Observaciones introductorias

IRS may take the position that the note is treated as a retained equity interest in the trust rather than as a mere note from the trust. If so, this would raise potential questions of whether some of the trust assets should be included in the grantor’s estate under § 2036 and § 2702. It would seem that § 2036 (which generally causes estate inclusion where the grantor has made a gift of an asset and retained the right to the income from that asset) should not apply to the extent that the grantor has sold (rather than gifted) the asset for full market value. See Ltr. Ruls. 9436006 (stock contributed to grantor trust and other stock sold to trust for 25-year note; held that § 2702 does not apply); 9535026 (property sold to grantor trust for note, interest-only AFR rate for 20 years with a balloon payment at end of 20 years; held that the note is treated as debt and “debt instrument is not a ‘term interest’ within the meaning of § 2702(c)(3)”; specifically refrained from ruling on § 2036 issue). One Technical Advice Memorandum concluded that § 2036 did apply to property sold to a grantor trust in return for a note, based on the facts in that situation. See Tech. Adv. Mem. 9251004 (transfer of $5.0 million of stock to trust in return for $1.5 million note in “sale/gift” transaction; ruling held that § 2036 applies to retained right to payments under note, reasoning that note payments would constitute a major share, if not all, of the trust income, thus causing inclusion of trust property in estate).

Analogy to private annuity cases would suggest that § 2036 should not typically apply to sale transactions. For example, the Supreme Court refused to apply the predecessor of § 2036 to the assignment of life insurance policies coupled with the retention of annuity contracts, because the annuity payments were not dependent on income from the transferred policies and the obligation was not specifically charged to those policies. Fidelity-Philadelphia Trust v. Smith, 356 U.S. 274, 277 (1958). Various cases have followed that approach, in both income and estate tax cases. For a listing of cases that have addressed the application of § 2036 in the context of private annuity transactions where are the grantor is retaining the right to receive substantial payments from a trust, see Hesch & Manning, “Beyond the Basic Freeze: Further Uses of Deferred Payment Sales,” 34th Annual Heckerling Institute on Estate Planning ¶ 1601.1 n. 55 (2000).

One commentator has suggested that there is a significant risk of § 2036(a)(1) being argued by the IRS if “the annual trust income does not exceed the accrued annual interest on the note.” U.S. Trust, Practical Drafting 4365-4370, at 4367

55

(Covey ed. Apr. 1996). Much of the risk of estate inclusion seems tied to the failure to have sufficient “seeding” of equity in the trust prior to the sale.

Various cases have addressed when promissory notes will be respected for general tax purposes. Deal v. Commissioner, 29 T.C. 730 (1958) (intent to forgive notes at time they were received cause gift treatment at outset); Estate of Holland v. Commissioner, T.C. Memo 1997-302 (loan owed by estate not treated as valid loan qualifying for estate tax debt deduction; “The determination of whether a transfer was made with a real expectation of repayment and an intention to enforce the debt depends on all the facts and circumstances including whether: (1) There was a promissory note or other evidence of indebtedness, (2) interest was charged, (3) there was security or collateral, (4) there was a fixed maturity date, (5) a demand for repayment was made, (6) any actual repayment was made, (7) the transferee had the ability to repay, (8) any records maintained by the transferor and/or the transferee reflected the transaction as a loan, and (9) the manner in which the transaction was reported for Federal tax is consistent with a loan.”); FSA 1999-837 (if intent to forgive loan as part of prearranged plan, loan will not be treated as consideration and donor makes gift to the full extent of the loan). The same nine objective factors listed in Estate of Holland were also described in Miller v. Commissioner, 71 T.C.M. 1674 (1996), aff’d, 113 F.3d 1241 (9th Cir. 1997). See also Santa Monica Pictures, LLC v. Commissioner, T.C. Memo. 2005-104.

If the note that is received from the trust is treated as debt rather than equity, the trust assets should not be included in the grantor/seller’s gross estate under §2036. A recent case reiterated some of these same factors in determining that advances from an family limited partnership should be treated as equity distributions rather than being recognized as advances in return for a note. Estate of Rosen v. Commissioner, T.C. Memo 2006-115 (decedent never intended to repay the advances, demand note with no fixed maturity date, no written repayment schedule, no provision requiring periodic payments of principal or interest, no stated collateral, no repayments by decedent during lifetime, no demand for repayment, only one note was prepared during lifetime even though numerous “advances” were made, decedent had no ability to honor a demand for repayment, no interest payments on the note, repayment of the note depended solely on the FLP’s success, transfers were made to meet the decedent’s daily needs, adequacy of interest on the note was questioned). For an excellent discussion of the impact of the Rosen case on potential estate inclusion, see Blattmachr & Zeydel, “Comparing GRATs and Installment Sales,” 41st Annual Heckerling Institute on Estate Planning ¶ 202.3[C][2] (2007).

John Porter reports that he has several cases in which the IRS is taking the position that notes given by grantor trusts in exchange for partnership interests should be ignored, based on the assertion that the “economic realities of the arrangement … do not support a part sale,” and that the full value of the partnership interest was a gift not reduced by any portion of the notes. (This position conflicts with Treas. Reg. § 25.2512-8(a), which provides that transfers are treated as gifts “to the extent that the value of the property transferred by the donor exceeds the value in money or money’s worth of the consideration given therefor.”) Porter, “Current Valuation Issues,” AICPA Advanced Estate Planning Conference ch. 42 at 51 (2004).

If the note term is longer than the seller’s life expectancy, the IRS would have a stronger argument that § 2036 applies.

56

The IRS has questioned the validity of a sale of limited partnership interests to a grantor trust in the Karmazin case, which was settled in a manner that recognized the sale. See Part One, Section V.G.7.

Practical Planning Pointers: One respected commentator summarizes planning structures to minimize the estate tax risk.

“The reasoning in Fidelity-Philadelphia Trust suggests that the estate tax case is strongest when the following features are carefully observed:

a. The note should be payable from the entire corpus of the trust, not just the sold property, and the entire trust corpus should be at risk.

b. The note yield and payments should not be tied to the performance of the sold asset.

c. The grantor should retain no control over the trust.

d. The grantor should enforce all available rights as a creditor.”

Aucutt, “Installment Sales to Grantor Trusts,” ALI-ABA Planning Techniques for Large Estates 1539, 1577 (April 2007).

6. Valuation Risk. If the IRS determines that the transferred assets exceed the note