Probate & Trust Law Section Conference Manual ... - Minnesota CLE

Summary of Option Strategies
7. for note to family
partnership or LLC
8. for note to grantor
trust for descendants
Same as 6, except that buyer is a
partnership/LLC composed of
family members and entities
Same as 7, except that the
purchaser is a “defective”
grantor trust – i.e., a trust whose
income, deductions and assets are
treated as owned by grantor; one
or more powers added to create
grantor trust status; possibilities
include donor’s power to
substitute assets of equivalent
value for trust assets and power
of independent party or trustee to
add beneficiaries to trust (e.g.,
charities); grantor status can be
terminated by renunciation of
tainted powers
Same as 6, except that resulting
wealth will be held and
administered by managing
partner or member of
partnership/LLC
Same as 7, except that ordinary
taint is not removed from options
Same as 6, except that
partners/members pay taxes
directly on ordinary income and
gains accruing to
partnership/LLC
Same as 7, except that sale is
ignored for tax purposes,
meaning that ordinary income is
deferred and taxed to seller when
options later exercised by trustee;
ordinary tax can be accelerated
by death of seller or loss of
grantor status before options are
exercised; income and gains
accruing to trust after option
exercise will be taxed directly to
grantor until grantor status ends
Same as 6
Same as 7, except that additional
estate tax savings should accrue
because ordinary taxes (and lost
income on same) paid by seller
on exercise of options and future
trust investment income and
gains will reduce seller’s taxable
estate; “seed” gift to trust is
needed to create adequate
security for note; usually, gift
equal to 10% of sale price is
advised, thus triggering gift tax
liability or use of credits on this
amount
Same as 6, except that control
over option exercise and resulting
stock held by managing
partner/member of
partnership/LLC
Same as 7, except that no reliance
is placed on installment method
to defer ordinary tax; note merely
eliminates buyers’ need for cash
to close sale; control over option
exercise and resulting stock held
by independent trustee
9. Transfer to grantor
retained annuity trust
(GRAT)
Holder transfers options to
GRAT – i.e., trust providing for
fixed annuity payments to donor
for specified period (usually 2 to
5 years), with any remaining
value passing to descendants or
trust for them; annuity usually
paid in kind (i.e., by transferring
requisite number of options back
to holder); holder can be trustee
during annuity term, but must
relinquish position in favor of
independent trustee at the end of
annuity term
Excess growth (i.e., growth
beyond statutory discount rate
used in valuing annuity stream)
in value of options (or resulting
stock) transferred to next
generation in a manner that
reduces potential estate tax
burden imposed if options were
to be retained until death
No income tax imposed on
transfer or on annuity payments,
since GRAT is grantor trust;
ordinary tax impose on donor
when options later exercised;
gains and income on other trust
assets (if any) taxed to donor
until annuity term ends, and
thereafter if trust continues to be
grantor trust
Taxable gift limited to excess of
FMV of options upon
contribution to GRAT over
actuarial value of annuity stream
(excess is usually less than 1% of
option FMV), subject to gift tax
exclusions and credits; growth in
value of options (and resulting
stock) beyond “7520 rate” (120%
of AFR) passes to descendants or
trust for their benefit free of gift
tax; annuity returned to grantor
(usually in kind) subject to future
gift and estate taxes
Option plan must permit transfer
to GRAT; control over option
exercise and resulting stock can
be retained by donor as trustee
until annuity term ends, but then
must shift to independent trustee;
death of donor before end of
annuity term causes remaining
trust assets to be subjected to
estate taxes; no cash payments
required; valuation of options and
associated discounts subject to
IRS challenge, but GRAT usually
has self-correcting mechanism
that adjusts annuity in that event,
reducing risk of gift tax exposure
on revaluation; if options or
resulting stock fail to perform,
holder gets options/stock back
tax-free
CONFIDENTIAL
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