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Low Interest Rates Offer Incredible Estate Planning Opportunities


June 15, 2012
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The world news is dominated by the Greek elections, the bailout of Spain, and the potential demise of the European Union.  In the U.S., the presidential election, the fiscal cliff, and taxmageddon are the major stories.  Hidden in plain sight is a fantastic estate planning opportunity to transfer assets to future generations at minimal cost relative to paying death taxes. The Internal Revenue Code requires related parties to charge a minimum rate of interest on inter-family transactions.  The rate of interest that is required to be charged on an inter-family loan depends upon the term of the note.  Alliance Bernstein projects July interest rates to be: (i) 0.24% for the short term rate (not over 3 years); (ii) 0.93% for the mid-term rate (over 3 years but not over 9 years); (iii)  2.30% for the long-term rate (over 9 years).  Imagine purchasing a successful family business or an income producing property while paying interest at a 2.30% rate for ten or twenty years.   The asset’s cash flow should be sufficient to pay interest and principal on the note. The appreciation in value of the asset after the sale will not be included in the estate of the seller.   The substitution of a note, with little appreciation potential, for an asset with substantial appreciation potential, in effect, caps the value of the seller’s estate. Those readers of this blog may recall the analysis of Grantor Retained Annuity Trusts (“GRAT”) by Facebook insiders.  The Applicable Federal Rate (AFR) for use by a GRAT is expected to be 1.2% for July.  This means that an asset, appraised at $100 on the date of gift to a GRAT, is expected to grow in value to $101.20 and to $102.41 at the end of years one and two, respectively. Thus, any appreciation in value in excess of $102.41 escapes transfer tax.    Consider that 1.2% is less than the expected return on blue chip stocks, investment grade bonds and municipal securities. What is surprising to me and my tax colleagues is how little attention transfer planning is actually receiving.  Clients should analyze their assets for appreciation potential and then calculate the expected tax savings that would result.  Clients should also analyze their own need for income (cash) so as to select the appropriate monthly payment of interest and principal. The federal estate tax exemption falls from $5,120,000 in 2012 to $1,000,000 in 2013.  Transfers should be made this year because the larger exemption offers more protection against audit adjustments.  The larger exemption also affords the transferor opportunity to use the technique of part-gift part-sale. This technique is especially useful where the asset being transferred is only beginning to generate cash flow or where the transferor has no need for large repayments on the note.