Business Development: Trust 101

Transcription

1 Business Development: Trust 101 The Basics of Delaware Trust Planning Commonwealth Trust Trust Company Company 29 Bancroft 29 Bancroft Mills Mills Road, Road 2 nd Floor Wilmington, Delaware P: (302) F: (302) E: businessdevelopment@comtrst.com *Copyright 2016, Commonwealth Trust Company. All rights reserved. These materials may not be reproduced without permission of the copyright holder.

2 Foundations of Trust Planning I. Basic Trust Planning II. Basic U.S. Transfer Taxation III. Basic U.S. Income Taxation IV. Basics of Delaware Trust Savings 2

3 Understanding Basic Trust Planning The concept of a trust is that legal ownership of a portion of an individual s assets are transferred to the trust. The new owner of the assets is the Trust and its Trustee, while the beneficial ownership (or the right to enjoy the benefits of the assets) is transferred to the beneficiaries (that individual or class of individuals named within the trust document). Transfer title of assets to the Trust c/o the Trustee TRUST The goal of trust planning is to allow an individual to sufficiently separate themselves from the asset such that the title and rights of ownership are transferred. Dependent upon the level of separation and the jurisdiction in which the trust is established, one can: Protect the asset from future creditors Remove the asset from their estate and exempt them from future estate and generationskipping transfer tax Protect the assets continued growth from state income taxation

4 Understanding Basic U.S. Federal Estate and Transfer Taxation Estate Tax: tax on your right to transfer property at your death. Currently, filing required if your worldwide assets have a fair market value in excess of $5,450,000 Gift Tax: tax on your right to transfer property during your lifetime. Paid by the donor and may be split by spouses to increase the amount of gifting that may be done Some exceptions apply: Gifts that are not more than the annual exclusion amount (currently $14,000 per donee); Tuition or medical expenses you pay for someone; Gifts to your spouse; or Gift to a political organization for its use. Currently, lifetime gifts will also be subject to an applicable exclusion of up to $5,450,000 Generation-Skipping Transfer (GST) Tax: tax on gifts made to a person, such as a grandchild, who is more than one generation younger than you. Completed Gift Trusts Gifts made to the trust in which the donor does not retain any ability to change beneficiaries or other incidents of ownership The gifts are not includible in the donor s estate and therefore NOT subject to federal estate tax at the donor s death Incomplete Gift Trusts Gifts made to the trust over which the donor has maintained an ability to change the beneficiaries through the use of a power of appointment or similar power These trusts are typically includible in the donor s estate and subject to estate tax at death

5 Understanding Basic U.S. Trust Income Tax Concepts Income Tax: an annual tax levied on the trust s annual income and capital gains, from whatever source derived, by both the federal and state governments. Similar to the annual income taxation of individuals in the U.S. Trusts are subject to a compressed rate schedule, so, most trust income is taxed at a rate of 35% The state in which a trust will be taxed is dependent upon the individual states tax regulations. Some states tax a trust based upon the residence of the settlor, the residence of the beneficiaries, the residence of its trustee(s), the state in which the trust is administered, or a combination of these factors. Grantor Trusts Taxation occurs at the individual level, not the trust level (may not require any separate tax filing) Allows trust assets to accumulate within the trust and grow without depletion by income tax Grantor can use to further reduce his or her assets for estate purposes through on-going payment of the trust s income tax liability Non-Grantor Trusts Taxation occurs at the trust level and separate returns are filed in the name of the trust Assets may accumulate, but, are subject to annual taxation at the trust s tax rate Prevents diminishment of the grantor s personal assets from the on-going expense of income tax due on the trust s assets

