SC Lawyer, September 2012, #4. Bottling Lightning.

• Author: By G.P. Diminich and Halsey O. Schreier

South Carolina BAR Journal

2012.

SC Lawyer, September 2012, #4.

Bottling Lightning

South Carolina LawyerSeptember 2012Bottling LightningUtilizing the Intentionally Defective Grantor Trust to Turbocharge Estate Tax Planning and Protect Assets from CreditorsBy G.P. Diminich and Halsey O. SchreierThis year's unique federal estate and gift tax environment presents an important tax planning opportunity for the estate planning attorney. Specifically, because the current $5.12 million estate and gift tax exemption is scheduled to dramatically drop to $1 million on January 1, 2013, a substantial number of previously unaffected clients would be subject to estate taxation at death. Therefore, the estate planning practitioner should contemplate advising clients whose net worth exceeds $1 million and who are consequently subject to estate tax liability to consider gifting assets and take advantage of the millions of dollars of lifetime gift tax exemption scheduled to disappear. By employing a specific type of irrevocable trust to accomplish a gifting strategy, clients may additionally protect assets from potential creditors, a significant ancillary benefit for clients with debt or other liability exposure.

Although the name "Intentionally Defective Grantor Trust" (IDGT) may conjure emotions in lawyers of something exotic (at best) or malpractice (at worst), the IDGT has been a tool that many estate planners have used for decades. Traditionally, it has been used as an "estate freeze" vehicle, whereby a grantor transfers assets out of his or her estate and into the IDGT, and thereby passes wealth to beneficiaries without being subject to the estate tax upon the grantor's death. Further, the estate tax benefits are "turbocharged" in that these assets are able to grow income tax free because the IDGT's income is taxed to the grantor. The IDGT, therefore, has the benefit of further reducing the grantor's estate for federal estate tax purposes. If combined with generation-skipping transfer (GST) tax planning, the IDGT's benefits become even more pronounced.

For this tax year in particular, the confluence of a number of independent developments has made the IDGT an attractive vehicle not only to avoid estate tax upon the grantor's death but also to protect the grantor's assets from possible creditors. The IDGT, unlike most other irrevocable trusts, offers both of these protections, giving it a unique advantage in the current favorable estate and gift tax environment and today's generally poor economic climate.

However, absent action by Congress and the President soon (and in an election year, no less), the high exemption amount for federal estate and gift taxes (unified at $5.12 million, the highest it has ever been) will expire by December 31, 2012, and an important planning opportunity could be lost. Further, the President has stated that he will propose legislation substantially reducing the estate and gift exemptions amounts and curtailing the tax benefits of an IDGT, making tax planning in 2012 more advisable. With the languishing economy, these events are so rare that they are the estate planning equivalent of lightning striking. A high net worth client or a client with significant potential creditor concerns should consider bottling the lightning by maximizing the opportunities presented by these unique circumstances and employing the IDGT in 2012 to transfer assets estate and gift tax free and shelter those assets from future creditors.

TABLE 1. ESTATE AND GIFT TAX EXEMPTIONS AND RATES

Year

Estate Tax Exemption/Rate

Gift Tax Exemption/Rate

2009

$3.5 million/45%

$1.0 million/45%

2010

N/A*

$1.0 million/35%

2011

$5 million/35%

$5.0 million/35%

2012

$5.12 million/35%

$5.12 million/35%

2013**

$1.0 million/55%

$1.0 million/55%

2013##

$3.5 million/45%

$1.0 million/45%

*For electing estates ** Scheduled # President's Green Book proposal

wnat is an IDGT?

