WEALTH TRANSFER
Generation-skipping transfers
that support family values

BY MIKE COHN

The opportunity to put family business stock (and other family assets) into a trust that is divorce-proof, creditor-proof and avoids estate taxes for future generations (as long as the assets stay in the trust) is a pretty compelling reason to take a look at generation-skipping planning strategies.

Why Multigenerational Trusts?
First of all, some basics: if the 50% estate tax (2002) is levied on each generation, with zero appreciation, an initial $1 million (owned by parents) will only be worth $250,000 when it reaches grandchildren (third generation). The same $1 million inside a generation-skipping, or multigenerational, trust still will be worth $1 million (again assuming no growth) when it reaches grandchildren. Who wouldn’t want to avoid a 75% reduction in family wealth over three generations?

Generation-skipping trusts are irrevocable. The grantor of the trust can protect assets from next generation divorces and bankruptcies, by prohibiting spouses, and creditors, from having rights to the assets in the trust. Assets are shielded from future estate taxes as long as they remain in the trust.

Flexible provisions regarding investments and distribution of income for beneficiaries can be written into the document. The trust can last as long as the grantor wishes; for example, two, three, or more generations (even longer in some states), usually splitting into separate trusts for the various family lines that evolve.

Furthermore, through the use of special trustees with specific powers, children (and grandchildren) can have access to some or all of the trust’s principal during their lifetimes, if the grantors create that option when the trust is drafted. Committees of beneficiaries can choose successor trustees, can vote family business stock, and can select investment advisors to manage assets.

Creating an Estate “Freeze”
Generation-skipping trusts can buy assets from the grantor (for a promissory note with interest) thereby creating an estate “freeze” and transferring the appreciation on those assets to future generations without taxation.

Properly structured, significant value can be transferred to a multigenerational trust without gift taxes. If the trust is intentionally defective, there will be no income or capital gains tax on sales to the trust by the grantor. And, if the trust owns survivorship insurance on the grantors, assets in the trust can be “leveraged” or multiplied to a larger number while remaining non-taxable.

Each individual has a $1 million generation-skipping exclusion ($2 million per couple). This is the amount that can be transferred to grandchildren (or later generations) without incurring a generation-skipping tax. Amounts beyond that are subject to a generation-skipping transfer tax (at 55%) when distributions are made to grandchildren or lower generation beneficiaries, in addition to an estate or gift tax (up to 50%) at the donor’s level (for 2002).

Many families mistakenly believe that, for only a $2 million benefit, the complexity of creating a generation-skipping trust isn’t worth the aggravation. What they and their advisors are missing is the extraordinary opportunity to “leverage” the transfer of wealth from generation to generation, by incorporating other planning techniques.

Family Bank
A multigenerational trust can become the "family bank" for future generations and fund entrepreneurial activities, make investments, buy real estate, make loans to beneficiaries and keep some or all of the family's wealth consolidated.

Single Pot Trust or Family Lines Trust
Say Mom and Dad have three adult married children and nine grandchildren. One question is whether the trust will continue as one trust (for all nine grandchildren) or, at Mom and Dad’s death (or sometime sooner) the trust can divide into three separate trusts, one for each family “line.”

A “single-pot” trust keeps the assets consolidated in one entity and the trustee could use the assets to support a grandchild with special needs, even if it wasn’t proportional to what the other grandchildren received. With a “family lines” trust, each of the three children would be assured of their children receiving their proportional (1/3) amount.

Term of the Trust
Seven states have abolished their rule against perpetuities ( Arizona, South Dakota, Delaware, Alaska, Wisconsin, Illinois, and Idaho), which means that if you create a trust in those states, the trust’s “life” can continue forever.

Trustees
Children can act as co-trustees (along with an independent trustee) but cannot make decisions about distributions to themselves unless distributions are limited to health, education, and support needs (called an ascertainable standard). Children can, however, have a power to remove and replace independent trustees, can select investment managers, and can vote family business stock held by the trust.

Limited vs. General Powers
The next generation (for example, children of the grantors) can have certain rights—known as limited powers. As long as the powers remain “limited” in scope, the assets in the trust will not be taxed in the children’s estate when they die. Children can be given a power to appoint their share of the trust assets to their children, or their spouse, at their death, if they do not want the trust to continue for another generation.

Discouraging/Encouraging Certain Behaviors
Generation-skipping trusts also can encourage certain behaviors and discourage others. For example, beneficiaries with a substance abuse or gambling problem could find their share of income directed to a treatment center for their benefit instead of to them personally. A grandchild who felt unfairly treated and elected to sue the trustee (or other family members) could find his/her share forfeited.

On the other hand, incentive arrangements can be included that provide special distributions to beneficiaries with unusual accomplishments. Similarly, income distributions could "match" W-2 income earned by the beneficiary.

Families with significant assets have long been concerned about doing the right thing for the next generation. Creating a multigenerational trust, with input from next-generation adult children, can be an effective bridge-builder for perpetuating family values, in addition to providing a tax-efficient vehicle that preserves family wealth.