Intra-Family and Other Business Transfer Techniques

Question 1

Grantor Trusts

Answer 1

• with a retained interest trust, a grantor places assets in an irrevocable trust and retains an interest for a period of time
• examples are GRAT, GRUT, and QPRT

Question 2

Grantor Retained Income Trust (GRIT)

Answer 2

• generally does not qualify for special benefits under the chapter 14 rules
• the valuation rules have greatly reduced their popularity because the value of the gift is the entire value of the assets placed in the trust (there is no reduction in the value of the gift)
• the gift is a future interest, so the annual exclusion is not available.

Question 3

Nonfamily GRITs

Answer 3

-if a GRIT is created in which the trust corpus will pass to a non-family member, the chapter 14 valuation rules do not apply

Question 4

Qualified Personal Residence Trust (QPRT)

Answer 4

• a grantor transfers a personal residence to an irrevocable trust and retains the right to live in the property for a term of years.
• at the end of the term the trust beneficiary receives full title to the residence
• in valuing the transfer to the trust, the gift will be the remainder interest, and the remainder is valued by subtracting the term interest retained by the grantor.
• If the grantor survives the term of the trust, the residence will be entirely removed from the grantor’s gross estate
• if the grantor does not survive the term, the FMV of the residence will be included in the grantors estate, but the adjusted taxable gift is then reduced to zero.
• generally recommended for wealthy individuals who have homes that are over $500,000 in FMV
• can only hold one residence
• cash sufficient to pay 6 months of mortgage payments can be transferred to the trust
• this is an exception to the chapter 14 valuation rules

Question 5

Tangible Personal Property Trusts

Answer 5

• another exception to chapter 14 valuation rules
• property that is non-wasting for which no depreciation is allowed can be transferred
• the retained interest must be valued according to the amount for which the term interest could be sold to an unrelated third party

Question 6

GRAT

Answer 6

• the grantor transfers property to an irrevocable trust and retains the right to an annuity for a stated number of years
• IRS section 7520 tables are used to calculate the present value of an annuity, and this amount is subtracted from the total value of the assets transferred to the trust to calculate the value of the remainder interest.
• thus the value of the gift, which is the remainder interest, can be relatively low for gift tax purposes

Question 7

GRUT

Answer 7

-another qualified interest is a right to receive annual payments of a fixed percentage of the trust assets, determined annually

Question 8

GRATs and GRUTs - Surviving the term

Answer 8

• the assets placed in the trust will pass to the remainderperson at the expiration of the term of the grantor’s retained annuity or unitrust interest.
• if the grantor survives the term the entire value of the assets will pass free of federal estate tax to the remainder person and the grantor has reported only a small taxable gift. The assets to not receive a step up in basis at the death of the grantor though
• if the grantor does not survive the term, the value of the trust assets will be included in the estate

Question 9

GRATs vs GRUTs

Answer 9

• A GRAT will accomplish more wealth transfer than a GRUT is the assets are expected to appreciate because the appreciating asset will lead to larger payments under the GRUT and thus more will be included in the estate
• property that is expensive to value should be placed in a GRAT since it need only be valued once.
• A GRUT accomplishes more wealth transfer when the assets are not expected to perform well because payments vary and do not exhaust as much of the trust corpus
• A GRUT is required if the grantor wishes to add additional assets at a later time.

