#292 - Ryan Heath - Founding Attorney @ Baker Heath, PLLC - Estate Planning 101

Chris Powers: Ryan, welcome to the show.

Ryan Heath: Thanks, Chris. I'm excited to be here. 

Chris Powers: Ryan and I are good friends, and he has educated me a ton on estate planning, which can be an exciting topic. And many folks, if they're at a place where it's something they should be thinking about, can be precious to what they have for themselves and their family.

I'm excited to dig in and learn more about estate planning. I posted it on Twitter. There were hundreds of comments, so more people are excited, so thanks again.

Ryan Heath: Yeah, you bet. Death and taxes are always exciting to discuss. 

Chris Powers: Let's start with your background.

Tell us a little about you, how you got into this, and why it's where you decided to focus your career.

Ryan Heath: Yeah. I back-ended my way into estate planning from somewhere other than Texas originally. I grew up on the Mississippi Gulf Coast; my dad and stepmom had small family businesses. At 15, I worked for the family meat market cleaning meat saws in the meat freezer on weekends and installing furniture during the summer.

You so got my first taste of entrepreneurship that way. I went to LSU as an undergrad and got my degree in business management. Still, ultimately the job market was terrible when I got out in 2011, so I decided to go to law school just on a whim and quickly realized that I did not want to fight all the time, which is what many lawyers do.

Or at least that's the stereotype. And so I stumbled into this estate planning internship during the summer, and I loved it. I was putting things together. Every family situation was different. It was unique, and I just fell in love with it. And so from there, I finished law school, worked for two firms in the D F W area, and cut my teeth in more of the high.

So ultra high net worth estate planning realm. But that entrepreneurship spirit drove me back to starting my firm in January 2020, which, as we all know, is a fabulous time to start a law firm. And so our firm's, baker Heath, has four attorneys now. Two of us do estate planning, trust administration, and probate.

And the other attorney does corporate law. Everything from the formation of new business entities to M&A work, so it's a small firm with considerable firm experience, and that's our model.

Chris Powers: I love it. All right, let's start from the most basic. What is the most critical time that anybody could do?

Just something? Let's start with the question of the six primary estate planning documents. But some people think, oh, I need to be rich to have an estate plan, or I need to have done this, or I need to have a business. Is there something that anybody on this planet should be doing?

Ryan Heath: Yeah. Really. To your point about the six documents, everyone should have the six essential estate planning documents, but let's hear those. And they're not that expensive, and they save costs later. Okay, so everyone needs a will. Just basic. Who will be in charge of your estate and gets your property?

And then, we shift gears and talk about lifetime planning. What happens if we're in an accident, right? Who will step in and make medical and financial decisions for us? And so, there's a financial power of attorney for financial decision-making. There's a medical power of attorney for medical decision-making.

It would help if you also had HIPAA authorization. So if you're hospitalized, who can call and get access to information? There's a Declaration of Guardian, which could be for you if a court decides you need a guardian to take care of you permanently. It could also be for minor kids. Who will take care of our minor children if both parents pass away? Then there's a directive to physicians, which is end-of-life, pull the plug or don't pull the plug document. So those six documents, regardless of net worth or place in life, if you're an adult and have more than just a bank account. Then you should have those documents.

Chris Powers: Is there a typical answer to those who make those decisions? Is it usually another family member? Is it a best friend? How do you tell your clients, or what guidelines do you give them on how to pick these people making huge decisions on their behalf if they're injured or incapacitated or have a loss of memory or anything else?

Ryan Heath: For married couples, it's relatively easy, right? So it will usually be a spouse in both of those roles. And They were looking at what happens if you and your spouse are in a common accident; then who's making those decisions? And usually, I like to defer to family, at least on medical decision making if there's someone in the family we trust.

Again, I will lean towards family first, but sometimes we don't have family members who can do those things. And if that's the case, it's just someone you trust financially for those financial decisions and on the medical side that you not only trust but you've communicated with. Here's what I would want to happen in these various scenarios.

So, the family's a great starting point, but the family's only for some. For those that don't have family members, we lean towards close friends, people that live close to us, and if none of those work, we've got corporate options, banks, and other folks that'll serve in those roles. 

Chris Powers: Okay. We were talking about this. You just had your beautiful daughter, Gigi. You are an estate planning attorney that knows everything about the estate planning world. An exciting spot to kick off this conversation is What did you do for your child, and what is something many listeners here having kids or having kids could start doing early on in life despite their financial situation?

Ryan Heath: Yeah, the planning we did when Gigi was born was twofold. One was getting our house in order, but the second was planning for Gigi's future. And so we ended up setting up a revocable trust for my wife, Lorna, and I. Really, that was set up so that if we were to pass away before Gigi's 30 or 35 years of age, her inheritance would pass in trust with someone else in charge of that money until she gets a little bit older, a little bit more mature.

And also, what we left in that inheritance for her is protected from spouses in the future protected from lawsuits and estate benefits. And so of the fun things we did was put a prenup requirement in the trust. When Lorna and I pass away, Lorna, my wife, when we both pass away, before Gigi can get distributions from the trust, she has to get a marital property agreement saying that everything from that trust is her separate property.

So it takes the burden off of her asking for one by saying, look, we have access to this bucket of money, but you've got to sign this document first. And so I like that one. And many folks have young kids, especially our generation, where we've seen divorce more frequently than prior generations. That's an exciting thing to do. 

Chris Powers: So basically, you're taking the burden off her having to ask her spouse, which can be very awkward. And you're taking the blame that my dad made me do this.

Ryan Heath: That's right. Yeah. Dangling the carrot saying, Hey, you can get access to these, this trust fund, but you got to sign this paper first saying that if we if things don't work out, it stays with me.

Chris Powers: Okay. So that spouse still has to sign something. 

Ryan Heath: Correct. Still, have to sign something.

Chris Powers: But it's not something that she cons drilled up. It's something that you had. 

Ryan Heath: Correct. 

Chris Powers: And what if that person doesn't sign?

Ryan Heath: We can stop distributions to Gigi or the person in charge of her trust.

They don't have to, but we'd probably rearrange things a little bit, create separate accounts and do things differently if that is the case. 

Chris Powers: What else did you do for Gigi? 

Ryan Heath: The other thing we did for Gigi that I  like, and it goes back to the entrepreneurial spirit side of me, are we set up an irrevocable trust for Gigi, and we gifted some money into that trust, and we turned around and invested the funds in things like Fort Capital deals actually, and some hard money loans out of New Jersey and New York.

And the game plan for that money is that it will be invested and reinvested and allowed to grow until she gets 18-20 years old. Again, she'll have a nice nest egg of money, an asset protected from spouses and creditors, but that money can be used for anything. It's not a 529 plan that's only available for college expenses.

It can be used for buying a first house for wedding expenses for college, or it can be maintained for future investments. And one of the essential things for me is that I grew up. As mentioned earlier, Mississippi stocks, bonds, or mutual funds were the only exposure to alternative investments.

That's all I knew growing up. And so when I stepped into the estate planning world and got exposed to private equity deals, hard money loans, and all these different types of investments, I realized how behind the curve I was. And I want Gigi to stay within the curve. So one of the exciting things about this gift trust we set up for her is that as she ages, we can sit down with Gigi, say when she's 18-19 years old.

