The full impact of COVID-19 is unknown. While we wait for questions to be answered many are asking what can we do right now? What’s next for our families? What’s next for family businesses and the people who work for them? Planning for our future generations is the greatest gift we can give, particularly during times of uncertainty.

Background
Many closely-held businesses have been impacted by the COVID-19 pandemic, leading to depressed company valuations. The current federal estate, gift, and generation-skipping transfer (GST) tax exemption is $11.58 million per person. That, coupled with the low AFR and Section 7520 rates, provides an opportune time to transfer wealth out of estates without using up exemptions.

Opportunity
There are estate tax planning techniques that can be implemented which transfer the greatest amount of value from an estate while using the least amount of exemption. Transferring assets while they have a low value is a technique that is used to lock-in or freeze those low values in anticipation the asset will one day significantly increase in value. This transfers the appreciation in excess of the frozen value out of the estate with the added benefit of preserving the exemption for additional transfers.

Estate Planning Strategies

GRATS
A grantor retained annuity trust (GRAT) is a powerful technique that allows a transfer of assets to a trust, in exchange for an annuity over a fixed term of years. After the annuity is paid off the assets transferred are owned by the trust for the benefit of the trust beneficiaries, normally the children.

A transaction can be structured to create a “zeroed-out” GRAT, where the annuity is structured in a manner so that the transaction does not produce a taxable gift. The calculation of the GRAT annuity payment is based on the Section 7520 rate in effect at the time of the transfer (for June 2020, the Section 7520 rate is 0.6%), thereby allowing more value to be transferred to the trust without using the exemption.

When transferring assets to the next generation, families are concerned about transferring too much to the younger generation, creating cashflow constraints and transfers that do not use their exemption in an effective manner. The zeroed-out GRAT can achieve financial stability, optimal estate tax results and flexible estate planning options. This simple, effective and time-tested strategy can achieve:

1. Financial stability. The GRAT can be structured to provide an annuity which suits the cashflow needs of the grantor.
2. Optimal Estate Tax Results. Provided the grantor survives the trust term, assets inside the trust, and all future appreciation, are not subject to estate taxes in perpetuity.
3. Flexible Estate Planning Options. If the assets transferred to the GRAT do not provide sufficient cashflows to cover the annuity, they are transferred back to the grantor. This reverse transfer back is tax-free and does not impact the grantor’s exemption or trigger additional income taxes. The only cost incurred is administrative fees.

IDGT
An intentionally defective grantor trust (IDGT) is an effective and efficient technique to transfer assets to a trust for future generations. Once the assets are gifted to the trust, they are considered taxable gifts and property of the trust. Those assets can remain in trust for multiple generations, allowing the gift to benefit both children and grandchildren, if desired.

The transaction can be structured as a sale of assets to an IDGT in exchange for a promissory note. This structure is typically an alternative to the aforementioned GRAT. However, this sale is not considered a taxable gift and does not create any gain for income tax purposes. The IDGT promissory note payment is based off the AFR in effect at the time of the transfer (for June 2020, the long-term AFR is 1.01% for promissory note terms longer than nine years), allowing more value to be transferred without using your exemption.

A sale to an IDGT is typically more successful than funding a GRAT as the AFR rate used as the interest rate in the promissory note is generally lower that the Section 7520 rate used to value GRATs. The promissory note can also be structured as an interest-only note with a balloon payment upon maturity, whereas a GRAT must be structured as an annual annuity. Moreover, sales to an IDGT allow for the immediate allocation of GST exemption. With a GRAT, the grantor cannot allocate GST exemption until the end of the GRAT term.

The sale to an IDGT can achieve financial stability, optimal estate tax results, and multigenerational estate planning options. This efficient, effective and time-tested strategy can achieve:

1. Financial stability. The IDGT can be structured to provide a promissory note that suits the cashflow needs of the grantor.
2. Optimal Estate Tax Results. Assets inside the trust, and all future appreciation, are not subject to estate taxes…ever.
3. Flexible Estate Planning Options. A sale to an IDGT can effectively transfer assets to the next generation, while minimizing transfer taxes.

