HOT TOPICS
UNDER THE 2001 TAX ACT AND TRANSFER PLANNING
GRANTOR TRUSTS INCLUDING
GRANTOR RETAINED INTEREST TRUSTS AND
INTENTIONALLY DEFECTIVE GRANTOR TRUSTS
by Michael V.
Bourland
Jeffery N. Myers
Bourland, Wall & Wenzel,
A Professional Corporation
Attorneys and Counselors
City Center Tower II
(817) 877-1088
(817) 429-3945 (metro)
(817) 810-0463 (facsimile)
mbourland@bwwlaw.com
(Email)
Presented to
Eleventh Annual Advanced ALI-ABA Course of Study
ESTATE PLANNING FOR THE FAMILY BUSINESS OWNER
Thursday – Saturday
© Bourland, Wall & Wenzel, P.C.
100120
BIOGRAPHICAL INFORMATION
MICHAEL V.
BOURLAND
EDUCATION
B.A.,
J.D.,
LL.M. in
Taxation,
PROFESSIONAL ACTIVITIES
Founding
Shareholder - Bourland, Wall &Wenzel, P.C.
Board
Certified (Estate Planning and Probate Law) –
Fellow,
Former
Member, Real Estate, Probate and Trust Law Council (State Bar of
ACADEMIC APPOINTMENT AND HONORS
Guest
Lecturer in Estate Planning at
The
Center for American and International Law
University
of
JEFFREY N.
MYERS
EDUCATION
B.A.,
J.D.,
LL.M.,
PROFESSIONAL ACTIVITIES, ACADEMIC APPOINTMENT AND HONORS
Shareholder - Bourland, Wall &Wenzel, P.C.
Board Certified (Estate Planning and
Probate Law) –
Adjunct
Instructor 1998-1999 –
Guest
Lecturer in Estate Planning at
Notre
Dame Tax and Estate Planning Institute
State
Bar of Texas – Advanced Estate Planning & Probate
Table
of Contents
I. Introduction............................................................................................................................... 1
A. What is a Grantor Trust......................................................................................................... 1
B. History.................................................................................................................................. 1
C. Common Types of Grantor Trusts.......................................................................................... 2
II. Grantor Trust Rules................................................................................................................... 3
A. §671 Trust Income, Deductions, and Credits
Attributable to Grantors and Others as Substantial Owners 3
B. §672
Definitions and Rules................................................................................................... 3
C. §673
Reversionary Interests................................................................................................. 4
D. §674 Power to
Control Beneficial Enjoyment........................................................................ 4
E. §675
Administrative Powers................................................................................................. 6
F. §676 Power to
Revoke........................................................................................................ 6
G. §677 Income for
Benefit of Grantor...................................................................................... 6
H. §678 Persons
other than Grantor Treated as Substantial Owners........................................... 7
III. Using the Grantor Trust......................................................................................................... 7
IV. GRANTOR RETAINED INTEREST TRUSTS.................................................................... 7
A. Introduction........................................................................................................................... 7
B. Section 2702:
General Rule, Definitions, and Exceptions........................................................ 8
C. Qualified Interests.................................................................................................................. 8
D. Examples............................................................................................................................ 11
E. Exceptions to Section 2702................................................................................................. 12
F. Certain Property Treated as Held in Trust............................................................................ 13
G. Tax Consequences.............................................................................................................. 13
H. Transfers of Retained Interest in Trusts................................................................................. 16
I. Planning Considerations....................................................................................................... 18
J. Personal Residence Exceptions – Personal Residence
Trust (PRT) and Qualified Personal Residence Trust (QPRT) 21
V. Intentionally Defective Grantor Trusts....................................................................................... 26
A. Introduction......................................................................................................................... 26
B. What is the Intentionally Defective Grantor Trust?................................................................ 27
C. Creating the IDGT............................................................................................................... 27
D. IDGT Taxation.................................................................................................................... 28
E. IDGT Sale.......................................................................................................................... 28
wealth migration using family limited
partnerships, grantor trusts,
and associated techniques
The grantor trust, over recent years, has been transformed from a trust to be avoided to a trust embraced as the “new” tool utilized by estate planning practitioners to migrate wealth from one generation to the next. By utilizing the grantor trust correctly the practitioner can assist his or her client in migrating wealth from one generation to the next with minimal transfer tax costs; however, without a clear understanding of the grantor trust rules which drive this wealth migration techniques, an unwary practitioner can create unintended income, gift and estate taxation.
A grantor trust is a trust under which the grantor or someone other than the grantor is treated as the “owner” of the trust assets for tax purposes, specifically income tax, under §§671 through 679 of the Internal Revenue Code of 1986, as amended (hereinafter referred to as “IRC” or the “Code”).
From 1924 through 1939 the United States tax laws attacked piecemeal the perceived abuses of taxpayers who sought to shift income from high tax brackets to lower tax brackets by creating trusts and retaining sufficient control to assure the grantor’s continued dominion over the trust assets and transactions. The 1939 codification of the tax laws into the Internal Revenue Code expanded the definition of gross income and the recodification of the tax laws in 1954 adopted the current grantor trust rules in substance. Over that time period there are two cases most practitioners associate with the grantor trust rules:
•Helvering v. Clifford, 309
•Mallinckrodt v. Nunan,
146 F.2d 1 (8th Cir. 1945), aff’g 2 T.C. 1128 (1944 cert. Denied,
324 U.S. 871 (1945)
a.
