Estate Dilution Due to: Repeat Estate Taxation & A Growing Family

Repeat Estate Taxation 1. Parents $100 Dilution Due to Repeat Estate Taxation Estate Tax Rate Generation 40% 50% 1 Parents $100 2 Children $60 $50 3 Grandchildren $36 $25 4 Great GC $21 $12 5 Great Great GC $13 $6 6 GGG GC $8 $3 IRS $$$ 2. Children $60 IRS $$$ 3. Grand-Children $36 $$$ IRS 4. Great GC $21 IRS $$$

How many people have a client say: Estate Dilution How many people have a client say: “I don’t care if the children get $60M rather than $100M?” (Plug in the numbers)

Estate Dilution Very few Clients are aware of the dilution due to the combined effect of Taxes A growing family

But what about the $5.45M/$10.9M Gift & GST Exemption … ? Dilution Due to Repeat Estate Taxation & A Growing Family (40% Estate Tax) Parents $100 $100 <$40> Estate Tax $60 to Children $20 /Child <$8> Estate Tax $12 to GC Child $20 Child $20 Child $20 GC $4 GC $4 GC $4 $4/GC But what about the $5.45M/$10.9M Gift & GST Exemption … ?

Dilution Due to Repeat Estate Taxation & A Growing Family ($10M Exemption, 40% Estate Tax) Parents $100 $100 - $10 = $90 x .4 <$36> Estate Tax $64 to Children $21.3 /Child $21.3 – $10 = $11.3 x .4 <$4.5> Estate Tax $16.8 to GC Child $21.3 Child $21.3 Child $21.3 GC $5.6 GC $5.6 GC $5.6 $5.6/GC If Parents funded a dynasty trust with $10M upon death, each GC’s share would increase to $6M. What could they accomplish with lifetime planning?

Generational Split Dollar Robert W. Finnegan, J.D., CLU (518) 424-8928 bfinnegan@highland.com

Traditionally - Which Pocket? Insured(s) & Funder(s) Insured’s Children, GC, etc. Trust (Dynasty Optimal) Traditional Planning The Client Is the insured and Source of funds Wealth: Private Financing

Generational Split Dollar (GSD) Plans A strategy where … Parents (G1) fund insurance on the life of children (G2) In a Dynasty Trust for the benefit of GC and subsequent generations (G3+) Split Dollar is the basis for Generational Split $ Economic Benefit Regime (Morrissette) Loan Regime (Superior) Freeze G1’s estate and move the appreciation (LI death benefit) to a Dynasty Trust

Generational Split Dollar (GSD) Plans Parents (G1) fund insurance on the life of children (G2) Dynasty Trust for the benefit of GC and subsequent generations (G3+) Split Dollar is the basis for Generational Split $ Economic Benefit Regime (Morrissette) Loan Regime (Superior) Freeze G1’s estate and move the appreciation (LI death benefit) to a Dynasty Trust

(G2 - Same Insured as Part I) Which Pocket? PARENTS (G1) CHILD (G2 - Same Insured as Part I) GC, GREAT GC, etc. (G3, G4, etc.) $$$ Dynasty Trust Required Generational Split $ Client (G2) is the Insured Parent (G1) funds G2 - Insureds Only

Generational Split Dollar (GSD) Plans Client Profile: UHNW Client (Senior Generation - G1) Older – age(s) 70+ Frequently in poor health (uninsurable) G1 has done substantial planning and moved significant wealth, but needs to do more G2 (Child) has or will have substantial wealth G2 has established need for insurance Keep a closely held business in the family (Control ownership) Fund estate taxes Reduce dilution of grandchildren’s & GGC interest

GSD – What’s the Attraction? For the CLIENTS Discounts! Range from 30% to 95%! G1 & Dynasty Trust enter into split dollar plan Policy insures G2 or G3 (Children or GC) G1 advances $30M in premium under Split $ plan G1 has right to recover $30M upon insureds death (the “Split $ Receivable” or “Receivable”) That recovery is a long time in the future Qualified appraisal values Receivable at $1.5M (95% discount) to $7.5M (75% discount)

GSD – What’s the Attraction? For the IRS Discounts! Range from 30% to 95%! Needless to say the Service does not like GSD plans (valuations)!!! The IRS has been Auditing every Economic Benefit Regime GSD plan Assessing gift tax deficiencies asserting a 100% gift Settling some plans Litigating others Note: The aggressive discounts have not yet been litigated

GSD – With all that attention … Why would we want to propose a transaction that is sure to invite IRS scrutiny? Planning with G1’s funds to purchase LI on G2 fbo G3 is a perfectly valid planning strategy. Split $ funding is an attractive planning strategy even without the discounts All the better if we can obtain discounts. GSD plans can be responsibly promoted, implemented and managed.

