Beneficiary Defective Trusts ("BDTs")
A Beneficiary Defective Trust (“BDT”) is an irrevocable trust that is structured so that the beneficiary pays the income tax on income earned in the trust. This is done by giving the beneficiary the power to withdraw the gift made to the BDT. The BDT is a wealth transfer strategy used for opportunity-shifting, or to transfer existing assets by sale.
Opportunity-Shifting is the process of having a new investment or business opportunity originally established or acquired by the beneficiary or a BDT. Giving good business or investment advice is not a gift. If the new investment or business opportunity does not require a large amount of capital, the BDT can be formed to be the original owner.
Regardless of the amount of appreciation, the investment will be held for the beneficiary/taxpayer and will beprotected from the beneficiary’s creditors and estate tax. The BDT allows a beneficiary to retain control, use and enjoyment of the new opportunity, while protecting the opportunity from creditors, the estate tax, and potentially divorcing spouses.
What if you have an already existing business that you want to transfer outside of your estate, but you want to retain control, use and enjoyment over the business? In this circumstance, a sale to a BDT may be a viable option. Because the BDT is income taxable to the beneficiary, the beneficiary may sell assets to the BDTwithout triggering an income taxable event. The sale may be structured as an installment note, paying interest only for a term of years, with a balloon payment of principal. If the asset being transferred is a closely-held business that provides cash flow, the cash flow from the business would be used to pay down the installment note owed to the beneficiary.
For more information on the BDT and whether it may be appropriate for your estate plan, please contact us.