Estate Planning
The Three Boxes

Box One – Who Gets What When

In Box One the discussion revolves around the personal lives of the beneficiaries, use of trusts to provide asset protection for the beneficiaries, choice of trustees, business succession, etc. In essence, in Box One we look at nontax issues.

Box Two – Static Analysis

In the second box the discussion revolves around alleviating the tax consequences if my client(s) were to die today. Typically, the subjects include 1) placing life insurance in irrevocable trusts so the proceeds are not added to the taxable estate; and 2) discount theory.

Discount Theory

The latter subject is worthy of a digression. The transfer tax (i.e., estate and gift taxation) is based on the fair market value of the property transferred. Fair market value is generally determined by reference to a hypothetical sale between a willing buyer and willing seller with each being reasonably informed of the material facts. The keys to understanding discount theory are:

1. The property which is taxed is the property which is transferred, and
2. Each transfer is a separate taxable event. That is, there is no aggregation.

Examples:

• Suppose Mr. Client owns 100% of the stock of SmallCo and the company is worth $1 million. If he gifts 20% of the stock to each of his 5 children, the total taxable gifts would be a lot less than $1 million because each gift would only be a 20% interest, thus qualifying for a minority discount for lack of control.
• Suppose Blackacre is worth $1 million and Mr. Client transfers a 1% interest in it to his wife. The value of his 99% interest might only be $750,000 because no one would want to buy a 99% interest.
• Suppose Mr. Client and his wife transfer all of their investment assets to a partnership with themselves as the only partners. If Mr. Client dies his taxable estate includes his partnership interest, but not the assets held in the name of the partnership. If the partnership agreement provides that a transferee of Mr. Client would not have the right to participate in any partnership level decisions unless the other partner(s) agreed, Mr. Client’s partnership interest might only be worth, say, 60% of the share of the partnership assets represented by Mr. Client’s partnership interest because a buyer would not have control.