onto different structures on how to not be one of those statistics.
Speaker 2 – 01:47
There’s lots of complex irrevocable trust. We did a podcast prior to this one. We hit special needs trust, we hit, Q
tips. You know, if you’re on your second marriage and want to preserve wealth for, you know, your second spouse
and also, you know, kids from a prior marriage, it’s a perfect one. And then we also hit irrevocable life insurance
trust. And today we’re going to take a step further into detail. I would say the three that we’re going to cover today
are a little bit more complex, all set up for different reasons. So the approach that we take is Making sure that
when clients set up these trusts that they, their intentions, their values, their goals are first and the trust is just
supporting that.
Speaker 2 – 02:30
We see a lot of times these are sold because of huge tax savings, but we totally miss that, you know, that the goal
is totally missed, like financial security right now while I’m living. If we put too much in a trust too quickly, you could
sacrifice your financial independence today. So it’s all a balancing act. It’s an artwork. The first one let’s cover
today is the, you know, is around charitable. So there’s several types of charitable trust, but the one we’re going to
cover today is a charitable remainder trust. It’s one of the most common and most powerful. So, you know, let’s go
through, you know, a couple examples. Jameson, do you want to give an example first?
Speaker 1 – 03:08
Yeah, I’ll just give a high level overview of how this works. So basically you gift money into a trust, ideally an
appreciated asset you get. I’m going to try to avoid all of the technicalities. High level, you get a deduction when it
goes in that trust, then you don’t pay taxes if it’s appreciated. If it’s an appreciated asset, you get the tax deduction.
You have to take an income stream out for your life as the grantor. There’s a calculation that’s roughly 5% and then
the benefit is as that asset grows at death, then no taxes are paid and it goes to a charity. So that’s high level
overview. I would say a specific use case is someone that’s very charitably inclined, wants to leave a legacy to
charity and be as tax efficient as possible.
Speaker 1 – 03:51
However, they still want an income stream from this asset to help support them while they’re living. And the best
use case, if you have a really highly appreciated asset, that could be a real estate sale or a real estate holding that
could be appreciated securities could be whatever asset you want, you put it in there, get a tax deduction, capital
gains tax are avoided and you get an income stream.
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Speaker 2 – 04:14
From it, no doubt. Okay, so let me go through an example. Numbers, right? So let’s just say that someone bought a,
a property and this property, you know, was bought in the right spot and the cost basis is essentially zero because
they’ve depreciate it, they’ve deducted it. They were, you know, real estate professionals, whatever the case may
be, it’s now worth 4 million bucks. So if they sell this thing, you know, approximately, they’re gonna about a million
dollars in taxes, capital gain taxes, they’ve held it over a year. It’s obviously they’ve held it for like 30 years. So if
they sell this $4 million asset, they get 4 million bucks, but ultimately $1 million goes right to the IRS, right, the tax.
They keep 3 million. Now what are they gonna do? 3 million, they’re retired.
Speaker 2 – 04:56
They’re gonna take income out of this, you know, safe withdrawal, right. Maybe, you know, 120 to 150,000 a year.
So we’ll just call it like 10 to 12,000amonth, net of tax they’re able to live off of for life. Now what happens if they
die? Let’s say they don’t have kids. It’s going to go to charity. Much better route if that’s the goal. If they want to
avoid tax, you know, later and now is they would put the property into the Charitable Remainder Trust. So now all
$4 million would end up staying in the Charitable Remainder Trust. So that’s benefit one is they don’t have to pay
that capital gain tax, right? They just saved a million bucks. Benefit number two, they got a tax deduction on the $4
million.
Speaker 2 – 05:42
So if they were at the highest tax bracket, so if out of the 4 million, all 4 million dollar stays, they save that million
dollars of capital gain tax. So right away that’s worth the price of admission. On top of that, they get up a deduction
that year up to 30% of AGI. Now it’s 60% of AGI if it’s cash at 30% of AGI if it’s an asset. But they can spread that
out. So if their AGI is a million bucks, they take 300,000 of that gift and they would deduct it right off their taxes if
they’re doing a Roth conversion that year or if they’re stepping up basis in another stock, we can make that tax
neutral for them or even get money back in their pockets.
