Low Interest Rates, Depressed Values and High Impact Estate Planning

May 7, 2020

Due to the current state of the economy, the IRS has issued incredibly low interest rates applicable to intra-family transactions initiated during the month of May 2020. Additionally, the value of certain closely held businesses and real estate holdings has been significantly impacted by the uncertain economic conditions. These factors, combined with the all-time high available exemption from gift taxes ($11.58 million per person; $23.16 million for a married couple), create a unique opportunity for high net worth individuals to achieve tremendous wealth transfer tax savings at this time. The following are a few examples of estate planning techniques to consider deploying this month.

GRATs. A grantor retained annuity trust (“GRAT”) is a trust which returns to the grantor the value of the initial contribution plus a certain rate of return (the “Section 7520 Rate”) over a set period of time (e.g., two years) and transfers to the grantor’s beneficiaries, free of gift tax, all income and appreciation on the trust assets in excess of the Section 7520 Rate. For May, the Section 7520 rate is 0.8%. This rate combined with depressed current asset values create optimal conditions for a GRAT to successfully transfer wealth tax free. The tax savings achieved by a $10,000,000 current transfer to a GRAT over a 2-year term under various investment return scenarios is shown in the following chart.

Loans. Applicable Federal Rates serve as benchmarks for the minimum interest rate that can be charged on intra-family loans to avoid being characterized as a gift. For May, that rate is 0.25% for loans with maturity dates under 3 years, 0.58% for 3 to 9-year loans and 1.15% for loans with maturity dates of 9 years or greater. One can take advantage of these rates by simply loaning money to descendants or a trust for their benefit to provide them with investment capital. If the investments made with the loan proceeds provide returns that exceed the Applicable Federal Rate, those excess earnings pass free of gift tax, estate tax, and can also pass free of generation-skipping transfer tax. Additionally, if intra-family loans or loans to trusts are already in place, it may be possible to refinance those loans to take advantage of the current lower rates. 

Sales to a Grantor Trust. Instead of loaning cash, a grantor could sell assets to a grantor trust in exchange for a promissory note bearing interest at the Applicable Federal Rate. No gain would be recognized on the sale and interest payments to the grantor would not be subject to income tax. As with a loan, any income and appreciation on the asset in excess of the Applicable Federal Rate could pass to beneficiaries free of gift tax, estate tax and generation-skipping transfer tax.

Gifts. For individuals who have not fully utilized their $11.58 million exemption from gift tax, prompt and careful consideration should be given to using that exemption during the month of May. The recent market volatility and uncertain economic forecasts have depressed the current fair market value of certain assets. Gifting these assets at their current value may save significant wealth transfer taxes, as the value of the asset and all future appreciation will be excluded from the transferor’s taxable estate. 

Whether undertaking estate planning for the first time, continuing an ongoing strategy or revisiting previously implemented vehicles to supercharge their tax-savings potential, this month presents a compelling window of opportunity.

To discuss wealth transfer techniques that may be appropriate to your circumstances, please contact one of the senior members of our Trusts and Estates Department listed below.

Katy H. Donlan at +1 212 592 1522 or [email protected]

© 2020 Herrick, Feinstein LLP. This alert is provided by Herrick, Feinstein LLP to keep its clients and other interested parties informed of current legal developments that may affect or otherwise be of interest to them. The information is not intended as legal advice or legal opinion and should not be construed as such.