Asset Sales to Grantor Trusts: Antidote to New Estate Tax?

PDF:   Sales of Assets to Defective Grantor Trusts

I.     Introduction

 

Asset sales to grantor trusts exploit income tax provisions enacted to prevent income shifting by capitalizing on different definitions of “transfer” for transfer and income tax purposes. The objective of the sale is to effectuate a complete transfer for transfer tax purposes, but not for income tax purposes. Since no transfer occurs for income tax purposes, no income tax gain is recognized by the grantor on the sale. Despite this, the grantor has made a complete transfer for gift and estate tax purposes. In the past, some have referred to the resulting trust as “defective”. However, the tax consequences of the sale are firmly grounded in federal tax law, and the use of asset sales to grantor trusts can effectively leverage the applicable exclusion amount for gift and estate tax purposes especially in prevailing low-interest rate environment.

 

II.     Overview of Asset Sale

 

For income tax purposes, following an asset sale, the grantor trust holds property the income from which the grantor continues to report. However, the grantor is no longer considered as owning the asset for transfer tax purposes. Therefore, trust assets, as well as the appreciation thereon, will be removed from the grantor’s estate

For as long as grantor trust status continues, trust income is taxed to the grantor. A corollary of the grantor trust rules would logically provide that no taxable event occurs on the sale of assets to the grantor trust because the grantor has presumably made a sale to himself of trust assets.4 If this hypothesis is correct, the grantor can sell appreciated assets to the grantor trust, effect a complete transfer and freeze for estate tax purposes, and yet trigger no capital gains tax on the transfer of the appreciated business into the trust.

 

Illustration.     Assume the grantor sells property worth $5 million to a trust in exchange for a $5 million promissory note, the terms of which provide for interest payable over 20 years, and a balloon payment of principal when the note terminates. If the trust is drafted so that the grantor retains certain powers, income will continue to be taxed to the grantor, even though for transfer tax purposes the grantor will be considered to have parted with the property.

The result of the sale to the grantor trust is that the income tax liability of the profits generated by the business remains the legal responsibility of the grantor, while at the same time the grantor has parted with ownership of the business for transfer tax purposes. A “freeze” of the estate tax value has been achieved, since future appreciation in the business will be outside of the grantor’s taxable estate. Nonetheless, the grantor will remain liable for the income tax liabilities of the business, and no distributions will be required from the trust to pay income taxes on business profits. This will result in accelerated growth of trust assets.3

 

Illustration.   Assume grantor sells a family business worth $5 million to the trust, and that each year the business generates approximately $100,000 in profit.  Assume further that the trust is the owner of the business for transfer tax purposes.2 With the grantor trust in place, the grantor will pay income tax on the $100,000 of yearly income earned by the business. If the business had instead been given outright to the children, they would have been required to pay income taxes on the profits of the business.

 

  1. Grantor Trust Provisions

In Internal Revenue Code

 

Achieving grantor trust status requires careful drafting of the trust agreement so that certain powers are retained by the grantor.  The following powers, if retained over trust property, will result in the IDT being treated as a grantor trust:

 

¶  IRC § 677(a) treats the grantor  as the owner of any portion of the income of a trust if the trust provides that income may be distributed to the grantor’s spouse without the approval or consent of an adverse party;

 

¶  IRC § 675(3) treats the grantor as owner of any portion of a trust in which the grantor possesses the power to borrow from the trust without adequate interest or security;

 

¶  IRC § 674(a) treats the grantor as owner of any portion of a trust over which the grantor or a nonadverse party retains the power to control beneficial enjoyment of the trust or income of the trust. [Sec. 674(a) is subject to many exceptions; for example, the power to allocate income by a nonadverse trustee, if such power were limited by an ascertainable standard, would not result in the trust being taxed as a grantor trust]; and

 

¶ IRC § 675(4)(C) provides that if the grantor or another person is given the power, exercisable in a nonfiduciary capacity and without the approval or consent of another, to substitute assets of equal value for trust assets, grantor trust status will result.

 

Caution.   The objective is for the grantor to part with as many incidents of ownership as are required to effectuate a transfer for transfer tax purposes, while retaining enough powers to prevent a transfer for income tax purposes.  Therefore, it is not necessarily advisable to include more powers than necessary to accomplish grantor trust treatment for income tax purposes, since the cumulative effect of retaining many powers which cause the trust to be a grantor trust for income tax purposes could also result in rendering the transfer incomplete for transfer tax purposes as well, entirely defeating the purpose of the sale. IRC § 675(4)(C), which provides that the grantor may in an nonfiduciary capacity substitute assets of equal value, should not result in an incomplete gift.