Speaker 2 – 06:16
Now once the money’s in the CRT Charitable Remainder Trust, they get to take an income stream off of that. So
they assign an interest rate. Let’s just say it’s, you know, 5%, making that up. So 4 million, 5%, 200 grand a year. So
now they get to take 200 grand a year out of the trust and they get a live off of that. Once they die, the $4 million
have to go to the charity that they’ve decided of their choice. That’s basic structure. But you can see huge tax
power, tax benefits. The downside here is obviously if they put the 4 million here, they can’t take the $4 million out.
They’ve given up the control of the principal. They can take the interest only while they’re living.
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Speaker 1 – 06:51
I think the best use case would be if you have a big income year, let’s say you sell a business, that 30% number is
going to be off of a bigger number. So that is when, if you take advantage of it in a very high income year, obviously
you could spread it out going forward. But if most of your income that year is at 37%, that’d be a really good year to
do it.
Speaker 3 – 07:11
And particularly if you’ve held the property for a really long time, the lower the basis, that’s the higher the capital
gains that you’d be avoiding by putting it in the crt.
Speaker 2 – 07:20
That’s a great example then. So if you buy a property for four and sold it for four, you know, you’d still get the
income tax deduction, 30% of the, your AGI, but you wouldn’t be avoiding that million dollars capital gain tax. So
the lower the basis, if you have an old stock, an old property, etc, the better. So this is obviously would only be
appropriate for someone very charitably inclined. If you’re not planning giving the money to charity either now or
when you die and someone’s trying to sell you the charitable remainder trust. Not appropriate. We don’t want to
lead, you know, whatever the saying is, the cart before the horse that don’t matter tax, tail.
Speaker 3 – 07:54
Wag the dog or something along those lines.
Speaker 2 – 07:56
You made that up. We’re going to put a Ben Ruttenberg next to that quote.
Speaker 1 – 08:00
I have seen these sold for ridiculous reasons.
Speaker 3 – 08:03
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Yes, but this goes back to what you said. If someone is not charitably inclined or someone is not. The purpose of
this is not to avoid the max, you know, a maximum tax deduction. Then there’s no reason for you to be doing this.
Speaker 2 – 08:15
No question. But if you’re in high net worth, some of your money is going to charity anyways. Other people just wait
and then end up wasting a lot of taxes while they’re living and when they die, this would obviously be a good fit. If
you’re worth, you know, 20 million bucks and you’re like, well, half my money’s due to charity. Yeah, Charitable
remainder trust would make sense to cover some of your baseline income and get your cake and eat it too,
essentially. Okay, let’s talk about GSTs. So generation skipping trust. And these are primarily for, you know, the
Purposes would be for grandchildren. So James, you want to give us an example again?
Speaker 1 – 08:47
Yeah, one example. We have a client and child, grown child, grown adult child. The parents are worth about $10
million. They’re probably going to be under the exemption unless that drops. However, the kid, adult kid, owns a
very successful business that is worth like 25 million bucks. He’s making a ton of money on cash flow. He’s in his
30s. He’s almost certainly going to be over the exemption. So use case for this that we did was the parents set up
a GST so when they died they used their credit. Money goes into the generation skipping trust. And the benefit is it
never hits the child’s estate for estate tax purposes. So if you don’t do that, assets go to the kid and it gets taxed at
their level when they die. But in this case goes to the trust.
Speaker 1 – 09:47
The child has enough assets that he’s going to be good for the rest of his life. Now this avoids that 40% tax and is
used for the benefit of the kids.
Speaker 2 – 09:56
And they get it. The adult children still get to use the income for their life.
Speaker 1 – 10:00
That’s right.
Speaker 2 – 10:00
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They just don’t touch the principal. And the principal and so they potentially, if, let’s say the grand parents were
above the limit and you’re just using the example of like the. If you don’t set this up, it gets taxed to 40% of them. It
goes to the adult children’s estate, it gets taxed 40% again, such as how you erode like almost cutting your wealth
in half. Cut it in half. Again, this avoids all that. If you set this up especially early on as it goes tax free, we avoid,
you know, getting it into their estate. Then it goes tax free of the grandkids and you get your cake and eat it too.
Because the adult children are 30 set, they’re not going to need the principal.
Speaker 2 – 10:38
If this is 10 million bucks, you know, the interest, if it’s four or five hundred grand a year, that’s plenty to supplement
their wealth. And then you know, the grandkids get the principal plus whatever interest wasn’t used and was
invested, reinvested instead.
