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ESTATE PLANNING STRATEGIES

When reduced to its simplest terms, there are only a few ways for a wealthy individual or married couple to avoid paying estate tax on their property – spend it, give it away during life, or leave it to charity. Alternatively, clients can draw upon many sophisticated and creative techniques to transfer significant amounts of property during life. Most of these techniques are designed either to reduce the value of the transferred property or to remove future appreciation and income, but not current value, from the estate. The following includes a summary of useful techniques to consider:

Annual Exclusion. The Internal Revenue Code currently provides an exclusion from gift tax for the first $15,000 given to any donee in any year . The annual exclusion applies to an unlimited number of donees per year and requires no familial relationship.

EXAMPLE: If you have a married couple with three children and an estate that would be taxed in the 40 percent bracket, gifts of $15,000 to each of the three children, to the spouses of the two married children, and to each of the five grandchildren would entail transfers of $150,000. These transfers would result in a federal estate tax savings of $60,000.

Transfers for Educational or Medical Expenses. Tuition payments made directly to an educational organization on behalf of a person, and payments for a person’s medical care made directly to the provider also are not treated as taxable gifts . As emphasized, payments for tuition and medical expenses must be made directly to the educational organization or medical provider. Donors may prepay tuition expenses for the current year and for several future years as long as they were not subject to refund .

EXAMPLE: If grandparents who already take full advantage of the annual exclusion for gifts to grandchildren can make additional tax-free transfers by paying tuition for their grandchildren’s directly to a private school or college. Alternatively, the exemption does not apply if an individual gives a grandchild $5,000 to pay medical expenses, even if the grandchild in fact uses the $5,000 for that purpose.

Dynasty trusts and use of GST exemption. GST tax ensures that each generation pays estate tax (or its equivalent); however, statistics demonstrate that the total estate tax and GST taxes due and payable on a parent’s and a child’s estates could consume up to 80 percent of an asset’s value by the time the asset passes to a grandchild, devastating a family’s wealth. The added complexity of GST tax creates difficulty when planning for future generations in a tax efficient manner. Individuals with significant wealth should take advantage of the GST exemption during life by setting aside property in an irrevocable trust for children and grandchildren. The sooner the GST exemption is used, the greater the amount of property that will be sheltered from transfer tax despite future tax law changes.

EXAMPLE: Parents give $20 million to an irrevocable trust for the benefit of their descendants and allocate their GST exemptions to the trust. If the trust assets grow on average at a six percent after tax rate (accumulated income plus appreciation) and Parents live for another 25 years, there will be over $85.8 million in the trust at their deaths. By creating the trust during life, Parents have set aside an additional $65.8 million that can pass tax-free to grandchildren.

Spousal Lifetime Access Trusts. Spousal lifetime access trusts (“SLATs”) are irrevocable trusts established by a spouse for the benefit of the other spouse and his or her descendants or other beneficiaries. Many couples with estates in the $10 to $50 million do not believe they can afford to make taxable gifts using their full exclusions due to lost cash flow. However, they may take partial advantage of the higher exclusions this year, and still have access to the property, by using a SLAT. Also, if the present federal estate and gift tax exemption amount decreases due to the 2020 federal elections, couples may want to take advantage of the full exemption before it is reduced. Clients must take specific care when establishing SLATs to avoid IRS scrutiny for treatment as reciprocal trusts, the result of which is inclusion in the decedent spouse’s estate.

EXAMPLE: Spouse 1 funds $11 million into SLAT 1 for the benefit of spouse 2 and her descendants. Spouse 2 has rights of access for health, education, maintenance and support, and has the right to direct the ultimate enjoyment of the trust estate upon her demise. Spouse 2 does the same for Spouse 1, at a later date, except the enjoyment rights for Spouse 1 may be different, the power to direct the assets at death may be modified or may not be permitted. These differences in the design and timing avoid what the IRS would otherwise view as “interrelated trusts,” i.e., the SLATs leave the spouses in the same economic position as they would have been in had they created the trusts for themselves. Done correctly, the funding of the SLATs allows spouses to take the full benefit of current exemption levels for estate and gift taxes today without fear of a dramatic, future reduction in gift and estate tax exemption levels.

Taking Advantage of Low Values. The possible lower value of assets as a result of the pandemic may make gifts of lower value assets more efficient.

EXAMPLE: Parent owns all of the stock of a closely held corporation. In January 2020, the stock is valued by an outside appraiser at $200 per share taking account of discounts for lack of marketability and lack of control. If parent made a gift of shares of stock in the closely held company to take full advantage of her gift tax annual exclusion to her child in January 2020, parent would give 75 shares to her child. However, in June 2020, the stock is valued at $100 per share as a result of the economic downturn caused by the pandemic by an outside appraiser. If parent made a gift of shares of stock in the closely held company to take full advantage of her gift tax annual exclusion in June 2020, parent would give 150 shares. One should be careful to use a qualified appraiser to value closely held assets to minimize the possible negative consequences of an IRS review of any gift.

