April 09, 2020

4-9-20 Estate Planning During the COVID-19 Crisis - Part 2 of 2


Part 2 of 2

In Part 1, we highlighted the practical considerations in updating your estate plan while introducing the concept of gifting in this financial environment. Part 2 will now delve into specific strategies and considerations for estate and gift tax planning purposes.

Gifting assets during a time when those assets are at a depressed value can be advantageous from an estate tax planning standpoint. That means less estate and gift tax exemption is used on such gifts. However, those benefits must be weighed against the potential pitfalls of carryover basis for income tax purposes. Given that the Federal estate tax rates exceed the capital gains tax rates, that is often a worthwhile trade-off, but every situation must be studied carefully to determine the best approach in a given case.

One common gifting plan involves the establishment of a Grantor Retained Annuity Trust (GRAT). A GRAT is an irrevocable Trust into which you gift assets (usually stock or shares of a business) in exchange for an annuity payment each year over a specified term of years. The goal is to transfer assets out of your taxable estate while using as little of your estate/gift tax exemption as possible. This is best accomplished by transferring the shares out of your estate at a low fair market value, while retaining value/cash flow through the annuity payments. Once the term of the Trust ends, the remaining Trust assets pass to your beneficiaries free of any additional transfer taxes. The benefit of the GRAT is directly related to the potential that the Trust property will appreciate at a rate faster than the "applicable Federal rate" (also known as the IRS 7520 rate).

During times where the 7520 rate is low, the "hurdle" to clear in order to maximize tax savings is also low. The 7520 rate published by the IRS varies monthly. For April 2020 it is 1.2%, a full percentage point lower than it was in February 2020. Even if the appreciation in the GRAT is modest or non-existent, there is no harm as you will receive full value back in the form of the annuity payments. Therefore, GRAT planning represents a low-risk, high-reward strategy during this low interest rate environment.

Charitable planning is also beneficial in times of crisis. First, there is an inherent benefit in supporting causes that improve the community; it boosts morale and provides much needed financial support for organizations that are helping those who are suffering from physical, emotional and financial ailments. COVID-19 hits all of us hard in some way, shape or form. The desire to "give back" during these times presents a great opportunity.

Charitable giving also represents sound tax strategy. One example is a Charitable Lead Trust (CLT) where you gift assets to an Irrevocable Trust in which a charitable beneficiary receives annual payments from the Trust for a period of years. Once the Trust term ends, the remaining assets pass to your individual beneficiaries (non-charities) named in the Trust. The above-referenced 7520 interest rate is relevant here as well; the lower the rate, the better opportunity to outperform the rate and pass tax-free assets to the next generation. A low interest rate also means that you use less of your estate and gift tax exemption on the portion of the assets allocated to the individual beneficiaries at the end of the Trust term.

On a related note, the CARES Act recently "paused" the limits on deducting cash contributions. Previously, you could only deduct cash contributions to charity up to 60% of your adjusted gross income in a given year. Now, you can deduct up to 100% of your adjusted gross income on cash contributions to charity in 2020, under certain circumstances. This also makes charitable giving more appealing during this crisis. These changes do not apply to contributions to donor advised funds and private foundations.

To refer back to Part 1 of this alert click here: Part 1

Please contact your Woods Oviatt Gilman attorney or the attorneys listed below for more information about updating your estate plan.