October 27, 2020 - Gifting strategies can provide for those you care about and organizations close to you. Understanding how to give the greatest possible amount with the smallest tax burden can be challenging – especially when gifting large amounts and valuable business assets. You've got to weigh the benefits of each option with your own financial goals to find the right strategy and structure for your objectives.
There are strengths and drawbacks to every option, and each is dependent on your preferences as well as your financial situation. With interest rates at historic lows and uncertainty about the future of wealth transfer exemptions, now is the time to set up a gifting plan to maximize the wealth you wish to pass to your beneficiaries while minimizing taxes.
The lifetime gift and estate tax exemption is one of many issues to consider as you develop your estate plan. If you’re not familiar with the basics, here’s a quick recap of the current limits:
An urge to promote economic growth during the ongoing coronavirus pandemic has led the federal government to drop the interest rates to some of the lowest in decades, also dropping the discount rate applied to remainder interest and life estates (a.k.a. the Section §7520 rate) to .4% – the lowest on record as of this writing. Gifting strategies locked in today, particularly trusts, will take advantage of today's §7520 rate when the government comes calling at the end of the trust's term.
In some cases, a grantor retained annuity trust allows the grantor (the person creating the trust) to pass an asset's appreciation to a remainder beneficiary with little to no gift. Established for a set number of years (we often recommend two to ten years for our clients), a GRAT pays the grantor an annuity during the GRAT term and the remainder passes to the beneficiary.
Per the IRS, the annuity must be calculated with an interest of at least the §7520 rate (again, currently .4%) – meaning that any appreciation over .4% will pass to the beneficiary without the grantor being considered to have made a gift.
Who it's for: A GRAT is ideal for corporate executives looking to gift assets – they typically have easily-valued stock and assets that appreciate over time. With today’s low rate, any appreciation they have in their stock will pass to the beneficiary at the end of the trust term.
In an IDIT, an owner sells property or company shares to a trust in exchange for a promissory note. The Trust is structured so no income tax is realized on the sale of the asset to the trust. All future appreciation of that asset is now held in the trust outside of the owner’s estate. The promissory note must carry an interest rate at least equal to appropriate applicable federal rate (AFR) to avoid an imputed gift. Current AFR rates will range from .13% to 1.17%, which are extremely attractive. The note can be structured as an interest only note; one that pays principal and interest; or even one that cancels on the death of the owner. The flexibility of the note and the trust create many opportunities to structure the transaction for a client’s specific needs.
The IDIT offers an additional benefit compared to the GRAT: the generation skipping tax exemption can be allocated to the trust at inception, so that the trust is free of estate tax for generations.
Who it's for: Owners of valuable, tangible assets. When properly structured, an IDIT can be the right gifting strategy for owners who expect their already valuable assets to appreciate over time, leaving the recipient to reap the benefits of their increased value (without being saddled with the increased tax liability).
An individual who wants to contribute to charity, receive a large upfront charitable deduction, and make discounted gifts to their heirs should consider a CLAT. The individual would create a trust and fund it with a gift of cash or other property, and the trust would direct annual payments during the term of the trust to be made to the charity of your choice. The individual would receive a large charitable income tax deduction up front.
At the end of the term, the trust could pay out to the donor or to their heirs. If it is paid to their heirs, the amount of the gift would be discounted due to the annuity paid to charity. That discount rate is calculated using the §7520 rate locked in when the trust is created. Due to the low interest rate used for the annuity calculation, the amount of the gift to the family can be enhanced.
Who it's for: This planning strategy is attractive for taxpayers who have a large taxable event during the year. For instance, if a taxpayer gifted $1,000,000 to a 5-year CLAT and the investments earned 10% annually, the taxpayer could receive a $1,000,000 charitable deduction. In five years, the trust remainder of $415,000 could pass to their heirs with no gift tax implications.
With a clear understanding of your personal, business, and financial objectives, your team of advisors should be able to help you structure your gifting strategy in a way that ensures your beneficiaries receive the greatest amount of assets possible.
For more information, or if you have questions about what gifting strategies might work best for you, you can reach out to Jon Fortin, J.D., Tax Director, Estate, Gift & Trust at Redpath and Company at 651-478-1508 or jfortin@redpathcpas.com.