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How Estate Freeze Trusts Work


Types of Estate Freeze Trusts
President Bush listens to Steve Preston, administrator of the Small Business Administration, speak about National Small Business Week on April 23, 2008. National Small Business Week is a good time to organize a healthy succession plan.
President Bush listens to Steve Preston, administrator of the Small Business Administration, speak about National Small Business Week on April 23, 2008. National Small Business Week is a good time to organize a healthy succession plan.
Saul Loeb/AFP/Getty Images

In 1990, the United States Internal Revenue Service repealed the complex tax code IRC Sec.2036(c) and added a provision known as Chapter 14 to the estate, gift and generation-skipping sections of the IRS tax code. Chapter 14 applies to the preserving or transferring of control in a family business.

In the past -- before Chapter 14 -- EFTs allowed family business owners to exchange most of their common stock (with voting rights) for preferred stock (with no voting rights) and give or sell any remaining shares to their families. The business owner could then retire and live off the dividends (payments) from the preferred stocks. The trust liberated members of the next generation from the heavy tax liability, freeing them carry on the family business.

Family-owned businesses incur a higher gift and estate tax rate than other businesses. Without careful planning, some companies may still have to liquidate assets in order to pay taxes. It's a good idea to talk to a professional.

If you decide to use an estate freeze trust to protect your family business, there are many different ones out there depending on what you need.

  • You might create an annuity to give your beneficiaries an income stream but shield them from gift taxes.
  • In a Grantor Retained Annuity Trust, you give your property to a trust that provides income to you (as an annuity) while you're alive. Your annuity is based on the value of the property when you create the trust; your beneficiaries profit when the property appreciates.
  • You can give property to beneficiaries, but couple it with an annuity or a unitrust -- which entitles the beneficiary to payments over time and thereby reduces the gift's current tax liability.
  • In installment sales, your beneficiaries essentially buy their inheritance over time. This may be appropriate if you expect the property to appreciate greatly (for example, if the property is company stock).
  • In installment sales to Intentionally Defective Grantor Trusts (IDGTs), you pay your beneficiaries' income taxes. Be aware that an IDGT may open you to heightened IRS scrutiny.

Hopefully one of these plans will help you save your family business in order for you to turn it over to your heirs. Of course, as with any matters of finance, it's best to speak with a professional to get advice to best suit your needs. In the meantime, see the links on the next page to get more information on estate freeze trusts and other financial topics.


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