An IDGT is an irrevocable trust whose assets are excluded from the grantor's estate for estate and gift tax purposes but whose income is attributed to the grantor for income tax purposes. To ensure that the assets of the IDGT are not included in the grantor's estate, the grantor is not included as a beneficiary of the trust. By contrast, in non-grantor irrevocable trusts the trust's income is attributed to the beneficiary(ies) of the trust. The IDGT name derives from the fact that the grantor intentionally includes a "defect" in the trust instrument that violates the rules contained in Sections 671 through 679 of the Internal Revenue Code and causes the income to be taxable to the grantor, thereby eroding the assets held in the grantor's estate. This in turn reduces the grantor's estate taxes.

By virtue of the grantor paying income taxes on the income of the IDGT, the assets held in the IDGT are therefore able to appreciate unreduced by income taxes. In essence, this "turbocharges" the appreciation of the assts held in the IDGT. This increases the value of the assets available for the IDGT beneficiaries, enabling more wealth to be passed to the beneficiaries. Put simply, the payment of income taxes by a grantor is a gift to the IDGT beneficiaries that is not subject to the gift tax.

Further, because the grantor is the owner of the IDGT assets for income tax purposes, the sale of an appreciated asset by a grantor to the IDGT will not trigger gain. Rev. Rul. 85-13, 1985-1 C.B. 184. Accordingly, highly appreciated assets (e.g., real estate, stocks, certain business interests, etc.) may be sold to the IDGT without any adverse income tax consequences. Although beyond the scope of this article, this sale presents further beneficial estate planning opportunities, such as the sale of appreciated assets to the IDGT in exchange for a promissory note.

The eventual estate tax savings upon the death of the grantor can be substantial, as traditionally the highest estate tax rate has been 55 percent. Therefore, an IDGT is commonly utilized to hold assets that are expected to substantially appreciate over the course of the grantor's remaining lifetime.

The estate planner must take great care in drafting an IDGT as it is unlike other irrevocable trusts. An IDGT is most commonly created in one or more of the following ways by various clauses and powers in the trust instrument itself:

1. The grantor, the grantor's spouse or some third party retains the power to reacquire the trust assets (e.g., the grantor retains the right to reacquire property out of the trust in exchange for property of equal value). l.R.C. 675(4)(C) (2006). There is a concern that this power creates a risk of estate inclusion; however, the Internal Revenue Service has ruled in Revenue Ruling 2008-22 that no such inclusion will occur merely because of the retention of a nonfiduciary power to substitute assets of equivalent value, based on the U.S. Tax Court's holding in Jordahl Estate v. Comm'r, 65 T.C. 92 (1975). To avoid this risk, one may grant the power to a party other than the grantor, such as some third party. 2. A "nonadverse party" controls to whom and when trust income and principal is to be distributed, exercisable during the grantor's lifetime, as well as the power to add beneficiaries (e.g., a nonadverse trustee may add beneficiaries of the trust income and/or principal). l.R.C. 674(a) (2006). 3. The grantor or a nonadverse party has the power over the entire trust that enables the grantor to borrow from the trust without adequate interest or adequate security, except where a trustee is otherwise given the right to make the loans under a general lending power. l.R.C. 675(2) (2006).

While this list is non-exhaustive, a prudent drafter should include more than one of these powers in the trust instrument to attract grantor trust status in the event one is held invalid. Moreover, the drafter should exercise caution not to inadvertently cause estate tax inclusion under l.R.C. 2036 or 2038.

Current estate and gift tax law

On December 17,'2010, the President signed into law the Tax Relief, Unemployment lnsurance Reauthorization and Job Creation Act of 2010 (TRUlRJCA), which "reunified" the estate and gift tax exemption amounts at $5.12 million and with top tax rates of 35 percent. ln effect, from a purely tax perspective in this transfer tax regime it makes no difference whether assets are passed at death or gifted during lifetime. This regime, however, is only in effect until December 31, 2012 (an "exemption" simply means an amount that is free from tax). Never before had the estate and gift tax exemption amounts been so high and their rates so low. See Table 1 for a chart of the estate and gift tax regimes. Previously, under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTR-RA), the gift tax exemption amount in recent years had been "decoupled" from the estate tax exemption amount (which was at $3.5 million and 45 percent rate in 2009, with no estate tax in 2010 for electing estates), and the lifetime gift tax exemption had been no more than $1 million, with up to a 55 percent rate. Simply put, in the previous EGTRRA estate and gift tax regime, it often seemed more estate and gift tax efficient to transfer assets at death than gifting them during lifetime.

