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Tips From the Pros: Kicking Off the New Year With “Healthy Habits” for Families, Their Family Offices And Their Advisory Team

N. Todd Angkatavanich suggests that the new year is a good time to take stock of where things stand with respect to a family’s overall structure.

Like many of you, I’ve kicked off 2023 with some New Year’s resolutions by ridding the house of the holiday junk food and stocking the shelves with protein shakes and healthy foods (perhaps, but hopefully not, in vain) and have logged in a handful of (attempted) “runs” for the new year (really more walks, or as my buddy calls them, hybrid “rualks”).   

On the financial side of things, beginning the new year serves as a good prompt to update the family balance sheet to make sure that our loved ones have a clear financial picture of the family map with contact and other information to help them navigate it in the future. Hopefully, the aforementioned, actual, healthy habits will ensure this financial GPS won’t be necessary for a long time. But you can never be too prepared in life, can you? And it helps me sleep at night to know that things are “in order” and that surprises are, hopefully, minimized if not eliminated.

Similar to an annual check-up with your trusted physician, the new year is always a good time to take stock of where things stand with respect to a family’s overall structure. Such a financial physical will allow the family, family office and other advisors to collectively go into the new year with open eyes as to the relative health of the overall family structure, as well as the different family vehicles that serve as its critical components. It allows for the family and advisors to level set and get a picture of the current state of affairs of the family structure. An annual health check allows the advisors to “pressure test” different vehicles that are part of the overall structure, identify new and often lingering “soft underbelly” issues that may have gone undiagnosed for years and proactively institute “healthy habits” to try to get the overall family structure and its component family vehicles as healthy as possible. It’s possible that there may exist potential ticking time bombs that may be lying dormant awaiting some triggering event to occur in the future (most often, but not necessarily, the death of the matriarch and/or patriarch). As with landmines long buried in an abandoned minefield from decades ago, these time bombs don’t expire or lose their potency—rather they often lay dormant and go unnoticed for years. What can be done to address such time bombs and how effective such remedial measures will be will vary depending on the circumstances, the nature of the issues and the client’s risk tolerance. However, what’s clear is that it’s always better to evaluate a structure proactively so that things can be properly evaluated in an educated and measured manner, rather than taking a wait-and-see or ostrich approach based on a false sense of security that “things feel okay” and/or “haven’t been a problem so far.”

Healthy Habits

As we begin 2023, here’s a non-exhaustive list of some healthy habits to embrace in evaluating a family’s overall structure as well as family vehicles that are component parts of the family structure:

Check status of intra-family loans. For years, the Internal Revenue Service has challenged the validity of intra-family loans as being gifts, subject to gift tax, rather than loans (or sales in exchange for a promissory note). The arguments have been based on different theories. The most traditional but still potent argument is that the parties never intended for the purported loan to be real debt, as evidenced by lack of proper documentation, lack of proper payment, enforcement of non-payment and tax reporting. This has generally been heavily a facts-and-circumstances kind of inquiry based on the post-loan conduct of the parties as an indication of their intention. The primary circumstances that have been taken into consideration generally include whether the payments required under the note were actually paid on time, whether the lender took appropriate actions to demand payments required under the loan in the case of late or nonpayment and whether interest payments required under the note were properly reported on the lender’s income tax return.1 While the traditional argument tended to focus on how the facts speak to the intention of the parties at the time the loan (or sale) was made to determine if the debt should be respected, the Bolles2 case from 2020 also determined that an otherwise valid debt at inception (so not a deemed gift initially) could later evolve into a gift based on the subsequent inability of the borrower/child to continue to handle the debt service based on changed circumstances.

Additional, more technical arguments have been made that a sale in exchange for a note should be recharacterized as a transfer in trust with a retained interest that doesn’t constitute a qualified interest in violation of Internal Revenue Code Section 2702.3 Alternatively, the IRS has attempted to recharacterize a note as a disguised second class of equity in the transferred entity interest (for example, a family limited partnership (FLP) interest), which would constitute a distribution right resulting in a deemed gift under IRC Section 2701.4

Stress test FLPs and limited liability companies (LLCs). FLPs and family LLCs were often in the past, and sometimes still, pitched by advisors as nothing to lose ventures. Meaning, as they were sometimes rather cavalierly pitched: If it fails (and the assets are included in the gross estate), you may lose the potential valuation discount, but, because both parents are U.S. citizens, there should be no downside, as the estate tax marital deduction should still defer all estate taxes until both parents die. Recent arguments and cases have clarified that such may not necessarily be the case.