Speaker 3 – 10:50
Plus the adult child can still be the trustee on the trust. That’s for the benefit of the grandkids. So you still want the
adult child to be involved, helping oversee distribution requests, making sure that the money is protected from
divorce and from lawsuits. All the benefits of why you have money in a trust in the first place. The adult child can
still be involved as A trustee but they’re as Jameson said, it’s avoiding a lot of the, it’s kind of missing their estate
back down to the grandkids.
Speaker 2 – 11:17
No question, no question. Well anything else to add on the GSTs? I think these are often we see these, this is for
high net worth person. You know you want to have different types of trust. Typically you’d have a revocable trust.
Maybe you’d have two spousal life access trusts. Maybe you have a life insurance trust that holds like a second
that I and if you have a lot of wealth then the GST would either be you know provisioned in some of those trusts or
it could be a separate trust by itself for that purpose.
Speaker 1 – 11:46
If, if you have parents that aren’t going to be subject to the estate tax and the kids will easiest use case use their
exemption, get a bunch of money in there if both parents and kids are going to be subject to the tax. Low hang fruit
is gift the 19,000 a year for however many beneficiaries they are every year get that in and then that way it’s not
going to hit either credit.
Speaker 2 – 12:09
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So the last one we’re going to talk about is an intentionally defective grantor trust and this one’s really a unique one
to especially for a business owner. We see it’s most common where you have this asset that you know is going to
be big. You still want to control it ultimately you still want to pay the you know, some of the taxes on the trust but
you ultimately want your business to go to your kids and you want them to avoid paying this big hit of estate tax.
So the idgt is a way to get it in still control it, get paid still while you’re operating it. But then also all this
appreciation that’s going to occur is going to be out of your estate. So let’s go through an actual example.
Speaker 2 – 12:54
So Jamieson, should we say someone’s like 40 years old and let’s say the business is worth you know, 5 million
bucks and you’ve got the goal wanna avoid this estate tax when you die and you ultimately want your kids to inherit
it, you know, as tax efficiently as possible and continue to run it. So let’s just go step by step.
Speaker 1 – 13:15
Okay. So as I say so if you didn’t do this and you put gifted the business into a trust you’re gonna use part of your
credit of $15 million. What the benefit of this is you do not use part of your credit because it’s a sale. So $5 million
asset. You sell it to the trust. That business is profitable, hopefully. So the business is sold to the trust with a
promissory note. Let’s say, for example, he’s going to continue to operate and run the business for a long time.
He’s 40. So he structures the note for 20 years. So it’s going to pay him back 350,000 a year for 20 years. At the
end of those 20 years, he’s taken that income. It’s now on his, in his, on his balance sheets, inside of his estate.
Speaker 1 – 13:58
But the business, let’s say it goes from 10 or 5 to 15 million, is now owned by that trust and it is not subject to any
estate taxes because it’s protected by the trusts.
Speaker 2 – 14:11
Two things right there. Just because people are following the math, so you sold 5 million. Why are you getting 350
for 20 years? Well, because that’s 7. 350 times 20 years. 7 million. Well, you would, when you do a promissory note,
the irs, it, I would say you get to, you actually have to, you have to use what’s called an AFR rate. So if you use an
AFR rate, there’s an interest rate right now long term is probably, you know, 3 to 4%. And so cheaper than a
mortgage, you know, because this is a promise. AFR rates, typically if you’re dealing with family, you know, or
friends. So that is a good thing because you get a, you get, you got to get that cash flow to your business, which
you would anyway throw a salary that 350 a year.
Speaker 2 – 14:49
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And now, as you gave the example, we haven’t used the exemption. The 5 million goes to 15. Or let’s say the 5
million goes to 50 million. When you pass it off to your kids, one, they already own the business, they can have. The
trust already owns the business. And all of that appreciation, including the initial, is out of your estate. So you’re
going to avoid ultimately that 40% hit when you pass it.
Speaker 1 – 15:10
The big thing is because it’s a grantor trust, intentionally effective grantor trust, when that sale occurs, this would
have to be the use case. You have to have. It’d be pretty high net worth because the big benefit is that trust does
not pay taxes on that sale, the grantor does. So the benefit is, let’s say it sells for 15 million. Your tax capital gains.
