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September, 2007 Technical Newsletter
Provided by Leimberg Information Services
See
other issues.
Transaction of Interest –
Toggling Grantor Trust
LISI wanted you to be aware
of something that may have a huge impact on the sales to grantor
trusts.
Our thanks to Larry Brody of Brian Cave for
bringing this to our attention:
EXECUTIVE SUMMARY:
The IRS and the Treasury
announced that they are aware of a type of transaction, that uses a grantor
trust, and the purported termination and subsequent re-creation of the trust's
grantor trust status, for the purpose of allowing the grantor to claim a tax
loss greater than any actual economic loss sustained by the taxpayer or to
avoid inappropriately the recognition of gain.
The two organizations have
stated that
"this transaction has the potential for tax avoidance or evasion, but lack
sufficient information to determine whether the transaction should be
identified specifically as a tax avoidance transaction."
Notice 2007-73 identifies
this transaction, and substantially similar transactions, as transactions of
interest for purposes of Code Sections 1.6011-4(b)(6) , 6111 and 6112.
It also alerts persons
involved with these transactions to certain responsibilities that may arise
from their involvement with these transactions.
MORE ON NOTICE 2007-73
TO FOLLOW. BUT FIRST, EDITOR ANDY DeMAIO ISSUES A LAWTHREADS ALERT!
RUDKIN
TRUST ISSUE: SHOULD WE CARE?
At first
glance, the issues to be addressed by the U.S. Supreme Court in the Rudkin
Trust case seem to involve relatively small amounts of money.
However,
participants in a recent online discussion point out that the amounts in
controversy may well exceed 2% of the estate's adjusted gross income.
To read
this and other recent LawThreads reports, log in to LISI at
http://www.leimbergservices.com.
Once you have logged in, click the blue LawThreads button under Recent
Entries.
NOW BACK
TO NOTICE 2007-73!
FACTS:
VARIATION 1:
- Grantor purchases four options.
- The value of each one of the
options is expected to move inversely in relation to at least one of the other
options over a relevant range of values so that, before expiration of any one
of the options, there will be a gain in two options (gain options) and a
substantially offsetting loss in the other two options (loss options).
- Grantor creates Trust and funds
Trust with the options and a small amount of cash.
- Grantor gives a short-term
unitrust interest in Trust to the Beneficiary and retains a noncontingent
remainder interest in Trust.
- The remainder interest is
structured to have a value as determined under § 7520 that equals the fair
market value of the options.
- Grantor takes the position that
Grantor's remainder interest is a qualified interest under Code Section 2702.
- Because of the retained remainder
interest, the Grantor treats the Trust as a trust Grantor Trust (one owned by
Grantor under the so-called grantor trust Code Sections 671 and following).
- The trust agreement also provides
that Grantor will have the power, exercisable in a nonfiduciary capacity, to
reacquire Trust corpus by substituting other property of an equivalent value
(the substitution power) and that this substitution power will become
effective on a specified date in the future. (Code Section 675(4)).
- After establishing and funding
Trust, Grantor sells the remainder interest in Trust to an unrelated person
(Buyer) for an amount equal to the fair market value of the remainder interest
(which is equal to the fair market value of the options).
- Grantor claims that the basis in
the remainder interest is determined by allocating to the remainder interest a
portion of the basis in all of the Trust assets (based on the respective fair
market values of the remainder and unitrust interests at the time of the
sale). Therefore, Grantor claims there is no gain recognized on the sale of
the remainder interest because Grantor's basis in the remainder interest is
the same as the amount realized (prearranged to be equivalent to the fair
market value of the options).
- Buyer gives Grantor an installment
obligation (Note), cash, or other consideration for the remainder interest.
- Grantor claims that the sale of
the remainder interest has terminated (toggled off) the grantor trust status
of Trust so that, during the period after the sale and before the effective
date of the substitution power, Trust is no longer a grantor trust under Code
Section 671.
- Grantor claims that, once the
substitution power becomes effective, Trust's grantor trust status is
restarted (toggled on).
- The loss options are then closed
out.
- The amount Grantor paid for those
options (the original basis of those options) is greater than the amount Trust
receives when the loss options are closed out. Grantor claims that Trust's
status as a grantor trust causes Grantor to recognize the loss on the two loss
options. Grantor calculates the loss based on the difference between the
amount realized and the original basis in the loss options, even though
Grantor previously used a portion of the basis in the Trust assets (equivalent
to the basis in all of the options) to eliminate Grantor's gain on the sale of
the remainder interest. Trust's remaining assets then consist of the two gain
options, the contributed cash, and amounts received, if any, upon the
termination of the loss options.
- Buyer then purchases the unitrust
interest in Trust from Beneficiary for an amount equal to the actuarial value
of that interest (which equals or approximates the amount of cash Grantor
contributed to Trust), making Buyer the owner of both the remainder interest
and the unitrust interest.
- Trust then terminates (by
operation of law or Buyer's action), and Trust's assets are distributed to
Buyer.
- Buyer claims a basis in the assets
(the gain options and the cash) from Trust equal to the amount paid by Buyer
for the two separate interests in Trust.
- Grantor does not treat the
termination of Trust as a taxable disposition by Grantor of the assets of
Trust.
- The gain options are exercised or
sold, or otherwise terminate, and Buyer claims to recognize gain on the gain
options only to the extent that the amount realized exceeds the basis Buyer
allocates to the gain options. The transaction has been structured so that
any gain recognized would be minimal.
