December Interest Rates for GRATs, Sales to Defective Grantor Trusts, Intra-Family Loans and Split Interest Charitable Trusts

The December § 7520 rate for use with estate planning techniques such as CRTs, CLTs, QPRTs and GRATs is 2.6%, up from 2.4% in November. The December applicable federal rate (AFR) for use with a sale to a defective grantor trust, self-canceling installment note (SCIN) or intra-family loan with a note having a duration of 3-9 years (the mid-term rate, compounded semiannually) is 2.10%, up from 1.99% in November.

Jerome Powell, the likely successor to Janet Yellen as head of the Federal Reserve, has expressed public support for the agency's current plan to continue interest rate hikes in the future. In light of the anticipated future increases, GRATs continue to offer valuable potential rewards on the transfer of assets that are expected to appreciate in the near-term.

The AFRs (based on semiannual compounding) used in connection with intra-family loans are 1.51% for loans with a term of 3 years or less, 2.10% for loans with a term between 3 and 9 years, and 2.62% for loans with a term of longer than 9 years.

Thus, for example, if parent makes a 9-year loan to child, and the child invests the borrowed funds and obtains a return in excess of 2.10%, the result is effectively a tax-free gift by the parent to the child in the amount of returns in excess of 2.10%. These same rates are used in connection with sales to defective grantor trusts.

2018 Unified Estate and Gift Tax Exclusion, Generation-Skipping Transfer Tax Exemption and Annual Gift Tax Exclusion Amounts Finalized (Rev. Proc. 2017-58)

The 2018 inflation adjustments were finalized by the IRS in Rev. Proc. 2017-58. As projected in our November newsletter, the following exclusion and exemption amounts will apply as of January 1, 2018 (under current law):

  • Unified Estate and Gift Tax Exclusion Amount: $5,600,000 per person (up from $5,490,000 in 2017)
  • Generation-Skipping Transfer Tax Exemption Amount: $5,600,000 per person (up from $5,490,000 in 2017)
  • Annual Gift Tax Exclusion Amounts
    • $15,000 per year, per U.S.-citizen donee (up from $14,000 in 2017); and
    • $152,000 per year for transfers to a non-U.S.-citizen spouse (up from $149,000 in 2017).

Grantor's Purchase of Remainder Interest of Grantor Retained Annuity Trust ("GRAT") Is Not a 'Bona-Fide' Sale for Adequate and Full Consideration

In Chief Counsel Advice Memorandum 201745012 (November 9, 2017) (the "CCA Memo"), Taxpayer created two GRATs ("GRAT 1" and "GRAT 2"), as well as a trust for his spouse and descendants ("Trust"), which was the remainder beneficiary of each GRAT. On the day before the annuity terms of GRAT 1 and GRAT 2 were to terminate, Taxpayer purchased the remainder interest in each GRAT from the Trustees of Trust in exchange for unsecured promissory notes. Taxpayer died the following day.

Pursuant to Internal Revenue Code (the "Code") Section 2036(a)(1), Taxpayer's executors included the principal of the two GRATs in his taxable estate. Pursuant to Code Section 2053, the executors also deducted the value of the outstanding promissory notes payable to Trust from Taxpayer's taxable estate. The Internal Revenue Service ("IRS") disallowed the deduction.

The IRS did not dispute that Taxpayer's indebtedness under the promissory notes legitimately reduced the value of his taxable estate. It also acknowledged that Trust's remainder interest in the GRATs had substantive economic value in the hands of Trust. However, the CCA Memo concluded that because Taxpayer still held a Code Section 2036 "string" to the GRATs at the time he purchased the remainder interests from Trust, the interests did not constitute adequate and full consideration for the purchase in Taxpayer's hands. Instead, Taxpayer had made a gift to Trust to the extent that the value of the promissory notes exceeded the value of the remainder interests (essentially worthless in Taxpayer's hands).

The author of the CCA Memo was careful to narrow the application of its analysis to the specific facts at hand, i.e. the purchase of a GRAT remainder interest occurring "on the donor's deathbed during the term of the annuity." This result leaves considerable room to reach a different conclusion under different facts. In particular, the door is still open for a non-gift purchase of a GRAT remainder by someone other than the grantor of the GRAT. But the CCA Memo also does not conclusively preclude the possibility of an economically-substantive purchase of a GRAT remainder by the grantor where the circumstances surrounding that purchase indicate a lower likelihood that the grantor will die during the annuity term.

