Mending Wayward Wealth
Strategies
John F. Bergner
Winstead P.C.
jbergner@winstead.com
5603975
Popular Techniques
• Grantor Retained Annuity Trust (“GRAT”)
• Installment Sale to Grantor Trust
• Qualified Personal Residence Trust
(“QPRT”)
Five Ways for Plans to Go Awry
• Bad design
• Economic changes
• Mortality changes
• Client’s wishes change
• Bad administration
Purpose of Presentation
• Discuss ways in which techniques may go
astray
• Discuss potential solutions and planning
considerations
• Consider drafting strategies to reduce,
eliminate or cope with problems or take
advantage of opportunities
GRATs
• Statutory technique
• Grantor must survive GRAT term
• Appreciation in excess of 7520 rate
Year
20
10
20
09
20
08
20
07
20
06
20
05
20
04
20
03
20
02
20
01
20
00
19
99
19
98
19
97
19
96
19
95
19
94
19
93
19
92
19
91
19
90
19
89
Section 7520 Rate
Section 7520 Rates
May 1989 - November 2010
14%
12%
10%
8%
6%
4%
2%
0%
Two Year GRAT
Stock with a
value of
$1,000,000
Value of
Remainder
Gift to
Children =
$1*
Grantor Retained
Annuity Trust
Annual annuity
payments to
Parent for the 2
year term total
$1,031,024
At the end of the 2 year term, the remaining trust
assets are distributed to children. With 25% annual
growth, $414,314 will be shifted to children.
Requirement: Parent must survive 2 year term
*Gift is computed under Walton case, using November
2010 Section 7520 rate of 2.0% and annuity payments
increasing by 20% per year
GRAT – Bad Design #1
• Incorrect Annuity Percentage - Transpose
annuity amounts
• Be careful
• Judicial modification or trust construction
• Proofread trust agreement
• Include savings clause
GRAT – Bad Design #2
• Trust agreement omits a necessary provision:
– Prohibition of commutation
– Prohibition of payment of annuity with a note
(9/99)
– Rely on savings clause
– Limited power to amend
– Judicial modification
GRAT – Bad Design #2
(continued)
• Trust agreement omits a necessary provision
• Drafting suggestions:
– Scrutinize GRAT forms
– Do red-lined comparison to trusted form
– Utilize a checklist
GRAT – Bad Design #3
• Law requiring minimum 10-year term effective
before (or same day) shorter term GRAT is
funded
– Apply to GRATs funded on or after “enactment date”
– Drafting suggestions:
• Include a provisions that automatically increases GRAT term
to minimum requirement; or
• Include provisions that Grantor may amend or revoke the
GRAT
GRAT - funded with problem assets
#1
• Interest valued under Section 2701
– Make 2701 elections to give substantial value to
preferred interest
OR:
– Avoid 2701 interests
– Transfer a “vertical slice”
– Computation of annuity amounts
GRAT – Economic Changes #1
• Burnt-out GRAT
•
•
•
•
Swap and re-GRAT
Sale to grantor and re-GRAT
Re-GRAT the annuity interest
Do nothing
• Drafting Suggestions:
– include a swap power
– Omit or modify spendthrift clause
– omit prohibitions against self-dealing
GRAT – Economic Changes #2
• “Home Run GRAT” - assets perform well
• Lock-in wealth shift:
–
–
–
–
Swap GRAT assets for less risky assets
Sell the appreciated GRAT assets
Purchase a collar on publicly-traded security
Pay annuity amounts as early as possible
• Drafting Suggestions:
– Include a swap power
– Omit prohibitions against self-dealing
GRAT – Mortality Issue #1
• Grantor’s life expectancy diminishes
– Early death may cause GRAT assets to be included in
grantor’s estate
• Possible Solutions:
• Grantor purchases remainder interest
• Separate grantor trust purchases GRAT assets for a private annuity
or SCIN
• Beneficiaries purchase assets from GRAT
• Carefully consider doing nothing – 2010
•
•
•
•
DRAFTING SUGGESTIONS:
Omit or modify spendthrift clause
Omit self-dealing prohibitions
Ensure grantor trust status
GRAT – Client Wishes Change #1-3
• Grantor desires to shift fewer assets to remainder
beneficiaries
• Grantor’s liquidity needs change
• The objects of the grantor’s bounty change
GRAT – Bad Administration #1
• Failure to timely make annuity payments
• Pay annuity as soon as possible with interest
• Drafting Suggestion:
– Include an agency provision (p 29-30)
GRAT – Bad Administration #2
• GRAT is funded on multiple dates
• Treat as two GRATs
• Return all contributions other than the first to the
grantor
• Treat cash as a loan
• Drafting Suggestions:
– Include a revocation provision
– Include a re-characterization provision
GRAT – Bad Administration #3
• Grantor pays GRAT’s expenses
• Risk of deemed additional contributions
• Repay the Grantor with interest
• Treat payment as a loan
• Drafting suggestion:
– Include re-characterization provision
Other GRAT problems – potential
solutions, drafting suggestions
• Funding after 7520 rate changes
• GRAT never properly funded
• Failure to elect out of automatic allocation of
GST exemption
• Failure to document GRAT transactions
• Failure to adequately report on 709
Other GRAT problems – potential
solutions, drafting suggestions
– GRAT funded with non-vested stock options
– GRAT funded with stock options that may violate
SOGRAT patent
– GRAT funded with community property
– GRAT funded with Insider Stock
– GRAT funded with Section 2036(b) stock
Installment Sales to Grantor
Trusts
(“ISGTs”)
Installment Sale to Grantor Trust
(ISGT)
• Popular wealth shifting technique
• $5MM asset appreciate to $20MM?
