Special Needs Trusts Through the Lens of a Financial Planner

Special Needs Trusts Through the Lens of a Financial PlannerI met recently with my friend and advisor, Lauren Pearson, CFP®, to learn more about Special Needs Trusts. Lauren is a managing director and partner at HighTower Twickenham, an industry leading wealth management firm. Lauren has a great deal of experience advising families in this area and has experience in her own family.

D.: Lauren, what is your advice?

Lauren: If you have a relative or a loved one with special needs, you naturally want to provide for them in some way. In most cases, this generosity is demonstrated by providing for them in your will. Although well intended, your outright gift could compromise Social Security Disability Income (SSDI) and Medicaid benefits for the special needs person. Reinstating these benefits normally falls upon the caregiver which is more than arduous. If you are thinking of providing for a special needs loved one in your will, you might consider the following:

1) Always talk to the primary caregiver of the special needs person about your intentions. Note that the primary caregiver may be unaware of the need for a Special Needs Trust. If this is the case, please reach out to your estate planning attorney, preferably an attorney with experience drafting Special Needs Trusts, for advice and counsel. See list of interview questions for trusted advisors below.

2) If you are the primary caregiver for a special needs person, you should review all your estate planning documents and beneficiary information. My family thought all beneficiary information was up-to-date until we met with our attorney. A piece of property was to be split per stirpes with my brothers, one who has Down syndrome. This arrangement would have jeopardized my brother’s SSDI and Medicaid benefits. Make sure to review your documents regularly with your attorney.

3) For primary caregivers, think about what you want your loved one’s life to look like after you are gone. I encourage the families with whom I work to designate one person as the trustee and one person as the primary caregiver, if possible. Check with these people every two to three years to make sure they are still willing and able to serve in this capacity.

4) Make sure your trusted advisors are coordinated. It is important for your financial planner, estate planning attorney, and CPA to understand your intentions to create or contribute to a Special Needs Trust. If you are utilizing life insurance, include your agent in the conversation.

D.: So, might a Special Needs Trust be an appropriate way for a parent or other family member to provide financial support for a Special Needs family member?

Lauren: Yes.  A Special Needs Trust can enable a person with a disability (mental, physical, or certain chronic illnesses) to have held for their benefit an unlimited amount of assets without affecting Social Security Disability Income (SSDI) and Medicaid benefits. In a properly drafted Special Needs Trust, the assets held in trust are not considered countable assets for purposes of qualification for certain governmental benefits. The purpose of this trust, which is why the assets are not countable, is to provide for the special needs person beyond resources provided by the government.

D: When is a Special Needs Trust unsuitable?

Lauren: I have run into the case where someone has a small insurance payout and they know they can’t leave it outright to their special needs loved one, but it would cost almost as much to set up a Special Needs Trust. If you do not have a loved one capable of serving as trustee and there are not substantial assets to place in trust, consider a pooled trust like The Alabama Family Trust.

D.: What advice do you give your clients to select the right team to handle a Special Needs Trust?

Lauren: Ask the right questions. The internet is your friend because most professionals have bios listed on their company websites. Look for information in the bios that shows the professional is a subject matter expert or has a true interest in serving families with special needs.

Once you narrow down your providers to specialists, you need to find the right fit for your family. Here is a list of interview questions for families with a loved one with special needs:

1) How did you start working with special needs families?

2) How many special needs families have you served?

3) How long have you been working with special needs families?

4) For financial advisors/planners: Will you serve in a fiduciary capacity 100 percent of the time for my family? Very important.

5) Ask for references. Some industries do not allow references for confidentiality reasons but it is good to ask.

6) Ask the advisor to give you a case study where they have worked with a family like yours.

Update On Proposed Tax Regulations Affecting Availability of Valuation Discounts to Family Business Owners

Update On Proposed Tax Regulations Affecting Availability of Valuation Discounts to Family Business OwnersIn September, we posted a blog discussing the Treasury Department’s issuance of proposed regulations under Section 2704 of the Internal Revenue Code (sometimes referred to as the 2704 proposed regulations) that could significantly impact the valuation of interests in family-owned businesses for estate and gift tax purposes. When first issued, there was significant discussion among business and estate planning advisors, valuation firms and business owners regarding the extent to which valuation discounts (primarily, lack of control and lack of marketability discounts) would be reduced (or even eliminated) when valuing gifts or other transfers of family-owned businesses. In the following months, a consensus emerged that the 2704 proposed regulations would not entirely eliminate valuation discounts, but many questions remained regarding their impact on valuations of family-owned businesses.

