Intra-family and other business transfer techniques / Qualified interest trusts (Lesson 8)

Question 1

Installment Sale

1) What is it and what’s the tax benefit?
2) ESTATE tax advantages & disadvantages

Answer 1

1) -A note from a buyer to a seller generally including a down payment that evidences a commitment to a series of payments. This is a SALE.
- Strangers will usually have an interest rate; loved ones will have an imputed interest rate.
- It spreads out and defers the taxable gain.
2) ADVANTAGE: seller can remove an appreciating asset from his/her estate and substitute installment payments. DISADVANTAGE: if THE seller dies during the installment sale period, the remaining payments (Present Value) are included in his/her estate. ALSO, if the Seller’s Will forgives the debt, it’s considered paid to the Estate and must report all of the remaining gain. AND if the installment sale triggers recapture of depreciation, all recapture must be recognized IN THE YEAR OF THE SALE!

Question 2

Self-Cancelling Installment Note (SCIN)

1) What is it?
2) Rooting to outlive, die during, or neither?

Answer 2

1) A SCIN is a VARIATION of the Installment Sale. This is a SALE. The note provides that the balance of any payments due at the date of death is AUTOMATICALLY CANCELLED. The SCIN balance is then REMOVED from the Estate!
- Buyer must pay a premium and the Seller pays more income tax while living (increases the installment payment).
2) Actually rooting for the Seller to die before the Note ends! No ESTATE tax if die before the end of the Note’s time period! However, the cancellation will trigger recognition of the entire remaining CAPITAL gain on the decedent’s ESTATE tax return.

Question 3

What is a Private Annuity?

1) What is it?
2) Rooting to outlive, die during, or neither?

Answer 3

• A Private Annuity involves the sale of an asset by the Client in exchange for the UNSECURED promise of a LIFE ANNUITY generally by ANOTHER FAMILY MEMBER. It is NOT a commercial annuity from an insurance company.
• It can generate periodic income for the client and will completely exclude the transferred property from the Seller’s Gross Estate!
• If designed properly, there will be NO taxable gift AS LONG AS the value of the property transferred equals the discounted value of the promised annuity.
• Rooting for the Seller to die!

Question 4

GRAT and GRUTs

1) What are they?
2) Rooting to outlive, die during, or neither?

Answer 4

1) A GRAT, Grantor Retained Annuity Trust, is an irrevocable trust into which the Grantor transfers appreciating or income-producing property in exchange for the right to receive a fixed annuity for a number of years. When the term of the trust ends, any remaining balance in the GRAT is transferred TAX-FREE to named beneficiaries.
- The Gift is a gift of FUTURE INTEREST, so doesn’t get the $15,000 Annual Exclusion.
2) If the Grantor DOES NOT live the term out, ALL the property is brought back into the Grantor’s Estate!
- GRUT = just a unitrust, but works the same way.

Question 5

Gifting S Corporation Shares

1) How does it work
2) When does it make sense
3) Any Requirements of the S Corporation?

Answer 5

• Gifts of shares can be made to younger family members over the years to take advantage of the annual gift tax exclusion. This would result in shifting income to family members. If the gift is to a child under 24, kiddie tax rules apply.
• Can be attractive for a closely-held family business because income can pass through to its shareholders.
• The S corporation must be capital sensitive. E.g.: manufacturing plant, a warehouse, X-ray equipment, etc. Under assignment of income prohibitions, a service-related business cannot shift income. E.g.: financial planners, CPAs, attorneys, consultants, etc.

Question 6

Family Limited Partnership (FLP)

1) Who is involved in an FLP?
2) What’s the financial benefit of making one?
3) How taxed?
4) What does it accomplish?
5) When appropriate to use?

