Not Another Estate Planning Article on the Pending Reduction of the Lifetime Exemption

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Chambliss, Bahner & Stophel, P.C.

If you aren’t keeping up with the IRS’ release of federal interest rates, they recently announced the applicable federal rates (AFR) for March 2021. March’s AFR for mid-term notes is 0.62%. For reference, just a year ago, as the pandemic was starting, it had gone down to 1.52%, and two years ago, the March 2019 rate was 2.59%. The point is: interest rates are incredibly low!

I know you’re wondering, “Why do I care?” You may also be wondering, “what on earth is an AFR Rate?!” Don’t worry — I’m NOT going to talk about the ins and outs of the revenue rulings that provide the applicable federal rates, though it would be riveting, I’m sure! Basically, it’s important to know that there are several estate planning techniques that look to these rates, and it impacts their ultimate effectiveness.

In times where interest rates are incredibly low, such as now, certain techniques are even more tax efficient than usual.

Three techniques are:

  1. Grantor Retained Annuity Trust  
  2. Charitable Lead Annuity Trust
  3. Intrafamily Loans
Grantor Retained Annuity Trust (GRAT)

When you create a Grantor Retained Annuity Trust (GRAT), the grantor will receive a stream of income, at least annually, for the term of the trust. The payout is based on the present value of assets using the effective AFR Rate. As a result of this payout requirement, there is often little to no estate tax exemption used when you fund a GRAT. 

As interest rates get lower, the required payout also gets lower. When interest rates are low, it is easier for the growth and income generated by assets in the trust to be greater than the required payouts, leaving more assets inside the trust at the end of the day. When the trust terminates, anything left in the trust is transferred to the remainder beneficiary — often children or trusts set up for the benefit of children. 

If you create a GRAT today, as long as the assets inside the trust grow in excess of 0.8%, there will be assets remaining in the trust for the remainder beneficiaries when the trust terminates.

While the concept of a GRAT might sound relatively easy, it takes a skilled practitioner to draft the documents appropriately to ensure it is structured correctly. Also, it will be important to discuss the other details and rules surrounding this technique to make sure this tool fits with both your short-term and long-term goals and plans.

Charitable Lead Annuity Trust (CLAT)

Similar to a GRAT, a Charitable Lead Annuity Trust (CLAT) makes set annual payments out of the trust, but instead of payments to you, they are made to a public charity. This is an added bonus if you are charitable and want to make plans for a set annual amount to go to various charities. 

Like a GRAT, this payout is also based on the present value of assets using the effective AFR Rate, so there could be minimal, if any, estate tax implication, and at the end of the term, any assets remaining in the CLAT will be distributed to the remainder beneficiaries — usually your children or trusts for the benefit of your children. Another distinguishing feature about a CLAT is that you could take a charitable deduction in the year that you fund it. 

Again, you will need someone that is skilled in estate planning to draft these documents and help you decide if this is a good option for you and your ultimate goals.

Intrafamily Loans

The simplest of the options, an intrafamily loan, is a loan that you make to your family members, to trusts, or a variety of other entities. Unlike the previous techniques, you cannot effectively move assets out of your estate without using any estate tax exemption by utilizing intrafamily loans. However, you can freeze the value of the note in your estate. The only growth you will experience over the term of the note is the interest generated by the note. That rate is based on the AFR rate and the length of the note. For a nine-year note created today, the interest rate would need to be 0.62% (for comparison purposes, the same note would have had to use a 2.59% interest rate in March 2019).

For example, if you loan your favorite estate planning attorney $1,000,000 today with a balloon payout at the end of nine years (I’m happy to take cash, check, or money order!), you would charge 0.62% interest. Each year, this person would pay you $6,200 of interest. After nine years, the value of that note would still only be $1,000,000, and hopefully, your favorite estate planner has invested wisely and has more than $1,000,000 left. 

For reference, I did a very thorough and scientific search. After looking for two minutes, Google told me that the best certificate of deposit (CD) on the market is currently paying 1.25% interest. If I borrowed $1,000,000 from you and just invested it in a CD that paid 1.25% interest, in nine years I would have $1,118,292. After paying you $6,200 of interest each year, I would still be left with $62,492 that was transferred to me without any estate tax implications.

Even though this is the easiest option, there are several things to consider before doing this. Chambliss can help you decide the best way to structure an intrafamily loan, what kind of terms to use, whether to make the loan to people, trusts, or partnerships, whether to refinance preexisting notes, and how to administer or service a note during its term. 

Ultimately, our goal is to make sure that you are making decisions that are not only effective in helping you and your family reach your goals, but that are also efficient — from both a cost and time standpoint and an ongoing administrative standpoint — in getting you there.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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