In Helvering v. Clifford, Mr. Clifford funded an irrevocable
trust with securities "for the exclusive benefit" of his wife and
declared himself to be trustee. As trustee, Mr. Clifford retained the right to
make discretionary distributions of trust income to his wife, along with
several important powers, including the power to: (1) vote the shares held by
the trust; (2) "sell, exchange, mortgage, or pledge" the stock and
any other trust properties, in whole or in part, and for such consideration and
under such terms as the trustee, in his sole discretion, should determine
appropriate; (3) invest the trust assets by loans, whether secured or
unsecured, in bank accounts, or by the purchase of any type of personal
property, without restricting the speculative character of the investments or
the rate of return, or any applicable state laws regarding trust investments;
(4) collect all trust income; (5) compromise and settle claims held by the trust;
and (6) hold property in the trust in names of "other persons or in"
the trustee's own name "as an individual." As trustee, Mr. Clifford
had no liability for losses to the trust assets except those which he caused by
"willful and deliberate" breaches of his fiduciary duty. The trust
terminated at the end of five years, at which time it was to pay the principal
to the grantor and treat any proceeds from the investment of the net trust
income as the separate property of the grantor's wife. Mr. Clifford paid a gift
tax on the trust's creation.
b.
The IRS contended that the general concept of gross income was
sufficiently broad to tax the grantor on the trust income. The Supreme Court
agreed and reasoned that the grantor should be taxed on the trust income because
the facts demonstrated that the entire trust arrangement was no more than a
"temporary reallocation of income within an intimate family group."
309
c.
Treasury promulgated the so-called "Clifford regulations" in
1946, based on the Supreme Court's interpretation of the gross income concept.
The regulations taxed the grantor on a trust's income if the trust corpus or
income would or might return to the grantor after a short term of years. This
could occur either by the grantor retaining a reversionary interest that would
vest within 10 years or less, or certain administrative powers that would vest
within 15 years. The grantor could also be taxed if the grantor or a nonadverse
person (or both) had a power of disposition over the beneficial enjoyment of
corpus or income. Finally, the grantor could be taxed if the grantor retained
any of a series of broad administrative powers primarily for the benefit of the
grantor. Section 29.22(a)-21; Treas.
Dec. 5488, 1946-1 C.B. 19.
a.
Mallinckrodt involved a trust established by the taxpayer's father to provide for
the taxpayer's mother and her children. The trust instrument designated the
taxpayer as co-trustee along with a corporate trustee. The trust instrument
directed net income first to the payment of certain debts and obligations
arising out of a building enterprise, and next to fund a $10,000 annuity for
the taxpayer's mother during her lifetime. Finally, the trustees could pay any
additional net income to the taxpayer upon his written request. Furthermore,
the taxpayer could request in writing that the trustees distribute principal to
him during his life, even to the extent of terminating the trust in his
favor. The trust recognized income in
excess of the amounts used to discharge debts and expenses and to pay the
$10,000 annuity to the grantor's wife, but the taxpayer did not actually
request distribution of any income or principal to him. The IRS contended that,
notwithstanding his failure to request distribution, the taxpayer should be
taxed on trust income to the extent he could have required its distribution.
The Tax Court agreed in a split decision and the Eighth Circuit affirmed. The Tax Court noted that, had the taxpayer
been the grantor, he clearly would have been taxed on trust income under the
grantor trust rules then in effect and under Clifford. The fact that a third
person held these powers, the court reasoned, should make no difference, since
these rules were based on the concept of gross income. The Eighth Circuit
agreed, equating the power to dispose of income with the receipt of the income.
b.
Since the 1954 Congress has been adjusting the grantor trust rules
providing us with what is now in under §§671 through 679 Code.
There are two common types of grantor trusts:
«Grantor Retained Interest
Trusts, including
Grantor Retained Income Trust
Grantor Retained Annuity Trust
Grantor Retained Unitrust
Personal Residence Trust
Qualified Personal Residence Trust
«Intentionally Defective
Grantor Trust
Under
section 671 a grantor or another person includes in computing his taxable
income and credits those items of income, deduction, and credit against tax
which are attributable to or included in any portion of a trust of which he is
treated as the owner. Sections 673 through 678 set forth the rules for
determining when the grantor or another person is treated as the owner of any
portion of a trust. Section 1.671-3 outlines the rules for determining the
items of income, deduction, and credit against tax that are attributable to the
trust.
Below
is a list of the IRC §§671-679 grantor trust rules.
§671 Trust Income, Deductions, and Credits
Attributable to Grantors and Others as
Substantial Owners
§672 Definitions and Rules
§673 Reversionary Interests
§674 Power to Control Beneficial Enjoyment
§675 Administrative Powers
§676 Power to Revoke
§677 Income for Benefit of Grantor
§678 Persons Other Than Grantor Treated as
Substantial Owners