Answer 6

1) Operates among members of a family (spouses, lineal descendants, and trusts established FOR those persons).
2) Gifts can qualify for various valuation discounts (marketability, control, etc.). A gift could be discounted by 50%, allowing a $30k tax-free gift to only be recognized as $15k and the Annual Exclusion covers it all!
3) IF a family owned partnership is a genuine partnership, it will be treated tax-wise the same as any other partnership.
4) The family partnership is used as a means to shift income from parents to children or other family members.
5) When an owner wants to maintain control but gift.

Question 7

Gift Leaseback

1) How does it work?
2) What’s the benefit?
3) When use?

Answer 7

1) The parent gives fully-depreciated business assets outright OR in a trust to a lower-bracket family member and then leases the asset back for use in his/her business.
2) The parent’s business can continue using the asset, can take a deduction for the release payment, and can still enjoy all the other advantages inherent in gifting.
3) When a business-owning parent wishes to gift assets but only business assets.

Question 8

QPRT - Qualified Personal Residence Trust

1) What is it?
2) Rooting to outlive, die during, or neither?
3) What are tax benefits?
4) Any rules with QPRTs?

Answer 8

1) A QPRT is an irrevocable trust into which a grantor transfers his/her personal residence, RETAINING an interest for personal occupancy for a period of years. After that term, the residence PASSES to the beneficiaries of the trust, either outright or in trust.
2) Have to OUTLIVE or comes back into Gross Estate!
3) The present value of the remainder interest (would be given) to the children is the value of the taxable gift. It is a gift of a FUTURE interest, so NO Annual Exclusion. At the end of the trust term, the value of the residence might grow to $2.0 million. It would pass ESTATE tax-free. Me: Also seems like get a discount in the amount of the retained right to live there; if didn’t have, the taxable gift would be the full value of the home.
4) Up to 2 residences may be transferred into the residence trust, BUT one must be the PRIMARY residence. The other residence, usually a vacation home, MAY be rented by the grantor a portion of the time, but the grantor must live in the vacation home for MORE than the greater of 14-days OR 10% of the number of days rented.

Question 9

GSTT, Generation-Skipping Transfer Tax

1) How much is it?

Answer 9

1) It’s the same as the federal ESTATE tax rate (40% in 2020). It is a FLAT tax.

Question 10

Skip Person

Answer 10

RELATED: A beneficiary who is at least 2 generations younger than the transferor is a skip person (typically a grandchild).
-Note: If an individual’s parent who is a lineal descendent of the transferor is deceased, then the individual and all succeeding generations MOVE UP one generation.

UNRELATED: unrelated persons who are MORE than 37.5 years younger than the transferor are Skip persons.

Question 11

GSTT Lifetime Exemption

Answer 11

For each individual donor, the first $11,580,000 in property transferred by direct or indirect lifetime or death time skips to all skip persons COMBINED can be declared exempt from the GSTT.

Question 12

GSTT Annual Exclusion

1) Is there one?

Answer 12

Similar to the gift tax, a $15,000 annual exclusion PER DonEE is available under the GSTT for LIFETIME generation-skipping DIRECT transfers only (remember there are 3 types of transfers to skip persons: Direct skips, Taxable Termination, and Taxable Distribution)..

And a spouse can consent to splitting the annual exclusion only (Me: I think they’re implying can’t split the Lifetime Exemption.)

Question 13

3 Types of transfers to Skip persons

Answer 13

Direct Skip, Taxable Termination, and Taxable Distribution

Question 14

Direct Skip

1) What is it?
2) When is GSTT imposed? Who pays?

Answer 14

1) Giving directly.
2) The GSTT is imposed at the time of the direct skip. The transferor (person making the gift or the transferor’s estate) is liable for the GSTT on direct skips.

Note; the allocation of the exemption is automatic with a Direct Skip, although the transferor CAN elect NOT to have the automatic election apply. All, a portion, or none of the Exemption may be allocated.

Question 15

Taxable Termination

1) What is it?
2) Is the Exemption automatic?
3) Can use the GSTT Annual Exclusion?

