woman filing taxes
Tax Reform Forgive Intra Family Loans

Intra-family transactions (e.g., installment sales to grantor trusts, loans, private financing of life insurance premiums or private split-dollar arrangements) often result in a debt obligation being included in the grantor’s/client’s estate and subject to estate tax. The increased gift and GST exemption amounts – $5 million per individual and $10 million per married couple – in 2011 and 2012, likely enable clients to forgive these loans. This approach should:

  • Take advantage of unique gifting opportunities available in 2011-2012
  • Simplify existing wealth transfer plans (e.g., eliminate split-dollar arrangements, loans, Crummey notices)
  • Free trust cash flow to fund life insurance premiums
  • Increase amount of wealth transferred to trust beneficiaries

Current Situation

John, 68, and Susan, 65, are a retired married couple with a net worth of approximately $50 million. Prior to 2011, they each utilized their lifetime gift tax exemption amounts. In May 2009, John sold his minority interest in the family business to a grantor trust (Trust) in exchange for a nine-year promissory note providing for payments of interest only at the mid-term AFR of 2.05 percent for May 2009 and a balloon payment of $7.5 million due in May 2018 (Note). The Note allows for prepayment of principal without penalty. The Trust regularly generates cash flow of approximately $350,000 per year. Approximately 44 percent of the annual cash flow is used to service the Note interest payments of $153,750. The balance of the cash flow is used to fund a survivorship guaranteed universal life policy insuring John and Susan.

Recommendation

John and Susan use their combined increased gift tax exemption amounts to forgive the balance of the Note. As a result, the Trust will no longer be required to make annual interest payments of $153,750 to John. This would allow the trustee of the Trust to use the additional $153,750 that would have otherwise been applied to pay interest to purchase another guaranteed survivorship life insurance policy on John and Susan, both preferred non-smokers, in the amount of $13,322,233. In addition, the balance of the Note will no longer be included in John and Susan’s estates. In effect, we have taken their same estate planning transaction and increased its internal rate of return.

Potential Benefit

By forgiving the balance of the promissory note and incorporating life insurance into their wealth transfer planning in such a manner, John and Susan may increase the amount of wealth transferred to their family at their joint life expectancy by $20,333,940 or 42 percent.

The following charts illustrate the potential benefit of the proposed plan.

Current Plan                                                                             Proposed Plan

Year Age Assets Inside Estate Estimated Estate Taxes Net to Heirs Assets Inside Estate Estimated Estate Taxes Increased Amount in Trust Net to Heirs
1 66 $50,031,250 ($14,010,938) $36,020,312 $42,377,500 ($13,957,125) $20,822,233 $49,242,608
5 70 55,490,374 (29,264,706) 26,225,668 47,221,624 (28,841,893) 20,822,233 39,201,964
10 75 63,867,063 (33,871,885) 29,995,178 54,227,860 (32,695,323) 22,124,275 43,656,812
15 80 74,004,589 (39,447,524) 34,557,065 62,447,563 (37,216,160) 24,568,130 49,799,533
20 85 85,756,760 (45,911,218) 39,845,542 72,074,007 (42,510,704) 27,401,227 56,964,530
25 90 99,380,747 (53,404,411) 45,976,336 83,331,250 (48,702,187) 30,685,564 65,314,626
27 92 (LE) 105,419,713 (56,725,842) 48,693,871 88,347,629 (51,461,196) 32,141,378 69,027,811
32 97 (LE + 5) 122,175,499 (65,941,525) 56,233,975 102,333,415 (59,153,378) 36,180,698 79,360,735
35 100 133,484,183 (72,161,300) 61,322,882 111,818,475 (64,370,161) 38,906,884 86,355,198

For traditional insurance products only; may not be used with variable life policies. Riders are available for an additional cost. Any guarantees offered by life insurance products are subject to the claims- paying ability of the issuing insurance company. There are considerable issues that need to be considered before replacing life insurance such as, but not limited to; commissions, fees, expenses, surrender charges, premiums, and new contestability period. There may also be unfavorable tax consequences caused by surrendering an existing policy, such as a potential tax on outstanding policy loans.

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