Deferred Payment Sales to Grantor Trusts, Grats and Net Gifts: Income and Transfer Tax Elements

Abstract

Estate planners have long recognized the attractiveness of the various freeze techniques for transfer tax purposes. An outright gift is a freeze technique, but one that requires immediate payment of gift tax once the lifetime exemptions and annual exclusions are exhausted. Both grantor retained annuity trusts ("GRATs") and charitable lead trusts also accomplish the freeze objective, and at a reduced gift tax cost because of the reduction for the value of the grantor or charitable interests. Deferred payment sales are estate freeze vehicles that limit the transfer tax inclusion to the deferred payment right and interest, but require the recognition of gain, usually capital gain, albeit on a deferred payment basis if the sale qualifies of the installment method (or as a private annuity sale). When the deferred payment sale is to a grantor trust, however, the capital gain is eliminated, at least for payments during life. This article discusses the income tax and transfer tax savings available by using net gifts, GRATs, and deferred payment sales to grantor trusts. The deferred payment sale to the grantor trust can take be a sale for an installment note, a private annuity or a self-canceling installment note ("SCIN") without changing the income tax and freeze advantages, and, in the latter cases, with potential additional estate tax benefits. The article concludes that, in most circumstances at least, a deferred payment sale is a better approach than a GRAT, particularly when the risk that the grantor will not live out the GRAT period is taken into account. It also tends to be better for taxable generation skipping transfers. The article also concludes that neither the grantor-seller nor his estate realizes capital gain when grantor-trust status terminates while the deferred payment obligation is still outstanding.