1
THE BENEFICIARY DEFECTIVE
INHERITOR’S TRUST
(“BDIT”)
“A Powerful New Wealth Planning Strategy”
Michael W. Halloran, AEP®, CLU®, CFP®, ChFC®
©2010 Richard A. Oshins and Robert G.
Alexander
2
A Special Acknowledgement
The Beneficiary Defective Trust, the original version of
the BDIT, was created by attorney Richard A. Oshins in
the 1970’s. In the ensuring years, under his tutelage,
the concept has gained prominence in estate and asset
protection planning among top attorneys around the
nation dealing with high-net-worth individuals and
families. Grateful acknowledgement is given to his
origination and further development of the BDIT and
related strategies.
©2010 Richard A. Oshins and Robert G.
Alexander
3
Topics
Primary high-end wealth shifting strategies
The BDIT Concept
– Benefits
Tax
Creditor protection
Client does not give up control
Modern wealth design
– Enhancing the value of gifts and bequests
©2010 Richard A. Oshins and Robert G.
Alexander
4
Topics – cont.
The squeeze, freeze and burn
Enhanced IDITs for estate tax depletion planning
Funded ILIT – the BDIT can buy life insurance on
– The client/beneficiary
– Others with an insurable interest
Life insurance correlation with the BDIT
©2010 Richard A. Oshins and Robert G.
Alexander
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Topics – cont.
Providing funds for retirement
– QRPs
– NIMCRUTs
– BDIT with CVLI
Life insurance as an asset class
©2010 Richard A. Oshins and Robert G.
Alexander
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Topics – cont.
Clients with business or investment opportunities
Planning with pass-through entities
Doctors and business owners with equipment leasing
Buy-sell strategies
©2010 Richard A. Oshins and Robert G.
Alexander
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Topics – cont.
Advanced asset protection strategies
– Self-settled trusts
Income tax strategies
Estate planning for professional athletes and
entertainers
Other planning opportunities
©2010 Richard A. Oshins and Robert G.
Alexander
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Primary Planning Choices for
High-End Wealth Shifting
GRAT – IRC §2702
– Gift to trust in exchange for an annuity substantially
equal in value to the transferred property
IDIT – Note Sale
– Non-controlling interest sold to an income tax
defective trust in exchange for an installment note
– Generally interest only with a balloon payment
ILIT
©2010 Richard A. Oshins and Robert G.
Alexander
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Primary Planning Choices for
High-End Wealth Shifting
These techniques involve moving wealth to trusts
created for someone else:
– Wealth depletion concerns – no direct access
– Control concerns
Loss of control
IRS exposure with too much retained control
A better alternative – the BDIT
– “The Beneficiary Defective Inheritor’s Trust”
©2010 Richard A. Oshins and Robert G.
Alexander
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Major Causes of Wealth Erosion
in the U.S.







Bad Investments/management
Taxes
Divorces
Lawsuits
Beneficiary/family problems
Bad economy
Changes in the law
©2010 Richard A. Oshins and Robert G.
Alexander
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The Client’s “Wish” List
Save taxes
Creditor and divorce protection
Control over the plan - assets and income
Full use and enjoyment of the plan assets
The right to decide who else uses or gets the property
– And when and how they get the property
Multi-generation/perpetuity
The ability to re-write the plan as needed
©2010 Richard A. Oshins and Robert G.
Alexander
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Fundamental Facts of Wealth Planning
Trusts enhance gifts and bequests
Inheriting in trust is better than inheriting outright
– Trusts offer many significant advantages that cannot
exists for assets owned outright
– Assets received and retained in trust are more
valuable to the inheritor than assets received outright
©2010 Richard A. Oshins and Robert G.
Alexander
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Fundamental Facts of Wealth Planning
- cont. -
A trust shelters inherited assets from the beneficiary’s
– Taxes
Transfer taxes
Income taxes
– Would be claimants
Creditors
Divorcing spouses
©2010 Richard A. Oshins and Robert G.
Alexander
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The Ultimate Creditor and Creditor
Protection Vehicle
A discretionary trust with “. . . the distribution discretion
held by an independent trustee . . . is the ultimate in
creditor and divorce claims protection – even in a state
that restricts so called ‘spendthrift’ trusts – since the
beneficiary himself has no enforceable rights against the
trust.” (Emphasis supplied)
Frederick R. Keydel
“Trustee Selection, Succession, and Removal: Ways to
Blend Expertise with Family Control,” 23 U.Miami Inst.
On Est. Plan., Ch 4 (1989) at §409.1
©2010 Richard A. Oshins and Robert G.
Alexander
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Overlooked Benefit – Particularly in
Today’s Volatile Economic World
Trusts enable the beneficiary to borrow for business or
investment purposes without exposing trust-owned
assets to risk
Lending institutions typically require personal guarantees
of business owners and their spouses
©2010 Richard A. Oshins and Robert G.
Alexander
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Critical Question
Can a wealthy client set up and fund a trust for
him/herself and protect his/her assets from his/her taxes
and creditors?
©2010 Richard A. Oshins and Robert G.
Alexander
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The Tax and Creditor Rights
Impediments
Income Tax – grantor trust
Estate Tax – grantor trust
Creditor rights – self-settled trust
– Estate tax inclusion
Creditor rights can create serious income and wealth
transfer tax issues!
