EFTA01097356.pdf

Cutting Edge Estate Planning Ideas What Have I Learned From My Colleagues?' Diana S.C. Zeydel, National Chair Trusts and Estates Greenberg Traurig, P.A. 333 SE 2°d Avenue Miami, Florida 33131 © 2012. Diana S.C. Zeydel. All Rights Reserved This outline consists entirely of materials excerpted front articles and outlines written by the author with other co-authors or written entirely by others. The author wishes to thank Tumey Berry, Jonathan Blattmachr, Stacy Eastland, Mitchell Gans, Carlyn McCaffrey and Donald Tescher for the ideas that contributed to the content of this paper. The author has given attribution to the individuals the author believes are primary responsible for creating the strategies discussed in this outline. The development of a strategy is frequently the result of collaborative efforts, and the author acknowledges that others may have also make substantial contributions to their development. EFTA01097356  Diana S.C. Zeydel, National Chair Trusts and Estates Greenberg Traurig, P.A. 333 S.E. 33131 Diana S.C. Zeydel is the National Chair of the Trusts & Estates Department and a shareholder of the law firm of Greenberg Traurig, P.A. She is a member of the Florida, New York and Alaska Bars. Diana is a member of the Board of Regents and immediate past Chair of the Estate & Gift Tax Committee of the American College of Trust and Estate Counsel. She is an Academician of The International Academy of Estate and Trust Law. She is a member of the Executive Council of the Real Property, Probate and Trust Law Section of the Florida Bar and an ACTEC liaison to the Section. Diana is recognized as a "key figure in shaping the whole wealth management legal profession," Chambers USA 2012 Client's Guide; "an incredibly intelligent and creative practitioner, particularly on the tax and business restructuring side," Chambers USA 2011 Client's Guide; and to be "at the cutting edge of federal tax matters," Chambers USA 2010 Client's Guide. She is a frequent lecturer on a variety of estate planning topics and has authored and co-authored several recent articles, including "Supercharged Credit Shelter Trustsm versus Portability, " Probate and Property, March/April 2014; "Portability or No: The Death of the Credit-Shelter Trust," Journal of Taxation, May 2013; "Imposition of the 3.8% Medicare Tax on Estates and Trusts," Estate Planning, April 2013; "Congress Finally Gives Us a Permanent Estate Tax Law," Journal of Taxation, February 2013; "Tricks and Traps of Planning and Reporting Generation- Skipping Transfers, " 47th Annual Heckerling Institute on Estate Planning, 2013; "New Portability Temp. Regs. Ease Burden on Small Estates, Offer Planning for Large Ones," Journal of Taxation, October 2012; "When Is a Gift to a Trust Complete: Did CCA 201208026 Get It Right?" Journal of Taxation, September 2012; "Turner II and Family Partnerships: Avoiding Problems and Securing Opportunity," Journal of Taxation, July 2012; "Developing Law on Changing Irrevocable Trusts: Staying Out of the Danger Zone," Real Property, Trust and Estate Law Journal, Spring 2012; "An Analysis of the Tax Effects of Decanting," Real Property, Trust and Estate Law Journal, Spring 2012; Comments submitted by ACTEC in response to Notice 2011-101 on Decanting, April 2012; Comments submitted by ACTEC in response to Notice 2011-82 on Guidance on Electing Portability of the DSUE Amount," October 2011; Contributor to A Practical Guide to Estate Planning, Chapter 2 Irrevocable Trusts, 2011; "Estate Planning After the 2010 Tax Relief Act: Big Changes, But Still No Certainty," Journal of Taxation, February 2011; "The Impossible Has Happened: No Federal Estate Tax, No GST Tax, and Carryover Basis for 2010" Journal of Taxation, February 2010; "Tax Effects of Decanting - Obtaining and Preserving the Benefits," Journal of Taxation, November 2009; "Estate Planning in a Low Interest Rate Environment" Estate Planning, July 2009; "Directed Trusts: The Statutory Approaches to Authority and Liability," Estate Planning, September 2008; "How to Create and Administer a Successful Irrevocable Life Insurance Trust" and "A Complete Tax Guide for Irrevocable Life Insurance Trusts," Estate Planning, June/July 2007; "Gift-Splitting - A Boondoggle or a Bad Idea? A Comprehensive Look at the Rules," Journal of Taxation, June 2007; "Deemed Allocations of GST Exemption to Lifetime Transfers" and "Handling Affirmative and Deemed Allocations of GST Exemption," Estate Planning, February/March 2007; "Estate Planning for Noncitizens and Nonresident Aliens: What Were Those Rules Again?" Journal of Taxation, January 2007; "GRATs vs. Installment Sales to IDGTs: Which is the Panacea or Are They Both Pandemics?" 