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Friday, May 3, 2024
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Case Studies |
Super Lead Trust Rescues $5M Bonus
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Case:
Thomas Cook IV, 38, is the chief operating officer of Savar Oil and Gas Corporation and the likely next chief executive officer of Savar. Thomas always knew he would do well in business. From a very early age, his father, a CEO himself, groomed young Thomas for this destiny. At his father's urging, Thomas attended the finest schools and earned MBAs in both business and finance. Not surprisingly, he graduated number two in his class and eventually became the youngest vice president ever in Global Communications' history. His reputation as a "wonder exec" thrust Thomas into the business world spotlight. As a result, Savar sought to retain his services and made him an offer he could not refuse. The offer consisted of huge deferred compensation arrangements if Thomas could work his magic at Savar. To everyone's surprise, except Thomas', Savar broke into the Fortune 500 this year. Not only was this good news for the company but it also triggered a $5 million bonus for Thomas. While extremely pleased with this additional wealth Thomas shuddered at the thought that his hard-earned money would be cut almost in half after federal and state income taxes were applied. Moreover, Thomas' lawyer, Stephen Akers, informed him that when he dies approximately half of his $20 million estate will also pass to federal and state governments. As you can imagine, Thomas then went from sickened to outraged.
Question:
Can Thomas set up a simple plan whereby he can significantly reduce his income and estate tax liability?
Solution:
Stephen suggested a super lead trust (aka defective grantor lead trust). He explained that this charitable trust would be drafted so that it would qualify for both an income and gift tax deduction. Moreover, it would provide income to his favorite charities. This last comment excited Thomas because he had been contemplating for years funding a new business building for his alma mater, which he naturally wanted to be named after his father.
After reviewing Thomas' income needs and estate plan, Stephen recommended that Thomas fund an annuity lead supertrust for his children with $4 million of the Savar bonus. The trust would make a 9% annuity payment of $360,000 to his alma mater for 14 years. Assuming a 10% trust return, the university would receive over $5 million and Thomas' children would receive over $5.1 million at the termination of the trust. More amazing, though, is that because the trust produces a gift tax deduction of about $3.35 million, the transfer to the children would not cost Thomas even one dollar of gift or estate taxes (taking into account his exemption amount).
With respect to income taxes, this lead supertrust would generate a $3.35 million charitable income tax deduction in the current year. This would help offset Thomas's other items of income subject to tax at his top tax rate. However, Stephen informed him that because this is a grantor trust for income tax purposes, he would have to recognize the trust income over the 14-year term of the trust. While this at first glance seemed undesirable, Stephen explained that because the trust would invest largely in growth stocks, Thomas would report mostly capital gain type income, i.e., at a 15% rate. This "arbitrage" of tax rates would benefit Thomas by over $1.5 million over the 14-year period!
To say the least, Thomas was very pleased with this plan. He would move over $5 million to family and charity with no tax cost and significantly reduce the amount of income tax he would owe in the current year. Thomas could now return his focus to what he does best, which is to run a business, not to pay outrageous taxes.
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