– Also, watch distribution standards and who is (are)
the trustees
©2010 Richard A. Oshins and Robert G.
Alexander
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The BDIT Solution
Anyone other than the client him/herself can set up and
fund the trust
Key Concept:
– The trust must be set up and funded by someone else
– The beneficiary cannot make “gifts” to the trust
©2010 Richard A. Oshins and Robert G.
Alexander
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Test Your Knowledge
Combining the planning opportunities of:
– Chapter 13
– IRC §678
– Rev. Rul. 2004-64
– Rev. Rul. 85-13
– Rev. Rul. 93-12
©2010 Richard A. Oshins and Robert G.
Alexander
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Question #1
Can I set up a trust for my descendants which will avoid
their:
– Transfer taxes, and
– Creditors, including divorcing spouses
– In perpetuity
Chapter 13 GSTT rules
©2010 Richard A. Oshins and Robert G.
Alexander
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The Typical Inheritor’s Trust
A trust set up and funded by someone else
– Generally as an accommodation
©2010 Richard A. Oshins and Robert G.
Alexander
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Transfer Tax Consequences
Measured by the amount of the contribution
Subsequent growth of the assets is irrelevant
GSTT exempt forever
©2010 Richard A. Oshins and Robert G.
Alexander
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Key Concepts
A trust created by someone else
No gratuitous transfers by the beneficiaries
– Sales for FMV are OK
©2010 Richard A. Oshins and Robert G.
Alexander
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Question #2
What are the income tax consequences of a gift subject
to a Crummey power of withdrawal?
IRC §§ 678 and 671
– Beneficiary income tax status
– Trust income is taxes to the beneficiary
Remember – the income tax provisions and the
estate/gift tax provisions of the IRC are not interpreted
in paria materia!
©2010 Richard A. Oshins and Robert G.
Alexander
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Tax Consequences of an Income tax
Defective Trust Including a BDIT
Rev. Rul. 85-13
– Non-recognition of gain of sales
The “tax burn”
©2010 Richard A. Oshins and Robert G.
Alexander
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The “Tax Burn” Concept
Estate depletion as a result of paying income tax on trust
assets
– Less assets exposed to estate taxes
– Less assets exposed to creditors
Trust assets grow income tax-free during the “Grantor”
trust status
Over time the wealth compounding is more powerful
than discounting
©2010 Richard A. Oshins and Robert G.
Alexander
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The Tax Burn - Illustration
©2010 Richard A. Oshins and Robert G.
Alexander
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The Tax Burn - Illustration
©2010 Richard A. Oshins and Robert G.
Alexander
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Question #3
What are the gift tax implications if I pay income tax as a
result of the grantor trust rules?
Rev. Rule. 2004-64
– No additional gift on payment of income tax
©2010 Richard A. Oshins and Robert G.
Alexander
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Question #4
If I make a sale to a trust that is income tax defective to
me, do I recognize taxable gain or loss?
Rev. Rul. 85-13
– Non-recognition of gain/loss on sales/exchanges with
an IDIT
©2010 Richard A. Oshins and Robert G.
Alexander
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Question #5
If I own 100% of an entity and I make a gift of a 20%
interest to each of my five (5) children, are the gifts of
each 20% interest valued as a non-controlling interest?
Rev. Rul. 93-12
– No family attribution rules for purposes of discounting
©2010 Richard A. Oshins and Robert G.
Alexander
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So What Makes A BDIT Work?
Combines the planning opportunities of:
#1 - Chapter 13 – GSTT rules
#2 - IRC § 678– beneficiary income tax status
#3 - Rev. Rul. 2004-64 – no additional gift on
payment of income tax
#4 - Rev. Rul. 85-13 – non-recognition of sales to
IDITs
#5 - Rev. Rul. 93-12 – no family attribution rules for
purposes of discounting
©2010 Richard A. Oshins and Robert G.
Alexander
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The Ultimate Trust
A Beneficiary Defective Inheritor’s Trust
Combining:
– A third-party settled trust with
– Grantor trust income tax status for the beneficiary
Finessing the “pipe dream”
©2010 Richard A. Oshins and Robert G.
Alexander
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BDIT Fact Pattern
Mom sets up the trust for the benefit of her son and his
children
– Transfer tax protection for the beneficiaries
– Creditor protection for the beneficiaries
– In perpetuity
Wealthy client (the son) is the grantor for income tax
purposes
– Income tax planning for the son
©2010 Richard A. Oshins and Robert G.
Alexander
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BDIT Fact Pattern – cont.
Client’s parent sets up the BDIT funding it with a gift of
$5,000
– Parent uses independent funds
– Parent is the settlor of the trust for transfer tax
purposes and for creditor rights purposes
Client (and only the client) is given a Crummey
withdrawal power over the entire gift
– The withdrawal right is allowed to lapse
©2010 Richard A. Oshins and Robert G.
Alexander
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BDIT Fact Pattern – cont.
Son owns one-third (1/3) of a pass-through entity
Value of 100% of the entity - $50 million
Value of son’s one-third (1/3) interest after discounting
– $10 million
Son sells discountable interests in the entity to the trusts
for installment notes
Son’s sale to the trust is for “full and adequate
consideration”
©2010 Richard A. Oshins and Robert G.
Alexander
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A Beneficiary Defective
Inheritor’s Trust
The trust is defective to the client for income tax
purposes
– Power of withdrawal – IRC §678(a)
– Transactions between the client and the trust are
ignored for income tax purposes
Rev. Rul. 85-13
©2010 Richard A. Oshins and Robert G.