On December 1, 2016, the IRS held a much-anticipated hearing on the 2704 proposed regulations. At the hearing, numerous valuation experts, business advisors and taxpayer advocacy groups commented on potential problems and other valuation issues that would result if the 2704 proposed regulations were finalized in its current form. Also at the hearing, the Treasury Department representative confirmed they did not intend to include a “deemed put right” in the 2704 proposed regulations that would eliminate the use of all discounts when valuing transfers of business interests, and that the Treasury Department planned to clarify this when the regulations were finalized. Therefore, while it is likely that the proposed 2704 regulations (if finalized) will still impact how family business interests are valued for gift and estate tax purposes, the impact on such valuations should not be as significant as originally feared.

It is difficult to predict what changes will be included in the final regulations, or when the 2704 proposed regulations will be finalized. The IRS must consider the comments made at the hearing and a very large number of written comments that it has received in response to the regulations. Most advisors believe the earliest the regulations could be finalized is late in the first quarter of 2017. Further, the timing of when the 2704 proposed regulations will be finalized (or whether they are finalized at all) may be impacted by the transition from the Obama administration to the new Trump administration in January 2017, including the possibility of the repeal of the estate tax under a Trump administration.

We will continue to post updates regarding the progress of the 2704 proposed regulations and any activity by the new administration regarding estate and gift tax issues of importance to family business owners. Please let us know if you would like to discuss these developments and their impact on transfers of ownership interests in your family business.

Charitable Lead Annuity Trusts: A Potential Win-Win for Your Assets

Charitable Lead Annuity Trusts: A Potential Win-Win for Your AssetsIn this final installment in our three-part series, we discuss the planning technique known as Charitable Lead Annuity Trusts (CLATs). Like Intra-Family Loans and Grantor Retained Annuity Trusts (GRATs) described in previous blogs, a CLAT is an excellent strategy to use during a low-interest-rate environment, and is particularly effective for individuals who are either currently making, or intend to begin making, sizeable annual gifts to charity and who also wish to transfer wealth to younger generation family members in hopes of minimizing estate and gift taxes.

A CLAT is similar to a GRAT in that it is established through an individual’s gift of assets to a trust to be held for a defined period of time, after which the remaining CLAT assets, if any, will be distributed to younger generation family members. The primary difference between a GRAT and a CLAT is that the annual annuity payments paid by the CLAT are not paid to the individual establishing the trust (the grantor), but rather are paid to one or more charitable organizations.

A charitable income tax deduction is available for the present value of the charitable annuity payments. The present value calculation uses the IRS-prescribed interest rate known as the “7520 rate,” which references the Internal Revenue Code section detailing how the rate is determined, in effect for the month of the grantor’s gift to the CLAT (or for one of the two preceding months, if that produces a larger deduction). The November 2016 7520 rate is 1.6%.

As with a GRAT, it is possible under current law to set the present value of the charitable annuity payments to equal the initial value of the assets transferred to the CLAT, so that the value of the taxable gift made to the CLAT is zero or close to zero. So, if the CLAT assets appreciate at a rate greater than the 7520 rate, there will be residual assets remaining in the CLAT at the end of its defined term to pass to younger generation family members, just as with a GRAT.

The principal objectives in establishing a CLAT are to create a win-win situation whereby you receive a charitable income and gift tax deduction for the value of some or all of the assets gifted to the CLAT, and also benefit lower generation family members to the extent the CLAT assets earn a rate of return greater than the 7520 rate during the defined CLAT term. Any excess appreciation will pass to non-charitable beneficiaries (i.e., younger generation family members) at the end of the CLAT term at no additional gift tax cost. Thus, a CLAT works best in a low-interest-rate environment since there is a greater probability of an investment return in excess of the 7520 rate. For this reason, CLATs are an ideal choice for individuals wishing to combine charitable pursuits with (tax efficient) transfers of wealth to family members.

