Planning for the transfer of wealth in the COVID-19 environment

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photo credit: charles taylor

Although the widespread deployment of COVID-19 vaccines allows us to “see the light at the end of the tunnel”, we are still feeling the effects of the pandemic in several ways. Some of these effects have created particularly beneficial opportunities for planning wealth transfer; in particular, the opportunities arising from depreciating asset values ​​and low interest rates, as well as the currently high federal exemptions for the taxation of gifts, estates and transfers of production.

The current federal transfer fee exemptions are $ 11,700,000 each per donor or per deceased person (indexed annually with inflation). These exemptions are exceptionally high by historical standards. Under current law, these exemptions are expected to decrease by about 50% by early 2026. However, President Biden, with support from Congress, may consider enacting legislation to reduce exemptions earlier and to further amounts. lower.

Under current IRS regulations, the applicable exemption amount at the time of a person’s death for federal estate tax is the greater of the exemption amount or the exemption amount used for tax purposes. federal donation tax for lifetime gifts. As such, and assuming these IRS regulations remain unchanged, a substantial donation by those who are wealthy could be considered in order to lock in the current high exemptions.

Married couples who are reluctant to separate completely from gifted assets, but would benefit from a reduction in their taxable estate, might consider using Spousal Life Access Trusts, or SLATs, as they are commonly referred to. For example, a spouse can create and fund a trust for the benefit of the other spouse (and potentially others, such as descendants). During the beneficiary spouse’s lifetime, the beneficiary spouse has access to the funds as the beneficiary of the trust. The donation to the trust is subject to donation tax; however, this would not result in the imposition of a gift tax to the extent of the exemption used. In addition, the trust would be drafted so as not to subject its assets to estate tax on the death of either spouse. This would lock in the benefit of the exemption used by the donation to the trust if it was greater than the exemption applicable at the time of the donor’s death.

In fact, each spouse could create and fund a trust for the benefit of the other spouse and thus double their use of the available exemptions. It is important to note that, if the beneficial rights of spouses in trust agreements are too similar, the IRS and the courts could apply the “reciprocal trust doctrine,” which treats the assets of each trust as eligible for inclusion. in the estate of the beneficiary spouse as if the beneficiary spouse were also the settlor of the trust.

To avoid trusts being viewed as reciprocal, trust agreements should be carefully drafted with significant differences. While there are no absolutely clear guidelines from the IRS or the courts regarding the various provisions that SLATs need to eliminate the risk of the doctrine of reciprocal trust, previous rulings and case law from the IRS can be enlightening.

For example, SLAT One may contain the following provisions:

  1. During the life of the beneficiary spouse, distributions can be sprayed to the spouse and descendants.
  2. The standard for distributions to beneficiaries is limited to health, education, maintenance and support.
  3. The beneficiary spouse is the trustee.
  4. The beneficiary spouse has an annual non-cumulative power to withdraw $ 5,000 or 5% of the value of the trust annually (a 5 and 5 power).
  5. The beneficiary spouse has a non-general life and / or testamentary power of appointment.

Conversely, SLAT Two may contain the following provisions:

  1. The beneficiary spouse is the sole beneficiary during his lifetime.
  2. Distributions may be made to the Beneficiary Spouse for any purpose at the discretion of an Independent Trustee.
  3. The beneficiary spouse is not the trustee.
  4. The beneficiary spouse does not have the authority to name the assets of the trust.

Using the SLAT strategy, spouses can transfer assets from their taxable estate and lock in current exemptions without completely losing access to those assets (provided the recipient spouse is alive and generous to the non-recipient spouse). Donations to trusts can be straightforward and simple, or can use rebates or other methods to leverage the value of the donation.

Another strategy, made particularly attractive by the current low interest rates, concerns intra-family loans. In order for an intra-family cash loans not to be treated as a gift (at least in part), interest must be charged in accordance with Applicable Federal Rates (AFR) announced by the IRS on a monthly basis. AFRs differ depending on the length of the loan. Short-term rates apply to loans that mature in three years or less, medium-term rates apply to loans made for three to nine years, and long-term rates apply to loans made for longer. nine years old. For March 2021, the short-term AFR is 0.11%, the medium-term AFR is 0.62%, and the long-term AFR is 1.62% (for annual payments). By comparison, before the pandemic, for February 2020, these AFRs were 1.59%, 1.75% and 2.15% respectively. For a low-interest loan to effectively transfer wealth, the funds loaned must be invested in a way that earns more than the applicable AFR; a seemingly low bar.