Unless Congress and the President modify or extend the TRUIRJCA, on January 1, 2013, the pre-EGTRRA law would then control as scheduled and the estate and gift tax exemption will be "reunified" at only $1 million, a significant drop from the current $5.12 million. The top tax rate would revert to 55 percent. Moreover, the President, in his annual "General Explanations of the Administration's Fiscal Year 2013 Revenue Proposals" released in February 2012 (commonly known as the "Green Book"), stated that he again wanted to "decouple" the estate and gift tax regime, with the estate tax exemption at $3.5 million and a 45 percent rate and the gift tax exemption at $1 million and 45 percent rate.

Therefore, absent action by Congress and the President by December 31, 2012, or if Congress adopts the President's Green Book proposals, the estate and gift tax exemption will be substantially lowered to $1 million with a rate of up to 55 percent on January 1, 2013. In an election year and divided branches of government, it is hard to foresee any agreement between the President and Congress.

Furthermore, also in the President's Green Book, the estate tax benefits of an IDGT would be eliminated, as the IDGT assets would be subject to estate tax in the grantor's estate. Importantly, the President's Green Book states that such a change is effective only "with regard to trusts created on or after the date of enactment . . . ." Dep't of the Treasury, General Explanations of the Administration's Fiscal Year 2013 Revenue Proposals

83 (Feb. 2012). Therefore, presuming the President is able to achieve passage of such legislation, the case for considering an IDGT for estate tax avoidance becomes stronger before such legislation is implemented. Accordingly, with the current gift tax exemption at $5.12 million (and any amount above that taxed at 35 percent) and likely to decrease next year along with the estate tax exemption, it is wise from an estate and gift tax perspective for high net worth individuals to maximize their gifts and consider gifting at least up to $5.12 million, as long as it holis-tically comports with their financial plans, tax planning, needs and other goals. If high net worth individuals wait until next year to gift or were to pass away in future years, it is possible that the estate and gift tax exemptions could be as low as $1 million, based on the current law for 2013 and the President's Green Book proposals.

The numbers: how an IDGT bene fits a high net worth client

Table 2, found at www.scbar.org/ sclawyer, is an example of how an IDGT benefits a high net worth client and "turbocharges" the assets the client is able to pass at death. Lester G. Detterbeck, CPA/PFS, MBA, CFP®, CFA, and Charles D. Capasso, CFP® of Detterbeck Wealth Management kindly assisted with these calculations. The hypothetical, for simplicity, is an unmarried client with a net worth of $10 million and a projected remaining life expectancy of 20 years. With no estate planning, at death, the client would pass $8.2 million to beneficiaries. If the client made a $3 million lifetime gift (out of a possible $5 million that could be transferred gift tax free) to a plain irrevocable trust, at death, the client would leave $10.07 million to his or her beneficiaries. With only a $3 million lifetime gift to an IDGT, however, the client passes $12.93 million in wealth, even with the supposed "claw back" (discussed below). Without the "claw back," the same client passes $14.58 million. Clearly, the tax benefits of an IDGT are substantial, even when only utilizing $3 million of the $5 million gift tax exemption available.

Conveying assets from the IDGT to the grantor in exigent circumstances

Understandably, the client may worry about transferring assets to an irrevocable trust, particularly an IDGT, where the client is not the beneficiary. While this may maximize the estate and gift tax benefits, the client will be concerned about irrevocably gifting assets to an IDGT, as the client may subsequently need the assets. The IDGT, however, can be drafted so that there is the power to transfer back to the grantor (or the grantor's spouse) assets held by the IDGT. Conveniently, this is the same power that is discussed below with regard to asset protection.

