Current Estate and Gift Tax Planning Opportunities
As the global economy continues to feel the disruptive effects of the COVID-19 crisis, now may be an appropriate time to consider potential estate planning opportunities:
- Low Interest Rates: The IRS prescribes minimum interest rates that taxpayers must charge on most loans (including installment sales) to avoid gift tax consequences. These IRS rates are now extremely low.
- In July 2020, in order to avoid a taxable gift, the interest rate for most intra‑family loans need only be 0.18% for loans with terms of up to three years, 0.45% for loans with terms of more than three years but not more than nine years, and 1.17% for loans with terms of more than nine years.
- Now may be time for individuals to lend money to family members or family trusts or to sell assets to family members or family trusts in exchange for promissory notes. Care should be taken in structuring any sales with respect to down payments and payment terms.
- Individuals or family trusts with outstanding loans to family members or beneficiaries may wish to renegotiate the terms of these loans in order to take advantage of lower interest rates and/or to extend the term of these loans.
- Valuations: Under current economic conditions, a combination of decreased demand for many types of assets and uncertainty regarding the future may have reduced the value of certain assets. Individuals who anticipate that values will return to pre-crisis levels may wish to consider giving or selling assets to family members or to trusts for their benefit. The combination of depressed asset values and low interest rates may offer an opportunity to shift assets that are expected to appreciate to younger generations.
- Historically High Federal Estate and Gift Tax Exemption: Over the past two decades, the Federal estate, gift and generation-skipping transfer tax exemption amount available to each individual has increased from $675,000 before 2001 to $11,580,000 ($23,160,000 for a married couple) in 2020. The exemption amount is now indexed for inflation. However, the exemption amount is scheduled to revert to roughly half its current level in 2026. It is also possible that Congress will take action to reduce the exemption amount before then.
- Individuals who expect to pay Federal estate tax may wish to make gifts now, in case the exemption amount reverts to the pre-2017 level as scheduled or Congress passes legislation to reduce the exemption amount before then. Current gifting has the added benefit of excluding post-gift appreciation from the donor’s taxable estate.
- There are additional factors that may affect the decision to make gifts that should be considered. For example, assets included in an individual’s taxable estate generally get a new income tax basis equal to the assets’ fair market value on the date of death. This rule applies even if the assets are inherited by a surviving spouse and no estate tax is paid or the estate is too small to pay estate taxes. Individuals who do not expect to pay estate tax may choose not to make gifts. This basis step-up reduces the capital gain incurred on the post-death sale of inherited assets.
- Individuals who live in a state with a state estate or inheritance tax (such as New York, New Jersey or Connecticut) may wish to make gifts and/or charitable contributions to reduce or eliminate their state estate or inheritance tax obligations.
- GRATs: A grantor retained annuity trust (or “GRAT”) is a trust to which the donor contributes property and retains the right to receive an annuity payment from the trust for a fixed term. Any property remaining in the trust after the final annuity payment will pass to, or in further trust for, the remainder beneficiaries free of estate and gift tax.
- Annuity payments are equal to a percentage of the value of the property contributed to the GRAT. Generally, a GRAT is most effective when the present value of the annuity payments is equal or close to the value of the property contributed to the GRAT. The present value of the annuity payments is measured by an interest rate set by the IRS each month known as the “Section 7520 rate,” which is 0.6% in July 2020. In essence, this means that any growth in value of GRAT assets in excess of the Section 7520 rate can pass to the remainder beneficiaries free of estate and gift tax.
- GRATs are often a preferred planning strategy because they use little or no estate and gift tax exemption, which makes them especially attractive for individuals who have used all or most of their exemption, and there is very little downside if the strategy fails. If the GRAT assets are insufficient to make the final annuity payment, the donor will receive the remaining assets, and nothing will be left in the trust. However, nothing will have been lost other than the costs of the transaction and the possible loss of the opportunity to have utilized a different technique.
The combination of a very low Section 7520 rate and depressed asset values could make this an ideal to time to use GRATs to transfer assets free of estate and gift tax.
- CLATs: Similar to a GRAT, a charitable lead annuity trust (or “CLAT”) provides for annuity payments to charity for a specified term, with the remainder at the end of the term passing to, or in further trust for, the remainder beneficiaries free of estate and gift tax. Like a GRAT, the present value of the CLAT annuity payments is measured using the Section 7520 rate, and the annuity payments can be structured so that their present value equals the value of the property contributed to the CLAT (i.e., there will be no taxable gift upon funding). Given current low interest rates, a CLAT may be attractive to individuals who are willing to commit to a specified level of annual charitable gifts.
- Remote Execution of Documents: In response to the COVID-19 crisis, a number of states, including New York, have enacted measures that allow for documents to be witnessed and/or notarized remotely via video conferencing. Consequently, it is possible to execute estate planning documents that require witnesses and/or a notary while still complying with social distancing guidelines.
The techniques described above are only a few of the estate and gift tax planning opportunities that are currently available. Other available techniques also may be effective for your specific situation. We are available to discuss any questions or concerns you may have. If you wish to discuss any aspect of your estate planning, please contact your primary Kleinberg Kaplan attorney or a member of our Trusts & Estates Practice Group.