Presented By:
Robert S. Keebler, CPA, MST, AEP (Distinguished)
Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication, including attachments, was not written to be used and cannot be used for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein. If you would like a written opinion upon which you can rely for the purpose of avoiding penalties, please contact us.
© 2010 Robert S. Keebler, CPA, MST, AEP (Distinguished)
All rights reserved

Mathematics of Gifting & Inter Vivos Sales
WEALTH TRANSFER PLANNING OBJECTIVES

Minimize estate tax exposure

Minimize income tax exposure

Minimize creditor exposure

Maximize benefits to children and family

Take full advantage of the currently low interest rates
© Robert S. Keebler, CPA, MST, DEP
Virchow, Krause & Company, LLP
All rights reserved
2

Mathematics of Gifting & Inter Vivos Sales
CONFISCATORY NATURE OF ESTATE TAXES*
$2,925,000
$7,075,000
Estate Tax Family
*Assuming death occurs in 2011 with estate of $10 million (plus a $3,500,000 estate tax exemption and a 45% estate tax rate)
3

Mathematics of Gifting & Inter Vivos Sales
KEY STRATEGIES

Inter Vivos Gifts

Annual Exclusion Gifts

Unified Credit Gifts

Dynasty Trust

Grantor Retained Annuity Trust (GRAT)

Intentionally Defective Grantor Trust (IDGT)
 Self-Canceling Installment Note (SCIN)

Private Annuity
4

Mathematics of Gifting & Inter Vivos Sales
5

Mathematics of Gifting & Inter Vivos Sales
GENERAL RECOMMENDATIONS
• Make full use of the Unified Credit during lifetime
• Transfer highly-appreciating assets to a Grantor
Retained Annuity Trust (GRAT)
• Sell highly-appreciating assets to an
Intentionally Defective Grantor Trust (IDGT)

Installment Note

Self-Canceling Installment Note (SCIN)
• Sell highly-appreciating assets to future generations in exchange for a private annuity
6

Mathematics of Gifting & Inter Vivos Sales
CURRENT INTEREST RATES
Short-Term AFR
Mid-Term AFR
Long-Term AFR
IRC Sec. 7520 Rate
July 2010
0.61%
2.35%
3.94%
2.80%
August 2010
0.53%
2.18%
3.79%
2.60%
September
2010
0.46%
1.94%
3.66%
2.40%
7

Mathematics of Gifting & Inter Vivos Sales
8

Mathematics of Gifting & Inter Vivos Sales
TAX EXCLUSIVE NATURE OF GIFTS
• Gift tax to the donor is calculated by the gift passing to the donee after the imposition of gift tax
• Estate tax is calculated based on the total taxable estate, regardless of the net amount passing to the beneficiaries of the estate
9

Mathematics of Gifting & Inter Vivos Sales
TAX EXCLUSIVE NATURE OF GIFTS
EXAMPLE
Total Taxable Estate / Gift
Effective Tax Rate*
Total Tax
Estate Tax
$ 10,000,000
45.00%
$ (4,500,000)
Gift Tax
$ 10,000,000
31.03%
$ (3,103,448)
$ 1,396,552 Savings $
* Effective Gift Tax Rate = 45%/145%
-
10

Mathematics of Gifting & Inter Vivos Sales
TAX EXCLUSIVE NATURE OF GIFTS
ADVANTAGES
• Removes highly-appreciating assets from the donor’s estate
• Favorable tax treatment on taxable gift versus taxable estate
11

Mathematics of Gifting & Inter Vivos Sales
TAX EXCLUSIVE NATURE OF GIFTS
DISADVANTAGES
• Taxable gifts and gift taxes paid by the donor are included in his/her estate if the donor dies within three years after making the taxable gift
• Potential repeal of the estate tax
12

Mathematics of Gifting & Inter Vivos Sales
13

Mathematics of Gifting & Inter Vivos Sales
DYNASTY TRUST
DISTRIBUTION UPON GRANTOR’S DEATH
Gift*
Grantor / Parent Dynasty Trust
No transfer tax paid.
Discretionary Distributions to Children for Life
Advantages
•
Creditor protection
• Divorce protection
• Estate tax protection
• Direct decedent protection
• Spendthrift protection
• Consolidation of capital
No transfer tax paid.
No transfer tax paid.
Discretionary Distributions to Grandchildren for Life
Discretionary Distributions to Great-Grandchildren for Life
No transfer tax paid.
* Gift should take advantage of any remaining Unified Credit /
GST exclusion remaining.
Future Generations
14

Mathematics of Gifting & Inter Vivos Sales
DYNASTY TRUST
ADVANTAGES OF AVOIDING GST TAX*
W ealth of Parents
Estate Tax Rate
Estate Tax
W ealth of Children
Estate Tax Rate
Estate Tax
W ealth of Grandchildren
Estate Tax Rate
Estate Tax
$ 10,000,000
$
$
$
$
45%
4,500,000
5,500,000
45%
2,475,000
3,025,000
45%
$ 1,361,250
$ 10,000,000
$ 4,500,000
$
$
$
45%
-
45%
-
5,500,000
45%
$ 2,475,000
$ 10,000,000
$ 4,500,000
$
$
$
$
45%
-
45%
-
-
45%
-
Wealth of Great-Grandchildren $ 1,663,750 $ 3,025,000 $ 5,500,000
% of Original Wealth Passing to Great-Grandchildren 16.6375% 30.2500% 55.0000%
* For sake of simplicity, it is assumed that the marginal estate tax rate at each generation’s death is 45%.
15

Mathematics of Gifting & Inter Vivos Sales
DYNASTY TRUST
ADVANTAGES

Takes maximum advantage of the lifetime gift exclusion amount of $1,000,000

Takes maximum advantage of the one-time application of the
$3,500,000 GSTT exemption

Appreciation of assets will be estate tax free
 Provides a layer of asset protection from the beneficiaries’ creditors
 No transfer tax will be paid at the death of the grantor’s descendants

