A Restricted Property Trust is an employee benefit plan for high-income earning business owners and key employees.

The first Restricted Property Trust plan was implemented in 2001. Since then, the strategy has a 100-percent successful track record with the Internal Revenue Service, including audits that have occurred at the highest level agreeing (or conceding) with the RPT’s deductibility.

The reason for this successful track record is the plan was built to defend.

A Restricted Property Trust (RPT) allows a qualifying business entity (S-Corp, C-Corp, LLC (not taxed as a sole proprietor), and most Partnerships) to make a 100-percent, fully-deductible contribution to an RPT.

When a business owner establishes a Restricted Property Trust, the RPT purchases a whole life insurance policy on the participant. The premium is deducted under Internal Revenue Code Section 162 and must be equal to the amount of premium necessary to fund the current death benefit.

The participant will recognize anywhere from 30 – 40% of the total contribution on their individual return under an Internal Revenue Code Section 83(b) election covering restricted property. Because of this, it is exempt from Internal Revenue Code Section 409A, which means restricted property is never considered a plan of nonqualified deferred compensation.

What Is Restricted Property?

It’s fair to say most people have never heard of restricted property. The most common form of restricted property from a tax perspective is stock. But, for purposes of this example, we’ll use a different analogy.

Imagine you decide to hire me as one of your employees. Behind your office building, you own a garage worth $30,000. You say to me, “You seem like a nice guy. If you come work for me for 5-years I will give you the garage.”

Unbeknownst to many, we just created a plan of restricted property. With the creation of restricted property, I as the employee, have a few tax choices. One of which is to pay tax on the fair market value of the garage today even though I’m not guaranteed to be an employee in 5-years.

If I get fired in 2-years I don’t get to keep the garage, and I wouldn’t be able to recoup the taxes I paid up front.

Most people would think why would anybody ever do that?

Well, if I work for you for 5-years, and you hand me title to the garage and a shopping mall goes up across the street increasing the value to $100,000, I wouldn’t have to pay taxes on it because I already did. When I decide to sell the garage, I would owe taxes at long-term capital gains and not ordinary income.

From a tax perspective, that’s how restricted property works, and that seems to make sense to most people.

With that said, when the Restricted Property Trust was designed it was known that if the IRS came knocking on the door we could not use the garage example and say our very wealthy client who is a 100-percent shareholder might fire himself.

That’s not a good defense.

However, the tax law states another condition may apply. If the property is subject to a substantial risk of forfeiture (stated differently – the individual could lose the property) – then the 83(b) election would be upheld.

A Restricted Property Trust requires a minimum 5-year funding commitment of $50,000 or more, resulting in a substantial risk of forfeiture.

Failure to make a contribution results in the liquidation of the trust assets (e.g. cash value). The assets are then distributed to a public charity designated by the participant when the trust is established.

The word substantial in the tax code means 33 to 50-percent. However, it would be very difficult to explain 33 to 50-percent to an IRS field agent.

The Restricted Property Trust defines substantial as an absolute 100-percent to remove any questions of how “substantial” may be defined or interpreted.

Once the plan is established the cash value cannot be accessed during the funding period. There are no loans from the trust or the policy. And, you can’t use the policy as collateral. If you could it would be taxable.

If the participant passes away while funding the Restricted Property Trust, the death benefit is paid to the trust. The proceeds are then distributed to the trust beneficiaries designated when the trust was established.

In most cases, all clients really care about is a deduction. They are not necessarily death benefit motivated. The tax deduction is what motivates them to do it. Once they own the life insurance many become emotionally attached to the death benefit and are usually really glad they did it.

Once the plan is established the cash value cannot be accessed during the funding period. There are no loans from the trust or the policy. And, you can’t use the policy as collateral. If you could it would be taxable.

If the participant passes away while funding the Restricted Property Trust, the death benefit is paid to the trust. The proceeds are then distributed to the trust beneficiaries designated when the trust was established.

In most cases, all clients really care about is a deduction. They are not necessarily death benefit motivated. The tax deduction is what motivates them to do it. Once they own the life insurance many become emotionally attached to the death benefit and are usually really glad they did it.

Once the participant completes funding of the Restricted Property Trust the policy is distributed from the trust to the participant. A tax is then owed on a portion of the cash value. Payment for the tax is typically done by taking a withdrawal from the policy. This allows the participant to avoid paying tax using other personal assets.

The impact of the withdrawal from the life insurance policy is negligible. In most cases, the participant will continue to allow the cash value of the policy to grow for a period of five years or more to take advantage of the favorable tax environment life insurance provides.

When the participant decides to take distributions from the policy they are TAX-FREE.

In many cases, an individual who utilizes a Restricted Property Trust would have to earn at least 8-percent in an after-tax investment to obtain equivalent results to the RPT. Since we are using a very conservative (and boring) whole life insurance policy, you would technically have to be able to earn 8-percent in a similar asset class like a bond or CD.

A Restricted Property Trust is one piece of the puzzle. It is never going to be the overall puzzle. While the plan itself offers a number of tax benefits, the strategy itself is more a mechanism of deferral than deduction.

Simply stated the Restricted Property Trust provides a tax deduction, tax-deferral, and tax-free withdrawals using a very conservative asset with very little volatility.

DISCLOSURE: Any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party and transaction or matter addressed herein.