Two factors make this year an opportune time to consider succession and wealth planning. First, the federal estate and gift tax exemption is at a historic high of $11,580,000 in 2020—$23,160,000 for couples if portability is elected on a federal estate tax return. Portability allows a married decedent’s unused estate and gift tax exemption to pass to the surviving spouse. The tax rate is 40%.
This exemption amount expires at the end of 2025, but if the Democrats win big in November, odds are good the exemption will fall sooner, perhaps as early as 2021, because Joe Biden has called for lowering it. He hasn’t given an exact figure, but we think the exemption could revert to pre-2018 levels of about $5 million ($10 million for couples), with inflation adjustments.
All-time low IRS interest rates are another reason for succession planning, according to Pamela Lucina, chief fiduciary officer and head of the trust and advisory practice for Northern Trust Wealth Management. The low rates make intra-family loans and certain estate and gift freeze strategies valuable planning tools. She advises high-wealth individuals to start planning now by reviewing their goals and figuring out how much of their wealth they are ready to part with.
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Estate and wealth advisers suggest several strategies—three of which we discuss here—to take advantage of the currently large estate and gift tax exemption as well as the low interest rates.
Make outright gifts. You can give up to $15,000 to each child, grandchild or any other person in 2020 without having to file a gift tax return, pay gift tax or tap your exemption. The recipient isn’t taxed on the amount received either. For example, if you are married with four children and six grandkids, you and your spouse can each give up to $15,000 in 2020 to each of your 10 relatives without gift tax consequences. That’s $300,000 in tax-free gifts.
Gifts made in 2020 that exceed the $15,000 per person limit will require the donor to file a gift tax return using IRS Form 709, but no gift tax will be due in 2020 unless your total lifetime gifts exceed $11,580,000. If you’ve been thinking of making a large gift to a family member, now may be the time to do it.
Consider a grantor retained annuity trust. A GRAT freezes the value of assets while transferring any appreciation to the next generation at little to no estate or gift tax. An individual transfers investments or other assets into an irrevocable trust for a fixed term, while retaining the right to receive an annual stream of income plus interest based on the IRS’s applicable federal rate, which was 0.4% in September. At the end of the term, the assets are distributed to the trust’s beneficiaries, typically the grantors’ children.
The actuarial value of the leftover assets in the GRAT is a taxable gift upfront, but the low interest rate trims the value of those assets, which tamps down the gift amount. If the assets appreciate at a rate higher than the 0.4% federal rate, your heirs will receive the value of the extra growth tax-free when the trust expires. Lucina advises that individuals who are thinking about a GRAT should begin working with an adviser now to set up the trust but can wait to fund it later.
Intra-family loans are another option. The interest rate on these loans must equal or exceed the IRS’s set interest rate for the month in which the loan is made, which is 1% for long-term loans in September. The IRS pays close attention to loans made between family members and in an audit may seek to recharacterize certain loans as disguised gifts subject to gift tax. Factors that can help prove the money was a loan include a written debt instrument with interest, a fixed repayment schedule and collateral, and a reasonable expectation that the amount will be repaid.
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