Alexander
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Variation
Spousal Irrevocable Trust (“SIT”)
Set up and seeded by the client’s spouse
Combines
– IRC §677(a) – income tax grantor trust rules
– IRC §1041(a) – no tax on transfers between spouses
– Rev. Rul. 85-13
©2010 Richard A. Oshins and Robert G.
Alexander
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Spousal Inheritor’s Trust – Cont.
Caveats
– Settler spouse is the “owner” of the trust income
– Subsequent divorce will not terminate grantor trust
status
IRC §672(e)(2)
The settler spouse cannot be a beneficiary
– Solution – give the beneficiary spouse a SPA
– Support trust risk
©2010 Richard A. Oshins and Robert G.
Alexander
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Funded ILIT
BDIT
Spousal Irrevocable Trust variation
©2010 Richard A. Oshins and Robert G.
Alexander
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So What Is A BDIT?
A dynasty trust set up for my descendants which avoids
their
– Transfer taxes
– Creditors, including divorcing spouses
A beneficiary “controlled” trust
Allows gifts and sales to a trust that is income tax
defective as to the beneficiary
– Crummey power of withdrawal – § 678
Wealth transfer leveraging with discounted entities
©2010 Richard A. Oshins and Robert G.
Alexander
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BDIT Design
Established and initially funded by a third party
Fully discretionary distribution standards
Controlled trusteeship
– Family trustee
– Independent trustee
The “use” concept
Broad SPA – a “re-write” power
Perpetual
Beneficiary has the functional equivalence of outright
ownership of the trust assets
©2010 Richard A. Oshins and Robert G.
Alexander
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“Seeding” the Trust
Must come from the donor’s funds
Economic validity
– Debt-equity ratio
– Rule of thumb – 10% or 9:1
©2010 Richard A. Oshins and Robert G.
Alexander
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Guarantees
Guarantees as “seed” money
– Must be legitimate
– Better than trust assets
– Often made by beneficiaries
– Need not be for the full amount of the note
©2010 Richard A. Oshins and Robert G.
Alexander
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Is a Gratuitous Guarantee a Gift?
Unsettled
– Cases seem to say no
We pay for the guarantee
– Get an appraisal
– Avoids risk of gift to the trust by the guarantor
– Income tax-free if the guarantor is the spouse or an
income tax defective trust
©2010 Richard A. Oshins and Robert G.
Alexander
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Seeding the Trusts
Gifts to Trust
$1,667
$1,666
Trust A
Trust B
FBO
Client
and Bob
FBO
Client
and Katie
Client – Power of Withdrawal
$5,000
©2010 Richard A. Oshins and Robert G.
Alexander
$1,667
Trust C
FBO
Client
and Sue
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Who is the Grantor?
Owner for Income Tax
Purposes - IRC § 678(a)
Transfer Tax
Creditor rights
Caveat: Client has a Power of Withdrawal over all gifts to BDIT
Caveat: Client never makes a gratuitous transfer to BDIT
©2010 Richard A. Oshins and Robert G.
Alexander
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Tax-Free Sale to BDIT
BDITs
Assets
Trust A
Trust B
Trust C
Installment Notes
Wealthy client sells discountable income
producing assets for an Installment Note
©2010 Richard A. Oshins and Robert G.
Alexander
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Note Sale to a BDIT with a Guarantee
Parent
“mom”
Gift Subject to Power of Withdrawal
Note Sale
H
1.
2.
3.
4.
Guarantee
BDIT
W
Fee
Family Trustee
Beneficiary
I/T Grantor
Seller
©2010 Richard A. Oshins and Robert G.
Alexander
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BDIT Tax Results
Estate freeze
– Installment notes in the estate
– Post-transfer appreciation shifted
Estate squeeze
– Discounted assets removed from the transfer tax
system
Income “tax burn” – the beneficiary pays the tax on the
income generate by the trust
IRC §678
Crummey power of withdrawal
©2010 Richard A. Oshins and Robert G.
Alexander
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BDIT Non-tax Results
The client/beneficiary is in control of the BDIT
Assets are creditor protected for the client/beneficiary
and his/her family
Assets are available after the “tax burn”
Client/beneficiary has a “re-write” power with a SPA
– Protects against potential family conflicts
– Protects against inadvertent gifts to the trust
©2010 Richard A. Oshins and Robert G.
Alexander
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Safe Transaction – Valuation Disparity
Gift Tax/Chapter 14
– SPA protects against an inadvertent gift
– The gift is incomplete
Reg. §25.2511-2(b)
EstateTax/GSTT
– Report the sale
©2010 Richard A. Oshins and Robert G.
Alexander
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IRS Reporting of Sale to Trust
Timely file from 709 gift tax return
– Non-completed gift
– Treas. Reg. §301-6501(c) - 1(f)(4)
If IRS does not challenge the valuation
©2010 Richard A. Oshins and Robert G.
Alexander
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IRS Reporting of Sale to Trust
- cont. -
If the IRS successfully challenges the valuation
– It is an incomplete gift
Treas. Reg. §25-2511-2(b)
– Allocation pro-rata between exempt and non-exempt
trusts for GSTT purposes
The BDIT is safer than alternative strategies
©2010 Richard A. Oshins and Robert G.