6 Understanding Basic Income Tax Savings with Delaware Trusts Taxation of Trusts in Delaware In general, Delaware does not impose any taxes upon trusts except in cases where one or more trust beneficiaries live in Delaware. How does this taxation work? Delaware resident trusts are allowed both an income tax deduction for the amount of their federal distributable net income ( DNI ) that is actually distributed and an income tax deduction for the amount of their federal taxable income (including capital gains) that is accumulated for future distribution to nonresident beneficiaries. The effect of these two deductions is that a Delaware resident trust never pays any Delaware income tax and is not required to file a Delaware income tax return, although it is good practice to file one to help establish the trust s situs This provides some unique planning opportunities using a Delaware trust for assets that are expected to (1) have significant annual income and (2) which are likely to be sold with substantial increase in value (capital gain) Income earned on the trust assets which is accumulated in the trust will grow without a loss for state income tax expenses Assets for which one may expect significant increases in value will not cause a substantial state income tax for the capital gain received upon their sale The extent of the savings will also be dependent upon the tax regime of the grantor s home state

7 Foundations of Delaware Trust Planning I. Directed Trusts II. Asset Protection Trusts III. DINGs IV. Dynasty Trusts 7

8 Planning with a Directed Trust WHO? An individual who wants to take advantage of the tax planning available through the use of a trust, but, who is hesitant to let a stranger control the distribution and/or investment decisions for the trust s beneficiaries. WHAT? Establish a Delaware directed trust, providing for a complete bifurcation of the classic trustee duties. This will allow the typical trustee duties to be split amongst co-trustees, a single trustee and advisers, or trustees and advisory committees. The individuals given authority over investments and/or distributions can potentially be family members, friends or trusted advisers who direct the trustee regarding these decisions. WHY? By allowing a complete bifurcation of duties, a trustee is able to focus on the trust s administration, while a separate adviser can direct the trustee as to investments and/or distribution decisions. This allows all to focus on their particular area of expertise. In addition, where there are specific family concerns, a trusted family friend can be included in the ultimate decision making so as to give the family comfort that its intentions will be carried out. HOW? The trust must be established under Delaware law and specifically incorporate the use of advisers, authorized to direct the trustee with regard to certain aspects of trust administration (such as distributions and/or investments). This allows grantors to work within an open architecture, combining the best trustee, advisers and key family members to ensure the success of their trust structure.

9 What trustee duties must remain with the Delaware directed trustee? 1. Maintain or arrange for custody of accounts; 2. Maintain storage of tangible property and evidence of intangible property; Investments Distributions Delaware Trustee Duties 3. Maintain trust records; 4. Provide office for Trustee meetings; 5. Prepare trust accountings and communications; 6. Respond to inquiries; 7. Execute documents and authorize trust account transactions; 8. Retain advisors in connection with the performance of the trustee s duties; and 9. Prepare or arrange for the preparation of trust income tax returns.

10 What does this mean? Direction Advisers (Investment, Distribution) Custodian/Portfolio Management Commonwealth Delaware Directed Trustee Services Administrative Services Administers trust in accordance with the trust agreement Exercises discretion with regard to distributions, where appropriate Maintains trust records and perform annual reviews Coordination of fiduciary activities Manages fiduciary risk Ensures continuity of administration during time of grantor s incapacity or disability, as well as in perpetuity Tax Services Maintains tax records, including tax basis adjustments Prepares and file fiduciary income tax returns Provides annual tax information to beneficiaries Accounting Services Maintains principal and income accountings Maintains Trust Records Processes discretionary distributions Processes expense payments

11 Creation of a Delaware Asset Protection Trust WHO? Good for individuals in high-risk professions, such as doctors, lawyers, and business owners. Also useful in estate planning situations. WHAT? Self-Settled Trust: Grantor creates a trust with his or her own assets and names self as a beneficiary (there may also be other beneficiaries named). WHY? To shield assets from future claims. HOW? Delaware law requires: 1. Transfer of assets from a solvent transferor; 2. A trust which is irrevocable, expressly incorporates Delaware law, and incorporates a spendthrift clause; and 3. At least one trustee who is a qualified trustee, that is, an entity authorized to exercise fiduciary powers in the state of Delaware and supervised by the Office of the State Bank Commissioner, and who materially participates in the administration of the trust.* *See Del. Code Ann. Tit ( Qualified Dispositions in Trust Act )

12 Pre-marital Planning Opportunities Creation of a Delaware Asset Protection Trust WHO? Good for individuals who are considering getting married who own an interest in a family business, have just received a significant inheritance, or otherwise have significant wealth that the individual or the individual s family is concerned about protecting from possible divorce. WHAT? Establish and fund a self-settled trust prior to the date of marriage. WHY? Protection of assets from a future spouse to prevent risk of potential divorce. HOW? Trust must be created and funded prior to the date of marriage. Good means of avoiding the disclosure requirements, timing requirements, fairness requirements, and other restrictions imposed by many states on the creation of a prenuptial agreement as the creation of a Delaware trust requires no disclosure to third parties.