Discounts Under-Promise/Over-Deliver We don’t know what discounts will be (if any!) in the future when G1 transfers Receivable (at death or during G1’s lifetime). Therefore: Initially, evaluate and propose the GSD strategy on it’s merits assuming no (0%) discount. Even with no discount when used to fund a fully guaranteed UL policy, EB regime GSD acts as an estate freeze. G1 is only entitled to receive the loans plus accrued interest back upon G2’s death. We’ve been promoting split dollar for years without discounts! Why are they so important now?

II. Estate of Morrissette vs. Commissioner 146 T. C II. Estate of Morrissette vs. Commissioner 146 T.C. 11 (April 13th, 2016) A recent favorable GSD case. See Also Estate of Levine vs. Comm. (July 13, 2016)

Estate of Morrissette Background Mrs. Client (G1) established three dynasty trusts, one for each son (G2) primarily for the benefit of grandchildren (G3). The trusts purchased life insurance on the sons (G2) to fund a cross purchase buy-sell agreement. Mrs. Client (G1) revocable trust contributed $30M in premiums pursuant to an EB Regime split dollar plan. The estate valued Mrs. Client’s $30M receivable at $7.5M A 75% discount!

Estate of Morrissette The IRS Treated the full value of $29.9M premium advances as gifts, and Assessed a gift tax deficiency of $13.8M and penalties of $2.7M. The Full Tax Court ruling in favor of the Client, granted summary judgement, holding that The agreements are subject to the split dollar economic benefit regime. The dynasty trusts’ only economic benefit under the agreements was the right to receive the current life insurance protection. Note: In granting summary judgement, the Tax Court held that the law was so well established the estate was entitled to prevail without proceeding to a full trial.

Estate of Morrissette Notes: The Tax Court emphasized Agreement exactly modeled example in the preamble to final split dollar regulations. The insurance was for a valid business purpose (buy-sell keep the business in family). Morrissette was a gift tax case. Some advisors overemphasize the importance of Morrissette. The IRS will certainly litigate or settle the estate appraisal of $7.5M for $29.9M of premium advances - a 75% discount!

Estate of Morrissette Notes: It is essential that clients entering into GSD transactions understand the unsettled valuation issues regarding this strategy. Although Morrissette Involved Economic Benefit Regime Split Dollar. We feel that Loan Regime Split Dollar is fine.

Understanding Generational Split Dollar Plans

Understanding GSD Plans Three Key Concepts Imputed Gift - One-Year Term Cost (Economic Benefit Regime) G1’s Split Dollar Receivable Valuation Methodology

Understanding GSD Plans 1. Imputed Gift With private split $, individual pays the premium. The economic benefit to the trust = Joint Life (Table 2001) M60/F60 4 ₵/$1,000 x $75,000,000/$1,000 = $3,000 M61/F61 5 ₵/$1,000 x $75,000,000/$1,000 = $3,750 Single Life (Carrier Rates) 50 (M or F) 72₵/$1,000 x $50,000,000/$1,000 = $36,000 51 (M or F) 76₵/$1,000 x $50,000,000/$1,000 = $38,000

Understanding GSD Plans 1. Imputed Gift Economic Benefit Regime Split $ Two alternatives for treating the economic benefit: Trust pays portion of the premium = the economic benefit. Imputed gift to the Trust = the economic benefit. GSD utilizes the imputed gift mode: G1 is obligated to pay the full premium. G1 makes an imputed gift to the Dynasty Trust. The Trust may optionally and unilaterally pay a portion of the premium equal to the one year term cost.

Understanding GSD Plans 1. Imputed Gift Single life term rates: Government Rates Table 2001 (replaced PS58 Rates) Carriers rates - Must satisfy the IRS' guidelines Reflect term rates made known to the general public (published) and Policies actually sold by the carrier (sold) Second-to-Die term rates: Government Rates Table 2001 (Morrissette) Carrier or Table 2001 Term Rates? Whether we use the Government Rates or the Carriers rates does not effect the valuation of the receivable. It does however dramatically effect the value of the imputed gift.