Show her the subscription documents that Fort Capital sends us. Show her what we're looking at to decide whether or not we want to invest in this specific deal and then make the investment with her, right? And so it's a great learning tool for her. And it's also, again, growing in a nest egg for her that'll be protected and can be used for various reasons in the future. 

Chris Powers: And is that a plan that you can stamp out when you have possibly future children? Or do you take every, because every child comes in, you don't even really. They still need to get a personality. You don't know what's going to happen. So do you start with the same template for each child as they enter the world?

Or would there have been any reason you might do something different with baby number two than baby number one?

Ryan Heath: I set up a trust for Gigi in my situation. And if we have future kids, we'll do separate trusts for them. From a cost perspective, it doesn't cost anything.

Cause I'm preparing the documents for a lot of my clients. What I tell them is, let's just set up one trust. That's what's called a pot trust. So all of the kids share in this common investment fund. Or a combination of funds. And then, once the youngest reaches age 23, we split it into a separate trust.

The reason we split it At age 23 or around, the kids have individual needs by then. And so if sibling one takes a distribution, it impacts sibling two. And so we want to avoid that fighting by splitting the trust into separate ones at that time. 

Chris Powers: And real quick, I want to get back to the family just for clarification.

What's the difference between revocable and irrevocable trust?

Ryan Heath: Besides the terminology, revocable means that you can change the trust over time. Irrevocable means that once you sign it, It's set in stone. But practically speaking, what's the difference? A revocable trust is just a substitute for a will.

That's the; there's no absolute asset protection and a revocable trust. There's no spousal protection, estate tax savings, and a revocable trust for your irrevocable trust. Those that can't be changed will have asset protection and estate tax benefits, and the trade-off is that you can only sometimes change and modify it as quickly over time.

Chris Powers: Okay. And if somebody's thinking about how somebody that has a limited amount of knowledge, who's guiding them towards which one they should do, is that what you're doing? Or should they have consulted with somebody? How do they know which one is best to do?

Ryan Heath: the best route is to meet with an estate planning attorney first. Financial advisors and accountants have a broad knowledge of these things, but when it comes down to the recommendation of what makes sense, it's best to have an estate planning attorney look at it. And it's not an either-or scenario. We have a revocable trust Lorna, and I do for our assets that will eventually funnel down to Gigi. Then we have an irrevocable trust that will be used for her benefit during our lifetime before we pass away. 

Chris Powers: We will spend time on the family because I have young kids, and many listeners have young kids. So you set up the initial estate plan when Gigi's birth, but then you'll have years before you start figuring out who your daughter is, what she likes, and where she's going.

Are you going to make more money or less money? Who knows what is going to happen? Some friction around estate planning is like you're always doing it. What are some significant milestones, or what do you think about when to revisit the plan?

Ryan Heath: Yeah, we generally say every three to five years, dust off your summary document and ensure the people you name to serve in financial and medical decision-making roles are still the ones you'd want to serve.

Yeah. Many times, as young adults in our first estate plan, we often name parents as our backups. And then, as the kids get older, they migrate into taking those roles over from their grandparents. Okay. But when the kids reach an age where you can start to sense will they be financially capable of managing money?

That's a good time to revisit the plan. If you notice a kid can't manage money. That's a huge issue. We need to get out in front of that. When kids get close to marriage, that's another time to revisit things. And then there must be a big sit-down meeting when you have grandkids to think, do we want to leave everything to the kids?

Do we want to split it among kids and grandkids? Do we want to do college funding for the grandkids? So that's that ultimate stage. The estate plan is a living, breathing thing that has to evolve because your life does. But there are significant milestones; there's a plan when starting with minor kids.

We want to review that to ensure all our roles, guardian designations, and all those things are correct and still the right people. And then, as the kids get out of high school in the college years, that's probably the next major revision piece because they'll start serving in medical and backup medical decision-making roles for you at that point.

Chris Powers: Is there any trust? When you think of these trusts, you think of kids becoming adults before it impacts them. Is there anything in some of the trusts you've seen that impacts them when they're in elementary or middle, or high school? Or is it generally at 18 and over?

Ryan Heath: Yeah, it's generally not going to be until they're adults. Indeed, there's always the risk that parents pass away prematurely. And then the kids inherit something. I think the key is flexibility in your estate plan documents. Some examples I can give you are that we have provisions about substance abuse, right?

So if a beneficiary, typically a child, is struggling with alcohol addiction, drug abuse, or mental health issues, we will have ways to require drug testing or send them to rehab and pay money on their behalf. Still, we won't put cash in a kid's pocket with a heroin addiction. Right?

We want to avoid that. And so that's one way that we can build flexibility in the estate planning documents to adapt to things that may happen in the future. And that's where finding a good estate planning attorney can make a difference because flexibility is critical. If we build enough flexibility in the documents, they should evolve through all the various situations without changing consistently.

Chris Powers: Okay. You said can versus can't manage money. Managing money takes work. No. And it's not easy if you come from a wealthy family and never even had to make money. The odds would show that there are often very wealthy kids that grow up, and money's always around, and It's not that they can't; it's they've never been taught to.

How are trusts set up to where if somebody can manage money, maybe it's set up X way, and if they can't, it's set up X way? 

Ryan Heath: In, so in any trust, you've got a division or a separation between the trustee, which I refer to as the manager of the trust, and the beneficiary, the person that gets the distributions, right?

The benefits of the trust. So if you've got a financially savvy, capable child or grandchild, they can also be the manager of their trust, right? They can make investment decisions and distribution decisions. Play an active role in managing the money for their benefit.

That's the most similar to getting something outright as a gift through inheritance. Suppose parents can be their trustees and the beneficiary of their trust. When we have a scenario where a kid's a spendthrift, is the way we refer to it in estate planning, meaning they're not able to manage money well, they spend it.

Not very thrifty. When that happens, we'll usually want a different manager or trustee of their trust. Okay. Someone else can manage the financial side of things and make distribution decisions for that child. And that can be multiple. People or banks. So some folks tend to name a friend.

They think I'll name my best friend cause I trust them, and they know the family well. So that's a great choice. Talk to that friend first. Because being a trustee or an executor is a ton of work, and often, the client doesn't realize it because all the work kicks in after they die.

The other option is to go the bank or corporate trustee route, which is excellent. Yes, they charge fees for what they do, and every corporate institution does. That's how they make money. But if you hire your friend, they will delegate the work to an attorney, a CPA, or a financial advisor.

When you pay for all three of those things, it costs about as much as the bank. But the benefit of the bank or the corporate trustee is that it provides a buffer between the kid and the money. And so many times we see this where especially if a child's come from a from an affluent family, they get out, they're in their twenties or thirties, and every single one of their friends is hitting them up to invest in a new restaurant deal or a new business, they're starting.

And so if we've got this corporate trustee out there, they can say, look, you got to talk to the bank. I don't control this money. It gives them a buffer. It protects them from themselves as well. And so, usually, what we do in our default plan is that kids can only control their money once they're 30 or 35.

At age 30 will let them step in and be a co-trustee of their trust—a co-manager. We will teach them how to use the trust for five years, and then we'll let them be in charge of their trust from that point forward. And those ages can be modified if we need to. And depending on net worth and the number of assets, and the trust, we may bump that to 40 or 45, or never, depending on the kid.

