Grantor Domestically Owned Trust Case Study

Grantor Domestically Owned TrustEstate Plan Concerns

Bill owns an asset worth $1,100,000 that he would like to give to his children. Bill expects that, for the foreseeable future, the asset will generate $66,000 of income each year and will grow at an annual rate of 8% (over and above the income generated).

? Desire to Minimize Gift and Estate Taxes

Understanding that such a gift would be a taxable gift for federal gift tax purposes, Bill would like to arrange the gift so that the impact of gift taxes (and estate tax is minimized).

? Desire for Trustee to Manage Estate Long-Term

He also thinks that it would be a good idea for the asset to be held by a trustee for the benefit of his children, and possibly for succeeding generations of his family.

Estate Plan Solution

Bill decides to use a tax saving technique known as a “Sale to a Grantor Domestically Owned Trust,” in which Bill will create a trust for his children, and then sell the desired asset to the trust in return for a promissory note. The term “defective”, here, is a good thing, describing the special tax status of the trust.

Grantor Domestically Owned Trust Process

Grantor Domestically Owned Trust Process

Grantor Domestically Owned Trust Process
  1. Bill (called the “grantor”) creates an irrevocable trust for the benefit of his children.
  2. Bill makes an initial gift equal to 10% of the value of the asset that will be sold to the trust. This gift may be sheltered from gift tax by Bill’s gift tax exemption or annual gift tax exclusions.
  3. Bill and the trustee enter into an agreement in which Bill sells the asset to the trustee in return for an interest bearing promissory note. The trustee’s payments on the note are funded with income from trust assets.
  4. The net value of the trust assets (i.e., the value of the assets, less the outstanding balance on the note) avoids estate taxes. Only the value of the promissory note is subject to estate taxes.

Benefits

  • No Gift and Estate Tax: Assets can be transferred to succeeding generations free of gift and estate tax.
  • Assets Protected in Future: Trust can be used to manage and protect assets for the benefit of the grantor’s family.
  • Integrates with Legacy TrustSM: Technique can be particularly effective with a Family Legacy Trust SM, providing favorable transfer tax benefits for many future generations of the grantor’s family.
  • Potential Income Tax Savings: Special tax status of the trust offers income tax planning opportunities.

Explanation

A Sale to a Grantor Domestically Owned Trust (GDOT) is a technique that allows an individual to transfer wealth estate tax free to his or her family by shifting appreciation in the value of selected assets to a trust for the family’s benefit. Very generally, this result is accomplished by the sale of selected assets in return for an interest bearing installment note. To the extent that the return on the assets (i.e., the income and capital appreciation on the assets) held by the trust is greater than the interest rate on the installment note, wealth is effectively transferred to the trust.

? Special Status Create Two Opportunities

The trust is designed to be classified as a “grantor income trust” for federal income tax purposes. This special tax status creates two important benefits. First, it neutralizes the income tax consequences of the sale of the assets. Second, it permits the income tax liability for taxable income earned on trust assets to be shifted to the grantor. While shifting the income tax liability to the grantor might initially be viewed as undesirable , it indirectly provides the benefit of increasing the accumulation of wealth for the grantor’s family.

? Techniques to Increase Asset Transfer and Protection

Other planning techniques may be used with the GDOT to increase the amount of wealth that is ultimately transferred to the grantor’s family. For example, often the trust is designed as a Family Legacy TrustSM for the purpose of providing benefits to the family for many generations and protecting assets from estate taxes, potential judgment creditors and divorce.

? Calculations Will Vary According to Current Market

Unless otherwise stated, actuarial calculations are based on the assumptions that the client is 65 years old and the Applicable Federal Rate (AFR) is 5.00%.

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The following notice is required by the IRS: Any U.S. Federal tax advice contained in this communication is not intended to be written or used, and cannot be used or relied upon, to avoid tax-related penalties under the Internal Revenue Code, or to promote, market or recommend to another any tax-related matter addressed herein.