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Largely unnoticed amidst this year’s significant events is the current historically low interest rate environment. These low interest rates present an opportunity for making gifts to family members at a low gift tax cost. This article will discuss three possible transfer strategies that are made more attractive by low interest raes.
Intra-family loans. A loan is not a gift because the lender receives a promise to be repaid. For a loan to be respected by the IRS it needs to be a bona fide debt and contain an interest rate at least equal to the monthly published applicable federal rate (AFR). For loans made in September, the short-term (three years or less) AFR is .14% (that’s .0014!); the mid-term (over three years but less than 10 years) AFR is .35%; and the long-term (over 9 years) AFR is 1%. That means a parent or grandparent could loan money to a family member for almost no interest. If the parent or grandparent later wishes to forgive a portion of the loan, they can do so provided the loan was valid and there was no preconceived plan to forgive the loan.
Grantor Retained Annuity Trusts (GRAT). A GRAT is a trust used for estate planning purposes. The basic concept is that the donor transfers property to the GRAT in return for receiving an annuity payment over a period of years. At the end of the GRAT term, whatever is left in the trust passes to the trust’s beneficiaries. A GRAT is effective at passing assets to family members if the rate of return of the trust’s assets exceeds the interest rate (the so-called §7520 rate) used in calculating the amount of the gift. The §7520 rate for September is .4%. The GRAT is often set up so that the amount of the gift is close to zero (zeroed-out GRAT). For example, if a parent transferred $1,000,000 to a five-year zeroed out GRAT in September and the assets in the GRAT grow at a rate of 5%, there will be approximately $157,900 of assets in the trust at the end of the term. This means that $157,900 of assets are passed to the beneficiaries at no gift tax cost. When the §7520 rate is as low as it currently is, the chances that the growth of the trust’s assets will exceed the §7520 rate (and the GRAT will be successful) are greater.
Charitable Lead Annuity Trust (CLAT). For those who are charitably inclined, a CLAT is another vehicle made more attractive by the lower §7520 rate. A CLAT is a trust providing an annual payment to a charitable beneficiary. At the end of the CLAT term the remaining property passes to a noncharitable beneficiary (usually the donor’s family). Because the extremely low §7520 rate is used to calculate the amount of the future gift to the noncharitable beneficiary, it is possible to structure the CLAT in such a way to maximize the chances there will be assets remaining at the end of the trust term to pass to family members free of gift tax cost.
The above are just three strategies to consider in a low interest rate environment. You should consult your estate planning team to determine whether these strategies are appropriate for your individual circumstances.
Timothy Barry, CPA/PFS, MST, CRPC® is a partner with blumshapiro. To learn more visit www.blumshapiro.com.