Provides flexibility
− Future trustees can be given the discretion to make distributions as appropriate, given the circumstances that exist at the time the distributions are made
− Grantor can use the trust to positively affect future behavior
16

Mathematics of Gifting & Inter Vivos Sales
17

Mathematics of Gifting & Inter Vivos Sales
GRANTOR RETAINED ANNUITY TRUST
STEP ONE: GIFT OF ASSETS
Grantor / Parent
Gift of assets
GRAT
For gift tax purposes, the initial gift is based upon a calculation of the present value of the annuity stream.
All growth in excess of the IRC §7520 rate inures to the beneficiaries, effectively freezing growth of assets to the
IRC §7520 rate
.
The IRC §7520 rate for September 2010 is 2.4%.
18

Mathematics of Gifting & Inter Vivos Sales
GRANTOR RETAINED ANNUITY TRUST
STEP TWO: PAYMENT OF GIFT TAX
Grantor / Parent
Gift tax payment
Most likely will equal zero
IRS
The amount of the taxable gift is the value of the property transferred to the trust minus the present value of the annuity interest that the grantor retains.
In valuing the lead interest, the IRS assumes that the trust assets produce a return equal to the IRC §7520 rate, effectively freezing growth of assets to the IRC §7520 rate.
19

Mathematics of Gifting & Inter Vivos Sales
GRANTOR RETAINED ANNUITY TRUST
STEP THREE: ANNUITY PAYMENTS
Grantor / Parent
Annuity payments
GRAT
The GRAT must provide for payment of an annuity to the grantor not less frequently than annually.
As cash flow may be insufficient to satisfy the GRAT annuity payments, in-kind distributions may have to be made to the grantor to satisfy the annuity payments.
However, these in-kind distributions could be contributed to new GRATs to avoid estate inclusion of the in-kind distributions.
20

Mathematics of Gifting & Inter Vivos Sales
GRANTOR RETAINED ANNUITY TRUST
STEP FOUR: PAYMENT TO BENEFICIARIES
GRAT
At conclusion of GRAT term, remaining assets are transferred to children.
At this point, no further tax is imposed.
Children
21

Mathematics of Gifting & Inter Vivos Sales
6
7
4
5
1
2
3
8
9
10
GRANTOR RETAINED ANNUITY TRUST
Year
EXAMPLE*
TEN-YEAR TERM – 10% GROWTH
Beginning
Balance
Taxable
Income
10.00%
Annuity
Payment
$ 795,680
Ending Balance
$ 10,000,000
$ 10,204,320
$ 10,429,072
$ 10,676,299
$ 10,948,248
$ 11,247,393
$ 11,576,452
$ 11,938,417
$ 12,336,578
$ 12,774,556
$ 1,000,000
$ 1,020,432
$ 1,042,907
$ 1,067,630
$ 1,094,825
$ 1,124,739
$ 1,157,645
$ 1,193,842
$ 1,233,658
$ 1,277,456
$ (795,680)
$ (795,680)
$ (795,680)
$ (795,680)
$ (795,680)
$ (795,680)
$ (795,680)
$ (795,680)
$ (795,680)
$ (795,680)
$ 10,204,320
$ 10,429,072
$ 10,676,299
$ 10,948,248
$ 11,247,393
$ 11,576,452
$ 11,938,417
$ 12,336,578
$ 12,774,556
$ 13,256,331
Benefit: $13,256,331 Transferred to Beneficiaries Tax-Free
* Assuming a $7,000,000 (after valuation adjustments) initial contribution
22

Mathematics of Gifting & Inter Vivos Sales
GRANTOR RETAINED ANNUITY TRUST
WHY GRAT WORKS – Difference Between Rates of Return
3
4
5
1
2
6
7
8
9
10
Year
Beginning
Balance
$ 10,000,000
$ 9,103,314
$ 8,185,108
$ 7,244,864
$ 6,282,055
$ 5,296,138
$ 4,286,559
$ 3,252,751
$ 2,194,131
$ 1,110,104
Taxable
Income
2.40%
$ 240,000
$ 218,480
$ 196,443
$ 173,877
$ 150,769
$ 127,107
$ 102,877
$ 78,066
$ 52,659
$ 26,642
Annuity
Payment Ending Balance
$ 1,136,686
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$
$
$
$
$
$
$
$
$
9,103,314
8,185,108
7,244,864
6,282,055
5,296,138
4,286,559
3,252,751
2,194,131
1,110,104
$ 61
3
4
5
1
2
6
7
8
9
10
Year
Beginning
Balance
$ 10,000,000
$ 9,863,314
$ 9,712,959
$ 9,547,569
$ 9,365,640
$ 9,165,518
$ 8,945,384
$ 8,703,237
$ 8,436,874
$ 8,143,876
Taxable
Income
10.00%
$ 1,000,000
$ 986,331
$ 971,296
$ 954,757
$ 936,564
$ 916,552
$ 894,538
$ 870,324
$ 843,687
$ 814,388
Annuity
Payment Ending Balance
$ 1,136,686
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$
$
$
$
$
$
$
$
$
$
9,863,314
9,712,959
9,547,569
9,365,640
9,165,518
8,945,384
8,703,237
8,436,874
8,143,876
7,821,577
Benefit: $7,821,516 Additional Wealth Transferred to
Beneficiaries Tax-Free (of which $1,640,473 is due to taxes paid to grantor)
23

