Transfer of S Corp to IDGT

Hello all, I hope you survived the Ides of September; well, and the 15th to be more accurate!

I have a client who met with their attorney; attorney’s idea is to transfer the client’s S Corp shares to an IRR Trust; I am assuming an IDGT. Makes sense, this S Corp is probably worth at least $8MM to $10MM. Their Net Income hovers around $1MM a year and their assets are worth around another $1MM, so I’m thinking a value of at least $4MM, not including their client list/contracts, which are highly coveted in this line of business.

The IDGT seems almost too good to be true; sell your shares to the Trust, realize no tax or gift tax, then the value of the shares upon death avoid any Estate Tax. Am I missing anything here? Does anyone have any horror stories or bits of advice on how to avoid IRS scrutiny and/or have there been any significant changes in this area of tax law that would make this move a no-no? Asking any tax attorneys or preparers familiar in this area of law, and I’d sincerely appreciate any guidance.

For the trust to be a qualified buyer it must first have some assets. To meet that requirement the grantor must gift cash or assets to the trust, subject to gift tax, or using up the lifetime exclusion. The trust makes the purchase of asset with a note. At the death of the grantor the balance of the note becomes part of the estate and is taxable. Any appreciation in the value of the trust assets in not included in the estate.

The S Corp shares can be gifted. This is how I've seen it done. Since it is an Intentionally Defective Grantor Trust the grantor continues to pay the tax on the S Corp income. The S Corp stock is removed from the grantor's estate.

Come one guys, I can Google this information; in fact I did earlier today and found the same information. I wanted hard hitting stuff, “Don’t do it, you’ll be arrested, they’ll send you to the Gulag!”

Just kidding around. Thank you for your replies. I’m curious, would it be wise to consider, this is a 50/50 husband and wife owned S Corp, to have them simply gift all the shares up front? They would both use up approx $4MM each (if the company is worth $8MM), and still have plenty of room in their Lifetime Exemption (save any changes in the newest proposals), and they wouldn’t have to bother with the note.

Anything I’m missing there, or is there a reason not to relinquish the shares all at once?

This is a transaction I have planned and consummated many times. The attorney is on the right path. Not only is the stock removed from his taxable estate, but the future income as well.

I usually do it with the wife as trustee and beneficiary of the IDGT, a HEMS standard, and expansive use of special powers. But instead of a note I use a GRAT which pours into the IDGT, primarily because I remain nervous about how the note balance at death will be treated in the future for income tax purposes. (Not at all sure, but I think the House tax bill would trigger gain.)

Having said that I should also mention that as an aggressive planner I usually convert the INC to an LLC and gift 99% without consent, claiming a discount because the donee gets no political rights, such as the right to information and vote. An even more aggressive plan would be to contribute his 99% membership interest (and preferably some other assets) to to an LLC holding company. S and QSSUB elections would be made. The husband would then transfer 99% of the holding company to the GRAT, claiming what amounts to a double discount. File a 709 and start the SOL. None of my clients who have done this have ever been challenged. It seems the only potential downside would be the loss of one or both discounts. (If the husband is unwilling to let his wife be in control via the 1% interest, he could keep the 1% or declare he is holding the 1% as Trustee of a second IDGT either fbo a child or fbo his wife under different terms than the IDGT which gets the 99% interest. I'd worry about a 2038 issue, however, and would probably try to reduce the exposure by recommending the 1% be held by husband and wife as trustees.)

I nevertheless have occasionally wondered whether transferring an S into an IDGT is too good to be true. So easy and so powerful. But then again, I view the estate tax as voluntary...

Not only is the stock removed from his taxable estate, but the future income as well.

The stock is removed from the estate by gifting, at the expense of eliminating the lifetime gift/estate tax exclusion.
The trust income is taxable to the grantor, same as doing nothing.

Correct. But the income belongs to the trust. In effect, the technique expands the annual exclusion to include the income.

Correct. But the income belongs to the trust. In effect, the technique expands the annual exclusion to include the income.

Can you explain exactly how the technique increases the annual exclusion. And if you are saying that the income is not taxable either to the trust or the grantor, explain how that is so.

The income is taxed to the grantor, but the income stays in the trust. It's phantom income. The net effect is the same as if the pre-tax income were paid to the grantor who then gifted it to trust, paying taxes out of his other assets. I say it is effectively the same as an increase in the annual exclusion because there is no taxable gift of the income.

Very well explained, Steve, thank you for the response! A side note, I have a high net worth client in FL that would do well having a chat with you if you are accepting clients. He has ownership in a few car dealerships in the state; I know he would be well served with a review of his Estate plan, if that is the type of service you provide.

I do have a clarifying question about the phantom income. Will this setup permit tax distributions to assist the prior owners (grantors) with their tax bill, or would they be required to pay the tax from other accounts outside of the Trust, as you mentioned? Also, I like the LLC conversion too; I’ve talked a few clients into this move, I think it makes good sense. I try not to give any legal advice, of course.

Thanks again for the thoughtful response!

I've always wanted to give 2nd opinions on estate plans. So sure, have him give me a call or send an email.

As to the source of the tax payment, it depends on the language of the trust whether a distribution is to be made for such purpose. But keep in mind that there are special powers, which make access easy. Further, his wife is the beneficiary and paying taxes on a joint return can be considered a need if they are short of funds. (Any plan is bad if it deprives access.)

This is my first experience with chatting. I quickly got addicted and went overboard. The negative reactions have caused me to apologize and stop chatting. I'll be happy to respond to a private message. My email is steve@gatortaxguy.com.

Ha! Don’t worry, I’m sure my opinions have nearly got me banned a few times. Do a bit of searching for CKenefick and you’ll see what can get you booted. The key is to be inflammatory in a creative way, but always be respectful to others whilst attempting not to anger the peanut gallery. After a while, you’ll get the hang of it.

And, thank you for posting your email address; I promise no spam, but in the future, you might want to do that over a private message. Sincerely, thank you for taking the time to review and post a thoughtful response; you’ll do well here.

That's what I was trying to do. But I was naïve.
I live by a rule that I don't communicate with anyone who shows a lack of respect.
Imputing motives is not ok.
I'll just stick with PMs.

Gatortaxguy, I have been involved with online forums and chat-rooms for a long time. In fact, that is how I met the lady who is now my wife. In a few weeks, we will celebrate twenty years of marriage. Here's the thing. Most people need to get to know you before they will go too far with a PM. It's a matter of building trust, just like in real life. To be brutally frank, you haven't built trust with this community yet.

I know you haven't asked for my advice but I'm going to give it anyway. Slow down. Answer a few questions with thoughtful observations. Try not to initiate a post that gives answers to topics that most of us here have no need for. That comes across as advertising. Whether it is or not, it has certainly rubbed a lot of people up the wrong way and I am pretty sure you now recognize that.

You are 73 years old with six stents. It sounds as if you don't need the upsetment. This is a positive, vibrant community and it's easy to be part of it. You just need to meet the existing members half-way.