41st Annual Heckerling Institute on Estate Planning, 2007; and "What Estate Planners Need to Know about the New Pension Protection Act," Journal of Taxation, October 2006. Diana received her LL.M. in Taxation from New York University School of Law (1993), her J.D. from Yale Law School (1986), and her B.A., summa cum laude, from Yale University (1982), where she was elected to Phi Beta Kappa. EFTA01097357  TABLE OF CONTENTS Page I. Installment Sales to Grantor Trusts with a Twist 1 A. General Tax Principles Applicable to Installment Sales to Grantor Trusts 1 I. Does Either or Both of I.R.0 1 2. Are the Trust Assets Included in the Grantor's Estate If the Grantor Dies While the Note Is Outstanding? 1 3. What is the Effect If the Installment Sale Is Not Administered in Accordance with its Terms? 9 4. Is Gain Recognized by an Installment Sale of Appreciated Assets? 10 5. Protecting an Installment Sale with a Formula Clause 11 B. Is it Possible to Make the Installment Sale to Trust Created by the Spouse? 15 I. Basis of the Promissory Note Held By Wife's Grantor Trust 15 2. Basis of the Promissory Note Held by Husband After Sale of Property 17 3. Rules for Gain Recognition of a Promissory Note under IRC Section 1001 17 4. Significant Modification Occurs if Promissory Note Has New Obligor 17 5. Significant Modification Exception -- Substantially Transferring All Assets 18 6. Significant Modification Exception -- State Law 19 7. Analogous Argument For No Gain Realization Based on Installment Sale Rules 19 8. Tax Consequences of Interest Payments Made Pursuant to the Promissory Note 21 C. Using Nonrecourse Debt to Avoid the Potential Gain Realization Issues 22 I. General Case Law 22 2. Authorities under Code § 1001 23 EFTA01097358  3. Other Authorities (Regulations §1.752-1(a)(1)) 26 4. Summary of Authorities 26 II. 99-Year GRAT 28 A. Basic Structure of a GRAT 28 B. Important Questions About GRATs Remain 29 1. How Small Can the Remainder in a GRAT Bey 29 2. Minimum Remainder Value? 29 3. How Short a Term May a GRAT Last? 29 4. Possible Language to Avoid Adverse Effect of Minimum Value and/or Minimum Term 30 5. What Is the Effect of Improper Administration of a GRAT? 31 6. Possible Language to Avoid Disqualification of a GRAT for Improper Administration. 32 C. Declining Payment GRATs 33 D. Enter the 99-Year GRAT 34 III. Leveraged GRATs 35 A. Use of Family Partnership and GRAT, But Inverted 35 I. Obtaining the Benefit of a Discount With a GRAT 35 2. Improved Financial Results 35 B. Risks in the Strategy? 36 IV. Supercharged Credit Shelter Trustsm 36 A. Testamentary Credit Shelter Trusts. 36 B. Making the Credit Shelter Trust a Grantor Trust 37 1. Using 678 37 2. Using a Lifetime QTIP Trust for the Spouse Dying First 38 3. Creditors' Rights Doctrine 40 EFTA01097359 V. Split Purchase Trustssm 42 A. Basic Structure 42 B. Joint Purchase Through Personal Residence Trust 43 C. Tax and Administrative Considerations 44 1. Estate Tax Considerations 44 2. Interest of Term Holder 46 3. Income Tax Considerations 47 4. Payments of Expenses 47 VI. Testamentary CLATs 48 A. The Transaction 48 1. Self-Dealing under the Private Foundation Rules 49 2. Safe Harbor under the Regulations 51 3. Survey of Applicable Revenue Rulings 54 B. The Results 56 VII. Turner and Protecting FLPs from Estate Tax Inclusion 56 A. The Turner Estate Tax Inclusion Problem 56 B. Attempt to Qualify for a Marital Deduction 57 C. Avoiding the Application of Section 2036. 58 D. If All Else Fails -- Qualifying the Included Property for a Marital Deduction 60 iii EFTA01097360 I. Installment Sales to Grantor Trusts with a Twist2 A. General Tax Principles Applicable to Installment Sales to Grantor Trusts 1. Does Either or Both of I.R.C. §§270l or 2702 Apply to an Installment Sale to a Grantor Trust? Essentially, under both I.R.C. §§2701 and 2702,3 certain interests in a partnership, corporation or trust owned or retained by a transferor are treated as having no value thereby causing the entire amount involved in the transfer to or acquisition by members of the transferor's family to be treated as a gift. If either section applies to an installment sale, the result would be adverse. In the Tax Court case involving taxpayer Sharon Karmazin, Docket 2127-03, the IRS took the position that both I.R.C. §§2701 and 2702 may apply to an installment sale—essentially, because, in the IRS's view, the note received in the sale did not constitute debt for purposes of those sections. That case was settled with the IRS and, accordingly to taxpayer's counsel, on grounds other than that either section applied. As long as the note, in fact, represents debt, it seems, as is discussed below, that neither section should apply.