Saturday April 20, 2024
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3.5.3 Super Grantor Lead Trust
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Benefits of Income, Gift and Estate Tax Deduction
Prior to 1969, it was possible to receive income, gift and estate tax deductions for creation of lead trusts. In some circumstances, the total tax benefits derived exceeded the value transferred to the trust. For this reason, the Code was changed to require the donor to recognize income if the grantor lead trust qualified for an initial charitable deduction. Sec. 170(f)(2).
However, it is still possible to obtain an income and gift tax deduction in the same trust. The trust must qualify as a grantor trust and therefore permit the income tax deduction, and also qualify as a complete gift. The combination of both tax benefits produces even greater leverage for the lead trust.
Super Grantor Trust Design
First, it will be necessary to create a trust that is not included in the taxable estate. For this reason, the grantor may not retain a reversion or control over the distribution of income. Sec. 2036(a).
However, the grantor must retain a power that does not cause estate inclusion, but does cause the trust to be a grantor trust. The preferred retained power is usually held by a non-adverse party to reacquire trust assets. Sec. 675(4).
The power to reacquire assets under Sec. 675(4), when held by a non-adverse party and exercised in a non-fiduciary role, causes the trust to become a grantor trust. In some circumstances, the trust grantor has retained that power. While it would seem unlikely that the trust grantor would exercise that power, since that could be construed to be a violation of the self-dealing rules under Sec. 4941, it is still a potential power that does require grantor trust status. The grantor retaining such a power could maintain that this exercise would be permitted under the "incidental exception" to the self-dealing rules. Reg. 53.4941(b)-3.
Alternatively, a brother or sister of the donor may hold the Sec. 675(4) power to reacquire assets. Since the Sec. 4941 disqualified persons category includes spouses, children, grandchildren and their spouses, but not brothers or sisters, this provision does not violate self-dealing. Sec. 4946(d). The brother or sister would also need to be able to exercise this power in a non-fiduciary capacity to cause the lead trust to be a grantor trust. PLR 200010036.
Example 3.5.3A Super Grantor Lead Trust
Harry Smith has a large income this year and desires a charitable deduction. In addition, he would like to create a fund that would be available for his grandchildren's college education. His oldest grandchild is age 11 and will be attending college in seven years.
Harry transfers stock with a cost basis of $100,000 and fair market value of $200,000 into a seven-year annuity lead supertrust. The present value of the 8% payout to charity is $92,582. Since his income is over $330,000 this year, Harry will be able to take the full deduction this year under the 30% of AGI limit.
The trust remainder will be transferred to family. Harry retains no control over the income or a reversion in the trust. He grants his sister a Sec. 675(4) power to reacquire the trust assets, thus enabling grantor trust status. In the year when the assets are transferred to the trust, Harry must file a Form 709 gift tax return. On the gift tax return, he reports a charitable gift deduction of $92,582 and a taxable transfer to his grandchildren of $107,418. He uses part of his gift exemption and his generation skipping tax exemption to cover the $107,418 gift to the grandchildren.
During each of the next seven years, it will be necessary to sell $16,000 of stock to make the required payment to charity. Approximately one half of this sale will be cost basis and not taxable to Harry. The balance will be taxed, but at capital gain rates. Thus, even with the potential for payment of state capital gains tax, the annual tax will be just over $2,500 on the $16,000 amount. Since the initial tax savings are $37,033 and there is an estimated growth rate on the savings of over 7%, at the end of seven years, the estimated net value of the tax savings to Harry is $33,720.
The net result is that Harry benefits from a substantial income tax deduction, receives a significant gift tax deduction and pays a modest level of income taxes during the term of the trust. The cumulative benefits to Harry make this a very attractive planning strategy.