Have Your Cake and Eat it Too? “Zeroed Out” Grantor Retained Annuity Trusts

Have Your Cake and Eat it Too? “Zeroed Out” Grantor Retained Annuity TrustsWith IRS-prescribed interest rates at historic lows and much like Intra-Family Loans described in a previous blog, a Grantor Retained Annuity Trust (GRAT) presents an excellent opportunity to transfer wealth to lower generation family members with reduced (or no) federal transfer tax costs.

A GRAT is a trust often established by a parent, the trust’s “grantor,” who transfers assets — such as stock or closely held business interests — to the trust for a specific term, typically between two and 10 years. GRATs often provide that the parent retains the right to receive back, in the form of annual fixed payments (the “annuity”), 100% of the initial value of the assets transferred to the trust, plus a rate of return on those assets based upon the IRS-prescribed interest rate known as the “7520 rate,” which references the Internal Revenue Code section detailing how this rate is to be calculated. The IRS’s 7520 rate for November 2016 is 1.6%. Any assets remaining in the GRAT at the end of the term pass to the named beneficiaries, typically the grantor’s children, without additional gift tax. This type of GRAT is often referred to as a “zeroed-out GRAT” since it does not result in making a taxable gift due to the retention of an annuity equal to 100% of the assets contributed to the GRAT.

As an illustration, assume the grantor contributes $1 million of XYZ stock to a two-year zeroed-out GRAT during November 2016. Here, the grantor will receive two payments of $512,033 each from the GRAT at the end of the first and second years. If the XYZ stock appreciates at more than the 1.6% 7520 rate during the trust’s two-year term, there will be a residual value left in the GRAT at the end of two years that would pass to the beneficiaries free of gift tax. So if the trust assets appreciate at 10% annually during the two years, there would be approximately $135,000 of value to pass to the beneficiaries transfer tax-free. If the trust assets appreciate at 7% annually, there would be approximately $85,000 left to pass to the beneficiaries transfer tax-free.

A downside of this technique is that the grantor must outlive the selected trust term for growth in excess of the 7520 rate to be distributed to the beneficiaries free of transfer tax. If the grantor dies during the trust term, the GRAT assets remain includible in the grantor’s estate for estate tax purposes. Accordingly, it is vital to select a term for the GRAT that the grantor is expected to survive.

To summarize, the GRAT technique presents somewhat of a “free shot” to shift future appreciation of assets to beneficiaries without any gift or estate tax. Under current law, there will be no taxable gift made assuming a zeroed-out GRAT is used. Further, if the grantor survives the GRAT term and the assets appreciate, a transfer to the trust beneficiaries will occur with respect to any appreciation over the 7520 rate on an annual basis. If such appreciation does not materialize, the grantor will receive all of the trust assets back through the annuity payments. In other words, the grantor will generally be no worse off from having tried the GRAT technique even if it does not work out as hoped. And in many instances, the grantor can “roll over” the annuity payments into a new GRAT and try again.

How Much Should I Expect to Pay An Investment Banker To Sell My Family-Owned Business?

How Much Should I Expect to Pay An Investment Banker To Sell My Family-Owned Business?In our last blog post, we highlighted the benefits of retaining an investment banker for the sale of your family-owned business. As you might expect, investment bankers do not work for free. In today’s blog post, we outline the typical fee structure for a middle-market investment banking firm that you might retain in the sale of your business.

Investment bankers typically charge a success fee or transaction fee, along with a retainer fee. The success fee is usually a percentage of deal value. The deal value includes the amount of cash and the fair market value of securities or other assets that you receive in the sale (and would include, for example, the amount of debt of your business that is assumed or paid off by the buyer at closing). Deal value also customarily includes the amount of any installment note payments, releases from escrow, or earnout payments made by the buyer after closing, but you should not pay a success fee on post-closing payments unless and until the payments are actually made by the buyer.

The percentage of deal value may be fixed (such as 2 percent or 3 percent), but can also be structured as an adjustable, formula-based success fee where the percentages change at certain amounts or “break points.” For example, the success fee might be structured as 1.5 percent for deal value up to $20 million, 2 percent for the portion of deal value in excess of $20 million up to $30 million, and 3 percent for any portion of the deal value in excess of $30 million. The success fee is typically subject to a minimum fee that the investment banker must be paid at the closing. In our experience, the minimum success fee usually required by experienced, middle market investment bankers is $500,000-700,000.