Low Interest Loans and Refinancing of Existing Loans. An alternative to making gifts to family members is to make low-interest loans, especially in the current low interest rate environment. The applicable federal rate (“AFR”) of interest rates for July 2020 to avoid adverse income tax and transfer tax consequences are:

EXAMPLE: Parent could loan a child $1,000,000 for five years at the .45 percent mid-term rate, simple interest. The child invests the $1,000,000 and earns 5 percent a year on the funds. At the end of five years, the $1,000,000 has grown to $1,276,300. The child owes $22,500 in total interest. The net benefit to the child is $253,800.

A second technique is to use low interest loans to benefit older generation family members who need financial assistance because of the pandemic. “Loans” do not add value in an otherwise taxable estate of the older generation and allow for more efficient cash flow for the parents when compared with bank lending rates.

Grantor Retained Annuity Trust (“GRAT”). A GRAT is an irrevocable trust in which the grantor retains the right to receive a fixed dollar amount annually for a fixed term of years. At the end of that period, any remaining property passes to the grantor’s designated beneficiaries or trusts for their benefit. Since the beneficiaries only receive the property remaining at the end of the annuity term, the value of the gift is not the full value of the property transferred to the trust. Rather, it is the value of the property reduced by the value of the annuity interest the grantor retains. The value of the annuity interest, and thus the value of the gift, is calculated using the IRS valuation tables and the Section 7520 rate for the month the GRAT is created. The lower the interest rate that applies, the smaller the gift. Thus, in the low interest rate environment of the last several years, the GRAT has been a more attractive technique.

Sale to “Defective” Grantor Trust. As mentioned in our previous advisory, the sale of property to an irrevocable trust that is intentionally structured to be a grantor trust (often referred to as a “defective grantor trust” in the literature) is an alternative to a GRAT. The technique is a variation on the commonly used installment sale, in which the taxpayer sells a high-growth asset for an installment note with interest set at the applicable federal rate. If the asset grows in value at a rate above the interest rate on the note, the taxpayer’s estate will be reduced. The special twist when using a grantor trust as the purchaser in the sale is that the trust is not treated as a separate taxpayer for income tax purposes, meaning that the sale does not cause the seller to realize capital gain. A regular installment sale reported under Code Section 453 permits the seller to recognize capital gain as payments are received over the term of the installment note. When a grantor trust is used, even this deferred gain can be avoided entirely, because as a grantor trust, interest paid on the installment note will not be taxable to the grantor.

Charitable Lead Trusts. Charitable lead trusts are especially effective estate planning tools when, as now, the interest rate assumptions underlying the valuation tables are low. A charitable lead trust provides charitable beneficiaries with a stated amount each year for a specified term of years or for the life or lives of an individual or individuals. At the end of the period, the remaining corpus is distributed to or in trust for the grantor’s descendants or other non-charitable beneficiaries. A charitable lead trust enables a person to satisfy current charitable intentions and at the same time transfer significant amounts of property to beneficiaries at a reduced transfer tax cost.

For many of our clients, we have employed one or more of the above-described strategies. The changing political environment may well bring pressures to foreclose use of these techniques. We may be on the verge of a sea change in estate planning. Let’s not let this pandemic hit twice: poise risk to our health and to our lifetime of work. Please keep yourself safe from this virus and we will continue to work to protect your estates as is our valued privilege.

MESSAGE TO OUR CLIENTS, BUSINESS PARTNERS AND FRIENDS
August 3, 2020

We at Barulich Dugoni & Suttmann are continuing to monitor the ever-changing information from the CDC and our local health departments as we follow their guidance. The well-being of our employees, clients, business partners and friends remains our constant priority. We are committed to delivering the client service that has been the bedrock of our Firm’s values over the last 35 years in a safe and effective manner.

Effective Monday, August 3, 2020, the San Mateo County government office imposed a Shelter In Place for San Mateo County, among many others. Barulich Dugoni & Suttmann, have temporarily closed their office during the Shelter In Place. All of our employees are working remotely to continue to provide excellent customer service to all of our clients. As we navigate this fluid environment, we are prepared to support you and your business needs at this time as follows:

WORK FROM HOME:

All staff are set up with remote access and can answer any communications to continue our great work. Please continue to reach out to your contact as needed.

MEETINGS/CALLS:

We have the ability to conduct video conference calls and meetings. Our team is ready to assist in setting up these sessions. Please reach out to your current contact and they can schedule an appointment as needed.

ADDITIONAL STEPS:

  • We have cancelled and will reschedule all group and office social events.
  • We have implemented the CDC’s suggested protocols among our employees to help prevent the spread of the virus. We will continue these measures once the Shelter In Place restriction has been lifted.

Of course, like everyone else, we are learning. The well-being of our employees, clients, business partners and community remains our constant priority. We are receptive to any suggestions that would make you more comfortable while working with us. We stand beside you as we sail these uncharted waters.

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