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Get smart with estate planning, make use of low interest rates

Rochester Business Journal
November 16, 2012

As you read this article, the election is over and either President Barack Obama has received a vote of confidence from the American people for four more years or the mantle has been passed to former Gov. Mitt Romney.
Either way, one of the most important agenda items for the lame-duck Congress is the impending "fiscal cliff," a combination of spending cuts and tax increases to help close our ever-increasing deficit.
While much has been written about the pending top individual income tax rate increasing from 35 percent to 39.6 percent, the rate on dividends changing from 15 percent to 39.6 percent and the capital gain rate increasing 5 percent to 20 percent, little has been made of the impending substantial increase in the estate tax.
During the Bush era, the estate tax fell to zero in 2010 (the year George Steinbrenner of Yankee fame died), but President Obama insisted on reinstating it and Republicans compromised on a 35 percent rate and a $5 million exemption for 2011, with the exemption rising to $5.12 million for 2012. On Jan. 1, the rate goes up to 55 percent and the exemption down to $1 million, exactly where they were in 2001.
No one can predict where this will end up. But one thing is certain: For the rest of this year, each individual has a $5.12 million exemption ($10.24 million per couple) that can be transferred out of estates free of estate tax. Therefore, wealth transfer should be considered this year.
One silver lining to our economic malaise has been the Federal Reserve's policy to keep interest rates historically low. The rate used to value transfers, known as the 7520 rate, is linked to U.S. Treasury notes and is calculated monthly. The current rate is 1 percent compared to a high of 12 percent in 1989. This interest rate environment provides substantial wealth transfer opportunities. Let's look at a few techniques.

Grantor retained annuity trust
A grantor retained annuity trust is an irrevocable trust into which the grantor (the creator of the trust) transfers assets while retaining the right to receive payment, at least annually, of a fixed dollar amount (the annuity) for a specified term of years. At the end of the GRAT term, the trust's remaining assets pass tax-free to designated beneficiaries, who generally are family members.
The Internal Revenue Service assumes the assets in a GRAT grow at a rate equal to the 7520 rate at the time the trust is established. The IRS does not look at actual growth, so if the actual growth surpasses the assumed rate (likely, given such low rates) the excess growth can be passed to beneficiaries free of gift and estate tax.

Charitable lead annuity trust
A CLAT is similar to a GRAT, except that the annuity payments are made to a designated charity rather than back to the parent/grantor, with the remainder interest paid to beneficiaries. Typical CLAT candidates are people who are charitably inclined or who are on the verge of a large pledge to a favorite charitable organization. They may appreciate the benefits of a CLAT because it allows them to accomplish the charitable pledge while reserving any appreciation in the assets of the CLAT for their own children.
As is the case with a GRAT, if the assets inside the CLAT appreciate at a rate greater than the 7520, the excess passes to beneficiaries tax-free.

Intentionally defective grantor trust
An IDGT is more complicated than a GRAT or CLAT but provides more powerful results.
Basically, an IDGT is an irrevocable trust, established to buy property under the installment method. The trust gives the grantor a note and pays for the property with interest over time. Since the property sold is generally not marketable and usually is a minority interest, its fair market value is subject to marketability and lack-of-control discounts, which generally range between 35 percent and 50 percent. Thus property worth $5 million may be sold to the trust for between $2.5 million and $3.25 million. To withstand an IRS attack, an independent valuation of the discounted property's value should be obtained.
Since the trust is a grantor trust but defective, it is ignored for income tax purposes-that is, the sale is considered never to have taken place, and the grantor continues to pay tax on the trust's earnings-but it does exist for estate tax purposes and all property "sold" is excluded from the grantor's estate.
Depending on the grantor's objective, the trust can be structured in such a way that the property contained in the trust and any subsequent growth will escape federal estate tax upon the death of the beneficiaries for multiple generations, perhaps in perpetuity. As with a GRAT or CLAT, any growth in the property that exceeds the 7520 rate is outside the grantor's estate.

Qualified personal residence trust
In a qualified personal residence trust, a grantor transfers a residence or vacation home into an irrevocable trust for a term of years and reserves the right to live there during the term. At the end of the term, ownership of the residence passes to the named beneficiaries or to a trust for their benefit.
Significant transfer tax benefits may be realized by moving property into a QPRT. For gift tax purposes, the value of the gift is not the fair market value of the property. The gift can be reduced to reflect the grantor's right to live in the residence during the term of the trust and the grantor's reversionary interest, which is the probability of death during the term, causing the property to revert to the grantor. Additionally, any appreciation in the value of the residence during the term of years escapes gift and estate taxation.
The reversionary interest is more valuable in an environment of low interest rates, and housing values are currently significantly depressed. A reversionary interest with a higher value produces a lower gift. This coupled with a depressed housing value may make a QPRT an attractive planning technique even in a low-interest-rate environment-particularly for older grantors.
The current environment of low interest rates presents unique opportunities for individuals to make transfers to children, grandchildren and charities without paying gift and estate tax. Because of the uncertainty about how long these low interest rates will last and the unknown post-election tax environment, you should consider the tax advantages of entering into one of the transactions described above.
As my mother always said, don't put off until tomorrow what you can do today. Contact your tax adviser now.

Frank A. Insero is the CEO of Insero and Co. CPAs and Insero Wealth Strategies, a registered investment advisory firm. He can be reached at (585) 454-6996 or (c) 2012 Rochester Business Journal. To obtain permission to reprint this article, call 585-546-8303 or email

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