GIFTS
Giving money to a family member in excess of the annual exclusion ($15,000 in 2020) will be a taxable gift. A simple way to provide cash to a family member is to make a loan to them. Historically, if the loan has an interest rate of at least the AFR, the IRS will respect the loan and not claim the transaction to be a gift. With the historically low AFR, cash can be loaned to a family member without creating a burden from charging the family member a high interest rate. June 2020 AFR rates are at historic lows (June 2020 short-term AFR is .18% which applies for terms less than three years, mid-term AFR is 0.43% for terms three years through nine years, and long-term AFR is 1.01% for terms longer than nine years).

The intra-family loan achieves financial stability, optimal estate tax results, and cashflow. This simple, effective and time-tested strategy can achieve:

1. Financial stability. The intra-family loan can be structured to provide a promissory note which suits the cashflow needs of the family member.
2. Optimal Estate Tax Results. Current intra-family loans can be refinanced to take advantage of the current AFR.
3. Cashflow. The loan proceeds can be invested in securities that produce a higher rate of return than the current AFR, allowing the family member continuous cashflow.

Planning for the future is not a task to be taken lightly, even in the best of times. During times of uncertainty it becomes even more important. The three estate planning strategies summarized above provide options.

Conclusion: The zeroed-out GRAT is an effective strategy to take advantage of the increased exemption, low Section 7520 rate, and current economic environment. These three factors significantly increase the amount of wealth a family can transfer to the next generation while using a minimal amount of their exemption. Alternatively, a sale to an IDGT can be an effective strategy to transfer wealth to multi-generations and take advantage of the extremely low AFR. Finally, low interest intra-family loans allow families to provide liquidity to various family members without overburdening the family with onerous interest payments.

Tax reform included major changes to gift and estate taxes. The new laws significantly reduces the number of taxpayers who will be subject to gift and estate taxes, at least for the next several years, but factoring taxes into your estate planning is still important if you live in a state with an estate tax.

Exemption increases

The Tax Cuts and Jobs Act (TCJA) more than doubles the combined gift and estate tax exemption and the generation-skipping transfer (GST) tax exemption, from $5.49 million for 2017 to $11.18 million for 2018.

This amount will continue to be annually adjusted for inflation through 2025. Absent further congressional action, however, the exemptions will revert to their 2017 levels (adjusted for inflation) for 2026 and beyond.

The rate for all three taxes remains at 40% — only three percentage points higher than the top income tax rate.

The impact

Even before the TCJA, the majority of taxpayers did not have to worry about federal gift and estate taxes. While the TCJA protects even more taxpayers from these taxes, those with estates in the roughly $6 million to $11 million range (twice that for married couples) still need to keep potential post-2025 estate tax liability in mind in their estate planning. Although their estates would escape estate taxes if they were to die while the doubled exemption is in effect, they could face such taxes if they live beyond 2025.

Taxpayers who could be subject to gift and estate taxes after 2025 may want to consider making gifts now to take advantage of the higher exemptions while they’re available.

Income tax planning, which became more important than estate planning back when exemptions rose to $5 million more than 8 years ago, is now an even more important part of estate planning.

For example, holding assets until death may be advantageous if estate taxes are not a concern. When you give away an appreciated asset, the recipient takes over your tax basis in the asset, triggering capital gains tax should he or she turn around and sell it. When an appreciated asset is inherited, on the other hand, the recipient’s basis is “stepped up” to the asset’s fair market value on the date of death, erasing the built-in capital gain. In this scenario, retaining appreciating assets until death can save significant income tax.

Be aware that many states impose estate tax at a lower threshold than the federal government does.

Whether you need to be concerned about federal gift and estate taxes, having an estate plan in place and reviewing it regularly is important.

The idiom “one person’s trash is another person’s treasure,” rings true when dealing with collectibles – those seemingly innocuous objects for which people will pay good money. Interestingly, the value of these collections comes with tax consequences when you transfer them to the next generation, donate them or sell them at a profit. It is beneficial to explore the tax implications for these three ways of distributing collectibles.

Estate planning

Transfers of collectibles to family members or other loved ones, whether during life (gifts) or at death (bequests), may be subject to gift or estate tax if your estate is large enough. And you may be required to substantiate the value of the collectible.

For estate tax purposes, if an item, or a collection of similar items, is worth more than $3,000, a written appraisal by a qualified appraiser must accompany the estate tax return. Gifts or bequests of art valued at $50,000 or more will, upon audit, be referred to the IRS Art Advisory Panel.