Mathematics of Gifting & Inter Vivos Sales
GRANTOR RETAINED ANNUITY TRUST
WHY GRAT WORKS – Valuation Adjustments
7
8
5
6
9
3
4
1
2
10
Year
Beginning
Balance
$ 10,000,000
$ 9,863,314
$ 9,712,959
$ 9,547,569
$ 9,365,640
$ 9,165,518
$ 8,945,384
$ 8,703,237
$ 8,436,874
$ 8,143,876
Taxable
Income
10.00%
$ 1,000,000
$ 986,331
$ 971,296
$ 954,757
$ 936,564
$ 916,552
$ 894,538
$ 870,324
$ 843,687
$ 814,388
Annuity
Payment
$ 1,136,686
Ending Balance
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$ (1,136,686)
$ 9,863,314
$ 9,712,959
$ 9,547,569
$ 9,365,640
$ 9,165,518
$ 8,945,384
$ 8,703,237
$ 8,436,874
$ 8,143,876
$ 7,821,577
Year
7
8
5
6
9
3
4
1
2
10
Beginning
Balance
$ 10,000,000
$ 10,204,320
$ 10,429,072
$ 10,676,299
$ 10,948,248
$ 11,247,393
$ 11,576,452
$ 11,938,417
$ 12,336,578
$ 12,774,556
Taxable
Income
10.00%
$ 1,000,000
$ 1,020,432
$ 1,042,907
$ 1,067,630
$ 1,094,825
$ 1,124,739
$ 1,157,645
$ 1,193,842
$ 1,233,658
$ 1,277,456
Annuity
Payment
$ 795,680
Ending Balance
$ (795,680)
$ (795,680)
$ (795,680)
$ (795,680)
$ (795,680)
$ (795,680)
$ (795,680)
$ (795,680)
$ (795,680)
$ (795,680)
$ 10,204,320
$ 10,429,072
$ 10,676,299
$ 10,948,248
$ 11,247,393
$ 11,576,452
$ 11,938,417
$ 12,336,578
$ 12,774,556
$ 13,256,331
Benefit: $5,434,754 Additional Wealth Transferred to
Beneficiaries Tax-Free
24

Mathematics of Gifting & Inter Vivos Sales
GRANTOR RETAINED ANNUITY TRUST
WHY GRAT WORKS – Payment of Taxes by Grantor
3
4
5
1
2
6
7
8
9
10
Year
Beginning
Balance
$ 10,000,000
$ 10,122,592
$ 10,252,539
$ 10,390,284
$ 10,536,292
$ 10,691,062
$ 10,855,117
$ 11,029,016
$ 11,213,349
$ 11,408,742
Taxable Annuity
Income Payment Less: Taxes @ Ending Balance
10.00% $ 795,680 40.00%
$ 1,000,000
$ 1,012,259
$ 1,025,254
$ 1,039,028
$ 1,053,629
$ 1,069,106
$ 1,085,512
$ 1,102,902
$ 1,121,335
$ 1,140,874
$
$
$
$
$
$
$
$
$
$
(795,680)
(795,680)
(795,680)
(795,680)
(795,680)
(795,680)
(795,680)
(795,680)
(795,680)
(795,680)
$
$
$
$
$
$
$
(81,728)
(86,632)
$ (91,829)
$ (97,339)
$ (103,180)
(109,370)
(115,933)
(122,889)
(130,262)
(138,078)
$
$
$
$
$
$
$
$
$
$
10,122,592
10,252,539
10,390,284
10,536,292
10,691,062
10,855,117
11,029,016
11,213,349
11,408,742
11,615,858
3
4
5
1
2
6
7
8
9
10
Year
Beginning
Balance
$ 10,000,000
$ 10,204,320
$ 10,429,072
$ 10,676,299
$ 10,948,248
$ 11,247,393
$ 11,576,452
$ 11,938,417
$ 12,336,578
$ 12,774,556
Taxable Annuity
Income Payment Less: Taxes @ Ending Balance
10.00% $ 795,680 40.00%
$ 1,000,000
$ 1,020,432
$ 1,042,907
$ 1,067,630
$ 1,094,825
$ 1,124,739
$ 1,157,645
$ 1,193,842
$ 1,233,658
$ 1,277,456
$
$
$
$
$
$
$
$
$
$
(795,680)
(795,680)
(795,680)
(795,680)
(795,680)
(795,680)
(795,680)
(795,680)
(795,680)
(795,680)
$
$
$
$
$
$
$
$
$
$ -
-
-
-
-
-
-
-
-
-
$
$
$
$
$
$
$
$
$
$
10,204,320
10,429,072
10,676,299
10,948,248
11,247,393
11,576,452
11,938,417
12,336,578
12,774,556
13,256,331
Benefit: $1,640,473 Additional Wealth Transferred to
Beneficiaries Tax-Free
25

Mathematics of Gifting & Inter Vivos Sales
GRANTOR RETAINED ANNUITY TRUST
WHY GRAT WORKS – Summary
Total Wealth Transferred
Reasons for Total Wealth Transferred
Differential Between Rates of Return
Valuation Adjustment
Income Taxes Paid by Grantor
Rounding Adjustment
Total Wealth Transferred
$ 13,256,331
$ 6,181,043
5,434,754
1,640,473
61
$ 13,256,331
26

Mathematics of Gifting & Inter Vivos Sales
GRANTOR RETAINED ANNUITY TRUST
WHY GRAT WORKS
Payment of trust income taxes by the grantor
Valuation adjustments on assets transferred
Difference between actual rate of return and IRC §7520 rate
27

