BDIT Beneficiary Defective Irrevocable Trust

By by Martin M. Shenkman, CPA, MBA, JD

RADIO SHOW: June 21, 2010

GARY GOLDBERG

The Coolest Estate Plan: “BDIT”

Martin Shenkman, CPA, MBA, PFS, JD

 

Introduction

 

With so much tax and economic turmoil one estate planning technique is receiving increasing attention -- the “beneficiary defective irrevocable trust,” better known by its acronym “BDIT” (pronounced “Bee – Dit”). A BDIT presents potentially the greatest estate and asset protection planning tool. Cold feet about jumping into estate planning with so many unknowns? Worried about giving away assets you might need at a future date? The BDIT may be in your comfort zone.

 

What is a BDIT

 

Here’s how a BDIT might work for you. The trust is specially crafted to achieve a number of special goals to achieve the BDIT results:

  • Parent sets up a trust for your benefit. Your parent is called the “settler” of the trust. One key to the BDIT benefits is that you are not setting up the trust for yourself (called a self-settled trust). Instead another person, Parent (called a “third party”), sets up the trust. Because you don’t set up the trust or gift any of your assets to the trust the BDIT can be a better safeguard to protect your assets, and give you more tax benefits, then a trust you establish for yourself.
  • The BDIT gives you the right to withdraw the gift made to the BDT. This is the commonly used demand or “Crummey power” that is ubiquitous in insurance trusts. This right results in you being the “grantor” for income tax purposes of the BDIT -- income of the trust is taxed to you.
  • The BDIT carefully prevents Parent from having any rights that might cause the trust to be taxed to Parent as if the parent were the “grantor” for income tax purposes.
  • Because the BDIT is treated as a grantor trust to you, you can sell large appreciated assets to the trust without triggering capital gains. You can sell your family business (or another appreciating asset) to the BDIT, no capital gains is triggered, the BDIT gives you a note for the purchase price, any appreciation in the value of the business after the sale should be outside your estate. You’ve “frozen” the value of what can be taxed in your estate.
  • The business that is in the trust can distribute income which the trustee can give to you, your kids or your great grandkids. The income and growth in assets inside the BDIT can benefit you and all your future descendants while never being subject to estate tax.
  • Because the trust is a grantor trust for income tax purposes you have to pay the income on all trust earnings even if you don’t get a nickel distributed back to you. While that might sound like a negative tax result, it is actually as close as you can get to the Holy Grail of tax planning. The income in the trust grows outside of your estate, you can use it if you need it, or let it grow if you don’t, and all while paying the income tax on it. So the assets inside the BDIT grow tax free, while you’re reducing your estate by the amount of income tax you’re paying.

 

BDIT Benefits

 

Clients want, and only the BDIT can provide, the following potential advantages:

  • Control. With more conventional planning techniques, and in particular a trust you establish for yourself, you cannot have the controls you typically would be given in a BDIT. In more traditional estate planning these controls would have adverse tax and asset protection results.
  • Income. In most traditional estate planning if you retain the right to the income from an asset you give away or give to a trust, or if you retain the use and enjoyment of property until your death, the entire value of that property is taxed in your estate. With a BDIT you can have these rights and the assets are not in your estate since you did not set up the trust or make gifts to it.
  • Bequest. With a BDIT, in contrast to most planning, you can be given the right to determine who gets the assets at death and how they receive it without jeopardizing your tax and asset protection results.
  • Safety. Creditor protection can be better since you did not establish the trust.
  • Tax. State income tax savings may be significant since you can choose to have the BDIT set up in a state with no income taxes.

 

Conclusion

 

While the estate tax law remains uncertain, most advisers believe that the estate tax will be reenacted and that whatever the details ultimately are, they won’t be favorable to the wealthy. The BDIT is a creative estate planning technique that offers such valuable benefits most transactions should evaluate its use as part of the planning process.