Answer 15

1) A termination of a Non-Skip person’s interest in income or principal of a TRUST, with the result that Skip persons become the ONLY remaining trust beneficiaries.
2) NOT automatic. It must be ELECTED by the executor/trustee.
3) NO, it’s a future interest.

Question 16

Taxable Distribution

1) What is it?
2) Is the Exemption automatic?
3) Can use the GSTT Annual Exclusion?
4) Who pays?

Answer 16

1) Any distribution of property OUT OF A TRUST to a Skip Person OTHER THAN a Direct Skip or Taxable Termination. When a trust has beneficiaries in TWO OR MORE generations and the Trustee makes a distribution to a Skip Person, it is a Taxable Distribution.
2) No, it must be elected by the executor/trustee.
3) No, it’s a future interest.
4) If/when the taxable distributions exceed, $11,580,000 then the grandkid(!) must pay the GSTT.

Question 17

Summary of liability for payment of the GST Tax

Answer 17

Direct Skip = Donor or Estate pays.
Taxable Termination = Trustee pays.
Taxable Distribution = TransferEE pays.

Question 18

Do Gift Taxes affect GST taxes?

Answer 18

Yes, figure out the GIFT tax due, subtract that from the amount of Taxable GST amount, and then multiply the remainder by 40%. Then add the two. (See Q#3 of Live Review page E-42.)

Question 19

Alternate Valuation Date

1) What is it?
2) What is the date of the alternate valuation?
3) Any requirements to use AVD?

Answer 19

1) The personal representative or Executor of a Decedent’s estate may file an ELECTION to have the assets included in the Decedent’s Gross Estate valued at their alternate valuation date.
2) 6-months after the decedent’s death. Fair Market value is the measure.
3) There are 2 requirements: must cause a REDUCTION in the TOTAL VALUE of the Gross Estate. AND the amount of federal estate tax liability must be REDUCED as a result of filing the election.

Question 20

Types of Personal Representatives

Answer 20

Executor = if a valid will
Administrator = if appointed by the Court.

They have to act as fiduciaries. Fiduciary = ~must handle property for the sole benefit of the other person.

Question 21

Any assets that can’t use the Alternate Valuation Date?

Answer 21

Yes, wasting assets: annuity payouts, pension/IRA payouts, mortgage payouts, or notes receivable. The value used is the Date of Death value, but the remaining assets CAN qualify for the AVD.

ALSO, assets sold or distributed BEFORE the AVD are valued as of the DATE OF SALE.

Question 22

What are the requirements of a Qualified Disclaimer?

Is disclaimed property still subject to any taxes?
If so, who would pay?

Answer 22

5 Requirements:

1) Must be an irrevocable refusal to accept the interest.
2) Must be in writing.
3) Must be received within 9-month of the death.
4) The intended Donee cannot have accepted any interest in the benefits, AND
5) as a result of the refusal, the interest will pass, without the disclaiming person’s DIRECTION, to someone else.

NOTE: the property may still be subject to gift, estate, or GST tax. The original donor or the deceased’s estate is responsible for the tax, not the disclaiming person (disclaimant).

Question 23

Disclaimer Trust

1) What is it and what’s the benefit?
2) Can the surviving spouse invade the corpus?

Answer 23

1) The trust is usually included as a clause in the decedent’s will, making it a testamentary trust in nature. Should the surviving spouse decide to disclaim a portion or the entire bequest, the property is transferred to the irrevocable trust and income is paid to the surviving spouse. So, the spouse can disclaim the property yet receive a stream of income from the disclaimed bequest.
2) The surviving spouse generally cannot retain any power to invade the corpus, but the corpus may be invaded using an ascertainable standard (HEMS), but no 5 or 5 rights are allowed.

Question 24

Can JTWROS property be disclaimed?

Answer 24

Yes.

Question 25

Requirements of an enforceable prenuptial agreement?

