With the economy still struggling, one bright spot remains for those who are willing to make an investment of time and money in estate planning. The confluence of lowered asset values, reduced interest rates, and the recent estate and gift tax reform presents a unique opportunity to implement estate planning techniques that will yield significant tax savings for you down the road.
In early 2013, Congress enacted an estate tax reform package that included a $5 million estate tax exemption (as adjusted for inflation to $5.43 million for 2015 decedents) and a maximum tax rate of 40%, generally applicable for estates of decedents dying after 2012. Although the increased exemption (combined with spousal portability of the exemption) will protect many middle class families from tax, those families subject to the estate tax will still face an onerous burden. It is also possible that Congress will crack down on a number of planning techniques that have been commonly used to transfer property at a reduced tax, such as family limited partnerships, grantor retained annuity trusts (GRATs), and qualified personal residence trusts (QPRTs). Those families subject to the tax will have fewer options for avoiding it.
Below are brief summaries of some tax planning techniques that are still available to you and that are especially meaningful under current economic conditions.
• Family Limited Partnerships. Those clients who already have family limited partnerships should consider making significant gifts of partnership interests to their children or grandchildren. Legislation has been introduced in Congress from time-to-time to eliminate the discounts available for such gifts and it is important that gifts be made before the effective date of any such change. If you do not already have a family limited partnership, you may wish to consider establishing one.
• GRATs. GRATs are trusts used to make future gifts of appreciating property to children and grandchildren on a virtually tax-free basis. A GRAT “works” only if the property appreciates at a rate faster than the “applicable federal rate” (AFR), which is an interest rate published monthly by the IRS. This is a superb time to establish a GRAT, because the AFRs have been at very low rates. IN fact for July 2015 the AFR was 2.2% slightly up from the June 2015 rate of 2.0%. If you have an asset that you expect to appreciate at a rate that is greater than the AFR, a GRAT may allow you to transfer that excess appreciation to children and grandchildren tax-free.
• Charitable Lead Trusts. If you are charitably inclined, this is the best time in many years for establishing a charitable lead trust (CLT). A CLT pays an annuity to charities that you choose and then, after a period of years, the principal is paid out to your children or grandchildren.
• QPRTs. Low real estate values and interest rates make this an excellent time to consider a QPRT. A QPRT is a trust to which you (and your spouse, if married) transfer your primary residence or vacation home for a set term that is less than your life expectancy. During the term of the trust, you continue to use the residence as your own. When the term ends, the trust continues for the benefit of your children (or grandchildren) and you must pay rent to the trust to continue to reside in the residence. The tax advantage of a QPRT is that there is a gift of only a fraction of the value of the property when you establish the trust. If you outlive the term of the QPRT the value of the residence is no longer included in your estate for estate tax purposes.