Chris Powers: If you're listening to this, and you came from wealth, and you have a trust, and there's a restaurant deal on your desk, it's a good idea to pass on.

Ryan Heath: Yes, that's right. It only sometimes works out. 

Chris Powers: No. When you mentioned addiction of some type, how does that work? Because people can be addicted and then they're not addicted, and maybe then they're addicted again.

And you mentioned drug tests; how do families usually set that up? And it doesn't even have to be around addiction. The more kids you have, there's typically one, sometimes more that we'll call it, marches to the beat of their drum. Yeah. How do you handle situations? And I'm getting away from the addiction part.

Where you have four kids, three pretty standard doing everyday things, maybe there's one that's just a superstar, and then you have one that's always the tough one. How do families handle that to where they don't let their wealth become the reason one of their kids hates or doesn't hate them?

You know what I mean?

Ryan Heath: Yeah. So it gets back to that trustee role. And the trustee, the trust manager, doesn't have to be the same for each kid. And so the successful and good stewards of money will let them be in charge while we put someone else in charge of the other's money.

What we don't want to do is put the responsible sibling in charge of the irresponsible sibling's money. Because then they're just going to fight. And so much of this planning is looking at how we avoid fighting. And it's often. One of the most overlooked things in estate planning is our goal is not just to transfer money.

It's to transfer money, but also a legacy and keep the family intact. And so when we're looking at, to your point, the kid that marches to the beat of his drum. We want him to have the same access to money and opportunities as the highly successful kid. But let's put someone else in charge and ensure the money will last for that child's lifetime. And that's where we can put someone else in charge of that money. That's where it'd be that corporate trustee or someone we trust as a friend to be in charge of that money. 

Chris Powers: It's probably not a great idea to make the trustee may be the father's best friend because that person that marches to the beat of their drum has a relationship with him.

It can get, even that could get hairy. That's where you say a corporate trustee is slightly more vanilla or bland and less emotionally swayed. 

Ryan Heath: Yeah. And going back to the flexibility piece, right? We don't want to name a corporate trustee and the child that marches to the beer; their drum is stuck with that bank for the rest of their life.

So we'll allow that child to remove that bank and find a new one. Only once every five years or for specific reasons. So we'll give enough flexibility to get out of that situation if they get a crappy person managing the trust. But we don't want Uncle Brian, who everyone's close to getting separated from the family because he was named as a trustee of someone's trust.

Chris Powers: Okay. Let's go back to multiple kids, and now we'll think about it from their careers where you might have one child that needs more distributions than another. How is it typically set up where things remain fair over the long term? How do you see families set that up?

Ryan Heath: So there are two situations, right? One is like when both parents pass away, right? We will have four separate trusts if there are four kids, and each may start with their own 25% or one-fourth of the estate. And so that way, if child one burns through their trust, they haven't impacted the other three.

Yeah. So that's one scenario how do we divvy it up at the surviving parent's death? We want to create a separate trust for each of the kids. But you might've been asking that we care for one child more than the other during life. And there are two ways to do that.

One way is to treat it alone. And just ongoing documentation of how much you're transferring to them is treated as a loan. They can repay it over time, or when they die, that loan is the asset allocated to their trust, right? So that's one option. The other option we do sometimes is to treat it as what's called an; it's called an advancement on the inheritance.

And so what that means is, on the back of the trust, your back of the will, there's a list of all the things we gave John over the years. And all of these things will be treated as a prepayment of John's inheritance. So when John dies, we start with an equal split, and then John is deducted that amount of money, and it's given to his siblings.

So both of those options work. And then some clients will say, look, we appreciate that this child needed more, and we don't want to track all these things. And so it's our money. We can do what we want with it. And we decided to take care of John. And so you guys get what's left over.

Chris Powers: Is there anything else that comes to mind on just bright things that families have done when planning for their kids? Is there anything we left out? 

Ryan Heath: Yeah, I've seen some things I liked. One is if you're charitably inclined, and many of your listeners may have donor-advised funds simply because of the income tax benefits of setting one up.

In a big year of liquidity. If you've got that donor-advised fund and you are charitably inclined, what an excellent way to get the kids involved in charitable giving early on. When they get to be 12, 13, 14, sit down with them, show them the list of charities, let them pick some charities that they're passionate about and that's such a great way to create a legacy of giving if that's your cup of tea, right?

So that's one that I like. It's not even really an estate planning tactic. It's more of just passing that legacy and being charitably inclined on. That's one exciting thing. Another thing that I saw is, Blended families are always the most complex. When I say blended family, I'm talking about you've got a second marriage and kids from prior marriages; how do we keep this whole thing together?

It's probably 70% of my practice because of our divorce percentages growing up. And so I have one client in particular whose step-siblings all get along excellently, take annual trips, and do things together. So we created a reunion trust in their estate plan.

So when mom and dad or stepmom and stepdad pass away, a sum goes into this trust to fund annual reunions between all the step-siblings. And that was a unique way of bringing the family together because so many times, again, with blended families, we see the connection to mom's kids severed when mom dies.

And this family didn't want that. They wanted everyone to come together still. And so, reunion trust was a unique idea to keep the family together. 

Chris Powers: That's interesting. It might be more just an observation, but have you seen what otherwise have been great family units that stuck together get torn apart because they didn't plan that had wealth that got torn apart purely because they didn't plan?

And over time, incentives in the family change, and you see what otherwise could have stayed intact as a family unit disband because there just wasn't an excellent plan for how the money and the assets would move on.

Ryan Heath: Yes. And it almost always happens in a small family business. Which is pertinent to the podcast here, then let's go. So many times, succession planning for business needs to be noticed. Estate planning everyone knows about; we all hear about it on tv. Some software programs allege they do estate planning, but we need to remember about the business side of things.

Yeah. And business. For any business owner listening, that's our baby, right? And we have to plan for that business and what happens when we pass away, or it will create immense issues. And so what I always see is a scenario where we've got four kids, right? Family, business, and one of the kids are already actively involved.

The other three have nothing to do with it and may get involved later, but they're doing other things. And so, in the estate plan, everything's split equally. And we've talked about succession planning, but it's tough to consider exiting your business and transitioning it over to kids and all the family dynamics that can implicate, so we don't touch it. 

Then Mom and Dad die. Now all four kids own a fourth of this business, but son, number one, that's been active in the business the whole time, is doing all the work. So he's disincentivized, right? Because for every dollar that he makes for the company, he's only getting 25 cents. At the same time, siblings can outvote them on all of the business decisions that occur daily.

And so, they either walk away from the business, which is usually the client's biggest asset, or they all end up fighting, and it gets thrown into court to figure out what will happen. And so succession planning, for anyone listening, doesn't have to be set in stone, but we need to plan for if you pass away today; what's the game plan?

It doesn't have to be leaving it to kids. And that's one of the biggest frustrations I sometimes have with clients on this succession planning piece because the kids don't want a part of the business. Some kids want to avoid being active in a business. They want to do their own thing or work for a corporate and be An artist.

Do some abstract paintings. But don't just assume your kids want to inherit your business. And sometimes, the best thing you can do for your family is set up a structure where you can sell the business after you pass away or before you pass away and leave the money to the kids to do their own thing with it.

But you've got to think about it, and you've got to plan for it. And if you don't, that's where all of the family dynamics get blown to hell. That's where siblings hate each other. That's where lawsuits start. We've seen a number in this town, and I'm sure every other town in America where families would get ripped to shreds because a business got in the way of family.

