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Situation
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Corporate or partnership freeze
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Installment sale to a grantor trust
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Transfer to a grantor retained annuity
trust (GRAT)
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The property increases in value after
the transfer
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Most effective. The use of the four-year
grace period for required distributions may allow you to shift the maximum
appreciation amount.
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Very effective. Assuming no principal
payments are required in the first few years, you may shift almost all
of the appreciation.
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Effective. Some leakage in the shifting
of growth is possible if making distributions to the grantor during the
early years of the trust term.
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The property decreases in value after
transfer
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Ineffective. If value falls below the
value of the retained applicable interest, no value is shifted. Even the
value of the initial gift may be lost.
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Marginally effective. If you can anticipate
the loss of value, the installment note may be prepaid by distribution.
If the trust becomes insolvent, you receive no gift back.
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Ineffective. If the annuity payments exceed
the remainder value of the trust property, you shift no value, and the
gift’s leverage is lost.
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The risk that the transaction’s structure
may be challenged by the Internal Revenue Service (IRS) on audit
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Fairly safe. You must follow the guidelines of Code Section 2701. Missing
any of the requirements could result in an unintended taxable gift.
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Risk must be considered. No Code section,
regulation, public ruling or case specifically approves aspects of the
transaction.
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Greater safety. You must follow code provisions,
regulations and proposed regulations. You also need to consider IRS ruling
positions on GRATs.
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The consequences of IRS adjustment of
valuation
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Worst result. A gift occurs to the holders
of the nonforeign interest. An increase in value may also cause a transaction
to be subject to special value rules, and you may owe a gift tax.
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Uncertain. If the installment note can
be automatically increased, a gift may not result. Revaluation clauses
are not favored by IRS, but some authority for them exists.
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Good result. The annuity payment should
be increased per the trust agreement, resulting in no increase in the
gift and no additional gift tax.
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Special concerns created by the new rules
on the gift tax statute of limitations
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Little impact. Generally, a gift tax return
is required and if the transaction is adequately disclosed, then the three-
or six-year statute of limitations will be applicable.
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Significant impact. If structured as a
sale for fair market value, there should be no apparent gift. If you don’t
file a gift tax return, the statute of limitations will not start. If
the IRS determines on a valuation issue that a gift occurred, you could
owe interest and penalties.
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Little impact. You must file a gifttax
return. A proper reporting of the transaction on the gift tax return starts
the statute of limitations.
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Flexibility of administration of annual
payment to the transferor
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Limited. The ability to defer your required
payment for up to four years gives you limited flexibility in administrating
cash flow.
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Flexible. The installment note can provide
for the deferral of interest or principal payments and may also provide
a right to prepay or accelerate interest and principal.
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Inflexible. The annuity must be paid each
year, and if cash is not available then a distribution should be made.
Making a loan to the GRAT to pay the annuity would disqualify the GRAT.
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The impact of the transferor’s early death
on the transaction
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Little effect. Appreciation from date of transfer to date of death is
out of your estate.
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Uncertain. Unpaid note balance may be
income in respect to a decedent, and transferred property may be included
in your estate under a “retained interest” argument.
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Least favorable. The transferred property
(or possibly a portion of it) is included by statute in your estate.
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