° 2. Are the Trust Assets Included in the Grantor's Estate If the Grantor Dies While the Note Is Outstanding? It is at least strongly arguable that, in general, property sold on the installment basis is not included in the seller's gross estate because the seller has not retained an interest in the property sold, but has received only the buyer's promise to pay for the property as evidenced by the note.5 The value of the buyer's note would be included in the seller's gross estate. However, in the case of an installment sale of property to a trust created by the seller which will continue to hold the property and the earnings thereon (together with any assets initially contributed by the seller), the trust's potential inability to satisfy the note other than with the property itself or the return thereon might support the argument that the seller has retained an interest in the property sold. The seller's retained interest would cause estate tax inclusion under I.R.C. §2036. 2 Excerpted in pan from J. Blattmachr & D. Zeydel, -GRATs vs. Installment Sales to IDGTs: Which Is the Panacea or Are They Both Pandemics?," 41st Annual Ileckerling Institute on Estate Planning, 2007. 3 All references to a section or § of the Code or IRC are to the Internal Revenue Code of 1986, as amended, and the all references to the regulations are to the Treasury Regulations promulgated thereunder. 4 See, generally, R. Keebler and P. Moldier, "Structuring IDGT Sales to Avoid Section 2701, 2702, and 2036," Estate Planning Journal (Oct. 2005). See Moss v. Comm'r, 74 T.C. 1239 (1980); Cain v. Comm 'r, 37 T.C. 185 (1961) (both involving so-called self-canceling installment notes). A similar rule applies in the case of a transfer of property in exchange for a private annuity. See Rev. Rut. 77-193, 1977-1 C.B. 273. The basic test was set forth in Fidelity-Philadelphia Trust Co. v. Smith, 356 U.S. 274 (1958), which holds that where a decedent has transferred property to another in return for a promise to make periodic payments for the decedent's lifetime, the payments are not income from the uansferred property so as to cause inclusion of that property in the decedent's estate, if the payments are (i) a personal obligation of the buyer, (ii) not chargeable to the transferred property, and (iii) not measured by the income from the transferred property. EFTA01097361  For purposes of section 2036, as well as sections 2701 and 2702, the critical question would appear to be whether the debt is bona fide. If it is, the seller should not be viewed as having retained an interest in the transferred property, which should preclude the IRS from invoking any of those sections. Indeed, the IRS appears to concede as much in PLR 9515039.6 That ruling focused on the resources available to the obligor with which to make payments on the note, finding no retained interest where the daughter/obligor had sufficient wealth but reaching a contrary conclusion where the trustee/obligor had no other assets. It would seem, therefore, that if the obligor (or guarantor) has sufficient independent wealth or, in the case of a trust, the trustee has other assets, the note ought to be respected as a bona fide one.' Moreover, if the asset subject to the installment sale and its anticipated total return are sufficient to satisfy the obligation on the note, the note should not fail as debt. Rather, if the trust is reasonably expected to be able to satisfy the note by making all payments when due, even if those payments must be made from the asset purchased and the total return thereon, the note obligation should be viewed as debt and not equity! The IRS has issued several private letter rulings and technical advice memoranda which, it seems, bear on this issue of possible gross estate inclusion. In the earliest such ruling, TAM 9251004, the donor transferred stock to a trust for the benefit of his grandchildren in exchange for a 15-year note bearing current interest with all principal due upon maturity. Because the value of the stock exceeded the value of the note, the donor intentionally made a part sale/part gift to the trust. The TAM states that, because the trust had no other assets, it must use the dividends on the stock to make interest payments on the note. The TAM characterizes this as a "priority right to the trust income," and also notes that although the trustee was not prohibited from disposing of the stock, "the overall plan as established by the tenor of the trust is that the trust will retain the closely held shares for family control