Sale to a Grantor Trust Strategy Leveraging wealth transfer using a sale to a defective grantor trust Not a bank or credit union deposit, obligation or guarantee May lose value Not FDIC or NCUA/NCUSIF insured Not insured by any federal government agency LIM-1334 5/16
Transferring assets to future generations in a tax-efficient manner Your hard work has paid off. You ve accumulated highly appreciated and incomeproducing assets such as a closely held business or real estate assets. Now you are concerned that these assets may be subject to transfer taxes, which can consume a significant portion of your wealth. You are also considering the purchase of life insurance held outside of your taxable estate in an irrevocable life insurance trust (ILIT) an estate-planning technique where the death benefit will generally be free of estate and income taxes. However, if you also want to efficiently transfer the future growth and income of your highly appreciated assets out of your estate, you could consider selling an asset to the trust using life insurance. A sale to a grantor trust is a very complex procedure and may have uncertain tax consequences. This brochure is designed to provide general information about the subject matter. It is not intended to give investment, legal, accounting, tax or estate planning advice. You should consult your own professional advisors for these services to determine whether the strategies or products discussed in this brochure would benefit your particular situation. Why use a sale to a defective grantor trust? In a typical ILIT strategy, you (or you and your spouse) establish the trust as the grantor(s) and then make gifts of cash or liquid assets to fund the purchase of an insurance policy. The trust is intentionally defective for income tax purposes, making the grantor(s) responsible for the trust s income taxes and leaving all of the trust s assets available for the beneficiaries. 1 Gifts are made in the form of annual gift tax exclusions and/or lifetime gift tax exemption(s). With the death benefit outside of your taxable estate, the proceeds are received by the trust free of federal estate and income tax. However, you may have limitations while making gifts, and you may be concerned about potential gift tax liability and losing control of the assets. As an alternative, selling the asset to the trust in return for an installment note can remove any of the asset s future growth and income from your estate by freezing the value of the asset included in your estate. To avoid adverse tax treatment of trust proceeds, the trust should be drafted by an attorney familiar with such matters and taking into account income and estate tax laws. 1 In a defective trust, the grantor(s) are treated as the owner of the trust for federal income tax purposes, but not for estate tax purposes. Refer to IRC 671-6792. 2 Sale to a Grantor Trust Strategy
The sale to a defective grantor trust solution In a sale arrangement, the grantor(s) you or you and your spouse seed the trust with an initial gift of liquid assets or cash equal to 10% or more of the value of the asset being sold to the trust. 2 The grantor(s) then sell the asset at fair market value (less a valuation discount, if applicable) to the trustee using an installment note. The promissory note is typically structured as an interest-only sale with a balloon payment of principal at the end of the note s term. The interest rate of the note should be at or above the current Applicable Federal Rate (AFR). 3 During the term of the note, the asset held in the trust generates income that is used to pay the interest due, and excess income is used to fund life insurance premiums and/or to repay the note. Upon death, the principal balance of the note may be repaid from the death benefit proceeds or earlier from trust assets. How the strategy works Grantor(s) Establishes and seeds the trust with a minimum gift of 10% of the asset s value sold. 2 The asset is then sold to the trust at fair market value for an interest-only note. Sells income-producing asset Note at applicable AFR rate Interest payments on note Note repayment Intentionally Defective Grantor Trust (IDGT) Owner and beneficiary of the policy on grantor s life. Trustee uses income from the asset and/or additional gifts to make interest and principal payments on the note, and excess income pays premiums to fund life insurance policy. Pays income tax on IDGT income 1 Pays death benefit Insurance Policy Pays premium 2 The trust should be seeded with cash or liquid assets equal to a minimum of 10% of the value of the installment note. See Letter Ruling 9535026. Any gift to an ILIT that is intended to be a present interest and completed gift must be made to an ILIT, which contains Crummey power language. The applicable federal estate tax exclusion amount (indexed for inflation) is $5.45 million per individual in 2016. The estate tax is unified with the federal gift tax and generation-skipping transfer, such that in 2016, the lifetime gift tax exclusion and generation-skipping transfer tax is $5.45 million (indexed for inflation) and the maximum tax rate for both of these taxes will be 40%. (Source: Frequently Asked Questions on Gift Taxes, IRS, accessed April 2016: www.irs.gov/ businesses/small/article/0,,id=108139,00.html). For current information and an assessment of your unique situation, please consult your tax professional. 3 The AFR is published monthly by the IRS. If the specified note interest rate is less than the AFR, then the difference is imputed for income or gift tax purposes. Sale to a Grantor Trust Strategy 3
