Sale of property to an intentionally defective grantor trust.

• Author: Ellentuck, Albert B.
• Position: Case study

Editor's note: This case study has been adapted from "PPC Tax Planning Guide--S Corporations," 12th Edition, by Andrew R. Biebl and Gregory B. McKeen, published by Practitioners Publishing Company, Forth Worth, Tex., 1998.

Facts: Ben Buckingham is 60 years old and divorced. In early 1999, he became more focused on the potential estate taxes that will arise on his death. Ben had taken some action in previous years to reduce taxes by making taxable gifts up to his $600,000 lifetime credit equivalent, but is now ready to do some additional planning. * Ben considers himself a sophisticated taxpayer and wants to be reasonably aggressive in conducting his business activities and planning his tax affairs. * The asset that will generate the most estate tax is his 100% ownership in Gregorian, Inc., an S corporation. Gregorian has an estimated fair market value (FMV) of $500,000, but Ben believes that it has the potential to grow much larger (based on some software it has developed). He would like to find a way to transfer Gregorian's value to his only child, Elizabeth, with minimal gift or estate tax cost to him and minimal income tax cost to her. He insists, however, that control of Gregorian not be shifted to Elizabeth (due to her lack of business experience). * Ben also feels strongly that Gregorian must remain an S corporation. * Though he is seeking ways to reduce his ultimate estate tax, Ben does not want to pay any current gift tax. His tax adviser tells him that, as a result of the phase-in of the increased lifetime credit in 1998 and 1999, Ben now has an additional $50,000 that he can give without incurring any actual gift tax liability. Issue: Can a plan be developed that transfers all of the Gregorian stock at no current gift tax and maximizes the value that ultimately can be transferred to Elizabeth?

Analysis

The tax adviser first reviews various basic options for reducing estate tax, to see if any fit Ben's situation:

1. An outright gift to Elizabeth would transfer future appreciation without gift tax, but would create immediate tax on Gregorian's current value (subject to reduction by the $10,000 annual exclusion and partially offset by the remaining portion of Ben's lifetime credit). The current gift tax that Ben would be required to pay and the control that would be placed in Elizabeth's hands makes this unacceptable to Ben.

2. A gift to a trust that qualifies for qualified subchapter S trust (QSST) treatment would not meet Ben's objectives, as it would require all of the trust income to be distributed to Elizabeth. In addition, Ben's initial gift to the trust would result in a substantial current gift tax liability (even after offset by the $50,000 lifetime credit exemption equivalent).

3. A gift to an electing small business trust (ESBT) would not meet Ben's objectives; the trust would be taxed on Gregorian's income at the maximum individual income tax rate. In addition, because the tax...