April, 2020 Newsletter
Provided by Leimberg Information Services
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Subject: Michael Geeraerts and Jim Magner - The Coronavirus’s Perfect Estate Planning Storm
“On top of all the health concerns, there is no doubt that the Coronavirus is having a major economic impact, as is evidenced by a declining stock market. Many investors are anxious and worried, not just about the short- term impact on their investments, but also the potential negative long-term impact this may have on investments and retirement savings.
However, for Americans with an eye on their long-term estate tax plans, especially considering the sunsetting after 2025 of the increased estate tax exemption under the TCJA, this may be a perfect time to gift assets out of their estates. Additionally, the low interest rate environment may make certain estate planning techniques very attractive. The Federal Reserve recently dropped the ‘fed funds’ rate, and many expect further rate cuts, and GRATs and note sales to IDGTs may make a lot of sense for wealthy Americans looking to reduce their taxable estates.
Amid the stockpiling of hand sanitizer, toilet paper and bottled water, financial advisors may want to give their clients a call to see if now is an advantageous time to gift assets out of the clients’ estates or to do a Roth IRA conversion.”
Michael Geeraerts and Jim Magner provide LISI members with commentary on the potential impact of the Coronavirus on estate planning strategies. Members who would like to learn more about these planning techniques should consider watching Bob Keeler’s LISI Webinar on Wednesday March 10th @ 1pm ET titled: “Income Tax, Estate Planning and Estate Administration Techniques That Work Well in a Volatile Market & Low Interest Rate Environment.” Click this link to learn more or to register: Bob Keebler
Michael Geeraerts, CPA, JD, CGMA®, CLU® is an advanced planning consultant at The Guardian Life Insurance Company of America. Prior to joining Guardian, Michael was a manager at PricewaterhouseCoopers LLP and a tax consultant at KPMG LLP. Michael’s experiences range from preparing tax returns for middle market companies, auditing mutual funds’ financial statements, to researching unique tax savings strategies for various companies. Michael has written articles for numerous national publications and has delivered continuing education courses to CPAs and attorneys on a variety of estate, business and income tax planning strategies.
Jim Magner is an advanced planning attorney at The Guardian Life Insurance Company of America.i Jim previously worked as an Attorney Advisor in the IRS’s Office of Chief Counsel in Washington, DC where he wrote private and public rulings on estate, gift, GST and charitable remainder trust issues.
Here is Michael and Jim’s commentary:
On top of all the health concerns, there is no doubt that the Coronavirus is having a major short-term economic impact, as is evidenced by a declining stock market. Many investors are anxious and worried, not just about the short-term impact on their investments, but also the potential negative long- term impact this may have on investments and retirement savings. However, for Americans with an eye on their long-term estate tax plans, especially considering the sunsetting after 2025 of the increased estate tax exemption under the TCJA, this may be a perfect time to gift assets out of their estates.
Additionally, the low interest rate environment may make certain estate planning techniques very attractive. The Federal Reserve recently dropped the ‘fed funds’ rate, and many expect further rate cuts, and GRATs and note sales to IDGTs may make a lot of sense for wealthy Americans looking to reduce their taxable estates.
The decline of asset values will likely permeate the entire economy, not just publicly traded stocks, and there are many closely held businesses that will be impacted. Just think of all the hotels, restaurants, and other businesses experiencing a drop in sales, many of which are closely held. White House
Economic Adviser Larry Kudlow has said that “We’re worried about small business. We might be worried about small farms. We might be worried about some sectors of the economy that are really hard hit.” So, this may be a good time to consider transferring a family business into a trust while the value of the business is reduced, especially if this was going to be part of the business and/or estate plan anyway.
