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Defective Solutions

     With historically low interest rates and a depressed stock market, financial uncertainty seems certain. The current perfect economic storm has everyone baffled. What about you? When it comes to the long-term future of the U.S. economy, are you a bear or a bull? When it comes to the long-term future of your personal wealth, do you believe it will decrease or increase?
     If you are bearish regarding the future of your personal wealth (i.e. you believe it will decrease), then this article will be of little interest to you. However, if you are bullish, then you may want to consider the aggressive estate planning technique introduced in this article.
     Known in estate planning circles by a variety of names, this technique involves the sale of a promissory note to an intentionally defective irrevocable trust (hereinafter an IDIT Sale). Under the right conditions, an IDIT Sale might help you freeze the value of your estate now, so you can transfer more of its value later on to your loved ones …instead of to the IRS. 

The IDIT Sale 
     Like most estate planning techniques, you must follow specific steps to establish an IDIT Sale.
     First, you sign a properly drafted IDIT. The term irrevocable means that you cannot change the terms of the trust once you sign it. The terms intentionally defective mean that you retain certain rights or powers as the Grantor, even though the trust is irrevocable. For example, you may elect to retain the ability to swap IDIT Sale assets for other assets of equivalent value. As a result, trust income, deductions and credits are attributed directly to you for income tax purposes as if the trust did not exist.
     Second, you make a gift to seed the trust. This amount should be at least 10 percent of the value of the asset used to complete the IDIT Sale. Depending on the value of the IDIT Sale asset, this 10 percent gift may require use of a portion of your $1 million Lifetime Gift Exemption to avoid paying gift taxes.
     Third, you sell the asset to the IDIT in exchange for a promissory note at fair market value. This promissory note should bear interest at an Applicable Federal Rate (AFR) with a repayment period within your anticipated life expectancy. [Note: AFR rates are determined and published monthly by the IRS, based upon the approximate current yield on U.S. Treasury obligations. Accordingly, they are often lower than market rates on other assets like corporate stocks or bonds. The latest AFRs are available at http://www.irs.gov/taxpros/lists/0,,id=98042,00.html.]

The Rewards
     Properly drafted and implemented, the IDIT Sale itself occurs with no gift taxes. You also should enjoy significant asset protection and federal estate tax benefits. From an asset protection standpoint, IDIT Sale assets should avoid the claims of your creditors since you have no legal or beneficial right to them. Your future federal estate tax liability should be reduced because you pay income taxes on any income generated by IDIT Sale assets during your lifetime. Upon your death, only the fair market value of the promissory note plus any accrued interest should be included in your estate value at death. 

The Risks
     As with all aggressive estate planning techniques, the IRS does not like the IDIT Sale. To make matters worse, there is neither an Internal Revenue Code section specifically covering IDIT Sales, nor is there an established body of case law upon which to rely. That said, what if the asset you sell to the IDIT tanks or it generates less income that the AFR? Bottom line: You must carefully assess all of the risks, along with the opportunities, before you take on the perfect economic storm.

Summary
     This has been a brief introduction to a complex and aggressive estate planning technique. No estate planning technique should ever be employed without a complete understanding of its attending rewards and risks. As always, seek competent legal counsel when evaluating the appropriateness of any technique for your unique circumstances.

Copyright © 2005 Integrity Marketing Solutions. All rights reserved. Some artwork provided under license agreement. This publication does not constitute legal, accounting or other professional advice. Although it is intended to be accurate, neither the publisher nor any other party assumes liability for loss or damage due to reliance on this material.