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Low Interest Rates
Can Lead to Tax Savings
The current low interest rate environment may lead to estate and gift tax planning opportunities for affluent individuals. Reason: The key interest rates used by the IRS for these purposes can result in tax savings when the rates decline.
Consider the tax benefits available with these six estate planning and gifting techniques:
1. A grantor retained annuity trust (GRAT) enables you to transfer wealth -- often represented by a business interest -- to relatives with little or no gift tax liability. You retain the right to receive fixed annuity payments from
the trust for a specified period of years. At the end of the trust term, the remaining assets are distributed to the designated beneficiaries.
This is a successful tool when undervalued assets transferred to the trust are expected to appreciate at a rate faster than the IRS-mandated interest rate. The gift tax consequences are minimized, and appreciating assets are removed from your taxable estate.
2. Private annuities - With a private annuity, you typically transfer assets to a child in exchange for his or her promise to pay you fixed payments for the rest of your life. For gift tax purposes, the value of the annuity payments is based on IRS interest rates and life expectancy schedules. If the fair market value of the assets transferred equals the value of the annuity under the valuation tables, there is no gift tax due. The lower the interest rates, the lower the gift tax cost.
Note: Under proposed regulations, some tax advantages of private annuities were eliminated for transactions entered into after October 18, 2006. However, transactions before April 17, 2007 may be exempt. Contact your estate planning professional for details.
3. A charitable lead annuity trust (CLAT) may be a viable planning tool for philanthropic taxpayers. With a CLAT, annual annuity payments are distributed to one or more qualified charitable organizations. Then, the remainder passes to beneficiaries such as your children. If the IRS interest rate is relatively low, the transfer to beneficiaries may avoid gift taxes (or keep them to a minimum). A lower interest rate also increases the charitable deduction.
4. A self-canceling installment note may be used to transfer business assets such as real estate. Typically, you sell appreciated property to a child in exchange for his or her promise to make periodic payments to you over a designated period. If properly structured, the self-canceling feature provides termination of the buyer's obligations if the seller doesn't survive the term of the note. And a low interest rate reduces the payments for the child.
5. An Intentionally Defective Irrevocable Trust (IDIT) - As the name implies, an IDIT fails the tax rules on purpose so the grantor is treated as the trust owner for income tax purposes but not for estate tax purposes. When the grantor dies, the assets are distributed to trust beneficiaries. Typically, the grantor sells appreciating assets to the IDIT via an installment sale, using the minimum IRS-approved interest rate, which avoids any gift tax consequences. No taxable gain is realized on the sale because the grantor is the trust owner for income tax purposes. The beneficiaries benefit from a low interest rate on the installment note, and the appreciating assets sold to the IDIT are removed from the grantor's taxable estate. Click here for more information.
6. Intra-family loans - A low interest rate environment is also a good time to arrange intra-family loans to children. Generally, no gift tax consequences result from a loan if you charge interest equal to the AFR for the month the loan is made. Click here for details. |
New IRS Ruling Gives More Flexibility to Grantors
If you control it, you own it. That's the general rationale applied by the IRS in the estate planning arena. In order to realize potential estate tax benefits, you have to give up control over assets. Otherwise, they will probably wind up back in your taxable estate.
However, in a surprising new Revenue Ruling, the IRS has given more latitude to certain grantors of irrevocable trusts. In the guidance, the IRS explains that the power possessed by the grantor to reacquire trust property by substituting other property of equal value will not result in a reversion to the grantor's estate. As a result, the grantor could exercise the power in a nonfiduciary capacity without obtaining approval from anyone acting as a fiduciary. (IRS Revenue Ruling 2008-22)
The new ruling effectively draws a distinction between the income tax treatment and estate tax treatment of a grantor's power to substitute property of equal value. In the income tax context, such a power exercisable in a nonfiduciary capacity causes the grantor to be treated as the owner of the property. But the ruling establishes that a nonfiduciary grantor is not the owner of the property for estate tax purposes.
Basic premise: Under the terms of the irrevocable trust, the grantor cannot serve as the trustee. When trust property is reacquired, the grantor must certify that the substitute property is of equivalent value. The trustee has the fiduciary duty to ensure that the properties meet this requirement. If the trust has multiple beneficiaries, the trustee must act impartially in managing trust assets.
Under federal estate tax law, property transferred to a trust is included in the grantor's estate if he or she retains the right to:
- Enjoy the property during his or her lifetime, or
- Designate someone to possess or enjoy the property. In other words, if you can change the beneficiary, the property is included in your estate.
Similarly, the assets generally must be included in the taxable estate if the decedent is able to exercise a power during his or her lifetime to change the enjoyment of the property or to alter, amend, revoke or terminate the trust.
The IRS indicated that the grantor did not have the power to reduce the value of the trust or increase his or her net worth. Reason: The terms of the trust and the trustee's fiduciary duty, required that any assets substituted must be equal in value.
Furthermore, the trustee was charged with preventing the grantor from substituting property that could shift benefits among trust beneficiaries.
Note: In Revenue Ruling 2008-22, the IRS distinguished this fact pattern from a prior Tax Court case where the grantor was acting as a fiduciary. (Estate of Jordahl, 65 TC 92) In the new ruling, the IRS emphasized that the power to substitute assets was held in a nonfiduciary capacity.
Consult with an experienced estate planning professional concerning application of these principles to your personal situation. |
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