 

IV.   The Note Received For Assets

 

Consideration received by the grantor in exchange for assets sold to the trust may be either cash or a note. If a business is sold to the trust, it is unlikely that the business would have sufficient liquid assets to satisfy the sales price. Furthermore, paying cash would tend to defeat the purpose of the trust, which is to reduce the size of the grantor’s estate. Therefore, the most practical consideration would be a promissory note payable over a fairly long term, perhaps 20 years, with interest-only payments in the early years, and a balloon payment of principal at the end.5 This arrangement would also minimize the value of the business that “leaks” back into the grantor’s estate. For business reasons, and also to underscore the bona fides of the arrangement, the grantor could require the trust to secure the promissory note by pledging the trust assets.  The note should permit prepayment, which can be of benefit if the parties wish to terminate the transaction earlier, or in the event the assets fall in value, in which case the parties could renegotiate the term of the Note.

If there is insufficient cash flow to make payments on the Note, resort will have to be made to payments in kind.  However, payments in kind conflict with the grantor’s objective in selling assets to the trust to remove them from his estate.  Payments in kind could also require costly valuations.

 

Caution.    Although balloon payments may be desirable from a cash flow standpoint,  periodic payments of principal and interest would imbue the note with a greater degree of commercial reasonableness.  Provided the other terms of the note are commercially reasonable, the provision for a balloon payment of principal should not be problematic.  However, the more the terms of the note deviate from those of a commercial loan, and the higher the debt to equity ratio, the greater the chance the IRS will assert that the debt is actually disguised equity.  In this case, the IRS could argue that inclusion in the grantor’s estate should result from IRC §2036.

 

If the value of the assets sold to the trust decreases significantly, the trust may seek to renegotiate the interest rate if the AFR has decreased since the date of the sale of assets to the trust.  Alternatively, the grantor could sell the note, at a discounted value, to another grantor trust. However, to the extent renegotiation is not feasible, wealth will be transferred back into the grantor’s estate.

 

The note issued in exchange for the assets must bear interest at a rate determined under § 7872, which references the applicable federal rate (AFR) under §1274.6 In contrast, a qualified annuity interest such as a GRAT must bear interest at a rate equal to 120 percent of the AFR. A consequence of this disparity is that property transferred to a GRAT must appreciate at a greater rate than property held by an IDT to achieve comparable transfer tax savings. As with a GRAT, if the assets fail to appreciate at the rate provided for in the note, the IDT would be required to “subsidize” payments by invading the principal of the trust.

While no taxable event occurs when the grantor sells assets to the trust in exchange for the note, if grantor trust status were to terminate during the term of the note, the trust would no longer be taxed as a grantor trust. This would result in immediate gain recognition to the grantor, who would be required to pay tax on the unrealized appreciation of the assets previously sold to the trust. Note that for purposes of calculating realized gain, the trust will be required substitute the grantor’s basis.

Even though the assets were “purchased” by the trust, no cost basis under § 1012 is allowed since no gain will have been recognized by the trust in the earlier asset sale. Another situation where gain will be triggered is where the trust sells appreciated trust assets to an outsider. One way of mitigating this possibility is for the grantor to avoid selling low-basis assets to the trust. If this is not possible, the grantor may substitute higher basis assets of equal value during the term of the trust, if the trust is drafted to permit the grantor to substitute assets of equal value.

Care should be exercised in selling highly appreciated assets to the grantor trust for another reason as well.  If the grantor dies during the trust term, the note will be included in the grantor’s estate at fair market value. However, assets sold to the trust will not receive the benefit of a step-up in basis pursuant to § 1014(a).

 

Solution to Basis Problem.     To avoid this result, the trust might either (i) authorize the grantor to substitute higher basis assets of equal value during his lifetime; or (ii) make payments on the note with appreciated assets.

If the grantor receives appreciated assets in payment of the note, those assets will be included in the grantor’s estate, if not disposed of earlier. However, they would at least be entitled to a step-up in basis in the grantor’s estate pursuant to § 1014.

 

What if Assets Decline in Value?

 

What happens if the assets in the trust decline in value so that the payments under the note can no longer be made?

