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Estate Planning Opportunities
A primary goal of estate planning is to transfer wealth from one generation to another in a tax-efficient manner. The current economic conditions create the perfect opportunity to implement a number of wealth-transfer techniques. The current IRS interest rates used to calculate gift taxes are currently very low. The low interest rates present families with an opportunity for their wealth transfer strategies. By making strategic estate planning decisions now, while interest rates are low, individuals are able to pass more to future generations and reduce or eliminate estate, gift, and GST taxes.
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Following is an analysis of some estate planning methods that can be particularly effective in:
Outright Gifts
Individuals may give an annual gift amount, adjusted for inflation, which is excluded from gift taxes. In 2017, this amount is $14,000, and can be given to any number of beneficiaries. A married couple can transfer double ($28,000) the annual exclusion amount per year per beneficiary. Additionally, payment of another person's medical or tuition expenses are exempt from gift tax liability and not counted toward the annual exclusion amount.
Why is this important? Annual exclusion gifting allows you to transfer funds, gift tax- free, to anyone you wish to assist immediately, rather than after your death. Annual gifting may also reduce your estate tax liability by removing assets from your estate during your lifetime. This is an especially useful tool with depressed assets. Leveraging the annual exclusion may allow you to transfer assets that have a low value today, but which you anticipate will rebound in the future while completely avoiding transfer taxes.
Family Loans
Loans to family members are a well-established estate planning tool and are an especially useful means of transferring wealth to a younger family member who may not yet qualify for traditional loans. You can loan the money at rock-bottom interest rates for use in investing, business start-up, education, home purchase, and other purposes. The IRS sets minimum interest rates for these types of loans, well below bank rates, depending on the maturity date. Lower rates assist the debtor by requiring smaller payments and do not greatly increase the amount coming back into your estate. The annual gift exclusion is often used in conjunction with family loans so that gifts of the loan's principal are made yearly by forgiving some or all of the amount due that year, estate tax burden. maximizing the transfer of wealth from one generation to the next and lowering your estate tax burden. If you are considering making a family loan, be warned that these loans must be properly documented to ensure you receive the intended benefits.
Grantor-retained Annuity Trusts ("GRATs")
GRATs are especially powerful tools in a down economy because, if planned correctly, they allow the transfer of an appreciating asset nearly transfer tax-free. Assets that are currently low in value, but which are expected to increase in value in the future, can be placed into a GRAT which is set to expire within a term of years. During the term of the GRAT, an annuity amount is paid to the grantor of the trust. When the trust expires, the assets pass to the beneficiaries transfer tax-free.
As with family loans, the IRS sets rates for GRATs, and if the trust is well planned, the pass to your beneficiaries tax-free. asset will appreciate at a rate higher than the GRAT rate allowing the excess amount to pass to your beneficiaries transfer tax-free
Charitable Lead Annuity Trust ("CLAT")
CLATS benefit both charities and private, non-charitable beneficiaries because the trust pays an annuity to the designated charity for a specified term with the remainder going to the private beneficiaries. A CLAT effectively keeps an asset in your name for the term of the trust, provides a funding stream to your favorite charity, and allows the beneficiary of your choice to keep the asset.
The lower interest rates utilized in a CLAT result in a larger gift or estate tax deduction for the annuity interest going to the charity and a smaller value for any gift of the remainder interest going to a non-charitable beneficiary.
Sales to Grantor Trusts
After forming a grantor trust, the grantor sells one or more assets to the trust (which should be property that the grantor has reason to believe will appreciate in value) in exchange for a promissory note from the trust. Because the trust is not a separate taxpayer for income tax purposes, the sale to the trust will not result in the realization of capital gain or loss to the grantor or the trust nor will the sale increase basis of the property sold promissory note. to the trust, and the grantor will not be taxed on the interest payments he receives on the The note must bear interest not lower than the applicable federal rate (AFR). Appreciation and earnings on property sold to the trust above the sales price will pass to the trust's beneficiaries entirely free of transfer taxes. As with a GRAT, the trust's income is taxable to the grantor. It is necessary that the trust have some measure of economic significance apart from the sale, and the trust should be funded with assets other than the purchased property. Generally, the assets should be equal to at least 10% of the value of the property sold by the grantor to the trust. This method is effective, especially in a low interest rate market, if the transferred asset earns more than the annual interest payment due to the grantor on the note. The excess will pass transfer-tax free to the beneficiaries.