Alexander
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BDIT Non-tax Results -Cont.
Opportunity shifting
– Business and investment opportunities
– Giving free advice or managing trust assets
Quintessential life insurance trust
– Life insurance on a beneficiary who is also a trustee
– Decision must be made by an independent trustee
– Beneficiary cannot have a SPA over life insurance
©2010 Richard A. Oshins and Robert G.
Alexander
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Benefits of This Strategy
The entity/assets are moved out of the client’s estate on
a discounted basis
The transaction results in a leveraged estate freeze
There is no income tax on the sales or the guarantee
All of the assets in the BDIT are still available to and
controlled by the Inheritor/beneficiary
©2010 Richard A. Oshins and Robert G.
Alexander
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Benefits - Continued
The Inheritor/beneficiary has a SPOA – a rewrite power
The taxable estate of the inheritor is depleted by
valuation discounts as well as payment of incomes taxes
on the trust income – the “tax burn”
The Inheritor and his/her family have creditor and
divorce protection in perpetuity
©2010 Richard A. Oshins and Robert G.
Alexander
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Benefits - Continued
The Inheritor and his/her family have GSTT and estate
exemption in perpetuity
The SPOA prevents a gift tax on transactions with the
trust
Otherwise resistant clients will move forward with
planning
©2010 Richard A. Oshins and Robert G.
Alexander
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Why Wouldn’t Everyone Do A BDIT?
Misconception – The BDIT is only for the ultra wealthy
– Planning alternatives involve giving to someone else
– BDIT includes the virtues of alternative estate
planning techniques
– BDIT benefits – substantial and forever
©2010 Richard A. Oshins and Robert G.
Alexander
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Planning For The Mid-range Client
The client with a:
– $5 million business
– $1 million home
– $2 million other assets
The dilemma:
– Tax and creditor exposure
– Cannot afford to give the wealth away!
©2010 Richard A. Oshins and Robert G.
Alexander
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Planning For The Mid-range Client
GRAT and IDIT
– Prohibition against transfers with retained rights
BDIT
– “Fair and adequate consideration” exception
Really the “only option”
©2010 Richard A. Oshins and Robert G.
Alexander
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THE BDIT vs. OTHER
STRATEGIES
The BDIT vs. Note Sales to IDITs
Wealth shifting benefits
– Retained interest often creates continued Sec. 2036
exposure
– No need to retain anything
Control
No economic risk
– Management
– Use and enjoyment
– Rewrite power
– Tax burn
©2010 Richard A. Oshins and Robert G.
Alexander
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The BDIT vs. Note Sales to IDITS
Safety
– Gift tax
– Step transaction
– Pierre vs. Comm’r
©2010 Richard A. Oshins and Robert G.
Alexander
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The BDIT vs. APTs
Greater creditor protection
– Not a self-settled trust
– Transfer tax savings
– Control
– Use and enjoyment determined by the client
– APTs continuing costs
©2010 Richard A. Oshins and Robert G.
Alexander
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BDIT vs. FLPs
Historical purpose of FLPs
– Control
– Valuation discounts
IRS Sec. 2036 exposure
– There is no IRS Sec. 2536
Substantial non-tax purpose
©2010 Richard A. Oshins and Robert G.
Alexander
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BDIT vs. ILITs
Built-in funded ILIT
No Crummey complexities and limitations
Living benefits of life insurance
– Access to “inside build-up”
©2010 Richard A. Oshins and Robert G.
Alexander
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The BDIT and Other
Estate Planning Vehicles
Revocable trusts – avoid probate
Gifting
Charitable planning
Business succession planning
©2010 Richard A. Oshins and Robert G.
Alexander
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The BDIT and Other Estate Planning Vehicles
- Cont. -
Pre-marital agreements
Unmarried, co-habiting partners
– Traditional
– Non-traditional
Planning for physicians
Planning for athletes and entertainers
Combined with charitable planning
©2010 Richard A. Oshins and Robert G.
Alexander
70
TOPICS
Advantages of trusts
Designing trusts from the viewpoint of the competent
inheritor
Opportunity shifting
Hypothetical fact pattern
The BDIT solution – freeze, squeeze, and burn
BDIT/life insurance compatibility
©2010 Richard A. Oshins and Robert G.
Alexander
71
ADVANTAGES OF TRUSTS
©2010 Richard A. Oshins and Robert G.
Alexander
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Key Concept
Trusts Enhance Gifts and Bequests
Assets received and retained in trust are much more
valuable to the inheritor/donee than assets received
outright
The foundational concept of modern wealth planning:
“Own everything in trust forever…”
©2010 Richard A. Oshins and Robert G.
Alexander
73
A Trust “Shelters” Inherited Assets
From the Beneficiaries’…
Taxes
– Transfer taxes
– Income taxes
Potential claimants
– Creditors
– Divorcing spouses
– Government/agencies
– Others
©2010 Richard A. Oshins and Robert G.
Alexander
74
Transfer Taxes
“In fact, we haven’t got an estate tax, what we have,
you pay an estate tax if you want to; if you don’t want to,
you don’t have to.”
Statement of Prof. A. James Casner
“Estate and Gift Taxes: Hearings Before the
House Ways and Means Comm.,” 94th Cong.,
2d Sess., pt. 2, 1335 (March 15-23, 1976)
©2010 Richard A. Oshins and Robert G.