Let’s say it’s what, 4 or 5 million in taxes?
Speaker 2 – 15:38
Yeah.
Speaker 1 – 15:39
If the grantor pays those taxes at the time of the sale, that entire $15 million balance gets paid into the trust. So
benefit is you’re using money that’s inside of your estate to pay that tax to get more money into the trust that’s
outside of your estate. So you obviously have to make sure you have other assets to support your lifestyle when
you’re doing that you don’t just funnel everything into the trust and have nothing to live off of. But the big benefit is
that the grantor is paying the taxes.
Speaker 2 – 16:06
Yeah. So and the defective just to income tax IRS is looking as a trust as if it’s still you estate tax. They’re looking
the trust if it’s not you where you save that 40% so you truly do get a have your cake and eat it too or whatever the
saying is. So yeah, this would be a great example for you know a young business owner that’s blowing it up. And
also we’ve seen it work for mature business owners. Someone that you know a 60 year old that not sure if they
want to pass money on to their kids through the business or if their business if their kids are going to come in. But
you can start this and like you gave an example of the business sells it goes into the trust.
Speaker 2 – 16:44
And sometimes we’ll see that clients will use part of because right now they’re gifting limits are 15 million each. So
sometimes you’ll use, you know if your business is worth 100 million for example, sometimes you use 10 million,
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get 10% of it in there and then do the rest of it through the promissory note. So you can do, you could use all of
your exemption to see this. You could use none of your exemption to cede. This just depends on how cash flow
wise the business can support paying that note off.
Speaker 1 – 17:10
And one thing I hear when we talk about this is that the business owner doesn’t want to give up control if the trust
owns it and the trustee is in control way around that is depending on the structure of your entity. Split the share
classes into voting and non voting shares and then that owner retains all of the voting shares but the rest of the
business goes into the trust. Now the trust gets the financial benefit and that owner still has full control over the
business.
Speaker 2 – 17:37
No doubt. So you could keep one voting share, you own that and then 99% of it or you know example goes into the
trust through the idgt sale.
Speaker 3 – 17:45
A question that people might be thinking about when considering an intentionally defective grantor trust. What if
they are not sure if their kids are going to succeed them into business. Does this strategy, if you’re in their shoes,
does that still make sense if you’re not 100 sure if the kids are going to take over or not?
Speaker 2 – 18:02
It could, it definitely could, depending on how long of a Runway that you have. And if your business still gets sold,
like Jamie’s mentioned, it’s still going to go into the trust. Now the math could work out. You know, why wouldn’t
we just put this into a slat or a different type of irrevocable trust? I think the with idgt gives if you’re still operating,
it gives you that cash flow back because most of the time if you put a big intro, if you big a put interest into a slot
now you’re losing cash flow like that slide. If it owns 10% of your business, has to get, if you’re an escort, has to get
10% of every distribution that’s taken versus IGT you’re able to, you know, sell it and you have a guaranteed cash
flow from the sale, the note payment.
Speaker 2 – 18:44
So it just depends on your goals, but it can make sense or not make sense or both could make sense if you’re
unsure. So, Jameson, any closing thoughts?
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Speaker 1 – 18:53
No. I think this is a very nuanced strategy. It’s got to really be the right situation. But it can be very effective for
transferring the business to somebody else or if it’s going to sell to save a ton of money on taxes.
Speaker 2 – 19:06
Yeah, I’d say, you know, real life example of a client that it’s like not sure my kids are graduating college, not sure if
they’re going to be part of the business or not. We would want to. What we often see is an attorney or CPA or they’ll
blanket recommend them just because they’ll see all these big tax savings. We want to get so intimately in the
know of your goals, your family, your situation and educate you on how these works, educate you on the pros and
cons, educate you on here’s if this happens, here’s what this would mean for this strategy. And then typically, you
know, we believe clients need to understand if you don’t understand it, you shouldn’t do it. Even if you’re trusted
professional, you’ve got to understand the strategy, know the pros and cons.
Speaker 2 – 19:46
Have someone that’s more focused on educating you, empowering you than trying to sell you a structure. You
know, that could come with a lot of fees as well. If you deal with the wrong, you know, attorney or they a lot of the
benefits could get taken away in the fees they’re charging you, so you got to look at what contract you’re about to
sign up for as well. So. But thanks for joining us, and we’ll catch everyone next week.