Creative Wealth Shifting

Robert G. Alexander (attorney, Milwaukee, WI) and Dallas E. Klemmer (attorney, Milwaukee, WI) recently published their article entitled Creative Wealth Planning with Grantor Trusts, Family Limited Partnerships, and Family Limited Liability Companies, 2 Est. Plan. & Community Prop. L.J. 307 (2010).  An excerpt from the introduction is below: 

Various closely-held entities also are helpful in accomplishing wealth shifting. Often family limited partnerships (FLPs), family limited liability companies (FLLCs), and S-Corporations are used for leveraged wealth shifting. Whereas a trust may designate the management, control, and beneficial enjoyment of many different varieties of assets, FLPs, FLLCs, and S-Corporations used in combination with trusts can significantly enhance the control and asset protection for certain, specific assets. In addition, these entities are useful in fractionalizing ownership interests in an asset in order to obtain appropriate discount valuations when gifts and sales are involved in the planning process. Typically, an essential component of moving wealth outside of the transfer tax system is the ability to obtain appropriate valuation discounts: “[p]assing on more value than meets the taxable eye in the transfer.”

Two of the most popular wealth shifting techniques used to disgorge existing wealth are installment note sales to IDGTs and Grantor Retained Annuity Trusts (GRATs).  The proper use of installment note sales to an IDGT consists of selling discountable, non-controlling interests in entities such as FLPs, FLLCs, and S-Corporations to an income tax defective trust in exchange for an installment note that is generally an interest-only note with a balloon payment at the end of the term. With a GRAT, the grantor transfers assets to a trust in exchange for an annuity substantially equal in value to the transferred property.

With both the GRAT and the IDGT, it is prudent for the estate owner to gift or sell a discountable income-producing asset to the trust, and to avoid receiving back payments with assets “in-kind” which are not discountable, such as cash, in order to maximize the potential for significant wealth shifting.  The goal is to avoid “in-kind” payments from the trust to the grantor when payments are subject to valuation discounts.  Transferring discounted assets into a trust and receiving discounted assets back out of the trust is inefficient because it will defeat the wealth transfer and asset protection originally built into the plan, and is costly to accomplish. These issues will be discussed more thoroughly throughout this article.