Understanding “Intentionally Defective” Grantor Trusts

Despite its odd name, the intentionally defective grantor trust (IDGT) is a powerful estate planning tool that can achieve a wide range of objectives: reducing the size of the grantor’s estate, transferring assets outside the probate process, removing assets from the reach of the grantor’s creditors, and reducing the future tax liability upon transfer or sale of an appreciating asset. The IDGT can be an especially effective device for transferring small business ownership from one generation to another.

To create an IDGT, the grantor first sets up an irrevocable trust funded with cash or other liquid assets in an amount approximately 10 percent of the value of the other assets to be transferred into the trust. Once the IDGT comes into being, the grantor can then sell assets to the trust in exchange for promissory notes, which can either call for interest-only payments with a balloon or amortization of the principal amount of the debt.

Using the IDGT to Transfer Interests in a Closely Held Business

The most common IDGT sales transactions involve transfer of a non-controlling interest in a business owned solely or principally by the grantor, who retains certain rights in the assets transferred – mainly, the right to substitute trust assets or manage them on a non-fiduciary basis. This retention of rights with respect to trust assets is what makes the trust “defective” for income tax purposes. The grantor will need to pay tax on income produced by trust assets, because the IRS will regard the transfer of assets as a sale by the grantor to him or herself.

For estate and gift tax purposes, however, a properly created IDGT will be recognized as valid. Beneficiaries of the trust will take title to the assets free of income, capital gains or estate tax. Because asset values are determined at the time of the grantor’s transfer, subsequent appreciation of assets can be essentially tax-free when the beneficiaries come into title.

Accurate asset valuations are an indispensable part of making an intentionally defective grantor trust work. The installment note taken by the grantor at the time of sale to the trust should be based on current values. When the assets “sold” are interests in an LLC or S corporation, the values can generally be discounted to reflect the non-controlling nature of the interest and the lack of marketability.

Upon the grantor’s death, the grantor’s estate may be liable for tax on any unpaid balance of the installment note at the unappreciated asset value. Transferring an appreciating asset (interest in a closely-held business) in exchange for a non-appreciating asset (the installment note received upon sale) by itself is one of the ways that an IDGT helps families manage estate tax liability for the intergenerational transfer of business interests.

Ridley Park Trusts and Estates Lawyer: Call 610-521-0604

Metro Philadelphia estate planning attorney Gregory J. Spadea has advised many Pennsylvania business owners about their options for protecting asset values while reducing tax liability through the proper use of trust instruments, gift transfers and asset protection strategies. To find out whether the IDGT can help you meet your estate planning objectives, contact Spadea & Associates in Ridley Park. To learn more about the firm and its lawyers’ experience, visit its website at http://spadealawfirm.com.

Learn About the Advantages of Organizing as an LLC

LLC benefits clipboard
Anybody interested in starting a new business, or in formalizing the organization of an existing sole proprietorship, should pay careful attention to the entity selection decisions they will need to make. An experienced business law attorney can guide you through the considerations that will affect your decision to form a C corporation, an S corporation, a limited liability company (LLC), any form of partnership, or stay with a sole proprietorship in your own name.

Though they are relatively new in the United States, LLCs have emerged as a highly popular and flexible way of organizing a new business entity. Virtually unknown in this country 40 years ago, LLCs can be formed today in every state, and in some industries, they represent the standard form of business organization.

Flexibility and Ease of Formation

Although the details vary from state to state, an LLC combines certain features of the business partnership and the business corporation. The personal liability of an LLC’s members is protected in much the same way that a corporation shelters its shareholders from liability. Unlike corporations, however, most LLCs are taxed on a pass-through basis to its individual members. In other words, the LLC pays no taxes on its profits, but each member pays income tax on his or her share.

Perhaps the main advantage of the LLC is its flexibility in organization and management. Corporations and partnerships alike are free to vary many of the state laws related to corporate and partnership governance through corporate bylaws and partnership agreements, but the level of default statutory regulation applicable to LLCs is very limited. An operating agreement defines the rights and responsibilities of the membership, and creating an LLC is as simple as filing a certificate of organization (Pennsylvania) or certificate of formation (New Jersey) together with a modest filing fee.