1. Imputed Gift Split $ - One Year Term Rates $75M Coverage, 1-Pay 1. Imputed Gift Split $ - One Year Term Rates $75M Coverage, 1-Pay* $15M Trust Carrier Rates Table 2001 Rates Share of Rate Single Cumulative Year Age DB Per $1,000 Life Gifts 1 50 60,000,000 0.72 43,200 2.30 138,000 6 55 0.98 58,800 301,200 4.15 249,000 1,117,800 11 60 1.36 81,600 664,200 6.51 390,600 2,804,400 16 65 2.03 121,800 1,178,400 11.90 714,000 5,592,000 21 70 3.37 202,200 2,012,400 20.62 1,237,200 10,693,200 26 75 5.69 341,400 3,415,200 33.05 1,983,000 19,008,600 31 80 9.79 593,208 5,797,008 54.56 3,273,600 32,485,800 t *Single premium to illustrate concept. In practice, ensure non-MEC. $4M/4 buys $76M.

Understanding GSD Plans 2. G1’s Receivable Pursuant to the Economic Benefit Regime Split $ Plan G1 advances shortest-pay non-MEC (“Receivable”) Upon insured’s (G2’s) death, G1 has the right to recover greater of Premiums Advances. Cash Value. A fully guaranteed UL G policy has very low cash value (always less than the premiums)

Understanding GSD Plans 3. Valuation Methodology G1 advances $16M in premiums (4-Pay $4/year) G1 has right to recover the $16M Receivable only upon Insured’s (G2) death. Dynasty Trust surrendering policy. Recovery is a long time in the future G2 age 50, Life Expectancy. 35 Years (general population), 39-years (preferred non-tobacco). Source: VBT 2008 Qualified appraisal values Receivable at time of transfer.

3. Valuation Methodology G1 is obligated to pay the full premium, the only interest for valuation purposes is the Split $ Receivable. Notes: If the Trust were obligated to pay a portion of the premium equal to the one year term cost, then that payment would have to be factored into the valuation of the split $ receivable. On the other hand, it may be desirable for the Trust to (optionally) pay the one year term cost in order to eliminate the deemed gift & GST transfer. Especially where the client has limited gift and GST exemptions. t

3. Valuation Methodology Discount Rate In calculating the present value of the expected recovery of the Receivable, the discount rate selected makes a big difference. What is the appropriate discount rate? Valuation firms are using rates from 14% to 18%*. Based on studies, for example, what is the expected return of funds invested by a life settlement company purchasing inforce life insurance policies? Is it reasonable to project that rate 50+ years in the future? *See Leimberg Estate Planning Newsletter #2444, by Espen Robak, Pluris Valuation

3. Valuation Methodology Example Mortality - VBT 2008 (A) (B) (C) (D)   (Preferred NT)  Prob. Expected Split $ Male  Death Payment of Year Receivable Age VBT 2008 1 4,000,000 50 0.032% 1,274 2 8,000,000 51 0.055% 4,419 3 12,000,000 52 0.075% 8,962 4 16,000,000 53 0.091% 14,536 5 54 0.106% 16,909 6 55 0.121% 19,378 7 56 0.138% 22,046 8 57 0.158% 25,219 9 58 0.182% 29,101 10 59 0.210% 33,580 … 100 For each year of the split $ plan, calculate Receivable x Prob(Death) (Col. A x Col. C) Calculate the Present Value of all of the expected payments (Col. D) over the life of the split $ plan. Notes: The mortality factors reflect the Age, Sex & Initial Underwriting Status of the insured. VBT 2008 is the current table used by insurance carriers. t

3. Valuation Methodology UL G, Economic Benefit Regime Value of Receivable* if transferred in given year Year Split $ Age  Present Value of Expected Payment of Receivable Of Receivable  of 5.00% 9.00% Transfer max(Prem,CSV) Insured PV Discount 5 16,000,000 54 4,157,883 74.0% 1,763,234 89.0% 10 59 5,163,920 67.7% 2,519,088 84.3% 15 64 6,332,088 60.4% 3,511,774 78.1% 20 69 7,665,226 52.1% 4,792,957 70.0% 25 74 9,102,695 43.1% 6,337,043 *Assumes 100% of VBT 2008 Mortality Rates for Male Non-Smoker Age 50.

