By Steven J. Oshins Esq., AEP (Distinguished)
Decades ago, Jane Fonda made the phrase “feel the burn” popular in her highly successful aerobic exercise videotapes. More recently, “feel the Bern” became popular as the de facto slogan during Bernie Sanders’ presidential bid.
But in advanced estate tax planning, we feel a different kind of burn called the “tax burn”. Very simply, our client transfers assets to an Intentionally Defective Grantor Trust (“IDGT”) and continues to pay all income taxes on income produced by the transferred assets, including capital gains taxes on sales of those assets.
By continuing to pay the income taxes on the transferred assets, the transferor’s taxable estate is reduced by the payment of that tax. In other words, this “burns” the taxable estate and thus saves estate taxes when the person dies. In any one-year period, this burn may be somewhat small, but over time the estate reduction can be very significant, especially when the transferred asset throws off a large cash flow.
The Proposed IRC §2704 Treasury Regulations
The recently-issued Proposed IRC §2704 Treasury Regulations scared many estate planners into believing that advanced estate tax planning will be incredibly difficult since many of the valuation discount opportunities will no longer be available. However, that is simply not the case. Even if the Final Regulations are similar to the Proposed Regulations, there will be plenty of techniques still available.
Bob Keebler and I joint gave a teleconference that can be accessed by clicking here. In that presentation, we went through a laundry list of techniques that will still be viable, even if the Proposed Regulations become Final as currently drafted. Advanced estate tax planning will still be able to be done. The difference is that we will have to adapt to the new rules and retool our approach and planning techniques to work around these new rules.
The tax burn, especially when combined with a sale to the IDGT, either for a Self-Cancelling Installment Note (“SCIN”) or for a Private Annuity, and/or combined with the purchase of a life insurance policy, is a simple strategy that will handle many of our clients’ estate tax planning needs.
Tax Burn Combined with SCIN, Private Annuity and/or Life Insurance
Even if the IRC §2704 Treasury Regulations become Final as written, we can still plan by combining bet-to-live techniques with bet-to-die techniques so that no matter when the transferor dies, we save a large amount of estate taxes.
Tax Burn: The tax burn is a bet-to-live technique because the longer the transferor lives, the larger the tax burn and thus the larger the amount of depletion from the transferor’s taxable estate.
Gift and Sale: The gift to an IDGT followed by a sale to the IDGT in exchange for a deferred payment, whether by regular installment note, SCIN or Private Annuity, is a bet-to-live technique since the gift and sale move assets out of the transferor’s taxable estate and thus move all future income and appreciation out of the estate, except for the payments back to the estate on the regular installment note, SCIN or Private Annuity.
SCIN: A SCIN is a promissory note that has one additional feature: a provision cancelling all remaining interest and principal owed if the seller dies prior to the end of the term of years of the promissory note. In exchange for this self-cancellation feature, the IRS requires either an interest rate premium or a principal premium. This premium is relatively small for younger sellers, but is high for older sellers. If the seller dies before the end of the term of the note, there is a huge wealth transfer because the rest of the note payments are cancelled. Thus, this technique works best for an earlier death and is considered a bet-to-die technique.
Private Annuity: A Private Annuity is a deferred payment that continues until the seller’s death, no matter how long the seller lives. Therefore, it is a bet-to-die technique, similar to a SCIN since the payments stop at the seller’s death. But unlike a SCIN, the seller continues to receive payments no matter how long he or she lives and thus has back-end protection in the event he or she lives longer than anticipated.
Life Insurance: Life insurance obviously is a bet-to-die technique. The shorter the period before the insured’s death, the larger the Internal Rate of Return (“IRR”) on the policy. Even for an insured who lives beyond his or her life expectancy, the IRR is on the death benefit is generally good and makes life insurance a good “investment” for the insured’s family. This is especially true given that the death benefit is received income tax-free. [One exercise I use when a client is resistant to life insurance is to have the insurance advisor run the numbers showing death at age 95.]
Conclusion
The tax burn is a great estate tax reduction strategy. This is especially true over a large number of years. However, because the tax burn takes time to have a significant impact and thus is a bet-to-live technique, it should often be combined with one or more bet-to-die techniques.
By combining the tax burn with a sale for a SCIN or for a Private Annuity, the taxable estate is significantly reduced regardless of when the transferor dies. If the transferor dies early, then there is a windfall on the SCIN or Private Annuity, and if the transferor lives a long time, the effect of the tax burn is substantial and thus substantial estate taxes are saved because of the burn. Alternatively, or in addition to the SCIN or the Private Annuity, the tax burn can be hedged with a large life insurance policy since life insurance has a similar effect as the SCIN or Private Annuity.
These are not merely post-2704 Treasury Regulations techniques. These are concepts that should be used right now and, in this author’s opinion, are underutilized by planners. Valuation discounts aren’t always necessary!
ABOUT THE AUTHOR
Steven J. Oshins, Esq., AEP (Distinguished) is an attorney at the Law Offices of Oshins & Associates, LLC in Las Vegas, Nevada, with clients throughout the United States. He is listed in The Best Lawyers in America®. He was inducted into the NAEPC Estate Planning Hall of Fame® in 2011 and was named one of the 24 Elite Estate Planning Attorneys in America by the Trust Advisor. He has authored many of the most valuable estate planning and asset protection laws that have been enacted in Nevada. He can be reached at 702-341-6000, ext. 2, at soshins@oshins.com or at his firm’s website, www.oshins.com.
OTHER ARTICLES IN THIS ISSUE
- PRACTICE-BUILDING: “Multiple Financial Advisor Referral Relationships May Be a Big MISTAKE!” by Philip J. Kavesh, J.D., LL.M. (Taxation), CFP®, ChFC, California State Bar Certified Specialist in Estate Planning, Trust & Probate Law
- SUPPORT & ADMINISTRATIVE STAFF: “Top 10 E-mail Etiquette Rules for Estate Planning Professionals (and Their Assistants and Staff)” by Kristina Schneider, Executive Assistant
- FINANCIAL PLANNING: “Knowing What You Don’t Know: What an Effective Financial Plan Anticipates” by Jason Oshins, Financial Advisor, MBA
- TAX PLANNING: “Reducing Or Eliminating Capital Gains On The Sale Of Businesses And Real Estate” by Bruce Givner, Esq.