585 ALI-ABA Course of Study Estate Planning for the Family Business Owner Cosponsored by the ABA Section of Real Property, Trust and Estate Law - ABA Section of Taxation July 9-11, 2008 Boston, Massachusetts Advanced Transfer Techniques By Marjorie J. Stephens Law Office of Marjorie J. Stephens Dallas, Texas
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587 Table of Contents I. INTRODUCTION....1 II. KEEPING IT SIMPLE - DIRECT GIFTS....1 A. Maximum Use of Tax Free Gifts...1 1. Maximum Use of the Annual Exclusion...1 a. Cumulative Effect and Compounding....2 b. Encouraging Client Use...2 c Generation Skipping Considerations....3 2. Judicious Use of Exemption...3 a. For Children or Grandchildren....3 b. For Spouse...3 c. Other Considerations in Judicious Use of the Exemption....4 3. Medical and Tuition Payments...4 4. Payment of Tax on Income Received by Defective Grantor Trust....4 B. Split Gifts....5 C. Net Gifts....5 1. Benefit to Donee....5 2. Benefit to Donor...5 3. Donee s Basis...5 III. FORM OF GIFT: OUTRIGHT, TRUSTS, CUSTODIANS, 529 PLANS, IRAS AND DIRECT PAYMENTS....6 A. Outright....6 B. Uniform Transfer to Minors Act....6 C. Direct Payments....6 D. 529 Plans....6 1. Benefits....7 2. Limitations....7 3. Specific Rules...8 E. IRAs...8 1. Funding IRA for Child...8 2. Stretch IRAs... 8 F. Trusts - the Premier Donee - Protection from Claims of Creditors....9 1. General Rule...9 2. Self-settled Trusts...9 3. Impact of Crummey Withdrawal Power....9 G. Trusts - the Premier Donee - Protection from Claims of Estranged Spouses...10 H. Trusts - the Premier Donee - the Defective Grantor Trust as the Most Powerful Wealth Transfer Tool....10 IV. MAXIMIZING THE WEALTH TRANSFER POTENTIAL FOR GIFTS...10 A. Making Gifts Soon, Often and Paying the Tax...10 B. Transfer Property Reduced in Value....10 1. Minority Interests in Closely Held Businesses...10 2. Undivided Interests in Real Estate....11 3. Real Estate Subject to an Option to Lease....11 4. Limited Partnership Interests....11 a. Consider 2036 in all Transactions....11 b. Avoid Step Transaction Situation...11 c. Obtain an Appraisal....12
588 5. Conservation Easements....12 C. Leveraged Transfers...12 1. Intervening Interest....12 2. Transfer Appreciation....12 3. Use Cash Flow from Asset for Transfer...12 V. DEFECTIVE GRANTOR TRUSTS...12 A. Defective Grantor Trusts - Trust Structured for Income to be Taxed to the Grantor...12 1. Grantor is Taxed on the Income...13 a. Nonadverse Trustee's Sprinkling Power...13 (1) Independent Trustee...13 (2) Grantor's Power...13 b. Nonadverse Trustee's Power to Add Beneficiaries...13 c. Premium Payment Power....13 d. Payment of Income to the Grantor's Spouse...14 e. Discretionary Payment of Income to Grantor...14 f. Administrative Powers...14 (1) Power to Borrow without Adequate Interest or Security....15 (2) Borrowing of Trust Funds...15 (3) Power to Reacquire the Trust Corpus by Substituting Property of an Equivalent Value...15 2. Trust is Structured as a Completed Gift...18 3. Trust is Structured so that the Property is Not Included in the Grantor's Estate...18 a. Grantor Does Not Retain any Interest in the Trust....18 b. Grantor Cannot Retain any Reversionary Interest in the Trust...18 c. Grantor Does Not Retain or Possess any Prohibitive Powers in the Trust....18 3. Broad Flexibility in Other Terms...18 4. Psychological Hurdle- Voluntarily Being Taxed on Income not Received.....19 B. Inheritor s Trust - Trust Structured to be Taxed to the Beneficiary...19 1. Use of Inheritor s Trust...19 2. Requirements for Income to be Taxed to Beneficiary...19 3. Drafting Considerations...20 C. Crummey Power - Effect on Defective Grantor Trust...20 1. Issue to be Addressed...20 2. Avoiding Issue...21 a. Eliminate the Withdrawal Rights...21 b. Use of "Wrapper Trust".... 21 3. Springing Beneficiary Defective Grantor Trust?...21 a. PLRs 9026036 and 9321050...21 b. PLRs9352017, 9449012, and 9449013...22 c. S Corporation Regulation Example...22 VI. WEALTH TRANSFER USING DEFECTIVE GRANTOR TRUSTS...22 A. Grantor Retained Annuity Trust...22 1. Overview of Technique...23 2. Situations Favoring Use of GRAT...23 a. Grantor Is in Good Health with Life Expectancy in Excess of GRAT Terms...23 b. Assets to be Transferred Have a Return in Excess of Current I.R.C. 7520 Rate...23 c. Appreciation on Assets to be Transferred is Uncertain or Volatile...23 3. Requirements...23 a. Payment of Annuity.... 23 (1) Right to Withdraw...23
589 (2) Time for Payment of Annuity....23 (3) Fiscal v Calendar year GRAT...24 (4) Payment of Annuity with Cash or Other Assets....24 (5) No Payment of Annuity With a Note...24 (6) Annuity Must be Paid...25 b. Annuity Amount....25 (1) Fixed Dollar Amount....25 (2) Fixed Fraction or Percentage....25 (3) Incorrect Valuation...25 (4) Short Taxable Years...25 c. Income in Excess of the Annuity Amount...25 d. Additional Contributions....25 e. Payments to Other Persons....25 f. Term...26 g. Commutation....26 h. Trust Must Prohibit Use of Notes to Pay Annuity...26 i. Permissible and Impermissible Contingencies....26 4. Tax Consequences...26 a. Gift tax Consequences....26 (1) Gift of the Value of the Remainder...26 (2) Computation of Amount of Gift...26 b. Generation Skipping Transfer Tax....27 c. Estate Tax....27 (1) Grantor Survives the Term...27 (2) Grantor s Death During the Term of the GRAT...27 d. Income Taxation of GRAT...28 (1) Grantor Trust Treatment is Desirable....28 (2) Section 677...29 (3) Section 673...29 (4) Intentional Grantor Trust Status...29 (5) S Corporation Stock Owned by GRAT...29 5. Community Property Considerations...30 6. Planning Considerations...30 a. Use Percentage or Fraction as Payout...30 b. Comparison of Using GRAT to Outright Gift...30 c. Funding the Trust with Closely Held Business Stock....30 d. Grantor as Trustee...30 e. Insufficient Income to Pay the Annuity Amount...30 f. Use of Multiple GRATs...31 g. Use of Rolling GRATs....31 h. Use Term GRAT rather than a Shorter of Term or Life GRAT....31 i. Increasing Annuity Payments Maximize Amount Passing to Remaindermen....31 j. Reciprocal GRATs...32 k. Beneficial Situations in which to Use a GRAT....32 (1) Grantor Has No Funds/Desire to Make Gift but Has Asset with High Future Appreciation...32 (2) Asset With Dramatic Appreciation Potential but Uncertain Future...32 (3) High Return - High Risk Investment....33 (4) Best Structure for the Risk and Tax Payment Adverse Client...33 B. Installment Sale to a Defective Grantor Trust...33 1. Overview...33