Even if your estate is not large enough for gift and estate taxes to be a concern (or the federal gift and estate taxes are repealed, as has been proposed), it’s important to include all of your collectibles in your estate plan. Even an item with little monetary value may have strong sentimental value. Failing to provide for the disposition of collectibles can lead to hurt feelings, arguments among family members or even litigation.

Donations

If you want to donate a collectible, your tax deduction will likely depend both on its value and on the way in which the item will be used by the qualified charitable organization receiving it.

For you to deduct the fair market value of the collectible, the donation must meet what is known as the “related use” test. That is, the charity’s use of the donated item must be related to its mission. This probably would be the case if, for instance, you donated a collection of political memorabilia to a history museum that then puts it on display.

Conversely, if you donated the collection to a hospital, and it sold the collection, the donation likely would not meet the related-use test. Instead, your deduction typically would be limited to your basis.

There are a number of other rules that come into play when making donations of collectibles. For instance, the IRS generally requires a qualified appraisal if a deduction for donated property tops $5,000. In addition, you’ll need to attach Form 8283, “Noncash Charitable Contributions,” to your tax return. With larger deductions, additional documentation often is required.

Sales

The IRS views most collectibles, other than those held for sale by dealers, as capital assets. As a result, any gain on the sale of a collectible that you have held for more than one year generally is treated as a long-term capital gain.

While long-term capital gains on most types of assets are taxed at either 15% or 20%, capital gains on collectibles are taxed at 28% (or your ordinary-income rate, if lower). As with other short-term capital gains, the tax rate when you sell a collectible that you have held for one year or less typically will be your ordinary-income tax rate.

Determining the gain on a sale requires first determining your “basis” — generally, your cost to acquire the collectible. If you purchased it, your basis is the amount you paid for the item, including any brokers’ fees.

If you inherited the collectible, your basis is its fair market value at the time you inherited it. The fair market value can be determined in several ways, such as by an appraisal or through an analysis of the prices obtained in sales of similar items at about the same time.

Proper handling

The tax implications are difficult to sort out. Your tax advisor can help you determine how to properly handle these transactions.

Among the taxes that are being considered for repeal as part of tax reform legislation is the estate tax. This tax applies to transfers of wealth at death, hence why it is commonly referred to as the “death tax.” Its sibling, the gift tax — also being considered for repeal — applies to transfers during life. Yet most taxpayers will not face these taxes even if the taxes remain in place.

Exclusions and exemptions

For 2017, the lifetime gift and estate tax exemption is $5.49 million per taxpayer. (The exemption is annually indexed for inflation.) If your estate does not exceed your available exemption at your death, then no federal estate tax will be due.

Any gift tax exemption you use during life does reduce the amount of estate tax exemption available at your death. But every gift you make will not use up part of your lifetime exemption.

For example:

• Gifts to your U.S. citizen spouse are tax-free under the marital deduction. (So are transfers at death, bequests.)
• Gifts and bequests to qualified charities are not subject to gift and estate taxes.
• Payments of another person’s health care or tuition expenses are not subject to gift tax if paid directly to the provider.
• Each year you can make gifts up to the annual exclusion amount ($14,000 per recipient for 2017) tax-free without using up any of your lifetime exemption.

What is your estate tax exposure?

A simplified way to project your estate tax exposure is to take the value of your estate, net of any debts. Also subtract any assets that will pass to charity on your death.

Then, if you’re married and your spouse is a U.S. citizen, subtract any assets you will pass to him or her. (But keep in mind that there could be estate tax exposure on your surviving spouse’s death, depending on the size of his or her estate.) The net number represents your taxable estate.

You can then apply the exemption amount you expect to have available at death. Remember, any gift tax exemption amount you use during your life must be subtracted. But if your spouse predeceases you, then his or her unused estate tax exemption, if any, may be added to yours (provided the applicable requirements are met).

If your taxable estate is equal to or less than your available estate tax exemption, no federal estate tax will be due at your death. But if your taxable estate exceeds this amount, the excess will be subject to federal estate tax.

Be aware that many states impose estate tax at a lower threshold than the federal government does. So you could have state estate tax exposure even if you do not need to worry about federal estate tax.