13 Planning Opportunities for an Appreciating Business Creation of a Delaware Incomplete Gift Non-grantor Trust WHO? An individual with closely held business interests that either produce significant income or which are anticipated to generate a substantial capital gains upon sale. WHAT? Establish an irrevocable trust which is considered a non-grantor trust from an income tax perspective and an incomplete gift from an estate and gift tax perspective; such a trust captures all state level income taxation within the trust, but, remains an incomplete gift for estate and gift tax purposes (therefore not resulting in any federal gift tax imposition upon funding). This trust is commonly referred to as a DING. WHY? Delaware does not impose state-level income tax on capital gains or income earned by a Delaware trust and held therein for future distribution to non-resident beneficiaries; therefore, there will be no state level income tax upon the sale of the asset. In addition, by creating the trust as an incomplete gift for estate and gift tax purposes, there is no limitation on the amount of the gift and no federal gift tax will be imposed upon the funding of the trust. HOW? The trust is established and the asset contributed, without consideration. The trust then owns the asset and all income accumulated is captured at the trust level. Any subsequent sale of an appreciated asset, resulting in capital gains recognition will similarly not cause the imposition of state-level income tax under Delaware law.

14 How does a DING work? *Taxpayer in the State of Delaware Family Business Family Business is contributed to the Trust while it has a low cost basis DELAWARE INCOMPLETE NON-GRANTOR TRUST Business Owner *Taxpayer in a state with a high capital gains tax rate At some time in the future, the Family Business is then sold to a third party for a substantial gain, but, as a Delaware Taxpayer, the trust does not pay any state level capital gains tax, resulting in a possible savings of 6% of the gains realized upon the sale. THIRD PARTY PURCHASER OF THE FAMILY BUSINESS

15 Planning Opportunity for Passing Wealth to Future Generations Tax Free Creation of a Delaware Dynasty Trust WHO? High-net-worth clients who are concerned about leaving a legacy for their descendants, and wish to minimize the impact of federal and estate death taxes on that legacy. WHAT? Client funds an irrevocable trust with assets client wish to gift to future generations. The funding is limited by the amount of the individual s remaining federal gift tax exemption. WHY? Extends gift, estate and GST tax advantages for future generations. Grantor can make non-taxable gifts to the trust that also qualify for a GST exemption and also avoid estate tax since the trust assets are not included in Grantor s estate. The longer the assets stay in trust, the more the tax savings are leveraged since Delaware does not tax trust income attributable to nonresident beneficiaries if properly structured. HOW? Delaware has abolished the rule against perpetuities so that personal property may remain in trust forever. Real property is subject to a 110 year limitation, but this limitation is easily avoided by putting the property in a limited liability or family limited partnership to be held in trust since the entity interest is considered personal property.

16 What Financial Gain does a Dynasty Trust Offer Over Time? EXAMPLE 1: A client funds a Delaware dynasty trust with $5,340,000 with the combined use of his or her generation-skipping transfer tax exemption and his federal estate and gift tax exemption. The trust will continue indefinitely, without being subject to further gift, estate or generation-skipping transfer tax. With a current federal estate tax rate of 40%, this could mean substantial savings over time: Client $5,340,000 Delaware Dynasty Trust Case studies are offered to show how Delaware Trust Planning may be a viable option for clients interested in a trust strategy. Results may vary. This is an example and does not guarantee a similar result. Trust recommendations should only be made after a complete review of each client s circumstances.