Therefore, to help ameliorate- but not eliminate-this possible concern of the client, an IDGT could be drafted so that the grantor grants a special power of appointment allowing a donee of that power to appoint assets to any person other than the donee, the donee's estate or the creditors of the donee of the donee's estate. The grant of this power needs to be to a non-adverse party and cannot be the same person as the grantor. "Nonadverse party" is defined statu-torily as "any person who is not an adverse party." l.R.C. 672(b) (2006). "Adverse party" means any person having a substantial beneficial interest in the trust which would be "adversely affected by the exercise or nonexercise of the [special] power [of appointment] which he possesses regarding the [lDGT]." l.R.C. 672(a) (2006). This special power allows the lDGT to be considered a "grantor trust" for income tax purposes. See l.R.C. 674 (2006).

Importantly, this special power of appointment allows the nonadverse party/donee to potentially appoint the assets of the IDGT back to the grantor or the grantor's spouse. Therefore, the grantor or the grantor's spouse would be able to utilize the assets of the IDGT in such a scenario. Obviously, the holder of the power must be someone who has the confidence of the grantor, but there can be no express or implied understanding between them that distributions would be made to the grantor, or the estate tax benefits would be lost. l.R.C. 2036(a)(1) (2006). Note that the trust instrument having the grantor and the grantor's spouse includible as permissible appointees of the lDGT assets alone is insufficient to cause the lDGT assets to be included in either of their estates because the special power of appointment is so broad it could include almost anyone as a permissible appointee. See Treas. Reg. 20.2042-1(c)(3) (1979). Additionally, the nonadverse party holding the special power should not be a person who is also a beneficiary of the lDGT, or any exercise of that power may result in a taxable gift. See Treas. Reg. 25.2514-1(b)(2) (1981).

The "claw back" issue

lf the estate and gift tax exemption returns back to $1 million as scheduled or future legislation (as proposed in the President's Green Book) results in an estate and gift tax exemption of less than $5.12 million, there is the potential for what is called a "claw back." This issue exists because of the calculation method for the estate tax upon death. Generally, the estate tax is calculated by adding the fair market value of assets owned by the decedent at death and the fair market value of the assets gifted during lifetime to which the estate and gift tax exemption has been applied. If this total is more than the value of the estate and gift tax exemption at date of death, the estate tax would be determined on the amount that the total exceeds the exemption at that time.

For example, assume the decedent dies in 2013 and has $3 million assets at death and the estate and gift tax exemption returned to $1 million. During 2011 and 2012, the decedent had gifted $2 million to which the lifetime gift tax exemption was applied. The estate's value for estate tax purposes would be the assets owned at death of $3 million, as well as the $2 million gifted during lifetime. This results in a "claw back" of $2 million of lifetime gifts, and the estate tax will be calculated on $4 million (rather than just the $3 million owned at death), which is the value of the taxable estate reduced by the estate and gift tax exemption at date of death.

However, most estate and gift tax law experts view this "claw back" possible issue as an unintended consequence of the TRUIRJCA not correlating well with the scheduled return of the estate and gift tax regime, perhaps because of the rushed nature of the TRUIRJCA passage in a lame duck session of Congress. Those experts point to a technical reading of the TRUIRJCA in conjunction with the offending provision (l.R.C. 2001(b)(2), scheduled to be revived in 2013, without action by Congress and the President) and its legislative history, which together support the conclusion that Congress did not intend for the "claw back" to have retroactive effect. Dennis l. Belcher, Carol A. Herrington, Jeffrey N. Pennell, et al., Recent Developments -2011, 46th Annual Heckerling Institute on Estate Planning (Jan. 2012). These experts also expect some technical correction, either from the Internal Revenue Service, the Treasury Department or Congress. Therefore, the "claw back" issue may well be moot. Nonetheless, until there are forms, instructions or other published guidance from the lRS on this issue, there will always be a certain risk in making gifts in 2012 if the TRUlRJ-CA regime is not made permanent.

