There is a trust defined by Code Sections 671-679 referred to as Grantor trust. A transfer to an irrevocable trust can be treated simultaneously as both (i) a completed transfer for estate and gift purposes and (ii) an incomplete transfer for income tax purposes. Therefore, it is possible to structure an irrevocable trust so that the assets of the trust will be excluded from the donor’s estate at his death, while at the same time the trust will be a grantor trust for income tax purposes during the donor’s lifetime.
Grantors commonly fund these trusts through the mechanism of an installment sale or a SCIN (self-canceling installment note). This avoids any gift tax issues, and transfers, at the very least, the future appreciation of the asset, out of the grantor’s estate. Using a SCIN, it is possible to transfer a lot more than just future appreciation out of the taxable estate, if the grantor dies prematurely.
When choosing between a SCIN and a standard installment note, the tax advisor must determine whether the client’s objective is estate tax reduction, income tax reduction, or both.
If the sole objective is the reduction of the estate tax, then either structure can be used. If the objective is to also incorporate income tax planning then a defective grantor trust cannot be used, as the transaction will be ignored for income tax purposes.
Provisions that should be contained so that a transfer of assets to the trust is complete for estate and gift tax purposes, but ignored for income tax purposes are: power to reacquire or substitute assets (Code Section 675(4)(c)); loans to grantor (Code Section 675(2)); power to control beneficial enjoyment (Code Section 674(a)); power to distribute to Grantor’s spouse (Code Section 677(a)); paying life insurance premiums (Code Section 677(a)(3)).
DISCLAIMER: This Blog/Web Site is made available by the lawyer or law firm publisher for educational purposes only as well as to give you general information and a general understanding of the law, not to provide specific legal advice. By using this blog site you understand that there is no attorney-client relationship between you and the Blog/Web Site publisher. The Blog/Web Site should not be used as a substitute for competent legal advice from a licensed professional attorney in your state.