 

Renegotiate Note.    One option is for the trustee and grantor to renegotiate the terms of the Note, perhaps by lengthening the term and decreasing the interest rate.  It is possible that the IRS would assert that a gift had been made in this situation.

 

Sell Note to Another Trust.   Another option would be to sell the note to another grantor trust whose beneficiaries are the same.  Since the purchase price would be lower, there is more of a chance that future appreciation would be shifted to family members.

 

Cancel the Note.     Finally, the grantor could extinguish the Note in exchange for the return of the assets sold to the trust.  This approach might violate the fiduciary obligations of the Trustee.

 

V.  Avoiding Sections 2036 and 2702

 

IRC § 2702.    The rules of Chapter 14 must also be considered. If  § 2702 were to apply to the sale of assets to a grantor trust, then the entire value of the property so transferred could constitute a taxable gift. However, it appears those rules do not apply, primarily because of the nature of the promissory note issued by the trust. The note is governed by its own terms, not by the terms of the trust. The holder in due course of the promissory note is free to assign or alienate the note, regardless of the terms of the trust, which may contain spendthrift provisions. Ltr.Ruls 9436006 and 9535026 held that neither § 2701 nor § 2702 applies to the IDT promissory note sale, provided (i) there are no facts present which would tend to indicate that the promissory notes would not be paid according to their terms; (ii) the trust’s ability to pay the loans is not in doubt; and (iii) the notes are not subsequently determined to constitute equity rather than debt.

 

IRC § 2036.    As noted above, since the assets are being transferred to the grantor trust in a bona fide sale, those assets should be excluded from the grantor’s estate. However, since the grantor is receiving a promissory note in exchange for the assets, the IRS could take the position that under IRC § 2036, the grantor has retained an interest in the assets which require inclusion of those assets in the grantor’s estate.7 In order to minimize the chance of the IRS successfully invoking this argument, the trust should be funded in advance with assets worth at least 10 percent as much as the assets which are to be sold to the trust in exchange for the promissory note.8

In meeting the 10 percent threshold, the grantor should himself make a gift of these assets so that following the sale, the grantor will own all trust assets. The IRS stated in PLR 9515039 that IRC § 2036 could be avoided if beneficiaries were to act as guarantors of payment of the promissory note.9 To enhance the bona fides of the note, all trust assets should be pledged toward its repayment. To emphasize the arm’s length nature of the asset sale, it is preferable that the grantor not be the trustee.

The grantor should be circumspect in employing guarantees.  If the assets decline in value, the guarantee could result in wealth being retransferred to the grantor, which result is the opposite of the objective. In addition, the guarantee will be liability of the guarantor, and will be required to be shown on the guarantor’s balance sheet.

Payment of trust income by the grantor is a desirable feature of  sales of assets to grantor trusts, since trust assets continue to grow without imposition of income tax.  The payment by the grantor of the income tax liability of the grantor trust can be considered a gift-tax free gift of the income tax liability by the grantor to the trust.

Although beneficial from an estate planning perspective, the grantor may at times not wish to pay the income tax liability of the trust. The trust instrument may authorize, but not require, the Trustee  to reimburse the grantor for income tax payments made by the grantor.  In that case, inclusion under IRC §2036 should not result.  However, if there is even an implied understanding that the grantor will be reimbursed for the income tax payments, it is the IRS position that inclusion in the grantor’s estate under §2036 will result.  Rev. Rul. 2004-64.

If the grantor is cash-short, he may borrow money from the trust to pay income taxes, if the trust so permits.  Recall that under IRC §  675(3), a provision in the trust allowing the grantor to borrow money from the trust without adequate security is a provision which actually causes the trust to be a grantor trust.

 

VI.   GST Tax Considerations

 

The sale of assets to a grantor trust has particularly favorable Generation Skipping Transfer (GST) tax consequences.  Since the initial transfer of assets to the grantor trust is a complete transfer for estate tax purposes, there would be no possibility that the assets could later be included in the grantor’s estate. The transfer would be defined as one not occurring during the “estate tax inclusion period” (ETIP).  Accordingly, the GST tax exemption could be allocated at the time of the sale of the assets to the grantor trust11.

In sharp contrast, the GST exemption may not be allocated until after the term of a GRAT has expired.12 If the grantor of a GRAT were to die before the expiration of the trust term, all of the assets in the GRAT would be included in the grantor’s estate at their appreciated value. This would require the allocation of a greater portion of the GST exemption to shield against the GST tax. The inability to allocate the GST exemption using a GRAT is quite disadvantageous when compared to the IDT, where the exemption can be allocated immediately after the sale, and all post-sale appreciation can be protected from GST tax.