17 How does this translate into real dollars? Assets Held by the Family Outright Assets Held in a Delaware Dynasty Trust Net Benefit of the Delaware Dynasty Trust Value Beginning Year 1 $5,340,000 $5,340,000 Value Beginning Year 25 $13,688,044 $13,688,044 Transfer Tax Due at Death One ($5,475,518) Value Beginning Year 50 $21,984,051 $36,490,086 $14,596,034 Transfer Tax at Death Two ($8,757,621) Value Beginning Year 75 $35,019,575 $97,276,597 $62,257,021 Transfer Tax Due at Death Three ($14,007,830) Value Beginning Year 100 $56,013,873 $259,323,484 $203,309,611 Transfer Tax Due at Death Four ($22,405,549) Balance After Year 100 $33,608,324 $259,323,484 $225,715,160 Assumes that there is a transfer from one generation to the next every 25 years and a transfer tax rate of 40% at a 4% annual growth rate. Also assumes no state income taxation of the trust assets and no distributions of either principal or income, instead on-going accumulation within the trust. In addition, the table assumes no generation-skipping transfer tax (at 55%).

18 There are also substantial state income tax savings available through the use of a Delaware dynasty trust Example: A family establishes a dynasty trust, funded with approximately $3,000,000. The trust is established in 2014, for the benefit of the grantor s five grandchildren. It is not anticipated that there will be any distributions to beneficiaries in the foreseeable future. Instead, any income will be accumulated at the trust level annually and added to principal. In year one, the trust has the following taxable income and deductions: Income: Dividends $75,000 Long-Term Capital Gains $50,000 Interest $10,000 Short-Term Capital Gains $50,000 Deductions: Trustee Fees $ 5,000 *With a Delaware trust, there would be no state-level income tax; however, with other states there would be state-level income tax would in many cases exceed the annual trustee fees (here, $5,000). Refer to the following slide for state-by-state specific numbers. Case studies are offered to show how Delaware Trust Planning may be a viable option for clients interested in a trust strategy. Results may vary. This is an example and does not guarantee a similar result. Trust recommendations should only be made after a complete review of each client s circumstances.

19 Examples of potential annual income tax savings: State/Entity of Residence Annual Income Tax Savings State/Entity of Residence Annual Income Tax Savings Alabama $9,000 Minnesota $17,730 Arizona $8,172 Ohio $9,240 California $22,140 New Jersey $16,146 Connecticut $12,060 New York $15,876 Florida None North Carolina $10,440 Illinois $9,000 Pennsylvania $5,526 Indiana $6,120 Texas None Massachusetts $9,360 Washington None Michigan $7,650 West Virginia $11,700 *These calculations are based upon the $3,000,000 trust and income tax circumstances listed on the prior slide.

20 Foundations of Delaware Trust Planning for International Families I. Basic International Planning II. III. Income Taxation & Estate/Transfer Taxation Some Examples 20

21 Understanding Basic U.S. Trust Income Taxation of Foreign Trusts Who is taxed? U.S. Persons defined as U.S. citizens, permanent residents of the U.S. (i.e. green card holders), and NRAs who meet the substantial presence test What is taxed? If deemed a U.S. Person, an individual is taxed on his or her worldwide income If deemed a Non-U.S. Person, taxed only on his or her U.S. source income How is it taxed? Grantor Trusts A foreign trust which is either revocable or whose class of current beneficiaries is limited to the grantor and his or her spouse. Taxation occurs at the individual level, not the trust level; therefore, a foreign trust will not be subject to U.S. taxation. All income and capital gains will be reportable directly to the grantor in his or her home country. Allows trust assets to accumulate within the trust and grow without depletion by income tax, either foreign or U.S. Non-Grantor Trusts Any trust which is irrevocable and whose class of current beneficiaries include more than the grantor and his or her spouse. Taxation occurs at the trust level; however, as a foreign trust it would be deemed a Non-U.S. Person and subject only to income taxation on U.S. source income Allows the trust to become a U.S. income tax payer while remaining classified as a foreign trust, thereby domesticating its assets.