If you’re not sure whether you’re at risk for the estate tax or if you’d like to learn about gift and estate planning strategies to reduce your potential liability, please contact your business advisor.

When’s the delivery date?

• Check. The date you mail it. 
• Credit card. The date you make the charge. 
• Pay-by-phone account. The date the financial institution pays the amount.
• Stock certificate. The date you mail the properly endorsed stock certificate to the charity.

Is the organization “qualified”?

Proposed Regulations Just Issued 

What are Discounts Anyway?

What You Should Do

Most of us have more than enough to do. We’re on the go from early in the morning until well into the evening — six or seven days a week. Thus, it’s no surprise that we may let some important things slide. We know we need to get to them, but it seems like they can just as easily wait until tomorrow, the next day, or whenever.

A U.S. Supreme Court decision reminds us that sometimes “whenever” never gets here and the results can be tragic. The case involved a $400,000 employer-sponsored retirement account, owned by William, who had named his wife, Liv, as his beneficiary in 1974 shortly after they married. The couple divorced 20 years later. As part of the divorce decree, Liv waived her rights to benefits under William’s employer-sponsored retirement plans. However, William never got around to changing his beneficiary designation form with his employer.

When William died, Liv was still listed as his beneficiary. So, the plan paid the $400,000 to Liv. William’s estate sued the plan, saying that because of Liv’s waiver in the divorce decree, the funds should have been paid to the estate. The Court disagreed, ruling that the plan documents (which called for the beneficiary to be designated and changed in a specific way) trumped the divorce decree. William’s designation of Liv as his beneficiary was done in the way the plan required; Liv’s waiver was not. Thus, the plan rightfully paid $400,000 to Liv.

The tragic outcome of this case was largely controlled by its unique facts. If the facts had been slightly different (such as the plan allowing a beneficiary to be designated on a document other than the plan’s beneficiary form), the outcome could have been quite different and much less tragic. However, it still would have taken a lot of effort and expense to get there.

This leads us to a couple of important points.

1. If you want to change the beneficiary for a life insurance policy, retirement plan, IRA, or other benefit, use the plan’s official beneficiary form rather than depending on an indirect method, such as a will or divorce decree. 
2. It’s important to keep your beneficiary designations up to date. Whether it is because of divorce or some other life-changing event, beneficiary designations made years ago can easily become outdated.

One final thought regarding beneficiary designations: While you’re verifying that all of your beneficiary designations are current, make sure you’ve also designated secondary beneficiaries where appropriate. This is especially important with assets such as IRAs, where naming both a primary and secondary beneficiary can potentially allow payouts from the account to be stretched out over a longer period and maximize the time available for the tax deferral benefits to accrue.

Adapting to the times – Estate planning focus shifts to income taxes

Until recently, estate planning strategies typically focused on minimizing federal gift and estate taxes, with less regard for income taxes. Today, however, the estate and income tax law landscape is far different. What does this mean for estate planning? For many people — particularly those who expect to have little or no estate tax liability — it means shifting their focus to strategies for reducing income taxes. 

Changing estate tax law

For many years, the combination of relatively low estate tax exemption amounts and high marginal rates could easily devour more than half of an estate’s value. Popular estate planning techniques often had income tax implications, but in general any income tax consequences were eclipsed by the estate tax savings.

Now that has changed. For one thing, since 2001, the federal exemption has grown from $675,000 to $5.45 million. And, unlike before 2013, the exemption isn’t scheduled to drop in the future. In fact, it will continue to gradually increase via annual inflation adjustments. Estate tax rates have also decreased significantly, from 55% to 40%. And the 40% rate has no expiration date.

For many people, this new gift and estate tax law regime means federal gift and estate taxes are no longer an issue.  

Income tax matters

At the same time that potential gift and estate tax liability has disappeared for many, individual income tax rates have increased. In 2001, the top federal income tax rate was 39.1%, substantially lower than the top federal estate tax rate of 55%. Now the top income tax rate has grown to nearly as high as the current top estate tax rate.

Taxpayers with taxable income of more than certain annually adjusted levels (for 2016, $415,050 for single filers, $441,000 for heads of households, and $466,950 for joint filers) are now subject to a 39.6% marginal rate. 