Mathematics of Gifting & Inter Vivos Sales
GRANTOR RETAINED ANNUITY TRUST
ADDITIONAL GRAT FEATURE – 20% Increasing Payment
Under Treas. Reg. §25.2702-3(b)(1)(ii)(B), the annual GRAT payment may increase by up to 20% over the annuity payment from the previous year.
Accordingly, by “back-end loading” the GRAT payments, more wealth is left to future generations.
7
8
5
6
9
3
4
1
2
10
Year
Beginning
Balance
$ 10,000,000
$ 10,204,320
$ 10,429,072
$ 10,676,299
$ 10,948,248
$ 11,247,393
$ 11,576,452
$ 11,938,417
$ 12,336,578
$ 12,774,556
Taxable
Income
10.00%
$ 1,000,000
$ 1,020,432
$ 1,042,907
$ 1,067,630
$ 1,094,825
$ 1,124,739
$ 1,157,645
$ 1,193,842
$ 1,233,658
$ 1,277,456
Annuity
Payment
$ 795,680
Ending Balance
$ (795,680)
$ (795,680)
$ (795,680)
$ (795,680)
$ (795,680)
$ (795,680)
$ (795,680)
$ (795,680)
$ (795,680)
$ (795,680)
$ 10,204,320
$ 10,429,072
$ 10,676,299
$ 10,948,248
$ 11,247,393
$ 11,576,452
$ 11,938,417
$ 12,336,578
$ 12,774,556
$ 13,256,331
Year
7
8
5
6
9
3
4
1
2
10
Beginning
Balance
$ 10,000,000
$ 10,682,836
$ 11,370,523
$ 12,050,860
$ 12,707,887
$ 13,321,005
$ 13,863,901
$ 14,303,245
$ 14,597,115
$ 14,693,081
Taxable
Income
10.00%
$ 1,000,000
$ 1,068,284
$ 1,137,052
$ 1,205,086
$ 1,270,789
$ 1,332,101
$ 1,386,390
$ 1,430,325
$ 1,459,712
$ 1,469,308
Annuity
Payment Ending Balance
$ (317,164)
$ (380,596)
$ (456,716)
$ (548,059)
$ (657,671)
$ (789,205)
$ (947,046)
$ (1,136,455)
$ (1,363,746)
$ (1,636,495)
$ 10,682,836
$ 11,370,523
$ 12,050,860
$ 12,707,887
$ 13,321,005
$ 13,863,901
$ 14,303,245
$ 14,597,115
$ 14,693,081
$ 14,525,894
Benefit: $1,269,563 Additional Wealth Transferred to
Beneficiaries Tax-Free
28

Mathematics of Gifting & Inter Vivos Sales
GRANTOR RETAINED ANNUITY TRUST
ADVANTAGES

Annuity payments provide income stream to the grantor

Ability to make gifts of substantial amounts of property tax-free

Grantor pays income tax on trust income, leaving more assets in the GRAT for remainder beneficiaries

Reduces the taxable estate of the grantor

Valuation adjustments increase effectiveness of sale for estate tax purposes
29

Mathematics of Gifting & Inter Vivos Sales
GRANTOR RETAINED ANNUITY TRUST
DISAVANTAGES

If the grantor dies before the end of the GRAT term, the assets in the GRAT are included in the grantor’s estate

The remainder beneficiaries will have the same basis in the property transferred to the GRAT as the grantor had at the time the property was transferred (no step-up in basis)

Risk that rate of return will not exceed interest rate resulting in no assets being transferred to remainder beneficiaries
30

Mathematics of Gifting & Inter Vivos Sales
31

Mathematics of Gifting & Inter Vivos Sales
SALE TO AN IDGT
STEP ONE: GIFT OF ASSETS
Gift
Grantor / Parent IDGT
Gift approximately 10% of total value that needs to be transferred to trust. This transfer will be a taxable gift that may require gift tax to be paid. The assets transferred, and the earnings on the assets transferred, will pay for future installment payments.
32

Mathematics of Gifting & Inter Vivos Sales
SALE TO AN IDGT
STEP TWO: SALE OF ASSETS
Grantor / Parent
Sale
Note payable
IDGT
The remaining assets are transferred to the IDGT in exchange for an installment note payable.
33

Mathematics of Gifting & Inter Vivos Sales
SALE TO AN IDGT
STEP THREE: INSTALLMENT PAYMENTS
Grantor / Parent IDGT
Installment payments
Annual installment payments are made from the IDGT to the seller/grantor. These may include interest and principal or just interest with a balloon payment due at the end of the term.
34

Mathematics of Gifting & Inter Vivos Sales
SALE TO AN IDGT
EXAMPLE*
TEN-YEAR TERM – 10% GROWTH
Year Beginning Balance Taxable Income
10.00%
6
7
8
9
10
1
2
3
4
5
$
$
$
$
$
$
$
$
$
$
10,000,000
10,743,800
11,561,980
12,461,978
13,451,976
14,540,973
15,738,871
17,056,558
18,506,014
20,100,415
$
$
$
$
$
$
$
$
$
$
1,000,000
1,074,380
1,156,198
1,246,198
1,345,198
1,454,097
1,573,887
1,705,656
1,850,601
2,010,041
Annual
Payment
$ (256,200)
$ (256,200)
$ (256,200)
$ (256,200)
$ (256,200)
$ (256,200)
$ (256,200)
$ (256,200)
$ (256,200)
$ (7,256,200)
Ending Balance
$ 10,743,800
$ 11,561,980
$ 12,461,978
$ 13,451,976
$ 14,540,973
$ 15,738,871
$ 17,056,558
$ 18,506,014
$ 20,100,415
$ 14,854,256
Benefit: $14,854,256 Transferred to Beneficiaries Tax-Free
* Assuming a $7,000,000 (after valuation adjustments) interest only, balloon payment feature installment note with a 3.66% annual interest rate (long-term AFR)
35

Mathematics of Gifting & Inter Vivos Sales
SALE TO AN IDGT
WHY SALE TO AN IDGT WORKS – Difference Between Rates of Return
3
4
5
1
2
6
7
8
9
10
Year
Beginning
Balance
$ 10,000,000
$ 10,000,000
$ 10,000,000
$ 10,000,000
$ 10,000,000
$ 10,000,000
$ 10,000,000
$ 10,000,000
$ 10,000,000
$ 10,000,000
Taxable
Income
3.66%
$ 366,000
$ 366,000
$ 366,000
$ 366,000
$ 366,000
$ 366,000
$ 366,000
$ 366,000
$ 366,000
$ 366,000
Installment
Payment Ending Balance
$ 366,000
$ (366,000)
$ (366,000)
$ (366,000)
$ (366,000)
$ (366,000)
$ (366,000)
$ (366,000)
$ (366,000)
$ (366,000)
$ (10,366,000)
$
$
$
$
$
$
$
$
$
10,000,000
10,000,000
10,000,000
10,000,000
10,000,000
10,000,000
10,000,000
10,000,000
10,000,000
$ -
1
2
3
4
5
6
7
8
9
10
Year
Beginning
Balance
$ 10,000,000
$ 10,634,000
$ 11,331,400
$ 12,098,540
$ 12,942,394
$ 13,870,633
$ 14,891,697
$ 16,014,866
$ 17,250,353
$ 18,609,388
Taxable
Income
10.00%
$ 1,000,000
$ 1,063,400
$ 1,133,140
$ 1,209,854
$ 1,294,239
$ 1,387,063
$ 1,489,170
$ 1,601,487
$ 1,725,035
$ 1,860,939
Annuity
Payment Ending Balance
$ 366,000
$ (366,000)
$ (366,000)
$ (366,000)
$ (366,000)
$ (366,000)
$ (366,000)
$ (366,000)
$ (366,000)
$ (366,000)
$ (10,366,000)
$
$
$
$
$
$
$
$
$
$
10,634,000
11,331,400
12,098,540
12,942,394
13,870,633
14,891,697
16,014,866
17,250,353
18,609,388
10,104,327
Benefit: $10,104,327 Additional Wealth Transferred to
Beneficiaries Tax-Free (of which $5,971,931 is due to taxes paid to grantor)
36

