January 2011 - Personal Planning: Estate Planning Update

The recent tax law passed by Congress opens up significant estate planning possibilities for the next two years because of the new unified “lifetime” exemption amount of $5 million. Any person can give away up to $5 million while still alive or bequest the same amount at death (less whatever may have already been gifted) and not have it subject to transfer tax. Any previous lifetime gifting covered by the “old” $1 million exemption amount–in place prior to 2011–reduces the total now available to give away; and anything transferred above $5 million is taxable, but at a historically favorable 35% rate. Again, this new estate and gift tax regime is only temporary and could change in the future. Since it is difficult to anticipate what might happen in two years and since bequests cannot be easily timed, it might make sense for some people to utilize additional gifting strategies now during this new window of opportunity. Coincidentally, there might be other benefits to acting right now–including the likelihood of lower asset values than just a few years ago plus the low current applicable IRS 7520 rate (or “hurdle rate”). These additional factors could help to reduce gift values, and thus result in even greater potential transfers of wealth.

QuoteOne such strategy is the Grantor Retained Annuity Trust (GRAT), whereby the donor gives an asset to an irrevocable trust and in return receives an annuity payment for a chosen period of years. Because the donor retains the right to receive a stream of income, the value of the donated asset is reduced for purposes of calculating gift tax. GRAT's work particularly well for income-producing real estate that is expected to appreciate (or recover) in value and the income helps to provide the cash flow to meet the donor's annuity obligations. Common stock that is likely to appreciate significantly over the term of the trust can also be an attractive asset for a GRAT. Any eventual appreciation over the 7520 “hurdle” rate, which is currently at 2.4%, transfers tax-free to the ultimate beneficiaries of the trust (typically the donor's children) and is permanently removed from the donor's estate–as long as the donor survives the designated term. While there are various strategies on how many years to use for the term of such trust, which will affect the net present value, the low current 7520 rate certainly provides attractive gifting opportunities and the new exemption amount increases the ability to shield the upfront gift from transfer tax.

Another specific gifting strategy is the Qualified Personal Residence Trust (QPRT), which enables discounted gifts to occur even though benefits are retained by the giver. These are limited in use to only two personal properties per individual, and one of these must be the primary residence. Once this irrevocable trust is funded, the transferred residence plus all future appreciation on it will be excluded from the grantor's estate. Frequently, QPRT's get utilized only for secondary or vacation homes because people worry about the eventual lack of ownership of (though not necessarily use of) one's primary residence. However, during the term of the trust the grantor retains the continued right to use the property, and even after the trust expires the grantor can continue to occupy the house as long as fair market rent is paid to the new owners–presumably family members. Due to the lack of any annuity or cash flow obligation, though, there is less reduction in the retained interest on a QPRT and thus a higher 7520 rate is actually desirable; and yet, the probability of lower property values in the currently depressed real estate environment might be more than enough to offset the low current rate and thus still make QPRTs attractive opportunities at present–especially in light of the higher, yet only temporary, “lifetime” exemption amount.

Again, like the GRAT, if the person who establishes a QPRT should die during the term of years defined by the trust, then that asset will come back into that person's estate–and there could be opportunity costs associated with this because these same or other assets could have been directly and permanently given away initially and thus any related future appreciation could have been more reliably transferred out of one's estate. And yet, these discounting techniques offer substantially greater wealth transfer potential. Of course, there are many other estate planning methods that might be more suitable or rewarding, and every person's situation is different and requires thorough examination. Whatever the circumstances, the new “lifetime” exemption amount invites cause for some renewed attention to one's estate planning during the next two years.