purposes." The TAM concludes that under the circumstances the donor made a transfer with a retained life estate under I.R.C. §2036. This TAM in the view of some is poorly reasoned and, perhaps, may be distinguished because the transfer was simultaneously donative in part. Moreover, subsequently, in PLR 9639012, the IRS appeared to adopt a somewhat different view. In PLR 9639012, the donors established qualified subchapter S trusts ("QSSTs") 9 for their children, and then partly sold and partly gifted nonvoting stock to the trusts. Apparently, dividends would be used first to pay interest and principal with respect to the stock purchase, with the full price to be 6 Under IRC § 6110(kX3) neither a private letter ruling not a technical advice memorandum may be cited or used as precedent. t CI Estate of Costanza v. Commissioner, 320 F.3d 595 (6th Cir. 2003) (analyzing whether the note was bona fide in the gift tax context). Bootstrap sales have long been upheld by the courts, despite IRS challenges asserting that they represent another relationship. See Commissioner v. Clay Brown, 380 U.S. 563 (1965); Meyerson V. Commissioner, 47 T.C. 340 (1966), ewe. 1969-2 C.B. 23. 9 IRC § 1361(d). 2 EFTA01097362  paid within three years.10 The IRS ruled that the agreement to use cash dividends to pay interest and principal on the note would not be considered a transfer or assignment of the income interest of the QSST beneficiaries, or cause them to fail to qualify as QSSTs, and also ruled that no part of the trust would be included in the donor-sellers' estates. In PLR 9535026, a donor contributed assets to a trust, and then sold stock to the trust in exchange for a 20-year note bearing current interest at the AFR under I.R.C. §7872, with all principal payable at maturity. The note was secured by the stock sold. The PLR does not recite that there was any request by the taxpayer for a ruling with respect to inclusion in the estate under I.R.C. §2036. However, the PLR did hold that if the fair market value of the stock equals the principal amount of the note, the sale would not result in a gift. This conclusion is stated to be "conditioned on the satisfaction of both of the following assumptions: (i) no facts are presented that would indicate that the note will not be paid according to its terms, and (ii) the [trust's] ability to pay the notes is not otherwise in doubt."" In addition, the PLR concludes that the note would not be an "applicable retained interest" under I.R.C. §2701 (and, therefore, the section will not apply), and that I.R.C. §2702 would not apply because the note would be debt, rather than a term interest. Although both I.R.C. §2701 and I.R.C. §2702 are gift tax provisions, these rulings (particularly the ruling under I.R.C. §2702, which section deals with valuation of transfers in trust to or for the benefit of family members when interests in the transferred property are retained) would seem analogous to any reasoning under I.R.C. §2036 for estate tax purposes. This conclusion was, however, stated to be "void if the promissory notes are subsequently determined to be equity or not debt. We express no opinion about whether the notes are debt or equity because that determination is primarily one of fact."12 Interestingly, the trusts were self-settled, discretionary trusts. The ruling does not analyze the potential estate and gift tax consequences of that fact. The IRS has also issued rulings involving what may be viewed somewhat analogous situations, wherein property is transferred to a trust in exchange for payments for life (an annuity). In PLR 9644053, a husband and wife owned as community property stock of a corporation which, in turn, owned a partnership interest. As part of a property settlement incident to divorce, the wife was to receive the stock and was to make annuity payments to a trust for the husband's benefit for the husband's lifetime. The PLR states that "it appears that the amount of the annual payments to [husband] under the annuity agreement and the obligation of [wife] to make the annual payments are independent of the value of 10 The facts are somewhat complex, because the donors had previously purchased voting stock of the corporation from a third party and then distributed the nonvoting stock as a dividend with respect to that voting stock, and from the facts it is not clear whether the interest and principal payments referred to were being made to the donors or directly to the third party. The practitioners who submitted the ruling have advised that the IRS also required that the trust have other assets of at least 10% of the value of the assets sold as a condition to the issuance of the ruling. 