Alexander
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Transfer Taxes – Cont.
“The perpetual generation-skipping trust may have
been the ultimate estate-planning scheme for those
who had the foresight to establish one.”
“…it appears possible to create … a perpetual trust,
permanently eliminating future transfer taxes.”
“For an intervening generation now the beneficiary
of a generation-skipping trust, estate planning is no
problem, because the trust is already the best
possible built-in estate plan.”
George Cooper
“A Voluntary Tax? New Perspectives on Sophisticated Estate Tax
Avoidance,” The Brookings Institution, Washington D.C. (1979), P 57,58
©2010 Richard A. Oshins and Robert G.
Alexander
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Power of Compound Growth
Assumptions
$1 million contributed to trust
Trust lasts 120 years
45% transfer tax imposed on non-dynastic trust
assets every 30 years
©2010 Richard A. Oshins and Robert G.
Alexander
77
Power of Compound Growth
Chart
____________________________________________________
Value
Value
of Trust
of Property
Annual
After
if no
Growth
120 Years
Trust
_____________________________________________________
4%
5%
6%
7%
8%
©2010 Richard A. Oshins and Robert G.
Alexander
$
110,662,561
348,911,986
1,088,187,748
3,357,788,383
10,252,992,943
$ 10,126,316
31,927,627
99,575,980
307,258,623
938,212,935
78
Observations
Chart only illustrates estate tax depletion
Ignores impact of
Divorce
Lawsuits
Reduced propensity to spend trust assets
State income tax savings
©2010 Richard A. Oshins and Robert G.
Alexander
79
INCOME TAXES
Reduced planning importance due to
Compressed rates
Reduced exemption
Kiddie tax
Defective trust accelerates growth during “owners”
lifetime
©2010 Richard A. Oshins and Robert G.
Alexander
80
The Ultimate Creditor and Creditor
Protection Vehicle
A discretionary trust with “. . . the distribution discretion
held by an independent trustee . . . is the ultimate in
creditor and divorce claims protection – even in a state
that restricts so called ‘spendthrift’ trusts – since the
beneficiary himself has no enforceable rights against the
trust.” (Emphasis supplied)
Frederick R. Keydel
“Trustee Selection, Succession, and Removal: Ways to
Blend Expertise with Family Control,” 23 U.Miami Inst.
On Est. Plan., Ch 4 (1989) at §409.1
©2010 Richard A. Oshins and Robert G.
Alexander
81
Creditor and Divorce Protection
Asset Protection Maxim
Divorces – Trust better than pre-nuptial
agreement
Use even if taxes were not a consideration
©2010 Richard A. Oshins and Robert G.
Alexander
82
Overlooked Benefit – Particularly
In Today’s Volatile Economic World
Enables beneficiary to borrow for business or investment
purposes without exposing trust owned assets to risk
Lending institution typically requires personal guarantees
of business owners and their spouses
©2010 Richard A. Oshins and Robert G.
Alexander
83
Why We Use Dynastic Trusts
Even If There Is No Estate Tax
Predator protection
State Income Tax
Income shifting
There will be a gift tax
Enables younger beneficiaries to participate in
family wealth earlier
Compare to a GRAT
©2010 Richard A. Oshins and Robert G.
Alexander
84
Receiving Assets in Trust
Enhances the Gift or Inheritance
Transfers from someone other than beneficiary
If beneficiary makes the transfer it is a selfsettled trust
– Taxes
– Creditors
Conclusion - Transfers in trust are more valuable
to recipients
©2010 Richard A. Oshins and Robert G.
Alexander
85
Beneficiary Controlled Trusts
Beneficiaries will like “in trust” inheritances only if:
They are placed in control of the trust
They understand benefits of receiving property
in trust
They understand the BCT concept
©2010 Richard A. Oshins and Robert G.
Alexander
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Our Goals
Maximizing “in trust” benefits
Maximize control and rights similar to outright ownership
while preserving “in trust” benefits
©2010 Richard A. Oshins and Robert G.
Alexander
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Client’s Goals
Transfer tax avoidance
Creditor Protection
Control
Use and enjoyment of the property
Determine who inherits
Safe transaction
©2010 Richard A. Oshins and Robert G.
Alexander
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Design of Trusts
©2010 Richard A. Oshins and Robert G.
Alexander
89
Traditional Trusts
Typical Characteristics
Pays out income
Principal may be invaded for
“HEMS” – “support trust”
Distributes assets at specified
ages
Beneficiary not in control
©2010 Richard A. Oshins and Robert G.
Alexander
90
Modern Trust Design
Fully Discretionary
Perpetual
“Use” Concept
Broad SPA’s – “Re-write power”
Controlled Trusteeship at Proper Time
Family Trustee
Independent Trustee
©2010 Richard A. Oshins and Robert G.
Alexander
91
Trusts Protect Assets
From Creditors and Predators

Trust must be set up by someone other than the
beneficiary him/herself

Third party settled trust

Makes sense even if there was no transfer tax

Modern theory of comprehensive wealth planning:
“Own everything in trust forever…”
©2010 Richard A. Oshins and Robert G.
Alexander
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Beneficiary Controlled Trust “BCT”
Goal – To maximize the benefits that an “in trust”
inheritance can provide
Family Trustee
Controls Investments
Controls Identity of the Independent Trustee
©2010 Richard A. Oshins and Robert G.
