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Wednesday, May 1, 2024
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Case Studies |
Transferring the Family Business
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Case:
Wayne and Kristine Caldwell, both age 70, have developed a fine 101 Flavors Ice Cream business. This business has been built up over the past 30 years and they now have a number of stores located in outlet malls throughout the southern portion of the state. Their estate is currently valued at $6 million, with the ice cream business valued at $2 million and their IRA accounts valued at $3.5 million. Because of Kristine's savvy investment skills, the IRAs have done extremely well and now are the major assets in their estate. Other estate assets include their home and approximately $250,000 in various stock and bond investments.
Wayne and Kristine anticipate retiring soon and they would like to develop a plan to enable their children to take over the family ice cream business. Each of their four children is actively involved in the business and the parents' desire is not only for the children to inherit the business, but also to see them benefit from a substantial portion of their estate. Also, as philanthropists, Wayne and Kristine would like to make substantial gifts to various charities in their estate plan.
Question:
Wayne and Kristine would like to transfer the business and also a substantial portion of the IRAs to their children. How can they reduce transfer taxes and couple this transfer with a substantial gift to charity?
Solution:
In meeting with their financial advisors, Wayne and Kristine are pleased to know that their objectives can be accomplished. The planning process would require four steps as discussed below.
First, Wayne and Kristine would create an irrevocable life insurance trust (ILIT), which would purchase $2 million of insurance on their joint lives. The premiums for the insurance can either be covered with the business income, by withdrawing cash from the IRA accounts or via a combination of both methods. Since they are both 70 years of age, they are now required to take minimum distributions from the IRAs.
Second, they will transfer the ice cream business, a C corporation, into a family limited partnership (FLP). While it is quite possible that the value of the business will continue to grow, the creation of the FLP will act to minimize the growth in the value of business for transfer tax purposes. Also, because of the lack of marketability and minority interest discounts on the FLP interests, plus the ability to use gift exclusions to give the FLP interests to the children, the value of the business will probably remain at or around $2 million for estate tax purposes.
Third, Wayne and Kristine will create a testamentary charitable remainder unitrust that will be funded with a portion of the IRA accounts. After discussion with their advisors they decide to leave $1 million from the IRAs outright to charity upon their passing and transfer the remaining balance of approximately $2.5 million to the testamentary unitrust. This charitable trust will pay 6% to their children for 15 years and, therefore, the projected income to the children during that 15-year term would be approximately $2.5 million.
Finally, when Wayne or Kristine passes away, the $2 million from the life insurance trust can be transferred to the survivor's estate in exchange for the remaining interest in the FLP not yet gifted to the children. This will provide the estate with sufficient liquid assets to purchase the FLP interest and pay any estate taxes due on the $2.5 million testamentary unitrust for the children.
The net bottom line for the children is that they will receive the $2 million ice cream business plus growth and approximately $2.5 million of income from the unitrust over the next 15 years. Charity, on the other hand, will receive an outright bequest of $1 million plus the unitrust assets, which are projected to grow to well over $3 million by the end of 15 years.
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