 

VII.  Choice of Trustee

 

Trustee designations should also be considered.  Ideally, the grantor should not be the trustee of an IDT, as this would risk inclusion in the grantor’s estate.  If discretion to make distributions to the grantor is vested in a trustee other than the grantor, then the risk of adverse estate tax consequences is reduced.  The risk is reduced still further if the grantor is given no right to receive even discretionary distributions from the trust. If the grantor insists on being the trustee of the IDT, then the grantor’s powers should be limited to administrative powers, such as the power to allocate receipts and disbursements between income and principal. The grantor may also retain the power to distribute income or principal to trust beneficiaries, provided the power is limited by a definite external standard.

The grantor as trustee should not retain the right to use trust assets to satisfy his legal support obligations, as this would result in inclusion under §2036.  However, if the power to satisfy the grantor’s support obligations with trust assets is within the discretion of an independent trustee, inclusion in the grantor’s estate should not result. However, if the grantor retains the right to replace the trustee, then the trustee may not be independent, and inclusion could result. Note that despite the numerous prohibitions against the grantor being named trustee, the grantor’s spouse may be named a beneficiary or trustee of the trust without risking inclusion in the grantor’s estate.10

The trust instrument should dispense with the typical requirement that the Trustee be required to diversify the investments of the trust.

 

VIII.   Death of Grantor

 

The following events occur upon the death of the grantor: (i) the trust loses its grantor trust status; and (ii) presumably, assets in the trust would be treated as passing from the grantor to the (now irrevocable) trust without a sale, in much the same fashion that assets pass from a revocable living trust to beneficiaries. The basis of trust assets would not be stepped-up under §1014(a) on the death of the grantor, nor would the assets be included in the grantor’s estate.  In contrast to the problem arising with a GRAT when the grantor dies before the expiration of the trust term, trust assets will never be included in the grantor’s estate, although the discounted value of the note will.

The tax consequences of the unpaid balance of the note must also be considered when the grantor dies. Since the asset sale is ignored for income tax purposes, the balance due on the note would not constitute income in respect of a decedent (IRD). The remaining balance of the note would be included in the estate and would acquire a basis equal to that value.13

Some authorities believe that if the grantor dies while the note is outstanding, the estate could realize capital gain to the extent that the debt exceeds the basis of the trust in the assets.

It may be possible to avoid inclusion of the note in the seller’s estate if a self-canceling installment note (SCIN) feature is included . A SCIN is an installment note which terminates on the seller’s death. Any amounts payable to the seller would are cancelled at death, and are excluded from the seller’s estate. However, use of a SCIN requires that the payments under the note be increased to avoid a deemed gift at the outset.

As a result of the increased payments, if the seller does survive the full term of the note, the amount payable to the seller from the trust utilizing the SCIN will be greater than if a promissory note without a SCIN were used.  This would tend to increase the seller’s taxable estate.

An existing Promissory Note can be renegotiated to include a SCIN, provided the grantor is not terminally ill (i.e., not a 50% probability that grantor will die within 1 year).  As noted, the inclusion of the SCIN will require an additional premium, determined actuarially.

In addition to not suffering from the same problems occasioned by the early death of the grantor as would be the case with a GRAT, the asset sale technique also accomplishes a true estate freeze by transferring assets at present value from his estate without being subject to the limitations imposed by IRC §§ 2701 or 2702, to which the GRAT is subject. As noted, the GST exemption may be allocated to the assets passing to the trust at the outset, thus removing from GST tax any appreciation in the assets as well. In these respects, sales to grantor trusts are superior to the GRAT. The principal disadvantages are that (i) no step-up in basis is received at the death of the grantor for assets held by the trust (or if the trust sells appreciated assets during its term); and (ii) the technique, though sound, has no explicit statutory basis, as does the GRAT.

 

IX.   Possible IRS Objections

 

The general principles governing the tax consequences of the asset sale seem firmly grounded in the Code and the law, and their straightforward application appears to result in the tax conclusions which have been discussed. Nevertheless, the IRS could challenge various parts of the transaction, which if successful, could negate the tax benefits sought. In particular, the IRS could attempt to assert that (i) the sale by the grantor to the trust does not constitute a bona fide sale; (ii) § 2036 applies, with the result that the entire value of the trust is includible in the grantor’s estate; (iii) the initial asset “sale” is actually a taxable sale which results in immediate tax to the grantor under IRC § 1001; or (iv) that § 2702 applies, the annuity is not qualified, and a taxable gift occurs at the outset.