Chris Powers: Okay. Let's go deeper so that what are some intelligent ways to plan for this. Let's keep going there. There are four children, one in the business. What would you be advising? 

Ryan Heath: So if we've got four kids, one's actions in the business, and we're still several years off from retirement from the patriarch, let's put a buy-sell in place that allows the son, number one that's in the business to buy the business from dad andPay either the surviving parent or the siblings for the business, correct? And we can structure that in a way where the business's cash flow covers the loan payments, and we can also peg the value of the business based on a current value.

One of the situations I see a lot, and you probably see this too, is that dad brings in the business's son; the son is instrumental in growing the business. A new mindset, technology and all these other things come in as we move into different generations. And so son makes the business grow, six or seven X, and so dad wants son to benefit from that growth.

We can peg values for estate planning based on valuation this year, and that's the sales price. It could be a formula, so X is the percentage of the business that Dad still owns. Times, whatever a 1% value the business is, that's our formula for what the business will cost son. 

So Son gets the benefit of all the growth after that price is locked in, but his siblings are still going to get the financial benefit; but Son’s going to own the business, make the decisions, and get all of the continued growth of the business. Does that make sense? 

Chris Powers: It does. Let's focus on that last part, though.

Okay. So we strike, let's say business is worth, I don't know, a hundred million dollars today. And then the son goes and grows at six or seven x; how are the other three siblings treated? Are they getting paid a hundred million, or how is their value calculated from the growth? That's the part I missed.

Ryan Heath: Yeah. It's the client's judgment call. So in this example, we just got the business valued, and it was valued at 7 million. So a lot smaller than a hundred million. It's a smaller business. Sun's been in the business for five years, contributing to its growth.

So we're gifting the son 10% of the business today for the past efforts. And then we locked in the purchase price of 7 million. Seven million equates to a hundred percent of the business. Son will only pay whatever remains that he doesn't already own. So let's say Dad dies, and he buys out that interest.

His siblings get the benefit of getting one-third of the loan payments right. That is made on that sale. So that's what they're getting is they're getting that the payout trickles down so that loan is an asset to the estate. And so it gets funneled down to the siblings eventually. And that's, they get the payout as if Dad had sold the business to a third party.

Chris Powers: So essentially, from 7 million on, that's all going to the son.

Ryan Heath: Because we've locked in this purchase price 

Chris Powers: Okay. Did you have something else to say? 

Ryan Heath: Yeah, there are some tax consequences you must consider whenever you peg a purchase price because it's not fair market value necessarily ten years from now.

So, there it gets more nuanced. That's way beyond the scope of what we're talking about today. I just didn't want people to be listening and think, you idiot, that will cause all kinds of tax problems in this scenario. We know the tax issues and still prefer to do it this way.

Chris Powers: What are the tax issues? Or is that too dense to go through? 

Ryan Heath: Yeah, so the tax issues you get, one is there's, but if you buy the asset for a lower price and fair market value, your primary starting point will be lower. It could be a long-term capital gains issue. That's one. And then just whether the I R S will respect the valuation from an estate tax perspective. So those are. These are some of the issues that come up. 

Chris Powers: There could be some biases to value this low so that it meets some threshold to transfer that there's no tax.

Okay. I don't know if I said that. Let's keep going on this. The father probably consulted with the other siblings that were getting bought out and said, Hey, you are not interested in the business. John, our son, has been working here, and I will sell it to him.

And again, every family's different, but you might consult the other siblings to let them know what's happening. They're not just told at Thanksgiving dinner, Hey, sold the business to your brother, and this is what you're getting. How does that usually play out?

Ryan Heath: This is universally true throughout.

Chris Powers: Because you're a psychologist as well.

Ryan Heath: I spend more of my time in counseling as a counselor. It's universally true throughout estate planning, especially when doing unfair things. In the business context, we're discussing what could be perceived as unfair. I require my clients to have that conversation before we move forward with the plan.

And it goes back to that harmony among siblings, right? If dad, and sometimes even mom's involved in that, right? Because even though it's dad's business, mom has played an integral part in the business by raising the kids and doing everything that encompasses. And so, Dad and Mom need to sit down with the kids and explain why.

It is why I've decided to do it this way. And this is why I set the price the way it is. And this is the benefit you'll get from all the hard work I put in over the years. And what that does is when it gives the siblings a chance to get ticked off at Dad, right? They can be angry if they want to be mad at Dad or Mom.

They can skip Thanksgiving dinner if they want to for a while. But when dad and mom die, it's not justified to be angry at the sibling, right? Because mom and Dad explained to them why they did it. They're reasoning behind it. And so our hope is it's never foolproof, but by getting out in front of it today, we're increasing the chance that the siblings can continue a good relationship after the parents are gone.

But that's true throughout estate planning. Anytime something's not equal, we almost always do a document called a statement of wishes. It's a letter from Mom and Dad to the kid saying, here's why we did it this way. And sometimes, clients will give that to their kids while they're alive. Other times they wait until death.

But either way, we're giving that to them as a letter from the grave saying, here's why we did it this way. We love all of you equally. We had to make some hard decisions. We decided on this, and we hope you guys will still get together, love each other, and keep our family legacy going.

And again, so, all of that is not foolproof, but the hope is that it shifts the anger. To the appropriate party, right? Shifts it to the person that should take the blame for making the tough decision. 

Chris Powers: And in those conversations and again, maybe it's just a situation by situation, are you participating in that conversation, or is there somebody you recommend that is like a third party to the conversation?

Most fathers or mothers that own businesses aren't equipped to have then this conversation, so it's not emotional.

Ryan Heath:  It was incredible. The example I've used throughout this is a great family I've worked with for seven or eight years.

They are an extremely close family, extremely religious. And they had this conversation, and there wasn't a dry eye on that Zoom call. Like I was crying just seeing the emotion of the family, and they all said, yes, this sibling deserved the business that they were. So it was just this incredible feeling—things you don't usually see because everything blows up on my end of the world.

That's when I usually get involved. So cool to see that happen. And so I participated in that client's kind of family conference. I have another client, though, who's got a similar business, a construction business, and he's got one or two sons actively involved in the business.

Two girls with nothing to do with the business and the sons are taking over the business together and have incredibly different personalities. They are great kids, but just one is a go-getter. One's more laid back, and Dad's worried about how this will play out when he leaves. And so he went to a religious counselor and did family counseling with the kids to see if they could make it work.

So in that scenario, I was not involved at all. And then there are also some business succession planners out there. I've had a not-so-great experience with them because they get a certification, but it doesn't have practical requirements. It's just studying for a test. And you need experience dealing with these family issues to resolve them.

So my answer is no. One approach works best, but sometimes the attorney can explain why it's structured a certain way. Counselors can provide the family kumbaya of Dad still loves you guys, and if you have some hidden feelings, let's let them out now.

So it's so funny how it shifts from legal to counseling more so quickly. But addressing it during life is essential and not waiting until you pass away.

Chris Powers: If you have a profitable business and it doesn't even matter if a son or daughter is working in it but is there, it's not going to, the business isn't be sold.

