Structuring Installment Sales to Intentionally Defective Trusts: Using Private Annuities and Promissory Notes

Description

A valuable but often misunderstood tool for removing appreciating assets from an estate is through a sale of the assets to an IDIT. Sales take two forms: in exchange for a promissory note or a private annuity. Both types of sales function to freeze the value of the estate. The private annuity transaction works when the client is ill and anticipates less time for the freeze of estate property to work.

Properly structured, a sale to an IDIT can be a highly effective vehicle for transferring appreciating assets out of an estate while minimizing the gift tax impact of transfers. The panel will note that the sale to an IDIT can be even more effective with assets currently depressed in value but whose value is expected to appreciate in the future.

Counsel can draft a private annuity transaction in several ways to ensure cash flow, establish a business succession, and provide asset protection. It is not appropriate if the client is in good health because a premium must be added to the sale price or interest rate to avoid gift tax. The premium increases the estate's value if the seller lives close to or beyond life expectancy.

In structuring a transfer financed by a private annuity, estate planners must ensure the transaction conforms to IRS regulations to avoid gift or estate taxes. Advisers must pay close attention to the so-called "exhaustion test." If the annuity is payable for the seller's life, the premium added to the sales price might be deemed to be depleting the trust, resulting in a gift upon the sale. To apply the "exhaustion test," counsel must assume that the seller might live to the age of 110 years in determining the amount of the gift.

The panel will also discuss the sale of assets to a so-called beneficiary intentionally defective irrevocable trust (BIDIT) in exchange for the BIDIT's promissory note. A BIDIT is an irrevocable trust established by another party that includes the seller as a beneficiary. The panel will discuss the parenthetical exception in IRC Sections 2036 and 2038 for bona fide sales for complete and adequate consideration and the likelihood that the parenthetical exception avoids the inclusion of assets sold to a BIDIT in the seller's federal gross estate.

Listen as our experienced panel provides a thorough and practical guide to the use of private annuities and discusses the latest developments in promissory notes in the context of intra-family asset transfers.