- If Buyer purchased the remainder
interest from Grantor with a Note, Buyer uses the proceeds from the options to
pay the Note. If Grantor borrowed to purchase the options, Grantor repays the
loan from the Note proceeds.
VARIATION 2:
In another
variation of the transaction, the facts are the same as described above except
for the following.
- Grantor contributes
to Trust liquid assets such as cash or marketable securities, rather than
options. Grantor's basis in the contributed assets equals or is approximately
equal to the fair market value of the assets at the time of contribution.
- Before the specified date on which
Grantor's substitution power becomes effective, Grantor sells the remainder
interest in Trust to Buyer for an amount equal to the fair market value of the
remainder interest and claims to recognize no gain or a minimal gain or loss
for the same reason as described above.
- As in the prior variation, Grantor
claims that the sale terminates (toggles off) Trust's grantor trust status.
- After the
substitution power becomes effective, Grantor substitutes appreciated property
for Trust's liquid assets. The fair market value of the substituted property
is equivalent to the fair market value of the liquid assets.
Grantor claims that, once the substitution
power becomes effective (prior to the exchange), Trust's grantor trust status
is restarted (toggled on), and, therefore, the substitution will not cause
Grantor to recognize gain.
- As described above, Buyer
purchases the unitrust interest in Trust from Beneficiary, terminates Trust,
and receives Trust's assets on distribution. For tax purposes, Grantor does
not treat the termination of Trust as a disposition by Grantor of the
appreciated assets in Trust. Buyer claims a basis in the assets of Trust (the
appreciated property and cash) equal to the amount paid by Buyer for the
interests in Trust.
- One of the purported tax
consequences of the first variation of the transaction is that Grantor sells
the remainder interest and receives an amount substantially equal to the fair
market value of the (non-cash) assets contributed to Trust but nevertheless
claims a tax loss attributable to those assets even though Grantor has not
suffered an equivalent economic loss.
- One of the purported tax
consequences of the second variation of the transaction is that Grantor avoids
the recognition of gain on the disposition of the appreciated assets
substituted for the original assets contributed to Trust.
- These transactions usually occur
within a short period of time during the taxable year (typically within 30
days), and, in each case, Grantor claims that the termination and subsequent
reestablishment of grantor trust status, combined with the series of events
regarding Trust's assets, result in tax consequences that could not be
achieved without both the toggling off and on of grantor trust status.
The transactions in this
notice, as described above, do not include the situation where a trust's
grantor trust status is terminated, unless there is also a subsequent
toggling back to the trust's original status for income tax purposes.
TRANSACTION OF INTEREST
Effective Date:
Transactions that are the
same as, or substantially similar to, the transactions described in this
notice are identified as transactions of interest effective August 14, 2007,
the date this notice was released to the public.
Persons entering into these
transactions on or after November 2, 2006, must disclose the transaction as
described in § 1.6011‑4.
Material advisors who make
a tax statement on or after November 2, 2006, with respect to transactions
entered into on or after November 2, 2006, have disclosure and list
maintenance obligations under §§ 6111 and 6112. See § 1.6011-4(h) and
§§ 301.6111-3(i) and 301.6112-1(g) of the Procedure and Administration
Regulations.
Independent of their
classification as transactions of interest, transactions that are the same as,
or substantially similar to, the transaction described in this notice may
already be subject to the requirements of §§ 6011, 6111, or 6112, or the
regulations thereunder.
When the IRS and Treasury
Department have gathered enough information to make an informed decision as to
whether this transaction is a tax avoidance type of transaction, the IRS and
Treasury Department may take one or more actions, including removing the
transaction from the transactions of interest category in published guidance,
designating the transaction as a listed transaction, or providing a new
category of reportable transaction.
Participation
Under Code
Section 1.6011-4(c)(3)(i)(E), Grantor, Buyer, and Beneficiary are participants
in this transaction for each year in which their respective tax returns
reflect tax consequences or a tax strategy described in this notice.
Time for Disclosure
See Code Sections
1.6011-4(e) and 301.6111-3(e).
Material Advisor Threshold Amount
The threshold amounts are
the same as those for listed transactions. See Code Section
301.6111-3(b)(3)(i)(B).
Penalties
Persons required to
disclose these transactions who fail to do so may be subject to the Section
6707A penalty or the 6707(a) penalty.
Persons required to
maintain lists of advisees under Code Section 6112 who fail to do so (or who
fail to provide such lists when requested by the Service) may be subject to
the penalty under Code Section 6708(a).
In addition, the Service
may impose other penalties on parties involved in these transactions or
substantially similar transactions, including the accuracy-related penalty
under § 6662 or § 6662A.
COMMENT:
Where is this all going and
what impact will it have on routine sales to grantor trusts? It's too soon to
know but Notice 2007-73 is sure to be one of the more significant warnings
from the IRS this year. LISI's Commentator Team will keep you informed.
Meanwhile, "Be Careful Out There!"
HOPE THIS HELPS YOU HELP
OTHERS MAKE A POSITIVE DIFFERENCE!
Steve
Leimberg
CITE AS:
Steve Leimberg's Estate
Planning Newsletter # 1161 (August 14, 2007) at
http://www.leimbergservices.com
Copyright 2007 Leimberg
Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to
Any Person Prohibited – Without Express Authorization.
CITES:
Notice 2007-73 -
Transaction of Interest – Toggling Grantor Trust
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