It will be inherited, and is there something you should be doing? To restructure how it moves to the next generation. Should you look at your LC docs, or should you look at your S-corp docs? If you know that I'm not selling the business and it will either be inherited by my kids or there's a plan for it posts my death, what things, from a purely legal standpoint or structure standpoint, are valuable, if any?

Ryan Heath:  Yeah. We must examine the company agreement, bylaws, partnership agreement, and entity type. We need to look at that. And the critical thing we're looking at is who can make the decisions on a day-to-day basis if something happens to Dad, right? Because it's dad's been the sole owner.

His company agreement doesn't matter; it doesn't matter who makes decisions cause he's the sole person in charge. But when we get a multiple-owner situation, we can't have a deadlock in the business, right? That's not good for anybody. And so we need to have either a board that makes decisions together. We need to have a succession of people in charge, and it's rank and file.

We need some governance structure in place. And the second thing that we need to look at in that company agreement is how we will compensate the beneficiaries, the kids actively involved in the business, to motivate them to keep doing well. So from a company agreement, operating agreement standpoint, that's necessary.

I think separately looking at the tax structure, so if it's an S-corp, for example, when the sole shareholder passes away, if it goes into a trust, certain types of elections have to be made so you don't break the S-corp status, which is a big deal to most of us that have an S-corp. If it's a disregarded LLC and a pass-through entity, it may become a partnership right when the patriarch dies and goes to the kids.

The other thing is, how will we address spouses in the future? So if four kids inherit the business and one gets divorced, we want to ensure the business doesn't get passed over to that spouse. We may want spousal protections where the business is required to buy back that interest, or the child that got divorced must buy back the interest to keep all of the business in the family and not go outsiders.

Chris Powers: All right. You brought up a hot topic. It wasn't in my notes, but we got to hit on this. Yeah. And we've been talking a lot about the kids. If the patriarch dies and the matriarch is still around or vice versa, it goes to them first. But that's obvious; the kids are where it gets a little more exciting and what people plan for more.

But you mentioned kid goes and marries a stupid ding dong. Yeah. We don't like him; he is a threat, or just; it's clear he won't add value to the situation. So maybe Susie, we love her to death. She's amazing. Everything was planned for, and then she married this stupid. How might you change documents to account for loose cannon entering the family?

That's not part of the technical blood family. 

Ryan Heath:  And this is an essential concept for any of the listeners that are in Texas. And I'm going together on a little soapbox for a few seconds here. So many people in Texas think it's my separate property if I own something before marriage.

End of story. Everything's a separate property from that point forward, its growth and changes. It's just simply not that clean-cut. Income on a separate property is community property. The growth and value on separate property is separate property. Why does all that stuff matter?

Because a court can divvy up community property however it wants, it doesn't have to be 50-50. A court can't divvy up the separate property. It has to be given to the person that it owns. If you owned a business before marriage and you've been married for 20 years, a portion of that business will likely be community property.

So it's not separate property despite what you read online on Google. Okay. And it creates a bunch of issues. Okay. So that's one comment. And the reason I say that is that's why prenups. Marital agreements are so important. So the first thing I'm going to do when my daughter, Gigi, marries the stupid is strengthened the provisions of my trust's prenup requirement.

Okay? Because I want the equity that goes into her trust to be governed by that prenup requirement. Okay. So that's my estate planning angle to protect. The second side is that I will enter company agreements for my businesses. And I will require Gigi to become a member of Baker Heath Properties.

Her spouse has to sign off on a spousal consent, which says that this is separate property, and if there's ever a divorce, And for some reason, a court would award stupid ex-spouse some interest, we get the right to repurchase it for a dollar—some figure. So we're going to make sure we keep that business separate.

The other thing we must consider is relevant to you, Chris, and Just. For all the businesses you've been involved in, we may want to consider not letting Gigi m, my scenario, be a manager of that business because we know her stupid spouse is going to be in her ear trying to tell her how to run the business, try to tell her how to do everything, and that may interfere with the success of the business, the potential success of the business.

So a lot of times that's what we end up seeing is it's not a spouse, it's not a divorce situation, it's that we've got four kids and one crazy daughter-in-law or son-in-law. And that crazy in-law is. It was barking in the spouse's ear, in our child's ear, and causing problems that otherwise wouldn't exist.

And so when we've got a spouse like that, we may want to remove that child that's married to that spouse out of the management equation to ensure we can grow the business.

Chris Powers: Yeah, Something that came to mind; I was on a wonderful guy, Mike Boyd, with a podcast called The Business of Family.

And he interviews families that have had dynasty businesses transferred to fourth, fifth, and sixth generations. They made their family of business the hierarchy and how it works. And he had just mentioned something. I asked him a similar question what are just some exciting things you've seen along the way?

He is one family with something to where if it's some, I'm going to botch it a little bit, but if One of your kids is married, and they wanted this one, either the husband or the wife. It doesn't matter if it's your kid or not, moves out of the house or there's, begins a separation like immediately that child is removed from the trust or the will or every, or whatever it is, until it's either been remediated or until something's done, like within 24 hours.

If you know that Susie and John have split up, there's a mechanism in place, and they are put in the penalty box until further notice, which was interesting. 

Ryan Heath:  Yeah, I love that. And the other successful family businesses that I've seen, there's a lot like in the Northwest and the Northeast that are seafood companies and things like that have just been around forever. And they do if you're a descendant, a blood descendant of the original patriarch. You get gifted a tiny amount of shares every year. And so as time goes on, you build up your shares, and then as your parents die, you inherit more, and they are, so it's strict about the prenup requirements.

It's strict about maintaining a particular faith even, and you must tithe a certain amount of your distributions yearly—detailed Family governance structures. And you can get details. You've seen, and I've seen, with family ranches, right?

Although a ranch can be a business, we are moving away from the business. How do we govern the use of the ranch, right? So how do we ensure people don't start carving it up and selling off small pieces? And how do we use the ranch for the intended purpose, right? Which might not be all oil and gas. It might be hunting or solar power.

Chris Powers: I'm heading to a ranch this afternoon with some of my buddies, and it's a big ranch, and I won't give too much detail, but I think there was something along the lines of this was a big decision to make—lots of kids, lots of grandkids. 

Ryan Heath:  Yeah. And they'll have a family constitution that governs it all.

Chris Powers: On the ranch topic, we've moved on to small businesses and wealthy families. What might you do if you're worth 10 million versus a hundred million versus a billion? What are some things that progress over time?

We can talk about slats. It was digits, just things that become pertinent to you at certain levels of wealth. 

Ryan Heath:  Yeah. So, anything, 5 million and below; we're probably talking primarily about doing the core planning. So we'll have linked the six documents we discussed earlier in the show notes, plus that trust, right?

The revocable trust, to give some protection if you pass away, delays the kids' money access. I think the exception I would say age is always a factor in the net worth, right? If you've got a young person to 5 million, a lot different from an 80-year-old at 5 million, right? Just cause of the growth potential.

But when we reach the 10 million range, in the five to 10 million range, and we're likely looking at the same foundational documents, the six plus the revocable trust. But we will start talking about, at a minimum, doing annual gifting to the kids. So every year, the IRS gives us a certain amount to give to as many people as we want.

I use Oprah as an example. I can give a specific dollar amount to everyone in this room. Everyone in the world, and it doesn't have any adverse tax consequences for me when I die. And that number this year is $17,000. So between my wife and I, collectively, we can give $34,000 to as many people as we want.