Mathematics of Gifting & Inter Vivos Sales
SALE TO AN IDGT
WHY SALE TO AN IDGT WORKS – Valuation Adjustments
7
8
5
6
9
3
4
1
2
10
Year
Beginning
Balance
$ 10,000,000
$ 10,634,000
$ 11,331,400
$ 12,098,540
$ 12,942,394
$ 13,870,633
$ 14,891,697
$ 16,014,866
$ 17,250,353
$ 18,609,388
Taxable
Income
10.00%
$ 1,000,000
$ 1,063,400
$ 1,133,140
$ 1,209,854
$ 1,294,239
$ 1,387,063
$ 1,489,170
$ 1,601,487
$ 1,725,035
$ 1,860,939
Annuity
Payment
$ 366,000
Ending Balance
$ (366,000)
$ (366,000)
$ (366,000)
$ (366,000)
$ (366,000)
$ (366,000)
$ (366,000)
$ (366,000)
$ (366,000)
$ (10,366,000)
$ 10,634,000
$ 11,331,400
$ 12,098,540
$ 12,942,394
$ 13,870,633
$ 14,891,697
$ 16,014,866
$ 17,250,353
$ 18,609,388
$ 10,104,327
6
7
4
5
8
1
2
3
9
10
Year
Beginning
Balance
$ 10,000,000
$ 10,743,800
$ 11,561,980
$ 12,461,978
$ 13,451,976
$ 14,540,973
$ 15,738,871
$ 17,056,558
$ 18,506,014
$ 20,100,415
Taxable
Income
10.00%
$ 1,000,000
$ 1,074,380
$ 1,156,198
$ 1,246,198
$ 1,345,198
$ 1,454,097
$ 1,573,887
$ 1,705,656
$ 1,850,601
$ 2,010,041
Annuity
Payment
$ 256,200
Ending Balance
$ (256,200)
$ (256,200)
$ (256,200)
$ (256,200)
$ (256,200)
$ (256,200)
$ (256,200)
$ (256,200)
$ (256,200)
$ (7,256,200)
$
$
$
$
$
$
$
$
$
$
10,743,800
11,561,980
12,461,978
13,451,976
14,540,973
15,738,871
17,056,558
18,506,014
20,100,415
14,854,256
Benefit: $4,749,929 Additional Wealth Transferred to
Beneficiaries Tax-Free
37

Mathematics of Gifting & Inter Vivos Sales
SALE TO AN IDGT
WHY SALE TO AN IDGT WORKS – Payment of Taxes by
Grantor
1
2
3
4
5
6
9
10
7
8
Year
Beginning
Balance
$ 10,000,000
$ 10,446,280
$ 10,919,337
$ 11,420,777
$ 11,952,304
$ 12,515,722
$ 13,112,945
$ 13,746,002
$ 14,417,042
$ 15,128,344
Taxable Annuity
Income Payment Less: Taxes @ Ending Balance
10.00% $ 256,200 40.00%
$ 1,000,000
$ 1,044,628
$ 1,091,934
$ 1,142,078
$ 1,195,230
$ 1,251,572
$ 1,311,295
$ 1,374,600
$ 1,441,704
$ 1,512,834
$
$
$
$
$
$
$
$
$
$
(256,200)
(256,200)
(256,200)
(256,200)
(256,200)
(256,200)
(256,200)
(256,200)
(256,200)
(7,256,200)
$
$
$
$
$
$
$
$
$
$
(297,520)
(315,371)
(334,293)
(354,351)
(375,612)
(398,149)
(422,038)
(447,360)
(474,202)
(502,654)
$ 10,446,280
$ 10,919,337
$ 11,420,777
$ 11,952,304
$ 12,515,722
$ 13,112,945
$ 13,746,002
$ 14,417,042
$ 15,128,344
$ 8,882,325
3
4
5
1
2
6
7
8
9
10
Year
Beginning
Balance
$ 10,000,000
$ 10,743,800
$ 11,561,980
$ 12,461,978
$ 13,451,976
$ 14,540,973
$ 15,738,871
$ 17,056,558
$ 18,506,014
$ 20,100,415
Taxable Annuity
Income Payment Less: Taxes @ Ending Balance
10.00% $ 256,200 40.00%
$ 1,000,000
$ 1,074,380
$ 1,156,198
$ 1,246,198
$ 1,345,198
$ 1,454,097
$ 1,573,887
$ 1,705,656
$ 1,850,601
$ 2,010,041
$
$
$
$
$
$
$
$
$
$
(256,200)
(256,200)
(256,200)
(256,200)
(256,200)
(256,200)
(256,200)
(256,200)
(256,200)
(7,256,200)
$
$
$
$
$
$
$
$
$
$ -
-
-
-
-
-
-
-
-
-
$
$
$
$
$
$
$
$
$
$
10,743,800
11,561,980
12,461,978
13,451,976
14,540,973
15,738,871
17,056,558
18,506,014
20,100,415
14,854,256
Benefit: $5,971,931 Additional Wealth Transferred to
Beneficiaries Tax-Free
38

