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Installment Sales to Intentionally Defective Grantor Trusts - YouTube
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hi my name is Jeremy Greene director of
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advanced planning for CBS brokerage
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today I'm going to discuss a technique
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called the installment sale to an
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intentionally defective grantor trust or
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Egypt the technique is used with
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business owners who have federally
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taxable States who wish to transfer
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assets off balance sheet without the use
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of lifetime exemption for those of you
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in the wealth management business or who
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do high in life insurance work there
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will also be opportunities to
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demonstrate skill expertise and concern
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for clients while also generating new
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business so one of the things we want to
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cover really quick is why do sales
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versus a gift gifting is pretty simple
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right well any gift you know that you
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file any gift over 15,000 not to file a
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gift tax return anytime you the the gift
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tax return is filed any dollar above
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that amount reduces the lifetime
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exemption dollar-for-dollar when you
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increase the lifetime exempt or decrease
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the lifetime exemption you also increase
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the taxable estate when you increase
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this taxable estate you increase these
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state taxes so really what have you
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accomplished where the gift is you
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really don't win on the gift itself you
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win on the future appreciation you got
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off the balance sheet well that can be
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achieved with a sale without using the
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lifetime exemption so when you sell
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something sell an asset to get it you
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get you get something back payments for
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those those assets and really just the
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future appreciation gets off the balance
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sheet without used to lifetime exemption
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as I said and you also get control of
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the principle but the principle that the
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grantor does and also the grantor may
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actually wish to get something in return
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for something as well so that's reasons
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for looking at a sale no a sale can
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cause problems too except when
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especially unique situations where you
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would be couldn't maybe you could solve
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something too much trust for example and
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not have to pay the tax on that sale so
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we could do all the things I just said
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without the downsides of paying a tax
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now business owners typically have
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depreciated most of the of their cost
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base out of the business so that's very
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important that we consider that so I'm
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going to demonstrate a technique that
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allows us to sell something without
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creating the tax of the sale and do you
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achieve the objectives I meant
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so very simply this technique is very
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basic in the sense that we're going to
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transfer an asset to the trust let's say
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it was just a million dollars for a
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round number okay and we're going to get
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a note back for that same 1 million and
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we also have to pay ourselves an
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interest rate that the government says
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is it's called the AFR rate and that
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rate is 1% the only question of is can
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the assets that we sold and transferred
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to the trust beat that 1% numbers by
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income or capital appreciation or some
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combination and if it does that means
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that that leftover will accrue inside
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this trust to the beneficiaries of this
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trust okay
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gifting estate tax free so now I'm going
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to show you a real-life example of that
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transaction so first of all in real life
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the client probably has if they have a
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federal taxable estate they may already
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have a trust for example they might have
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an eyelid or wente number of things and
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the question is is it intentionally
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defective already if it is we can we can
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we can enter into this transaction
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simply signs to something to an existing
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trust that is already funded it has to
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have economic substance in this trust to
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be otherwise be a sham transaction no
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one would sell something to it to a
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person or an entity that didn't have any
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money to pay it back right the IRS knows
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that so effectively we have to at least
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have 10% of the transaction funded in
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the trust as seed money they call it so
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in this example number 10 that we have
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to set up a new trust but if a client
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didn't have a real trust already wecbs
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would help you we would review that
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trust document to identify for it
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already is in digit we should work with
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that otherwise alternatively we can take
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an existing trust that isn't an idjit
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and make sure that we could administrate
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elite add certain powers to make it an
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intentionally defective grantor trust
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what I'm talking about here is it says
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Ministry of a trust modification but
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let's assume now that we're setting up a
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new trust and we're going to fund money
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into its system so that
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economic substance in this example we
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want to send so we want to do eight
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million dollar transaction so eight
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million dollars of business interests
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we're first going to seat 800 thousand
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of it and we're going to take seven
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twenty two million dollars and sell a
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note for a note into this into this
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trust so seven point two nine dollar
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business interest for a seven point two
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dot point two million dollar note so
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we're we're getting back we put in no
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gift and we need to pay yourselves back
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that one percent I talked about that's
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that's seventy two thousand of the seven
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point two nine d'Arnaud so seven seventy
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two thousand when the trust is producing
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ice in here six hundred and forty
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thousand dollars of income so that means
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the difference between that six forty
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and seventy two is available to
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accumulate inside that trust due to any
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number of things we could have asked us
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under managed we're gonna manage we
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could buy life insurance and let's just
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look at what that would do if we did buy
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life insurance we could take two hundred
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thousand of that and buy an eleven