That's my hypothetical. And so if you're doing that, since I'm Your way, maybe Johnny some, I'm sure Johnny wants some too. I've got to grow some more and print some more first, but at a minimum, when you get to that 10 million mark or 5 million mark, we probably want to start talking about the low-hanging fruit, which is the ability to gift that $34,000 if you're married, or $17,000 each your kids, it can be outright, or you can gift it into a trust. That's where that gift trust idea about Gigi, which I talked about earlier, comes into play. That's the first step I usually approach someone in the five to 10 million range. When you get above 10, you start getting in the 10 to 20 million range.

Then we're talking about more advanced tax planning, and that's where that slat comes into play. To simplify it, but also to cover some political environment where we are. This year for 2023, you can give away during life or die with a combined 12.92 million.

If you're married, you can combine those. So it's 25.84 million. I hope my mask is correct on top of that 12.92 million I can give away during life or die with. I also have that $17,000 that I can give away each year. That's not subject to tax, and that 12.92 million is the highest we've ever had, except for one year, which was 2010, when no exemption existed.

It was the most incredible year to die if you were a billionaire. And we already know that this 12.92 figure is indexed for inflation, so it goes up yearly. It's been climbing for the last couple of years. It's set to go back down and be cut roughly in half at the end of 25. So Trump's tax plan passed this doubling of the exemption.

It went from 5 million to 10 million indexed for inflation, at 12.92 million and but needed more votes to make it permanent so it sunsets at the end of 2025. When that happens on January 1st or at the end of that January 1st, the exemption will go back down to about $7 million per person.

So you had 12.92 million that you could die with. You're losing roughly 5.92 million of that exemption this year. For folks in that 10 to 20 million and up net worth range, we want to use as much of your 12.92 million as possible before it goes down to 7 million. And the reason for that is the IRS has said that if you use all of your 12.92 million exemption and then we reduce it to seven, we won't go back and tax the difference.

You took advantage of it while it was higher. Good for you; you seized this window of opportunity. A little higher is even better if we've got folks in the 10 to 20 million net worth range. We may give 12 million to a trust to benefit a spouse and then kids.

That's a s slap. So that's one option that a lot of folks use. It's a relatively easy-to-understand option. Lastly, I would say before we get super complex is when folks get above 25 million, and they've got a lot of different business interests, which I suspect many of your listeners have; they've got different entities that do different investments and real estate.

That's when the F L P, the family-limited partnership structure, often makes sense. And so the idea is we take a lot of the various business entities you have, we roll them into a family limited partnership structure. So it centralizes. And puts all the entities in one basket and centralizes the management over them.

And when you gift those interests to a spouse or kids or trust, the value is not 100% of everything in it. You get discounts for lack of control, lack of marketability, etc. And so the family-limited partnership is an add-on to the rest of the planning.

We've discussed the gift trust, the slat, the core six documents, and the revocable trust. And there are a million other types of trust out there. But those are just the ones to me that make the most sense. And when I was looking at the comments to your post the other day, one of the questions like, how do we balance all this, like the money and the kids, and what to do?

Only some people want to save every penny they can on taxes. On one end of the continuum, we've got.

Chris Powers: Only some people on earth optimize for tax benefits.

Ryan Heath:  Yeah. On one end of the spectrum, we've got, I want to pay zero estate tax right when I die.

We can do that. You'll give a lot of money to charity, and you'll probably only be aware of that after you meet with me. But that's one end of the spectrum, right? Do I want to pay zero or as little state tax as possible? If you're on that end of the spectrum, guess what?

Your life will be tremendously more complicated than someone on the other end of the spectrum I'm getting ready to discuss. So the more you try to achieve tax savings, the more complicated your life is in trying to achieve those goals. The other end of the spectrum is that I don't need my kids to receive every dollar I've built.

So I'm okay with each kid getting. 1 million, 5 million, 10 million, right? Whatever that number is for your family. Let's set up a plan that leaves them that money, and everything else falls into place. But this allows for simplicity. Because we've just set up a dollar amount, we want to leave the kids; we can build a plan that achieves that goal, and then if the kids can't make it off of 10 million, right?

With investments and growth on the assets, then that's on them. And so, for anyone listening to this podcast, I go for the balance between tax savings and simplicity. We can get complicated, but you won't know how to administer and run everything.

You need a family office to take care of these things for you, right? Let's find the balance between achieving all your objectives, getting as much money to the kids as possible, and keeping the plan simple to where you can. Understand what you have in place. 

Chris Powers: The note I have is, I'm calling it Money by Surprise, and I just came with when you said, if you're 80 years old and you have 5 million, you know what you got.

But in business and sometimes assets. If you had owned minerals in the Eagle ford Shale in oh eight, maybe you thought you were worth a million bucks, and you found out six months later you were worth a hundred million suddenly. Or you have a business, and it's chugging along, and suddenly, one of your patents becomes worth a gazillion.

Or I never thought I'd sell my business, but now we will sell it. The question is, Are there things to be fair and we won't have to go into detail? Something that happened in my life in 2021 was a little unexpected. And I remember everybody was like, oh, you should do this.

Or, get your assets in this as quickly as possible, or whatever it was. It was like; I wish I had known this before. And obviously, this is the underlying surprise. What do you do when you don't think you've got a lot, and all of a sudden, the market moves or something happens, and all of a sudden, what you thought might have been a lot becomes way more? Is there stuff to do?

Ryan Heath:   Yeah. So it's Right. There's like levels to the surprise. Sometimes you've built a successful business, you think it's worth a lot, and then you get approached, and the offers a lot more than what you thought, right? And that sort of scenario, getting a good estate planning attorney on the line, As soon as you can before the liquidity event happens.

That's key, And the reason is we can get a business appraised with discounts and all these other things for a lot less than what it's typically sold for. But once that LLOI is signed and a contract for a fixed price, it becomes much harder to justify that lower value.

And that seems counterintuitive. So, from an estate planning perspective, we want everything valued as low as possible. It's a counterintuitive shift in thinking because we usually want everything to be shown as valuable as possible unless you're trying to get a real estate appraisal for something.

So that's one thing to keep in mind. We want low values. And so if we know there's getting ready to be an exit or a liquidity event, get ahead of it before you get the money. That's the number one key. Now, if there's a huge surprise and to your point with oil and gas, right?

In that scenario, you will have to do an F L P and take discounts where you can get them and adapt afterward. But what I caution people against is the surprise that happens. You get the information about potential and estate tax liability, and you call a law firm; they put up this tremendous plan and tell you what it costs. It's a drop in the bucket compared to what you will save in the long run.

I sometimes tell clients to step back and look at this for a second, take a deep breath, and make sure do you want to do this right. A perfect example, if we have time, is just for a short story, there's a pharmaceutical company that has been raising equity for a while, and they took in a lot of folks who were very blue-collar, lower or middle-class citizens for investors.

It's neither here nor there whether they were accredited. Not getting into that, but ultimately, we have people whose net worth is a hundred thousand dollars, and it's getting ready to be 20 million. And so I'm getting calls from all of these investors in this deal, and they're saying, Hey, we want to set up all these complicated trusts and save taxes.

