Now is an exceptionally advantageous time to make gifts to children and grandchildren to reduce estate tax exposure. The current federal exemption from gift and estate tax is $11.58 million per person — twice that amount for a married couple. This exemption level is the highest it has ever been, but it will be cut almost in half, to about $6 million per person, in 2026 under current law. Immense budgetary pressure on the national level could result in new legislation that reduces these amounts much sooner than 2026. The general election in November 2020 could also have an effect. With private and publicly-traded company values relatively low in many cases, and interest rates at record lows, you should strongly consider making gifts to use these higher — but likely temporary — exemptions and take advantage of low interest rates.
Gifts to trusts for children and later descendants
You can transfer assets to trusts for the benefit of children and later descendants ("generation skipping" or "GST” trusts) to use the high exemptions before they are gone. The trusts can be set up to continue for many generations. Holding assets in trust can provide estate tax reductions for children and later descendants as well as reduce exposure to creditors and in divorce settlements.
You can also choose to pay the income taxes on income earned in the trusts, even though you would not receive the income. These income tax payments are not treated as gifts and would not use up any of your gift tax exemption.
Another technique to consider is a “GRAT” — a grantor retained annuity trust. GRATs take advantage of the unprecedented combination of low interest rates and low asset values. You — the grantor — set up the GRAT to last for a specific term, such as two, five, or ten years. A specified payment amount comes back to you each year from the GRAT. You should transfer assets into the GRAT that you anticipate will have a higher rate of return than the Internal Revenue Service (IRS) assumes.
The rate assumed by the IRS is often called the “hurdle rate.” For GRATs set up in July 2020, the IRS is assuming a hurdle rate of only 0.60%, a record low rate. In basic terms, at the end of the GRAT period, the children — or trusts for them — will receive the amount by which the actual rate of return on the GRAT assets exceeds the 0.60% hurdle rate. This amount could be in the thousands, hundreds of thousands, or millions of dollars depending on the size and performance of the GRAT assets. However, the amount of the gift reported to the IRS can be very low, such as a few dollars, due to the IRS’ low interest rate assumption.
The grantor must still be living at the end of the GRAT term for the GRAT technique to work. Otherwise, the GRAT appreciation is not removed from the grantor’s estate — in most cases. Other than administrative time and expense, however, there is no other downside to starting a GRAT.
The grantor — you — would be responsible for income taxes earned in the GRAT during the term. As is the case with gifts in general, any assets that pass to children will have the same basis in the children's hands as they had in the parents’ hands.
Charitable lead trusts
Similar to GRATs, charitable lead trusts can greatly benefit children when interest rates are low. With a charitable lead trust, a charity receives a distribution during the specified period, such as 10 to 15 years. If the assets outperform the hurdle rate, the appreciation passes to children at the end of the term.
Low interest rates can be helpful if you want to assist family members without making gifts. The interest rates for intra-family loans are also at unprecedented lows, with the rate depending on the term of the loan.
Taft’s estate planners can help you think through the approach that best fits your situation. We expect that the remainder of this year will be very active with GRATs and other asset transfers. Contact Taft's estate planners to discuss whether one of these techniques makes sense for you.