New York State Determines that Substitutions with IDGTs are subject to Real Estate Transfer Tax and Sales Tax
An irrevocable trust that is designed as an “intentionally defective grantor trust” (“IDGT”) is a key estate and gift planning tool. Often a key component to blunt the impact of irrevocable gifts to the trust (and for other reasons, such as qualifying it as an IDGT) is to permit the settlor of the trust to substitute property in the trust with other property of equal value. This power is sometimes referred to as the “power to reacquire” or the “power to substitute.” For purposes of both federal and New York income tax, transactions between an IDGT and its settlor are disregarded, as they are treated for these purposes as the same person.
In an Advisory Opinion released December 22, 2014 (TSB-A-14(2)R, Dec. 4, 2014) the New York State Department of Taxation and Finance determined that “the conveyance of a New York condominium apartment by [the trust settlor] to the [IDGT in which the settlor retained a power to reacquire] in exchange for cash equal to the value of the apartment is a conveyance, subject to the New York Real Estate Transfer Tax [Tax Law §1402(a) (“RETT”)].” The tax would be based on the cash received from the trust.
Not feeling compelled to view the IDGT and the settlor as separate pockets in the same pair of trousers for purposes of the RETT, the Department held that the transaction was between two separate parties:
Once the apartment is substituted for the cash as an asset of the IDGT, under the terms of the IDGT, [the settlor] would no longer hold any beneficial interest in the real estate. This transfer of the [settlor’s] condominium apartment to the IDGT fits within the statutory definition for RETT purposes of a conveyance of real property or interest therein.
This is consistent with other positions recently taken by the Department. Previously, in January, 2014, the Department issued an advisory opinion (TSB-A-14(6)S, Jan. 29, 2014) that the exercise of this power of substitution by transferring tangible personal property to the trust in exchange for intangible assets of the trust was subject to the New York sales tax (Tax Law §1105(a)) notwithstanding that the trust and the settlor are treated for income tax purposes as the same person. In fact the Department said this would be the case regardless of whether it is a grantor trust or a revocable living trust (citing TSB-A-99(22)S), as a sale for state sales tax purposes occurs if the assets transferred would be subject to sales tax if the parties were unrelated. According to the Department “[i]f there is consideration given in any form in connection with the transfer, a retail sale of tangible personal property occurs and sales tax is imposed. . . .” The Advisory Opinion hints that there may be “other exemptions” to the application of New York sales tax, perhaps referring to situations where there is a substitution of tangible personal property for tangible personal property between the irrevocable trust and its settlor.
The moral? Great estate and gift tax planning often butts up against other taxes. Don’t be caught unaware. Seek advice before taking irreversible actions.