12 Cf: PLR 9436006, involving an installment sale of partnership units and marketable securities to a trust in exchange for a 35 year note with interest at the AFR. The IRS ruled, without further caveats, that IRC §§ 2701 and 2702 would not apply because the seller would hold debt. 3 EFTA01097363  the stock or the income generated by the stock although the taxpayer agrees that the source of the annuity payments will be the payments of partnership profits to [corporation]. In order to prevent the immediate dissolution of the partnership to effect the property settlement, the payments to [husband] are secured by the guarantee of [partnership]. . . . Default by [wife] may only indirectly result in the sale of [corporation] stock by [wife]. Thus, it appears that [husband] has not retained any control over the stock . . and that the transfer of property and property interests between [husband] and [wife] will be a bona fide exchange for full and adequate consideration." However, the PLR concludes that whether I.R.C. §2036 applies can best be determined upon consideration of the facts as they exist at the transferor's death, and so did not rule on that issue. In PLR 9515039, the taxpayer entered into what purported to be a split purchase with a trust, with the taxpayer acquiring a life estate and the trust acquiring the reminder interest in a general partnership interest. The PLR first recharacterizes the transaction as a transfer of property to the trust in exchange for the right to receive a lifetime annuity. The PLR reaches this conclusion under section 2702 which the ruling concludes applies whenever two or more members of the same family acquire interests in the same property with respect to which there are one or more term interests. The PLR then concludes that because the trust held no assets other than the remainder interest, not only did the annuity interest retained by the taxpayer fail as a qualified annuity interest, but, "the obligation to make the payments is satisfiable solely out of the underlying property and its earnings. Thus, the interest retained by [taxpayer] under the agreement, being limited to the earnings and cash flow of Venture [the investment held by the family entity subject to the joint purchase] will cause inclusion of the value represented by the [trust's] interest to be includible in [taxpayer's] gross estate under section 2036 (reduced, pursuant to section 2043, by the amount of consideration furnished by [the trust] at the time of the purchase)."13 There seems to be little case law addressing the gift and estate tax effects of an installment sale to a trust. However, in a series of cases which involved what might be viewed as a somewhat analogous issue under the income tax law,14 the United States Court of Appeals for the Ninth Circuit (the "Ninth Circuit") has repeatedly taken the position that the transactions were properly characterized as sales in exchange for annuities rather than transfers with retained interests in 13 This may be compared with the conclusion in PLR 9515039 that a transfer of assets by the taxpayer to her daughter in exchange for a lifetime annuity would not cause inclusion of the transferred property in the taxpayer's estate because the daughter held sufficient personal wealth to satisfy her potential liability for payments to the taxpayer, and neither the size of the payments nor the obligation to make those payments related to the performance of the underlying property. See Rev. Rul. 77-193, 1977-1 C.B. 273 (payments will not represent a retained interest in the transferred property causing estate tax inclusion under section 2036 so long as the obligation is a personal obligation, the obligation is not satisfiable solely out of the underlying property and its earnings, and the size of the payments is not determined by the size of the actual income from the underlying property at die time the payments are made). 14 In those cases, taxpayers transferred property to trusts in exchange for annuity payments for life, which they claimed were taxable under the special rules of IRC § 72 relating to annuities; the Service contended that the transactions were not, in fact, sales in exchange for annuities, but rather were transfers with retained interests resulting in grantor trust status for income tax purposes. 4 EFTA01097364  trusts, except in one case where the annuity payments were directly tied to the trust income.15 The Ninth Circuit relied on the fact that any trust property (not just the income) could be used to pay the annuity, the transaction was properly documented as a sale, and the taxpayer/seller did not continue to control the property after the sale to the trust.'