Timely Estate Planning Strategies: Part Two
Oct 21, 2021
Low-Interest Rate Opportunities
An important component of personal financial and estate planning often includes transferring assets and future growth of those assets to younger generations or to charitable organizations while reducing current income taxes and future potential estate taxes. Once properly made, appreciation of such transfers and any future income generated thereon can be free of transfer taxes.
The current low-interest-rate environment provides an excellent opportunity to shift wealth to future generations. While we cannot predict the future, we can anticipate the writing on the wall. As noted in our previous post, Estate Planning Strategies Before Year-End: Part One, recent and proposed massive spending by the federal government will likely put pressure on rates. This coupled with various proposals to modify tax laws relating to gift and estate taxation, individuals should plan on implementing any such plans sooner rather than later.
Planning techniques benefitting from lower rates include the following:
1. Charitable Lead Annuity Trust (CLAT). This trust can be set up to provide annual distributions to charity for a specified number of years. Any growth in the value of the assets above the applicable federal interest rate passes to the non-charitable remainder beneficiaries (i.e. the taxpayer’s children) free of estate or gift tax at the termination of the trust.
2. Intra-Family Loans. It’s a good time to loan money to family members or trusts for members’ benefit. Interest can be charged at very low rates; to the extent the borrowers are able to leverage the funds to generate a return greater than the stated rate, wealth will be transferred without any transfer tax.
3. “Defective” Grantor Trusts. When a taxpayer (grantor) transfers assets to fund this trust, certain rights might be retained causing the trust to be “defective”. This may include the right to substitute other assets of equal value in future years. As a result, the annual income of the trust remains taxable to the grantor even though the income inures to the benefit of the beneficiaries. The effect of this is to reduce the grantor’s taxable estate by the amount of the income taxes paid annually. These trusts are often used to sell assets expected to grow in the future to the trust in exchange for a low-interest rate promissory note. The grantor does not recognize gain from the sale, and no income is recognized on the interest payments. The appreciation in the assets will be realized by the next generation without any transfer tax.
4. Charitable Remainder Trust. If a current income tax deduction is more important than saving transfer taxes, this trust may be implemented. The trust will make annual payments to its beneficiaries for a period of time. At the termination of the trust, the principal balance goes to the specified charity. This “remainder interest” is calculated at a present value to determine the current charitable contribution income tax deduction available to the donor. Lower interest rates translate to a larger remainder interest, and thus larger income tax deduction.
5. Grantor Retained Annuity Trust (GRAT). A grantor transfers assets to the trust and retains the right to receive specified payments from the trust for a specified number of years. At the end of the trust term, the accumulated principal of the trust passes to the specified donees, often the grantor’s children.
The annual payments can be structured so that the present value of the annual payments will equal the value of the property transferred to the trust. The trust is said to be “zeroed-out” because the donees’ remainder interest has no value for gift tax purposes, thus no gift tax exemption is used and no gift tax is due. To the extent, the increase in the value of the assets exceeds the annuity stream paid to the grantor, the assets remaining in the trust pass to the beneficiaries becoming a tax-free gift.
These are just some of the planning opportunities your William Vaughan advisor can discuss with you. We encourage you to take this important step now to avoid potentially detrimental changes which have been proposed in Washington. Early adoption and implementation have perhaps never been more important.
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wvco.com | 419.891.1040
Categories: Estate Planning, Tax Planning
Timely Estate Planning Strategies: Part One
Oct 11, 2021
Current Ideal Estate & Gift Planning Environment On Its Way Out
For the past few years, we have experienced a near-perfect environment for estate and gift planning purposes given the vastly expanded exemption amounts, low-interest rates, and retention of step-up in basis at death.
The Perfect Storm
How did we get here you ask? When Congress passed the 2017 Tax Cuts and Jobs Act (TCJA), substantial changes were made to the estate, generation-skipping transfer, and gift tax laws. Most notably, the TCJA included:
- A doubling of the basic exclusion amount from $5 million to $10 million, indexed for inflation, and an exclusion amount of $11.7 million for 2021. Coupled with proper planning around the concept of portability of a spouse’s amount, this could allow a married couple up to $23.4 million of assets to be exempt from the estate tax.
- The retention of the concept of “step-up” in basis at death. With the increased estate exclusion amount, income tax savings from the basis step-up at death sometimes became more important than trying to avoid estate tax via gifting or other transfer techniques.
These provisions were to be effective from 2018 through the end of 2025. Furthermore, regulations subsequently issued by the IRS stated there would be no clawback or adjustment of increased amounts taken by taxpayers during this period when the amounts reverted back to the old amounts on January 1, 2026.
This coupled with recent ultra-low interest rates left taxpayers and their planners taking a renewed interest in reviewing family gift and estate plans to take advantage of the perfect storm.
Changing Winds
While these conditions were expected to remain until 2026, the political winds have changed and with that is incredible uncertainty regarding what changes might be coming and when.
A number of proposals have been outlined which would greatly impact gift and estate plans—both existing and those contemplated. Among the proposed changes:
- drastic reduction in the basic estate exclusion amount
- possible increase in estate tax rates
- restrictions on certain transfers in trust
- restrictions on discounts when valuing property
More critical are the various effective dates proposed which may be retroactive to earlier this year.
While no one can predict the future, these potential changes make for increased risks and uncertainty in planning in the current environment. What is clear, however, is that regardless of what changes are ultimately made and when their effective date might be, the estate and gift tax rules will be far less liberal or beneficial than they are right now.
What Should I Do Now?
We believe significant planning opportunities exist under the current law and urge you to review your personal plans now. If new trusts or other asset transfer plans are contemplated, you will need to act immediately.
Here are some basic recommendations. Stay tuned to our series as we will delve into two other opportunities you should be considering before year-end:
- Make Gifting A Priority – Your timeframe to complete gifts may be much shorter if your plan involves an irrevocable grantor trust or gifts of interests in nonbusiness assets held in a limited liability company (LLC), partnership, or other private entity.
- Fund Grantor Trusts – Irrevocable grantor trusts allow you to gift assets and continue to be the owner of those assets for income tax purposes. Under the new proposals, these tax benefits would no longer be possible as soon as the new law is enacted.
- Complete Gifts of Nonbusiness Assets in LLCs or LPs – Currently, if you gift a minority or non-controlling interest in a private entity, the interest is valued at a lower price to account for the lack of control and marketability. Under the new proposals, these discounts would go away if the LLC’s assets include publicly traded securities, non-operating cash, or other passive, non-business assets.
We highly encourage you to not only contact your William Vaughan Company practitioner but also your financial advisors so your personal situation can be reviewed and updated before your potential risk may increase.
Connect With Us.
wvco.com | 419.891.1040
Categories: Estate Planning, Tax Planning