Family Gift Planning — Perhaps the Best Time Is Now
With an upcoming election, economic uncertainty, and a dining room that has become both a school and a home office, family gift planning may be far from the top of your to-do list. The current environment, however, creates an opportunity for high-net-worth individuals to save on wealth transfer taxes, and this window of opportunity may close quickly.
Estate and Gift Tax Exemptions Are at All-Time Highs
The current $11.58 million per individual ($23.16 million collectively for a married couple) federal gift, estate, and generation-skipping transfer tax lifetime exemption is scheduled to be reduced to approximately $6 million on January 1, 2026. Many believe, however, that this scheduled decrease could be accelerated depending on the outcome of the upcoming general election and that such a decrease could become effective as soon as January 1, 2021. While future changes to tax laws can’t be predicted with certainty, if you are contemplating making further wealth transfers, it may be prudent to consider making 2020 gifts that fully utilize your lifetime gift tax exemption in light of this potential “use it or lose it” scenario.
The preferred method for transferring wealth to a younger generation is to make lifetime gifts to one or more irrevocable trusts.
Making gifts in trust, rather than outright to individual beneficiaries, allows you to separate the timing of the gift (often driven by tax motivations such as those described above) from the timing of the distributions (driven by family and other non-tax financial factors). In addition, gifts to trust can provide you with tax and creditor protection benefits not available with outright gifts. If desired, the terms of the trust can give your beneficiaries significant (although not total) control consistent with enhancing tax and creditor protection goals.
Irrevocable trusts can be structured so that your transfers to them are completed gifts for estate and gift tax purposes, but allow you to remain the owner of the property for income tax purposes. Your ability to pay income taxes on behalf of these trusts (called “grantor trusts”) is not considered an additional gift, making this a potentially highly effective wealth transfer strategy.
In the absence of gifts, your surplus wealth will continue to accumulate, and at death, will be split between the government and your beneficiaries. By making gifts now, an irrevocable trust can effectuate a much better split between the government and your family members. Of course, the non-tax aspects of gifting are important. If you are concerned about having some ability to access the gifted funds in the future, you could name your spouse as a beneficiary of the irrevocable trust. A so-called “spousal lifetime access trust” allows the older generation to have access to the trust through the spouse’s beneficial interest during the spouse’s lifetime.
Interest Rates Are at Historic Lows
Today’s historically low interest rates create an important opportunity for tax-favorable wealth shifts from the older generation to the younger generation. In contrast to making gifts of today’s wealth by making a substantial gift to an irrevocable trust, gifts that take advantage of low interest rates help you take advantage of future growth in wealth.
Take, for example, a sale of assets to an irrevocable trust:
Assume you sell assets with a 2020 fair market value of $10 million in exchange for an interest-only, nine-year promissory note at the October 2020 minimum annual interest rate of 0.36% payable annually.
Such a sale would not be treated as a gift because the purchase price is equal to the current value of the property and because the interest rate on the note is equal to the federal minimum rate. Since there is no gift, no gift exemption is needed to use this technique, so the technique can be used by those who have already used their lifetime gift exemptions or as a supplement to gifts that use lifetime gift tax exemption.
If the property sold to the trust were to appreciate at, say, 10% annually during the nine-year note period, at the end of the nine years, the trust would retain, after repaying the note, approximately $12.9 million available for the trust beneficiaries, represented by the difference between the 10% actual rate of return earned by the trust and the trust’s 0.36% cost of funds.
There are many variations of this technique, including the grantor retained annuity trust (“GRAT”), where you receive annuity payments back from the trust rather than interest on note payments. The general idea, however, is the same: transfer future appreciation out of the older generation’s estate with very little gift tax consequences.
We often encourage clients to consider gifting as part of a year-end planning review. This year, we suggest acting sooner and potentially making transfers by year-end 2020.