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    • Kathleen Reynolds
      Post count: 428

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      Shows the economic consequence of an installment sale of property to an income trust structured to avoid any gift tax. It also illustrates the gift tax advantage of this kind of installment sale over a comparable grantor retained annuity trust (GRAT).

      Like a grantor retained annuity trust (GRAT), an installment sale to an income trust may be an effective means for a wealthy client to transfer part of the future income or appreciation from a high-income or rapidly-appreciating asset with little or no gift or estate tax cost.

      An “income trust” is a trust of which the grantor is considered the owner for federal income tax purposes. This means that the grantor must report, on the grantor’s individual income tax return, all of the income, deductions, and credits of the trust, just as if the grantor was the owner of the trust grantor assets. The IRS has also ruled that a sale or other transactions between an income trust and the grantor does not result in any capital gain or loss, or any other tax consequences. The trust is ignored for federal income tax purposes and the grantor is still the owner.

      IDIT Input Screenshots

      Entering Data

      1. Transfer Date: Enter the month and year.
      2. §7520 Rate: The program automatically enters the correct §7520 discount rate if you have kept the AFR Rates Manager up-to-date. If the AFR Rates Manager is not up-to-date, the program shows a 30% value for the selected transfer date. The program automatically rounds the rate to the nearest 2/10 of 1% as required under §7520.
      3. Term of Payment: Enter the number of years that the trust will provide income to the grantor.
      4. Gift in Trust: Enter the value of the gift that is placed in the trust before the installment sale.
      5. Sale to Trust: Enter the value of the property to be sold to the trust (i.e., the principal amount of the installment sale note.)
      6. Payment Periods: Select the number of payments that will be made to the beneficiary during normal full year.
      7. Payment Timing: Select Begin or End to indicate when the payment should be made for the selected payment period. A Begin case is assumed to be the same as an End case with an additional payment made at the beginning of the period.
      8. Applicable Federal Rate: Enter the annual applicable federal rate for the month that the transfer occurs (long-term, mid-term, or short-term). The long-term rate applies to installment sales with terms of more than nine years, the mid-term rate to terms of more than three years and not more than nine years, and the short-term rate to terms of not more than three years. The program will display a message to the right of the input field, suggesting which AFR is appropriate. When a note is an installment note, providing for payments of principal during the term of the note (i.e., the note is not interest-only), the “term” of the note for purposes of determining whether to apply the short-term, mid-term, or long-term rates is the “weighted average maturity” of the note as defined by Treas. Reg. Sec. 1.1273-1(e)(3). The AFR Manager included with this program tracks and downloads the monthly updates to the federal midterm rates.
      9. Income Earned by Trust: Enter the annual yield for the principal of the trust, combining both capital growth and ordinary income. The maximum rate is 20%, and trust assets can be assumed to depreciate by entering a negative growth rate.


      The Summary Tab displays the amounts of the Future Value of Remainder, the Payment on the Note, the Gift Tax Value of a GRAT, and the Gift Tax Value of an IDIT. The program calculates an amortized annual loan payment based on the amount of the sale, the term of the sale, and the applicable federal rate entered by the user.

      The future value of the trust is then calculated by adding the income or growth of the trust assets each year, and subtracting the installment payment from the trust each year. The calculation begins with the sum of the initial funding of the trust and the property sold to the trust. The percentage yield is applied to that value to determine the income or growth of the trust that year. The installment payment is subtracted, and a value calculated for the trust at the end of the year. The rows for each year after that begin with the ending balance from the previous row. The final value of the last row is the projected value that should pass to the beneficiaries, free of federal estate and gift tax.

      Because the transaction is a sale for fair market value at a market rate of interest, there is no gift for federal gift tax purposes. For purposes of comparison, the program also shows the value of the transfer for federal gift tax purposes if the property subject to the installment sale were not sold to the trust, but instead contributed to a comparable GRAT (i.e., a GRAT with the same assets as the proposed grantor trust following the installment sale, and paying an annuity to the seller/grantor equal to the amortized installment sale payments for a period equal to the term of the installment sale note). The gift tax value of the remainder interest in the GRAT is calculated as a trust for the same term as the installment note and without regard to the mortality of the grantor (i.e., as a “Walton-style” GRAT).

      IDIT Results Screenshot

      IDIT Schedule Screenshot

      The Table Tab displays the Beginning Principal, Growth of Trust, Payment on Note, and Ending Principal for the term of the trust.

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