22 Basic U.S. Estate and Transfer Taxation of Non-U.S. Persons Who is taxed? U.S. Persons defined as U.S. citizens, individual residing and domiciled in the U.S. physically present and intending to remain within the U.S. either permanently or indefinitely What is taxed? If deemed a U.S. Person, an individual is subject to U.S. transfer and estate tax on his or her worldwide assets If deemed a Non-U.S. Person subject to transfer tax only on his or her U.S. situs assets, such as real estate, tangibles, and assets physically located in the U.S. (including cash in a U.S. bank account) Subject to estate tax only on his or her U.S. situs assets, such as real estate, tangibles, cash held in a U.S. bank account, shares of a U.S. corporation, U.S. mutual funds, U.S. bonds, etc. U.S. Person Subject to U.S. Estate and Transfer Tax? Worldwide Assets Non-U.S. Person Subject to U.S. Estate and Transfer Tax? U.S. situs assets only

23 Basic International Tax Planning with a Delaware Trust Creating a Delaware trust is a good means of domesticating assets for U.S. beneficiaries Foreign persons establish Delaware trusts to hold assets for their U.S. children. May elect to toggle between U.S. and foreign trust status to take advantage initially of avoiding U.S. income tax and later be subjected to U.S. income tax when the U.S. beneficiaries are ready to receive distributions. Some foreign trusts are subsequently split to maintain a portion as a foreign trust for the foreign beneficiaries and a portion as a U.S. trust for the U.S. beneficiaries and to isolate UNI with regard to the U.S. beneficiaries Creating a Delaware trust is also useful for transitory families Some use as a means of planning for their move to the U.S. by transferring assets prior to their change in citizenship, thus allowing transfers in advance of subjecting themselves to U.S. transfer tax rules. Some are funded by foreign family members, not subject to U.S. transfer tax rules, with family assets, as a means of transferring wealth to U.S. family members without U.S. gift tax consequences *Beware of the Throwback Rules when domesticating assets.

24 Planning Techniques for Non-U.S. Persons Using Delaware Trusts Type of Trust Planning Goal Technique Delaware Irrevocable U.S. Trust Delaware Revocable Foreign Grantor Trust Delaware Irrevocable Foreign Grantor Trust Delaware Irrevocable Foreign Non-Grantor Trust Delaware Irrevocable Foreign Non-Grantor Trust Non-U.S. Parent with U.S. Beneficiaries Non-U.S. Parent with U.S. Beneficiaries Non-U.S. Grantor and Family Non-U.S. Grantor and Family Non-U.S. Grantor and Family Assets contributed to a U.S. trust. Gift reported in the U.S. and income subject to U.S. taxation. Assets contributed and any U.S. source income producing assets are held inside of a foreign corporation. Creating trust in a safe and reputable jurisdiction for family succession and avoidance of forced heirship rules. Purchase of U.S. real estate through gift of cash and subsequent creation and funding of an LLC to purchase the real estate. Pre-Immigration planning for a Non-U.S. Person planning to move to the U.S. U.S. Income Tax Treatment Non-Grantor Trust is subject to U.S. income taxation. Grantor Trust, not subject to U.S. income taxation except where there is U.S. source income. Switches to nongrantor trust upon the death of the grantor, so be careful of UNI. Grantor trust, not subject to U.S. income taxation. Non-grantor trust, so subject to U.S. income taxation on rental income and any realized capital gains. Non-grantor trust, so subject to U.S. income taxation on U.S. source income. Switches to a U.S. grantor trust upon grantor s immigration. U.S. Estate & Transfer Tax Treatment No U.S. estate, gift or GST taxation in perpetuity. No U.S. estate, gift or GST taxation if the trust continues in perpetuity. No U.S. estate, gift or GST taxation in perpetuity. No U.S. estate, gift or GST taxation in perpetuity. No U.S. estate, gift or GST taxation in perpetuity.