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million dollar death benefit so we have
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leverage on top of leverage now this
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first part of the transaction saved the
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clients money on the state taxes we
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should always look to reduce the the
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taxable estate first and reduce them the
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taxes that we can and then secondarily
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find a way to pay for whatever is left
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but in this example estimated that we've
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saved three million two hundred thousand
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dollars and the state taxes just from
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this first part of the transaction from
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the accumulation there would be 7.2
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million dollars of assets either shares
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of the business or actual cash
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accumulated in here I mean if anything
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else we simply take the shares we can
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should we sold here and pay ourselves
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back you can pay the note back in kind
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and just have accumulated the income in
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here and I would do that and that's how
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we get you know seven point two nine
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dollar assets at a forty percent rate
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it's about thirty two hundred thirty
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three million two hundred thousand I'm
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sorry and we also leverage some of that
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money to buy a life insurance policy now
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this is a great technique right where I
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just showed you for an exit strategy for
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premium financing to for those of you
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who do any kind of insurance work or run
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into
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who has that situation going on when you
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premium financing you basically have an
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insurance policy here that's that is
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taking loans instead of sales to a trust
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to get around think the lifetime
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exemption use and the there's usually
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the collateral inside that insurance
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policy is being used too much to pay out
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the note but that may not be that mean
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I'm working that's not recommended you
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should have other ways of getting funds
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in there to offset the collateral
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requirements the client has and this is
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certainly one of the best techniques for
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that now there is a downside this
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transaction we have to consider I
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wouldn't call it downside by the risk
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the assets that the clients sold the
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reason why it wasn't taxable in the
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first place is that this the tax ID of
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this trust ultimately flows back to the
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grantor so it doesn't a separate tax
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number it will need to be a separate tax
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filing for that trust but it will flow
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back to the grantor so numbers he sold
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an asset to himself effectively and
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that's not an taxable event that's why
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there's no tax on the sale or the
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interest payments to the grantor because
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he's effectively going to pay tax on the
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income of the trust anyway as if it was
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on his balance sheet so think about that
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all the businesses retransferred he was
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paying tax on before he did his transfer
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he maintains the tax liability of those
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trusts so he has to have or she has to
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have the wherewithal to pay the taxes of
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from this trust without the cash flow
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from the trust okay so you do need
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somebody who's got that economic
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wherewithal to do that now if for some
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reason he wants to eat that's not
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tolerable over time or doesn't want to
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if there's a homerun hit let's say we
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transferred 8 million of discounted
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valuation by the way when we transfer
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these shares we get a valuation discount
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on that 8 million it was really 11
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million dollars in fair market value in
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that right here we go and that's true
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because you get discounts on a transfer
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of business for lack of marketability
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and closely minority interests so we're
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assuming as a minority interest here so
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even on the transfer initially the
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business interest at a 30 percent
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discount we kind of we already want
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against that one
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interest rate so there would be a
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remainder in there excuse me
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so let's go on to what what powers make
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this not taxable how do you know if it's
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an intentionally defective grantor trust
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there's there's about 16 different
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powers that can make something either
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partially or wholly intentionally
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defective without getting into the weeds
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on that but there's the nested three of
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them that are very popular that's the
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ability for the grantor to swap assets
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with the trust items on his balance
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sheet this is actually very useful
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because for for cost basis planning we
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might want to get swap assets in the
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trust so that we get step up and paces
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on items in this balance sheet so if he
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sold something on his balance sheet no
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he's a high basis he might want to swap
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something for the little bases in the
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trust and can do some continuous do
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continuously do that the ability for a
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non adverse party to add class of
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beneficiaries and the trustee the
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ability to loan money to the grantor
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forever with and without adequate
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security there's some powers that we
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would add that don't impact this digit
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status one of things that we would like
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to you should always add the ability to
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surrender these powers so that we can
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turn off the taxation to the grantor and
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that is that provides some flexibility
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down the road should he or she decide
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that that's kind of not something they
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want to do for forever also we could
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make a spouse a permissible beneficiary
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of the trust so that the trustee has
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broad discretion to basically unwind
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this whole transaction and bring the
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assets back to the grantors balance
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sheet if they would chose to we use mind
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mapping software as a project manager
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software to coordinate and collaborate
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with you dear accountants the attorney
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whoever and kind of manage the project
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if we want us to or not it's just
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something that's available and also if
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you have any cases we'd love to work
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with you here's our telephone number you
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can also email me Jeremy at CBS
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brokerage donut thank you for watching
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this video hope to hear from you
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