ALI-ABA Course of Study Estate Planning in Depth

Transcription

1 1455 ALI-ABA Course of Study Estate Planning in Depth Cosponsored by Continuing Legal Education for Wisconsin (CLEW) of the University of Wisconsin Law School June 13-18, 2010 Madison, Wisconsin Sales to Intentionally Defective Grantor Trusts By Mark S. Poker Michael, Best & Friedrich, LLP Waukesha, Wisconsin

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3 1457 Mark S. Poker, Eq. Michael Best &Friedrich LLP Two Riverwood Place, Suite 200 N19 W24133 Riverwood Drive Waukesha, Wisconsin (262) Mark S. Poker is a partner and Chair of the Wealth Planning Services Practice Group. His areas of emphasis include estate and trust litigation, advising individuals and businesses on family wealth transfers, wealth preservation, asset protection planning and succession planning. Mr. Poker is a Fellow of the American College Trust and Estate Counsel and is named in The Best Lawyers in America. He currently serves on the Board of the Real Property, Probate and Trust Law section of the State Bar of Wisconsin. Mr. Poker has served as an adjunct professor for the University of Wisconsin-Milwaukee Business School and is the former Chairperson of the Milwaukee Bar Association Tax Section and former President of the Waukesha Estate Planning Council. Mr. Poker has taught numerous estate and tax planning courses for Notre Dame Estate Planning Institute, ALI-ABA, AICPA, WICPA, National Law Institute, the Wisconsin and North Carolina State Bars and other professional and community organizations. Mr. Poker serves on the Board of Directors for several closely-held businesses, family foundations and public charities. He has published numerous articles in various professional and business journals. Mr. Poker received a B.S. in 1985 from Marquette University and a J.D. in 1988 from Marquette Law School, where he was Managing Editor of the Marquette Law Review. He also earned an L.L.M. with honors, in taxation, from Georgetown University in 1990.

4 1458 TABLE OF CONTENTS -i- Page I. INTRODUCTION... 1 A. Scope... 1 B. Defining an IDGT... 1 II. BASICS OF INSTALLMENT SALES TO IDGTS... 1 A. Establishing an IDGT... 1 III. IDGT TAX SUMMARY... 6 A. Gift Tax... 6 B. Estate Tax C. Income Tax IV. GRANTOR RETAINED ANNUITY TRUSTS A. Defining a GRAT B. GRAT Requirements C. Gift Tax Considerations D. Estate Tax Considerations E. Income Tax Considerations F. GRAT Benefits V. IDGT BENEFITS A. No Gain on Sale B. Survival Not Required C. Favorable Rates D. Payment of Taxes E. Backend Loading F. GST Leveraging G. Increasing or Preserving the Discount H. More Effective For Illiquid Assets VI. CORPORATE ISSUES A. Ownership Agreement B. Underwriters Lockup VII. IDGT ADMINISTRATION A. Terms of Sales Agreement B. Transaction Reporting C. Refinancing the Note D. Decreasing Value of IDGT Assets... 27

5 1459 I. INTRODUCTION A. Scope. This outline provides an overview of the tax treatment, structure and use of intentionally defective grantor trusts ( IDGT ). Particular focus is given to the benefits and risks associated with implementing IDGTs. A comparison of IDGTs to grantor retained annuity trusts ( GRATs ) is also undertaken. The economic impact of various IDGT designs is also addressed. B. Defining an IDGT. An IDGT seeks to take advantage of the differences between the estate tax inclusion rules of IRC and the grantor trust income tax rules of IRC An IDGT is an irrevocable trust that effectively removes assets from the grantor s gross estate. As a result, a sale of assets to an IDGT can freeze an individual s estate by converting appreciating assets into a non-appreciating asset with a fixed yield. For income tax purposes, however, the trust is defective and the grantor is taxed on the trust s income. Accordingly, sales of assets between the IDGT and the grantor are not taxable. The grantor is treated for income tax purposes to have made a sale to himself or herself. Therefore, the traditional disadvantage of recognizing substantial income tax gain on a sale is eliminated. II. BASICS OF INSTALLMENT SALES TO IDGTS A. Establishing an IDGT. 1. Grantor Trust. The first step in implementing a sale to IDGT is to create the buyer (i.e., the IDGT). The IDGT is structured as grantor trust for income tax purposes. A grantor trust can be created a number of ways, as discussed below. IRC Because the IDGT is defective for income tax purposes, all of the trust s income is taxed to the grantor, which produces an additional tax-free gift to the IDGT. In Rev. Rul the IRS reaffirmed that the payment by a grantor of tax on the trust income does not constitute a gift to the trust. However, an issue may exist as to whether a reimbursement power gives creditors access to the IDGT. Moreover, if the trust does not require the trustee to reimburse the grantor for the payment of income tax, then the discretionary reimbursement of tax payment will not cause estate inclusion. As a grantor trust the IDGT can hold S corporation stock. In addition, the IDGT could purchase an existing life insurance policy on the life of the grantor without subjecting the policy to taxation under the transfer for value rule. For income tax purposes the sale of the policy should be treated as a sale to the grantor-insured and the transfer for value exception under - 1 -