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Planning
Today for Today's LifeStyle.
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With historically low interest rates and a depressed stock market,
financial uncertainty seems certain. The current perfect economic storm
has everyone baffled. What about you? When it comes to the long-term
future of the U.S. economy, are you a bear or a bull? When
it comes to the long-term future of your personal wealth, do you believe
it will decrease or increase?
If you are bearish regarding the future of
your personal wealth (i.e. you believe it will decrease), then this
article will be of little interest to you. However, if you are bullish,
then you may want to consider the aggressive estate planning technique
introduced in this article.
Known in estate planning circles by a variety of
names, this technique involves the sale of a promissory note to an
intentionally defective irrevocable trust (hereinafter an IDIT
Sale). Under the right conditions, an IDIT Sale might help you freeze
the value of your estate now, so you can transfer more of its value later
on to your loved ones …instead of to the IRS.
The IDIT Sale
Like
most estate planning techniques, you must follow specific steps to
establish an IDIT Sale.
First, you sign a properly drafted IDIT. The term
irrevocable means that you cannot change the terms of the trust
once you sign it. The terms intentionally defective mean that you
retain certain rights or powers as the Grantor, even though the trust is
irrevocable. For example, you may elect to retain the ability to swap IDIT
Sale assets for other assets of equivalent value. As a result, trust
income, deductions and credits are attributed directly to you for income
tax purposes as if the trust did not exist.
Second, you make a gift to seed the trust.
This amount should be at least 10 percent of the value of the asset used
to complete the IDIT Sale. Depending on the value of the IDIT Sale asset,
this 10 percent gift may require use of a portion of your $1 million
Lifetime Gift Exemption to avoid paying gift taxes.
Third, you sell the asset to the IDIT in exchange
for a promissory note at fair market value. This promissory note should
bear interest at an Applicable Federal Rate (AFR) with a repayment period
within your anticipated life expectancy. [Note: AFR rates are determined
and published monthly by the IRS, based upon the approximate current yield
on U.S. Treasury obligations. Accordingly, they are often lower than
market rates on other assets like corporate stocks or bonds. The latest
AFRs are available at http://www.irs.gov/taxpros/lists/0,,id=98042,00.html]
The
Rewards
Properly
drafted and implemented, the IDIT Sale itself occurs with no gift taxes. You
also should enjoy significant asset protection and federal estate tax benefits.
From an asset protection standpoint, IDIT Sale assets should avoid the claims
of your creditors since you have no legal or beneficial right to them. Your
future federal estate tax liability should be reduced because you pay income
taxes on any income generated by IDIT Sale assets during your lifetime. Upon
your death, only the fair market value of the promissory note plus any accrued
interest should be included in your estate value at death.
The Risks
As with all aggressive estate planning techniques,
the IRS does not like the IDIT Sale. To make matters worse, there is neither an
Internal Revenue Code section specifically covering IDIT Sales, nor is there an
established body of case law upon which to rely. That said, what if the asset
you sell to the IDIT tanks or it generates less income that the AFR? Bottom
line: You must carefully assess all of the risks, along with the opportunities,
before you take on the perfect economic storm.
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