Aggressive Generational Split Dollar Plans

Aggressive GSD Plans Gift or sell the receivable at a fraction of the premium advances, shortly after inception Cash in the policy when CSV = split $ receivable Example: G1 advances $16M premiums to fund $76M DB on G2 owned by a Dynasty Trust. Year 4, G1 sells the receivable for $800,000 (95% Discount) to a separate Dynasty Trust in exchange for a note. Year 6, Dynasty Trust #2 cashes in the policy when the CSV = $16M. Dynasty Trust #2 is a defective grantor trust, i.e. no gain on sale! Move $15.2M to Dynasty Trust with no gift or GST tax. An added twist: G1 borrows initial $16M from bank (G1 uses OPM!). After cashing in the policy, Dynasty Trust #2 lends $16M to G1 to repay bank. That $16M is a debt against the estate. t

Aggressive GSD Plans Carriers will not issue if they suspect Aggressive GSD. Many carriers are restricting GSD entirely or policies available for GSD Will not allow use of accumulation products where there is a risk of surrender. Advanced Sales will work with you to educate carriers when necessary. t

Economic Benefit or Loan Regime?

Example 1 Economic Benefit Regime Split $ - G1 Advances $15M Premiums M50 Preferred Non-Tobacco G1 creates a Dynasty Trust For benefit of GC, GGC, etc. Defective grantor trust (grantor pays Trust income taxes). Economic Benefit Regime Split $ Trust owner & beneficiary. Trust assigns G1 100% of CV, DB = premium advances. Imputed annual gift to Trust equal to the 1-year term cost. G1 advances $16M Premium (Receivable). $76M Universal Life NLG (Fully guaranteed coverage). t

Example 1 10-Pay – 9-Year Note Economic Benefit Regime Split $ Total DB = $76M * Imputed Gift   Insured's Parents (G1) Dynasty Trust Split $ Death Imputed Gifts - Carrier Rates Year Age Premium Receivable Benefit Per $1,000 Life ∑Gifts 1 50 4,000,000 72,000,000 0.72 51,840 2 51 8,000,000 68,000,000 0.76 51,680 3 52 12,000,000 64,000,000 0.80 51,200 4 53 16,000,000 60,000,000 0.85 51,000 5 54 0.91 54,600 260,320 6 55 0.98 58,800 7 56 1.06 63,600 8 57 1.13 67,800 9 58 1.21 72,600 10 59 1.29 77,400 600,520 11 60 1.36 81,600 12 61 1.45 87,000 13 62 1.54 92,400 14 63 1.69 101,400 15 64 1.86 111,600 1,074,520 16 65 2.03 121,800 1,196,320 21 70 3.37 202,200 2,030,320 26 75 5.69 341,400 3,433,120 31 80 9.79 593,208 5,814,928 Example 1 10-Pay – 9-Year Note

The Risks of Private Split $ (EB Regime) Following the first death or on a Single Life Policy Switch from joint to single life term rates. The term rates increase substantially (Carrier rates 2X – 34X joint rates). Do the carrier term rates meet the IRS “published and sold” requirements? If not, must use Table 2001 rates (5x carrier rates). The imputed gift must be sheltered from the gift and GST tax, so it is significant which rates/$1,000 apply.

Example 1 10-Pay – 9-Year Note Economic Benefit Regime Split $ Imputed Gift: Carrier or Table 2001 Rates/$1,000   Carrier Rates Table 2001 Rates Year Age Benefit Per $1,000 Life ∑Gifts Premiums 1 50 72,000,000 0.72 51,840 2.30 165,600 2 51 68,000,000 0.76 51,680 2.52 171,360 3 52 64,000,000 0.80 51,200 2.81 179,840 4 53 60,000,000 0.85 51,000 3.20 192,000 5 54 0.91 54,600 260,320 3.65 219,000 927,800 6 55 0.98 58,800 4.15 249,000 7 56 1.06 63,600 4.68 280,800 8 57 1.13 67,800 5.20 312,000 9 58 1.21 72,600 5.66 339,600 10 59 1.29 77,400 600,520 6.06 363,600 2,472,800 15 64 1.86 111,600 1,074,520 10.41 624,600 4,937,000 16 65 2.03 121,800 1,196,320 11.90 714,000 5,651,000 21 70 3.37 202,200 2,030,320 20.62 1,237,200 10,752,200 26 75 5.69 341,400 3,433,120 33.05 1,983,000 19,067,600 31 80 9.79 593,208 5,814,928 54.56 3,273,600 32,544,800 Example 1 10-Pay – 9-Year Note