Lower Gift Tax Value
With depressed asset values due to the recent stock market decline, the value of assets that are gifted will have a reduced gift tax value. Gifting could be as simple as outright gifts to children or grandchildren using the annual gift tax exclusion ($15,000) or gifts in trust using the annual gift tax exclusion through Crummey powers. For example, the gifting of a stock portfolio that has been knocked down in value due to the recent market decline could be very effective because if and when those stocks pop back up in value all the appreciation will be out of the client’s taxable estate.
Clients who are interested in getting assets that are depressed in value out of their taxable estates in order to take advantage of the recent market decline but who still want access to those assets may consider using Spousal Lifetime Access Trusts (SLATs). With a SLAT, the grantor spouse gifts assets to the trust, but the other spouse is a trust beneficiary so that the couple may still enjoy the assets. Clients who are fearful of divorce may opt for a “floating” spouse provision in the SLAT, meaning that the SLAT may define “spouse” as the person to whom the grantor is married to at the time instead of naming the current spouse so that upon a divorce, the ex- spouse would no longer be a beneficiary and a future spouse would be a beneficiary and able to benefit from the SLAT. Alternatively, giving an independent trust protector the power to add the grantor as a trust beneficiary in the future may be something to consider, so that in the event of a divorce or the spouse’s death, the grantor could be added as a discretionary beneficiary; however, with this structure the trust will need to be sitused in a state that allows self-settled asset protection trusts.
The grantor-spouse can make a gift to the SLAT using some or all of his or her current $11.58 million lifetime gift/estate tax exemption. The SLAT
provides the beneficiary-spouse access to the funds during life (children are often trust beneficiaries as well). If the client wants the beneficiary- spouse to be the trustee, the trustee-spouse’s ability to make distributions to himself or herself must be limited by an ascertainable standard (e.g., health, education, maintenance, and support); otherwise, an independent trustee should be used.
A grantor retained annuity trust (GRAT) may be an effective way for a client to gift a highly appreciating asset out of his or her estate. A GRAT would be created by the client transferring assets that have declined in value but are expected to rebound into the trust and retaining the right to an annuity interest for a fixed term of years. When the term ends, assets in the GRAT go to the remainder trust beneficiary. If income earned on the trust assets is insufficient to cover the annuity, the payments will be made from principal. All income and appreciation in excess of that required to pay the annuity accumulate for the benefit of the remainder beneficiary. Thus, if the assets increase in value, the remainder beneficiary may receive an asset that have a much higher value that when it was transferred to the GRAT.
The gift tax value is determined by subtracting the value of the annuity interest from the fair market value of the assets transferred in trust. The value of the annuity is based on the current 7520 rate. A GRAT transfers asset appreciation above the 7520 rate. The March 2020 7520 rate is 1.80%, which, combined with depressed asset values that will hopefully rebound once the Coronavirus has settled down, may result in a lot of growth being removed from a client’s taxable estate. Some advisors are predicting an even lower 7520 rate in April.
If the grantor dies during the term of the GRAT, there will be an estate inclusion issue, so the client may wish to insure against the risk of premature death with life insurance to cover the estate taxes due if the grantor dies prematurely.
Low interest rates may also spur more financing of life insurance premiums. Clients who are interested in using a GRAT as part of their exit strategy in a premium financing transaction may want to review how this may be particularly effective given the current environment. High net worth clients who are illiquid will often look to finance with a commercial lender the premiums on a life insurance policy to cover estate taxes due at death. As advisors in the premium financing space know, clients need a strategy to repay the loan to the lender (i.e., exit strategy), and wealthy clients will often look to use a GRAT to efficiently transfer assets to an ILIT that owns the premium financed life insurance policy so that the ILIT has funds to repay the premium finance loan when the lender requires repayment, which may be about 10 years.
Clients who have a long-term view of their stock portfolios, closely held businesses, or real estate portfolios, will likely predict that the value of these assets will rebound and continue to grow once the Coronavirus crisis is behind us. Therefore, being able to transfer the asset at a reduced gift tax value now may prove to be very effective once those assets rebound in value.
