The use of installment sales to grantor trusts, installment sales to non-grantor trusts, and private annuity sales to grantor trusts are popular estate planning techniques, simultaneously involving three separate tax regimes: the income tax, the gift tax and the estate tax.

An irrevocable grantor trust is treated as a separate entity for the Federal gift and estate taxes, while at the same time the irrevocable grantor trust is the practical equivalent of a disregarded entity for the Federal income tax purposes. The income tax issues relating to estate planning techniques using grantor trusts are complex because the separate tax regimes have inevitable overlap. The income tax treatment, such as the step-up in basis at death under Section 1014, the treatment of income in respect of a decedent under Section 691 and the treatment of gifts under Section 102, need to be coordinated with the transfer taxes. The speakers will address the income tax issues that arise when a grantor trust becomes a non-grantor trust, and when a non-grantor trust becomes a grantor trust, focusing on the income tax treatment when a grantor dies while the grantor trust’s note obligation remains outstanding. The proper resolution of the income tax, gift tax and estate tax issues has received considerable attention with the issuance of CCA 2009-23-024 and the misinterpretation of the CCA by commentators in their attempts to resolve these income tax issues.

The speakers began by covering the fundamental income tax principles used to resolve transactions dealing with assets encumbered by liabilities, identifying the income tax issues that arise when liabilities, including seller-provided financing, are part of a sale transaction and the issues arising when encumbered assets are transferred by gift and at death. The anomaly is that a transaction treated as a sale for adequate consideration for gift and estate tax purposes is not a sale for the income tax. The speakers hope to resolve the confusion about the income tax consequences when the grantor trust sale becomes an income tax realization event, either while the grantor is alive or upon the grantor’s death.

In 60-90 minutes, the speakers offered practical advice on:

• Whether the termination of grantor trust status by reason of the grantor’s death, where all of part of the trust’s note obligation remains outstanding, requires the realization and recognition of gain. And, in the unlikely event that gain is reported, identifying the person responsible for reporting that gain.
• Whether the conversion of a non-grantor trust to a grantor trust while the grantor is alive is treated as an income tax termination of the deferred payment obligation, resulting in gain recognition for the gain previously deferred under the installment method.
• Whether the grantor’s lifetime transfer of an installment note issued by a grantor trust to a person who is not the grantor of the trust is treated as an income tax disposition that requires the reporting of gain.
• When grantor trust status terminates by reason of death, whether the trust’s income tax basis in the asset purchased from the grantor of a grantor trust is (i) a carryover basis; (ii) a tax-free step-up in basis under Section 1014; (iii) a cost basis for an asset acquired by purchase; or (iv) something else.
• Whether there is there income in respect of a decedent when the grantor dies.
• The surprising income tax exposure if the grantor’s liability to pay the income taxes on the grantor trust’s income is toggled off while the grantor is living.

Educational Objectives

Upon completion of the program, participants were able to:

• Understand the income tax results when grantor trust status is “turned off.”
• Advise clients on how to avoid income tax realization events when there is a change in grantor trust status.
• Minimize the tax risks when making sales to grantor trusts.

Jerome M. Hesch, Carlton Fields; Jonathan G. Blattmachr, Eagle Advisors; Mitchell Gans, Hofstra University School of Law; Elliott Manning, University of Miami School of Law