For example, consider a parent who lends a child (or child trust) $ 2,000,000 for nine years at a rate of 1.62%. Under the terms of the note, the child pays interest, compound, as well as the principal in the form of a lump sum payment due when due. The amount then due, including interest, will be $ 2,311,228. If, however, the $ 2,000,000 yields 7% compounded annually, at the end of the loan term, the child will have a fund of $ 3,676,918 from which to repay the principal and interest on the loan. ; leave the child with $ 1,365,690 (before income tax is considered). If there is a family business or rental real estate, perhaps the loan proceeds could be used to purchase an interest in it, the value of which could be temporarily depressed by the current economic downturn caused by the epidemic. of COVID-19; and, if the purchase is for a non-controlling interest (as might be expected), the value could be further reduced by valuation discounts.

If one has already entered into an intra-family loan agreement at a higher interest rate that can be prepaid at the borrower’s discretion, one might consider renegotiating the loan to take advantage of the current lower rates.

A third strategy to consider in today’s low interest rate environment is a private annuity. In a private annuity, one party, the seller / annuitant, transfers the assets to another party, the buyer / assignee, in exchange for the buyer’s promise to make periodic, fixed payments to the seller for the remainder of the term. seller’s life. The buyer can be a seller’s family member or a seller’s family trust. The annuity provides a flow of income to the seller and keeps the transferred assets available to the family. Since the obligation to make annuity payments ends on the seller’s death, the annuity is not an asset included in the seller’s taxable estate. The annuity amount is calculated using IRS tables which take into account the interest rate known as the IRS Section 7520 rate and the life expectancy of the annuitant (note that the seller cannot be in a “terminal state” as defined by the IRS at the time of transfer). The IRS Section 7520 rate is announced by the IRS on a monthly basis; and, for March 2021, the rate is 0.8%, which is close to an all-time low.

For example, a seller / annuitant, aged 65, creates a trust for the benefit of the spouse and children of the seller / annuitant. The seller / annuitant then sells assets worth $ 2,000,000 to the trust in exchange for an annuity. At the IRS Section 7520 rate of March 2021, the annuity generates cash for the seller of $ 123,185 per year for the life of the seller. The seller now has an income stream for the rest of the seller’s life and has transferred $ 2,000,000 to the seller’s family without reducing the seller’s inheritance and gift tax exemptions. As above, the asset sold can be an interest in a family business or rental real estate at depressed and / or discounted values.

If the purchaser / assignee is a trust that is treated as a “transferor trust” for income tax purposes, the sale is unlikely to be a taxable income event for the seller / annuitant. A ceding trust is a trust that has certain provisions that exclude the trust from being considered by its settlor for income tax purposes. If the buyer in the example above is a transferor trust, the sale to the trust should not result in a taxable gain (note that the buyer’s base in the transferred property would then be that of the seller, and there would be no basic adjustment for cost or value on the seller’s death). Like the intra-family loan, the trust must exceed annuity payments for there to be an efficient transfer of wealth.

The above are just three examples of wealth transfer planning that can be used and do not include many of the intricacies needed to properly plan and implement strategies. The examples are not intended to be exhaustive and are provided for illustrative purposes. For example, planning with Grantor Retained Annuity Trusts (FREE) is also enhanced by low interest rates; although the Libres do not tend to effectively provide multigenerational wealth transfer benefits (due to the way the generational transfer tax exemption is calculated for transfers to the remaining FREE recipients); and, as the effectiveness of the GRATs depends on the survival of the grantor during the life of the FREE, there is a risk of premature death compromising planning.

We cannot predict future events and legislation; however, current circumstances make consideration of this type of planning particularly timely.

Judson M. Stein is a partner of Genova Burns in Newark, where he chairs the Trust, Estates and Wealth Management Practice Group. Lauren P. Nakachi, is a collaborator of the firm Practice Group on Trusts, Estates and Wealth Management.

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