Broker Check

To Eliminate Estate and Gift Taxes, Feel the Freeze!

January 06, 2024

KEY TAKEAWAYS:

  • Using a trust to freeze the value of your company can help you
    pass on sizable sums to your heirs—free of estate taxes.
  • These solutions can be flexible and tailored to your specific
    situation and goals.
  • Despite the powerful benefits of freezing the value of a business,
    this strategy is overlooked by many entrepreneurs—and their
    advisors.

A 60-year-old business owner who has done well financially wants to take care of his children
and grandchildren. He knows that he will sell his business one day—and he detests taxes.

His solution: He freezes the value of his business by gifting some of his company stock to
a trust and selling more of it to that same trust for a promissory note, for a grand total of $5
million.

Result: The value of his firm grows by 10 percent annually for the next nine years, at which
point he sells. But the $5 million in company stock in the trust—along with all the appreciation
on that stock over nine years and all future appreciation in the trust assets after that—
remains outside of the owner’s estate and not subject to estate taxes when the assets get
passed on to the kids and grandkids.

Get familiar with the basics of freezing trusts

Certain estate planning tools and strategies, such as this type of irrevocable trust—which
we often refer to as a freezing trust—can effectively transfer assets such as privately held
business interests to the next generation in highly tax-efficient ways. Freezing trusts can
be especially powerful if you use assets that you believe will significantly appreciate over
time—such as your business.

By using this trust, you can reacquire trust assets for cash or other assets. You are
responsible for paying income taxes on the income generated by the assets in the trust,
but the expectation is that the interests in the business that are now inside the trust will
appreciate rapidly.

Check out these scenarios to see how a freezing trust can have a massive impact on
entrepreneurs’ and investors’ wealth.

Scenario #1: The entrepreneur with selling on his mind

A business owner expects to sell his company in about five years. The company is currently
valued at $30 million. It is doing quite well, growing at about 15 percent each year for the last
half-dozen years, and the owner can conservatively assume continued 15 percent annual
growth over the next five years.

On the advice of his team of professionals, the owner decides to freeze half the company
and transfer the value to his grandchildren. He does so as follows:

• He makes what is referred to as a seed gift of $1.5 million to the trust.
• He sells $13.5 million to the trust for a promissory note with a government-set interest
rate of 1.95 percent annually.
• When the stock in the company is sold to the trust, no income taxes or capital gains
taxes are owed.
Important: The terms of the promissory note are very flexible and can be structured in
multiple ways. Some business owners prefer straight amortization, while others choose
paying only the interest with a balloon payment when the note matures. In this case the
business owner chooses to pay only the interest, a little over $250,000 annually.
The value of the company shares transferred to the trust is set on the date the transfer
occurs. After that date, any appreciation escapes transfer taxes. And growth above the
promissory note’s interest rate is transferred to heirs with no gift or estate taxes.
When the business owner sells the company six years later, the shares have appreciated to
over $28 million. Upon the sale, the $13.5 million of principal repaid to the business owner to
pay off the debt.
Result: Nearly $19 million was transferred to the trust, potentially saving the family over $7.5
million of estate taxes