Question 10

Intentionally Defective Grantor Trusts

Answer 10

• the grantor contributes assets sufficient to make a down payment on the purchase of a business interest
• the grantor can then sell a business interest to the trust in return for a down payment on an installment note
• the transfer is not a gift, so no gift tax is owed
• the grantor pays tax on the income received from the trust and the beneficiaries receive the income free of tax
• the trust is irrevocable so the assets are not included in the grantor’s gross estate

Question 11

Installment Sales

Answer 11

• appropriate vehicles when the property owner is seeking income, security, and income tax deferral
• capital gain on the sale is spread out over several years, deferring tax liability over that period
• the present value of remaining payments is included in the deceased seller’s estate
• the payments to the seller are secured by the property sold
• if an installment sale triggers recapture of depreciation, this recapture must be recognized in the year of the sale

Question 12

Income Tax Consequences of Forgiveness of Note

Answer 12

• if the holder of an installment forgives a payment of cancels the note, the holder is deemed to have been paid in full for income tax purposes
• the maturity date for future payments is accelerated, and the seller is in receipt of taxable income, measured by the difference between his or her cost basis and the fair market value of the installment note forgiven
• the holder has made a taxable gift equal to the FMV of the remaining payments due and any forgiving accrued interest
• gift taxes may be minimized by forgiving, canceling, or making gifts of installments in the amount of the annual exclusion.

Question 13

Unpaid Installments at the Owners Death

Answer 13

• the holder’s estate will include the present value of the unpaid note
• if the installment note is forgiven in the holders will, the debt is considered to be paid to the estate, and the estate must report any gain and accrued interest on the note as taxable income.

Question 14

Resale Rules

Answer 14

• the original sellers gain will be accelerated if a related party resells within 2 years of the installment sale.
• a seller could be forced to pay tax on all the gain from the installment sale before the installment payments are made

Question 15

Self -Cancelling Installment Note (SCIN)

Answer 15

• the obligation is cancelled upon the happening of an event, usually the death of the person holding the note
• since the debt under a SCIN may be cancelled before all installments are paid, the note is not worth as much as other installment notes of the same face value
• the buyer must pay an additional principal amount or pay a higher rate of interest to avoid the IRS treating it as a gift.
• usually used in a family sale of assets such as real estate, and the seller becomes the holder of the SCIN

Question 16

Sale-Leaseback

Answer 16

• a transaction in which one party sells property to another and then leases it back from the purchaser
• the selling party obtains cash that is needs without losing the property and at the same time is able to deduct the monthly lease payments in computing income taxes

Question 17

Gift-Leaseback

Answer 17

• intra family business transfer device that involves a gift of property used in the donor’s business to another family member
• the donor frequently gives the property to a trust, and the donor leases the property back from the trust, thereby acquiring an income tax decuction for the cost of leasing the property from the trust
• provides a stream of income that can be distributed by the trust to a family member in a lower marginal tax bracket, as well as providing valuable income tax deductions to the donor
• the gift is made with fully depreciated assets
• it is not advisable to employ this technique for gifts to children under the age of 18 due to the kiddie tax

Question 18

Family Limited Partnership (FLP)

Answer 18

• parents may transfer limited partnership interests to their children and retain general partnership interests.
• therefore the parents retain control of the family limited partnership by retaining the general partnership interests.
• discounts for lack of marketability and minority interests are available to reduce the gift tax value of the limited partnership interests
• lifetime gifts of limited partnership units over a period of years may transfer substantial values
• enables income shifting to those in lower marginal tax brackets
• the gift will be effective only when capital invested in the business is a material income-producing factor
• are usually not recommended unless the owners have a net worth of $3 MM or higher
• future appreciation of the property or business is transferred out of the owner’s estate

Question 19

Private Annuity

Answer 19

• are appropriate vehicles for a sale when the property owner is seeking an income stream, income tax deferral, and estate tax reduction
• the property is transferred to the recipient for a promise (payments are not secured)
• no value of the private annuity is included in the owners estate
• there is no depreciation recapture
• annuity interest paid is not deductible

Question 20

Main Advantages of a Private Annuity

Answer 20

• the smaller payments that will be required if the seller has a shorter than average life expectancy
• the exclusion from the gross estate of any value attributable to the annuity

Question 21

Disadvantages of a Private Annuity

Answer 21

• the buyer cannot take a deduction for interest expense
• the sellers payments are not secured
• the buyer may pay more for the business interest if the seller lives a long time