The IRS has recently interposed the step transaction doctrine in situations where limited liability companies were formed shortly before the sale to the grantor trust.  In view of this, it is advisable to permit the limited liability company  (or partnership) to “age” prior to transferring the asset to the trust.

Although the sale to a grantor trust is not a gift, the grantor may wish to file a gift tax return solely for the purpose of commencing the statute of limitations.  If this route is taken, the transaction should be disclosed on the return. Often, the transaction will be disclosed in any event by reason of the grantor’s gift of “seed” money to the trust.

 

 

 

 

 

X. Sale of Discounted

Assets to Grantor Trust

 

By combining the LLC form with asset sales to grantor trusts, it may be possible to achieve even more significant estate and income tax savings. LLC membership interests are entitled to minority and marketability discounts since the interests are subject to significant restrictions on transfer and management.  If the value of the LLC membership interest transferred to the trust is discounted for lack of marketability and lack of control, the value of that interest will be less than a proportionate part of the underlying assets.  Consequently, in the case of an asset sale to the trust, the sale price will be less than if the assets had been directly sold to the trust.

 

Illustration

 

Step 1. Parent forms an LLC with two children. Parent is Managing Member.  Members each contribute $10,000 in exchange for a 33 percent interest in the LLC.  Parent may give children the money to purchase their interests.

 

Step 2. Parent transfers real estate worth $1 million to the LLC.  Parent’s capital account is now $1.01 million, and Parent now owns 99.7 percent of all membership interests in the LLC;

Step 3.    In determining the fair market value of the LLC membership interest to be sold by parent to the trust, parent engages the services of a real estate appraiser and a professional valuation discount appraiser. A copy of the LLC operating agreement (containing restrictions which depress value of membership interests).  The valuation discount appraiser determines that the membership interests should be discounted by 30 percent after application of the lack of control and lack of marketability discounts.

 

Step 4.    Parent decides to sell a 90 percent membership interest to the trust. Before doing so, parent makes a taxable gift of $90,000 (10 percent of the value of interests to be sold to the newly formed grantor trust).  The children are the only beneficiaries of the trust.  The gift reduces parent’s available lifetime gift tax exclusion from $1 million to $0.91 million. The following year, a federal gift tax return is filed reporting the gift of “seed” money to the trust.

 

Step 5.    Parent sells a 90 percent membership interest to the trust in exchange for a 10-year promissory note whose principal amount is $630,000, which bears interest at 4.47 percent pursuant to IRC § 1274 (the long-term AFR for May, 2010) and which calls for a balloon payment of principal at the end of the 10-year term of the Note;

 

The discounted value of the note is determined by the following formula:

 

Value of Note =

Value of undiscounted interest sold x (1 – discount)

 

Solving the equation:

 

Value of Note  = $900,000 x (1 – .3)

= $900,000 x 0.7

= $630,000

 

The required yearly interest payments under the Promissory Note are $28,162. No income tax consequences attach on payments from the trust to the grantor, since they are considered to be the same taxpayer for income tax purposes.

 

Step 6.     If the real estate appreciates at a yearly rate of 10 percent, the FMV of trust assets  will increase by $90,000 in year one; ($900,000 x 0.10). The grantor will report and pay tax on trust’s distributive share of income reported by the LLC. The payment by the grantor of the income tax liability of the trust will result in trust assets continuing to appreciate without the imposition of income tax on trust assets. The grantor trust provides that the trustee has discretion to reimburse the grantor for income tax payments made. No income tax consequences attach to the reimbursement by the trust to the grantor of income tax. [

[Had the membership interests not been discounted, the trust would have paid of $900,000, and the yearly interest would have been $40,230 (i.e., $900,000 x .0447). By discounting the property purchased by the trust, the required interest payment to parent was reduced from $40,230 to $28,162.]

If the underlying assets grow at a rate of 10 percent, then 68.71 percent of the growth ($61,838/90,000) will remain in the trust.  If the trust had been required to pay income tax, the rate of growth of trust assets would be significantly lower.