Capital gains rates also have increased. Currently, the top rate is 20% (up from 15%) — 23.8% for taxpayers subject to the Affordable Care Act’s 3.8% net investment income tax (NIIT). It applies to certain net investment income — including dividends, taxable interest and capital gains — earned by taxpayers whose modified adjusted gross income tops $200,000 ($250,000 for joint filers, $125,000 for separate filers). The NIIT thresholds aren’t annually adjusted.

Fortunately, many estate planning strategies are available that can help reduce income taxes. Consider the family limited partnership (FLP). A properly structured and operated FLP allows parents to shift income to children or other family members in lower tax brackets by giving them limited partnership interests. But watch out for the kiddie tax, which can undo the benefits of income shifting if you transfer FLP interests to dependent children under the age of 19 (age 24 for certain full-time students).

Tax basis planning

The heightened importance of income taxes also means that there may be an advantage to holding assets until death rather than giving them away during your life. If you give away an appreciated asset, the recipient takes over your tax basis in the asset, triggering capital gains taxes should he or she turn around and sell it. 

When an appreciated asset is inherited, on the other hand, the recipient’s basis is “stepped up” to the asset’s fair market value on the date of death, erasing the built-in capital gain. So, from an income tax perspective, there’s an advantage to retaining appreciating assets until death rather than giving them away during your lifetime.

For those with large taxable estates, however, this advantage may be outweighed by estate tax concerns. From an estate tax perspective, it’s preferable to remove appreciating assets from your estate — through outright gifts or contributions to irrevocable trusts — as early as possible. That way, all future appreciation in their value will be shielded from estate tax. 
If your net worth is safely within the estate tax exemption, retaining assets until death will minimize the impact of built-in capital gains on your heirs. Alternatively, if you want to share your wealth with your children or other family members, consider using an estate defective trust, which provides current income to your beneficiaries without removing the trust assets from your estate. (See below under “Have your cake and eat it.”)

Charitable planning

Higher income taxes can also have a big effect on charitable giving strategies. If your estate plan includes charitable bequests, for example, it makes sense to fund those bequests with assets that otherwise would generate “income in respect of a decedent” (IRD).

IRD is income that a deceased person earned but never received, such as IRA or qualified retirement plan distributions. Unlike other inherited assets, which are income-tax-free to the recipient, IRD assets can trigger a significant tax bill. But you can avoid these taxes by donating the assets to charity.

If your estate is within the exemption, it’s preferable to make charitable gifts during your lifetime. This is because, if you have no estate tax liability, charitable bequests won’t yield any tax benefits. But lifetime donations can generate valuable income tax deductions.

Do the math

Identifying the right estate planning strategies for you and your family is in part a matter of running the numbers. Projecting your income and estate tax liabilities — including state as well as federal taxes — will help you determine whether it’s better to focus on reducing estate taxes or income taxes.

A trust is a versatile estate planning tool. It’s a vehicle for transferring wealth to the next generation in a tax-efficient manner. It can also provide incentives for your beneficiaries, serve as a financial “safety net” for your family, protect assets from creditors, achieve your philanthropic goals and leave a lasting legacy.

But no matter how well it’s designed and drafted, a trust won’t reach its full potential unless all of the stakeholders — grantor, trustee and beneficiaries — understand the trust’s goals and their roles in achieving them.

Grantor

No one understands the goals of a trust better than you, the grantor. But it’s critical that you communicate your goals to your advisors and understand how the trust will achieve them.

You should also educate yourself about the trustee’s duties and responsibilities to ensure that you select the right person for the job. You want to be sure, for example, that your trustee possesses the requisite financial, business, organizational and interpersonal skills.

It’s also important to consider potential conflicts between the trustee and the beneficiaries, particularly if the trustee is a family member. To avoid conflicts and ensure the trustee is qualified, it may be desirable to engage a professional trustee, such as a bank, trust company, attorney or financial advisor.

Trustee

Once you’ve identified potential trustees, you should educate them about what’s involved so they can make an informed decision about whether to accept the job. Some people, for example, may feel that they’re not qualified to manage investments or that they’re too close to the family to make objective decisions regarding distributions and other matters.

It’s also critical to educate the trustee about what you hope to accomplish with the trust. Although it’s possible to include very specific instructions in the trust document, often trusts are more effective if the trustee has broad discretion in managing and distributing trust assets. Educating the trustee helps ensure that he or she will exercise this discretion with your goals and principles in mind.

