Several estate planning techniques have become extremely attractive due to historically low U.S. Treasury rates. The rates change monthly, therefore the benefits of a technique depend on the rates in effect for the month in which the transfer occurs. October 2011 rates reached a new low. In most cases, these techniques use little or no gift tax exemption. However, as with all gifts, the transferee receives the transferor’s basis in the property (“carryover basis”) for income tax purposes rather than a “stepped-up” basis to date of death value (assuming the value exceeded the basis). Thus, potential additional capital gains on any future sale will offset, to some extent, the potential estate tax savings from the transfer of low-basis assets.

1. INTRA-FAMILY LOANS

Intra-family loans are a way to provide funds to a family member for some purpose, such as the purchase of a house or starting a business, without making a gift. The loan proceeds can also simply be used to invest in a portfolio of securities with the aim of attaining a total return in excess of the loan interest. Any income or growth on the invested funds over the interest paid is free of gift or estate tax. Interest at the applicable federal rate (“AFR”) must be charged on the loan to avoid making a taxable gift. The AFR is determined based on the term of the loan and the month in which the loan is made. In October, for example, the rate ranges from .16% for a loan of 3 years or less, 1.19% for a loan of 3-9 years, and 2.95% for a loan of more than 9 years. The lender may always choose to forgive the loan at a future date and make a gift at that time.

2. GRATS

A Grantor Retained Annuity Trust (GRAT) is a trust which pays to the donor a specified dollar amount for a term of years, with any remainder passing to the trust beneficiaries at the end of the term. The general approach is to set the payment high enough so that the gift tax is negligible. It is a technique used where the donor expects the assets transferred to the GRAT to increase greatly in value. If the assets grow at a rate greater than the Treasury rate for GRATs (known as the 7520 rate -1.4% for October), the growth passes tax-free to the trust beneficiaries at the end of the term. The success of the technique strictly depends on whether the investments outperform the IRS rate. If not, then the property is essentially returned to the donor, but since there was not much of a gift at the outset, there is very little that is lost. On the other hand, if the investments perform very well, significant amounts can be moved tax-free to the beneficiaries.

The grantor must survive the term in order for the assets to not be taxed in his or her estate. Under current law, the GRAT term can be any number of years. There is proposed legislation that would require a minimum ten-year term. Clients who are interested in GRATs would be advised to act soon.

3. CLATS

A Charitable Lead Annuity Trust (CLAT) is similar to a GRAT except that the annuity payments are made to a charity instead of to the donor, and the donor is not required to survive the term for the technique to be successful. In addition, the donor may use the 7520 rate for the month in which the transfer occurs or either of the two prior months, if lower.

4. SALE TO AN IDGT

This technique involves the sale of assets to a trust (known as an “Intentionally Defective Grantor Trust” or “IDGT”) established by the seller in exchange for a promissory note which bears interest at the AFR. The benefit of this technique is that any future growth of the trust assets in excess of the loan principal and interest passes tax-free to the trust beneficiaries. Because the trust is designed as a “grantor trust” for income tax purposes, no capital gains are recognized when the assets are initially sold to the trust, and interest paid to the seller is not taxable to the seller.

The GRAT and the sale to the IDGT each has advantages and disadvantages. As such, clients should fully evaluate both techniques before taking any actions. For more information, please contact Lisa F. Metz (lmetz@brodywilk.com).