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How many of you as kids used to play the game, “red light, green light”? Remember the goal was to advance forward as much as you can when the light was green, (the person who was “it” wasn’t looking)  but stop and freeze before the light turned red (the “it” person turned around). Transferring wealth from one generation to the next is very similar. In our planning process, as Tax Attorneys, our job is very simple. We want to transfer wealth from “red boxes” (assets that are subject to Estate Taxes when we die)  to “green boxes” which are Trusts and other entities created to be free of Estate Taxes upon the death of generation one. In most cases “red boxes” are Trusts, but could be other vehicles such as IRAs, Life  Insurance (which is free of Income Taxes, but not Estate Taxes), and in almost all cases boxes that are green are Trusts.

Create green boxes when the Exemption is so high and shrink your red boxes.

So, the plan is simple, while you are alive shrink red boxes and grow green boxes. What makes a  box green? A few general rules:

  1. The Trust must be Irrevocable;
  2. The Donor of the Trust cannot be a Beneficiary;
  3. The Donor of the Trust cannot be the Trustee; and
  4. Transfers into green boxes must comply with the Federal Gifting Rules.

Green boxes can be created in our Wills or Trusts to come into existence when we die (we call this a “Testamentary Trust”). Or green boxes can be created while we are alive (we call this a “Stand-Alone Trust”). What’s the advantage of either? Well, a green box created while we are alive can lock in the use of our Federal Gift/Estate Tax Exemption. Subsequent reductions in the Exemption by Congress will have no impact. And the future growth and appreciation of the assets inside of a green box always remain green.  Since a green box must comply with a gifting rule when assets are transferred in, there is a limitation on how much can be stuffed into a green box. However, there is no limitation on how much can pass to generation two when the green box terminates. So, a green box stuffed with $10 million on inception that grows to $30 million by the time the Donor dies, it is still all green. A simple rule to remember, “once green always green”. And a related rule, “green boxes created and funded during your lifetime are better than green boxes created at your death”.

Green boxes can be set up to last only one generation below the Donor, or they can last multiple generations. A green box that lasts multiple generations is often referred to as a “Generation Skipping  Trust” (“GST Trust”). This doesn’t mean the benefits of the Trust “skip” your children. It means that the wealth can pass from generation to generation without any Estate Taxes. Absent a “skipping trust”, wealth will be subject to Estate Taxes at the death of each generation. So, another simple rule: “multi-generational skipping Trusts are better than single generational Trusts”.

The next question is, “Who can be a beneficiary of a green box?” We learned above that the Donor of the Trust cannot be a beneficiary of the Trust (there are a few exceptions to this rule that are risky and beyond the scope of this Article). It is easy to set up a green box for your children and grandchildren. And,  in cases with a lot of wealth, that is generally the best solution. But, what if the client and his or her spouse want to set up a Trust but still enjoy the “economic benefits” of the Trust? This is a bit more challenging because the Donor cannot be a beneficiary. However, the Donor’s spouse could be the beneficiary of the green box. Wow, that is cool. So, I can set up a “Spousal Gift Trust” for my wife (commonly referred to as a SLAT, for Spousal Lifetime Access Trust). I can make him or her the Trustee, and I can make him or her, and your descendants all beneficiaries. I am the only one that can’t be a beneficiary. But, as long as I  am married, I can “indirectly” enjoy the benefits of the Trust. For example, our cabin in the woods is owned by a Spousal Trust I set up for my wife. I can still go to the cabin and enjoy it as much as my wife does.  The only real risk to me is a divorce. However, my wife can also set up a Spousal Trust for me (which cannot be created at the same time). In essence, we “divorce” the assets now and split them up into two Spousal  Trusts.

Now, if we divorce, the assets are already split. All of our assets are in these two green boxes. No matter how large they grow during our lifetimes they are still green. Remember, “once green always green”.  And, upon our deaths, they pass into generation-skipping Trusts for our kids and grandkids. Remember,  “multi-generational Trusts are better than single generation Trusts”.

Ok, this is good stuff. How much can I stuff into a green box now? Let’s understand the “gifting rules” which limit how much I can put into a green box initially. Two simple rules:

  1. Your Federal Estate Tax Exemption is also the same as the Federal Gift Tax Exemption and can be used during your lifetime. Currently, that Exemption is about $12 million. That means  I can create a Spousal Gift Trust for my wife, fund it with $12 million of assets, and the box is green for multiple generations, regardless of the growth and appreciation.
  2. Also, a green box can be funded annually, without using any of your Gift Tax Exemptions by using the Annual Exclusion Rule. This rule allows a Donor to reduce his or her estate by  $16,000 per year multiplied by the number of beneficiaries that are included in the green box.  So, with 2 kids and 4 grandkids, the client can contribute free of any Gift Tax $16,000 X 6  Donees for $96,000 per year. And the client’s spouse could contribute the same amount Gift Tax-Free. This is a nice way of “chipping away” at reducing your red box and increasing a  green box.

Next question, what should we give or contribute to a green box? Generally, we do not want to give away cash or cash equivalents like stocks and bonds. Too easy for the IRS to value. Instead, we want to give away assets that are difficult to value. Using a Family Limited Partnership and giving away partnership units is a preferable asset to put into a green box.