Promissory note structure The promissory note is often structured as an interest-only sale with a balloon payment of principal at the end of the note s term. Interest should be charged on the note at or above the appropriate Applicable Federal Rate (AFR) to avoid any federal income or gift taxes. 4 The length of the note term determines the appropriate AFR and falls into three categories: Short-term Mid-term Long-term a note term not > 3 years a note term > 3 years and < 9 years a note term > 9 years Note repayment / exit strategies A termination or repayment plan is a key element to help reduce the overall risk of the promissory note arrangement. Several strategies are available: Death Benefit Upon death, the proceeds can be used to repay the outstanding note balance, plus any interest due. Other IDGT Resources The IDGT may repay the outstanding note from other trust assets. Policy Cash Values If the policy has sufficient value that exceeds the outstanding loan balance, the IDGT trustee can withdraw and/or borrow policy cash values to repay the outstanding note. The removal of policy cash values will reduce the death benefit and may cause the policy to lapse. 5 Additional Gifts Over time, it may make sense to forgive all or part of the IDGT s repayment obligation. This is a taxable gift and may reduce the grantor s lifetime gift tax exemption, if available. 6 4 The AFR is published monthly by the IRS. 5 Loans and withdrawals are only available prior to the death of the grantor(s) and will reduce the policy death benefit and cash surrender value. This may cause the policy to lapse and may be taxable. Withdrawals or loans on modified endowment contracts (MECs) may be subject to federal income tax and a 10% IRS penalty on amounts taken prior to age 59½. 6 Refer to footnote 2 on page 3 for source information. 4 Sale to a Grantor Trust Strategy
The benefits of a sale to a grantor trust strategy Using a sale to a defective grantor trust using life insurance has several advantages: Frozen asset value In many cases, the value of the asset or property sold to the trust is frozen at the fair market value. Any future appreciation is passed on to trust beneficiaries without gift, estate or generation-skipping transfer taxes. Discounted sale The asset may be sold to the trust at a discount due to the lack of marketability and control. 7 Low interest rates In the current low interest rate environment, the Applicable Federal Rates (AFRs) may be attractive enough to lock in a rate by taking a note from the trust. The trustee can then use excess income after interest and repayment of the note to fund life insurance premiums. Minimized capital gains tax Highly appreciated assets sold to the trust by the grantor(s) may be transferred without incurring capital gains to the grantor(s). 8 No income tax Interest payments on the note are not subject to income tax if your trust is a grantor trust for income tax purposes. 9 Reduced taxable estate Tax-free gifts to the trust can help reduce the size of your taxable estate. Currently, individuals may gift up to $14,000 annually (per beneficiary), and married couples may double the annual gift to $28,000 (per beneficiary). Plus, as long as you remain under the $14,000 limit, these annual gifts do not count against your $5.45 million lifetime cumulative gift-tax exemption or your $5.45 million estate-tax exemption. 10 7 The value of a closely held corporation, a partnership, or other asset may qualify for a valuation discount due to a lack of marketability and/or a minority interest as owner may not have power to manage or control the asset. Valuation discounts should be documented by an independent professional appraiser. 8 No gain or loss is recognized on the sale to the trust as the grantor(s) are considered the same person(s) for income tax purposes. Refer to Revenue Ruling 85-13. 9 Note that interest income paid to you from the IDGT will not be treated as taxable income if the IDGT is established as a grantor trust for income tax purposes. Refer to Revenue Ruling 85-13. 10 Refer to footnote 2 on page 3 for source information. Sale to a Grantor Trust Strategy 5
Key considerations of a sale to a grantor trust strategy Note interest The note interest paid by the trust is not deductible. Asset control The grantor(s) should retain no control over the asset sold to the trust in order to prevent inclusion in the estate. Refer to IRC 2036. Asset valuation Hard-to-value assets or appropriate valuation discounts should be documented by an independent professional appraiser. Liquidity The grantor(s) must have sufficient cash flow available to pay the ongoing income taxes of the trust. Estate tax The note repayment and outstanding interest will be included in the grantor(s) estate for estate-tax purposes. Is the sale of an asset to a defective grantor trust right for you? You may benefit if: You wish to minimize or eliminate gift taxes. You own one or more income-producing assets that have the potential to highly appreciate. You want to efficiently transfer assets to future generations. You have used up or don t want to use either your lifetime gift tax exemption(s) and/or gift tax annual exclusions. You d like to leave a larger legacy to your beneficiaries. If any of these apply to you, contact your insurance professional for more information. 6 Sale to a Grantor Trust Strategy
Sale to a Grantor Trust Strategy 7
Symetra Life Insurance Company 777 108th Avenue NE, Suite 1200 Bellevue, WA 98004-5135 www.symetra.com Symetra is a registered service mark of Symetra Life Insurance Company. Life insurance is issued by Symetra Life Insurance Company, 777 108th Avenue NE, Suite 1200, Bellevue, WA 98004-5135. Products are not available in all U.S. states or any U.S. territory. Guarantees and benefits are subject to the claims-paying ability of Symetra Life Insurance Company. Neither Symetra Life Insurance Company, any of its affiliates, insurance producers or advisors give tax or legal advice. Consult your attorney or tax advisor for more information.