Mathematics of Gifting & Inter Vivos Sales
SALE TO AN IDGT
WHY SALE TO AN IDGT WORKS – Summary
Total Wealth Transferred
Reasons for Total Wealth Transferred
Differential Between Rates of Return
Valuation Adjustment
Income Taxes Paid by Grantor
Total Wealth Transferred
$ 14,854,256
$ 4,132,396
$ 4,749,929
$ 5,971,931
$ 14,854,256
39

Mathematics of Gifting & Inter Vivos Sales
SALE TO AN IDGT
WHY A SALE TO AN IDGT WORKS
Back end-loading of installment payments
Payment of trust income taxes by the grantor
Valuation adjustments on assets sold
Difference between actual rate of return and AFR
40

Mathematics of Gifting & Inter Vivos Sales
SALE TO AN IDGT
INTENTIONALLY DEFECTIVE GRANTOR TRUST
• Trust income is taxed to the seller/grantor
• Trust assets sold are not in seller/grantor’s estate for estate tax purposes
• Payments of income tax on behalf of the trust should not be an additional gift to the trust
41

Mathematics of Gifting & Inter Vivos Sales
SALE TO AN IDGT
ADVANTAGES
• Freezes value of appreciation on assets sold in the seller/grantor’s taxable estate at the low interest rate on the installment note payable
• No capital gains tax due on installment sale
• Interest income on installment note is not taxable to the seller/grantor
• Grantor pays income tax on trust income, leaving more assets in the IDGT for remainder beneficiaries
• Valuation adjustments increase effectiveness of sale for estate tax purposes
42

Mathematics of Gifting & Inter Vivos Sales
SALE TO AN IDGT
DISADVANTAGES
• Estate inclusion of note if seller/grantor dies during term of installment note
• No step-up in basis at seller/grantor’s death
• Trust income taxable to seller/grantor during his/her life could cause a cash flow problem if there is not sufficient income earned by the seller/grantor
• Possible gift and estate tax exposure if insufficient assets are used to fund the trust
• Possible taxable gift for amount of loan
• Possible taxable estate inclusion under Karmazin
(retained life estate)
43

Mathematics of Gifting & Inter Vivos Sales
44

Mathematics of Gifting & Inter Vivos Sales
SALE TO AN IDGT USING A SCIN
• Transaction similar to an ordinary installment sale to an IDGT
• Cancellation at death feature added to note
• Premium must be paid, either in the form of additional principal or increased interest rate to compensate for the cancellation-at-death feature
• OBJECTIVE: Reduction of estate tax if premature death occurs
45

Mathematics of Gifting & Inter Vivos Sales
SALE TO AN IDGT USING A SCIN
THREE TYPES OF SCINs
• Hedge SCIN – A SCIN designed to hedge against the possibility of death during a bettolive strategy (taxable gifts, GRAT, etc…)
• Bridge SCIN
SM –
A SCIN designed to take advantage of the increases in the Unified
Credit
• Mortality SCIN – A SCIN designed for those who have a high likelihood of dying within a short period of time
46

Mathematics of Gifting & Inter Vivos Sales
SALE TO AN IDGT USING A SCIN
SAMPLE OF SCIN RISK PREMIUMS*
Age
53
58
63
68
73
78
SINGLE LIFE
SCIN Risk
Premium AFR
Total
Interest
Rate Age 1 Age 2
0.872% 3.660% 4.532% 53 53
1.350% 3.660% 5.010% 58
2.048% 3.660% 5.708% 63
58
63
3.190% 3.660% 6.850% 68
5.125% 3.660% 8.785% 73
8.229% 3.660% 11.889% 78
68
73
78
JOINT LIFE
SCIN Risk
Premium AFR
Total
Interest
Rate
0.660% 3.660% 4.320%
0.151% 3.660% 3.811%
0.328% 3.660% 3.988%
0.733% 3.660% 4.393%
1.655% 3.660% 5.315%
3.514% 3.660% 7.174%
*Assumptions
Term of Note
AFR
Payment Frequency
Type of Note
10
3.66%
Annually
Interest Only with Balloon Payment
47

Mathematics of Gifting & Inter Vivos Sales
SALE TO AN IDGT USING A SCIN
EXAMPLE*
TEN-YEAR TERM – 10% GROWTH / 78 YEAR-OLD SELLER
Year Beginning Balance
8
9
10
5
6
7
1
2
3
4
$ 10,000,000
$ 10,167,770
$ 10,352,317
$ 10,555,319
$ 10,778,621
$ 11,024,253
$ 11,294,448
$ 11,591,663
$ 11,918,599
$ 12,278,229
Growth
10.00%
$ 1,000,000
$ 1,016,777
$ 1,035,232
$ 1,055,532
$ 1,077,862
$ 1,102,425
$ 1,129,445
$ 1,159,166
$ 1,191,860
$ 1,227,823
Annual
Payment
$ (832,230)
$ (832,230)
$ (832,230)
$ (832,230)
$ (832,230)
$ (832,230)
$ (832,230)
$ (832,230)
$ (832,230)
$ (7,832,230)
Ending Balance
$ 10,167,770
$ 10,352,317
$ 10,555,319
$ 10,778,621
$ 11,024,253
$ 11,294,448
$ 11,591,663
$ 11,918,599
$ 12,278,229
$ 5,673,822
Benefit: $5,673,822 Transferred to Beneficiaries Tax-Free
* Assuming a $7,000,000 (after valuation adjustments) interest only, balloon payment feature installment note with a 11.889% annual interest rate (3.66% long-term AFR + 8.229% risk premium )
48

