Market uncertainty caused by the coronavirus pandemic has created an opportunity for the very rich to pass more wealth to their children free, or virtually free, of tax.
Many people are in financial distress because the pandemic has forced businesses to temporarily shutter their operations, leading to furloughs and layoffs across the country. But those with enough wealth to shield themselves from any real hardship may find that it is an ideal time to deploy new tax-planning strategies.
Depressed asset values, combined with historically low interest rates, unprecedented estate and gift tax exemptions, and a favorable political climate, are making some tools more attractive than ever—especially those that allow parents to shift appreciable assets that have temporarily lost value to their children in a way that minimizes future estate and gift tax, according to estate tax attorneys.
“It creates, in many ways, a perfect storm for a transfer plan,” said Brett Berly, a shareholder in the trusts and estates section at Chamberlain, Hrdlicka, White, Williams & Aughtry.
The stock market took a big hit at the onset of the coronavirus pandemic. The S&P 500 Index, hit a three-year low on March 23. The index has rebounded some since, but closed Friday down about 11% from the beginning of the year.
Transferring depressed stocks, business interests, and real estate holdings to family members now could help individuals avoid estate and gift tax liabilities down the road, said Michael Rudegeair, tax director at Anchin, Block & Anchin LLP and incoming chair of an American Institute of Certified Public Accountants estate planning panel.
Tools to Consider
There are a variety of tools wealthy individuals can consider, planners said. One that may be especially attractive given the current mix of factors is the grantor retained annuity trust, or GRAT.
Under this type of plan an individual, typically a parent, transfers assets to a trust for a specified number of years. In a “zeroed-out” GRAT, the parent retains the right to get 100% of the initial value of the assets back over the trust’s life in annual fixed payments, plus a rate of return based on an IRS-prescribed interest rate. The rate, called the Section 7520 rate, is 1.2% for April and 0.80% for May.
Anything remaining in the trust at the end of its term—meaning any appreciation above the interest rate for the month when the initial transfer occurred—goes to the beneficiaries, typically the grantor’s children, free of additional gift tax.
“It’s hard to imagine that you couldn’t beat that in the next few years,” Rudegeair said of the current rate.
Meanwhile, the parent has managed to shield any of the assets’ future appreciation from his or her estate tax bill.
Sales to intentionally defective grantor trusts are attractive right now for similar reasons, several estate planners said. Intentionally defective grantor trusts contain a purposeful flaw that allows a person to transfer assets into the trust and continue to pay income taxes on the trust’s earnings, but locks in the assets’ initial value for estate tax purposes so any gain escapes the 40% tax at death.
Wealthy individuals may also want to think about intra-family loans because of the low interest rates. Gifting outright—without the extra hassle of a vehicle like a GRAT—is another appealing option because lower asset values mean parents have to use less of their gift and estate tax exemption.
Clock Is Ticking
The 2017 tax overhaul doubled the estate tax exemption until the end of 2025. Wealthy individuals, starting in 2020, can transfer up to $11.58 million to beneficiaries over their lifetime without paying estate tax at death, and a married couple can transfer twice that.
Samantha Weyrauch Davis, a shareholder and director at Hall Estill, said estate planners have been discussing potential opportunities with clients since Congress raised the exemption levels but that Covid-19 is a “motivating factor” for people to consider new estate plans or update existing ones.
The window for taking advantage of these strategies may be relatively small, especially if former Democratic Vice President Joe Biden wins the presidential race and decides to raise estate taxes.
“There’s uncertainty in our political environment as to whether these exemption amounts are going to stay around depending on what happens in the elections in November and after that,” Berly said.
The large sums of money the government is hurling at the economy through stimulus packages likely comes with strings, said Steve Parrish, co-director of the New York Life Center for Retirement Income.
“When you have trillions of dollars, you’re going to have to pay the bill,” Parrish said, predicting that taxes likely won’t go down after the government’s spending blitz.
Tough to Stomach
Still, estate planners said while many of their wealthy clients are considering these opportunities, very few have actually pulled the trigger yet.
That’s because their own health and the well-being of any businesses they own supersede tax-planning considerations, Berly said. It is something they might look at more seriously once those concerns are allayed, he said.
Rudegeair said there’s an “ick factor” to overcome in calling clients’ attention to ways they could use the distressed economy to lower their tax bills.
“Getting someone to stomach these opportunities right now” has been challenging, he said.