Where Donor of Contribution to Private Foundation is a "Disqualified Person" with respect to Foundation, Return of Contribution Pursuant to Refunding and Indemnity Agreement is Not an Act of "Self-Dealing" or Taxable Expenditure.

Private Letter Ruling 201745001 (November 9, 2017) provides the useful, if unsurprising, conclusion that a "disqualified person" (defined in Code Section 4946(a)) with respect to a private foundation may make a conditional gift to that foundation, and, if the condition is not fulfilled and the contributed property is returned to the disqualified person, the refund will not be treated as (1) an act of self-dealing by the disqualified person, or (2) a taxable expenditure by the foundation (both of which are punishable by fine).

An estate will find this Ruling helpful where the decedent's executors wish to make an advance distribution to a private foundation (with respect to which the decedent is a disqualified person) in satisfaction of a residuary bequest, where the total value of the residue, as finally determined for estate tax purposes, is uncertain at the time of the distribution. If it is later determined that the value of the distribution exceeded the amount that the foundation was entitled to receive (e.g. because of unanticipated taxes, expenses, and debts of the decedent), the executors may seek a refund from the foundation without fear of incurring self-dealing penalties, and the foundation may return the distribution without exposing itself to penalties for taxable expenditures.

However, in states like New York, the reduced administrative burden afforded by this Ruling will not apply because the Attorney General would be a necessary party to any such Refunding agreement.

The PLR may be of greater value in the income tax context, as a reminder that an individual may make a contribution to his or her private foundation, conditioned on the individual's ability to take an income tax charitable contribution deduction in the full amount of the value of the contributed property.

Tax Reform

Both houses of Congress have now passed a version of the "Tax Cuts and Jobs Act." Some key provisions of each version are summarized below; however, it remains unknown which provisions will survive or change during reconciliation:

(1) Income Tax Brackets.

  • House: contains four income tax rates, of 12%, 25%, 35% and 39.6%, at income brackets (for married, joint-filers) of $0, $90,000, $260,000, and $1,000,000, respectively.
  • Senate: contains seven rates, of 10%, 12%, 22%, 24%, 32%, 35%, and 38.5%, at income brackets (for married, joint-filers) of $0, $19,050, $77,400, $140,000, $320,000, $400,000, and $1,000,000, respectively.

(2) Standard Deduction.

  • House: increases the standard deduction from $6,350 to $12,200 for individual filers, and from $12,700 to $24,400 for married individuals filing jointly.\
  • Senate: increases the standard deduction to $12,000 for individual filers, and $24,000 for married, joint-filers.

(3) Itemized Deductions.

  • Both: elimination of most itemized deductions, including the deduction for state and local taxes (with an exception for up to $10,000 in real property taxes paid).
  • Both: the charitable contributions deduction remains, with an increase in the percentage limit on the deduction from 50% to 60% of AGI for contributions of cash to public charities.
  • House: (a) lowers the limitation on qualifying acquisition indebtedness to $500,000 (indebtedness incurred on or before 11/2/2017 is grandfathered in at $1,000,000), and (b) eliminates the deduction for interest on indebtedness incurred to purchase a second home.
  • Both: elimination of the deduction for home equity interest indebtedness.

(4) Alternative Minimum Tax.

  • House: repeals the AMT.
  • Senate: retains the AMT, but increases (a) the exemption amount from (i) $54,300 to $70,300 for single filers, (ii) $84,500 to $109,400 for married individuals filing jointly; and (b) the phase-out thresholds from (i) $120,700 to $156,300 (single filers), (ii) $160,900 to $208,400 (married filing jointly).

(5) Estate, Gift, and Generation-Skipping Transfer Tax.

  • House:
    • doubles the basic exclusion amount for estate and gift tax purposes for decedents dying and gifts made, respectively, after December 31, 2017;
    • repeals the estate and GST tax for decedents dying and transfers made, respectively, after December 31, 2024;
    • reduces the gift tax rate from 40% to 35% after 2024.
    • Senate: doubles the basic exclusion amount for estate and gift tax purposes for decedents dying and gifts made, respectively, after December 31, 2017 and before January 1, 2026.

(6) Corporate Tax Rate.

  • Both: reduction in corporate tax rate to 20%.

(7) Modification of 529 Accounts.

  • House: allows aggregate annual distributions of up to $10,000 from 529 Plans to be applied toward the cost of elementary and secondary school tuition.
  • Senate: allows total aggregate distributions of $10,000 from 529 Plans to pay for elementary and secondary school tuition.