Grantor Retained Annuity Trust (GRAT)

        This vehicle is similar to a QPRT except the grantor retains a life interest in the home (instead of a term interest) and the remainder interest is sold to the children for the appraised value of the remainder interest (which can be paid on an installment basis). Thus, unlike a QPRT the grantor can remain in the home for life and never has to pay rent.
        The PRLET may be better where the grantor's resources are more limited and it would be desirable for him to receive additional income during life. The grantor must get a qualified appraisal to insure the exchange is for full and adequate consideration, otherwise the entire property value could be included in his estate for estate tax purposes.

        By selling an asset to family members on an installment basis, subsequent appreciation of the asset's value is shifted to the family members and removed from the seller's estate. This works only if the purchase price is for full and adequate consideration and is sufficiently documented to create a legally binding obligation. Upon the death of the note holder, the unpaid balance is included in his taxable estate. The asset that was sold is not included, including post-sale appreciation of its value. The installment note can be secured by the underlying property.

        Another version of the asset installment sale employs the use of a promissory note that, by its terms, expires upon the death of the payee. In addition to its appreciation shifting feature the self canceling installment note is reduced to zero at death. There is therefore no transfer tax cost to the note holder. The purchase price, however, must reflect full and adequate consideration - which in this case means the note must be sold at a premium to compensate for the self canceling feature. The amount of premium would have to be documented by a valuation expert.

        An individual who owns a majority interest in a closely held corporation or similar enterprise may reduce his or her estate tax liability by a gift of sufficient shares to reduce the donor's holdings below 50% of the total voting power. This is because the Tax Court recognizes minority interests to be worth substantially less than their pro rata portion of the entire entity, due to the lack of marketability and control features of minority interests. QTIP or other irrevocable trusts can be set up to receive transfers of minority interests from the entity owner in order to achieve entity (and hence, estate) valuation discounts.
        The formation of a family partnership or corporation is another estate-valuation-discount planning vehicle sometimes used by persons with over $2,000,000 in assets who wish to transfer property to younger generation family members at reduced transfer tax costs. It involves setting up one or more corporate or partnership organizations in which asset and control features are differentially distributed to younger generation family members over time.
        In the beginning the parents own and control. Later they may own less as a result of transferring shares to children while retaining control, at least initially. Limited Partnerships and Limited Liability Corporations are the preferred forms of business organization because corporate shares do not receive a step-up in basis for appreciation of the underlying assets when the shares are transferred at death. The operating entity is preferably comprised of an ongoing business rather than merely security investments.
        The result is that lifetime gifts, including annual exclusion gifts, and the balance of the parents' interests at death, may be discounted for tax purposes because of the lack of liquidity and control inherent in shares of closely held business organizations. Such interests are typically appraised at 35% to 45% of the value of the underlying assets. (If you want family partnership interests to qualify as annual exclusion gifts interest transferability and general partner income distribution discretion provisions need to be drafted carefully).
        Another effect may include increased protection from creditor claims. To the extent family assets consist of shares or interests in family partnerships creditors may only be able to attach future distributions of income. Such distributions are subject to considerable control and discretion of the family members possessing the control features of the organization.
        Additional advantages include the spreading out of income among family members (thus potentially lowering overall income tax rates), less exposure to divorced spousal claims (shares of family organization are not easily commingled with marital assets), and facilitation of annual exclusion giving (no need to divide up assets - shares of family organization gifted instead).
        In the case of a preexisting family owned corporation valuation discounts and control flexibility can be achieved through recapitalization. The articles of incorporation may be amended creating a nonvoting class of common stock, which is distributed to current owners by stock dividend. Thereafter nonvoting and voting shares are distributed to younger family members as desired. Over time the control features of the organization can be held among several family members thereby achieving minority and liquidity valuation discounts.

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