Wealth Transfer Strategies Amid COVID-19 Outbreak

Thoughtware Alert Mar 23, 2020
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In the last week especially, the coronavirus disease 2019 (COVID-19) pandemic has affected nearly every aspect of our lives. While our thoughts and actions focus primarily on protecting our families and communities, many also grapple with the uncertainty of our rapidly changing economy.

While the current situation is troubling, the down economy coupled with historically low interest rates present an opportune time to effectively transfer wealth and work toward financial security for your families and community well into the future. This article discusses basic lifetime gifting considerations in addition to more significant wealth transfer strategies given the current economic environment.

Basic Lifetime Gifting Considerations

Lifetime gifting offers several benefits for those facing an estate tax liability. First, annual gifting allows you to use your annual exclusion amount ($15,000 in 2020) to transfer future appreciation outside of your estate without incurring a transfer tax. In addition, you can transfer an amount up to the lifetime estate, gift and generation-skipping transfer tax exemption prior to paying any transfer tax ($11,580,000 per person for 2020 or $26,130,000 per marital unit). Lastly, taxable transfers made where gift tax is incurred allow you to exclude from the estate any amount paid in gift tax to the extent it was transferred at least three years prior to death.

To illustrate, on a $1 million lifetime gift, you might pay $400,000 in gift tax, assuming your estate and previous gifts are greater than the lifetime exclusion. If, however, you held this total $1.4 million until your death, you would pay $560,000 in estate tax on the total $1.4 million, leaving only $840,000 after the federal estate tax to your beneficiaries.

Wealth Transfer Strategies for Those with Estate Tax Exposure

Grantor Retained Annuity Trusts (GRAT)

A GRAT can be an efficient vehicle for transferring assets expected to appreciate to future generations. With a GRAT, you make a one-time transfer of property to an irrevocable trust. In exchange, you receive the right to a fixed annuity stream for a specified number of years. At the end of the term, the asset remaining in the trust passes to the beneficiaries named in the trust document or can remain in the trust for their benefit.

Here’s how a GRAT works and the tax considerations:

  • You report a taxable gift at the time of contribution in an amount equal to the fair market value of the property transferred less the value of your retained annuity interest.
  • Appreciation and growth beyond the Section 7520 rate (1.19 percent for April 2020) at the end of the trust term pass to your named remainder beneficiaries free of gift and estate tax. If the assets in the GRAT don’t appreciate by at least this rate, it’s returned to you during the trust term.
  • High-basis assets that are expected to increase in value or are high income-producing property are good candidates for this strategy, as property transferred receives a carryover basis.
  • If the GRAT is properly structured, it’s treated as a grantor trust for income tax purposes, meaning the trust assets being transferred are not reduced by income tax payments, which can further enhance the benefit of this strategy.

Charitable Lead Annuity Trusts (CLAT)

If you’re looking to combine your wealth transfer strategies with your philanthropic goals, you could contribute assets expected to appreciate to a CLAT instead of a GRAT. A CLAT is like a GRAT, but the annuity stream is set up to go to a charitable entity instead of the grantor. At the end of the term, the trust assets are transferred to your intended beneficiaries. If you elect to have a grantor CLAT, the value of the annuity stream is treated as an income tax deduction to you in the year of the transfer. Your taxable gift at the time of contribution is an amount equal to the fair market value of the assets, less the value of the annuity stream the charity receives.

Intentionally Defective Grantor Trust (IDGT)

Like the above strategies, a transfer or installment sale to an IDGT aims to freeze the value of certain assets and transfer any future appreciation out of an estate. This strategy uses a trust that is “defective” for income tax purposes but complete for transfer tax purposes. In general, the strategy involves a combination of a gift and a sale of highly appreciated property by you to the IDGT in exchange for an installment note. You must charge the IDGT interest on the note at a rate equal to at least the current applicable federal rate (AFR), which is at historic lows.

To the extent the future growth and appreciation of the assets held by the IDGT are greater than the interest rate on the installment note, the excess is passed on to the trust beneficiaries free of transfer tax. An added wealth transfer benefit of this strategy is that you report all income, gains, loss and deductions on your individual income tax return, allowing you to make additional contributions of the income tax paid and effectively transferring the assets before income tax to the trust.

Other Intra-Family Transfers

If you’ve considered transferring a family business interest to the next generation, now may be an opportune time to outright gift or sell such interest if the value has declined. In addition, the historically low AFR rates offer an additional incentive to make or refinance any personal loans.

Wealth Transfer Strategies for Those Without Estate Tax Exposure

With the decrease in asset values, you may no longer face an estate exposure given the increased lifetime exemption amount. In this situation, traditional estate planning may not be the most tax-efficient approach, and planning for income tax issues such as the “step-up” in basis at death to the fair market value at that time may have a bigger effect. As a result, now may be a good time to evaluate which assets will be included in your estate and to explore the possibility of unwinding or eliminating previously implemented wealth transfer strategies that leverage the lifetime exemption and swapping assets held in IDGTs.

BKD COVID-19 Resource Center

This is an unprecedented time with many challenges and uncertainties. In response, BKD has created a COVID-19 Resource Center to help disseminate important information for our clients and friends as we evaluate ways to mitigate the inevitable financial effects. Through this resource center, we’ll keep you up to date with relevant news, changing guidelines, new regulations and anything else we believe you need to know.

Be sure to reach out to your BKD Trusted Advisor™ or use the Contact Us form below if you have questions or would like to discuss the wealth transfer strategies included in this article.

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