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Financial Planning Opportunities For Individuals and Selected Corporate Tax Matters 2010 and 2011 Considerations - Part 3

Table of Contents 

Wealth Transfer Planning Opportunities: Estate and Gift Tax Fundamentals

Polling Question Have you considered any estate planning structures during this low interest rate environment?

  • Yes
  • No

Initial Estate Planning Considerations 

  • The Fundamentals
    • We discussed current law - 2010 estate and gift tax rules
    • Considering our clients’ current and forecasted balance sheet
      • Current estate plan should include will(s) language (who, what, how much, and when)
      • Trust provisions
        • Beneficiaries and fiduciaries/trustees
         
      • Special needs
      • Designating holders of financial power of attorney, health care directives
      • Provisions for 2010
       
    • Vehicles in place that hold assets – During lifetime, establish trusts and/or LLCs
    • Insurance in force and how to title, and how much?
    • Other considerations
     

Intra-family Loan and Grantor Retained Annuity Trusts 

  • Asset Transfer Techniques to Avoid and Reduce Estate and Gift
    • Intra-family Loan
    • Transfers to a Grantor Retained Annuity Trust (GRAT)
    • There are others
    • Objective
      • To transfer assets to younger generations Without incurrence of gift/estate taxes By earning a rate of return that is higher than the IRS assumed earnings (interest) rate
       
     
  • Intra-family Loan Points to Remember: Advantages and Disadvantages
    • Interest payment to parents (lender) is tax-free. Parents pay interest on trust income with no gift tax consequences
    • If the trust’s total earnings rate does not exceed the IRS assumed rate, assets come back to parent and nothing is achieved
    • No income tax basis step-up on death for assets in the trust
    • If parents dies while note is outstanding, the unpaid principal remains in parent’s estate upon trust formation, may be necessary to fund the trust with some equity (10%)
    • Alternatively, assets could be sold tax-free to trust for a note, same terms: securities, LLC interests, other assets
    • Compare to private annuities and self-cancelling notes
     
  • Grantor Retained Annuity Trust (“GRAT”) – Asset Transfer Technique
    • $1,000,000 transferred to a GRAT with a 5-year term
    • Grantor receives $220,853 each year for 5 years
    • Grantor pays income tax on the GRAT’s income
    • At the end of 5 years, the children receive assets with a value of $173,672 – no transfer tax
     
  • Caution: Note the assumptions on which this illustration is based

Grantor Retained Annuity Trust (“GRAT”) 

Assumptions:    Summary:   
Initial Assets: $1,000,000 Amount Transferred to Children: 173,672
Annual Annuity: $220,853 Amount of Taxable Gift: Zero
Percent Return: 8%    
Assumed Tax Rate: 40%    
Number of Years: 5    
IRS Interest Factor: 2.0% (11/10)    

 

Year  Beginning Balance   Annual Earnings   Annuity to Grantor   Ending Balance   Tax Paid by Grantor   Net to Grantor  
1 $1,000,000 80,000 220,853 859,147 32,000 188,853
2 859,147 68,732 220,853 707,026 27,493 193,360
3 707,026 56,562 220,853 542,735 22,625 198,228
4 542,735 43,419 220,853 365,301 17,368 203,485
5 365,301 29,224 220,853 $173,672 11,690 209,163
          Total $993,089

Nine-Year Loan at Applicable Federal Rate to Defective Grantor Trust 

Assumptions:    Summary:   
Initial Assets: $1,000,000 Amount Transferred to Children: $423,000
IRS Interest Rate (AFR): 4.4% Amount of Taxable Gift: Zero
Assumed Percent Return (includes 1% Yield: 8% Trust Transfers: $1,343,500
Assumed Tax Rate: 40%    
Number of Years: 9    
IRS Interest Factor: 2.0% (11/10)    

 

Year  Beginning Balance in Trust  Annual Earnings in Trust   Tax Free Interest Paid to Parent   Trust Income Tax Paid by Parent   Principal Paid to Parent   Ending Balance in Trust  
1 1,000,000 80,000 -44,000 4,000 -25,000 $1,011,000
2 1,011,000 81,000 -43,000 4,000 -25,000 1,024,000
3 1,024,000 82,000 -42,000 4,100 -25,000 1,039,000
4 1,039,000 83,000 -41,000 4,200 -25,000 1,056,000
5 1,056,000 84,500 -40,000 4,200 -25,000 1,075,000
6 1,075,000 86,000 -38,500 4,300 -25,000 1,098,000
7 1,098,000 88,000 -37,000 4,400 -25,000 1,124,000
8 1,124,000 90,000 -35,000 4,500 -25,000 1,153,000
9 1,153,000 92,000 -23,000 4,600 -800,000 $423,000
  Totals 766,500 343,500 38,300 $1,000,000  

 

Grantor Retained Annuity Trust (“GRAT”) 

  • Advantages
    • Tax paid by grantor on GRAT income is not a gift
    • GRAT distributions are not taxable
    • The GRAT can be funded with assets valued at a discount from underlying value (e.g., a limited partnership interest)
    • Ideal for an asset on which rapid appreciation is anticipated
    • If cash flow from the assets is insufficient to pay the annuity, assets can be distributed in-kind (appraisal usually desirable)
     
  • Disadvantages
    • Grantor must survive the term of the GRAT or the assets will be taxed in the grantor’s estate and nothing will have been achieved
    • If the earnings rate does not exceed the IRS assumed rate, assets come back to grantor and nothing is achieved
    • No income tax basis step-up on death for assets transferred via a GRAT
    • Pending federal legislation (H.R. 4849) would require a minimum ten-year term, and not allow tax-free funding (initial gift) to the trust
     

Philanthropic Objectives: Fund With Appreciated Property 

  • Philanthropy and Charitable Gifts
    • Income tax deduction for the full fair value of the assets donated
    • Charitable contribution by estate creates estate tax deduction; greater tax savings while family retains an interest?
    • Avoid paying long term capital gain tax on appreciation (20% in 2011)
    • The charity must actually receive the property
    • With securities, must be held for more than 12 months
    • The fair value of the property must be more than the cost
    • Donations of property other than securities:
      • Property subject to depreciation or income recapture inventory
      • Artwork (28%)
       
     

Next > International Tax Planning Considerations

The material contained in this presentation is for general information and should not be acted upon without prior professional consultation. 

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