Alexander
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Beneficiary Controlled Trust “BCT”
Independent Trustee
Controls all non-tax sensitive decisions
Individual or institution who meets the criteria of
IRC § 672(c)
“Independence” does not require a confrontational
relationship
©2010 Richard A. Oshins and Robert G.
Alexander
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Opportunity
Shifting
©2010 Richard A. Oshins and Robert G.
Alexander
95
Opportunity Shifting
Referrals of favorable business or investment
opportunities
Giving free advice or managing assets
Inheritor’s Trust as recipient
BDIT often preferable
©2010 Richard A. Oshins and Robert G.
Alexander
96
Basic Inheritor’s Trust
Opportunity Shifting
Income Tax Options
Traditional Trust
IDGT
BDIT
SIT
Combination
Tax Burn
IDGT
SIT
BDIT
©2010 Richard A. Oshins and Robert G.
Alexander
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Putting the BDIT on Steroids
Hypothetical Fact Pattern
Client owns 1/3 of a pass-through entity
Value of entity $50 million
Valuation discounts assume 40%
©2010 Richard A. Oshins and Robert G.
Alexander
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The BDIT Strategy
Client’s parent sets up BDIT funding it with
$5,000
Client is given power of withdrawal
Client sells his 1/3 interest in the entity to
the trust for a $10 million note
©2010 Richard A. Oshins and Robert G.
Alexander
99
Variation – Spousal
Irrevocable Trust
Client’s spouse is the Settlor
IRC §677(a)
IRC §1041(a)
©2010 Richard A. Oshins and Robert G.
Alexander
100
Parent is Settlor
Client’s parent sets up BDIT funding it with $5,000
Parent uses independent funds
Parent is Settlor for transfer tax and creditor right
purposes
Sale by the beneficiary is for “full and adequate
consideration”
©2010 Richard A. Oshins and Robert G.
Alexander
101
Beneficiary Defective Trust
Trust is defective to the client/inheritor for income tax
purposes
Power of withdrawal IRC § 678(a)
Transactions between client and trust ignored.
Rev. Rul. 85-13
©2010 Richard A. Oshins and Robert G.
Alexander
102
Seeding the Trusts
Gifts to Trust
$1,667
$1,666
Trust A
Trust B
FBO
Client
and Bob
FBO
Client
and Katie
Client – Power of Withdrawal
$5,000
©2010 Richard A. Oshins and Robert G.
Alexander
$1,667
Trust C
FBO
Client
and Sue
103
Who is the Grantor?
Owner for Income Tax
Purposes - IRC § 678(a)
Transfer Tax
Creditor rights
Caveat: Client has a Power of Withdrawal over all gifts to BDIT
©2010 Richard A. Oshins and Robert G.
Caveat:Alexander
Client never makes a gratuitous transfer to BDIT 104
Tax-Free Sale to BDIT
BDITs
Assets
Trust A
Trust B
Trust C
Installment Notes
Wealthy client sells discountable income
producing assets for an Installment Note
©2010 Richard A. Oshins and Robert G.
Alexander
105
Note Sale to a BDIT with a Guarantee
Parent
“mom”
Gift Subject to Power of Withdrawal
Note Sale
H
1.
2.
3.
4.
Guarantee
BDIT
W
Fee
Family Trustee
Beneficiary
I/T Grantor
Seller
©2010 Richard A. Oshins and Robert G.
Alexander
106
Results - Tax
Freeze, Squeeze and Burn
Estate Freeze
Installment Notes in the beneficiary’s
estate
Post-transfer appreciated shifted
Estate Thaw
Discounted assets are removed from the
transfer tax system forever
Tax Burn – client beneficiary pays the
income tax on trust income
©2010 Richard A. Oshins and Robert G.
Alexander
107
Results – Non-Tax
Client/inheritor is in control of the BCT
Hot assets are creditor protected for client
and family
Assets available after “tax burn”
Re-write power
Protects against potential family
conflicts
Protects against inadvertent gift tax
©2010 Richard A. Oshins and Robert G.
Alexander
108
“Seeding” the Trust
Must come from donor’s funds
Economic Validity
Debt-Equity Ratio
Rule of thumb 10% or 9:1
©2010 Richard A. Oshins and Robert G.
Alexander
109
Guarantees
Guarantees as “seed” money
Must be legitimate
Better than trust assets
Often made by beneficiaries
Need not be for full amount of the note
©2010 Richard A. Oshins and Robert G.
Alexander
110
Is a “Gratuitous” Guarantee a Gift?
Unsettled
Cases seem to say “no”
We pay for the guarantee
Get appraisal
Avoids risk of gift to trust by guarantor
Income tax-free - if spouse or defective
trust
©2010 Richard A. Oshins and Robert G.
Alexander
111
Ancillary Considerations
Economic Risk – Estate Depletion
Exposure
Toggling
Reimbursement Clauses
Forum shopping to avoid self-settled trust
BDIT resolves dilemma
SIT exposure
Basis Monitoring
©2010 Richard A. Oshins and Robert G.
Alexander
112
ENHANCED PLANNING
OPPORTUNITIES
WITH BDITs
Significant Life Insurance Sales Potential
©2010 Richard A. Oshins and Robert G.
Alexander
113
Life Insurance - ILIT
BDIT is also a funded ILIT
So is the SIT variation
Insurance on the life of a beneficiary who is
also a trustee
Decisions made by independent
trustee
No power of appointment
©2010 Richard A. Oshins and Robert G.