Mathematics of Gifting & Inter Vivos Sales
SALE TO AN IDGT USING A SCIN
ADVANTAGES
•
Future appreciation above the note interest rate, including the risk premium, is removed from the seller/grantor’s estate
• Asset not included in seller/grantor’s estate in case of premature death during SCIN term
• Value of assets transferred out greatly exceeds value of payments coming back into the estate of the seller/grantor if he/she passes away prematurely
• No gain or loss on sale
• Trust income taxable to seller/grantor allows for greater appreciation to inure to future generations, thereby creating an additional tax-free gift
• Valuation adjustments increase effectiveness of sale for estate tax purposes
49

Mathematics of Gifting & Inter Vivos Sales
SALE TO AN IDGT USING A SCIN
DISADVANTAGES
•
•
Complex calculation of risk premium
• Possible gift tax exposure if SCIN risk premium is inadequate
• Possible gift tax exposure if insufficient assets are used to fund the trust
Possible taxable estate inclusion under Karmazin (retained life estate)
• No step-up in basis at seller/grantor’s death
• Possible acceleration of capital gain at seller/grantor’s death
• Trust income taxable to seller/grantor during his/her life could cause a cash flow problem if there is there is not sufficient income earned by the seller/grantor
• Possible upstream transfer to seller/grantor if he/she survives term of note (or lives a significant portion of the term and/or is relatively old)
50

Mathematics of Gifting & Inter Vivos Sales
SALE TO AN IDGT USING A SCIN
WHY A SALE TO AN IDGT USING A SCIN WORKS
Back end-loading of installment payments
Payment of trust income taxes by the grantor
Valuation adjustments on assets sold
Cancellation-at-death feature
Difference between actual rate of return and risk-adjusted AFR
51

Mathematics of Gifting & Inter Vivos Sales
52

Mathematics of Gifting & Inter Vivos Sales
PRIVATE ANNUITY
Sale
Parent Children
Annuity payments for life
The seller’s age and the current IRC §7520 rate are used for purposes of determining the amount of the annuity.
Provided that the annuity is calculated correctly, the future value of the assets sold less the future value of the payment stream retained by the seller inures to the buyer (beneficiaries) free of transfer taxes, thus effectively freezing the growth of assets at the IRC §7520 rate
.
The IRC §7520 rate for September 2010 is 2.4%.
53

Mathematics of Gifting & Inter Vivos Sales
PRIVATE ANNUITY
SAMPLE OF PRIVATE ANNUITY AMOUNTS*
Age
53
58
63
68
73
78
Private
Annuity
Amount
$ 366,944
$ 414,992
$ 478,639
$ 565,885
$ 690,969
$ 871,449
*Assumptions
Value of Assets Sold
IRC §7520 Rate
Payment Frequency
Timing of Payment
$7,000,000
2.40%
Annually
End of Period
54

Mathematics of Gifting & Inter Vivos Sales
PRIVATE ANNUITY
EXAMPLE*
TEN-YEAR TERM – 10% GROWTH / 78 YEAR-OLD SELLER
7
8
5
6
3
4
1
2
9
10
Year Beginning Balance
$ 10,000,000
$ 10,128,551
$ 10,269,957
$ 10,425,504
$ 10,596,605
$ 10,784,817
$ 10,991,849
$ 11,219,585
$ 11,470,095
$ 11,745,655
Growth
10.00%
$ 1,000,000
$ 1,012,855
$ 1,026,996
$ 1,042,550
$ 1,059,661
$ 1,078,482
$ 1,099,185
$ 1,121,959
$ 1,147,009
$ 1,174,566
Annual
Payment
$ (871,449)
$ (871,449)
$ (871,449)
$ (871,449)
$ (871,449)
$ (871,449)
$ (871,449)
$ (871,449)
$ (871,449)
$ (871,449)
Ending Balance
$ 10,128,551
$ 10,269,957
$ 10,425,504
$ 10,596,605
$ 10,784,817
$ 10,991,849
$ 11,219,585
$ 11,470,095
$ 11,745,655
$ 12,048,772
Benefit: $12,048,772 Transferred to Beneficiaries Tax-Free
* Assuming a $7,000,000 (after valuation adjustments) sale
55

Mathematics of Gifting & Inter Vivos Sales
•
PRIVATE ANNUITY
ADVANTAGES
Provides an income stream to the seller for life
• Asset not included in seller/grantor’s estate in case of premature death during the annuity term
• Value of assets transferred out of the seller’s estate greatly exceeds value of payments coming back if he/she passes away prematurely
• Valuation adjustments increase effectiveness of sale for estate tax purposes
56

Mathematics of Gifting & Inter Vivos Sales
PRIVATE ANNUITY
DISADVANTAGES
• If not structured correctly, an immediate gain could be recognized by the seller
• The buyer’s payments are not deductible as
“interest”, thus causing more ordinary income to be recognized (double taxation)
• Potential upstream transfer if seller lives for a long period of time (especially if the seller lives longer than his/her life expectancy)
• If assets are sold to a trust, possible gift tax exposure could occur if the trust has inadequate assets to support the payments
57

Mathematics of Gifting & Inter Vivos Sales
PRIVATE ANNUITY
WHY PRIVATE ANNUITY WORKS
Valuation adjustments on assets transferred
Cancellation-at-death feature
Difference between actual rate of return and IRC §7520 rate
58

Mathematics of Gifting & Inter Vivos Sales
COMPARISON OF ESTATE PLANNING TECHNIQUES
(Assuming Seller/Annuitant Lives Term)
Net Wealth to Family
$25,000,000
$20,230,934
$20,949,999
$19,687,531
$20,000,000
$16,818,803
$15,000,000
$10,000,000
$14,265,584
No Planning
GRAT
Sale to IDGT
SCIN to IDGT
Private Annuity
$5,000,000
$0
Gross Value of Assets Transferred
Net Value of Assets Transferred
IRC §7520 Rate
AFR
Term / Life Expectancy
Payment Frequency
Type of Payment (Installment Note/SCIN)
Age of Seller / Annuitant
Estate Tax Rate
Year 10
$10,000,000
$7,000,000
2.40%
3.66%
10 Years
Annually
Interest Only with Balloon Payment
78
45%
59