Answer 25

1) Must be in WRITING (not oral) and SIGNED by both parties.
2) It must be preceded by a FULL AND ACCURATE disclosure of each party’s NET WORTH.
3) It must be WILLINGLY executed by both parties.

Question 26

Memory Tricks:
Section 303
Installment Method 6166
Special Use Valuation (2032A)

Answer 26

Section 303:
Think 3 is the business owner and he’s reaching over the pearly gates to himself, the other 3 to allow stock redeemed for his estate’s liquidity.

Installment Method 6166:
Think 6166 looks like a series of payments, and the “1” stands for Interest-only (for first 4-years, and 6166 is 4 digits long).

Special Use Valuation 2032A
Think: the A = Farm building. It’s a $1,180,000 reduction in decedent’s Gross Estate.

Question 27

What is a Section 303 stock redemption?

Answer 27

1) Section 303 allows a CLOSELY-HELD CORPORATION to make a distribution of a portion of stock of a decedent that will NOT be taxed as a dividend.

2) There are 3 requirements:
- Business MUST be a regular corporation OR an S corporation (closely-held).
- The value must be MORE THAN 35% of the ADJUSTED Gross Estate.
- Only an amount of stock EQUAL to a total of all ESTATE taxes AND ADMINISTRATION expenses can be redeemed.

Question 28

Installment Method, Section 6166?

1) What is it?
2) Are there any requirements?

Answer 28

If the estate qualifies, the estate tax ATTRIBUTABLE to the closely-held business interest (sole proprietorship, partnership, or corporation) can be paid in 10 equal installments BEGINNING 4-years AFTER the decedent’s death. Able to pay interest-only for the first 4-years (the interest is a low rate and NOT deductible). An additional advantage of the tax deferral is that a portion of the deferred tax incurs an interest rate of 2% (first $1,570,000 of business value in 2020).

2) There are 2 requirements:
- The gross estate must include an interest classified as “closely held,” the value of which exceeds 35% of the ADJUSTED Gross Estate.
- Aggregation of various business interests of the decedent is ALLOWED for purposes of meeting the percentage requirement, IF the decedent owned at least 20% of the total value of each.

Question 29

Special Use Valuation, Section 2032A

1) What is it?
2) Are there any requirements?

Answer 29

1) 2032A is a method to discount the valuation of real estate used IN CONNECTION with a CLOSELY-HELD BUSINESS OR a FARMING OPERATION.
- IF elected by the executor of the estate, special use valuation can result in a maximum reduction of $1,180,000 (2020) from the decedent’s GROSS Estate.

2) Yes there are NUMEROUS requirements:
-At least 50% of the value of the GROSS Estate, reduced by liens, must consist of REAL OR PERSONAL property DEVOTED to qualified use.
-The value of the REAL property must be at least 25% of the GROSS Estate.
-The property must have been held for “qualified use” AND ACTIVELY MANAGED by the DECEDENT OR the decedent’s FAMILY for 5-out-of-the-8-years PRIOR to the decedent’s death.
The qualifying property must pass to a qualifying heir and must CONTINUE in a qualified use for AT LEAST 10-years AFTER the Decedent’s death.

Question 30

1) What are the best planning strategies for nontraditional relationships with Children of another relationship/Cohabitation/Adoptions?
2) What are NOT good planning strategies?

Answer 30

A revocable trust or possibly Tenancy In Common are the best answers for the Exam.

Notes:

• Being unmarried, the partners will NOT be entitled to advantages such as Elective Share or the Unlimited Marital Deduction.
• If the partners do not have children in common, Guardianship may be undermined.

2) Not good:
- Wills: can be contested by family members. Note: no Will means the Court decides the disposition of the decedent’s assets.
- JTWROS: can be dangerous. One of the partners can SEVER the Joint Tenancy. The partner can make withdrawals and the withdrawal may create a taxable gift. The asset may be exhausted without the contributing partner’s knowledge. The asset also will be reachable by the creditors of BOTH partners.