Alexander
114
Life Insurance Correlation with a BDIT
Life insurance has two component parts
Death benefit
Inside buildup
Asset class
QRP and NIMCRUT alternative
©2010 Richard A. Oshins and Robert G.
Alexander
115
Life Insurance Correlation
with BDIT – Cont.
Early Death
Negligible Tax Burn
Win on the Mortality Bet
Later Death
Greater estate tax depletion
Tax-free build-up more dramatic
©2010 Richard A. Oshins and Robert G.
Alexander
116
Decreasing:
need for
estate tax
liquidity during
“burn” (& net
amount at risk
outside estate)
Now
Increasing:
income tax
deferred cash
value –
available for
use and
outside the
estate
Estate accessible
Estate tax free
“Tax burn”
Insurance
+
A FIXED component
of an investment
portfolio outside the
estate
Increasing Cash Value
Decreasing Net Amount
at Risk
EXHIBIT F
Future
Derived from “Life Insurance as an Asset Class” by Richard M. Weber, MBA, CLU and Christopher
©2010 Richard
A. Oshins
and Robert
G.Ethical Edge Insurance Solutions, LLC. For further information contact
Hause,
FSA, MAAA
© 2009
Alexander
Dick@EthialEdge.biz
117
Primary Retirement
Planning Alternatives
Goal – tax exempt or tax deferred wealth
accumulation
Vehicles
Qualified Retirement Plans (“QRPs”)
NIMCRUTs
Cash Value Life Insurance (“CVLI”)
©2010 Richard A. Oshins and Robert G.
Alexander
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QRP’s
Tax deferral – not exemption
Tax at ordinary income rates
Often converts capital gain into ordinary income
IRD
Non-alienation prohibits transfers to escape the
estate tax
©2010 Richard A. Oshins and Robert G.
Alexander
119
QRP’s - Cont.
Too Soon-Too Late – Too Much-Too Little
Contributions
Distributions
Administrative and Legal Costs
Government Regulations
IRS
Department of Labor
Legislative Changes
Non-discriminatory
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Alexander
120
NIMCRUTs
Tax-deferral-not exemption
Four-tier Rule – worst first
10% Rule
Eliminates younger clients
Reduces potential accumulation period
Goes to charity at death
Early death risk
Administrative and legal costs
Fully discriminatory
©2010 Richard A. Oshins and Robert G.
Alexander
121
Cash Value Life Insurance - CVLI
Tax exempt access to the investment fund
Can access fund on a temporary basis and pay back
E.g. - college
Survivorship feature
Early death – win on mortality bet
No administrative and legal costs
Fully discriminatory
©2010 Richard A. Oshins and Robert G.
Alexander
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Major Comparisons
Deferral v. Tax exempt access to income
Access to funds on a temporary basis
Survivorship Feature
Risk of early death for QRPs and
NIMCRUTs
Decedent's Receipt
QRP-IRD
NIMCRUT – none
CVLI in trust – tax-free
©2010 Richard A. Oshins and Robert G.
Alexander
123
Life Insurance in a Beneficiary
Defective Inheritor’s Trust


Adjustments – beneficiary controlled

Special Trustee

Not subject to power of appointment
Accessing Inside Build-up


Two-step process
Wrap Trust™ - there may be serious tax
problems
©2010 Richard A. Oshins and Robert G.
Alexander
124
Accessing Policy Cash Values
Loan money to the beneficiary
– No income tax consequence
Purchase other assets from the beneficiary
– Non-recognition of gain
Distributions to the beneficiary
– Worst alternative
Assets no longer protected
©2010 Richard A. Oshins and Robert G.
Alexander
125
Accessing Policy Cash Values – Cont.
MEC
– Income tax issues
– Estate tax inclusion issues
Back-end loaded policies
Other planning issues
©2010 Richard A. Oshins and Robert G.
Alexander
126
Other Planning Opportunities
With a BDIT
Tax and asset protected forever
Advanced “wealth shifting” opportunities
– Family income tax planning
– Valuation/discount planning
– Structured gifts and loans
– New businesses – seed money
– Investment opportunities
©2010 Richard A. Oshins and Robert G.
Alexander
127
Planning Opportunities – Cont.
Grantor trust income tax planning
Sales of “hot” assets – IRC§ 751
Structuring buy-sell arrangements
State income tax planning
Multi-jurisdictional asset protection planning
Private retirement plan
©2010 Richard A. Oshins and Robert G.
Alexander
128
Planning Opportunities – Cont.
Advanced Life Insurance Planning
– Access to cash values
– No transfer for value problems
– Super-charge the insurance funding
– Super-charge life insurance partnership planning
– Premium financing techniques
– Split dollar arrangements
©2010 Richard A. Oshins and Robert G.
Alexander
129
Physicians/Equipment Leasing
The doctors purchase $3 million worth of equipment in
an LLC
Each doctor sell his/her 1/3 interest in the LLC to a BDIT
for a note
– Rev. Rul. 85-13
– Discount
©2010 Richard A. Oshins and Robert G.
Alexander
130
Physicians/Equipment Leasing
- cont. Equipment is leased to the medical practice
Cash flow from the equipment leasing business
– Pays the note
– Buys CVLI
For retirement-pension substitute
As an asset class
For family protection
For buy-sell purposes
©2010 Richard A. Oshins and Robert G.
