Dedon on Estate Planning

Taking Advantage of Existing Estate Planning Strategies

There has been much written recently on Congress’ failure to enact estate tax legislation so that taxpayers would have some certainty as to the current estate tax laws and appropriate planning. Congress allowed the $3.5 million exemption amount existing in 2009 to expire resulting in no estate tax for one year, 2010. Next year, the estate tax exemption amount is only $1 million, meaning a married couple, if they plan properly, can only protect $2 million. Besides this uncertainty, we have the current mess of having to track the basis of assets because upon death, there is no longer a "step up in basis."

Although not discussed as much, there is also uncertainty in other areas because of proposals that may eliminate or curtail current estate tax planning strategies. Two strategies involve Grantor Retained Annuity Trusts and transferring assets among family members at discounted values.

GRATs

GRATs allow donors to transfer closely held stock, real estate, or marketable securities to a GRAT for a minimum of two years. If the donor receives an annual annuity from the GRAT, the appreciation in the transferred assets will pass to the donor’s family at the end of the GRAT term at a reduced value and is removed from the donor’s estate. The asset value is reduced for gift tax purposes because of the retained annuity. Obviously the greater the annuity and the longer the GRAT term, the greater the reduction in value of the transferred asset for gift tax purposes. In fact, it is possible to "zero out" (meaning eliminate) the gift tax.

One catch: the donor needs to survive the GRAT term. Thus, an 80-year old donor would not choose a 20-year GRAT. In fact, regardless of age, many donors choose two-year GRATs with the same assets (so called "rolling GRATs").

Under one proposal, GRATs less than 10 years in duration would be prohibited, meaning the donor must live 10 years to remove the asset from the donor’s estate. A separate proposal in Congress would not change the length of the GRAT, but would require a minimum gift imposed on the donor, perhaps as much as 10 percent of the transferred asset (thus eliminating zeroed-out GRATs).

Transfers of Assets at Discounts

Taxpayers and the IRS have battled for years over family members transferring their business and investment interests to family members at discounted values. With the appropriate appraisals, the discounts applicable to such transferred interests can range between 20 percent and 50 percent. The planning typically involves forming an LLC, or creating non-voting stock, and transferring non-controlling interests.

The Court cases pertaining to discounting of family assets are split, with victories for both the IRS and taxpayers. The IRS often prevails because of taxpayer greed (if taxpayers seek to discount all their assets); lack of a business purpose (personal assets transferred, such as a residence); procrastination (so-called "death bed" planning – transfers shortly before death); failure to observe formalities (co-mingling assets, not creating proper accounts and record keeping); or the retention of control.

The Obama Administration and Congress may seek to eliminate the discounts for transfers of non-controlling interests among family members. Typically, if new laws are passed, they carry the date of enactment as the effective date but Congress could seek to impose a retroactive date.

Thus, acting before certain planning opportunities are eliminated is important.

Potential Changes In Estate Strategies

Attached is a copy of an article I wrote that was recently published in the Virginia Business Magazine on the Obama administration proposals to restrict certain estate planning strategies.  You can see the article by clicking below.

Download Va bus art 5-19-09

The Latest On GRATs

In prior columns I have written about GRATs and how they allow taxpayers to transfer more assets to their families and less to the IRS. GRATs, and other similar strategies are particularly important knowing that the federal estate tax, with rates perhaps as high as 45%, will remain long into the future. The Obama Administration and Congress are considering restricting GRATs.

GRATs allow the donor to transfer closely held stock, real estate, or marketable securities to a Trust for a minimum of two years. If the donor receives an annual annuity from the GRAT, the transferred asset or at least its appreciation, will pass to the donor’s family at the end of the GRAT term at a reduced value and is removed from the donor’s estate. The asset value is reduced for gift tax purposes because of the retained annuity. Obviously the greater the annuity amount and the longer the term of the GRAT, the greater the reduction in value of the transferred asset for gift tax purposes. In fact, it is possible to "zero out," meaning eliminate, the gift tax.

One catch: the donor needs to survive the term of the GRAT. Thus, an 80 year old would not choose a 20 year GRAT. In fact, regardless of age, many business owners choose 2 year GRATS to capture any savings possible, and then simply do repeated 2 year GRATS with the same assets (so called "rolling GRATS").

Under the Obama plan, the law would prohibit GRATS less than 10 years in duration, meaning the donor must live 10 years to remove the asset from the donor’s estate. A separate proposal in Congress would not tinker with the length of the GRAT, but would require a minimum gift imposed on the donor, perhaps as much as 10% of the transferred asset (thus eliminating zeroed-out GRATS).