It’s no surprise that the IRS continues to be more aggressive in its challenges under IRC Sections 2036(a)(1) (bad facts) and 2036(a)(2) (retained control) theories, the application of either, or perhaps both, of these sections can result in the assets originally contributed by a parent into the entity to get pulled back into their gross estate, resulting in a phantom estate tax on the contributed assets, based on their (appreciated) date-of-death values. However, in such event, if, as is usually the case, the parent has made transfers by gift and/or sale of partnership or LLC interests during their lifetime, likely to children or their trusts, such will result in a “mismatch;” that is, while the contributed assets will be pulled back into the parent’s estate for estate tax purposes, the interests in the partnership or LLC (that owns those contributed assets) that have been transferred during the parent’s lifetime are no longer owned by the parent’s estate for property law purposes. As a consequence, no estate tax marital deduction would be available to offset the phantom estate tax inclusion in the parent’s estate. This is because the estate wouldn’t actually own the partnership interests for property law purposes and so can’t actually pass those interests to the U.S. surviving spouse or marital deduction trust. This can result in a first death estate tax liability (quite to the contrary of what was pitched perhaps decades ago). To make matters worse, such can trigger an estate tax on downward spiral because each dollar paid to the IRS will itself not qualify for the estate tax marital deduction and will therefore be subject to estate tax, and so forth.5

A lifetime stress test while the parent is still living will always be better than a wait-and-see, false sense of security approach. Such will enable the family and advisory team to take a sober look at the relative health, or lack thereof, of the entity and make an assessment while they still can as to the issues of concern that may exist and what types of fortification measures the family can undertake to improve the health of the entity. Importantly, this stress test should involve an analysis of whether and to what extent the parent’s contribution of assets on the initial formation of the entity may be able to satisfy the bona fide sale exception to the application of Section 2036(a). While it’s not possible to determine with certainty whether the exception is satisfied while the parent is still living, as the evaluation is very facts-and-circumstances driven and doesn’t get tested until after the parent passes, like an actual medical stress test, it will give the family and advisors a decent idea of the relative health, which will inform the types of measures to consider. Or, in more extreme situations, in which it’s determined that the entity is just too infected (perhaps with a history of repeated Section 2036(a)(1) bad facts and/or Section 2036(a)(2) retained control), the dissolution of the entity may be considered. In such case, consider the potential application of the 3-year lookback rule under Section 2035, particularly in situations in which the parent is elderly and/or in poor health, as well as various partnership and general income tax considerations before a decision is made to liquidate.

Check status of grantor-retained annuity trust (GRAT) payments. The numerous technical requirements for a GRAT must be strictly adhered to for it to be effective and not violate Section 2702, resulting in a large, deemed gift. The failure to satisfy any of these requirements can have potentially harsh consequences. While there are a number of statutory requirements for a GRAT under Section 2702, perhaps the most prominent is that the annuity payment must be made annually, subject to a grace period of 105 days. Arguably, the violation of any of the  requirements could cause the initial transfer into the GRAT to fail the requirements of a qualified interest under Section 2702 and, accordingly, trigger the zero valuation rule with respect to the grantor’s retained annuity interest. In such event, rather than the taxable gift equaling the actuarial value of the remainder interest (which, in the case of GRATs that are zeroed out, is very close to zero), the taxable gift could instead equal the entire value of the asset transferred into the GRAT from inception. While the consequence of a failed GRAT isn’t entirely clear, in Estate of Atkinson,6 the operational failure of a charitable remainder annuity trust (CRAT) due to non-payment of annuity payments resulted in the CRAT’s disqualification.