° In Fabric v. Comm'r,17 a case which was appealable to the Ninth Circuit, the Tax Court (albeit with expressed reluctance) applied the analysis of the foregoing cases in the estate tax context under I.R.C. §2036, observing that "the rationale of these cases is fully applicable to the case at bar." In Moss v. Comm'r,I8 the decedent sold his stock in his closely held company to the company in return for an installment note that would be canceled upon his death, and the note was secured by a stock pledge executed by the other shareholders. The Tax Court observed that "[e]ven should we consider the payments to decedent as an `annuity' the value of the notes would still not be includible in his gross estate. . . . While the notes were secured by a stock pledge agreement this fact, alone, is insufficient to include the value of the notes in decedent's gross estate.s19 It seems that a sale to a trust is somewhat analogous to a sale secured by the transferred property. One disturbing development in the jurisprudence on distinguishing debt from equity is the Tax Court's analysis of the applicable factors in Estate of Rosen v. Comm 'J.." In Rosen, the decedent contributed substantial marketable securities to a family limited partnership in exchange for 99% of the limited partnership units. Subsequent to the formation of the partnership, the decedent received assets from the partnership that she used to continue her cash gift giving program and for her own support and health care needs. The taxpayer argued that the partnership IS In Lazarus v. Comm 58 T.C. 854 (1972), aff'd, 513 F.2d 824 (90t Cir., 1975), the court held that the taxpayer made a transfer with a retained interest based largely on the fact that the trust immediately sold the transferred stock for a note the income of which matched exactly the payments due to the grantor and, because it was non-negotiable, the income from which represented the only possible source of payment. The Ninth Circuit also cited the fact that the arrangement did not give taxpayer a down payment, interest on the deferred purchase price or security for its payment as indicative of a transfer in trust rather than a bona fide sale. However, in subsequent cases the court repeatedly distinguished Lazarus (and reversed the Tax Court) to reach the opposite result. See, e.g., Stern v. Comm'r, 747 F.2d 555 (9th Cir. 1984); La Fargue v. Comm 'r, 689 F.2d 845 (9th Cir. 1982). For example, in La Fargue, the taxpayer transferred $100 to a trust and a few days later transferred property worth $335,000 to the trustees in exchange for a lifetime annuity of $16,502. While noting that, as in Lazarus, the transferred property constituted the "bulk" of the trust assets, the court held there was a valid sale because there was no "tie in" between the income of the trust and the amount of the annuity. But see Melnik v. Comm 'r, T.C. Memo 2006- 25 (sale of stock to foreign company owned by foreign trusts in exchange for private annuities treated as a sham lacking business purpose where taxpayers were unable to document chronology of establishing the structure and subsequently borrowed funds from the corporation and defaulted on the notes, although accuracy-related penalties under IRC § 6664 were abated based on taxpayers' reasonable reliance on the advice of counsel). 1° The Tax Court has been particularly attentive to this control issue in applying the La Fargue rationale to subsequent cases. See. e.g., Weis! v. Comm'r, 84 T.C. 1192 (1985); Benson v. Comm'r, 80 T.C. 789 (1983). See also, Samuel v. Comm'r, 306 F.2d 682 (1st Cir. 1962). Ir 83 T.C. 932 (1984). Is 74 T.C. 1239 (1980). 19 The court cited Fidelity-Philadelphia Trust Co., discussed supra at note 49. The IRS has acquiesced only in the result in Moss (1981-2 C.B. I), indicating a disagreement with at least some pan of its reasoning. i0 T.C. Memo. 2006-115. 5 EFTA01097365  distributions were loans, not evidence of a retained interest that would cause the partnership assets to be included in the decedent's estate under I.R.C. §2036. The Tax Court disagreed, found the payments not to be loans, but rather distributions from the partnership, and further found that because the parties had agreed that such payments would be made, they were evidence of a retained interest. Unsettling, for purposes of determining how best to structure an installment sale to avoid recharacterization of the debt as a retained interest, is the Tax Court's application of what it determined to be the relevant factors for purposes of making the debt/equity distinction. Rather than applying the factors