Last week we discussed some opportunities and incentives presented by The Coronavirus Aid, Relief and Economic Security Act (CARES) passed by Congress in late March 2020. This week we’ll focus on some opportunities presented by the historically low-interest rates that now exist.
When low rates are an advantage
Low-interest rates can be used for effective tax planning for higher net-worth individuals who need to remove assets from their taxable estates in a leveraged way and parents or grandparents looking to help their descendants in a tax-effective manner. The planning, however, can be complex and requires legal and tax advice.
Grantor retained annuity trusts
A Grantor Retained Annuity Trust (GRAT) works like the Charitable Remainder Trust we discussed last week, but the beneficiary is your child or another non-charitable person.
You create a trust — the GRAT — and transfer property to it. You receive the right to an annuity payment from the trust for a term of years. At the term’s end, what remains in the trust passes to your named beneficiary.
The gift of the remainder interest to your beneficiary is valued based on the present value of the estimated gift to the beneficiary, through a formula that includes a presumed interest rate known as the Section 7520 rate. The 7520 rate for the month of May is set at 0.80%.
In other words, you gift X$ into a GRAT and reserve the right to Y% annuity payments for 10 years, at which point the remaining trust assets are distributed to your beneficiary. The gift made is valued, for gift tax purposes, at $X less the Y% annual payments, assuming the trust funds grow at only 0.80%.
The GRAT yields an estate and gift tax savings if you survive the term of the trust and the trust property generates a return in excess of the 7520 rate (currently 0.80%). In other words, you pass along more value than that which was subject to gift tax. Gifting lower-value property (marketable securities or real estate which has recently declined in value) now to a longer-term GRAT that could yield a return in excess of the low 7520 rate, could result in substantial assets passing to your beneficiaries free of the estate and gift taxes.
This strategy works best when the 7520 rate is low, as it is now, and the grantor is likely to survive the chosen term of the trust.
Charitable lead trusts
Where a Charitable Remainder Trust can help you affect an IRA stretch as we discussed last week, a Charitable Lead Trust (CLT) can help you pass more assets to your heirs free of estate or gift tax, much like the GRAT.
In a CLT, the property is transferred to a trust you create that provides an annual payment to a charity for a specific term, with the remainder being paid to the named non-charitable beneficiary at the end of the term. You can get a charitable income tax deduction immediately, which is based on the value of the asset transferred to the trust, less the presumed value of what will remain in the trust at the term’s end thereby passing on to the non-charitable beneficiary.
With the 7520 rates being so low, the built-in presumption is that less will be available to your beneficiary and that results in a higher charitable deduction and a smaller presumed gift (hence lower gift tax or less gift tax exemption used up).
Sales to grantor trusts
Sale of partial business interests (perhaps discounted for minority interests and/or lack of marketability) to family members through an irrevocable grantor trust in exchange for an installment note is a common business succession planning technique. The lower interest rates, and perhaps lower values of real estate and/or business assets, make this an even more attractive tool.
The grantor trust is considered a separate entity for gift or estate tax purposes, but the income generated in the trust is passed through to the grantor (e.g. “mom and dad” who created the trust for the children’s benefit). The lower applicable federal interest rates (AFRs) allow for lower interest rates on the note and therefore, less income tax to the grantor. In addition, the post-sale appreciation on the transferred business interest passes to the children outside the estate of the parents, and therefore free of estate and gift taxes.
A parent can loan assets or cash to a child or grandchild at the required AFR without making a gift, so long as the loan is honored and payments made as though the loan were between arms-length parties (i.e. non-relatives).
Often, the parent or grandparent will forgive the loan payments annually up to the annual gift tax exemption amount (currently $15,000). Currently, the AFR for a loan term of nine years or less is under 1%. The lower interest rates allow for more of the principal to be forgiven each year, and if the assets appreciate at a higher rate than the AFR, that return has been passed on to the child free of estate or gift tax.
The COVID-19 pandemic and the dire economic situation have certainly brought a lot of bad news. But with the incentives and opportunities discussed in our last several columns, there is at least a silver lining or at least some lemonade to be made, just in time for summer.
This is not legal or tax advice to you individually, and you should rely on your own attorney or tax advisor to guide you, particularly given the nuances of the various techniques described.
Teresa J. Rhyne is an attorney practicing in estate planning and trust administration in Riverside and Paso Robles, CA. She is also the #1 New York Times bestselling author of “The Dog Lived (and So Will I)” and “Poppy in The Wild” coming in Fall 2020. You can reach her at Teresa@trlawgroup.net
Powered by WPeMatico