Self-Canceling Installment Note ("SCIN")
Another method of accomplishing the sale to a grantor trust is with a self-canceling installment note (SCIN). A SCIN is a sale for an installment note that is cancelled upon the grantor's death. In the case of a SCIN, the decedent has no interest in the installment note after his death and, therefore, any remaining balance due under the installment note is not includible in the grantor's gross estate. To avoid a taxable gift, the trust must pay a premium for the self-canceling feature, either in the principal value of the installment note or in the interest rate of the note. The preferred method is to pay the premium in the principal amount of the installment note rather than in the interest rate, since the advantage to a SCIN is that the property will likely appreciate at a rate higher than the AFR. Appreciation and earnings on the assets sold to the trust in excess of the AFR passes to the beneficiaries entirely free of transfer taxes. Payments required under the SCIN should be made when due to avoid the IRS treating the entire sale as a gift. As with a sale to a grantor trust, in a SCIN transaction the trust should be funded with property other than the sale property and the property should be appraised at the time of the sale.
Intentionally Defective Grantor Trust
An Intentionally Defective Grantor Trust ("IDGT") takes advantage of both depressed asset values and low interest rates. IDGT, generally, is an irrevocable trust created for the benefit of one's children and grandchildren. Gifts to the IDGT are complete for gift and estate tax purposes, but "defective" for income tax purposes because the grantor of the IDGT remains responsible for the income tax burdens and consequences of the IDGT. IDGT is an effective estate planning tool because: (1) it allows one to "freeze" the value of assets transferred to the IDGT; (2) the appreciation occurs within the IDGT tax free to the benefit of the children and grandchildren beneficiaries; and (3) the grantor's ultimate estate tax burden is reduced by paying the income taxes on behalf of the IDGT. First, the grantor creates an irrevocable trust which is intentionally defective for income tax purposes. After the IDGT is created, the grantor makes a gift to the IDGT. The next step is a sale between the grantor and the IDGT. In exchange for a deposit of approximately 10% of the sale price from the IDGT, the grantor transfers property to the IDGT and in return receives an installment note for the remaining 90% of the fair market value of the assets transferred. The interest rate should be no less than the applicable federal rate (AFR).
Intentionally Defective Grantor Trust (2)
There is no capital gain on transfer of appreciated assets to the IDGT. In addition, interest payments to the grantor are ignored and the IDGT takes no interest deduction because for income tax purposes, it is a loan by the grantor to an entity taxed to the grantor. The grantor is responsible for the payment of the income tax on the IDGT's dividends, interest, capital gains and any other tax consequences.If the sale to the IDGT is properly structured, the only gift is the initial trust contribution which subsequently funds the down payment. Accordingly, the grantor can allocate theGST exemption based on the initial contribution. Since the remainder of the assets that come into the IDGT are by way of sale and not by gift, the entire trust is eligible to be exempt from GST by allocating only the original contribution. This is one of the most attractive features. Practically any type of property can be sold such as real estate, closely held stock (voting or non-voting), marketable securities, family limited partnership interests, limited liability company interests and alike. The key is that the assets are reasonably calculated to appreciate after the transfer because the installment note has the effect of freezing the value of the assets at the date of the transfer. Assets whose fair market value is subject to valuation discounts such as family limited partnership interests, closely held stocks, and fractional interest in real estate, provide greater leverage than the portfolio of marketable securities. In these instances, an appraisal is critical to set the fair market value of the assets with appropriate discounts for minority, lack of marketability and similar items.
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