The “DEEPFREEZE”
What is a “Deepfreeze”? A combination of three of the best tax savings techniques: the Grantor Trust; Installment Sales to Grantor Trusts; and Family Limited Partnerships.
Who should be interested in a “Deepfreeze”? If you are unwilling or unable to eliminate estate taxes through the use of the annual exclusion, the unified credit, or the charitable deduction and are willing to commit a substantial portion of your assets on a permanent basis to benefit your family, a deepfreeze should be of interest to you.
When should you consider a “Deepfreeze”? As soon as you can set aside a substantial portion of your assets for your family and have enough other assets to maintain your lifestyle.
Where should you form a “Deepfreeze”? You should only use counsel who has experience in formulating these entities and the wherewithal to do battle with the Internal Revenue Service if the arrangement is challenged.
How is this “Deepfreeze” formed?
Step 1. A grantor trust is formed and funded with assets having a value of at least 10% of the promissory note described in Step 3. The transfer to the grantor trust is a completed gift for gift tax purposes. You file a gift tax return and allocate unified credit and generation-skipping tax (“GST”) exemption to the gift. The transfer is “defective” for income tax purposes. Consequently, you continue to report all income and capital gains and losses on your individual income tax return and all transactions between you and the trust are ignored for income tax purposes. Since the trust is ignored for income tax purposes, you are making tax-free gifts to the trust beneficiaries in the amount of the income taxes which would have otherwise been paid by the trust and allow the trust to grow tax free.
Step 2. A family limited partnership is formed by you with an “S” corporation as the general partner. You own 100% of the “S” corporation stock. The “S” corporation owns 1% of the family limited partnership. You are the limited partner who owns 99% of the family partnership. The formation of the family limited partnership is not a gift. Therefore, no gift tax return is filed and the Internal Revenue Service is not involved in the transaction.
Step 3. You sell your limited partnership interests to the grantor trust at a value established by an appraisal. The value of the limited partnership interests are discounted for lack of control and marketability from 20% - 50%, depending on the notes for underlying assets. The sale “freezes” the discounted value of the limited partnership interests at the value of the note. If the trust can out-perform the “applicable federal rate” (for example, the long-term rate for March 2003 is 3.8%), the excess passes tax free to the beneficiaries of the grantor trust.
Final Structure
You control the family partnership as the owner of the “S” corporation, which is the general partner. The limited partnership shares are owned by the grantor trust. Any appreciation in the value of the grantor trust escapes taxation in your estate. You own a note. Interest only is paid by the trust to you each year based on the applicable federal rate. The note balloons after a specified number of years and the trust re-pays the note. To hedge against your death before the note balloons, the grantor trust can buy insurance on your life so that the note will be re-paid on your premature death.
Conclusion:
The “Deepfreeze” provides immediate transfer tax savings since the limited partnership shares are discounted when they are sold to the trust. The discounted value is “frozen” in your estate and any appreciation passes income, gift, estate, and GST tax-free to your family.
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