Congressional inaction on transfer taxes and historically low interest rates have created several estate planning opportunities which may disappear after December 31, 2010 or sooner. We recommend that you review and evaluate these opportunities as soon as practicable.
2010 Lifetime Transfers to Your Descendents
Donative transfers to your children and grandchildren before the end of 2010 may yield significant overall tax savings for your family. Generally, transfers by gift are subject to a federal gift tax and transfers to persons more than one generation below the donor, such as grandchildren and more remote descendants, are subject to federal generation-skipping transfer (?GST") tax. The federal gift tax and GST tax rates traditionally have hovered in the range of 41-55%, but this year the federal gift tax rate is 35% and the GST rate is 0%. These historically low rates only apply to transfers made in 2010, and, unless Congress modifies the current gift and GST tax laws, are set to increase on January 1, 2011 to rates of 41-55% for the federal gift tax and a rate of 55% for the federal GST tax.
The tax savings available for 2010 gifts could be significant. As illustrated below, if you have already fully utilized your lifetime gift tax exemption (currently, $1,000,000) a gift to a child of $1,000,000 could save up to $85,000 in federal gift taxes if made on or before December 31, 2010. Donative transfers to a grandchild or more remote descendant, whether by gift or by trust distribution, could save an additional $550,000 in GST tax if made this year.
Please see table.
Due to the anticipated reinstatement of the GST tax in 2011, gifts made in 2010 to trusts (or trust equivalents) for the benefit of grandchildren or more remote descendants may not achieve the same GST tax savings as outright gifts.
2010 Transfers to Grantor Retained Annuity Trusts
Current law allows taxpayers to structure a short-term (e.g., 2 years), zero-gift Grantor Retained Annuity Trust (a "GRAT"). A GRAT is an irrevocable trust that pays its grantor annual annuity payments over a fixed trust term. When the fair market value of the property transferred to the GRAT equals the present value of the annuity returned to the grantor based on the IRS assumed interest rate (i.e., the GRAT is ?zeroed-out"), no gift tax will be due upon creation of the GRAT. Since the grantor must survive the trust term for the GRAT to be effective, a short 2-year term minimizes the risk that the trust assets will be returned to the grantor without any tax savings due to his or her death. Thus, both the ability to fully zero-out the gift and the availability of a 2-year term have made GRATs very attractive.
Low interest rates can substantially enhance the overall effectiveness of a GRAT. If the appreciation of assets held by a GRAT exceeds the IRS assumed interest rate, the trust assets remaining after payment of the annuity would be transferred to or for the benefit of your children (or other descendants) without additional gift tax consequences. The IRS assumed interest rate is 2.0% for transfers during November, 2010 to GRATs. This low interest rate increases the likelihood of successful transfers from GRATs to your children or descendants if the trust invests in or holds assets which grow at a rate higher than the IRS assumed interest rate.
Both the U.S. House of Representatives and the Obama Administration have proposed making GRATs less attractive by preventing taxpayers from structuring GRATs in this manner. Several bills passed by the U.S. House this year would have restricted GRATs by requiring (1) a 10-year minimum term and (2) a taxable gift upon creation. While these proposals were not passed by the Senate in 2010, these restrictions on GRATs are likely to be considered in 2011 and could be passed retroactively effective as of January 1, 2011.
2010 Transfer of Closely-Held Business Interests
Due to difficult business and economic conditions, the values of many closely-held businesses have reached all-time lows. Combining GRATs with other planning techniques which benefit from the historically low interest rate environment can transfer a significant percentage of your interests in a closely-held business to family members at the current reduced values. The Obama Administration has proposed legislation which would artificially inflate the value of interests in family-controlled businesses and other entities over their independently appraised fair-market value when transferred to other family members. While it is unclear whether such legislation will be enacted, we recommend that those who may wish to transfer closely-held businesses and other interests consider doing so as soon as practicable.
When to Act
The U.S. House and Senate will return from recess to a full agenda of tax and non-tax matters after the November elections. With a limited amount of time to address the federal estate, gift and GST tax and other political issues, it is unclear whether Congress will be able or willing to act in 2010. Nevertheless, taxpayers may have limited time before the end of 2010 to take advantage of these planning opportunities.