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Case Studies on Super Grantor Lead Trust
Super Lead Trust Rescues $5M Bonus:
Thomas Cook IV, 38, is the chief operating officer of Savar Oil and Gas Corporation and the likely next chief executive officer of Savar. Thomas always knew he would do well in business. From a very early age, his father, a CEO himself, groomed young Thomas for this destiny. At his father's urging, Thomas attended the finest schools and earned MBAs in both business and finance. Not surprisingly, he graduated number two in his class and eventually became the youngest vice president ever in Global Communications' history. His reputation as a "wonder exec" thrust Thomas into the business world spotlight. As a result, Savar sought to retain his services and made him an offer he could not refuse. The offer consisted of huge deferred compensation arrangements if Thomas could work his magic at Savar. To everyone's surprise, except Thomas', Savar broke into the Fortune 500 this year. Not only was this good news for the company but it also triggered a $5 million bonus for Thomas. While extremely pleased with this additional wealth Thomas shuddered at the thought that his hard-earned money would be cut almost in half after federal and state income taxes were applied. Moreover, Thomas' lawyer, Stephen Akers, informed him that when he dies approximately half of his $20 million estate will also pass to federal and state governments. As you can imagine, Thomas then went from sickened to outraged.
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Private Letter Rulings
PLR
199908002 Lead Unitrust and Lead Annuity Trust - Sub S Grantor Trusts:
Grantor plans to fund a charitable lead unitrust and a charitable lead annuity trust with Subchapter S stock. Both trusts would pay out for six years with a payout rate calculated to produce a charitable deduction of 59.9%. With a charitable deduction below the 60% level, the lead trusts would not be subject to the Sec. 4943 excess business holdings rules. Trust distributions would be to a family foundation, and grantor may serve as a director of that foundation, but any lead trust funds transferred would be maintained in a segregated account under the control of other directors.
PLR
199922007 Unitrust Lead Trust With Income Tax Deduction:
Taxpayer created a lead unitrust paying 5% for a 10-year term, with remainder to grandchildren. Taxpayer also created a second charitable trust that qualified as a private foundation. The Service determined that the first trust could potentially be a grantor trust because of a retained Sec. 675(4) power. Second, the first trust was a qualified unitrust that qualified for both a gift tax deduction under Sec. 2522 and an income tax deduction under Sec. 170(f)(2)(B. Since the Sec. 675(4) power does not require inclusion under Sec. 2033, Sec. 2036(a) or Sec. 2036(a)(1) of the Code, the trust would not be includable in taxpayer's estate.
PLR
199936031 Creative Lead Annuity Trust May Hold Subchapter S Stock:
Taxpayer plans to transfer voting and nonvoting Subchapter S stock to a charitable lead annuity trust. The trust would pay an annuity equal to 9.9% of initial net fair market value for a term of 15 years, with remainder to children or grandchildren if a child were deceased by the end of the 15 years. In order to hold the Subchapter S stock, the trust would be a lead "supertrust" with grantor trust status.
PLR
200010036 Lead Trust With Income and Gift Tax Deductions:
Several Private Letter Rulings for "lead supertrusts" have been issued recently. In this ruling, the married couple proposed to create an 8% - 15-year lead annuity trust funded with marketable securities. Presumably, the securities were highly appreciated and would be held for the term of 15 years. A portion of the securities gains would be recognized each year to make the annual payments of the annuity to a public charity.
PLR
200011012 Annuity Lead Defective Grantor Trust:
The taxpayers in this trust plan to fund an annuity lead trust, which is intended to qualify for income, gift and estate tax deductions and also last for 30 years. In contrast to remainder trusts, which are limited to no more than 20 years under Sec. 664 and may not pay less than 5%, lead trusts may be of any duration and may pay out any percentage amount.
PLR
9224029 Super Grantor Lead Trust - Municipal Bonds:
Lead trusts are usually divided into two categories - grantor lead trusts with a current income tax deduction and return of the assets to the grantor and family, or non-grantor, lead trusts with the trust remainder distributed to family members. This lead trust creatively combines both concepts. Through use of the Sec. 675(4) power to substitute assets, it is a grantor trust, but it does not under Sec. 2036 require inclusion in the grantor's estate.
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