Note Sale to IDGTs
Intentionally defective grantor trusts (“IDGT”) can accomplish numerous tax goals. With this strategy, the grantor sells property to the IDGT in exchange for a note. The sale is not taxable because the sale of assets from the grantor to his or her grantor trust is not recognized. The interest on the note is also not taxed because of the grantor trust status. If the note equals the fair market value of the asset sold to the IDGT, then there is no gift.ii Additionally, any income that the asset produces in the trust is taxed to the grantor. Upon the grantor’s death, the outstanding balance on the note would be included in his or her estate, thus the note sale to the IDGT freezes the value of the asset so that appreciation after the sale is excluded from the grantor’s taxable.
The interest rate on the note should equal at least the AFR, which for March 2020 is fairly low. The short-term AFR is 1.50%, the mid-term AFR is 1.53%, and the long-term AFR is 1.93%. So, as long as the assets in the IDGT produce more income/growth than the AFR, the strategy will be effective to shift appreciation out of the grantor’s estate.
The assets in the IDGT may be used to pay for life insurance premiums in the trust, potentially further increasing the wealth left to future generations. Additionally, life insurance may be used to cover the estate tax due for the inclusion of the note in the grantor’s estate if the note is still outstanding at the time of the grantor’s death.
Secure Act Planning
For clients who have large IRA balances that have been hit by the recent market decline, Roth IRA conversions may be very advantageous now. Being able to convert assets that have dropped in value but are expected to rebound and further increase in value in the future could add to the benefit of doing a Roth IRA conversion. Many investors expect asset values to go back up when the Coronavirus is under control, so for those who hold this belief, now is the time to do a Roth IRA conversion.
Under the Secure Act, with limited exceptions, inherited IRAs must be liquidated within 10 years of the owner’s death, and a Roth conversion has been top of mind as a planning tool ever since the Secure Act was signed into law, so advisors may want to ask their clients who were considering converting at some point in the future anyway or even clients who weren’t necessarily thinking of converting but who could benefit from a conversion, why not convert while asset values have been dropped due to the Coronavirus?
Will an Alternate Valuation Date Election Help?
With the S&P500 down 8% for the year, advisors need to consider whether the alternate valuation date may be beneficial. Choosing to use a date six months subsequent to the date of death to value an estate may result in less estate tax, but that potential estate tax savings needs to be weighed against the fact that beneficiaries of the estate will have that alternate valuation as the cost basis of assets they receive. Because this could result in higher capital gains exposure when those assets are sold, a cost benefit analysis that looks at the valuation issue from multiple perspectives can help.
A Back to Basics Mentality in Tough Times
“Tomorrow marks the 11-year anniversary of the bull market. If the massive selling we’re seeing in futures market is any indication, we may be days away from the end of the longest stock run in U.S. history.” Akane Otani writer for the Wall Street Journal, on Sunday, March 8, 2020, just before the Dow dropped 2,014 points in Monday’s trading.
A market rout coupled with a worldwide pandemic may cause some clients to think about their mortality, and some want to review their estate planning documents, especially health care proxies. When things become unhinged and it appears that the center cannot hold, life insurance and disability insurance can be reassuring fallbacks. Enough said.
HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE
LISI Estate Planning Newsletter #2781 (March 9, 2020) at http://www.leimbergservices.com, Copyright 2020 Leimberg Information
Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited - Without Express Permission. This newsletter is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that LISI is not engaged in rendering legal, accounting, or other professional advice or services. If such advice is required, the services of a competent professional should be sought. Statements of fact or opinion are the responsibility of the authors and do not represent an opinion on the part of the officers or staff of LISI.
i Guardian, its subsidiaries, agents, and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation. Not practicing for Guardian or any subsidiaries or affiliates thereof. 2020-96447 (Exp. 3/2022).
ii A “seed” gift is often made to the trust so that the trust can put a down payment on the note sale.
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