The depressed values in the markets, low interest rates and historically high federal estate, gift and generation-skipping transfer tax exemptions have created some excellent opportunities for you to make impactful gifts to your family and generate potentially significant tax savings. Below is a brief summary of some wealth planning tools that may be applicable to your situation.
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Create GRATs and CLATs
Grantor-retained annuity trusts (GRATs) and charitable lead annuity trusts (CLATs) shift appreciation in excess of the IRS “Section 7520” interest rate to the next generation.- The lower the 7520 rate, the lower the annuity amount payable to the grantor (from a GRAT) or charity (from a CLAT) and the more that can be transferred to beneficiaries with no gift or estate taxes.
- The Section 7520 rate for May of 2020 is 0.8%. You can’t get much lower than that, making this a great time to create GRATs and CLATs.
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Take advantage of the historically-high federal exemptions
Federal estate, gift and generation-skipping transfer tax exemptions are at an all-time high (currently $11.58 million for individuals or $23.16 million for married couples, reduced by prior lifetime gifts). These exemption amounts will sunset after December 31, 2025, but the size of the exemptions could drop significantly as early as next year depending on the outcome of this year’s election. The coming months are the perfect time to make large gifts using your and/or your spouse’s remaining transfer tax exemptions. -
Give away assets that have depressed values
During this time where asset values are low, consider giving them to your children and grandchildren, or create trusts for their benefit, thereby sheltering the gift with your unused and currently-high federal transfer tax exemptions.- Because transfer taxes are based on the value of the assets given, you will use less of your exemptions to give assets with depressed values.
- When the market rebounds, the appreciation will belong to or benefit the donee and will not be in your estate.
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Create a Spousal Lifetime Access Trust (SLAT)
If you are concerned about giving too much to children and grandchildren and not having enough left to provide for the needs of your spouse, establish a Spousal Lifetime Access Trust (SLAT) for your spouse, with children or grandchildren as current or remainder beneficiaries. The gift to the SLAT removes assets from your estate, and the gift can be sheltered from gift tax by utilizing the high federal exemption during your lifetime. Plus, the assets can still be available to provide for your spouse’s future needs. The SLAT may be solely funded with direct gifts, or funded by combining gifts and a sale of assets, taking advantage of the depressed asset values at the time of funding. In the right circumstances, and if the trust terms differ, it is possible for both spouses to create SLATs. -
Make gifts to grantor trusts
Rather than giving assets outright, give them to a grantor trust. Because you will pay the income taxes on the trust’s income, rather than using trust assets to pay the taxes, the trust grows tax-free. Your payment of the taxes is essentially a gift to the trust—one that doesn’t use any of your gift tax exemption. -
Sell property to a grantor trust
Selling property (that may have a depressed value now, but is expected to appreciate) to a grantor trust using an installment loan takes advantage of low values and low interest rates to create a situation that can shift significant appreciation to children and grandchildren free of estate, gift and generation-skipping transfer taxes. -
Review your current GRATS or previous sales to grantor trusts
If you have previously created a GRAT or sold assets to a grantor trust in exchange for a promissory note, the GRAT or sale transaction might not be working as intended. With the current depressed value of the GRAT’s assets, consider substituting cash, other assets or even a promissory note for those assets. You can then start all over with a new GRAT while benefitting from a low initial value and low interest rates. The sale to a grantor trust might also be “unwound,” permitting you to start over with today’s low values. -
Make or refinance intra-family loans
These loans also offer benefits when interest rates are low. So as not to trigger gift taxes, these loans must bear interest at a rate at least equal to the Applicable Federal Rate (AFR), but these rates are much lower than rates on loans from financial institutions. Loan funds can be used for any purpose, from buying a home to investing. These loans have other benefits including:- Keeping the interest in the family instead of paying it to a financial institution.
- Avoiding the loan costs charged by a financial institution, such as appraisal fees and closing costs.
- Allowing a borrower who has invested the borrowed funds to capture more of the appreciation due to low interest rates and transaction costs.
The mid-term AFR rate for May 2020 is 0.58% (for loans of up to nine years), and the rate for longer loans is 1.15%, making this an attractive time to make these loans to the ones you love. If you already have an intra-family loan in place that has an interest rate higher than the current rate for May, consider re-financing the current loans using the lower interest rate.
Take advantage of current planning opportunities
Now is a good time to explore planning ideas that are effective in the midst of a market downturn. In part two of this series, we will explore other tax planning opportunities for the current market situation. For more information on wealth planning strategies for individuals and families, please contact your Warner estate planning attorney or Mark Harder, Chair of our Private Client and Family Office Practice, at 616.396.3225 or mharder@wnj.com.