previously used by the Tax Court to distinguish a loan from a gift in Miller v. Cornm'r, 21 the Tax Court embarked on an analysis applying the factors used in the income tax context to distinguish a loan from a capital contribution to an entity to determine whether distributions from the family partnership to the decedent were loans or partnership distributions that constituted evidence of a retained interest in the assets transferred to the partnership. Because the funds were flowing in the opposite direction, out of the partnership, rather than into the partnership, the Court struggled to apply the new factors in a sensible way, and even when those factors would have supported the conclusion that the arrangement was a loan, miraculously concluded the opposite. The factors that are common to both a gift tax and an income tax analysis are: (1) the existence of a promissory note or other evidence of indebtedness; (2) the presence or absence of a fixed maturity date; (3) the presence of absence of a fixed interest rate and actual interest payments; (4) the presence or absence of security; and (5) the borrower's ability to pay independent of the loan proceeds or the return on the asset acquired with the loan proceeds. Although factor (5) might give one pause in the case of an installment sale to a trust, which may or may not have substantial assets independent of those purchased in the installment sale, it would appear that so long as the trust is solvent from inception, and in fact is able to satisfy the obligation by its terms when payments are due, that the lack of a "sinking fund" or independent assets should not cause the installment obligation to fail as debt, consistent with the cases involving sales in exchange for a private annuity discussed above. Moreover, in Miller, the court's analysis of the debtor's ability to repay reveals that a finding of insufficient independent assets to repay the debt was relevant only because the court found that the taxpayer would not have demanded repayment from the assets purchased with the loan proceeds. On the other hand, in an installment sale, the assets purchased by the trust typically 2i See Miller v. Comm's., 71 T.C.M. 1674 (1996), ard, 113 F.3d 1241 (9th Cir. 1997) ("The mere promise to pay a sum of money in the future accompanied by an implied understanding that such promise would not be enforced is not afforded significance for Federal tax purposes, is not deemed to have value, and does not represent adequate and full consideration in money or money's worth.... 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 any security or collateral, (4) there was a fixed maturity date, (5) a demand for repayment was made, (6) any actual payment was made, (7) the transferee had the ability to repay, (8) 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 purposes is consistent with a loan"). See, also, Santa Monica Pictures, LLC v. Comm's. TC Memo 2005-104. 6 EFTA01097366  expressly secure the debt; thus, the grantor necessarily contemplates repayment with the assets purchased if the trust is otherwise unable to repay the loan. The foregoing is consistent with the income tax cases as well because the income tax cases support a finding of debt if the loan proceeds are used for daily operations rather than for investment.22 Such use of the loan proceeds would require another source of funds to repay the debt, a distinguishing factor from an installment sale to a trust. The court in Rosen ignored the following additional factors held applicable in the gift tax context: (I) whether there was a demand for repayment; (2) whether there was actual repayment; (3) whether the records of the transferor and transferee reflected a loan; and (4) whether the transfers were reported for tax purposes consistent with a loan. These factors certainly seem relevant to the analysis as they demonstrate the intent of the parties, and would show conduct consistent with that intent. Instead, the court in Rosen applied the following additional factors: (1) identity of interest between creditor and equity holders; (2) ability to obtain financing from an outside lender on similar terms; (3) extent to which repayment was subordinated to the claims of outside creditors; (4) the extent to which the loan proceeds were used to acquire capital assets; and (5) adequacy of the capitalization of the enterprise. Although the decedent was the only borrower, and the other partners borrowed nothing, the court, in complete conflict with the analysis in the income tax cases cited by the court, concluded that additional factor (1) indicated the distributions were not loans. With regard to additional