Planning to Meet the Client's Goals and Limit Estate Tax Liability

Last week we profiled a client and the strategies used in his estate plan to protect his loved ones after doctors diagnosed him with a likely fatal disease. While we did a great deal of planning in his final months, as with many endeavors, planning prior to discovering problems leads to greater success. When we began working with this client, we immediately recognized that he faced significant potential issues related to estate planning, tax planning, and family dynamics.

After analyzing his situation, we found three areas of potential concern. First, due to the scope of business and invested assets, as well as his real estate holdings there was likely to be a substantial estate tax liability at both the client’s death and the death of his wife. Second, because he wanted to provide that some of his assets went to his daughters from his first marriage if he predeceased his current wife, we were unable to set up the traditional marital/residuary strategy to eliminate taxes on the first death. Finally, we knew that the value of his real estate holdings continued to increase and increased the potential estate tax liability.

We first discussed the potential estate tax liability and the effect it would have on his business if he died suddenly and a significant tax liability arose. He recognized that while his assets generated significant annual income, most of his assets were illiquid and would not provide cash for taxes without adversely affecting the business itself. Without planning, we would have to "kill the golden goose" to provide sufficient assets to satisfy tax liability. To address this issue we recommended a number of Irrevocable Trusts to own life insurance on the client’s life and on both the client and his wife’s lives jointly.

One Irrevocable Trust held a policy on his life alone, which matured at his death and provided the funds to pay the estate tax liability at that time. Since we could not know at that time if the client or his wife would die first, the second Irrevocable Trust held a second to die policy, which would mature in any event on the second death and provide funds to pay any additional tax liability at that time. After years of continued success and an increasing estate, we also later set up an Irrevocable Trust to own a policy on his wife's life, to provide additional protection against tax liability whenever she passed away. In addition to providing liquidity to the estate to offset potential tax liability, these Trusts freed up estate assets for other family planning. As an added benefit to the client, premiums paid were a fraction of the policy face value, so the client was able to pay estate taxes at his death with cheaper dollars.

When it came time to address the matter of the client’s evermore-valuable real estate holdings, the client indicated that he did not need the asset value or the income from these properties and was willing to gift the property to his five daughters, as long as he could maintain control of them. Using limited liability companies to own the property, we gave our client a 1% voting interest in the entities and gifted the 99% nonvoting interest to the daughters. While he was alive, the client maintained control of the properties with the voting interest and the LLCs held the rental income received for the benefit of the daughters. Eventually we entered into an agreement where the LLCs loaned money to the Irrevocable Trusts to pay life insurance premiums, which freed up a significant amount of cash flow for the client. In order to protect the children, we annually distributed a sufficient amount of money to pay taxes on the "phantom income" they received from the LLCs.

As you can see, while it is possible to complete some planning when emergencies arise, the best planning is done beforehand by anticipating issues and using strategies that protect the client and loved ones. It is important that we as planners anticipate our clients’ needs because they are often too busy to do so themselves.

Alan Ferrara