By Melissa S. Kampmann
April 21, 2009
If your assets, including life insurance proceeds and retirement assets, are close to or worth more than $3,500,000, you have very attractive estate planning opportunities because of the rare convergence of the following three events:
Depressed asset values;
Historically low interest rates; and
The potential for a limited time frame to continue receiving valuation discounts when transferring assets by gift or inheritance.
Currently, there are limitations placed on your ability to transfer assets to others during your lifetime and at death without tax ramifications. The three events existing today create a unique opportunity to maximize the transfer of your wealth to your family and friends during your lifetime and at your death.
Event One: Depressed Asset Values
The decline in asset values due to the recent economic downturn is both a blessing and a curse. On a positive note, gifting assets now that asset values have declined translates into reduced gift taxes. If the value of the asset rebounds in the future, the increased value occurs outside of your taxable estate, ultimately benefiting your heirs.
Event Two: Low Interest Rates
The current interest rates set by the federal government, called the Applicable Federal Rates (AFRs), are considerably less than the average AFRs over the last eleven years. The silver lining in the current economic downturn is that certain estate planning techniques are more effective when interest rates are low.
Intra-Family Loans. If you have used your lifetime gift tax exemption amount of $1,000,000, you are not able to gift assets above the annual gift tax exclusion amount of $13,000 without incurring a gift tax. If you want to transfer assets to family members and avoid the gift tax, you should instead sell the assets to a family member and receive a note in return. Today’s extremely low interest rates and depressed asset values mean the transferred assets will likely appreciate at a rate greater than the interest rate paid under the note. You will have removed any appreciation in the transferred assets from your estate while ensuring that there are assets left for the recipient after the loan has been repaid.
Grantor Trust. To further maximize your estate plan, you could also transfer assets to an irrevocable “grantor trust” of which your family members are beneficiaries. The trust will execute a note in your favor. The grantor trust structure means that you are treated as the owner of the trust assets for income tax purposes but not estate tax purposes. Transactions between you, the grantor, and the trust are ignored for income tax purposes. As a result, you will not recognize capital gain when you sell appreciated assets to the trust. As the grantor, you report the trust’s income as your own income. This is the equivalent of an additional tax-free gift to your beneficiaries because the beneficiaries and the trust are not burdened with the tax.
The favorable interest rates also benefit the Internal Revenue Code 7520 rate making certain techniques, such as grantor retained annuity trusts and charitable lead trusts, more attractive. A grantor retained annuity trust (GRAT) is a trust to which a person transfers property that is likely to rapidly appreciate in value and reserves an annuity interest in the property for a term of years or his or her lifetime. The trust property remaining after the annuitant’s death or at the expiration of the trust term passes tax free to the remainder beneficiaries.
The 7520 rate determines the amount of the annuity payment that must be made to the grantor. As the 7520 rate decreases, the annuity payment that must be made to the grantor decreases, leaving more assets for the remainder beneficiaries with no gift tax implications. Extremely low 7520 rates increase the probability that the assets transferred to the trust will appreciate at a rate greater than the 7520 rate, leaving significant assets for the remainder beneficiaries with no tax implications.
Event Three: Potentially Limited Time Frame For Valuation Discounts
Current laws permit you to reasonably discount the value of certain assets that you transfer during your lifetime and at death. These discounts are commonly applied to transfers of interests in Family Limited Partnerships (FLPs) and Limited Liability Companies (LLCs) due to minority interests in the entity and/or lack of marketability of the asset.
Many individuals transfer assets such as rental real estate or securities to FLPs and LLCs. The individuals then transfer interests in the entities to family members, such as children. The value of the asset transferred for gift tax purposes or estate tax purposes is discounted if the interest is a minority interest in the entity or there is not a ready market to sell the interest. The discounts are commonly between 25% and 35%.
House Bill H.R. 436, introduced in early 2006, would eliminate the minority discount for transfers if the recipient and members of his or her family have control of the entity. The bill also eliminates discounts for transfers of entities holding nonbusiness assets (any asset not used in the active conduct of one or more trades or businesses).
Assuming H.R. 436 or similar legislation is enacted, the loss of the ability to discount interests in FLPs and LLCs will lead to greater estate tax and gift tax consequences. H.R. 436 only applies to transfer made after the bill s enactment into law. Individuals who do not want to risk losing the benefit of higher valuation discounts might consider transferring assets to an FLPs or LLCs and transferring their interest in those entities prior to enactment of any legislation.
Now Is A Great Time For Estate Planning
Depressed asset values, historically low interest rates, and the potential for the loss of valuation discounts create one of the best opportunities for you to minimize or eliminate your estate tax liability. These three events enhance many estate planning techniques that maximize the benefit to you and your heirs. Current circumstances make it an ideal time for you to create your estate plan or review and update your plan.
If you are interested in learning more about how to maximize your own estate plan, please feel free to contact Melissa Kampmann, the author of this article, or any of the attorneys in the Trusts & Estates Practice Group of Ruder Ware.
This document provides information of a general nature regarding legislative or other legal developments, and is based on the state of the law at the time of the original publication of this article. None of the information contained herein is intended as legal advice or opinion relative to specific matters, facts, situations, or issues, and additional facts and information or future developments may affect the subjects addressed. You should not act upon the information in this document without discussing your specific situation with legal counsel.
© 2021 Ruder Ware, L.L.S.C. Accurate reproduction with acknowledgment granted. All rights reserved.