The Risks of Private Split $ (EB Regime) Value of the policy at rollout No lapse guarantee UL is the product of choice. Premium advances always exceed the cash value (low or no). Is the value upon rollout The greater of premiums or cash values or Does the policy have a higher or lower value?

The Risks of Private Split $ (EB Regime) Upon G1’s death or if transferred during G1’s lifetime, the receivable Must go to a separate dynasty trust If it goes to the original dynasty trust, it may eliminate discounts (see Neff). Is the insured a trustee of that other trust or have a power of appointment over trust assets? The Receivable continues to generate a benefit to the original dynasty trust The economic benefit would likely be characterized as a trust distribution. If the trust that holds the Receivable is not fully exempt, then it could taint the original dynasty trust. What is the value of the $16M Receivable? Does the grantor or the estate have sufficient GST exemption to shelter? What if a 75% discount was planned on, on audit 35% was agreed to? To the extent that there is insufficient GST exemption, The dynasty trust must purchase the receivable from G1’s estate. Does that dynasty trust have sufficient assets to purchase?

Economic Benefit Regime Split $ - Issues # Issue Comments 1 EB Regime Imputed gift must be sheltered from gift and GST tax. Trust can pay some of the term costs, but would require pre-funding = increases cost and complexity. 2 Transfer of Receivable during G1’s life or upon death, requires sufficient GST exemption. Dynasty Trust can buy the Receivable, but would require pre-funding = increases cost and complexity. 3 If IRS assesses a higher value to the Receivable, the GST exemption issue is exacerbated. Must plan for possibility of a higher valuation of the Receivable. 4 Receivable must be left to a separate Dynasty Trust. Added complexity and cost. 5 Do carrier term rates meet “published and sold” requirement? If disallowed, dramatic increase to imputed gift, use/need more GST exemption.

Example 2 Private Financing (Loan Regime) - G1 Lends $15M to Dynasty Trust Takes advantage of favorable Loan Regime Split Dollar Regulations. Accrual of Interest. Locks in low Applicable Federal Rates (AFRs). Client lends funds to a Dynasty Trust ILIT sufficient to Pay annual premiums $60M UL G policy. Repay loan plus accrued interest. The policy death benefit plus loan proceeds invested by Trust in excess of the loan balance is transferred to the Dynasty Trust.

Example 2 $60M UL G - M50 Life-Pay Policy – Lifetime Term Loan Dynasty Trust Cash Flow & Value of Trust Assets (Side Fund) Net to Family 2.75% LT AFR Beginning of Year End of Year Life Trust Age  Thru LE (A84) Lifetime 6.00%   Insurance Assets - Of Then Value of Annual Pre-Tax Note Total Death Loan Yr. Insured 1.97% MT AFR Assets Premium Earnings Repayment Trust Assets Benefit Balance $15,000,000 1 50 15,412,500 15,000,000 (600,000) 864,000 15,264,000 60,000,000 (148,500) 2 51 15,836,344 879,840 15,543,840 (292,504) 3 52 16,271,843 896,630 15,840,470 (431,373) 4 53 16,719,319 914,428 16,154,899 (564,420) 5 54 17,179,100 933,294 16,488,193 (690,908) 35 84 38,180,051 42,504,511 2,514,271 44,418,782 6,238,731 36 85 38,932,198 2,629,127 46,447,909 7,515,711 37 86 39,699,162 2,750,875 48,598,783 8,899,621 38 87 40,481,236 2,879,927 50,878,710 10,397,474 39 88 41,278,716 3,016,723 53,295,433 12,016,717 ⁞ 100 52,166,922 91,648,679 5,462,921 96,511,600 44,344,677