Recently, in Chief Counsel Advice 202152018, the donor was the founder of a company, who transferred shares into a 2-year GRAT. The value of the shares was determined based on an appraisal as of a date about seven months earlier that had been obtained to report the value of a nonqualified deferred compensation plan under IRC Section 409A. Prior to the transfer to the GRAT, however, the donor had been negotiating with several corporations about a possible merger and, in fact, had received offers from five different corporations; just three months after creating the GRAT, the donor accepted one of the offers. However, on their gift tax return, the donor relied on the stale appraisal for gift tax valuation purposes without any mention of the offers or merger discussions. Additionally, the donor relied on a subsequently obtained higher valuation appraisal for purposes of reporting a charitable gift and taking an income tax deduction.

The IRS determined that the aggressive undervaluation of the shares caused the GRAT to fail. It contended that ignoring the facts and circumstances of the pending merger would undermine the basic tenets of fair market value and treated the GRAT annuity as not constituting a “qualified interest” under the Section 2702 requirements. Accordingly, it determined that the donor was treated as making a gift equal to the full, finally determined (increased) value of the shares transferred to the GRAT, without any reduction for the value of the donor’s retained annuity payments. Citing Atkinson, the IRS concluded that basing the annuity payments on an undervalued appraisal was an operational failure that resulted in the donor not having retained a qualified annuity interest under Section 2702. Importantly, the self-adjustment feature in the Section 2702 regulations that’s often regarded as providing protection against revaluation of assets gifted into a GRAT didn’t provide protection to the donor, which suggests that there’s a practical limitation, in the eyes of the IRS, to the application of these adjustment provisions.

Evaluate buy-sell and other entity agreements. While there’s no single, correct way to structure a buy-sell, as that’s dependent on the economic deal struck by the parties, the results under the buy-sell agreement shouldn’t be random. Often, a buy-sell agreement is negotiated and valuation and funding mechanisms (for example, life insurance) are set, based on the circumstances and values existing at that time. As time goes by, however, and circumstances change, the value of the company may increase (or decrease) substantially, and the buy-out funding requirements or other circumstances may change. Unless the buy-sell agreement is properly kept up to date, in the event of the death of a partner, dramatic, unanticipated results can occur. Even the most perfectly crafted and coordinated buy-sell agreement today, may, as circumstances and values change, become outdated and consequently problematic five or 10 years down the line. Business owners frequently fail to review their existing succession provisions following changes in tax laws, changes to their estate plans or changes in the valuation or dynamics of the business and changes in personal circumstances that can have a significant impact on the business succession plan. That’s why it may be advisable to include provisions in a buy-sell agreement requiring shareholders to revisit and reapprove the terms of the agreement periodically or following specified events to ensure that the agreement continues to serve the best interests of the business and its owners. In addition, it’s good practice to create a system (for example, a tickler system or as part of the agenda of periodic meetings) incorporating the review of existing buy-sell agreements to make sure that the ongoing maintenance actually takes place.

Evaluate overall trust structures to ensure they’re being administered and distributions and investments are made pursuant to a “distribution protocol” and “growth protocol.” Often a family structure may consist of a number of different trusts that may have been created over the years, and these trusts will often have different characteristics from an income tax, generation-skipping transfer (GST) tax and distribution longevity standpoint (as well as other considerations, such as perpetuities periods). The family office and other advisors should keep in mind the relative efficiency and inefficiency (for tax and other purposes) of these different trusts when planning for distributions and growth. For instance, when considering distributions that may be made to various beneficiaries, perhaps at different generations, it’s important to consider the tax and other implications. From a multigenerational preservation standpoint, it would be very GST tax inefficient to make distributions to Generation (Gen) 2 beneficiaries from a GST tax-exempt trust created by Gen 1 if there are available assets in a GST non-tax-exempt trust from which distributions can be made. The GST non-tax-exempt trust will eventually be subject to GST tax at some point on either the death of the Gen 2 beneficiary or perhaps even earlier when assets are distributed to Gen 3. Therefore, because such a trust will essentially be soft money from a multigenerational standpoint, it makes sense to distribute from that less efficient trust first before considering distributions from the multigenerational GST tax-efficient GST tax-exempt trust.

