How to Preserve a Family Fortune Through Tax Tricks

Charitable Lead Annuity Trust

CLATs are typically long-term trusts that make annual payments to charity. Whatever is left over at the end of the trust's term goes to a non-charitable beneficiary, usually the donor's heir.

Low IRS return estimate turns a charitable trust into a tax-avoidance vehicle

The IRS uses a formula to assign a value to the promised future charitable contributions in a CLAT. Since 1989, that rate has varied based on Treasury bond yields. That "discount rate" touched an all-time low of 1 percent in March 2013. If the trust's investments outperform the low IRS rate, the extra earnings pass to the heirs tax-free.

Monthly IRS discount rates on CLATs

Capitalizing on a Low Rate

A donor puts $20 million
into a 20-year CLAT

IRS estimates vs. market reality

Knowing the IRS discount rate, a donor can set annuity payments so that the trust "zeroes out" — incurs no gift or estate tax. The IRS doesn't charge gift tax on the trust amount because it estimates that all of the trust's assets will be needed to fund the future charitable payments.

In reality, the trust is likely to be left with a surplus
that passes to heirs tax-free.

Annuity payments
of $1.15 million would
"zero-out" the gift in this
example and leave no money
to the heir after 20 years.

Family-Limited Partnership

In a second tax trick, parents put their stock holdings into a partnership and give minority stakes to their children. They can claim those gifts are worth less than the value of the underlying stock because they lack control and liquidity.

A Discount Keeps More Money in the Family

A mother and father set up a limited partnership that holds $40 million of publicly traded stock, and divide it into fourths.

Since owners of the minority interests don't have control over the partnership, and can't easily sell them, the parents claim each interest is worth 20 percent less than its proportional share of the stock.

The parents give an interest to one of their children. They have to pay gift or estate tax on only the discounted value of the stock.

Grantor Retained Annuity Trust

Pioneered by Audrey Walton, the ex-wife of a Wal-Mart co-founder, Walton GRATs are used to avoid the estate tax. A wealthy individual puts money in a two-year trust that pays her an annuity. Any money left over passes to heirs tax-free.

Heads I Win, Tails We Tie

If the GRAT outperforms the IRS rate:

If the GRAT underperforms the IRS rate:

The mother retains all the stock and pays no tax bill. She can put the stock into another GRAT and try again.