Regardless as to the potential of the "claw back" issue and the appropriate level of risk, a high net worth client should still consider making gifts in 2012 to utilize the $5.12 million gift tax exemption. lmportantly, the value of the gift is "frozen" at the 2012 value, thereby removing any increase in the gift's value from the client's estate. Moreover, the growth of the IDGT would be "turbocharged" because the grantor would pay any income tax on the appreciation of the IDGT's assets. Finally, by using the IDGT, the client would further reduce the estate's assets because the IDGT's income is taxed to the client, saving on subsequent estate taxes. Therefore, in the unlikely yet possible event the "claw back" issue becomes a reality, the high net worth client still derives a significant benefit by gifting assets to an IDGT in 2012.

IDGTs ana asset protection

The benefits of the IDGT extend beyond traditional estate tax planning and into the realm of asset protection. The term "asset protection" unfortunately brings to mind a less than savory area of the law that involves hiding assets and moving assets offshore through a series of entities and maneuvers in an attempt to elude and evade creditors. However, in today's society with a volatile economy and potential creditors looming around the corner, asset protection is necessary to protect whatever nest egg, business or investment a client has developed throughout his or her life.

Background for asset protection

Recently, most asset protection trusts have been based on the concept of a self-settled trust (i.e., a trust created by the grantor for his or her own benefit). Historically, the general rule has been to deny asset protection to a self-settled trust. This began to change when laws were passed in offshore jurisdictions, such as the Cook Islands and the Isle of Man, which protect the assets in a self-settled trust. Thirteen states now offer some degree of asset protection for a self-settled trust, including Alaska, Delaware and Nevada.

In South Carolina, during the lifetime of a grantor, any creditor of the grantor can get to all of the assets held within a revocable trust created by the grantor. With respect to an irrevocable trust, a creditor of the grantor may reach the maximum amount that can be distributed to or for the grantor's benefit. S.C. Code Ann. 62-7-505 (2011). Therefore, traditional revocable and irrevocable trusts in which the grantor is a beneficiary offer little (if any) protection from creditors. In fact, after the death of the grantor, any property that was in a trust that was revocable at the grantor's death will be subject to the claims and creditors of the grantor and his or her estate. S.C. Code Ann. 62-7-505(a)(3) (2011).

Special power of appointment

The special power of appointment (SPOA) can be implemented to replace and improve on the concept of a self-settled trust. The special power of appointment is perhaps the most powerful and unappreciated tool in estate planning and asset protection. Many estate planners regularly use special powers of appointments to add flexibility to trust documents; however, they often do not fully recognize many of the most powerful uses of this tool. Whether designing a trust solely to protect against potential creditors, or to protect against estate taxes as well, a special power of appointment can be used to build a better asset protection trust.

Unlike self-settled asset protection trusts, powers of appointment are not a novel concept. The concept of a power of appointment has been a part of the English common law for hundreds of years. This concept is well recognized in all 50 states and in the federal tax laws.

There are two primary types of powers of appointment: The general power of appointment and the SPOA, the latter of which was alluded to above as creating a "defect" in the IDGT to have the grantor pay taxes on its income. A power of appointment is "general" to the extent that the power is exercisable in favor of the holder of the power, the holder's estate, or the creditors of the holder or the holder's estate, regardless of whether the power is also exercisable in favor of others. A power that is not general is referred to as a "special" or "nongeneral" power of appointment. Property that is subject to a presently exercisable general power of appointment is generally subject to the creditors of the holder of the power because it is a power that is equivalent to ownership. Conversely, property subject to a SPOA is exempt from claims of the holder's creditors. The holder of a SPOA is not considered to have a property interest in the property subject to the power because it cannot be exercised for the economic benefit of the holder. Since the holder has no property interest, the property subject to the power of appointment is not included among the property of the holder for purposes of judgment collection, bankruptcy, divorce, Medicaid eligibility, estate tax inclusion or other determinations that involve the property of the holder. See Lee S. McCullough 111, Use "Powers" to Build a Better Asset Protection Trust: A Creatively Drafted Special Power of Appointment Can Be Used to Increase Flexibility, Asset Protection, and Anonymity of a Trust, Est. Plan. J. (Jan. 2011).

