Tansey Estate Planning

Protecting You and Your Loved Ones

Sale to Intentional Grantor Trust

An alternative to a GRAT is a sale of income producing property to an Intentional Grantor Trust for a note. A Grantor Trust is an Irrevocable Trust with one big difference: for income tax purposes: the trust does not exist. The Settlor is liable for the income tax owed by the trust. That means that the trust would be allowed to keep all of its income, and the Settlor would pay the trust’s income tax. The IRS’ position is that the Settlor is not making an additional gift to the Grantor Trust when it pays trust’s income, because the Settlor, by law, is liable for the payment of the Grantor Trust’s income tax. This allows for additional tax-free compounding and potential for greater leverage. For example if the Grantor Trust’s assets’ investment yield was 5% over 20 years, it would transfer approximately 50% more to the beneficiaries of a grantor trust than a trust that pays the combined federal and California income tax rate (about 40%).

The sale to a Grantor Trust is a Freeze Transaction. The seller receives a note that does not change in value in exchange for assets that will increase (hopefully) in value greater than the IRS minimum AFR interest rate over the time of the note. This is how the transaction works: the Settlor would contribute 10% of the value of assets he or she would contribute to the trust. Then, the Settlor would then sell the remaining 90% of the value of assets for an interest-only note for a maximum term of 20 years. Since the Settlor is considered the income tax owner of the trust, there are no income tax consequences when he or she sells the remaining 90% of the value of assets to the trust for a note. At the end of 20 years the principal would be paid.

The primary advantage of the sale to a grantor trust as compared to the GRAT is that the Settlor would not have to outlive the term of the note. However, the value of the note would be included in the Settlor’s estate. Correspondingly, the sale to a Grantor Trust has disadvantages to a GRAT: 1) if the IRS successfully challenges the value of the property contributed to the grantor trust, the Settlor would be liable for a taxable gift; and 2) if the value of the assets sold to a grantor trust decrease, rather than increase, in value, the transaction would be under water. The trust would have to pay interest on a note that was worth more than the asset in the Grantor Trust.

The Intentional Grantor Trust uses two Advanced Estate Planning Principles: Post Transaction Appreciation and the Responsibility to Pay Income Taxes on Gifted Property.