Investment bankers try to lock in the success fee and protect themselves against your terminating their engagement before the closing occurs. The engagement letter will likely include a “fee tail” period that remains in effect for nine to 12 months after the engagement is terminated. If you terminate the engagement before closing and then later complete a transaction on your own (or with another investment banker) during the fee tail period, you will still owe the success fee to the first investment banker. You may be able to negotiate certain exceptions to the fee tail. For example, the investment banker may agree that the fee tail applies only to buyers that the investment banker contacted about the deal during the engagement.

Investment bankers customarily require payment of an up-front retainer fee when the engagement begins. The retainer fee is generally non-refundable, but should be credited against the success fee due at closing. In our experience, the typical retainer fee ranges from $50,000-100,000 in middle-market transactions. You will also be required to reimburse the investment banker for out-of-pocket expenses.

While the success fee, the retainer fee, the fee tail period, and the expense reimbursement are common elements in almost every engagement letter, you should remember that the dollar amounts, percentage amounts, break points and many other terms in the engagement letter can and should be negotiated. If properly structured, the engagement letter terms will motivate the investment banker to help you achieve your goals in the sale of your family-owned business.

Should You Hire An Investment Banker To Sell Your Family-Owned Business?

Should You Hire An Investment Banker To Sell Your Family-Owned Business?Yes. In almost all circumstances, the buyer (whether a strategic buyer or a financial buyer) will have more financial resources and will be more experienced in buying and selling businesses. Retaining an experienced and effective investment banker will help you level the playing field.

If your goal is to maximize price, you need to get as many offers as you can and take the highest one. You will not achieve the highest price without a competitive process. An investment banker should know your industry and the best potential buyers. The banker should get to know your business well.

With your help, the banker will prepare a confidential memorandum (or “book”) about your business, including historical financial information, financial projections, and information about operations and customers. The investment banker will then contact and solicit offers from as many potential buyers as possible and then help select a smaller group with the best potential to close on the best terms for you. If the banker knows your industry well, the banker should already have a short list of potential buyers for your business before the engagement begins.

In our experience, though, good investment bankers do much more than just identify potential buyers and then wait until closing to collect a fee. They also:

  • assist with financial modeling;
  • propose and analyze different transaction structures;
  • analyze and compare the offers from different potential buyers;
  • help to manage unrealistic expectations about price and other deal terms;
  • organize and manage the seller’s due diligence disclosures (typically through a virtual, on-line “data room”); and,
  • once a buyer is selected, assist the seller and its counsel in negotiating the definitive acquisition agreements.

Negotiations with a potential buyer can be heated at times and involve some degree of posturing by both sides. A good investment banker can also serve as a buffer between you and the buyer, either helping to defuse tensions or, in some cases, acting as the “bad guy” on your behalf. Having an investment banker to act as the bad guy during negotiations can be especially helpful if you will be required to work with–or for–the buyer for some period of time after closing.

It can be challenging to run your business and manage the sale process at the same time. The sale process may take up to 12 months. You will better serve your business if you stay focused on management and day-to-day operations and let an experienced investment banker run the sale process for you.

Please stay tuned for our next blog post: “How Much Should I Expect to Pay My Investment Banker When I Sell My Family-Owned Business?”

Using Phantom Stock in a Family-Owned Business

Using Phantom Stock in a Family-Owned BusinessLike any business, a family-owned business needs to attract, retain, motivate and reward key employees. A competitive salary and benefits package may not be enough to do this in today’s market. Many businesses issue stock or stock options to employees as a form of long-term incentive compensation. For most family-owned businesses, though, issuing stock to non-family member employees is not a viable solution. Family members may not want to dilute family ownership or manage the corporate governance and fiduciary issues associated with having non-family member minority shareholders. Issuing stock would give non-family members voting rights, rights to attend shareholder meetings, rights to inspect books and records, and other fiduciary rights as shareholders.

A phantom stock plan is one way for family-owned businesses to provide long-term incentive compensation to key employees without actually issuing stock. Phantom stock is a way to give key employees the economic benefit of owning stock without requiring family members to give up any equity in the business.

