By: Randall A. Denha, Esq.
Let’s face it: Congress has not acted and probably won’t act before year end. That said, its imperative that certain transfer tax techniques receive serious consideration before they disappear. Combine the transfer tax inaction with historically low interest rates and we have a serious recipe for planning. We recommend that you review and evaluate these opportunities as soon as practicable.
2010 Lifetime Transfers to Your Descendents
Transfers to your children and grandchildren before the end of 2010 may result in significant overall tax savings for your family. As a general rule, transfers by gift are subject to a federal gift tax and transfers to persons more than one generation below the donor, such as grandchildren and more remote descendants, are subject to federal generation-skipping transfer (“GST”) tax. The federal gift tax and GST tax rates traditionally have hovered in the range of 41-55%, but this year the federal gift tax rate is 35% and the GST rate is 0%. These historically low rates only apply to transfers made in 2010, and, unless Congress modifies the current gift and GST tax laws, are set to increase on January 1, 2011 to rates of 41-55% for the federal gift tax and a rate of 55% for the federal GST tax.
The tax savings available for 2010 gifts could be significant. As illustrated below, if you’ve already used your lifetime gift tax exemption (currently, $1,000,000), a gift to a child of $1,000,000 could save up to $85,000 in federal gift taxes if made on or before December 31, 2010. Transfers to a grandchild or more remote descendant, whether by gift or by trust distribution, could save an additional $550,000 in GST tax if made this year.
|Planning Opportunity||2010||2011||Potential Tax Savings from 2010 Transfers|
(55% max. rate)
gift to child
gift to grandchild
|$1,000,000 distribution from existing GST Non-Exempt Trust to grandchild||$0||$0||$0||$550,000||$550,000|
Due to the anticipated reinstatement of the GST tax in 2011, gifts made in 2010 to trusts (or trust equivalents) for the benefit of grandchildren or more remote descendants may not achieve the same GST tax savings as outright gifts.
2010 Transfers to Grantor Retained Annuity Trusts
Current law allows taxpayers to structure a short-term (e.g., 2 years), zero-gift Grantor Retained Annuity Trust (a “GRAT”). A GRAT is an irrevocable trust that pays its grantor annual annuity payments over a fixed trust term. When the fair market value of the property transferred to the GRAT equals the present value of the annuity returned to the grantor based on the IRS assumed interest rate (i.e., the GRAT is “zeroed-out”), no gift tax will be due upon creation of the GRAT. Since the grantor must survive the trust term for the GRAT to be effective, a short 2-year term minimizes the risk that the trust assets will be returned to the grantor without any tax savings due to his or her death. As such, both the ability to fully zero-out the gift and the availability of a 2-year term have made GRATs very attractive.
Low interest rates can substantially enhance the overall effectiveness of a GRAT. If the appreciation of assets held by a GRAT exceeds the IRS assumed interest rate, the trust assets remaining after payment of the annuity would be transferred to or for the benefit of your children (or other descendants) without additional gift tax consequences. The IRS assumed interest rate is 1.8% for transfers during December, 2010 to GRATs. This low interest rate increases the likelihood of successful transfers from GRATs to your children or descendants if the trust invests in or holds assets which grow at a rate higher than the IRS assumed interest rate.
Both the U.S. House of Representatives and the Obama Administration have proposed making GRATs less attractive by preventing taxpayers from structuring GRATs in this manner.
2010 Transfer of Closely-Held Business Interests
Due to difficult business and economic conditions, the values of many closely-held businesses have reached all-time lows. Combining GRATs with other planning techniques which benefit from the historically low interest rate environment can transfer a significant percentage of your interests in a closely-held business to family members at the current reduced values. The Obama Administration has proposed legislation which would artificially inflate the value of interests in family-controlled businesses and other entities over their independently appraised fair-market value when transferred to other family members. While it is unclear whether such legislation will be enacted, we recommend that those who may wish to transfer closely-held businesses and other interests consider doing so as soon as practicable.
In light of current low interest rates, there are planning opportunities associated with loans to your family members or other individuals. The current annual Applicable Federal Rates for December are .32% for short-term loans of three or fewer years, 1.53% for mid-term loans in excess of three years and fewer than nine years, and 3.53% for long-term loans in excess of nine years.
The loan documents could provide for a balloon payment at the end of the loan term. If the return on the principal amount loaned exceeds the interest owed on this amount, then the borrower will receive a tax-free gift of the excess return. Although interest will be due during the term of the loan, you can forgive this repayment as a gift to the borrower. However, in most cases you will still have to pay income tax on the amount of interest that you would have received.
Any loan outstanding now may be forgiven prior to the end of 2010 to take advantage of the 35% gift tax rate (but only after it becomes certain that the gift tax rate will remain at 35% for 2010).
Of possibly greater planning significance to some will be the use of loans in connection with the sale of assets to trusts for the benefit of family members. Favorable investment returns compared to the hurdle rate associated with the low rates of interest, combined with favorable income tax attributes, make sales to trusts an important planning tool, especially at this time.
THIS ARTICLE MAY NOT BE USED FOR PENALTY PROTECTION.
CIRCULAR 230 DISCLAMER: NONE OF THE ARTICLES IN THIS NEWSLETTER ARE INTENDED OR WRITTEN BY THE VARIOUS AUTHORS OR DENHA & ASSOCIATES, PLLC, TO BE USED, AND THEY CANNOT BE USED, BY YOU (OR ANY OTHER TAXPAYER) FOR THE PURPOSE OF AVOIDING PENALTIES THAT MAY BE IMPOSED ON YOU (OR ANY OTHER TAXPAYER) UNDER THE INTERNAL REVENUE CODE OF 1986, AS AMENDED.