Mathematics of Gifting & Inter Vivos Sales
COMPARISON OF ESTATE PLANNING TECHNIQUES
(Assuming Seller/Annuitant Dies Midway Through Term)
Net Wealth to Family
$16,000,000
$14,000,000
$12,000,000
$10,000,000
$8,000,000
$6,000,000
$4,000,000
$2,000,000
$0
$8,857,805 $8,857,805
$12,251,243
$13,818,719 $13,710,973
No Planning
GRAT
Sale to IDGT
SCIN to IDGT
Private Annuity
Gross Value of Assets Transferred
Net Value of Assets Transferred
IRC §7520 Rate
AFR
Term / Life Expectancy
Payment Frequency
Type of Payment (Installment Note/SCIN)
Age of Seller / Annuitant
Estate Tax Rate
Year 5
$10,000,000
$7,000,000
2.40%
3.66%
10 Years
Annually
Interest Only with Balloon Payment
78
45%
60

Mathematics of Gifting & Inter Vivos Sales
SM
61

Mathematics of Gifting & Inter Vivos Sales
Tax Burn SCIN SM
• SCIN used in combination with IDGT
Grantor / Parent
Gift/Sale
SCIN
IDGT
62

Mathematics of Gifting & Inter Vivos Sales
Tax Burn SCIN SM
• Income tax liability of IDGT is paid by grantor due to the “defective” nature of the trust
Taxable income Investment
(i.e. closely-held stock, marketable securities, etc.)
Cash flow
Grantor /
Parent
IRS
Payment of income tax on IDGT’s taxable income
IDGT
63

Mathematics of Gifting & Inter Vivos Sales
Tax Burn SCIN SM
• To the extent that the income tax liability on IDGT’s income is greater than installment payments received back from the trust, the excess income tax liability will reduce the grantor’s taxable estate (i.e. “tax burn”).
Year
1
4
5
2
3
Income Tax on
IDGT Income*
$ (400,000)
$ (440,000)
$ (484,000)
$ (532,400)
$ (585,640)
EXAMPLE
Installment
Payment
Received From
IDGT**
$ 378,000
$ 378,000
$ 378,000
$ 378,000
$ 378,000
"Tax Burn"
$ (22,000)
$ (62,000)
$ (106,000)
$ (154,400)
$ (207,640)
Cumulative
"Tax Burn"
$ (22,000)
$ (84,000)
$ (190,000)
$ (344,400)
$ (552,040)
* $ 10,000,000 FM V o f assets held in IDGT x 10% return x 40% tax rate (co mpo unded by 10% per year)
** $ 6,300,000 SCIN principal (disco unted) x 6% interest rate (A FR + mo rtality risk premium)
64

Mathematics of Gifting & Inter Vivos Sales
Tax Burn SCIN SM
• If grantor dies during term of SCIN, the note and assets sold to the IDGT are out of the grantor’s estate
• If the grantor survives the term of the SCIN, then the
“Tax Burn” will have eroded the grantor’s estate to the point where the repayment of the note will not increase the grantor’s taxable estate
EXAMPLE
Year
1
5
10
15
Income Tax on
IDGT Income*
$ (400,000)
$ (585,640)
$ (943,179)
$ (1,518,999)
Installment
Payment
Received From
IDGT**
$ 378,000
$ 378,000
$ 378,000
$ 378,000
"Tax Burn"
$ (22,000)
$ (207,640)
$ (565,179)
$ (1,140,999)
Cumulative
"Tax Burn"
$ (22,000)
$ (552,040)
$ (2,594,970)
$ (7,038,993)
SCIN Balance
$ 6,300,000
$ 6,300,000
$ 6,300,000
$ 6,300,000
Assets
Included in
Grantor's
Estate
$ -
$ -
$ -
$ -
$ -
* $10,000,000 FM V of asset s held in IDGT x 10% ret urn x 40% t ax rat e (compounded by 10% per year)
** $6,300,000 SCIN principal (discount ed) x 6% int erest rat e (AFR + mort alit y risk premium)
Cumulative effect o f "tax burn" eliminates value o f SCIN co ming back into granto r's estate upo n repayment
A sset no t included in granto r's estate during no te term
65

Mathematics of Gifting & Inter Vivos Sales
SM Tax Burn SCIN
• Initial Burn Point (a.k.a “Tax Burn”) – The point at which the income tax liability paid by the grantor becomes greater than the installment payments received from the trust.
• Full Burn Point – The point at which any cumulative reinvested “positive transfers” (i.e. installment payment received > tax liability) by the grantor and
Year
1
5
10
15 the SCIN are eliminated by the cumulative effect of the
“tax burn”.
EXAMPLE
Income Tax on
IDGT Income*
$ (400,000)
$ (585,640)
$ (943,179)
$ (1,518,999)
Installment
Payment
Received From
IDGT**
$ 378,000
$ 378,000
$ 378,000
$ 378,000
"Tax Burn"
$ (22,000)
$ (207,640)
$ (565,179)
$ (1,140,999)
Cumulative
"Tax Burn"
$ (22,000)
$ (552,040)
$ (2,594,970)
$ (7,038,993)
SCIN Balance
$ 6,300,000
$ 6,300,000
$ 6,300,000
$ 6,300,000
Assets
Included in
Grantor's
Estate
$ -
$ -
$ -
$ -
$ -
* $ 10,000,000 FM V o f assets held in IDGT x 10% return x 40% tax rate (co mpo unded by 10% per year)
** $ 6,300,000 SCIN principal (disco unted) x 6% interest rate (A FR + mo rtality risk premium)
Initial Burn Point
Full Burn Point
66

Mathematics of Gifting & Inter Vivos Sales
Tax Burn SCIN SM
EXAMPLE
Net Taxable Estate
$10,000,000
$9,000,000
$8,000,000
$7,000,000
$6,000,000
$5,000,000
$4,000,000
$3,000,000
$2,000,000
$1,000,000
$-
Natural "tax burn"
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Year
SCIN Note Outside Assets
67

Mathematics of Gifting & Inter Vivos Sales
68