𝐓𝐡𝐞 𝐌𝐨𝐬𝐭 𝐂𝐥𝐨𝐬𝐞𝐥𝐲 𝐆𝐮𝐚𝐫𝐝𝐞𝐝 𝐒𝐞𝐜𝐫𝐞𝐭 𝐈𝐧 𝐌𝐞𝐫𝐠𝐞𝐫𝐬 𝐀𝐧𝐝 𝐀𝐜𝐪𝐮𝐢𝐬𝐢𝐭𝐢𝐨𝐧𝐬: See How Savvy Investors Are Using IDGT Trusts to Buy Businesses
Savvy investors are using IDGT Trusts to purchase businesses as a tax-efficient strategy for both the buyer and the seller.
Here's a real example:
James is the owner of a successful healthcare business that he has built over the years. He is approaching retirement age and wants to sell the business in order to enjoy his retirement and spend more time with his family. However, he is concerned about the high capital gains tax liability that would result from selling the business outright.
After consulting with his financial and legal advisors, James decides to sell the business to an IDGT in exchange for a promissory note. The IDGT is structured in a way that allows the sale to be completed without triggering income tax liability for James.
Under the terms of the promissory note, James will receive payments from the IDGT over a period of 10 years. The note provides for annual principal payments of $200,000, with interest calculated at a rate of 3% per year.
After the sale to the IDGT is complete, the trust takes ownership of the business and begins to operate it. At the end of five years, the IDGT decides to sell the business to a private buyer for $5 million.
Because the sale was structured as a sale to an IDGT, the capital gains tax liability on the sale is minimised. In addition, John has received a steady stream of income from the IDGT over the past five years, providing him with financial security in retirement.
It's important to note that the specifics of each IDGT transaction can vary based on the individual circumstances of the business owner and the business itself. It's important to work with a qualified financial and legal advisor to determine the best approach for achieving your financial and estate planning goals.
In the example I provided, the $5 million from the sale of the business would go to the IDGT trust as the legal owner of the business. The terms of the promissory note would determine how the proceeds from the sale are distributed between the trust and the business owner (or beneficiaries of the trust, if applicable).
Typically, the trust would use the sale proceeds to pay off the outstanding balance of the promissory note owed to the business owner, with any remaining proceeds being distributed according to the terms of the trust agreement. The ultimate distribution of the proceeds would depend on the specific terms of the trust and the goals and objectives of the trust grantors.
Here are a few ways in which they are doing so:
Tax Savings for the Seller: By selling a business to an IDGT trust, the seller can avoid paying capital gains tax on the sale, as the trust is considered a tax-exempt entity. Instead, the seller receives a promissory note from the trust for the purchase price, which is paid off over time, thereby spreading out the tax burden.
Favourable Interest Rates: Because the promissory note is issued by a trust, it is considered a low-risk investment, and as such, can offer favourable interest rates to the seller.
Flexibility in Payment Terms: The terms of the promissory note can be customised to suit the needs of the buyer and the seller. For example, the note can be structured with a balloon payment due at the end of the term or with monthly payments over a longer period.
Asset Protection: The assets held in an IDGT trust are protected from creditors, which can provide peace of mind for both the buyer and the seller.
Estate Planning: An IDGT trust can also be a useful tool for estate planning, as it can help to transfer assets to the next generation with minimal tax consequences.
Overall, using an IDGT trust to purchase a business can be a win-win for both the buyer and the seller, providing tax savings, flexibility in payment terms, asset protection, and estate planning benefits.
The tax consequences of a sale to an IDGT depend on several factors, including the purchase price, the terms of the promissory note, and the timing of payments.
When a business owner sells their business to an IDGT in exchange for a promissory note, the sale is generally not recognized for income tax purposes. However, the business owner will still owe taxes on the payments received under the terms of the promissory note.
The tax treatment of the payments received will depend on whether they are considered principal payments or interest payments. Principal payments are generally not taxable, as they represent a return of the business owner's investment in the business. However, interest payments are taxable as ordinary income.
The amount of tax owed on the interest payments will depend on the business owner's individual tax situation, including their tax bracket, deductions, and other factors.
If the payments received under the promissory note are considered principal payments, they would generally not be taxable as they represent a return of the business owner's investment in the business.
For example, if the business owner sells the business to the IDGT for $1 million in exchange for a promissory note, and the terms of the note provide for principal payments of $100,000 per year for 10 years, the business owner would not owe any taxes on the principal payments received.
Promissory Note Example
Principal Amount: $5,000,000.00
Interest Rate: 5% per annum
Term: 5 years
Payment Schedule: Monthly instalments of $94,368.42 beginning on the first day of the month following the sale of the business
Maturity Date: [Date 5 years from the sale of the business]
FOR VALUE RECEIVED, the undersigned [Name of the IDGT Trust] (the "Borrower"), promises to pay to [Name of the Business Owner] (the "Lender"), the principal sum of Five Million Dollars ($5,000,000.00), together with interest on the outstanding balance from time to time remaining unpaid at the rate of five percent (5%) per annum, calculated and payable monthly.
The principal amount of this Note, together with all accrued but unpaid interest thereon, shall be due and payable in full on the maturity date set forth above. The Borrower may prepay this Note, in whole or in part, at any time without penalty.
This Note is secured by all assets held by the IDGT Trust, and the Lender shall have the right to enforce its security interest in the event of default.
This Note shall be binding upon the Borrower and its successors and assigns, and shall inure to the benefit of the Lender and its heirs, executors, administrators, and assigns.
Dated: [Date of the Sale of the Business]
[Name of the IDGT Trust]
By: [Name and Title of Trustee]
Accepted and agreed to this [Date of Acceptance] by:
[Name of the Business Owner]
Basically an IDGT is a type of irrevocable trust that can be used for tax planning purposes, and it can be created by individuals with the assistance of an attorney and other professional advisors.
Cost to set up an Intentionally Defective Grantor Trust (IDGT) starts at $3,000.
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Mergers and Acquisitions Expert / Investor / WorldTraveller
The information shared is solely for personal and informational purposes. It should not be considered as financial, tax, or legal advice. Any action taken based on the information provided is solely at the reader's own risk. It is highly recommended to consult with a financial, tax, or legal professional before making any decisions related to finance or business.