I'm like, you don't even have enough money yet to enjoy it. Yes, you may owe a million, 2 million in estate taxes, but don't you want to have access to this money and be able to enjoy it, right? Instead of giving it all to a trust and losing access and control, you've always got to sit back for a second, listen to your attorney, and think through whether you want to part with control or access to these assets.

Because anything that we're talking about, Chris, on tax savings, you're losing the financial benefit of it, right? That's the trade-off for getting tax savings. And so, I caution people to reach out quickly. Don't wait to reach out, but then digest it and ensure you are okay with the idea that you may not have access or control over these funds anymore.

Chris Powers: Okay. I want to reconsider something I missed on the family, and then I want to go back to folks over 25 million, where you will be inheriting more than tax-free. But on the family side, I've heard people say you don't want to write the will such that even though the father and mother are dead, it's almost like they're still alive.

They're still making decisions along the way. But have you seen anything in family estate planning where look, maybe the parents died early, and the kids were young, where they set up things that, like if different milestones might be achieved in their lives, like the will or the trusts kind of change what they're capable of doing.

Again, I've heard people say you don't want to keep making decisions for your kids post you're gone. But then I've also heard of some things where things get interesting if the kids are, do something incredible to where I thought the trust would work like this and ended up working like this. Do you see that? 

Ryan Heath:  Yeah, I've seen it. So what you're referring to is dead-hand control—controlling from the grave. And there is a stigma on it, and I would say you have to strike a balance, right? Yeah. You can't anticipate every single scenario in a person's life.

But I have seen those milestone-type structures where we say, if you graduate college right, we will make a particular distribution to buy you a house. If you get a graduate degree, we're going to give you. A hundred thousand dollars, they were going to pay your tuition for it.

I've seen things like that, that I've found interesting. I've also had conversations with a client. We're having ongoing conversations about doing a match on income, saying that we'll match your income dollar for dollar from the trust. But if you get to 90,000 or a hundred thousand dollars a year, we will match it at 1.25.

If you get to one 50 or 200 a year, we will pay you one and a half times. Interesting. And Trying to dangle the carrot instead of the stick to say, if you do these things, you'll get more significant distributions. The flip side is that your kid may be a passionate person who wants to be a teacher, which may be challenging.

And then, does it feel like a stick when intended to be a carrot? Yeah, there's always that risk, but as the kids get older, you can modify your plans to incentivize them to do better and incentivize them from a monetary perspective.  

Chris Powers: Have you seen somebody incentivize their kids to be like great kids that are friendly, kind, generous like you can't monetarily measure it?

Ryan Heath:  Yeah. Where that gets hard is just how you police it. Yeah. And that's where, when we make that statement of wishes in the trust document, we put provisions about the intent, right? So one of the things I put in my trust is that, Traditionally, you're restricted on what you can take distributions from the trust for things like health maintenance, support, and living standards.

But I put a provision to my trust that says, look, if you want broader access to the trust, then just maintaining a standard of living. You've got to work full-time, stay at home to raise a family or volunteer for charity. If you're doing those things, we'll give you access to the trust beyond just maintaining your standard of living in those scenarios.

There are ways we can incentivize through the document. That's where being more broad and generic is a better option than having a dead hand control with all these specific rules laid out because we need to know. Attending college and graduating in 10 years may not be worth it.

We are still determining what it is going to look like. And so we need more flexibility.  

Chris Powers: There are probably people that pass away, their kids love them, and then as time goes by and they live by the trust, they start disliking their parents after they're gone. That's got to be a tricky situation.

All right, over 25 million, or let's call it at a hundred million, to where the assets are moving to your children or to whomever, but they're way above the threshold of what goes tax-free. Then what do people start doing? 

Ryan Heath:  Yeah, so in that scenario, the key, For now, if you've done nothing, you need to use all of your estate tax exemption, right?

Like today, or at least over this year and next, there are some benefits to staggering things out, but we want to use all combined. If you're married 25.84 million, then there are some other things you can do. But your strategy is more so that you've used all your exemptions, right?

And so unless you want to leave things to charity, whatever you have left and the growth on, it will be subject to estate tax, right? That's just where you are. And so the goal at that point is to shift the growth of assets outside of your estate. And so you can do things like sell assets to a trust you've created.

Pay yourself back a note alone. But the growth of those assets you sold to the trust is outside your estate. There are things like Grats, which is a grantor-retained annuity trust. So you put things into this great, and it pays you an annuity back over two years. It pays you the amount you put in, but all the growth goes into this trust outside your estate.

The grats are what, from my understanding, a lot of the big tech guys did to shift billions of dollars out of their estates. They would set up these grants for two years. It's a two-year term for the annuity. So I put in 30 million.

Chris Powers: Paid of cash or stock?

Ryan Heath:  Whatever you want, you want it to be appreciated quickly.

So if you're going to do cash, you need to get invested, and it's got to surpass a hurdle rate. Now that hurdle rate's a lot higher than it was last year. It's about 4% where it was 0.6%Last year. But if I put 30 million into scrap. I pay myself back the 30 million plus some interest, right?

Anything above that goes into this trust outside of my state. And it's only for a two-year term. So every two years you do a new one. You do a new one. They call it Rolling Grats. And so if you Google Search Rolling Grats, you'll see some Forbes articles and things like that. That's like the, and it could be more advanced cause it's a pretty straightforward strategy.

But that's what you're doing because the goal is to shift all of the future growth out of your estate. It's called an estate tax freeze strategy. 

Chris Powers: Okay. All right. A lot of folks on here own real estate. Often you see families that have owned it so long it's depreciated to zero. Anything about transferring real estate among generations differs from something we've discussed.

Ryan Heath:  So if you're one of the fortunate folks that. Either doesn't have an estate tax problem, or you have an estate tax problem that's so great that you can only pick and choose certain things to get out of your estate, and just by its nature because it is passed on, it tends to have the shallow basis for income tax, capital gains reasons.

But we typically want that land to be included in the person's estate when they die—so gifting it when Grandpa is 80—is a bad idea. Let Grandpa die first and then pass it to you in his will. That is because land gets a new starting point for capital gains purposes. It's called a step up in income tax basis at death.

Okay? So when we're doing planning, if you don't have an estate tax problem, Then we want everything to get a step up in basis. If you do have an estate tax problem, we may not want to fund those irrevocable trusts with land that has a zero basis. We can put other things in there. And keep the land in your estate so it gets a basis adjustment.

So that's the big piece there. And then setting up similar structures, as we discussed earlier, family government structures for like LPs, all those sorts of things also come into play. Is that more what you're asking about? So anytime you and land really should not be in your name, except for your primary house.

You'll usually want your land, an LLC, or some entity from an asset protection standpoint. 

Chris Powers: What about an industrial building? Is that different than land?

Ryan Heath:  I would treat any real estate. Any surface real estate should be in some business entity.

There's an art to whether you do a new LLC or partnership for everything you buy or if you put them into buckets, but just from a liability protection standpoint, it makes sense to have real estate in an LLC or some business entity. 

Chris Powers: Can you move real estate to a trust without having mortgage holders called loans?

Ryan Heath:  You can move your primary residence, so your primary residence is exempt under federal law. When you get to secondary residences or commercial real estate, technically speaking, the transfer to an LLC or trust will trigger the dual on-sale clause. So it has been 12 years since I've seen it happen.

