It seems increasingly likely that Congress will not allow the estate tax to expire as scheduled in 2010, even for a single year. The same economic conditions that may preserve the estate tax, however, also present immediate transfer tax planning opportunities. Falling asset values and historically low interest rates make several planning techniques particularly attractive.
Intra-Family Loan. Loans to family members must bear interest at the applicable federal rate (AFR) to avoid immediate gift tax consequences. The December AFR is only 1.36 percent for term loans of three years or less, 2.85 percent for loans of three to nine years and 4.45 percent for loans of more than nine years. The borrower can use such a loan to repay other higher-interest debt or to invest for a higher return. Interest generally is deductible by the borrower, and any net after-tax return on investments inures to the borrower’s benefit without gift tax.
Grantor Retained Annuity Trust (GRAT). The creator of a GRAT places assets in an irrevocable trust for a specified term of years. During that term the creator retains the right to receive a specified yearly payment from the trust; and at the end of the term, the entire remaining trust value goes to the creator’s children or other designated beneficiaries. Only the actuarially discounted value of the remainder interest is subject to gift tax. The current low AFRs produce relatively higher values for a GRAT annuity interest and thus attribute less value to the currently taxable remainder interest. If the trust creator lives for the GRAT’s full term and the trust assets appreciate faster than the AFR, the extra amount passing to the remainder beneficiaries will escape gift tax.
Charitable Lead Annuity Trust (CLAT). A CLAT is the charitable equivalent of a GRAT. That is, the creator places property in an irrevocable trust that makes a specified yearly payment to one or more charities for a period of years and then distributes the remaining trust assets to the creator’s children or other designated individuals. A charitable contribution deduction shelters the annual payments from gift tax, so only the actuarial value of the remainder interest is taxable as a gift. As with a GRAT, current low AFRs yield a higher value for the charitable payments and a correspondingly lower value for the taxable remainder. Likewise, any appreciation in excess of the AFR passes to the children or other individual beneficiaries free of gift tax.
Those who believe that interest rates will rise and the stock and real estate markets will recover significantly in the next few years should consider using one or more of these techniques to pass additional value on to children or other beneficiaries at reduced transfer tax cost.