Economic Benefit Regime Issue Private Financing (Loan Regime) Private Financing (Loan Regime) Overcomes Economic Benefit Regime Split $ Issues # Economic Benefit Regime Issue Private Financing (Loan Regime) 1 EBR Imputed gift must be sheltered from gift and GST tax. (Trust can pay the term cost, but would require pre-funding and increases complexity.) There is no gift with Private Financing. All benefits are accounted for with loan and accrued interest. 2 Transfer of Receivable during G1’s life or upon death, requires sufficient GST exemption? (Funded Dynasty Trust can buy the Receivable, but would require pre-funding.) Depending upon investment performance, loan includes funds sufficient to repay the loan (or a significant portion of it). 3 If IRS successfully assesses a higher value to the Receivable, the GST exemption issue is exacerbated. The Receivable is repaid from invested loan proceeds and/or policy death benefit. Funding is designed to repay full Receivable (undiscounted). 4 Receivable must be left to a Dynasty Trust. Receivable can be transferred to GST or non-GST exempt trust. 5 EB Regime split dollar is complex. Clients understand loans. 6 SUL NLG or hybrid products produces best result. Works with any product (UL, UL G, IUL, VUL, 2TD) 7 Discounts for NLG UL & SUL may be stronger. Discounts may be weaker than EB Regime.

Generational Split Dollar Plans Designing Generational Split Dollar Plans

T A K E A W A Y S D E S I G N G1 funding life insurance on G2 fbo G3+ is a perfectly valid strategy. Promote GSD concept based on no (best) or low discount. Establish valid need for the insurance, plan to keep in force & follow all split $ formalities. Policy design Identify the policy that best suits the client’s needs. UL, UL G, IUL, VUL, Single Life, Survivorship. Select optimal GSD design. Economic Benefit vs. Loan Regime EB Regime poses many gift and GST issues. Loan regime superior since there is no gift. Strictly observe formalities - follow split $ rules & regulations. G1 cannot unilaterally terminate the agreement.

D E S I G N T A K E A W A Y S Discounts Trust – Always use Under-promise & Over-deliver. Design to maximize discount - leave negotiating room. Inform Client to expect further IRS attacks. Trust – Always use Dynasty Trust (Consider GST implications). Defective Grantor Trust. Second dynasty trust to receive Receivable. All trusts allow trust-to-trust transfers. Independent trustee with absolute discretion best. Avoid aggressive plans. Aggressive early discounts. Early surrender programs. Ensure that highly qualified counsel is involved. Select a highly qualified and experienced valuation firm.

3. Valid Need, Keep In Force & Observe Formalities Establish a valid business or estate planning need for the insurance Keep a closely held business in the family Control ownership of a family business Fund Children’s estate taxes Reduce dilution of future generations interest in estate (G1 parents, G2 Children, G3 GC, G4 …) Plan to keep insurance inforce Notes: Avoid aggressive early surrenders

3. Valid Need, Keep In Force & Observe Formalities Observe all formalities of the split $ plan For Economic Benefit Regime account for economic benefits Imputed gift to the Trust or Trust (optionally) pays one –year term cost Account for all of G1’s rights under the plan (greater of premiums advanced or cash value) For Loan Regime Account for principal and loan interest Trust pays interest or accrues (better result)

3. Valid Need, Keep In Force & Observe Formalities Observe all formalities of the split $ plan The Morrissette Court emphasized: The agreement exactly modeled an example in the preamble to the final split dollar regulations. The insurance was for a valid business purpose (buy-sell to keep the business in the family). The parties accounted for (reported or paid) all economic benefit costs (i.e. term costs).

2. Split $ Plan Design G1 cannot unilaterally terminate the split dollar agreement: G1 and Trustee (independent trustee preferred) must unanimously agree to terminate or Independent Trustee can have the unilateral right to terminate (best practice). Note: G1’s unilateral right terminate the agreement at any time would affect the valuation. G1 would be in constructive receipt and there would be no or low discount.

6. Discounts Under-Promise/Over-Deliver We don’t know what the discount and the discounting rules will be in the future when G1 transfers Receivable (at death or during G1’s lifetime)! Therefore: Initially, evaluate and propose the GSD strategy on it’s merits assuming no and/or reasonable discount (0%-35%) Even with no discount EB Regime - GSD is an estate freeze with UL G or SUL G policy. G1 is only entitled to receive the premiums advanced back (due to low CV of policies). Even some cash value policies will result in a “soft” freeze. Loan Regime – No gift or GST transfer.

