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A Better Partnership


Oct 2011
October 31, 2011

Contingency Planning--Estate Planning in an Uncertain Tax and Low Interest Rate Environment

The 2010 Tax Relief Act included a new $5,000,000 exemption for estate, gift and generation-skipping transfer (GST) taxes, together with a maximum 35% estate, gift and GST tax rate. The Act also introduced “portability,” which generally permits the estate of a surviving spouse to utilize the unused estate tax exemption of the predeceasing spouse. These changes are scheduled to expire at the end of 2012, which under current law would mean a return to the pre-2001 law including the $1,000,000 estate, gift and GST exemption and 55% top tax rate.

While the 2010 Tax Relief Act created a two-year window to take advantage of the expanded gifting opportunities, recent developments suggest that you may not want to wait until the end of next year to make these gifts. The near record low interest rate environment also creates unique opportunities for certain gifts.

Deficit Reduction Initiatives May Reduce Window for Expanded Gifting Opportunities

The Budget Control Act of 2011 included the creation of a 12-member Joint Select Committee on Deficit Reduction that is currently reviewing ways to reduce the federal deficit over fiscal years 2012 through 2021. The House Democrats recently released an unofficial summary of revenue-raising provisions that they intend to submit to the Committee. Several of these provisions have been proposed in past tax reform efforts, including new restrictions on valuation discounts and a minimum ten-year term for grantor retained annuity trusts. These proposals also include troubling language regarding the timing of the scheduled change in the estate tax rules after 2012. The proposal states that “Revenue could be raised against a current-law baseline by reverting to 2009 levels one year early (in 2012).” (This language is inaccurate, as the current law will mean a 2013 reversion to the pre-2001, $1,000,000 estate exemption and not the $3.5 million estate tax exemption available in 2009.)

A return to the $1 million gift tax exemption a year early, in 2012, would eliminate a significant opportunity for individuals intending to take advantage of the 2010 Tax Relief Act provisions. While it is too early to tell whether House Democratic proposals will ultimately be adopted by the Joint Select Committee, and it is likely that these proposals will face significant opposition from Republican Committee members, you may want to consider making large gifts before the end of this year to lock in this opportunity. Gifts this year would also remove appreciation on the gifted property from your taxable estate. Today’s depressed stock market and real estate values may mean that these gifted assets will realize significant appreciation.

Strategies that Take Advantage of Current Low Interest Rates

The IRS specifies gift tax valuation interest rates each month that rise and fall with market interest rates. Lower interest rates mean that the discount rate used to value a retained annuity is lower, and the value of the retained annuity interest is higher. The October 2011 “section 7520 rate” used to value retained annuities for gift tax purposes dropped to a record low of 1.4%.

A grantor retained annuity trust (GRAT) is an ideal vehicle to take advantage of these low interest rates. These trusts provide that the settlor retains an annuity interest for a fixed number of years, with the remainder passing to named beneficiaries. The amount of the taxable gift is the value of the remainder interest passing to trust beneficiaries. Low interest rates mean that a smaller retained annuity is required to produce a minimal gift to remainder beneficiaries.

For example, if the section 7520 rate is 8%, the annuity needed to “zero out” a ten-year, $1 million GRAT would be $149,029 because the discounted value of this annuity would be approximately $1 million, and the value of the remainder interest is therefore zero. Using the October 2011 rate of 1.4%, the annuity required in this example to “zero out” the GRAT would be only $107,861. The lower annuity amount means that more assets are shifted to the next generation.

The success of a GRAT is generally tied to the spread between the total return on GRAT assets and the section 7520 interest rate. The extremely low section 7520 rate increases the likelihood that this spread will be substantial.

The extremely low interest rates favor other planning strategies tied to the value of retained annuities. These include Charitable Lead Annuity Trusts, where a charity is named as the initial beneficiary of an annuity interest, with the remainder passing to children or other beneficiaries. The annuity interest passing to the charity is eligible for a gift tax charitable deduction. As with the GRAT, the value of the annuity interest passing to the charity will be relatively high, and the value of the remainder passing to family beneficiaries will be relatively low.

Other planning strategies that take advantage of low interest rates include charitable gifts of a remainder interests in a personal residence or farm and sales of assets to defective grantor trusts.

Please contact an estate planning specialist at Warner Norcross if you have any questions regarding current planning opportunities.

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