Alexander
131
Buy-sell Planning
Newco is owned 50/50 by A and B
A’s parent set up A’s BDIT which buys A’s entity
interest from A
B’s parent sets up B’s BDIT which buys B’s entity
interest from B
©2010 Richard A. Oshins and Robert G.
Alexander
132
Buy-sell Planning cont’d
A’s BDIT
B’s BDIT
Owns A’s interest
Buys Life Insurance on
B’s Life
Owns B’s interest
Buys Life Insurance on
A’s Life
©2010 Richard A. Oshins and Robert G.
Alexander
133
Estate Planning for Professional
Athletes and Entertainers
Split between shiftable and non-assignable
– A BDIT is wonderful for income opportunities which
can be assigned
Athlete/entertainer pays the income tax on all income
©2010 Richard A. Oshins and Robert G.
Alexander
134
Estate Planning for Professional
Athletes and Entertainers – cont.
Income tax and current expenditures deplete nonassignable wealth
BDIT grows income tax-free
– Divorce and creditor protected
Better than a marital property agreement
– Cash value life insurance as a pension substitute or in
addition to those provided by the sport
– Death benefit protects the family
©2010 Richard A. Oshins and Robert G.
Alexander
135
Premium Financing Strategies
Premium Financing strategies to Consider
– Private loan arrangements
– Bank loan arrangements
– Private split-dollar arrangements
Special thanks to Northwestern Mutual Life insurance
Company in the preparation of slides 124-136. Used by
permission, with modifications
©2010 Richard A. Oshins and Robert G.
Alexander
136
Background
Large life insurance need
– Large premiums
Often a 6 or 7 figure premium
Insufficient gift tax capacity
– However - No gifts allowed with the BDIT!
©2010 Richard A. Oshins and Robert G.
Alexander
137
Background
Client has cash flow or other assets available but must
deal with gift tax limits
– However - No gifts allowed with the BDIT!
or
Client wants flexibility
or
Client does not have sufficient cash flow or other assets
available and wants to avoid selling assets
©2010 Richard A. Oshins and Robert G.
Alexander
138
Critical Planning Points With the BDIT!
Private premium financing arrangements
– The arrangement must accrue interest at the AFR and
pay the accrued interest with the principal at the end
of the term so that there is no deemed gift to the BDIT
Private split-dollar arrangements
– The arrangement must be a contributory arrangement
– The BDIT, from its own funds, must contribute the
economic benefit portion of the premium
Therefore, initially the BDIT must be independently
funded with sufficient assets to make these
payments
©2010 Richard A. Oshins and Robert G.
Alexander
139
Premium Financing Overview
Personal (“private”) loans
Regular bank loans
 pay interest in cash
 accrue interest
Current trends: interest rates, estate taxes
Planning flexibility  lend, don’t give
Non-equity split dollar
Exit strategies
©2010 Richard A. Oshins and Robert G.
Alexander
140
Private Financing: How It Works
Loans
Client(s)
Gifts (= interest)
Interest
TRUST
Life
Insurance
Policy
Premiums
Ins.
Co.
Private Financing: Why Do It?
Low gifts
– interest < premium
Generally lower interest rate than bank loan
Gift tax efficient—gifts other than cash can be made
– However: No gifts allowed with the BDIT!
Flexibility
©2010 Richard A. Oshins and Robert G.
Alexander
142
Private Financing: Risks & Drawbacks
Does it make financial sense over the long term?
Interest rates vary unless a lump sum is loaned
The cost of an increasing death benefit vs. the cost of a
static death benefit
©2010 Richard A. Oshins and Robert G.
Alexander
143
Bank Financing: How It Works
Lender
Loans
Interest
TRUST
Life
Insurance
Policy
Client(s)
Gifts (= interest)
Premiums
Ins.
Co.
Bank Financing: Why Do It?
Lower out of pocket cost
 interest < premium
Gift tax efficient
– However – No gifts allowed with the BDIT!
Other people’s money
Minimize the need to sell performing assets
©2010 Richard A. Oshins and Robert G.
Alexander
145
Bank Financing: Risks & Drawbacks
Does it make financial sense?
Interest rate uncertainty
Lender uncertainty
Additional time and expenses
Collateral requirements in addition to policy
Is grantor’s personal guarantee a gift?
©2010 Richard A. Oshins and Robert G.
Alexander
146
Non-Equity Split Dollar:
How It Works
Prem. Payments
Client(s)
Gifts (= term cost)
Term cost
TRUST
Life
Insurance
Policy
Premiums
Ins.
Co.
Non-Equity Split Dollar:
Why Do It?
Term cost < premium
Term cost < interest
Gift tax efficient
– However – No gifts allowed with a BDIT!
©2010 Richard A. Oshins and Robert G.
Alexander
148
Non Equity Split Dollar
Risks & Drawbacks
Failure to terminate plan before:
– CV significantly > premiums
– Term cost gets too big (leverage is lost)
Works best for younger insureds
©2010 Richard A. Oshins and Robert G.
Alexander
149
Contact Information
Robert G. Alexander, Esq
Alexander & Klemmer, S.C.
933 N. Mayfair Road, Suite 301
Milwaukee, Wisconsin 53226
Tel: 414-476-5020
E-mail: bob@alexander-klemmer.com
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Alexander
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