Asset Allocation Where There Are Discounted Assets
By Ed Mendlowitz, CPA, Mendlowitz Weitsen LLP CPAs
Asset allocation can be difficult if there are value-discounted estate assets. This is so for a number of reasons. First, estate tax valuation discounts will apply to the value of family partnerships, corporate stock, and other assets in which the recipient owned a noncontrolling interest. Discounted assets carry reduced estate tax liability.
In addition, nondiscounted assets placed in a qualified terminable interest property trust (QTIP) for a surviving spouse will not be subject to estate tax, whereas distribution of discounted assets to the taxpayer’s children will be. Discounted assets will reduce the estate tax.
For the spouse and the children, when trusts are established for all assets, the money generated by full-valued assets can be balanced against the income to be received by discounted assets so the ultimate cash flow is the desired amount, but the estate tax savings can be substantial (see example below). Finally, consideration should be given to lifetime funding of the trusts with living trust provisions that mirror those in the will. The trusts could be funded with the exact assets that are to pass. The allocation could be adjusted periodically as long as the grantor is living.
An individual owns $5 million outright in stocks and bonds, plus a family partnership with stocks and bonds also worth $5 million before discounting, meaning that the actual gross estate assets total $10 million (see the Exhibit). Because of applicable valuation adjustments, the partnership is valued for estate tax purposes at $3.5 million, making the taxable estate $8.5 million. The individual wants to leave “half” the assets of the gross estate to her children and the balance in trust for her spouse. The will says there should be a 50/50 split.
Should she leave the stocks and bonds in trust, or the partnership shares? If the partnership is left, the spouse gets assets valued at $3.5 million for tax purposes but worth $5 million for cash flow purposes. To make up the 50% split, she would have to add another $750,000 from the undiscounted assets, so her spouse would receive assets worth $4.25 million but the lifetime income generated by $5.75 million.
The estate tax would be based on the $4.25 million left to the children. Assuming a 50% rate, the children would be left with $2.125 million, while the spouse will have $5.75 million generating income.
If the children are to get the discounted assets, they will have $5 million in gross assets plus $750,000 from the undiscounted portfolio providing cash flow and pay the same $2.125 million in estate taxes. This leaves them $750,000 in additional stocks and bonds providing cash flow and capital appreciation.
The $5.75 million gross assets would be reduced by the $2.125 million estate tax, leaving the children the income from $3.625 million, a much closer division with the spouse. To the extent the assets’ value grows, discounted assets will have greater value than nondiscounted assets. Provision could also be made to discount the stocks and bonds further when they pass to the children from the surviving spouse.
Mitchell A. Drossman, JD, CPA
U.S. Trust Company of New York
Robert L. Ecker, JD, CPA
Ecker Loehr Ecker & Ecker LLP
Peter Brizard, CPA
Jeffrey S. Gold, CPA
J.H. Cohn LLP
Ellen G. Gordon, CPA
Margolin Winer & Evens LLP
Jerome Landau, CPA
Harriet B. Salupsky, CPA
Debra M. Simon, MST, CPA
Richard H. Sonet, JD, CPA
Marks Paneth & Shron LLP
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