With Economic Benefit Regime 6. Discounts Design plan to optimize discounts, maximize wealth transferred With Economic Benefit Regime G1 is obligated to pay the full premium, the only interest for valuation purposes is the split $ receivable. Optionally and occasionally, the Trust may pay the one year term cost in order to eliminate the deemed gift & GST transfer. With Loan Regime Lump sum loan. Full pay premiums. Accrue interest. No gift!

6. Discounts C. Managing the Discounts Year G1 transfers the policy (the farther from issue date, the lower the discount) Discount rate makes a huge difference Assumed rollout or termination date of plan Use a policy that generates cash value rather than a UL G policy (Economic Benefit) Use a loan rate greater than the appropriate AFR (Loan Regime) Select a highly qualified and experienced valuation firm! Work with highly competent counsel and tax advisors Note on “Discounts”: We all speak of “discounts”, but that is just a convention. We are really talking about the FMV of property. Would you pay $10M today for the right to receive $10M 40-years in the future?

6. Discounts Managing the Discounts How low do you go? Can a 95% discount be defended upon audit by IRS? A 55-75%% discount? Maybe 35-50% discount? Reasonable Don’t go too low - Leave some negotiating room! Note: The Service just settled a case at a 35% discount where the appraisal produced a 95% discount. See Unfinished Business Leimberg EP Newsletter #2418 by Jensen & Berselli.

6. Discounts Expect further IRS attacks based upon Sham Transaction Step Transaction Code §2703 Modification of Agreement Reg. §1.61-22(c)(1)(ii)(B)(2) Code §§2036 and 2038 Code §2043 for excess policy value over value of discounted receivable. Notes: In a recent case filed with the Tax Court, Estate of Cahill vs. Comm., the Service is asserting #s 3, 5 and 6 above. Is the Service merely using legal attacks to induce the parties to settle?

3. Discounts Summary We don’t know what the discounting rules will be in the future when G1 transfers Receivable. Evaluate plan on merits assuming no or low discount Manage the discount Be reasonable with discount to minimize audit risk But not too low - leave some negotiating room Avoid aggressive discounts File a protective gift tax return to start the statute of limitations running IRS can be expected to audit the plan Use a highly qualified appraiser.

4. Defective Grantor Trust Make the Dynasty Trust a defective grantor trust (for income tax purposes) with respect to G1 If Trust pays a portion of the premium or loan interest Under the split $ regulations, that creates income to the grantor (G1). If the Trust is defective grantor trust with respect to G1 (and his spouse), then the deemed income is negated (a transaction between the grantor and him or herself cannot create taxable income).

5. For EBR GSD Consider GST Tax Implications The imputed gift will be a transfer for gift and GST tax purposes. The Receivable should pass to The original Dynasty Trust (with a merger of interests). Not advisable. See Neff case. To a separate Dynasty Trust (with authority to make distributions to original Trust) We don’t know When G1 will pass What the ultimate valuation of the Receivable will be Again, the most conservative approach is to assume no or low/reasonable discount for G1’s receivable to ensure sufficient GST exemptions or pre-fund.

5. Consider GST Tax Implications If insufficient GST exemptions to shelter transfer of Receivable (during G1’s lifetime or upon death) Consider implementing a discounted sale to a defective grantor trust at the time the GSD plan is implemented. See Example next slide. Consider the Trust purchasing the Receivable with a promissory note during G1’s lifetime or upon death. G2 could gift funds to the Trust (must shelter from gift & GST tax) provided G2 is not a beneficiary of Trust. Consider transferring a portion of the Receivable to a non-GST exempt trust using a defined value clause. Problematic. Notes: IRS does not like defined value clauses. If Receivable left to non-GST trust, may cause deemed GST transfer issues (with imputed transfer to original Dynasty Trust).

6. Life Insurance Policy Design Decide the appropriate type of policy to meet the client’s need UL G, CV UL, IUL, or VUL. Note: Only use loan regime split $ with high CV (UL, IUL & VUL). Single Life or Survivorship. Decide Optimal Funding Pattern Single Premium (MEC). Shortest # of Payments to create non-MEC. Note: Short-pays create favorable discounts.

highly competent counsel is involved. 9. Legal Counsel Be certain that highly competent counsel is involved.

highly competent valuation firm is involved. 10. Qualified Valuation Be certain that a highly competent valuation firm is involved.