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Planning After ATRA

Day Pitney LLP - Hartford Office

January 3, 2014

Previously published on December 30, 2013

After years of flux, the federal estate, gift and generation-skipping transfer (GST) tax laws have finally settled into a "permanent" state. With the enactment of the American Taxpayer Relief Act of 2012 (ATRA) as of January 2013, for the first time in over a decade, the federal estate tax statutes do not have built-in expiration dates and the uncertainty that came with the scheduled changes.

Now that the $5,250,000 federal estate, gift and GST tax exemptions are permanent and will continue to increase based on automatic annual inflation adjustments, the decision-making process for making significant gifts has changed for many individuals. The "use it or lose it" atmosphere that influenced planning decisions to capture larger exemptions (and thus accelerated the gifting process for many individuals) is gone.

The stability in the transfer tax laws, however, does not change the opportunities for making gift transfers. For example, maximizing the use of annual exclusion gifts, now permitting gifts of $14,000 per donee, will always be a strategic way to benefit family members. In addition, we continue to be in a period of historically low interest rates, which make transactions permitting the transfer of wealth using little or no gift tax exemption very appealing. A brief summary of some planning techniques that take advantage of the low interest rate environment follows.

  • Grantor Retained Annuity Trusts (GRATs). GRATs are designed to transfer future appreciation without any gift or estate tax charged on that growth. The trustee of the GRAT annually pays to the person setting up the trust (the grantor) a designated percentage of the initial fair market value of the trust for the term of the trust, say two years. That percentage is based on the prevailing federal interest rate for the month that the GRAT is funded. The assets originally transferred to the trust, plus interest, are thus returned to the grantor. Any growth in excess of the applicable annual interest rate is accumulated in the trust and, so long as the grantor is living at the end of the trust term, passes to children(or other beneficiaries) free of tax. GRATs offer the potential for transfers to the next generation without tax cost because they can be "zeroed out" for gift tax purposes. More important, they offer that potential with no significant tax risk, because they have been specifically approved by the IRS.
  • Sales or Loans to Grantor Trusts. Similar to a GRAT, a sale or loan to a grantor trust (a trust, the grantor of which is treated as the owner for tax purposes, i.e., all items of trust income and deduction will be reported on the grantor's personal income tax returns) allows the future appreciation of an asset to escape estate tax. The transaction is not subject to gift tax, because the trust is paying fair market value for the asset or repaying a loan from the grantor. In addition, because the trust is a grantor trust for income tax purposes, any income tax payments the grantor makes on behalf of the trust are essentially tax-free gifts that serve to reduce the grantor's estate. In the sale scenario, the grantor sells an asset to a trust for a specified price in a commercially reasonable way, generally taking back an installment note. The trust repays the grantor in whole or in part out of the earnings of the purchased asset. If the asset sold to the trust appreciates in value at a rate in excess of the combined interest rate and purchase price, the appreciation is removed from the grantor's estate. Similarly, cash can be the subject of an installment sale in the form of a loan. If the borrower-trust invests the cash in an asset that produces income in excess of the interest charged on the loan, the income and appreciation accrue in the trust tax-free and not in the seller's estate.
  • Intrafamily Loans. An intrafamily loan can provide a significant benefit to a junior generation family member with relatively modest tax implications to the senior generation family member. These intrafamily loans may be made without gift tax implications as long as the lender charges interest at a rate no less than the "applicable federal rate." The applicable federal rates are determined and published by the IRS on a monthly basis and are based on the average market yield on outstanding marketable U.S. government obligations of varying lengths. The applicable federal rates for December 2013 are 0.25% for a loan term less than three years, 1.65% for a loan term between three and nine years, and 3.32% for a loan term longer than nine years. In addition, the payment terms can be designed to fit the specific needs and resources of the borrower. Balloon notes that require only the payment of interest at the outset provide an attractive way to provide liquidity for a child or grandchild without the immediate burden of substantial loan payments.


The views expressed in this document are solely the views of the author and not Martindale-Hubbell. This document is intended for informational purposes only and is not legal advice or a substitute for consultation with a licensed legal professional in a particular case or circumstance.

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