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Sale To An IDIT For A Note: The Best Transfer Tax Strategy (Gimmick) Going

Learn about the best transfer tax strategy by selling assets to an IDIT in exchange for a promissory note. This strategy allows for estate tax exclusion, income tax benefits, and generation-skipping tax advantages. Discover different asset options and formula transfers to maximize your tax planning.

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Sale To An IDIT For A Note: The Best Transfer Tax Strategy (Gimmick) Going

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  1. Sale To An IDIT For A Note: The Best Transfer Tax Strategy (Gimmick) Going Michael D. Mulligan BKD Leadership Conference June 18, 2015

  2. I. Historical Background Grantor Trust Rules. 1986 Changes in Rates and Income Taxation of Trust Defective Trust (IDIT). Estate Tax Exclusion. Income Tax to Grantor (Rev. Rul. 85-13). Payment of Income Tax Not a Gift (Confirmed in Rev. Rul. 2004-64). Fund by Gift. Move More into IDIT with a Sale. Interest Rate. Frazee and True Hold Interest Determined under IRC Sec. 7872.

  3. II. Estate Planning Benefits If total net return (appreciation + net income) exceeds interest on note, excess excluded from Seller’s estate. Estate actually reduced if payments made on promissory note to provide funds to Seller to pay income taxes.

  4. III. Generation-Skipping Tax Any assets excluded from Seller’s estate can be insulated from generation-skipping tax. Should make a small gift to the IDIT and allocate GST exemption to the IDIT, in the amount of the gift. Sale will not change inclusion ratio, so long as value of assets sold does not exceed face amount of note.

  5. IV. Avoiding IRC Secs. 2036 and 2702 Fidelity-Philadelphia Trust Co. Case. Ten Percent Cushion (Minimum). Woelbing Cases (Karmazin).

  6. V. What is Best Method of Furnishing Cushion? Gift by Seller. Gift Tax. Possible Decrease in Value. Guarantee by Beneficiary – no gift? Who should be Guarantor? What happens if property sold to IDIT decreases in value? Guarantee by party other than Seller’s spouse. Guarantee by Seller’s spouse.

  7. VI. Different Kinds Of Assets To Be Utilized In Sale Transaction S Corporation Stock. Good candidate, because no income tax imposed at entity level. Potential retained vote problems under IRC Sec. 2036(b) avoided by recapitalizing and selling non-voting stock to IDIT. Seller’s retention of voting stock does not create IRC Sec. 2036(b) problems. Marketable Securities and Cash. Results generally not as good as with S Corporation stock. Consider utilizing LLC or limited partnership to produce valuation discount (see below).

  8. VI. Different Kinds Of Assets To Be Utilized In Sale Transaction - Continued Limited Partnership. Seller might contribute marketable securities and cash in exchange for limited partnership interest, and sell limited partnership interest to IDIT at a discounted price. Seller should not retain general partnership interest. Limited Liability Company. Seller might contribute marketable securities and cash in exchange for non-voting membership interests and sell non-voting membership interests to IDIT at a discounted price. Seller should not retain voting membership interest.

  9. VII. Formula Transfers Rather than describing interest sold as a number of shares of corporate stock or units or percentage interest of partnership or LLC, describe interest sold as a dollar amount, e.g. “that number of shares having a value equal to $X.” Theory is that if IRS adjusts value upwards, formula operates to reduce interest transferred to keep the value transferred at $X. Tax Court’s decision in Wandry indicates that these types of clauses are effective against IRS argument and that they are contrary to public policy in the enforcement of the gift tax law.

  10. VIII. Reporting Sale on Gift Tax Return Seller should consider reporting sale transaction on a gift tax return, which takes the position that the sale does not constitute a gift because the note represents full and adequate consideration. If adequately disclosed, three-year statute of limitations precludes subsequent challenge by IRS. A strong argument can be made that statute of limitations also precludes IRS argument that assets sold are includable under IRC Sec. 2036(a), i.e., as a retained income interest.

  11. VIII. Reporting Sale on Gift Tax Return - Continued If Seller retained an “interest” in the IDIT, no value would be assigned to promissory note under IRC Sec. 2702, and the gift would be the full value of the assets sold. If no gift under IRC Sec. 2702, there is no retained interest. There should also be no retained interest under IRC Sec. 2036(a). Guarantor might also file gift tax return reporting guarantee and taking position that guarantee does not constitute a gift. This conclusion is binding on IRS if a three-year statute of limitations runs on the return.

  12. IX. Sale For An Annuity Terminating At Seller’s Death When annuity terminates at Seller’s death, nothing remains to be included in Seller’s estate. Terminal interest exception to use of IRS actuarial tables. Premium to avoid gift (amount determined under IRS actuarial tables). Exhaustion test must be considered. Exchange promissory note from an earlier sale for an annuity if Seller becomes ill. Measuring life not limited to Seller’s.

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