  1. We can play some “valuation games” on how we value the assets going into the green box.  Check out our article on Family Limited Partnerships and learn how you can take a 30% discount on the value of the assets going into a green box.
  2. Stocks, bonds, cash, and other cash equivalents are easy to value. But cash equivalents inside of an FLP are difficult to value. The reason is that the client, at death, did not own cash equivalents. He or she owned an FLP non-voting interest in a Partnership. This lack of control, along with lack of marketability makes the valuation of an FLP limited partnership interest worth about 30% less because of these discounts.
  3. So, another rule, giving away FLP units or other hard-to-value assets is always better than giving away cash equivalents.

Another example of hard-to-value assets would be to gift a minority interest in a closely held family business. Family businesses are often difficult to value and add to that a non-controlling minority interest in the family business.

Also, stock in a “startup” is often times difficult to value. The key is to get the stock in the green box early before the stock starts to appreciate in value.

How much control can a client retain over a green box? Generally speaking, the client is creating a green box because he or she wants to reduce the Estate Tax exposure at death. So, the client knows he or she needs to make an irrevocable gift to a green box. But the client wants to retain control over the gift. He wants to control the timing and the number of cash distributions to the beneficiaries. Also, the client wants to retain control over the assets. He wants to be able to control how the assets are invested. And last, he or she wants to control the timing and the amounts of cash distributions to the beneficiaries (distributions to the beneficiaries from a green box do not need to be equal). How does he do that when, as the Donor, he or she cannot be the Trustee and retain such control? Well, lets learn some basic rules of all green boxes and show how much control can be achieved by the Donor and how much flexibility, if wanted, can be given to a beneficiary.

  1. The Trustee of the green box has the power to invest and reinvest the assets. The Trustee also has the power to control the timing and the amount of the distributions to the beneficiaries.  The client wants to retain these powers but cannot. The client cannot be the Trustee. But:
  2. The client can retain the power to remove and replace the Trustee if they are not performing to his or her liking (I like to call this the “power to whisper”). The client can select a Trustee that during his or her life will listen to these “whispers”.
  3. The client can also retain control over the assets by creating an LLC or an FLP and giving to the green box a non-voting, non-controlling interest in the LLC or the FLP.  Even though the client gives away “slivers” of the Partnership, the client retains all control over the assets themselves, the power to invest and reinvest, etc.
  4. The client cannot retain the power to alter, amend or revoke the Trust. This makes many clients nervous because they know that these Trusts may last multiple generations and experience multiple changes in the Tax Laws and in the beneficiaries’ lives. Even though the client cannot retain the power to amend the document, the client can appoint a Trust Protector, usually the lawyer that drafted the Trust, to retain the power to amend. The lawyer can amend the Trust in the event tax laws change and more provisions are needed in the Trust, or some provisions may need to be deleted.
  5. The client can retain the power to “swap assets” with the Trust in the future. As such, for whatever reason, putting in closely held family stock made sense in the beginning, but for whatever reason doesn’t make sense now, well, no problem, the client swaps assets of equal value with the Trust and pulls out the Company Stock.
  6. The client may not like the rules by which Trusts are taxed. Well, no problem here, the client can retain the power to pay all income taxes on Trust assets as if the client still retained those assets.

In conclusion, the client needs to convert red boxes to green boxes. The most common green boxes we use in Estate Planning are green boxes for either our spouses or our children and grandchildren. The  Spousal Trust, or the SLAT, as discussed above is very common for Estates in the $15 million range to the $20 million range. In these cases, the client wants to retain some “indirect economic benefit” to the assets through their spouse. Between the powers that the client can retain as the Donor, as described above, and the powers the client can give to the Spouse to be the Trustee, between the client and the Spouse you would be hard pressed to think of a scenario where one of them wouldn’t have the power to do what they wanted to do.

SLATs have been used throughout my career in that they really are a “B Trust”, or a “Decedent’s  Trust” that was created in a Revocable A/B Trust. However, traditionally the SLAT wasn’t created until the first spouse died. However, with the higher Exemptions coming into play in the last 5 to 6 years, creating a “lifetime B Trust”, or a SLAT has become more popular.

The green boxes for the kids have always been popular inside of the Revocable Trust, to come into existence at death. But, once again, because of the increased Estate and Gift Tax Exemptions being so high,  they have become increasingly more popular to create while the client is alive. We see green boxes for the kids created during life becoming popular for clients exceeding $20 million. In these cases, the client is not looking for any economical benefit over the Trust, the client is looking to maintain control.

In the end, these green boxes are high-performance “airplanes”, but they are simple to create by  “pilots” that have been flying for many years. In my professional humble opinion, it is malpractice for an  Attorney to practice in Estate Planning that doesn’t understand and explain the power of a “green box”.  Email us your situation and we are happy to prepare flowcharts that will help you understand how a green box can help your family.

Matt Dana

The Dana name has become the symbol of a quality Estate Plan in Arizona. It has taken over 34 years to develop and continues to strive for excellence in the Estate Planning community. At its core is Estate Planning lawyer Matt Dana. [Learn more about Matt]

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