8 Strategies for Building a Liquidity Plan for Your Illiquid Estate

Key Takeaways:

• Proper liquidity planning can help you avoid unintended consequences for your loved ones.
• An illiquid estate can pose difficulties in accessing funds to pay liabilities, leading to the forced sale of assets at a lower value.
• There are several liquidity strategies to plan for an illiquid estate, including life insurance, deferral options, loans, buy-sell agreements, and more.

A comprehensive estate plan should always include a robust strategy for managing liquidity. While illiquid assets have a place in your estate, when you need to pay expenses, like taxes or loans, it can be difficult to access funds to pay your liabilities. For example, if the payment window is short, such as with estate tax liability, you may experience financial impacts. These impacts include: assets being sold for less than fair market value, assets not being sold in time to pay the liability or a forced sale of assets to generate the necessary cash.

This can be especially difficult when liquidating assets that are meaningful to heirs. Which is why evaluating your family’s goals, priorities and circumstances can help you and your advisers determine the best planning strategy for your situation. If you hold a significant amount of illiquid assets, this information is for you. Here, we’ll go over eight common strategies to help you devise a liquidity plan for your illiquid estate.

Liquidity Planning Strategies

1. Liquidity Planning

Self-insurance, or setting aside cash, to pay your estate tax is a common planning technique. This requires accurately estimating the amount of estate tax liability and adjusting your savings when your finances change.

2. Life Insurance

Life insurance is another way to provide liquidity at death. A common strategy is to hold the life insurance policy in an Irrevocable Trust. Note: You need to work with an attorney to establish this structure.

3. §6166 Deferral

This deferral option is for estates with a closely-held business interest worth more than 35% of the value of the adjusted gross estate. If the deferral is elected, then estate taxes and interest attributable to the closely-held business interest can be paid over 14 years instead of the standard nine-month period. Think of this like a loan from the IRS.

4. Loans

Loans, in the form of an intra-family loan or a commercial loan from a bank, can also be taken out to supply the cash necessary to meet financial obligations. It’s critical for your Executor to understand the terms of the loan so it can be managed and repaid in a timely manner. Additionally, the estate may be able to deduct the interest of the loan on the estate income tax return.

5. §303 Redemption

A redemption of stock by a closely-held business may be eligible for capital gains tax treatment instead of being treated as ordinary income. The result of pairing the §1014 step up in basis with a §303 redemption is minimal taxable gain for the redemption of the client’s interest in the closely-held business. If choosing this strategy, you will need to discuss the §303 redemption with your tax adviser.

6. Buy-Sell Agreements

Buy-sell agreements are legally binding contracts between the owners of a business that outlines the conditions and process for transferring ownership in the event of predetermined triggering events, such as the death, disability, or exit of an owner.

These buy-sell agreements can include stock repurchase clauses, where the company purchases the shares of the impacted individual. Alternatively, the agreement could require the remaining business owners to purchase the impacted individual’s interest directly. Both options provide liquidity to the estate. But valuation and payout terms should be reviewed carefully before making a final decision.

7. Charitable Planning

For families that have charitable intent, creating a charitable split interest trust, such as a Charitable Remainder Trust or a Charitable Lead Trust, could be advantageous from an estate tax perspective. Keep in mind, there are additional tax considerations if the charitable split interest trust will be funded with an interest in a Subchapter-S closely held business.

8. §2032A Special Land Use Valuation

This special land use valuation allows an estate with active use farmland to include that land in the estate at a reduced valuation. The land will be included for estate tax purposes at farm use value, not the highest and best use value. The reduced valuation can result in estate tax savings. Note: there are additional requirements to use this provision.
Deferrals, redemptions and buy-sell agreements are popular liquidity strategies among business owners.

Start Planning Today

As the saying goes, a little planning goes a long way. Especially when it comes to illiquid estates. You can avoid tension, complications and questions among family members and loved ones by having a plan for after you’re gone. Remember to consult with financial experts–attorneys, accountants and wealth advisers–to ensure you adhere to process and documentation requirements. Contact your Comerica Relationship Manager or request to speak with a Comerica Wealth Manager near you.