A reoccurring theme among estate planners in these hard times is taking advantage of low values to transfer assets to future generations. A second factor working in a family’s favor is that the interest rates that the IRS mandates must be used are at historically low rates.
One simple technique involves loans between family members. Take this example: In May 2007 Dad loans children $2 million to purchase assets. The loan is for 9-years, interest only, with a balloon payment. The "mid-term" (loans 4 to 9 years) federal rate is 4.61%. After nine years, children will have paid $829,000 in interest (9 x $92,200).
This same transaction in February 2009 would require an interest rate of only 1.65%, or interest of $33,000 per year for a total of $297,000. The family saves interest of $532,000 over the life of the loan. In other words, Dad transfers an additional $532,000 out of his estate in 2009 because of the low applicable federal interest rate. (The February interest rate for short term loans – three years or less – is .6%.)
An open question is whether the Dad in my example could prepay the 2007 loan and enter into a new loan in 2009 at the lower interest rate. Certainly in an arm’s length transaction with unrelated parties, assuming the loan allowed for prepayment and Dad’s credit was good and there was a lender, Dad would rush to enter into a new loan. In a family situation there is an issue as to whether a new loan would raise income or gift tax issues. However, depending on the facts, there is authority to support a new loan at today’s lower interest rates.