Unlike corporations, LLCs are not managed by boards of directors with specific duties and responsibilities.  Instead, the management functions of an LLC are spelled out in the operating agreement. When the LLC has more than one member, the operating agreement can also spell out details as to the transferability of interests, rights of first refusal and restrictive covenants with respect to proprietary information, customer lists and noncompetition terms.

Tax Election Options for LLCs

Some entrepreneurs or existing businesses might find the tax characteristics of an LLC to be disadvantageous. Because the LLC itself is not taxed, distributions to members are taxed as ordinary income to the individuals. For most startups, however, this will represent no practical difference from self-employment tax. LLCs can also elect to be taxed in any of several ways: sole proprietorship, S corporation, or if there are multiple members, as a C corporation or partnership. LLCs seeking corporate tax treatment can set up a Simple IRA retirement plan and pay themselves a reasonable salary to reduce some of their self-employment tax that they would incur as a sole proprietorship.

When the primary impetus for organizing as an LLC is to shelter personal assets from business liability, the limited liability company form is hard to beat. Many real estate companies, property investment and management firms set up a separate LLC for each building, to ensure that the tort or contract liability for each project is contained to the asset value of that property. The LLC elect to be taxed as partnerships are taxed with the general partner organized as a corporation or another LLC.

Contact Spadea & Associates, LLC in Ridley Park: 610-521-0604

Any business entity selection and formation decision should be based on your own personal and business objectives, needs and characteristics. The Law Offices of Spadea & Associates works with business owners and entrepreneurs in Greater Philadelphia, southeastern Pennsylvania and South Jersey on matters of business law, tax law and estate planning. To learn more about the ways an LLC could meet your objectives in Pennsylvania or New Jersey, contact us in Ridley Park.

Why Should I Have a Will?

A will is the starting point of any good estate plan. A will is a legal document that directs how your estate is administered and allows distribution of your assets to your named beneficiaries and contingent beneficiaries after your death. A properly drafted will protects your family by helping them meet their future financial needs after your death. A will minimizes your taxes by reducing the size of your taxable estate. Having a will also avoids intestacy proceedings to determine how your estate should be distributed. Having a will also avoids your beneficiaries from posting a bond to probate your estate. It is very important to name an executor who is responsible for settling the estate, filing all the inheritance tax, estate tax and income tax returns and carrying out the provisions of the Will.

It also enables you and your spouse to set up a testamentary trust for your children if you both were to die at the same time. You would also name a trustee that would watch over the trust assets and distribute them to pay for support, education and maintenance of your children until they reach twenty five or any age you and your spouse deem appropriate. A will allows you to name a guardian to raise minor children, which avoids having the Orphans Court appoint a guardian based on the information it can gather after you and your spouse die.

You can state in your will that you may leave a memorandum suggesting the distribution of certain personal items that you want distributed after your death such as jewelry, china, coin collections, memorabilia, tools or golf clubs etc. You can avoid potential conflict by leaving a signed and dated list with your will explaining who should get these personal items.

You should consider updating your will if any of the following occur:

1. Substantial increase or decrease in your estate assets.
2. You retire or sell your residence.
3. If you get married or get divorced.
4. Any new births or deaths in your family.
5. You move to another state or country.
6. You start a business, add a partner or terminate one.
7. The federal estate tax or income tax laws change.
However, a will only covers assets in your name. It does not cover jointly owned assets or assets with named beneficiaries such as retirement or brokerage accounts. Therefore you should regularly update your beneficiary designations on those types of accounts.
The most important thing a will gives you is peace of mind knowing that your family and loved ones are taken care of.

© 2020 The Law Offices of Spadea & Associates. All Rights Reserved. Sitemap | Disclaimer | Privacy Policy by VPS Marketing Agency, LLC