25 Other Opportunities I. Existing Trusts II. Other Delaware Advantages 25

26 How to Take Advantage of Delaware Trust Planning with Existing Trusts Appointment of a Delaware Trustee If the Trust document has all pertinent language and a portability clause, Guardian s clients can simply appoint a Delaware Trustee as the sole or co-trustee. Court Modification A Delaware attorney can be engaged by Guardian s clients to file a consent petition in the Chancery Court to modify or update their trust with the consent of the trust s beneficiaries. Decanting If the trust instrument contains a decanting provision, that is, a provision authorizing the trustee to distribute trust assets to another trust, or if the trust is currently sitused in a state with a decanting statute, the current trustee may distribute some or all of the trust assets into a newly created Delaware trust. A decanting allows the trust to be simultaneously moved to Delaware and modified (within the limits set by the applicable decanting statute) to incorporate the various provisions available under Delaware law. Merger If the trust instrument includes a merger provision, that is, a provision authorizing the trustee to merge the trust with a substantially similar trust (created by the same grantor or another party) or if the trust is currently located in a state with a merger statute, then the current trustee may merge the current trust into a newly formed Delaware trust. As with a decanting, a merger allows the trust to be simultaneously moved to Delaware and modified (within the limited set of applicable merger provisions or statute) to incorporate the various advantageous provisions available under Delaware law. Nonjudicial Settlement Agreements If the trust instrument does not allow any of the above methods to be used, it might be possible for interested persons to enter into a binding non-judicial settlement agreement with respect any matter involving the trust, so long as it does not violate a material purpose of the trust.

27 Other Delaware Advantages to consider Delaware Court of Chancery a court of equity with over 250 years of case law. Judges appointed, not elected, and specialize only in corporate and trust law. Known to handle matters quickly; appealable only to the Delaware Supreme Court. Trust legislation is updated regularly to ensure a competitive advantage by a cooperative effort between the DSBA and the DBA. Confidentiality is maintained as to all trusts as there are no trust filing requirements in the State of Delaware and court matters are done under seal. Ability to eliminate beneficiary notification of the existence of the trust for a period of time (typically the grantor s lifetime) allowing a grantor to maintain his or her privacy. These trusts are sometimes referred to as Silent Trusts. Decanting statute allows ease of transfer from an existing trust to a new, updated trust, in essence amending an irrevocable trust without the court costs. Purpose Trusts are permitted as a means of creating a trust for non-charitable purposes, such as maintaining a private cemetery, family vacation home, or holding private stock.

28 Who is Commonwealth? 28

29 Commonwealth Trust Company? Since 1931, Commonwealth Trust Company ( Commonwealth ) has been an independent, privately held, trust company with one office located in the State of Delaware, providing unparalleled Delaware directed trustee services as a specialized member of a client s team of advisers. Commonwealth s professional team is composed of approximately 35 team members, including: attorneys (with professional designations including master s degrees in taxation and international planning designations), Certified Business Counselors, Certified Financial Trust Advisers, Certified Public Accountants, Certified Mergers & Acquisitions Advisers, an Internal Revenue Service Enrolled Agent, and Trust Administrators. As such, we are able to expeditiously address complicated issues involving unique assets, foreign planning issues, closely held businesses and complex tax and estate planning elements. Commonwealth does not have an investment platform and does not offer independent legal or investment advice. At Commonwealth, we believe in offering strong trust administration services and allowing our investment partners to exercise all investment discretion on behalf of the trust. Commonwealth is a customer-focused company that understands that serving our clients needs is the key to our success. We understand that each client is unique and focus on administering each trust in a manner that is consistent with the settlor s intent and in accordance with the highest professional standards. 29

30 Disclaimer Commonwealth Trust Company is pleased to provide this presentation as a guide. Commonwealth Trust Company is not engaged in the practice of law and is not providing legal advice by the provision of any presentation materials. Commonwealth Trust Company further recommends that clients should seek the opinion of their attorney regarding the specific legal and tax issues addressed in these presentation materials. Commonwealth Trust Trust Company Company 29 Bancroft 29 Bancroft Mills Mills Road, Road 2 nd Floor Wilmington, Delaware P: (302) F: (302) E: businessdevelopment@comtrst.com *Copyright 2016, Commonwealth Trust Company. All rights reserved. These materials may not be reproduced without permission of the copyright holder.