Low interest rates and market downturns can create opportunities to transfer wealth to the next generation without paying taxes. This can be done through techniques like giving gifts, making loans within the family, or setting up trusts. The IRS sets minimum interest rates for these transactions, which can affect how much wealth can be transferred tax-free. It’s important to pay attention to the IRS’s monthly interest rate updates to take advantage of the lowest rates available. Intra-family loans allow parents or grandparents to lend money to their children or grandchildren at lower interest rates than commercial lenders. If the interest rate on the loan is very low, the IRS may consider it a gift and the lender will have to pay taxes on the interest. There are two types of family loans, term loans and demand loans. To avoid the IRS considering the loan a gift, the interest rate on the loan must be at least as high as the federal rate. The loans must also have a written repayment schedule and, if applicable, a provision for collateral. If the loan is not structured properly, the IRS may consider it a taxable gift. If the property loaned appreciates at a rate faster than the interest rate, assets can be shifted from one generation to the next tax-free. When structuring a loan between family members, it’s important to consider the impact of income taxes. To reduce the tax impact, the senior family member can create a trust for the junior family member and make a loan to the trust instead. This trust is called a grantor trust, and it has two main benefits. First, the senior family member can pay income tax on the trust’s income without it being considered a gift for gift tax purposes, which can save money on estate taxes. Second, because the trust is a grantor trust, any transaction between the senior family member and the trust is tax-free. An example of this is when the trust takes a loan from the senior family member. Before 2001, people didn’t like making gifts because they didn’t want to pay gift tax. But now, with estate taxes still around, people are into making outright gifts again.
Here’s an example: If someone with a $40 million estate waits until they die, their kids will get $10 million each after estate taxes. But, if they give their kids $10 million each before they die, they will pay gift taxes but their kids will end up with more money after the person dies.
Outright gifts are best when the stock market or real estate market is down. If the gifted money grows, even more money can be transferred from the person’s estate to their kids, free of taxes. When a family member gives a gift, they might have to pay gift taxes. If they die within three years of giving the gift, the taxes are added to the recipient’s inheritance. There are ways to minimize the impact of taxes, like setting up a trust or selling assets to a trust at a lower value. It’s important to consider the impact of income taxes and the loss of a tax benefit when the senior family member passes away. Overall, there are ways to give gifts with less tax burden, but it’s important to consider all the factors involved. The family can set up a Family Limited Partnership (FLP) where the children own a small part and the parents own the rest. The parents can then sell their part of the FLP to a trust for the benefit of the children, in exchange for a special type of loan. This allows the parents to pass on the ownership of the FLP to the children without paying a lot of taxes. When you create an irrevocable trust, you should put some assets into it. This is usually about 10 percent of the value of the promissory note. If there’s already a trust but it’s not perfect, you might be able to move the assets to a new trust under Florida law. If you can’t put enough assets into the trust, the beneficiaries can personally guarantee the promissory note, but this has some risks. The trust can use the assets it holds to make payments on the note, and when the note is due, it can repay the balance to the person who made the trust. A Grantor Retained Annuity Trust (GRAT) is when an older family member transfers assets to a trust and gets paid a set amount of money from the trust each year for a certain number of years. At the end of the annuity period, the remaining money in the trust goes to the family member’s children without any extra taxes. This can be a way to pass on money to family members without owing a lot in taxes. It’s like giving a present to your kids without having to pay extra fees. A GRAT is a way to pass on money or property to family members without having to pay a lot of taxes. If the person setting up the GRAT (the senior family member) lives through the set amount of time, none of the money or property in the GRAT will be taxed when they die. But if the senior family member dies during that time, some of the money or property will be taxed.
The amount of money or property put into the GRAT is based on the current interest rate. When the interest rate is low, it’s a good time to set up a GRAT because less money is needed to be paid out each year, leaving more for the family members later on.
Short-term GRATs are usually used because they have less risk, but when interest rates are low, a longer-term GRAT might be better. It’s important to think about the effects of using different terms for a GRAT in a low-interest environment. A Charitable Lead Annuity Trust (CLAT) is a way for a family member to give money or assets to a trust that pays a fixed amount to a charity for a certain number of years. After that, the remaining money goes to the family members or other beneficiaries. When the family member puts money into the trust, they have to pay taxes on the value of what will go to the noncharitable beneficiaries later. But they can use certain rates to make the taxes lower. If the trust makes more money than expected, the extra money goes to the noncharitable beneficiaries without being taxed. A CLAT is a way to transfer wealth to a charity while also receiving some tax benefits. It works best when interest rates are low and the value of the assets you contribute is expected to increase in the future. However, there are rules and limitations to consider, especially if the CLAT is funded with interests in a closely held entity. These rules can make things more complicated. Overall, it’s a good idea to consider taking advantage of these tax savings techniques during times of low interest and market downturns. David Pratt and Scott L. Goldberger are experts in estate planning. They focus on helping people with their wills and trusts. They work at a law firm in Boca Raton. David leads the Tax Section and is a fellow of the American College of Trust and Estate Counsel and the American College of Tax Counsel. Scott is a lawyer who studied at Georgetown University Law Center and the University of Florida.
Source: https://www.floridabar.org/the-florida-bar-journal/estate-planning-during-turbulent-times/
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