We hope you are staying well. While our physical offices are currently closed due to Governor Wolf’s order, our Estate Planning attorneys are working remotely to make updates to our clients’ estate plans and are available via phone and email. Pennsylvania law does not require many estate planning documents to be formally executed, so we can certainly make updates to your testamentary documents and give guidance on how they should be executed.
In this historically low interest rate environment, our team has provided guidance on estate planning techniques some clients may now want to consider.
Loans to Family Members
In a low interest rate environment, loans to family members can be a simple but effective estate planning and wealth transfer tool with minimal income tax consequences. A parent can provide a financial benefit to a child at an interest rate that is lower than is available commercially, and the payment terms can be structured to provide maximum flexibility for repayment. With low interest rates (0.99% as of April 2020 for loans between 3 and 9 years), a loan can be made to a child to purchase a residence, pay down higher-interest debt or fund an investment that may outperform the loan rate. A loan must be repaid, and the lender is required to recognize interest on an income tax return, even if interest is not actually paid by the borrower. A loan should be documented in writing with the creation of a promissory note, and payments should be tracked to avoid IRS scrutiny.
The following two estate planning techniques should be considered by wealthier individuals:
Grantor Retained Annuity Trusts (GRATs)
With historically low interest rates, a Grantor Retained Annuity Trust (GRAT) allows individuals to transfer appreciating assets to family members (typically children or trusts for them and their children) with little federal gift/estate tax consequences. Individuals can establish a GRAT to freeze the value of assets placed in the GRAT at the current level and transfer most future appreciation to the beneficiaries, depending on how much the assets increase in value over the life of the GRAT. Significant valuation discounts are also possible for a transfer of a closely held business interest. For a “zeroed out GRAT,” the grantor would contribute assets to the trust and retain a right to receive future annuity payments equal to the contributed assets, with a rate of return set forth by the IRS. For GRATS established in April 2020, as long as the assets contributed to the GRAT grow more than 1.2%, the GRAT will succeed and the additional growth in the assets can be passed to the beneficiaries. The higher the rate of growth of the GRAT assets, the more wealth can be transferred without gift/estate tax consequences. When the GRAT term – which can be as short as 2 years – expires, any remaining assets are distributed to the beneficiaries or trusts for them.
Installment Sales to Intentionally Defective Grantor Trusts (IDGTs)
An installment sale to an Intentionally Defective Grantor Trust (IDGT) is an estate planning tool that involves the sale of appreciating or appreciated assets to a trust so the assets in the trust (including growth) can be excluded from the grantor’s estate. For Federal income tax purposes, the grantor is considered the owner of the trust’s assets, is taxed on the trust’s income, and can pay the trust’s income tax bill without it being considered a gift. Further, the grantor can sell a closely held business or other appreciated assets to the trust in exchange for an installment note without triggering capital gains taxes, because the transaction between the grantor and the trust is disregarded by the IRS. Like the GRAT, as long as the assets grow quicker than the interest rate on the note (0.99% as of April 2020 for notes between 3 and 9 years), the grantor can shift significant assets and growth to beneficiaries with little or no federal gift/estate tax consequences. This is especially true with recent declines in the stock market and possibly significant valuation discounts available for business assets.
We are here to help if you would like to move forward with any of these estate planning strategies. In these uncertain times, implementing one or more of these tools can provide peace of mind and significant benefits to your family, as well as further your long-term estate planning goals.