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"With Low Real Estate and Stock Market Values, and Even Lower Interest Rates... Now May Be the Right Time for Estate Tax Planning"

Greensfelder Trusts & Estates Newsletter
October 2011

Current Estate Tax Laws

In 2011, the estate/gift tax exemption is $5,000,000 per person. If you are married, this allows you and your spouse to transfer $10,000,000 to your children without estate tax, assuming your estate plan is drafted appropriately. However, the estate tax exemption is scheduled to return to $1,000,000 in 2013 unless Congress acts sooner.

Estate Tax Reduction Techniques

If your estate is valued at more than $10,000,000 (the amount a married couple can transfer estate tax free in 2011), or you expect your estate to be valued at more than $10,000,000 before you die, you should consider estate tax reduction techniques. Techniques to consider include:

  • $13,000 annual exclusion gifts
  • Gifts in excess of your annual exclusion
  • Grantor retained annuity trust (GRAT)
  • Installment sale to a grantor trust (SALE)
  • Qualified personal residence trust (QPRT)
  • Charitable remainder trust (CRT)

Most of these techniques work best after a downturn in the market, when property has a low value. Making gifts of low valued property means that you are using less of your gift tax exemption to remove the property from your estate for estate tax purposes. The GRAT, Sale, and QPRT are referred to as “freeze” transactions, as they freeze the value of assets for estate tax purposes at the asset’s current value.

Historically Low Interest Rates

The success of many estate planning transactions depends on the interest rate in the month the transaction is implemented. For purposes of these transactions, you use a government defined interest rate (the “applicable federal rate” or “AFR”) to value the property involved. The AFR is based on the yields of actual Treasury instruments from the previous two months. The lower the AFR, the better a GRAT or Sale works. The AFR for October 2011 is at an all time low. The AFR used to value a GRAT (the 7520 rate) is 1.4% for October, 2011. A few years ago, this AFR was 6%, and has been as high as 11.6%. The mid-term AFR used for many Sale transactions is 1.19% for October, 2011.

When the AFR is low, GRATs and Sales provide better results. On the other hand, when the AFR is low, QPRTs and charitable remainder annuity trusts are less effective (charitable remainder unitrusts are largely unaffected by the AFR).

Annual Exclusion Gifts

You may give $13,000 to each of an unlimited number of individuals per calendar year. This is called the "annual exclusion." Gifts covered by the $13,000 annual exclusion do not reduce your $5,000,000 gift or estate tax exemptions. If you do not utilize the annual exclusion during the year, it is lost forever. By transferring $13,000 ($26,000 for a married couple) per year to each of your children and grandchildren (or to a trust for them), you can remove a significant amount of wealth from your taxable estate.

Gifts In Excess of the Annual Exclusion

The gift tax exemption (the amount you can give away while you are alive in excess of the annual exclusion, without paying tax) is $5,000,000 per person. Any gift tax exemption used during lifetime reduces the $5,000,000 estate tax exemption available at death. If you expect your assets to increase in value before you pass away, then a large gift may make sense. You can remove up to $5,000,000 ($10,000,000 for married couples) from your estate at one time without paying gift tax. The benefit of making such a gift is the future income and appreciation on the assets given away will not be subject to estate tax when you die.

GRAT

With a GRAT, you transfer property to a trust and retain the right to receive a percentage of the property back each year. If the total return (income plus appreciation) of the assets in the GRAT is higher than the AFR in the month the GRAT is created, then the excess return passes estate tax free to your children. If the GRAT does not produce returns in excess of the AFR, then you will eventually receive all of the property back, and you can start over again. In other words, if the GRAT does not work, you are in the same position as if you had done nothing. This makes GRATs a particularly attractive estate planning technique, especially in the current low market, low interest rate environment.

Sale

An installment sale to a grantor trust is an exchange of a promissory note for other assets (usually a business, securities, or real estate). If the total return of the assets is more than the interest rate on the note (the AFR), then the excess return passes estate tax free to your children and grandchildren. You are essentially loaning assets to a trust for your family. The lower the AFR, the less that must be paid back to you as the lender, and the more that passes estate/gift tax free to your children and grandchildren.

A Sale is often combined with a family limited partnership, which may allow you to reduce (or “discount”) the value of your assets by 30% or more due to the lack of marketability and lack of control associated with limited partnership interests. The trust purchasing the assets can be structured to avoid estate taxes for all future generations.

QPRT

With a QPRT you transfer your home to a trust, and retain the right to live in the home for a number of years. The value of the home less the value of your retained right to live there is a gift that will use a portion of your $5,000,000 gift tax exemption. If you outlive the term of the trust, the home passes estate tax free to your children. QPRTs work best when interest rates are high. However, a QPRT may still be attractive now if your home is expected to substantially increase in value prior to your death.

CRT

With a CRT, you transfer assets to a trust and retain the right to receive an income stream for your life or for a certain number of years. With a charitable remainder annuity trust, you receive a fixed dollar amount from the trust each year. With a charitable remainder unitrust, each year you receive a percentage of the fair market value of the trust, revalued annually. When your right to receive the income stream ends, the remaining trust assets pass to charity. CRTs are often used by clients that wish to give a substantial amount to charity but would like to retain an income stream from the assets given away.

Divorce and Creditor Protection

Many of these techniques work best when combined with lifetime trusts for your family members. It is now possible to create a lifetime trust for a child that will protect the trust assets from the child’s creditors, even if the child is serving as sole Trustee and has the discretion to distribute the income and principal to him/herself. In addition, under Missouri law if the trust is drafted appropriately, the assets will not be subject to a marital property division if a child divorces. If the trust contains express rights of withdrawal, or will terminate at a certain age, this protection is lost.

If your estate plan was drafted prior to 2005, it should be reviewed to ensure it provides your children with the maximum creditor and divorce protection allowed by law.