Presented by Mike Halloran, CFP, AEP (Distinguished), ChFC, CLU ©2010

Presented by Mike Halloran, CFP, AEP (Distinguished), ChFC, CLU ©2010
THE BENEFICIARY DEFECTIVE INHERITOR’S TRUST (“BDIT”) “A Powerful New Wealth Planning Strategy” Presented to Quad Cities Estate Planning Council May 17th, 2018 Presented by Mike Halloran, CFP, AEP (Distinguished), ChFC, CLU ©2010 ©2010 Richard A. Oshins and Robert G. Alexander

Nothing contained in this material is intended to
constitute legal or tax advice. The general information contained in this presentation should not be acted upon without obtaining specific legal or tax advice from a licensed professional.

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

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

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

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

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

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

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

©2010 Richard A. Oshins and Robert G. Alexander
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

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

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

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

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

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

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

Tax Consequences of an Income tax Defective Trust Including a BDIT
Rev. Rul Non-recognition of gain of sales The “tax burn” ©2010 Richard A. Oshins and Robert G. Alexander

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

The Tax Burn - Illustration
©2010 Richard A. Oshins and Robert G. Alexander

Question #3 What are the gift tax implications if I pay income tax as a result of the grantor trust rules? Rev. Rule No additional gift on payment of income tax ©2010 Richard A. Oshins and Robert G. Alexander

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 Non-recognition of gain/loss on sales/exchanges with an IDIT ©2010 Richard A. Oshins and Robert G. Alexander

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 No family attribution rules for purposes of discounting ©2010 Richard A. Oshins and Robert G. Alexander

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 – no additional gift on payment of income tax #4 - Rev. Rul – non-recognition of sales to IDITs #5 - Rev. Rul – no family attribution rules for purposes of discounting ©2010 Richard A. Oshins and Robert G. Alexander

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

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

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

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

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 ©2010 Richard A. Oshins and Robert G. Alexander

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

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

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

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

Seeding the Trusts Gifts to Trust
$1,667 $1,667 $1,666 Trust A Trust B Trust C FBO Client and Katie FBO Client and Bob FBO Client and Sue Client – Power of Withdrawal $5,000 ©2010 Richard A. Oshins and Robert G. Alexander

Transfer Tax Creditor rights
Who is the Grantor? Transfer Tax Creditor rights Owner for Income Tax Purposes - IRC § 678(a) 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

Tax-Free Sale to BDIT Assets Installment Notes
BDITs Trust A Trust B Trust C Wealthy client sells discountable income producing assets for an Installment Note ©2010 Richard A. Oshins and Robert G. Alexander

Note Sale to a BDIT with a Guarantee
Parent “mom” Gift Subject to Power of Withdrawal BDIT Note Sale Guarantee H W Fee Family Trustee Beneficiary I/T Grantor Seller ©2010 Richard A. Oshins and Robert G. Alexander

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

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

Safe Transaction – Valuation Disparity
Gift Tax/Chapter 14 SPA protects against an inadvertent gift The gift is incomplete Reg. § (b) EstateTax/GSTT Report the sale ©2010 Richard A. Oshins and Robert G. Alexander

IRS Reporting of Sale to Trust
Timely file from 709 gift tax return Non-completed gift Treas. Reg. § (c) - 1(f)(4) If IRS does not challenge the valuation ©2010 Richard A. Oshins and Robert G. Alexander

IRS Reporting of Sale to Trust - cont. -
If the IRS successfully challenges the valuation It is an incomplete gift Treas. Reg. § (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

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

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

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

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

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

Presented by Mike Halloran, CFP, AEP (Distinguished), ChFC, CLU ©2010

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Presented by Mike Halloran, CFP, AEP (Distinguished), ChFC, CLU ©2010

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