Recent events have led to weighty economic issues in the United States and around the world. While this will continue to cause anxiety and present serious challenges, the current situation has also created a significant opportunity to maximize wealth transfers and avoid transfer taxes. Two factors have converged to make this opportunity. First, asset valuations are significantly lower than three months ago. Second, in an effort to stimulate the economy, benchmark federal interest rates were lowered in mid-March to the lowest rate ever. Working together, these two factors combine to create a unique window for people seeking to transfer assets and avoid substantial transfer taxes.
The economy shrunk in the first quarter of 2020, with many companies projecting lower annual revenue. This impacts how investment assets are valued, whether the asset is a publicly traded mutual fund or an interest in a privately held company. Equity markets, such as the S&P 500, are trading significantly less today than in January. In this uncertain economy, individual businesses may be eligible for substantial discounts in market valuation for transfer tax purposes.
The Federal Reserve Bank, responding to the unsettled market, aggressively cut interest rates by half of a percent on March 15th. This lowered interest rates on home mortgages to below 3.5%, a full percent lower than March 2019. More importantly for estate planners, these benchmark rates are used by the IRS to set rates used in a variety of personal and estate planning tools such as family loans, charitable trusts and grantor retained annuity trusts (GRATs).
These factors, and the current economic environment, affect family business clients differently and, not surprisingly, there is not one solution for every client. Our estate planning team has identified the following four planning areas that should be reviewed as soon as possible:
1. Stress Test your Business Succession Plan. If you have a business succession plan, now is a great time to review this plan and “stress test” it to determine if your plan still meets your goals. For example, you can critically evaluate if the payout formula is equitable or if the plan is well-funded.
Additionally, if you are looking to pass equity in your company to the next generation, now can be ideal time to accomplish this in a tax-efficient manner.
2. Intrafamily Loans. It is not uncommon for one generation to help finance succeeding generations, usually through a combination of gifts and loans. If you are in a position financially to support your descendants, now is a great time to make this happen.
Also, if you have an existing loan, it has likely occurred to you that you can refinance this loan. While this can be done, you should be cautious before making any adjustments. There are simple precautions you should take before changing loan terms that avoid an IRS challenge.
3. Review Your existing GRAT or Create a New GRAT to Transfer Wealth. A GRAT is a trust intended to transfer appreciating assets to your beneficiaries tax-free. A person contributes assets to the trust, agreeing to receive a series of annuity payment. These payments are a return of principal plus a rate of return based on current interest rates. After annuity payments are made, remaining trust assets are passed to your beneficiaries.
A low interest rate plus appreciating assets increase the likelihood of significant wealth transfer. If the assets owned by the trust do not appreciate, nothing is transferred and the GRAT fails. If you have a GRAT, you should review this now to determine if it is likely to fail. Instead of waiting for the GRAT to fail, you can unwind the existing GRAT and create a new GRAT to hold the devalued assets. A proactive review can greatly increase the likelihood of success in passing wealth to your beneficiaries tax-free.
4. Packing Assets Into Existing Irrevocable and GST Trusts. If you are the grantor or beneficiary of an irrevocable trust or if you desire to maximize assets that you leave to your family exempt from generation skipping transfer (GST) tax, there are strategies to leverage these trusts and maximize trust assets. An irrevocable trust that is properly set up and funded can be a great vehicle for protecting assets from creditors and future estate tax.
While we have chosen to highlight these specific scenarios, there are many other reasons the current economic situation may impact your business or personal planning. Our corporate and estate planning attorneys can review your situation and find the right solution that best accomplishes your objectives in a tax-efficient manner. For more information, please contact Andy Holstine or Andrew Bell, or call (312) 648-2300.