factor (3), the court held it was either inapplicable or indicated the distributions were not loans because the loans were unsecured (actually a repetition of common factor (4)). Although the use of the loan proceeds for daily operating expenses weighs in favor of debt in the income tax arena, the court somehow reached the opposite conclusion in Rosen, and held that the decedent's use of the distributed funds for daily needs weighed against debt or that additional factor (4) was irrelevant. The court held that because an arm's length lender would not have lent to the decedent on the same terms, additional factor (2) indicated that the distributions were not debt. And the court held that additional factor (5) was irrelevant. Thus, out of all the additional factors analyzed by the Rosen court, only additional factor (2) (whether the seller could have obtained independent financing on similar terms) would appear at all relevant in the installment sale context, with the potential to weigh against the installment sale obligation constituting bona fide debt. It is interesting that the Rosen court appears to imply that the parties should have agreed to a higher rate of interest to accommodate the fact that the decedent may have been viewed as a high risk creditor. Yet, an increased interest rate would appear to enhance the argument that the debt constituted a retained interest. Suppose for example that the installment obligation bears interest in excess of the 12 See. e.g.. Roth Steel Tube Co. v. Comm's. 800 F.2d 625 (616 Cir. 1986); Stinnett's Pontiac Serv., Inc. v. Comm's, 730 F.2d 634 (1116 Cir. 1984). 7 EFTA01097367  applicable federal rate, the rate approved by the Tax Court in Frazee v. Comm Y3 to avoid recharacterization of a loan as a gift? The taxpayer would be well advised to obtain independent verification of the rate that an arm's length lender would require if a rate in excess of the AFR is used. Given the possible risk of recharacterization of the installment obligation as a retained interest in the trust, a structure that avoids the contributor to the entity that is the subject of the installment obligation being the same person as the seller of the entity interest in the installment sale transaction would appear to be good practice. So, for example, husband could contribute assets to an entity owned by wife, and wife would engage in the installment sale transaction with her grantor trust. Wife could not be said to have retained an interest in the underlying partnership assets, because she did not transfer those assets to the partnership. More encouraging is the Tax Court case Dallas v. Commissioner,24 involving two sets of installment sales to trusts for the decedent's sons. Among the issues in Dallas was the value to two separate self-cancelling installment notes used in the first set of sales in 1999. The authors understand that each of the trusts was funded with cash and the proceeds of a third party note representing in the aggregate 10% of the purchase price of the stock sold to the trusts. The balance of the purchase price was funded with an installment note bearing interest at the applicable federal rate. At trial, the only issue concerning the 1999 notes was whether they should be discounted to take account of the self-cancelling feature. The Tax Court held that a discount should be applied; however, the IRS apparently did not otherwise challenge the bona fides of the notes, or argue that the notes constituted a retained interest in the trusts for purposes of sections 2701 or 2702.25 The IRS did not challenge at all the bona fides of the second set of notes issued in 2000 which did not have the self-cancelling feature. In Estate of Lockett v. Commissioner, 26 the Tax Court considered whether transfers from a family limited partnership to family members of the decedent were loans or gifts. The court relied on factors established in Estate ofMaxwell v. Commissionern to determine whether a bona fide debtor-creditor relationship existed. The court held that 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 any 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 transferee 13 98 T.C. 554 (1992). 2.4 T.C. Memo 2006-212. 25 Because the taxpayer was living, no argument could have been raised that the taxpayer had retained an interest under IRC §2036 so as to cause the trust to be included in the grantor's gross estate. 26 T.C. Memo 2012-123. 21 98 T.C. 594 (1992), eV, 3 F.3d 591 (god Cir. 1993). 8 EFTA01097368  reflected the transaction was a loan, and (9) the manner in which the transaction was reported for Federal tax purposes is consistent with a loan. In many respects the