With phantom stock, the company awards hypothetical or “phantom” shares to key employees under the terms of a phantom stock plan. The company has a contractual obligation to pay the phantom shareholders at a future date based on the terms of the plan and the value of the phantom shares, which typically track the value of the company’s actual shares. A plan participant may be entitled to receive a payment annually or at retirement based on the appreciation in the value of the phantom shares. Some plans also make payments to phantom shareholders equal to dividends paid on actual shares. Under other plans, payments are due only when the company is sold. In this case, the phantom shareholder typically receives an amount of cash for each phantom share equal to what the participant would have received in the sale if the participant owned the same number of actual shares in the company. An award of phantom shares may also be subject to vesting over time. Payments are generally contingent on continued employment with the company. The financial metrics, vesting schedules and payment triggers can be tailored for each plan.

There is no tax impact when phantom shares are awarded to a key employee. When payments are made under the plan, they are taxable wages for the employee and subject to applicable withholding taxes. There is no opportunity for capital gains treatment. The company generally receives a tax deduction for each payment. It is important for family business owners to consult with employee benefits counsel to confirm that the plan is structured to avoid being subject to certain complex rules under the Employee Retirement Income Security Act (ERISA) and Section 409A of the Internal Revenue Code, which imposes restrictions on the timing of certain deferred compensation payments.

If granting equity to non-family member employees is not feasible in your family-owned business, adopting a phantom stock plan may be a good solution for rewarding key employees and better aligning their interests with those of the family member owners.

Proposed Tax Regulations Limit Availability of Valuation Discounts to Family Business Owners

Proposed Tax Regulations Limit Availability of Valuation Discounts to Family Business OwnersFor family business owners who desire to transfer ownership of part of their business to the next generation, the valuation of the business interest is often an important factor to consider. This is especially true for family business owners with sufficient assets who are concerned about minimizing estate taxes at their deaths. Under current tax law, each individual has a gift and estate tax exemption amount of $5.45 million, which allows the individual to transfer (either during life or at death) that amount of assets to younger family members before being subject to estate taxes. For spouses, this combined amount is $10.9 million under current tax law.

Historically, family business owners who transfer ownership of part of their business interests to younger family members have been able to make transfers at values that take into account appropriate valuation discounts. For example, a transfer of a 10 percent interest in a family business from parents to children does not represent a controlling interest in the business. The 10 percent interest is also not readily marketable and cannot be sold quickly like publicly traded stocks and other marketable securities. Discounts for “lack of control” and “lack of marketability” have therefore historically been applied to arrive at the value (for gift or estate tax purposes) of a minority, closely held business interest whenever the interest has been transferred. If a family business is valued at $100 million and a business owner gifts a 10 percent interest to children, then the 10 percent interest would historically be valued at something less than $10 million. In this example, it might be valued at $6.5 million for gift and estate tax purposes (after applying combined lack of control and lack of marketability discounts of 35 percent).

In August 2016, the Treasury Department issued proposed regulations under Section 2704 of the Internal Revenue Code that, if finalized in their present form, would significantly impact the valuation of transfers of family-owned businesses for gift and estate tax purposes. Specifically, the proposed regulations would severely reduce, or even eliminate, a family business owner’s ability to take advantage of valuation discounts (such as the lack of control and lack of marketability discounts described above) when transferring interests in family businesses to other family members. It is especially worth noting that the proposed regulations would apply to operating businesses as well as passive holding companies, and would apply to all types of business entities (whether corporations, LLCs or other entities).

A hearing on the proposed regulations is scheduled for December 1, 2016, and the regulations will likely be finalized and become effective sometime in early 2017. Thus, there is a short window of time for owners of family businesses to make transfers of interests in their businesses and be able take advantage of the valuation discounts applicable under current law. Whenever the proposed regulations are finalized, the availability of traditional valuation discounts will likely be impaired.

If you are interested in making transfers of ownership interests in your family business, we are available to discuss whether these proposed regulations will impact your family business and the various strategies available to you before year-end.

Intra-Family Loans: An Estate Planning Strategy in a Low-Interest Rate Environment

Intra-Family Loans: An Estate Planning Strategy in a Low-Interest Rate EnvironmentIn the current economic environment, IRS-prescribed monthly interest rates for certain intra-family transactions are at historic lows. As a result, an excellent opportunity exists to transfer wealth to lower generation family members while minimizing taxes through the use of “Intra-Family Loans.”

