TrustsEstates_dv716064_Feature_1920x945

07.22.20

Historically low interest rates yield tax saving opportunities

BY Bryce J. Helfer

Every month, the IRS publishes the applicable federal rate (in short, the "AFR") for determining the present value of an annuity interest. In June 2020 the AFR is 0.6%. In June 2019 the AFR was a full two percent higher at 2.8%. For many gift planning strategies, a lower AFR can amount to an unprecedented opportunity for estate and gift tax savings.

To understand the significance of a lower AFR, consider a common wealth transfer strategy known as a Grantor Retained Annuity Trust, or a "GRAT." A GRAT is an irrevocable trust that pays a fixed annuity to the individual (the "grantor") who establishes the GRAT for a fixed term of years. After the fixed term expires, any remaining property is held or distributed to remainder beneficiaries chosen by the grantor and set forth in the trust document.

Let's assume that in June 2019, Carol established a GRAT with the help of her attorney. She transfers 1,000 shares (then equal to $10,000,000) of closely held stock in her company, Carol's Enterprises, to the GRAT. Under the terms of the GRAT, Carol is required to receive distributions (back to her) for three consecutive years, which equal the amount she originally contributes, plus a pre-determined "growth" factor based on the AFR at the time of creating the GRAT. Using the AFR in June 2019 (2.8%), at the end of the three-year term, Carol will receive shares back to her that equal approximately $10,600,000 and the balance of the shares held would be distributed tax-free to Carol's children. Let's assume that at the end of the three-year term, the same 1,000 shares in Carol's Enterprises is now worth $13,000,000, resulting in a tax-free transfer at the end of the three-year term to Carol's children of shares that equal roughly $2,400,000 ($13,000,000 - $10,600,000).

Now let's consider the impact of the June 2020 AFR. If Carol funds the GRAT in June 2020 with 1,000 shares (then equal to $10,000,000) of stock in Carol's Enterprises, using the AFR in June 2020 (0.6%), at the end of the three-year term, Carol will receive back roughly $10,130,000, and the balance of the shares held would be distributed tax-free to Carol's children. At the end of the three-year term, 1,000 shares in Carol's Enterprises is now worth $13,000,000, resulting in a tax-free transfer to Carol's children of approximately $2,870,000 ($13,000,000 - $10,130,000).

As shown, implementing the GRAT using the June 2020 AFR will result in a net increase of the tax-free gift to Carol's children of $470,000 ($2,870,000 - $2,400,000).

Bottom lineā€”the AFR changes monthly so you should consider whether implementing a GRAT (among other strategies) now can help you achieve (and maximize) your wealth planning goals.

author img

Author

Bryce J. Helfer

Associate

Posts By this author