Published by: Private Wealth Advisor; Campden Publishing / Campden Media
Author: Howard Rosen, Esq.
Date of Publication: November, 2000
Usually articles and studies concerning offshore trusts have focused on their use for asset protection. However another, very important, use of a certain type of offshore trust, is to effect estate tax savings. This can be accomplished by ‘freezing’ the value of trust assets vis-a-vis the settlor’s estate at current values.
Result? Any future growth in asset values will escape US federal estate taxation, thus increasing the amounts received by children and other beneficiaries. A variation of this technique can also be used for non-resident aliens owning US real estate, or those wishing to immigrate to the United States, to practically eliminate any US estate tax on death. Some examples of common estate-freeze techniques are:
- Outright gift – an outright gift is the simplest and least desirable method of implementing of an estate freeze; the transferor loses all property interests in the transferred asset. If properly structured, any post-transfer appreciation in the asset will be excluded from federal estate taxation;
- Gifts in trust – generally this works the same as an outright gift where the transferor is not also a beneficiary of the trust;
- Sale of appreciating assets – the sale (usually to a family member or to a trust) of assets which are likely to appreciate in exchange for a promissory note (issued at the date of sale for fair market value) will also effect an estate freeze. This is because the value of the promissory note held by the transferor will usually be subject to federal estate tax at a value equal to its unpaid balance (although “self-cancelling” notes “disappear” at death). However, the transferor will lose all property interests in and any potential benefits from the asset(s) sold.
The major impediments to the implementation of a typical estate freeze are that it may constitute a taxable gift and, more importantly, it will result in a loss by the transferor of all interest in the property given away. This effectively undercuts the purpose of the whole exercise. People want to obtain the estate tax benefit and retain some type of interest in the transferred property. In the usual case, if they retain any type of interest in the transferred property, the transfer will not be complete for federal transfer tax purposes, thereby not effecting an estate freeze.
A little technical background is necessary here. In order to effect an estate freeze, a ‘completed transfer’ is required for federal transfer (estate and gift) tax purposes. Under the trust law in most jurisdictions, property transferred to a trust in which the transferor is also a beneficiary can be reached by the transferor’s creditors to the extent the transferor could possibly receive benefits from the trust.
The Internal Revenue Service (IRS) says, because of that, the transfer is [in] fact incomplete for transfer tax purposes. Thus, in the usual case, a trust of which the transferor is a beneficiary will be included in the transferor’s estate for federal estate tax purposes (no freeze).
In our next scenario the individual wants to have an interest in the transferred property and obtain an estate tax benefit. How is this to be accomplished? The IRS, in several well-reasoned public and private rulings, has held that if a transferor establishes his/her trust in a jurisdiction whose laws will not permit the transferor’s creditors to reach trust assets (as they would be able to in most places as a result of the transferor being a discretionary beneficiary of the trust), that the transfer will be complete, and will be excluded from the transferor’s estate for estate tax purposes.
Although the laws of a few states allegedly restrict a creditor’s access to trusts under the circumstances described above, there are numerous uncertainties in that regard. However, some offshore jurisdictions will be very effective to that end. You can set up a trust in certain jurisdictions and be a discretionary beneficiary of your trust, and it will be excluded from estate taxation in your estate.
Do your assets have to be offshore? The answer is, no.
Can they stay at your favourite broker? The answer here is, yes.
Note that nothing has been mentioned about US income tax. That is because, even though the trust described above will not be subject to US estate tax in the transferor’s estate, it will still be a ‘grantor trust’ for US income tax purposes, requiring the transferor to report all trust income personally.
Variations of the technique discussed can be effectively implemented for non-resident aliens owning US real estate or for those wishing to immigrate into the United States. Properly implemented, such planning can result in the elimination of US estate tax. The structure discussed here will only be effective if certain rules are carefully followed in the planning and operation of the trust.
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