Many individuals hold concentrated positions in volatile assets, such as closely held businesses, some publicly traded securities, precious metals, commodities, cryptocurrencies, etc. These individuals frequently ask, “What -- if any – estate planning should I do with these assets?” Often the concern is more precisely stated as, “What if the value of the asset falls dramatically (potentially to zero) after I transfer the assets?”
With highly volatile assets, the risk is far greater that the value will fall substantially in the short term; over the long-term the value may recover and more, but will a dramatic fall in the asset’s value undermine the planning? The answer depends upon the strategy implemented. However, certain estate planning strategies are better suited for volatile assets. Two of those strategies are the focus of this article.
Grantor Retained Annuity Trusts
If the goal is to retain the asset in the family, an excellent strategy for volatile assets is the Grantor Retained Annuity Trust, or GRAT. With a GRAT, the grantor (that is, the individual who establishes the trust) retains an annuity interest for a specified number of years (the annuity lead interest). At the end of that annuity lead-interest term, the remainder is distributed to other non-charitable beneficiaries – often descendants or other family members, to be held in a continuing trust according to the terms you design.
For gift tax purposes, the value of the gift is based on the calculated present value of the remainder interest at the time of trust creation. That remainder interest is determined by taking into consideration the value of the grantor’s retained annuity interest based on the duration of the annuity and an imputed growth rate published by the IRS, the so-called “Section 7520” rate (also often referred to as the “hurdle” rate.) GRATs are usually formed in a way that causes the calculated value of the remainder gift to be as small as possible, typically only a few dollars.
From a federal gift and estate tax perspective, GRATs present a gamble of sorts:
You “win” the gamble by outliving the initial term of the trust. To the extent the trust assets outperform the IRS hurdle rate, the excess in the trust is shifted into trusts for your beneficiaries free of gift tax. Thus, GRATs are especially powerful in low interest rate environments like the present interest rate environment. And this win can be compounded by volatile assets – if the assets grow significantly during the initial annuity term, all growth above the hurdle rate inures to the benefit of the remainder beneficiaries free of estate and gift tax.
You “lose” by dying during the initial term of the trust. In that case, a portion of the value of the trust is included in your estate for estate tax purposes – which may include the entire remaining value in the GRAT. However, in the long run you’re no worse off than if you hadn’t done the GRAT. With volatile assets, there is the additional risk that the value of the assets could fall dramatically; worst-case scenario, the asset value falls to zero and the GRAT collapses upon itself.
Thus, while it is a gamble, it’s a “heads you win; tails you don’t lose” proposition. Since the remainder value is typically only a few dollars, you will have used little of your combined gift and estate tax exemption in establishing the GRAT.
A GRAT creates a stream of funds back to the trust creator during term of trust and returns all principal (with a very small amount of interest) over time. If the trust assets do not produce income, under current law the trust can distribute the assets “in kind.” Because the value of the grantor’s retained annuity is fixed when the trust is created, if the assets have appreciated in value, the trust remainder will grow because of the increased value.
Charitable Remainder Unitrusts
If the goal is to eventually sell the volatile assets, one of the best strategies is the Charitable Remainder Unitrust, or CRUT. With a CRUT, the trust grantor retains an annuity interest for lifetime or a specified number of years not to exceed 20 (the annuity lead interest). At the end of that annuity lead-interest term, the remainder is distributed to the charitable beneficiaries selected by the grantor.
With a CRUT, the trust pays a fixed percentage annuity amount based upon the prior year-end balance. Because the annuity amount is based on a percentage of the trust’s value each year, the amount distributed to the beneficiary each year generally reflects the financial performance of the assets inside the trust. As the value inside the trust increases, the annual distribution to the noncharitable beneficiary increases. As the trust value decreases, so does the distribution to the beneficiary.
A gift to a CRUT will qualify for income and gift tax charitable deductions only if it meets certain requirements:
- The trustee must revalue trust assets each year and pay at least annually a fixed percentage of the trust assets value to one or more noncharitable beneficiaries (who must be alive at trust establishment).
- The present value of the charity’s remainder interest must be at least 10% of the value of any assets contributed to the trust. The donor receives an upfront income tax deduction for this present value of the remainder interest.
- The trustee cannot distribute anything other the fixed percentage during the term of the trust and the balance to charity at the end of the trust term.
Critically, because a CRUT is exempt from federal income tax, the income and gains of the trust are only taxed when they are distributed to the noncharitable beneficiaries as part of the fixed percentage of trust assets distributed each year. Thus, these trusts are frequently used to defer income tax on gains to be realized upon a future sale. For example, the donor can give the asset to a charitable remainder unitrust, time the sale, and reserve the right to receive a fixed percentage of the value of the trust for life (and for the life of the donor’s spouse). The trust can then sell the asset and reinvest 100% of the proceeds without paying any upfront income tax.
There are several varieties of CRUTs, each of which serves different objectives. However, particularly with volatile assets, a specific type of CRUT design can allow the trust to toggle on the income payments only upon the occurrence of a specific event, such as the sale of the asset, “retirement,” or the attainment of a specific age. This can be especially attractive if the asset does not produce income initially.
Volatile assets require careful consideration and drafting to ensure that the strategy selected meets the family’s planning objectives. While there are several options, your objectives will typically determine the best strategy for you under the circumstances.
|Jonathan A. Mintz, Esq.
Evergreen Legacy Planning, LLP
Jonathan Mintz lives in Evergreen, Colorado and splits his time between Evergreen and Southern California. Jonathan focuses on the areas of estate planning, long-term trust design & implementation, domestic and international asset protection, and strategic international tax planning. He has an extensive clientele of individuals and families with diverse international interests, including non-U.S. individuals and professional athletes. Jonathan is an author and regular national speaker as well as a member of the California Bar Association, the Society of Trust & Estate Practitioners, and WealthCounsel. Prior to his career at Evergreen, he taught as an adjunct professor at the Chapman University Fowler School of Law and served as chair of STEP-Orange County.
Jonathan A. Mintz, Esq. and the law offices of Evergreen Legacy Planning, LLP are not affiliated with First American Trust, FSB or its affiliates. The information presented here is offered for general educational purposes only. It is not intended to constitute legal advice, and it does not indicate or establish any attorney-client relationship. Always consult a licensed attorney before making any decision concerning your estate plan (or any other legal matter).