In addition to a distribution protocol, advisors should consider a growth protocol, meaning having a clear vision of which trusts and/or entities will serve as the most efficient bucket in which to grow assets—for example, a GST tax-exempt dynasty trust. In contrast, perhaps more cash flow-oriented, and less growth-oriented assets, might be held in the less efficient trusts, such as GST non-tax-exempt trusts, qualified terminable interest trusts or perpetuities limited trusts, so as to contain further growth in such less efficient buckets.   

When the asset values in these different trusts are large enough, consider layering into the family structure certain appreciation shifting arrangements among the various trusts, such as intra-trust sales, loans and perhaps Section 2701-compliant preferred and common partnerships or derivatives.

Evaluate available gift exemptions and exclusions for current (and other) generations. The gift tax exemption for 2023 has increased to $12.92 million, up from $12.06 million—a 1-year increase of nearly $900,000. While I’m dating myself here, it’s interesting to note that this year’s inflation adjustment alone is roughly 150% the size of what had historically been the actual lifetime unified credit amount of $600,000! At this rate of inflation adjustments, and we all know what inflation looks like nowadays, perhaps the gift exemption could approach $15 million by the time the bonus gift tax exemption sunsets at the end of 2025 and returns to an inflation-adjusted $5 million. Part of the annual financial check-up includes making sure to take advantage of the low hanging fruit items of planning to fully absorb the current generation’s increased gift tax exemptions for 2023 (as well as the increased annual gift tax exclusion of $17,000) and anticipating the same for 2024 and 2025.

Additionally, it may make sense to begin thinking about funding mechanisms that can be implemented to provide funds to the hands of other generational family members (perhaps older “Upgen” or younger “Downgen” members) to enable them to use the valuable increased gift tax exemptions well in advance of the scheduled sunset at the end of 2025.  Doing so in a thoughtful and coordinated way may provide a powerful opportunity to elongate the multigenerational preservation of the family’s wealth in an even more tax-efficient manner. However, it will take a long time to socialize such a concept so it’s better to start such discussions with a lot of runway.

Sweep the minefield for Chapter 14 and other transfer tax pitfalls. There are a number of transfer-tax pitfalls that can arise under IRC Chapter 14 in connection with transfers of business interests or transfers in trust when family members are involved. These include numerous gift and estate tax provisions that are designed to curtail perceived abuses with respect to certain types of transactions or arrangements entered into among members of the same extended family. However, the breadth of these provisions can cause unanticipated, severe deemed gift or estate tax consequences to occur in situations that one might not think that there should be such implications. In general, these provisions are analogous to a strict liability type of concept, in that the existence or non-existence of donative intent is irrelevant. The violation of one or more of these provisions can cause a significant, unanticipated deemed gift or increase in the value of one’s estate, which can potentially result in the imposition of an unanticipated gift or estate tax or an increase in such taxes.

The broad application of these provisions can have potentially draconian implications and impact a number of transactions involving family members, including (but not limited to):

  • FLPs and LLCs,
  • restructuring and recapitalizations,
  • preferred and common entities,
  • profits interest transactions,
  • GRATs,
  • sales to grantor trusts,
  • buy-sell agreements,
  • multigenerational split-dollar arrangements,
  • carried interest estate planning,
  • special purpose acquisitions companies and other arrangements.

Many of these IRC sections under Chapter 14 are written very broadly and aren’t so intuitive and can unexpectedly apply, and potentially wreak havoc on a transaction, even when a transaction hasn’t been structured with the intention of achieving estate or gift tax savings or in circumstances in which wealth transfer may not even be the objective.


1. Miller v. Commissioner, 71 T.C.M. (CCH) 1674 (1996).

2. Estate of Bolles v. Comm’r, T.C. Memo. 2020-71.

3. Estate of Donald Woelbing v. Comm’r, T.C. Docket No. 30261-13 (2013).

4. Karmazin v. Comm’r, T.C. Docket No. 2127-03 (2003).

5. See James I. Dougherty and N. Todd Angkatavanich, “Turn(er)ing Back to Basics With FLPs,” Trusts & Estates (March 2019).

6. Estate of Atkinson v. Comm’r, 115 T.C. 26 (2000), aff’d, 309 F.3d 1290 (11th Cir. 2002), cert. denied, 540 U.S. 946 (2003).

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