Following that line of reasoning then, a permissible appointee (including the grantor of the power) has no property interest in a power of appointment. Any attempt to include the interest of a permissible appointee for purposes of judgment collection, bankruptcy, divorce, Medicaid eligibility, estate tax inclusion or other determinations that involve the property of the holder would be a logical and practical impossibility because most special powers of appointment include everyone in the world as a permissible appointee, except for the holder, the holder's estate, and the creditors of the holder and the holder's estate. Id. at 30.

An IDGT with a SPOA that includes the grantor as a permissible appointee could provide a better vehicle for asset protection than a self-settled asset protection trust. No case law supports the asset protection provided by the self-settled asset protection trust because the statutes that allow for such vehicles are relatively new and untested. On the other hand, the inability of a creditor of a permissible appointee to reach the assets of an irrevocable trust with a SPOA is supported by centuries of common law and federal bankruptcy courts. Many commentators doubt whether the self-settled asset protection trusts will hold up in the courts of those states without the necessary enabling statute or in federal bankruptcy court. Along these same lines, a self-settled asset protection trust governed by the laws of a foreign jurisdiction may carry a negative stigma and perception of wrongdoing.

Therefore, the 1DGT can be greatly improved if the settler grants a SPOA to the trustee in his or her nonfiduciary capacity, allowing the holder of the SPOA to appoint the 1DGT's assets to "any person other than the holder, the holder's estate, or the creditors of the holder or the holder's estate." This holder of the SPOA (i.e., the "nonadverse party" discussed above) should not be a person who is also a beneficiary of the trust, or the exercise of such power may result in a taxable gift. While the grant of such a power to a "non-adverse" party is one way to cause an irrevocable trust to be treated as a "grantor trust" for income tax purposes pursuant to l.R.C. 674, this SPOA also allows the holder to potentially appoint assets of the trust back to the grantor or the grantor's spouse once the threat from creditors has subsided.

South carolina's Statute of Elizabeth

As with any asset protection scenario, an attorney must be wary of the sharpest arrow in the creditor's quiver, the ability to challenge the transfer of an asset as a fraudulent transfer. South Carolina creditors can use the Statute of Elizabeth to attempt and unwind any transfers. S.C. Code Ann. 27-23-10 (2011). The S.C. Supreme Court has held that a transfer shall be set aside under two conditions:

(1) Where the transfer is made by the grantor with the actual intent of defrauding his creditors where that intent is imputable to the grantee, even though there is a valuable consideration; and (2) Where a transfer is made without actual intent to defraud the grantor's creditors but without consideration. 1f the transfer was not made on a valuable consideration, no actual intent to hinder or delay creditors needs be proven. Windsor Props., Inc. v. Dolphin Head Constr. Co., 331 S.C. 466, 470 (1998). The first condition deals with the actual intent of the debtor to defraud creditors, which is difficult to prove, as the circumstantial evidence surrounding the transaction will be subject to a subjective analysis by the court. Additionally, since the current estate and gift tax regime is so favorable to a grantor gifting assets into an IDGT, it would seemingly be more difficult for a creditor to prove that the gift into an IDGT is an attempt by the grantor to defraud creditors rather than opportunistic estate and gift tax planning.

