Oct 1, 2011 12:00 PM

Consult with an appraiser in the early stages of planning

By Alex W. Howard & Bradley A. Gates

A freeze transaction is an estate-planning technique that uses the interplay of the differing financial and valuation characteristics of preferred equity and common equity securities to transfer assets from one generation to another while minimizing estate and gift taxes. A reverse freeze is a wealth transfer strategy that uses a limited partnership (LP) or a limited liability company that's structured to have both preferred and common interests (we'll assume the use of an LP structure). In a reverse freeze transaction, the transferred partnership interest is the preferred interest. The preferred partnership (PP) interest is structured to receive a preference return that's senior to any distributions made to the common partnership (CP) interest. As discussed later, the preference rate is tied to the risk profile of the partnership. The preferred LP interest is generally structured to be cumulative and compounding, so that the preference rate will compound for any arrearages of preference payments not paid within a four-year grace period. The common LP interest of the partnership only shares in partnership income after the preferred payments have been made to the preferred interest holder. (For more information on these transactions, see “Preferred Partnership Freezes,” by N. Todd Angkatavanich and Edward A. Vergara, p. 20, in the May 2011 issue of Trusts & Estates.)

A leveraged reverse freeze, which is a modification of the traditional reverse freeze, involves the sale of the PP interest to a family member in return for a note or a transfer of the PP interest to a grantor retained annuity trust (GRAT) or other estate-planning vehicle (both with interest paid at the applicable federal rate (the AFR) or the Internal Revenue Code Section 7520 rate). Generally, the seller or transferor of the PP interest retains the CP interest in the partnership. Thus, the family member or GRAT will receive a significant portion of the appreciation and cash flow generated by the partnership in excess of the installment payments or GRAT annuity payments, which is the ultimate goal of a leveraged reverse freeze. For the reverse freeze strategy to be effective, the preference rate for the PP interest necessary to sustain a value equal to its face value should be significantly higher than the AFR or the Section 7520 rate.

Topics of Interest

Estate Tax	Donor Advised Funds
GSTs	Family Offices
Private Foundations	Life Insurance
2010 Tax Act News	Industry Trends Surveys

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Topics of Interest

Estate Tax	Donor Advised Funds
GSTs	Family Offices
Private Foundations	Life Insurance
2010 Tax Act News	Industry Trends Surveys

E-Newsletter Signup

2011 Trust Glossary

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50 Years Ago This Month

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50 years ago, in May 1962, we featured articles such as: "Future of Canadian Trusteeship" by Arthur H. Mingay", "Training Trust Employees" by Ian M. Marr, "What is a Trust Officer?" by Eric J. Brown, and "Selling Services" by Donald I. Webb.

Conrad Teitell's Guide to Tax Benefits For Charitable Gifts

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