 

Step 7.   The LLC asset sale to the IDT will result in the following favorable tax and economic consequences: (i) $900,000 is transferred out of the grantor’s estate; (ii) the value of the note is included in the grantor’s estate if the grantor dies during the term of the note; (iii) future appreciation of the asset sold is transferred out of the estate; (iv) unlike the situation obtaining with a GRAT, the favorable tax result does not depend on the grantor surviving the trust term; (v) since the note could bears a lower rate of interest than a GRAT, fewer funds would be brought back into the grantor’s estate, resulting in a more perfect “freeze” for estate tax purposes; (vi) since the LLC assets are discounted, the purchase price by the trust reflects that discount, making the effective yield of assets within the LLC even higher; (vii) the sale does not occur during an estate tax inclusion period (ETIP), meaning that GST exemption can be allocated initially, before the trust assets increase in value; and (viii) while no basis step up occurs at the grantor’s death; however, this problem can be ameliorated by substituting assets with a higher basis during the grantor’s life.

 

___________________________

 

 

Endnotes:

 

1. A grantor trust is a trust defined in Secs. 671 through 679 of the Code. To be taxed as a grantor trust, the grantor must reserve certain powers, the mere reservation of which in the trust instrument will confer grantor trust status, unless and until those powers are released.

 

2.   IRC Secs. 2036 and 2038, which cause the retention of interests or powers to result in estate inclusion must be avoided when funding an IDT. The retention by a grantor-trustee of administrative powers, such as the power to invest and the power to allocate receipts and disbursements between income and principal will not result in inclusion, and will not negate the transfer for transfer tax purposes, provided the powers are not overbroad and are subject to judicially enforceable limitations.  See Old Colony Trust Co., 423 F2d 601 (CA-1, 1970).

 

3.    The IRS has indicated displeasure with the payment of income taxes by the grantor of a grantor trust when the grantor receives no distributions.  However, as the payment of taxes by the grantor is mandated by the grantor trust  provisions themselves, it is doubtful that the IRS would prevail on this issue were it to litigate.

 

4.   The IRS takes the position that a wholly grantor trust is disregarded for income tax purposes, and that transactions between the trust and the grantor have no income tax consequences.  Rev. Rul. 85-13, 1985-1, C.B. 184.

 

5.     Treas. Reg. § 25.2702-3 prohibits this type of “end loading” with respect to a GRAT.  That regulation provides that an amount payable from a GRAT cannot exceed 120 percent  of the amount paid during the preceding year.  However, if  § 2702 does not apply to the IDT, which appears likely, then the promissory note could provide for a large principal payment at the conclusion of the term of the note.

 

6.     A promissory note given in exchange for property must bear interest at the rate prescribed by  § 1274.  Sec. 1274(d) provides that a promissory note with a term of between two and ten years should bear interest at the federal midterm rate.

 

7.  Fidelity-Philadelphia Trust Co. v. Smith, 356 U.S. 274 (1958), held that where a decedent, not in contemplation of death, transfers property in exchange for a promise to make periodic payments to the transferor, those payments are not chargeable to the transferred property, but rather constitute a personal obligation of the transferee. Accordingly, the property itself is not includible in the transferor’s estate under § 2036(a)(1).

 

  1. In an analogous situation,  § 2701 requires that the value of common stock, or a “junior equity interest,” comprise at least 10 percent  of the total value of all equity interests.

 

9. Presumably, if the beneficiaries were to guarantee the note and if the value of the assets which secure the note were to decline, there would still be a realistic prospect of the note being repaid.

 

10.  Sec. 677(a), which treats the grantor as owner of any portion of a trust whose income may be distributed to the grantor or the grantor’s spouse, has no analog in the estate tax sections of the Internal Revenue Code.

 

11. Sec. 2642(f) prohibits allocation of any portion of the Generation Skipping Transfer tax exemption to a transfer during any estate tax inclusion period (ETIP).  Sec. 2642(f)(3) defines ETIP as any period during which the value of transferred property would be included in the transferor’s estate if the transferor were to die.

 

12. The period during which the grantor receives annuity payments from a GRAT is an ETIP.  Therefore, no part of the GST exemption may be applied to the GRAT until after its term; at that point, the property inside the GRAT will have appreciated, requiring a greater allocation of the GST exemption.

 

13.  Some argue that a sale occurs immediately before the death of the grantor, causing capital gain to be recognized by the grantor’s estate to the extent the balance due on the note exceeds the seller’s basis in the assets sold to the trust. This view is inconsistent however, with the central premise that the sale by the grantor of assets to the IDT produces no taxable event.

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