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Historic Gifting Opportunity in the Time of COVID-19

Melissa Abbott, CPA, J.D., Marco Svagna, CPA, and Scott T. Ditman, CPA/PFS

5.6.20 | Wealth of Insights – COVID-19 Update

The dramatic decline in asset values combined with historically low interest rates makes this an opportune time to consider tax efficient wealth transfer strategies.  AFRs (applicable federal rates) are interest rates published each month by the IRS. They are the lowest rates you can charge when making intra-family loans and are also an important factor in certain gifting strategies. Because they took a substantial dip in May from already low rates (see chart), now may be a good time to accelerate any gifting or other wealth transfer strategies you are planning.

Section 7520.80%1.20%1.80%

The current estate and gift tax exclusion is $11.58 million ($23.16 million for a married couple). Barring congressional action, these numbers are scheduled to revert to half those amounts in 2026. And they could go even lower depending on the results of this year’s election. In addition, the tax rates could be significantly higher.

In this environment, the following techniques are advantageous:

Intra-Family Loans: Parents can make low-interest loans to children or to trusts for the benefit of children or other family members, who may pay interest annually and the loan principal at the end of the term. Since the AFR rates are still lower on average than the commercial lending rates, these loans are useful for providing investment capital and funding home purchases. And with interest rates at rock-bottom levels, it might make sense to refinance existing debt obligations at a much lower rate.

Grantor Retained Annuity Trust (GRAT): The grantor transfers assets to a trust for a term of years and receives an annual annuity. GRATS are typically structured so that virtually no taxable gift is incurred at creation. If the grantor survives the term, the assets pass to the beneficiaries virtually estate and gift tax free. The annual annuity the grantor receives is based on the 7520 rate, which is based upon mid-term AFR. The lower the 7520 rate, the less the grantor is required to receive. This means the more the trust earns and appreciates, the more that passes to the beneficiaries.

Example:  A taxpayer creates a two-year “zeroed-out” GRAT in May 2020 when the 7520 rate is .80%. The trust would pay annual annuities of $505,996 per year – a two-year total of $1,011,992 – per $1 million transferred to the GRAT. Potential Benefit: Any appreciation in excess of the $11,992 per $1 million passes to the grantor’s beneficiaries free of gift tax. This provides an excellent planning opportunity for taxpayers holding assets with depressed values.

Gifts/Sales to Intentionally Defective Grantor Trusts (IDGTs)/Generation-Skipping Trusts (GSTs): By making a complete sale, complete gift, or a combination of both to an IDGT/Generation-Skipping Trust, the grantor will still pay the income tax on the income generated by the trust, including capital gains tax. However, this will allow the property sold and/or gifted to the trust to grow for the beneficiaries outside of the grantor’s estate and unencumbered by income tax.  Any purchase money note received by the grantor will be eligible for these historically low AFR interest rates.  Further, through the allocation of the grantor’s unused GST tax exemption to the trust, an amount up to that exemption may benefit several generations of the grantor transfer tax free.

Swap Assets Out of Existing Grantor Trusts: If a taxpayer created a grantor trust that includes a provision that allows for the substitution of property by the taxpayer, there is an opportunity to substitute cash for depressed value/low income tax basis assets.

Potential Benefit: The trust then has the value in cash, while the taxpayer’s future beneficiaries will benefit from a step-up in income tax basis that would not have been available if the assets had remained in the trust. This is a great planning opportunity for older taxpayers who are planning on holding the assets until death.

Roth IRA Conversion: When a taxpayer converts a traditional IRA to a Roth IRA, the income taxes are based on the IRA’s value at the time of conversion. So, if a taxpayer has considered such a conversion, doing so at a time of depressed asset values could substantially reduce the income tax cost of conversion. And, unlike a traditional IRA, the main advantage of a Roth IRA is that the taxpayer and, ultimately, the beneficiaries will not have to pay income taxes on the dollars withdrawn.

Should you have questions about how to plan and structure your gifting and overall estate planning to achieve the maximum tax benefits, contact your trust and estate attorney and Melissa Abbott at 212.331.7424| MAbbott@berdonllp.com, Marco Svagna at 212.331.7644 | MSvagna@berdonllp.com or Scott Ditman 212.331.7464 | SDitman@berdonllp.com or your Berdon advisor.

For more information on any other matter related to the COVID-19 pandemic, please contact your Berdon Advisor.

Berdon LLP New York Accountants