• IRS is a partner in growth (45% ?);
• Effectively converts assets with high income or appreciation
potential into fixed-yield, non-appreciating assets (low
interest rate Note)
• Unlike a GRAT, effective for leveraged GST planning
Installment Sale to Grantor Trust
Parent
$10MM
assets
$1MM
Cash Gift
1% GP &
99% LP
Interests
Limited Partnership
(owning $10MM assets)
Grantor Trust
for Descendants
Installment Sale to Grantor
Trust
Parent
Sale of limited
pshp. interests (99%)
$1MM
Cash & $6MM
installment
note
Limited Partnership
(owning $10MM assets)
Grantor Trust
for Descendants
Resulting Ownership
Parent
$6MM
Installment
Note
1% GP
Interest
Grantor Trust
for Descendants
99% LP
Interest
Limited Partnership
(owning $10MM assets)
Five ways for ISGTs to go awry
• Bad Design
• Economic changes
• Mortality changes
• Client’s wishes change
• Bad administration
ISGT – Economic Changes #1
• Underwater transaction
•
•
•
•
Renegotiate the note
Contribute the note to a GRAT
Sell the note to a grantor trust
Unwind the transaction
• Drafting Suggestions:
– Eliminate duty to diversify
– Permit prepayment of note
– Limit guarantees
ISGT – Economic Changes #2
• Transferred assets perform well - the
“home run”
• Lock in wealth shift:
– Prepay the note
– Swap for a less risky asset
– Sell the appreciated asset
• Drafting Suggestions:
– Include a swap power
– Omit prohibitions against self-dealing
ISGT – Economic Changes #3
• Transferred assets perform too well the “grand slam home run”
• Limit further wealth shift:
–
–
–
–
Exercise swap power
Sell assets back to Grantor – tax free
Add or change beneficiaries
Turn off grantor trust status
• Drafting solutions:
•
•
•
•
Include a “waterfall” provision
Draft to facilitate grantor trust termination
Include power to lend to grantor
Permit 3rd party to change beneficiaries
Potential
benefit of
waterfall
provisions
ISGT – Mortality Issue #1
• Seller’s life expectancy diminishes
• Problems:
– Future interest payments taxable
– Continuing debate – tax consequences when holder of
installment note dies
• Possible Solutions:
–
–
–
–
–
Pay off note before death
Keep note in place (possible discount in Seller’s estate)
Sell note for an annuity
Restate the note as a SCIN
Exchange low basis assets in trust for high basis assets owned by seller
Other ISGT problems – potential
solutions, drafting suggestions
• 3 problems relating to:
– “clients wishes have changed”
• 6 problems relating to:
– “bad administration”.
Qualified Personal
Residence Trust (“QPRT”)
QPRT Example
Value of Gift =
$390,430
Qualified Personal
Residence Trust
Amount Passing
Tax-Free $609,570
Client Home
(plus appreciation )
$1,000,000
Client retains
the right to
live in the
home for
20 years
At end of 20-year term, Home is distributed to children - tax-free
Requirement: client must survive 20-year term
Assumptions: client is age 60; retains reversion if death occurs before trust
terminates; Section 7520 rate is 2.0% (November 2010)
QPRT – Problems
• Grantor/trustee powers too broad
• Impecunious grantor
• Grantor’s life expectancy reduced
• Grantor stays too long
QPRT – Bad Administration
• Grantor stays too long
• Grantor continues to live in the residence after
the QPRT term without paying rent.
• Grantor should sign a lease and pay “back rent”
• Drafting Suggestion:
– QPRT should grant Grantor right to lease residence;
lease should be signed before QPRT terminates