106-9 Intrafamily and Other Property Transfers: Gifts & Trusts Flashcards
Estate Freezes
aka Chapter 14 Valuation Rules
- Corporate recapitalizations
- Partnership capital freezes
- Grantor retained trusts (such as the grantor retained income trust, or GRIT)
- Buy-sell agreements
These estate freeze transactions typically involve the transfer of a property or business interest in which the transferor retains some sort of interest, such as an income stream, for a specified term
At the end of the term, the transferee owns the property outright
Often used by owners of closely-held businesses
The value of the gift for gift tax purposes is the total value of the property transferred minus the value of the interest retained by the transferor
Zero Valuation Rules
Provide that if such a transaction is not structured in a way that complies w/ the rules, the transferor’s retained interest will be valued at zero for gift tax purposes
This means that the entire value of the transferred property is considered to be a gift
The Chapter 14 valuation rules generally apply only to business or property estate freeze transactions between family members
However, in the case of buy-sell agreements, the rules also apply to nonfamily members
Gift-Leaseback
Uses the same concept of transferring property to a junior family member and then leasing it back as does the sale-leaseback technique, except that now a gift of the property is made instead of a sale
The senior family member creates a deductible lease payment for the business and income to the junior family member
Family Limited Partnership (FLP)
A partnership that is created to transfer assets to junior family members at a reduced gift tax valuation and cost
Typically, a senior family member (usually a parent) transfers assets such as securities or a closely held business interest to the partnership in exchange for a 1% general partnership interest and a 99% limited partnership interest
To avoid an argument w/ the IRS:
- The FLP must be established for reasons other than the avoidance of transfer taxes
- The FLP’s income must be distributed to all partners in accordance w/ their % ownership in the partnership
- The FLP’s capital must be a material income-producing factor for the partnership
Corporate Recapitalization
Used by a senior family member who owns a controlling interest in a family-owned C corporation and wishes to transfer future ownership rights to 1 or more junior family members
Voting preferred stock and nonvoting common stock is issued
The senior family member retains operating control of the family corporation through the voting preferred stock
The senior family member also retains the right to income from the corporation via dividend rights associated w/ the preferred stock
The nonvoting common stock interests are then gifted by the senior family member to junior family members, taking advantage of the valuation discounts
Because the future appreciation in the value of the business is attributed to the common stock, the value of the preferred stock retained by the senior family member is “frozen,” and the preferred stock will be valued in the senior family member’s gross estate at its liquidation value
Because partnerships don’t issue stock, they must use partnership capital freezes instead of corporate recapitalizations
Grantor Retained Income Trust (GRIT)
A grantor transfers property into a trust for some period for the eventual benefit of someone else (the remainderman) while simultaneously retaining the right to income from the trust during this period
If the grantor survives the income period, the trust property passes to the remainderman and the FMV of the asset is removed from the grantor’s gross estate
The grantor reports all trust income items for the year on an income tax return
To avoid the zero valuation rules, the grantor’s retained income interest in the GRIT must be in the form of a qualifying annuity or unitrust payment
Grantor Retained Annuity Trust (GRAT)
The grantor transfers an asset to the trust and retains the right to be paid a fixed annuity each year for the term of the trust
This annuity is calculated using the value of the assets initially transferred to the GRAT and reflects a growth rate of the assets assumed by the IRS
The GRAT is most effective where a single, appreciating asset is transferred to the trust, and the term of the trust is relatively short (e.g., no longer than 10 years)
A GRAT is usually used to transfer property to a family member when the property is likely to appreciate and the grantor has a better-than-average probability of outliving the term of the trust
Grantor Retained Unitrust (GRUT)
Uses the same operational structure to transfer appreciated property to a family member-remainder beneficiary except that the income interest payable to the grantor is in the form of a fixed % of the net FMV of the trust assets as determined annually (a unitrust payment)
Qualified personal residence trust (QPRT)
A type of GRIT that includes a personal residence as the corpus of the trust
Because most of the property consists of a residence and no substantial income is generated, a QPRT is specifically exempted from Section 2702 and the zero valuation rules do not apply
Personal Residence Trust (PRT)
Similar to a QPRT in most respects and shares the same tax advantages
2 differences are that, unliked a QPRT, a PRT is generally prohibited from holding any cash, and unlike a QPRT, the trustee of a PRT is not allowed to sell the residence and reinvest the proceeds in another residence
Intentionally Defective Grantor Trust (IDGT)
An irrevocable trust in which the grantor-family member is treated as the owner of the trust for income tax purposes but not for transfer tax purposes
This means the grantor is taxed on the income from the trust and receives all the deductions and credits attributable to the trust
Also means that when the grantor pays the income tax attributable to the trust income, she, in effect, makes a tax-free gift to the trust because the grantor is paying income tax that would otherwise have to be paid by the trust
