CEA Family Governance & Wealth Transfer 3 — Questions and Answers
Question 1: An intentionally defective grantor trust (IDGT) is considered 'defective' because:
- It fails to remove assets from the grantor's taxable estate
- It is treated as a grantor trust for income tax but not for estate tax purposes (Correct answer)
- It cannot hold life insurance policies
- It triggers immediate capital gains on transferred assets
Correct answer: It is treated as a grantor trust for income tax but not for estate tax purposes
An IDGT is 'defective' for income tax purposes only — the grantor pays income tax on trust earnings, which is itself a tax-free gift, while the assets remain outside the taxable estate.
Question 2: Which of the following best describes the role of a family office in wealth transfer planning?
- A government agency that oversees estate tax compliance
- A private entity that coordinates investment, tax, legal, and philanthropic services for ultra-high-net-worth families (Correct answer)
- A type of mutual fund restricted to family members
- A court-appointed administrator for large estates
Correct answer: A private entity that coordinates investment, tax, legal, and philanthropic services for ultra-high-net-worth families
A family office provides centralized, customized financial and administrative services for families with substantial wealth.
Question 3: A grantor retained annuity trust (GRAT) is most effective when:
- Interest rates are high and asset growth is expected to be low
- Interest rates are low and the transferred assets are expected to outperform the IRS hurdle rate (7520 rate) (Correct answer)
- The grantor expects to die before the annuity term ends
- Assets inside the GRAT generate ordinary income only
Correct answer: Interest rates are low and the transferred assets are expected to outperform the IRS hurdle rate (7520 rate)
GRATs work best when assets appreciate beyond the IRS Section 7520 rate, transferring the excess appreciation to heirs gift-tax free.
Question 4: In a family governance structure, a family bank (or private trust company) is primarily used to:
- Offer FDIC-insured deposits to family members
- Provide intra-family loans, financial education, and entrepreneurial seed funding governed by family rules (Correct answer)
- Replace commercial banking relationships entirely
- Hold all family assets in a single pooled account
Correct answer: Provide intra-family loans, financial education, and entrepreneurial seed funding governed by family rules
A family bank is a governance tool that pools family capital to offer loans and grants to family members, promoting financial education and entrepreneurship.
Question 5: Which estate planning technique involves selling highly appreciated assets to a grantor trust in exchange for a promissory note, effectively freezing the estate value?
- Charitable remainder trust (CRT)
- Installment sale to an intentionally defective grantor trust (IDGT) (Correct answer)
- Qualified personal residence trust (QPRT)
- Pooled income fund
Correct answer: Installment sale to an intentionally defective grantor trust (IDGT)
Selling assets to an IDGT for a promissory note freezes the seller's estate at the note's value while future appreciation passes to trust beneficiaries outside the taxable estate.
Question 6: The primary risk associated with a spousal lifetime access trust (SLAT) is known as the 'Unhappy SLAT' scenario, which occurs when:
- The trust generates insufficient investment returns
- The couple divorces, leaving the grantor without indirect access to trust assets (Correct answer)
- The IRS reclassifies the SLAT as a revocable trust
- The trustee invests in prohibited transactions
Correct answer: The couple divorces, leaving the grantor without indirect access to trust assets
If the couple divorces, the grantor loses any indirect benefit from the SLAT since the spouse-beneficiary is no longer their partner.
Question 7: A qualified personal residence trust (QPRT) transfers a home to heirs at a reduced gift tax value because:
- The home qualifies for the annual gift tax exclusion
- The grantor retains the right to live in the home for a term of years, reducing the present value of the gift (Correct answer)
- Real estate is exempt from gift taxation
- The home is transferred at its depreciated book value
Correct answer: The grantor retains the right to live in the home for a term of years, reducing the present value of the gift
The retained right to use the home for a specified term reduces the present value of the gift to heirs, lowering the taxable gift amount.
CEA Family Governance & Wealth Transfer 3
An intentionally defective grantor trust (IDGT) is considered 'defective' because: