College of William & Mary Law School William & Mary Law School Scholarship Repository William & Mary Annual Tax Conference Conferences, Events, and Lectures 2011 Planning for the Next Generation: Installment Sale to an Intentionally Defective Grantor Trust John B. O'Grady Repository Citation O'Grady, John B., "Planning for the Next Generation: Installment Sale to an Intentionally Defective Grantor Trust" (2011). William & Mary Annual Tax Conference. 665. https://scholarship.law.wm.edu/tax/665 Copyright c 2011 by the authors. This article is brought to you by the William & Mary Law School Scholarship Repository. https://scholarship.law.wm.edu/tax ; 1.1 i' , l ! PRESENTED BY: John B. O'Grady Benjarnin S. Candland Relationships That Drive Results 900 LAWYERS I 17 OFFICES I www.mcguirewoods.com ( Step 1: Fund the Trust You establish a grantor trust and make a gift to the Trust. The gift should be between 10-20%) of the appraised value of the asset to be sold. The gift will use some or all of your remaining unified credit. You ~ _____G_if_t ____~~ Trust Step 2: The Sale You sell the assets to the Trust. The Trust gives you a promissory note. Because you are treated as the owner of the Trust, there is no gain or loss recognized as a result of the sale. Transfer of Stock ~ You Trust < Promissory Note Step 3: Payments on the Note Each year the Trust makes principal and interest payments to you. Because the Trust is a grantor trust, you will continue to be taxed individually on the Trust's income and gain. Trust Principal & Interest Payments You ( , " -~ 1. Why make the Sale? By selling an asset, such as a closely held business, to an intentionally defective grantor trust, you have the opportunity to transfer significant assets to a trust for the benefit of your children while removing the asset from your estate for estate tax purposes. The transaction offers an opportunity to leverage depleted asset values along with possible valuation discounts (e.g., minority interests). 2. What kind of Trust will be created? As a general description, you will create a trust that is intentionally drrlfted so that you will be treated as the owner of the trust assets for income tax purposes, but not for gift, estate, or other transfer tax purposes. You will not be a beneficiary of the trust. Instead, the trust will be established for the benefit of your descendants. 3. How do I fund the Trust? The trust will need to be funded with seed money. Generally, you will make a gift of cash or other liquid assets with a value that equals 10-20'];, of the appraised value of the assets that will be sold to the trust. The gift to the trust may use some, or all, of your remaining unified credit amount. As a result, you will owe gift tax on any amounts that are in excess of your remaining credit. 4. How will the Sale to the Trust work? You sell the asset, such as an ownership interest in a closely held business, to the trust in exchange for a promissory note bearing interest at the applicable federal rate. The trust then uses the income that it receives from the assets to make payments to you to pay down the promissory note. 5. Will I have to pay capital gains tax because of the Sale? Because you are treated as the owner of the trust assets for income tax purposes, and transactions between you and the trust havc no income tax conscquences, there is no gain or loss recognized upon the s.ale. 6. What happens after the Sale? During your lifetime, you will continue to receive payments from the trust until the promissory note is paid off. Because you will be considered the owner of the trust, you will continue to be taxed individually on the trust income and gain. John B. O'Grady, Partner 804 775.1 023 [email protected] One lames Center LJ01 East Cary Street Richmond, Virginia 23219-4030 Mr. O'Crady's practice concentrates on estate and gift taxCltion, generation-skipping transfer taxes, estate planning, estate adlllillistration, and chancery litigation. He is it Fellow ofThe ,'\mericctn College of Trust and Estate Counsel, a member of the Legislative Committee for the Trusts and Estates Section of the Virginia Bar Association, and past chair 01' the Virgtnia Stale Bar Trusts and Estates Section. Benjamin S. Candland, Associate 804.775.1047 hcand land@' rncgu i rev'lOods .com One James Center 901 East Cary Street Richmond, Virginia 23219-4030 /v\r. Clildland's practice involves est;itc planning, estate administration, estate and gift taxation, ami chancery litigation. f Ie: provides inclividual clients with advice on varioLis estate planning ma.tters involving estate, gift. ami generatiun-skipping transfer taxes. Estate Tax Changes Past, Present and Future Charting the rates, Planning for mates, Watching the states, Handling the waits, And predicting the fates Of the effective dates. Featuring John B. O'Grady McGuireWoods LLP One James Center 901 East Cary Street Richmond, Virginia 23219-4030 . Telephone: (804) 775-1023 Facsimile: (804) 698-2132 E-mail: [email protected] © Copyright 2011 by McGuire Woods LLP. All Rights Reserved. Estate Tax Changes Past, Present and Future Table of Contents I. The Turbulence Created by the 2001 Tax Act.. ............................................................. l A. The Phase In and Out of EGTRRA ......................................................................... 1 B. The Gift Tax ............................................................................................................ 1 C. The State Death Tax Credit. .................................................................................... 1 D. Carryover Basis ....................................................................................................... 2 E. Three Shall Nots and One Had Never Been ........................................................... 3 II. Past Reminiscences ........................................................................................................ 5 A. The World War I Era .............................................................................................. 5 B. The Kennedy-Johnson Studies and the Nixon Administration ............................... 5 C. The Ford Administration ......................................................................................... 6 D. The Reagan Adnlinistration .................................................................................... 6 E. The Clinton Administration .................................................................................... 8 III. Republican-Led Efforts to Repeal or Reform .............................................................. 10 A. Early Efforts After 2001 To Make Repeal Permanent.. ........................................ 10 B. RepOlis of Compromise Efforts ............................................................................ 11 C. The 2004 Election ................................................................................................. 11 D. The Final Push for Repeal or Compromise ........................................................... 12 E. PETRA .................................................................................................................. 13 F. ETETRA ............................................................................................................... 14 ( G. Adjournment ......................................................................................................... 15 IV. Reassessing the Likelihood of Repeal ......................................................................... 15 A. Milestones in the History of the Repeal Movement ............................................. 15 B. What Might Have Been ........................................................................................ 16 V. "Options" Presented by the Joint Committee Staff.. .................................................... 17 A. Perpetual Dynasty Trusts ...................................................................................... 17 B. Valuation Discounts .............................................................................................. 18 C. Lapsing Crummey Powers .................................................................................... 19 D. Consistent Basis .................................................................................................... 20 E. 529 Plans ............................................................................................................... 20 VI. "Middle Class" Focus Under Democratic Leadership ................................................. 20 A. The Fiscal 2008 Congressional Budget Resolution (March 2007) ....................... 20 B. The Fiscal 2009 Congressional Budget Resolution (March 2008) ....................... 24 C. Finance Committee Hearings ................................................................................ 25 VII. The Incredible One-Hundred-Eleventh Congress ........................................................ 27 A. The First Pomeroy Bill (H.R. 436) ....................................................................... 27 B. The Arithmetic of the Estate Tax .......................................................................... 28 C. The Obama Administration's Fiscal 201 0 Budget Proposal. ................................ 29 D. The Fiscal 2010 Congressional Budget Resolution .............................................. 29 E. The First Baucus Bill (S. 722) .............................................................................. 30 - 11 - F. The