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The BDIT, Part 2: An Example

As we explained in our last post (If you haven’t already, please read that post first), BDITs work due to some fun legal quirks. The same quirks that allow BDITs to work also make BDITs hard to grasp in the abstract, so we figured it would be helpful to walk through an illustrative example.

A BDIT Example.

Ethan is a New York resident with assets that he expects to appreciate. For the sake of this example, let’s say Ethan works in venture capital and the assets are carried interest from a couple of venture deals he worked on. (For any readers who are not familiar, carried interest, or carry, is when you get a percentage of an investment as a reward for putting a deal together.)

Ethan is the type of person who believes in paying taxes but also hates being a sucker. He understands and believes in the benefits of government services so he wants to pay all of the taxes that he owes. But he doesn’t want to pay a penny more than some very wealthy and well-resourced person would pay if they were in the same situation. So Ethan reached out to Valur.

Valur explained to Ethan that a properly structured BDIT could protect these assets from potential creditors, minimize gift or estate taxes should he want to transfer these assets in the future, and minimize state income taxes on any appreciation of the assets, all while maintaining control of the assets. Ethan thought that sounded great, and agreed to move forward with Valur. Here is how Ethan worked with Valur to make that happen.

1. Finding a third party.

First Ethan had to find a third-party to set up the trust. Parents or grandparents typically act as the third-party with BDITs and Ethan chose his parents.

2. Appraising the asset(s).

Ethan had his carry appraised by an independent party. The fair market value was deemed to be $250,000.

3. Drafting the BDIT.

Valur set up the BDIT so that:

  1. The trust is situated in South Dakota, where there is no state income tax;
  2. Ethan’s parents are the grantors for estate tax purposes (but they retain no rights in the trust);
  3. Valur serves as an additional trustee/advisor to make sure that Ethan doesn’t take any actions that would jeopardize the trust as they move forward, but Ethan retains the power to remove and replace the trustee at any time
  4. The trust gives Ethan enough control to manages his assets; and shift the tax liability of these assets to South Dakota
4. Seeding the BDIT.

Ethan’s parents seeded the trust with $25,000, which is 10% of the value of Ethan’s carry. (Ethan’s parents did this with their own money and that is important because the BDIT would not withstand scrutiny if Ethan had given the money to his parents so that they could seed the trust.) Ethan’s parents know that they are not getting this seed money back, but they were happy to do it because they think that $25,000 is nothing compared to the amount that will potentially be saved in gift and estate taxes when Ethan starts transferring wealth to his kids.

5. Selling the asset(s) to the BDIT.

Finally, with the BDIT all set up and seeded, Ethan sold his carry to the trust for its fair market value of $250,000. Since the trust only had $25,000 the sale was actually for $25,000 plus a promissory note to pay Ethan the remaining $225,000 over time with market interest rates.

With those steps, Ethan was able to take advantage of all of the BDIT benefits described in section 1 of this article.

Learn More.

We built a platform to give everyone access to the tax and wealth building tools of the ultra-rich like Mark Zuckerberg and Phil Knight. We make it simple and seamless for our customers to take advantage of these hard to access tax advantaged structures so you can build your wealth more efficiently at less than half the cost of competitors. From picking the best strategy to taking care of all the setup and ongoing overhead, we make it easy and have helped create more than $500m in wealth for our customers. Schedule a time to chat with our team and learn more about how we can help you!