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Estate Planning Opportunities in a Poor Economy

The natural tendency in a bad economy is to “circle the wagons” and wait until the problem goes away. The reality is that times like these provide significant opportunities for those in a position to seize them. When the economy takes a breather or retreats, it allows us, sometimes forces us, to review and re-evaluate and prepare for the next period of growth.  It also allows financially successful individuals a second chance to do things they regret not having done previously with respect to estate and business succession planning.

In most cases the economic recession has returned values of assets and businesses to the levels of several years ago.  While history doesn’t always repeat itself, there is solid reason to believe that when prosperity and economic growth returns, values will not only return to, but will exceed pre-recession levels.

For the wise and well positioned owner of devalued assets or businesses this “second chance” is an opportunity to employ some estate and succession planning techniques that were missed and capture the benefits that appeared to have been lost.

The need to plan with a view to minimize estate tax has not gone away as was once expected.  It appears almost certain that the repeal of the estate tax scheduled to take effect next year will not happen.  Instead the current $3,500,000 per person exemption is likely to be carried into 2010 and beyond, possibly with a schedule of upward adjustments.  

The following is a brief description of planning techniques that can be particularly effective in the current economic climate:

Gifts, Outright or In Trust

A simple way to take advantage of depressed asset and business valuations is to make gifts of those assets (or of divided or undivided portions) to the persons identified to receive them at death.  Gifts of up to $13,000 per donee annually can be made with no impact on the lifetime estate and gift tax exemption (currently $3,500,000 per person).  Gifts in excess of $13,000 per donee per year also can be made without incurring gift tax up to an accumulated maximum of $1,000,000, however those gifts do reduce the lifetime estate and gift tax exemption.

Often it is not desirable for the recipient to have control of the asset being given, because of age or other reason.  In these cases gifts can be made to a trust which provides direction to a trustee and/or gives the trustee discretion in making the benefits of the trust (income or principal) available to the beneficiary or beneficiaries.

Low Interest Intra-Family Loans

Tax law requires that loans between related parties must bear interest at or above certain minimums published periodically by IRS.  Those minimums change with commercial rates, but are substantially lower.

With interest rates at historically low levels intra-family loans provide a simple and effective way to build the estate of the younger generation rather than the older generation by allowing the borrower to acquire income producing and/or appreciating assets at depressed prices.

Limited Partnerships or Limited Liability Companies

A particularly popular and effective method of transferring value to younger generations is to have assets owned by a family limited partnership or limited liability company, and transfer fractional interests in the partnership or limited liability company by gift or sale.  Because minority fractional interests in such entities typically have much lower values than the same fraction of the value of the assets owned by the entities, these fractional interests can be given or sold at a much lower value than the assets themselves.  Often there may be an existing business that can be restructured to facilitate these kinds of gifts and/or sales.  In other cases, assets already owned or to be acquired at bargain prices can be put into the limited partnership or limited liability company.

With the market value of most classes of assets being currently very low, and then applying a discount, often in the 25% - 45% range, such transfers can be especially effective at reducing the value of one’s estate.

Sales to Family Members

Selling an asset to the person that you want to receive it on your demise is a way to accomplish that transfer at today’s depressed value, instead of the value it is expected to have years in the future.  This is particularly useful for income producing assets which have the ability to pay for themselves on an installment basis at currently low interest rates.  As discussed above, the tax laws establish minimum interest rates that must be charged on loans or installment sales between related parties.  Those rates are significantly lower than commercial rates.

The ability to sell assets to family members on an installment basis at very low values with very low interest rates is an attractive method of reducing one’s estate.  Typically the gain, if any, from the sale would be capital gain, which is taxed at comparatively favorable rates.  In this economy many assets which once had significant taxable gain may have little or none at today’s valuations.  For those who want to be particularly aggressive, the installment note can have a self cancelling feature under certain circumstances.

A variation on the installment sale that can further increase the estate planning benefit and avoid or at least defer the recognition of taxable gain is a sale to a grantor trust.  Because the trust is a grantor trust, the sale is disregarded for income tax purposes, so the grantor/seller continues to pay the tax on the income from the asset even though the income goes to the buyer.  The payment of the income tax by the grantor results in an additional benefit to the related buyer.  Because the buyer is receiving the income and using it to actually pay for the asset, he or she is treated as having purchased it, so that it is removed from the grantor’s estate.

If the property to be transferred can’t produce enough income to fully support an installment purchase, the sale can be coupled with a gift of a fractional interest in order to reduce the amount of the installment payments.

Grantor Retained Annuity Trusts (GRAT)

Such trusts can allow a person to give away an asset with only minor gift tax implications, regardless of the value of the asset.  An asset (or assets) are put into a trust that provides that the creator (the “grantor”) of the trust receives an annuity, an annual dollar amount, or percentage of the trust’s initial value or in some cases, such as a residence, the use and enjoyment of the assets which has an ascertainable value.  The trust continues for a certain number of years, at the end of which the asset is distributed to the named beneficiary.  Based on the value of the asset, the amount of the annuity and the number of years, the value of what will be received by the beneficiary years in the future (the “remainder”) can be calculated using a formula from IRS.  Because of currently low values and the low interest rates which affect the calculations of value, there will often be little value attributed to the remainder interest which is given away.

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