One simple technique that is particularly effective in the current low-interest-rate environment is to loan money to a child, grandchild, or other family member – or perhaps to a trust for the benefit of one or more family members – with the borrower paying interest on the loan at the appropriate interest rate (referred to as “Applicable Federal Rates” or “AFRs”). The transaction must be properly documented with a promissory note, and interest should be paid on the loan.

The following table shows “safe harbor” AFRs for loans between family members made during July 2016, depending on the term or duration of the loan:

Loan Type

Loan Terms


Short-term AFR

Up to 3 years


Mid-term AFR

More than 3 years and 9 years or less


Long-term AFR

More than 9 years


The borrower can use the borrowed funds to make investments with the goal of realizing a rate of return in excess of the interest rate payable on the loan. The borrower will eventually repay the loan principal and will keep any investment returns in excess of the interest paid without the excess being subject to estate or gift taxes. This transaction is obviously most effective when AFRs are lower, since the investment return does not have to be as high to exceed the AFR, meaning there is a greater potential for a tax-free transfer to the borrower. AFRs can also be used for loans related to the purchase of a personal residence by a family member or investment in a business.

As an illustration, assume a $1 million loan is made during July 2016, with a term of eight years and interest payable at the “mid-term” AFR of 1.43 percent, and further, that the investment return over the period is 7 percent on an annual basis. Under these facts, the amount the borrower will have remaining after repaying the loan principal, plus interest, at the end of the eight-year term will be in excess of $500,000.

As an alternative, the borrowed funds could be used by the borrower to pay off existing higher-rate debt, the result of which would afford the borrower the opportunity to satisfy the debt sooner than may have otherwise been permitted. In addition, if the existing debt is owed to a bank or other third-party lender, the act of refinancing with an intra-family loan ensures that the interest payable over the life of the loan will remain within the family.

Do You Need Directors and Officers (D&O) Insurance for a Family-Owned Business?

Do You Need Directors and Officers (D&O) Insurance for a Family-Owned Business?Family business owners may assume that D&O insurance coverage is necessary only for publicly traded corporations and large, non-family owned private businesses. That is not the case. Individual directors and officers of a family owned business may be subject to many of the same types of claims as their counterparts at other businesses—claims by employees, disgruntled shareholders, customers, competitors and government regulators.

The first line of defense for directors and officers is indemnification by the corporation itself.  Most corporate bylaws (and operating agreements for limited liability companies) contain indemnification provisions under which the corporation may be obligated to pay defense, settlement and judgment costs for individual directors and officers. The corporation’s indemnification, however, is only as good as the corporation’s ability to pay. And in a family-owned business, where a substantial portion of the owners’ personal wealth may be tied up in the business, indemnification by the corporation essentially means family owners making payments out of their own pockets.

Properly structured D&O coverage can help to shift the financial risk of claims to the insurance carrier. In addition, it will be difficult to attract and retain qualified directors and executives from outside of the family unless the corporation has D&O coverage. D&O policies generally contain three types of coverage:

  • Side C coverage is coverage for the corporation itself.
  • Side B coverage reimburses the corporation for money that it has paid to indemnify individual directors and officers.
  • Side A coverage provides coverage for individual directors and officers that are not indemnified by the corporation.

The coverage should be structured to protect both the corporation and individual directors and officers.

Before purchasing coverage, you should carefully review the key policy provisions with your broker or an independent insurance expert. Key provisions include the definition of “claim,” the policy limits, the deductible or self-insured retention amount, and the policy exclusions. As with most insurance policies, D&O policies contain a number of exclusions. Of particular importance to family businesses is the “family exclusion.” D&O policies routinely exclude coverage for claims brought by family members against the corporation or other family member directors and officers. Carriers want to avoid being pulled into family disputes and also avoid collusion between family members to fabricate claims. The family exclusion typically extends to multiple generations and will include shares held in a family trust. If you are concerned about obtaining coverage for potential claims by disgruntled minority family shareholders, you should carefully review the terms of the family exclusion with your broker before purchasing coverage.