I've been practicing for ten years, whatever. My mentor has been practicing for 30-something years and has never seen it happen. And so when interest rates were meager, we're like, yeah, if they call the note, we'll refinance it. It's slightly different cause we've got folks with 2% interest rates, and they don't want to risk triggering that problem.

And so, for those people, we usually ask the bank if they will approve the transfer. And some have; they have no issues. They still need to change the interest rate. They've just approved it as long as we have specific provisions in the documents. But if you're trying to avoid probate, which is that court process when you pass away On a piece of land, there's an alternative to transferring it to the trust during your life.

So we now have a transfer on death deed that you file on the property records, and it says, when I die, the property goes into this trust, and it's not effective until I die. And so because of that, it doesn't trigger the due on sale provisions. 

Chris Powers: Okay. It is a Twitter comment. I think you read it,

The explanation of the strategy ultra high net worth families use to transfer real estate held in LLCs using loans at the IRS, the minimum interest rate to finance errors to buy more percentage of the LLC each year, plus a discussion of the lack of control discount.

Ryan Heath:  Yeah. Let's digest that a little bit.

It's one general strategy. So I talked about that earlier. Parents can give $17,000 to each. So 34 collectively to each of their kids every year, at least for this year. That's our number. And so one strategy you see many times is parents have, so let's make it simple.

Let's say the son wants to go out and buy a house and wants to avoid getting bank financing. Mom and Dad can loan the money to the child and the interest rate that has to be charged. So you can't charge 0% interest. The IRS won't respect that. And so they set what's called the AFR rate. It's called the Applicable Federal rate, 75-20 rate.

It's got some different names. Again, that number was like 0.6 a year and a half ago. Now it's 4%. So it's not nearly as sexy as it was a few years ago, but the idea is that you can loan your child the money to buy the house, the right child pays back the interest and the principle, or however, you structure it.

And the parent has the ability, as long as it's not a prearranged plan to forgive up to $34,000 worth of interest every year. As long as they've made no other gifts, if you take that simple example of buying a primary residence, and then can I shift gears to say you had an FLP that the parents owned, they were selling FLP interest down to the kids.

The same concept applies, right? If you loan a child money, they're repaying you at a lower rate than what banks charge. And the added benefit of the F L P is that you can get discounts. You're making, selling, or loaning on the asset's value. Did that make any sense at all, or did I lose?

Chris Powers: It's look, it's complicated. Yeah. I'd have to ask you ten more follow-ups, but it sets me to understand at a high level what it means. If I were to do that tomorrow, I would be calling you going; help me set this up. 

Ryan Heath:  The key is that you can loan money to your kids at a lower interest rate than they would get in the general public.

That's the idea. And then you can forgive kids' interest as long as it's not prearranged. That's the big thing you can't like everybody can't agree, we're not going to charge you this interest. If you do that, the IRS will say it's not legit. 

Chris Powers: I bet there's much winking in the state.

All right. I will bring it home on a topic you sent me, but this relates to many folks, even what we do in real estate private equity. Still, there are a lot of private equity listeners. You wrote a comment; you said, using trusts in private equity investments, let's discuss what you wanted and why it might apply to some people listening.

Ryan Heath:  Yeah, suitable for folks with an estate tax problem on the horizon? Investing with the trust makes a lot of sense. And the trust we're discussing here is irrevocable. Cause a lot of Fort deals to have perfect multiples regarding returns.

The vast majority of investments we make that are outside of stocks and bonds have pretty good returns. And so if we're investing with the trust, The benefit is the assets in that trust are protected from lawsuits, protected from creditors, suitable? So we're building a nest egg of protected assets.

And so I'll give the example of the slat. I create a trust for Lorna's benefit, and then when Lorna dies, or if we get divorced, it goes down to Gigi, right? We're not getting divorced, Honey; if you listen, I'm just throwing out an example. In that scenario, Lorna could be in charge of the trust as a trustee, and she can make all the investment decisions.

And so she can choose which fort deals to invest in or outside deals to invest in when the deal pops, right? So when the liquidity event happens, the money goes into the trust. It's outside of our estate. For estate tax reasons, it's protected from lawsuits. So if I'm sued for malpractice, that trusts foreseeably should be protected from that lawsuit.

If I'm in a car accident should also be protected, right? And then the money can turn around and be invested again and again and again. And so I think for folks like you, and I suspect many of our listeners, the money benefit is great with investing, but it's more fun doing the deal and seeing it come to fruition.

And with an irrevocable trust, like a slat, you can still benefit from making the investment decision, seeing it pop, and seeing the growth happen in this trust, but it's all protected. And usually, you don't get that protection, right? If it goes into a bank account, savings account, stocks, and bonds if you get in a car accident, they may be able to reach that money in a trust that'll be protected, and the trust has better protection.

Generally, irrevocable trusts have better protection than LLCs.

Chris Powers: You had one more comment. You said this could be dense. And so if you're listening to this, get your pen out. But you said this is the first I've heard of this vertical slicing for fund managers. What does that mean? 

Ryan Heath:  Yeah. So if we think about anyone that's a general partner or has a carried interest in the fund, How great would it be after everything I've talked about today to gift the interest to a trust?

Values are essentially zero. That's what we always tell ourselves. The growth potential is tremendous. And that's where many of our state tax problems could come. So why don't we just all today? We'll leave here and call Ryan. He'll set up these cool trusts. We'll gift all of our carries into it, and we will save millions in estate taxes.

The IRS is more intelligent than that. Sometimes at least. And so, they said that a carried interest has to have value. It can't be zero. And if you put a $0 valuation on it, you will get an audit—no doubt about it. So you got to put a number on, but where? I had some heartburn.

You gave your carry away, but you kept the other interest. Your class A and class B interests you kept. And so what the IRS said is you can't do that anymore. You can't just gift your carry. It will help if you put a vertical slice of all your ownership in this entity into the trust.

So I can't gift my carry, but I can gift an equal, say, 25% of my class A, class B and if C'S the carry, class C is attractive. So you're taking a vertical slice of the pie and gifting it to a trust. I got it. Not as sexy or appealing. But there's still a tremendous upside to it.

And so for folks that have carried interest, one, be aware that you cannot simply gift your carried interest alone and carried interest. I have many different phrases or terminology use forms carried as just the general idea promote that. The idea here is that it pays disproportionately to what you put in.

That's the idea here. When you have a carried interest, you need to be aware of this vertical slicing strategy and simplify it even more. Here's what I typically do. If a client's various interests in a private equity fund, some of which are caries, we will put all of those interests into an LLC.

So the LLC owns all of the investments in that deal. From there, we can then gift whatever percentage of the LLC we want into a trust, and it's automatically vertically sliced. I wanted to mention that because I get many client calls, especially in oil and gas. You can understand why it's probably the same in private equity and real estate too, but the potential is tremendous, and they want to give the carries, and we can't just do that.

But this option out here is not quite as sexy, but it's still got a significant upside benefit. 

Chris Powers: All right, man. It has been excellent. I look forward to continue working with you over the years. How would somebody contact you if they have a question or want to reach out or do some work?

Ryan Heath:  Yeah, if you can, give me a call. I'll drop my number in the show notes; give me an email; just Ryan Baker@heath.com; I and love to catch up with you. We're also happy to review anyone's estate planning documents. We typically only charge for that if you've got seven binders, but we're happy to look at it.

Make suggestions for any of your text listeners here on call. Thanks so much.