COVID-19, social distancing, and sheltering-in-place brought new changes to our perspectives and the need to re-evaluate current estate planning documents (or lack thereof). COVID-19 has created a stew of significant factors creating opportunities to maximize estate tax planning in the near term.
What are some of these Factors?
The gift and generation-skipping tax (“GST”) exemption amounts remain high and currently stand at $11.58 million. These exemptions are temporary and will be cut in half in 2026.
Interest rates were already near historic lows but the Federal Reserve’s response to COVID has led to a reduction in interest rates that will produce perhaps the lowest rates in history for estate planning purposes.
Valuations of securities have been depressed. This has impacted valuation of a wide range of businesses and other properties because of the slowing economy due to mandatory closures and quarantines and other factors. Thus, this is an opportune time to transfer assets out of any wealthy client’s estate.
Taxes will have to go up to get the economy going so the government can spend, spend, spend no matter which political party wins in November. Higher tax rates; lower exemptions; loss of step up in basis; elimination or reduction in discounts; essentially an elimination of GRATs are all possibilities. With this background in mind, here are some options in this new environment.
- Grantor Retained Annuity Trusts (a.k.a. “GRATs”)
A GRAT is an irrevocable trust whose objective is to remove appreciation from the grantor’s estate. A GRAT is created when a grantor contributes assets with appreciation potential to a fixed-term, irrevocable trust. The grantor then retains the right to receive an annuity stream over the trust’s term. At the end of the term, the assets are distributed to noncharitable beneficiaries — typically, the grantor’s children. The amount of the annuity payment required to be paid to the grantor during the GRAT term of the is calculated by using an interest rate the IRS determines monthly called the Section 7520 rate. The section 7520 rate for May 2020 is an astoundingly low 0.8 percent. In other words, the IRS is assuming the assets will grow at just 0.8%. If they grow faster than that, the excess goes to the grantor’s children without using any estate and gift tax exclusion.
For clients that have not yet begun GRATs, now may be an ideal time to do so. With low interest rate and low stock market and other valuations transferring assets into a GRAT may be a valuable estate planning step.
- Intra- Family Loans
With historically low interest rates mentioned above, a very common and simple estate planning technique is for a client to make a low interest loan to a trust, family member, or family business entity, which could then invest to seek a greater return. It also follows that the lower interest rates provide an opportunity to see if notes can be renegotiated with a lower interest rate. This could be useful for cash flow planning and perhaps in certain transactions to reduce the negative income tax impact of interest payments. It’s possible that a mere change in interest rate could be viewed as a gift in a family context, but if the lender receives other benefits it may be feasible to re-negotiate the note without triggering a gift tax issue
- Valuation Considerations – Alternate Valuation Date
When someone passes away, Internal Revenue Code (“IRC”) Section 2031 states that the estate is valued as of the date of death for estate tax purposes. However, IRC Section 2032 permits the use of an alternate valuation date that is six months after the date of death for the estate’s assets where (1) the overall value the estate is less and (2) there’s a reduction in the estate tax. This technique hasn’t received much attention (or use) due to the market growth of the last decade, but it merits review with the recent market pullback from its highs. Depending on the length of the current market pullback and a possible contraction in the real estate market due to COVID’s effect, utilizing an alternate valuation date can provide significant benefits.
- Income Tax Considerations
Roth IRA Conversions. Converting a regular or traditional IRA to a Roth IRA has been a common part of tax planning for some time. The SECURE Act, passed at the end of 2019, has eliminated the stretch IRA by requiring IRAs be liquidated in 10 years for all but a few situations and has brought even greater consideration to Roth conversions. A Roth conversion, or a series of incremental Roth conversions, are a possible means of reducing the negative tax impact of the 10-year rule under the SECURE Act. Put another way, rather than wait until the 10th year end following the plan holder’s passing to distribute and tax all plan assets at perhaps the highest tax bracket, consider converting the IRA in small yearly increments while the account holder is alive to a Roth IRA which may reduce the overall tax cost. With the stock market pullback reducing the IRA values, it’s a good time to consider converting traditional IRAs to Roth IRAs because the lower IRA values will result in lower tax cost, particularly at today’s lower rates.
Loss Harvesting. This is an extremely common tax planning technique. Typically, clients’ investment advisors endeavor to offset capital gains with capital losses to reduce taxable capital gains. With the nearly 10-year bull market this area hasn’t received much attention, so with the recent pullback, it is important to keep an eye out for these opportunities to reduce income tax exposure.
You can see that with the increased need for tax revenues, the halving of the exemption, interest rate environment and market environment, this presents a unique window of time to reduce estate and income tax exposure.
Contact a Morris Hall Estate Planning Attorney
To get started on your estate plan or if you have additional questions about estate planning, contact one of our experienced estate planning attorneys at Morris Hall, PLLC by calling 888-222-1328 to schedule your appointment today. For more information, please join us for an upcoming FREE webinar.