Beneficiaries

Don’t underestimate the importance of educating a trust’s beneficiaries. So long as they’re old enough, they shouldn’t be simply passive recipients of your wealth. Make sure they understand your goals and how the trust will provide financial security for them and their dependents down the road.

This is particularly critical if the trust is required to provide beneficiaries with withdrawal rights in order to qualify contributions for the $14,000 annual gift tax exclusion. Although you can’t ask your beneficiaries to agree not to exercise their withdrawal rights, you should educate them about the long-term benefits of keeping assets in the trust.

Providing beneficiaries with financial training and educating them about their rights will enable them to monitor trust performance (particularly after you’re gone) and, if necessary, replace the trustee. It’s also a good idea to set up periodic meetings between the trustee and beneficiaries to keep the lines of communication open.

Read the owner’s manual

A trust is a powerful estate planning tool. But like any other tool, it won’t produce the best results unless all stakeholders learn how to use it properly.  

It’s no secret that the cost of a college education continues to soar. Taxpayers with grandchildren often want to help for the education costs of their grandchildren, but it’s important to structure the payments correctly so that they don’t have negative gift and estate tax consequences. This article contains three strategies to help a grandparent pay for the education of a grandchild. 

1. Make direct tuition payments.

A simple but effective technique is to make tuition payments on behalf of your grandchild. So long as you make the payments directly to the college, they avoid gift and generation-skipping transfer (GST) tax without using up any of your gift or GST tax exclusions or exemptions.

But this technique is available only for tuition, not for other expenses, such as room and board, fees, books and equipment. So it may be desirable to combine it with other techniques.

A disadvantage of direct payments is that, if you wait until the student has tuition bills to pay, there’s a risk that you’ll die before the funds are removed from your estate. Other techniques allow you to set aside funds for future college expenses, shielding those funds from estate taxes.

If your grandchild is planning to apply for financial aid, also be aware that most schools treat direct tuition payments as a “resource” that reduces financial aid awards on a dollar-for-dollar basis.

2. Create grantor and Crummey trusts.

These trusts offer several important benefits. For example, they can be established for one grandchild or for multiple beneficiaries, and assets contributed to the trust, together with future appreciation, are removed from your taxable estate. In addition, the funds can be used for college expenses or for other purposes.

On the downside, for financial aid purposes a trust is considered the child’s asset, potentially reducing or eliminating the amount of aid available to him or her. So keep this in mind if your grandchild is hoping to qualify for financial aid.

Another potential downside is that trust contributions are considered taxable gifts. But you can reduce or eliminate gift taxes by using your annual exclusion ($14,000 per recipient; $28,000 per recipient for gifts by married couples) or your lifetime exemption ($5.43 million in 2015) to fund the trust. To qualify for the annual exclusion, the beneficiary must receive a present interest. Gifts in trust are generally considered future interests, but you can convert these gifts to present interests by structuring the trust as a Crummey trust.

With a Crummey trust, each time you contribute assets, you must give the beneficiaries a brief window (typically 30 to 60 days) during which they may withdraw the contribution. Curiously, the law doesn’t require that you notify beneficiaries of their withdrawal rights. Notification, however, is typically recommended.

If a Crummey trust is established for a single beneficiary, annual exclusion gifts to the trust are also GST-tax-free. 

3. Consider a Section 2503(c) minor’s trust.  

Contributions to a Sec. 2503(c) minor’s trust qualify as annual exclusion gifts, even though they’re gifts of future interests, provided the trust meets these requirements:

• Assets and income may be paid to or on behalf of the minor before age 21,
• Undistributed assets and income will be paid to the minor at age 21, and
• If the minor dies before reaching age 21, the trust assets will be included in his or her estate.

When the beneficiary turns 21, it’s possible to extend the trust by giving the minor the opportunity to withdraw the funds for a limited time (30 days, for example). After that, contributions to the trust no longer qualify for the annual exclusion, unless you’ve designed it to convert to a Crummey trust. Then, so long as you comply with the applicable rules, gifts to the trust will qualify for the annual exclusion.

Conclusion

While this is not an all-inclusive list, these ideas could be beneficial for some taxpayers and their beneficiaries. These ideas offer suggestions for paying the high costs of education while helping to limit a taxpayer’s estate and gift tax exposure.