The trials and tribulations of the family office: get ready to deal with the trappings of wealth and leveraging the next generation's tax exemptions.

• Author: Jackson-Cooper, Brenda
• Position: TAX ADMINISTRATION

If you're a veteran family office adviser, you've spent decades working with the family's estate-planning counsel to ensure that wealth is passed to succeeding generations as tax efficiently as possible. You faithfully oversee the implementation of annual exclusion gifts, intrafamily loans, and rolling grantor-retained annuity trust (GRAT) programs, and you are well-versed in the benefits of lifetime gifts and leveraged sales to grantor trusts. Due to your efforts and those of the estate-planning team, each member of the senior generation (G1) has taken full advantage of his applicable exclusion amount and generation-skipping transfer (GST) tax exemption.

That's the good news.

The Challenge

The challenge is that Gl's remaining assets will be subject to federal (and possibly state) estate tax when they pass to the next generation (G2) at his death (or at the death of his spouse, if a surviving spouse has an intervening life interest). A Gl estate worth $100 million will pay a federal estate tax bill of approximately $40 million (plus state estate tax, if applicable) within nine months of Gl's death. Absent the incorporation of charitable giving into Gl's testamentary plan (and ignoring for present purposes the benefits that could have been achieved by making additional tax-exclusive lifetime gifts), the $40 million tax bill is unavoidable.

To make matters worse, the assets passing to G2 will be unshielded by GST exemption, i.e., the assets will be GST nonexempt. Absent further planning, when the GST nonexempt assets held in trust for G21 later pass to G2's children (G3), there will be a "taxable termination" for GST purposes. The taxable termination will trigger a GST tax equal to forty percent of the value of the GST nonexempt assets. The GST tax on taxable terminations is designed to be a proxy for the estate tax that would have been owed by G2's estate had the assets been owned directly by G2 rather than held in trust for G2's benefit. In other words, the GST tax is designed to ensure that wealth is subject to transfer tax at every generation.

But suppose G2 does not have a taxable estate large enough to use his applicable exclusion amount and GST tax exemption (both of which are indexed for inflation going forward and will be $5,450,000 in 2016). Ideally, G2 would be able to cause trust assets with a value equal to his applicable exclusion amount to be included in his own taxable estate. This would make him the transferor of the assets for GST purposes (2) and therefore allow him to allocate his own GST tax exemption to the trust assets. An allocation of $5,450,000 worth of GST tax exemption not only would reduce the GST tax due at G2's death by $2,180,000 ($5,450,000 x .40) but also would shield the trust assets from further estate and GST taxes as they pass through the generations.

The Solution

A technique known as "springing the Delaware Tax Trap" would allow a G2 beneficiary to use his applicable exclusion amount and GST tax exemption and provides practical guidance for ensuring that Gl's estate plan is structured to make the technique available to G2 and more remote generations.

The Delaware Tax Trap is a term estate planners use to refer to Code section 2041(a)(3) (an estate tax provision) and Code section...