In Estate Planning as in Life, Timing is Everything

Estate Planning Techniques

Estate planning is a process. Through the process, the estate plan is tailored to your particular needs by implementing techniques that meet these needs. The following are some techniques that you may want to consider for your estate plan.

Lifetime Exemption Planning:

Under current gift tax laws, a person can give up to $11,180,000 ($22,000,000 if gift splitting is elected) to family members without paying gift tax. Additionally, by taking advantage of the current economic conditions and the strategies discussed below, amounts in excess of $11,180,000 can be transferred to family members without ever being subject to gift taxes.

Annual Exclusion Gifts:

One of the most simplistic estate planning tools are annual exclusion gifts. These outright gifts of cash or property can be made to family members, friends and certain trusts. Annual exclusion gifts do not use any of the donor’s $11,180,000 applicable exclusion amount and can be a quick and easy way to reduce the size of an estate, thereby saving estate taxes. If gifts of stock are being considered for annual exclusion gifts, the donor should gift stock with a high basis rather than a low basis, if possible. If the fair market value of the stock is below the cost basis of the stock, considered selling the stock to take advantage of the capital loss and gift the cash proceeds to family members.

Low Interest Rate Loans:

Another technique is low interest rate loans to family members. The concept is not complicated. A parent or senior member of the family makes an interest only loan to a child, grandchild or generation-skipping trust and charges the appropriate applicable federal rate (AFR). To the extent the borrower invests the loan proceeds and achieves a total return (income and growth) in excess of the AFR, the parent has affected a “freeze” equal to the AFR. All appreciation in excess of the AFR occurs outside of the parent’s estate.

Grantor Retained Annuity Trusts:

Another wealth transfer strategy to consider is a grantor retained annuity trust (GRAT). A GRAT is an irrevocable trust to which the grantor contributes assets and retains an income stream for a fixed term of years specified by the trust. At the end of the trust term, any property remaining in the GRAT will be removed from the grantor’s estate. The assets then can either remain in the trust or be transferred to the trust beneficiaries, usually the children of the grantor. Although, the transfer of assets to a GRAT is considered a gift, only the value of the asset in excess of the grantor’s retained interest will be considered a taxable gift. A GRAT is a great technique to use when interest rates are low. With low interest rates, the value of the grantor’s retained interest is greater and the gift to the beneficiaries of the trust is lower. Gifts to a GRAT do not qualify for the annual gift tax exclusion so the grantor will use a portion of their $11,180,000 applicable exclusion amount. However if the grantor is unwilling to use a portion of the applicable exclusion amount, the grantor could consider using a zeroed-out GRAT as in the Tax Court’s decision in Walton v. Comm’r, 115 T.C. 589 (2000). If assets in the GRAT appreciate, substantial wealth can be transferred to family members free of gift and estate taxes. The key is to place assets in the trust that have future appreciation potential or a return in excess of the grantor’s retained interest. It may also be possible to leverage a grantor’s gift to the GRAT by gifting assets to the trust that may be subject to valuation discounts. These assets can produce significant savings since the annuity to the grantor is based on the discounted value.

Intentionally Defective Grantor Trusts:

A sale to an intentionally defective grantor trust (IDGT) is often considered an alternative to a GRAT and is a beneficial estate planning device. The grantor of the trust sells assets to the IDGT in exchange for a promissory note that bears interest at the AFR. The repayment of the note’s principal may be deferred until the end of the note term, which allows assets to stay in the trust for a longer period of time and hopefully appreciate in value. However, the trust is required to make annual interest payments to the grantor of the trust. At the termination of the promissory note, all appreciation in trust assets remain in the trust or pass to the beneficiaries of the IDGT. When interest rates are low, it may be possible to shift substantial appreciation to family members if assets with a total return in excess of the AFR are used to fund the IDGT. In addition, if the grantor funds the IDGT with assets that can be discounted, he or she can shift even more wealth to family members. If the grantor dies before the note is fully paid the unpaid balance of the note will be included in the grantor’s estate. This is in contrast to a GRAT. If the grantor dies during the GRAT trust term, most or all the GRAT property, including appreciation, will be included in the grantor’s estate. Since the IDGT is considered a grantor trust for income tax purposes, the grantor does not recognize gain or loss on the sale of assets to the IDGT. In addition, the grantor is not taxed on the annual interest payments received from the note.

Charitable Lead Trusts:

For those individuals that are charitably inclined, a charitable lead trust (CLT) is a popular wealth transfer technique. A CLT is an irrevocable trust, which provides an annual income stream to a qualified charity for a term of years. At the end of the trust term, the remaining trust assets, including all appreciation, pass to noncharitable beneficiaries. The noncharitable beneficiaries are usually children and/or grandchildren. CLTs allow individuals the opportunity to benefit the charity of their choice, in addition to shifting future appreciation to family members. The transfer of assets to a CLT is considered a gift. However, only the value of the interest that will be transferred to the noncharitable beneficiaries is a taxable gift. The value of the gift is discounted because the family members do not receive assets from the trust until the termination of the charity’s interest. Thus for gifting purposes, the taxable gift is the value of the assets transferred to the trust less the charity’s interest in the trust. A CLT is an excellent tool to use if the trust achieves a rate of return greater than the value of the charity’s interest. If this result is achieved, the excess will be shifted to family members free of any gift or estate taxes.