Update Your Planning To Take Advantage Of The Low-Rate Environment
By: Stuart R. Morris, Esq., CPA, B.C.S. - March 22, 2020
I hope you and your family members are well and weathering these unprecedented times in our country with the COVID-19 coronavirus and its impact on financial markets. There is no doubt we're in uncharted territory here, but we are all in this together. That's why it's important to have each other's backs and look out for each other now more than ever before. Here at Morris Law Group, we continue to have our clients' best interests in mind. It is along those lines that we wanted to keep you apprised of certain planning opportunities to consider in this low-interest-rate environment.
The Applicable Federal Rate (AFR) Has Dropped
The AFR is the minimum interest rate that the IRS permits for private loans. The AFR is determined by the IRS on a monthly basis and is published during the last week or two of the preceding month. The IRS has recently published the new AFR for April 2020, and it is near an all-time low (the minimum interest rate on all loans under nine years has fallen below 1%, with a minimum rate of 1.44% for all loans longer than nine years). Therefore, we feel that it is advisable for our clients to be aware of such low interest rates, as it may be directly applicable to their estate planning. Below is a list of areas where the new figures are applicable. Additionally, any private loan below the AFR threshold may have gift tax implications.
These low AFR numbers are significant for two reasons:
- It is now a good time to loan money between family members should the need arise; and
- It may be a good time for individuals with existing promissory notes to renegotiate these notes to utilize the new interest rates.
Grantor Retained Annuity Trusts (GRATs)
As many are aware, a GRAT is an extremely useful estate planning technique used to minimize taxes on large financial gifts to family members. Specifically, a GRAT is created by transferring one or more high-yield assets into an Irrevocable Trust and retaining the right to an annuity interest for a fixed term of years. When the retention period ends, assets in the trust (including all appreciation) go to the named "remainder" beneficiary(ies).
GRATs provide a fixed annuity payment, usually expressed as a fixed percentage of the original value of the assets transferred in trust. For example, if $100,000 is placed in trust and the initial annuity payout rate is 3 percent, the trust would pay $3,000 each year, regardless of the value of the trust assets in subsequent years. If income earned on the trust assets is insufficient to cover the annuity amount, the payments will be made from the principal. Therefore, the client-transferor is assured steady and consistent payments (at least until the principal is exhausted).
All income and appreciation in excess of the amount required to pay the annuity accumulate for the benefit of the remainder beneficiary(ies). Consequently, it may be possible to transfer assets to the beneficiary(ies) when the trust terminates with values that far exceed their original values when transferred into the trust and, more importantly, that far exceed the gift tax value of the transferred assets.
The minimum interest rate for GRATs is also determined on a monthly basis by the IRS and is currently at a very low 1.2%. Therefore, GRATs may be beneficial for clients with high-yield assets.
Sale to Grantor Trusts
Another common beneficial estate planning technique is through the sale of appreciating assets to an (intentionally defective) Grantor Irrevocable Trust in exchange for a promissory note. In general, a “defective grantor trust,” now more simply known as a “grantor trust,” is a trust that is disregarded for income tax purposes. Thus, all the trust’s income, deductions, etc. are treated as though they are received by (or paid by) the grantor.
Furthermore, although the trust is disregarded for income tax purposes, it is respected for estate and gift tax purposes, thereby enabling a grantor to transfer assets outside of his or her estate without any income tax consequences.
The result of this technique is twofold. First, for estate tax purposes, all future appreciation of the assets sold to the trust will grow outside of the grantor’s estate. Second, for income tax purposes, the grantor does not need to recognize any income tax on the sale, because the sale to a grantor trust is deemed to be a sale to the grantor himself or herself. In addition, all income from the trust will be taxed at the grantor’s individual tax rate rather than the rate for trusts. Once again, with the AFR close to an all-time low, such transactions can be entered into in exchange for promissory notes with very low interest rates.
If you have any questions about these techniques or would like to discuss how the low-interest-rate environment can be used to your advantage with your estate plan, please contact us. We will continue to monitor the situation and keep you apprised of any further developments. For the time being, you can still meet with our attorneys by calling (561) 750-3850.
Stuart Morris, Esq., CPA, B.C.S.
Founding Partner, Morris Law Group