We previously discussed in our recent client alert memorandum that clients should ensure their basic documents, such as wills, revocable trusts, power of attorney, health care directives and beneficiary designations are in proper order during this unprecedented time. Beyond that, however, the pandemic crisis has created unique wealth transfer opportunities for clients who may be subject to estate taxes. All time low interest rates and depressed asset values are making it an opportune time to consider the transfer of assets. Depending upon the situation, this may allow a client to transfer substantial wealth with minimal estate or gift tax consequences.

Currently the federal estate and gift tax exemption is $11.58 million per individual ($23.16 million for a married couple), while the Connecticut estate and gift tax exemption is $5.1 million per individual ($7.1M in 2021, $9.1M in 2022, and matching the federal exemption starting in 2023). For federal gift and estate tax purposes, a 40% tax rate applies to gifts made or assets at death exceeding the exemption amount (while the Connecticut tax rate would be around 10-12%). The current federal exemption, however, is set to expire at the end of 2025, at which time it will revert to $5 million per individual. The uncertainty surrounding the upcoming election and the resulting change which may occur is another factor to be considered. Accordingly, clients should be aware of certain planning strategies which are advantageous in this environment.

Intra-Family Loan

Money can be lent from a senior family member to a junior family member at a very low interest rate (the May 2020 short term rate is .25% while the mid term rate is .58%). The junior family member can then invest the loan proceeds into an asset that is expected to grow over the loan period. In such cases, the appreciation above the interest rate charged passes to the junior family member free of gift, estate and generation-skipping taxes.

Grantor Retained Annuity Trust (GRAT)

A GRAT involves a grantor transferring specific assets into a trust while retaining the right to receive an annual income annuity payment for a certain number of years. When the term expires, the remaining assets held in the trust pass to the beneficiaries. The IRS values the gift to the trust based on the value of the annuity stream and the assumed rate of return, using the interest rates under code section 7520 (May 2020 rate of .8%). Through proper planning, the assets can be transferred with minimal gift tax consequences. The use of assets that can take advantage of currently lower valuations, and are expected to recover from the economic downturn, will most benefit from this strategy. Another option for clients who wish to include a charity(s) in their estate plan is the Charitable Lead Annuity Trust (CLAT). Similar to a GRAT, a CLAT involves the transfer of assets to a trust in which a charity(s) is designated to receive an income stream for a term of years with the remainder passing to individual beneficiaries.

Spousal Lifetime Access Trust (SLAT)

A SLAT is an irrevocable trust for the benefit of a spouse that allows a person to take advantage of a current federal estate tax exemption amount which may decrease in future years. Presuming a person has unused gift tax exemption available, a donor spouse could gift up to $5.1 million (currently the CT estate/gift tax exemption) to a trust for the benefit of the donee spouse, free of gift taxes. Additional gifts can be made in 2021 through 2023 to take advantage of the increase in the Connecticut exemption. During the term of the trust, the donee spouse can be the sole trustee and receive all the income as well as principal distributions for his or her accustomed manner of living. The donor’s children and other family members can be beneficiaries as well. Upon the death of the donee spouse, the remaining trust assets are not subject to estate taxes. The advantage is that if the estate tax exemption is reduced in the future after the gifts were made using up the higher exemption, the trust assets are still not subject to estate tax. In other words, a person can secure the higher exemption amount, which in the event the exemption is subsequently reduced, will result in significant estate tax savings (40% of the amount transferred plus any appreciation). Note that the trust is designed as a “grantor trust” which means that the donor pays the income taxes on the trust income, thereby increasing the amount passing to beneficiaries. In addition, the trust and the donor may make loans or sale of assets back and forth without any income tax consequences. Please contact us if you have any questions regarding your estate plan or the strategies discussed above.