taxes

Estate and Tax Planning in These Unexpected Times

The serious health and economic crises families everywhere are facing right now have left them with many questions. Take a look at answers to a couple of questions that could give you ideas about your own plans.

Our law firm has received myriad questions about estate and tax planning from clients due to the current coronavirus health crisis and the resulting stock market and economic fallout. These unusual times have created equally unusual opportunities and challenges for many people.

An Estate Question about an Ailing Elderly Parent

One client reached out to us about an elderly parent with a life-threatening illness. The client asked what the family should be thinking about as far as the parent’s estate plan, considering the historic stock market plunge we’ve seen in the past few weeks. As the gift tax is based on the value of the asset at the time of the transfer, a declining asset value allows a larger portion of the asset to be transferred without gift tax. This applies to securities, real estate and business valuations.

We told the client that certain tax laws can offer significant advantages to protect their assets and save on estate taxes, due to the current, but temporary, decline in asset class valuations. These laws offer particular opportunities for those unfortunate individuals afflicted with an illness for whom a shorter life expectancy has been diagnosed.

As a tax-saving measure, individuals with a shorter life expectancy may transfer their assets to a (grantor) dynasty trust. The assets would be held outside of the senior taxpayer’s taxable estate (meaning they would not be subject to estate taxes) in exchange for a promissory note from the trust’s beneficiaries. This type of note, known as a SCIN (self-canceling installment note) vanishes at the senior taxpayer’s death if not repaid. The borrower wouldn’t have to report forgiveness of indebtedness income.

These notes avoid both gift and estates tax if established when the afflicted individual, or grantor, has a better than 50% chance of living at least 12 months after the sale of their assets. As long as they live for 18 months after the transaction was concluded, the IRS will not challenge the “death bed” transfer of their assets. If the taxpayer doesn’t live the 18 months, the IRS may claim this was a “death bed transfer” and include the value of the assets in the decedent’s estate. Careful planning is required here, but there is no downside to attempting to plan for one’s estate whose life expectancy may be shortened due to illness or accident.

Employing a strategy such as this, or others, can present significant planning savings.

Recovery from a Life-Threatening Illness

If an individual contracts a life-threatening illness, such as COVID-19, but thankfully regains their health, what would happen with the tax-saving legacy plan described above?

Someone who contracts a life-threatening illness can reverse the estate planning moves immediately upon recovery. High-risk surgeries and other medical procedures and potentially temporary medical conditions present unusual legacy planning offerings. Using a dynasty trust with the flexibility to reclaim the gift if they live provides greater flexibility in their planning. Most people who make the gift to the grantor dynasty trust never reclaim it unless they are in need of financial resources or have an issue with their children.

How do the new low interest rates impact our estate planning?

Another client noticed the new very low interest rates announced recently. They wondered how their family might take advantage of the lower rates through tax and estate planning efforts.

We explained that creating a trust within the family, such as the HYCET Trust (which stands for Have Your Cake and Eat It Too), presents tremendous planning opportunities in this very low interest rate environment (1.44% for loans nine years and longer) and depressed asset value temporary period. If you have used up your gift tax exemption and have appreciating assets you wish to remove from your estate, consider selling the assets to the HYCET Trust for a long-term IOU. The trust need only pay interest at the rate of 1.44% per annum for the duration of the note. If the assets are appreciating at a rate higher than 1.44%, the taxpayer is way ahead of the game.

Basically, this is how it works: Very wealthy families may wish to consider this if their estate would be subject to estate tax by using all or part of their current $11.58 million gift and estate tax exemption, as this amount is set to be cut in half on Jan. 1, 2026. There is a video about the HYCET Trust on our website (https://jmvlaw.com/hycet-trust/) that further explains how to utilize this planning opportunity.

Life insurance can be expensive but it doesn’t have to mean a big cash outlay

For some, the past few weeks have highlighted what actual life insurance coverage would deliver. The stock market has been going up for 11 years. Investors got used to an increasing portfolio. But nothing goes up for ever. Owning life insurance that pays a death benefit will ensure the family has the liquid assets to even out the rough patches. Seeing the losses families are going through recently has highlighted the importance of life insurance. With that in mind, several individuals wondered how they could obtain better coverage with the least financial outlay.

It turns out that more than a few individuals are underinsured from a life insurance standpoint, but they need incentives to consider obtaining more coverage. We suggested they consider premium financed life insurance as an option.

Most people don’t mind owning life insurance, they just hate to pay for it. Premium financed life insurance solves this conundrum by allowing the purchaser to finance the premiums by borrowing the funds from the bank, paying the bank interest only (a substantial reduction in outlay to carry the policy) and when the insured dies, the insurance carriers issue two checks from the death benefit: one to repay the lender the amount borrowed to pay the premiums and the other to the beneficiaries of the policy. This video can shed additional light on this topic: https://jmvlaw.com/premium-financed-life-insurance/.

With borrowing rates under 3% and with rates expected to remain low for the foreseeable future, another planning option might include leaving a significant amount of liquidity in a dynasty trust as a legacy for children and grandchildren without impeding your lifestyle. If you want to ensure the family will have liquidity in their dynasty trust for the kids and grandkids to have sustained cash flow, the trust can borrow the premiums from the lender to obtain the life insurance for the parents (insured) and use the assets gifted to the trust to pay the annual interest costs due the lender, creating a second asset class — the life insurance policy. During the insured’s lifetime the cash surrender value may be accessed income tax free through borrowing from the policy. And at death, the loan is repaid and the net proceeds are then available to augment the assets otherwise transferred to the dynasty trust.

Our challenging times

Due to our country’s recent developments, we hope we have shared a bit of clarifying information and provided you with a few significant planning options for those who want to get out ahead of these current events.

About the Author

Jeffrey M. Verdon, Esq.

Managing Partner, Jeffrey M. Verdon Law Group, LLP

Jeffrey M. Verdon, Esq. is the managing partner of the Jeffrey M. Verdon Law Group, LLP, a Trusts & Estates boutique law firm located in Newport Beach, Calif. With more than 30 years of experience in designing and implementing comprehensive estate planning and asset protection structures, the law firm serves affluent families and successful business owners in solving their most complex and vexing estate tax, income tax, and asset protection goals and objectives.

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