This proposal, if enacted, will likely carry the date of enactment as the effective date. Thus, acting now becomes even more important.

A Time For Giving

In today's Wall Street Journal (Monday, April 13, 2009), there is an article, "A Time For Giving," pertaining to Grantor Retained Annuity Trusts (GRATs) in which I am quoted. I have written several times on the advantages of GRATs and this article is consistent with those articles. Here is the link for your information.

http://online.wsj.com/article/SB123914012709598523.html#articleTabs%3Darticl

GRATs and GRAT Rescue Planning

Prior posts have discussed the estate and gift tax advantages of Grantor Retained Annuity Trusts (GRAT) to transfer family assets to beneficiaries. Reprinted below are my January 28, 2008 and April 21, 2008 posts, which discuss GRATs in detail. The dismal economy presents a unique opportunity to leverage GRATs by funding them with low value marketable securities and real estate. Another advantage is the applicable IRS interest rate, which is only 3.4% for December.

In fact, several clients are now creating new GRATs ("GRAT 2") to hold assets that within the last year had been transferred into GRATs ("GRAT 1"). Because the current values in GRAT 1 are unlikely to exceed the hurdle rate, those assets are being purchased by the client from GRAT 1 and then transferred into GRAT 2. These GRAT "rescue plans" are a highly desirable strategy in the current environment.

Bad Times Make Good Gifting Opportunities

In my October 13 Post, I discussed how this is an opportune time to make gifts to family members because of reduced stock values. The same could also be said for real estate and perhaps closely held businesses.

Recent articles from two leading newspapers follow these same lines. In an October 18th Wall Street Journal article, captioned "Why Now Is the Time to Help Your Heirs," the Journal mentions several techniques to make generational transfers, including GRATs (which I have written about in the past), gift and sales to Intentionally Defective Trusts, and family loans. These go hand in hand with the Family Partnership concept that I wrote about last week. In the charitable arena, the Journal also mentioned Charitable Lead Annuity Trusts.

The second article was an October 16th New York Times piece by Warren Buffett in which he urged investors to continue to buy American stocks and take advantage of buying opportunities. As Buffett says, "be fearful when others are greedy, and be greedy when others are fearful." As Buffett's October 16th article states: yes the financial world is a mess, but it also presents opportunities in the long term for generational transfers.

Taking Advantage of Low Interest Rates and a Declining Market

The January 28, 2008 Post explained why 2-year GRAT’s (Grantor Retained Annuity Trusts) are an essential estate planning tool for affluent taxpayers looking to pass wealth to children and other beneficiaries with little or no gift or estate tax consequences. No other tax strategy is as straight forward, effective and IRS sanctioned.

What was a wonderful idea in January 2008 is even a better idea in Spring 2008 for the following two reasons: First, the interest rate applicable to GRAT’s is now one percent lower than in January: the rate has decreased from 4.4% to 3.4%. Therefore, if assets transferred to a GRAT appreciate at greater than 3.4%, the excess appreciation passes to beneficiaries chosen by the taxpayer estate tax free. Perhaps this interest rate will decline even further in coming months, however, at 3.4% the rate is attractive regardless of future fluctuations. Second, although nobody can time the stock market, many believe it has bottomed out. (Note, GRAT’s also can be used with real estate and closely held businesses, but this Post assumes taxpayers hold marketable securities.)

For example, if in April a taxpayer transferred $1 million to a 2-year GRAT, when the applicable rate is 3.4%, and the assets appreciated at 10% over a 2-year period, approximately $106,000 would pass to beneficiaries tax free. The taxpayer would have received from the GRAT approximately $1,050,000. The taxpayer would then roll the $1,050,000 into the next GRAT.

Grantor Retainer Annuity Trusts

For husbands and wives with more than $4 million of assets, additional estate planning measures beyond marital and bypass trusts are necessary to reduce the federal 45% estate tax rate.  A tool of choice is a Grantor Retained Annuity Trust ("GRAT").  GRAT'S can be used to transfer public securities, closely held stock, LLC interests, or real estate.  Although the GRAT design differs depending on the asset to be transferred, the concept is the same:  (1) the donor transfers assets to a GRAT for a period of time; (2) the donor receives an annual annuity during that time period, consisting of the GRAT income or assets; and (3) if the appreciation in the assets exceeds the applicable federal interest rate, then the appreciation passes to family members estate tax free with virtually no gift tax.