Another issue that comes out of the first condition is what constitutes "valuable consideration." The S.C. Supreme Court has found that "grossly inadequate" consideration is a strong "badge of fraud" but specifically rejected the argument that gross inadequacy of consideration reduces the conveyance to the state of one made without consideration. Jeffords v. Berry, 247 S.C. 347, 351 (1966). Therefore, even with grossly inadequate consideration, the creditor will still need to prove actual intent to defraud as grossly inadequate consideration is a badge of fraud that creates a rebuttable presumption of intent to defraud. See Dinkins v. Robbins, 200 S.C. 475 (1942). As defined by the S.C. Supreme Court, "grossly inadequate consideration does not mean simply less than the actual value of the property. It means a consideration so far short of the real value of property as to shock a correct mind." McGhee v. Wells, 57 S.C. 280 (1900). Therefore, valuable consideration may be less than the fair market value of the asset, but how much less is a risk taken on by the client in any asset protection transaction.

The second condition deals with transactions that completely lack consideration. In these cases, if there is no consideration for the transfer, then actual intent need not be proven by the creditor. The creditor will simply need to prove constructive intent of the debtor to defraud the creditor. If the transfer is made without consideration, the transfer will be set aside if the creditor establishes that: (1) the debtor was indebted to the creditor at the time of transfer; (2) the conveyance was voluntary; and (3) the debtor failed to retain sufficient property to pay the indebtedness to the creditor in full. Mathis v. Burton, 319 S.C. 261, 265 (Ct. App. 1995).

Some states have adopted the Uniform Fraudulent Transfers Act (the "Act"). Under the Act there are two applicable tests, the actual intent test and the constructive fraud test. Under the actual intent test, the creditor would have to demonstrate the client's underlying intent for transferring the assets. Intent is demonstrated by examining the circumstantial evidence surrounding the transfer of the assets to the trust by looking at the "badges of fraud." Establishing intent is a subjective analysis by the court. Other than the arguments and the spin established by the parties, there are few objective factors to consider. Because of this, creditors prefer to focus on establishing the second test, the constructive fraud test. See Jacob Stein, Practical Primer and Radical Approach to Asset Protection: Clients Tend to be Most Receptive to Implementing Asset Protection Measures When They Anticipate Creditors Will Soon be Calling, and Advisors Should Discuss Potential Risks and Rewards, Est. Plan. J. (June 2011).

Establishing constructive fraud is far more straightforward than actual fraud. Here fraud is established if the transfer is made for less than fair market value and the debtor is insolvent at the time or as a result of the transfer. However, constructive fraud may only be established by present creditors. Therefore, to establish constructive fraud under the Act the creditor must exist at the time of the transfer. Arguably, if a transfer is made before an event of default, the creditor is not a present creditor. Id.

Installment notes: ideal vehicle in low interest rate environment

One way to help alleviate the potential pitfalls associated with the Statute of Elizabeth or the Act when using the IDGT with a SPOA is for the grantor to sell the assets to the IDGT with a SPOA in exchange for a promissory note. The note can be structured as the parties see fit. One such structure is an installment note, as long as its interest rate is equal to or higher than the Applicable Federal Rates (AFR) that the IRS publishes each month (otherwise, there may be unintended gift tax consequences to the grantor of the IDGT). By selling the assets to the IDGT in exchange for a note, the grantor would increase the chances that a court would hold that the grantor is transferring his assets for valuable consideration, depending on the note's terms. With the AFR (which are generally lower than prevailing market interest rates) at, or near, historic lows, now seems the perfect time to sell assets to an IDGT in exchange for a low-interest note. The note could therefore be structured to help meet the threshold test of "valuable consideration" at relatively minimal cost to the IDGT.

Conclusion

The current estate and gift tax regime alone should have estate planners considering the use of an IDGT. The fact that a much less favorable regime is scheduled to be in place on January 1, 2013, along with the President's stated hostility to the current favorable tax environment and treatment of the IDGT, makes smart tax planning in 2012 even more important. The laggard economy causing potential creditor issues makes the IDGT invaluable to many clients. These unique events allow the savvy estate planner to seize a golden opportunity to minimize a client's taxes while maximizing protection from future creditors, an opportunity which the planner may not see again.