May • June 2009
Feature Estate Planning
An ESTATE PLAnnInG
the market downturn and the shift in political winds make
this a perfect time to revisit wealth transfer plans.
By Domingo p. Such iii and tina Davis milligan
xx | private wealth magazine | month 2009 www.pw-mag.com
it SeemS likely the FeDeral eState tax iS here to Stay now
that the Democrats rule the White House and Congress. Couple this with the
turbulent economy and an increased desire by families to preserve their wealth,
and the need for advisors to “tune up” their clients’ estate plans is clear.
Under the Economic Growth and Tax exclusive to taxable estates above the $3.5 $13,000 a year per individual, including
Relief Reconciliation Act of 2001, the fed- million threshold. There is a univer- the front-loading of 529 plans with five
eral estate and generation skipping transfer sal need that varies based on goals, age, years of the annual exclusion. Also, each
tax exemptions went from $2 million to wealth, health and many other factors. person may give $1 million during their
$3.5 million this year. The highest federal A well thought-out plan should protect, life without incurring a gift tax. Finally,
estate and gift tax rates remains at 45%. preserve and ensure the distribution of gifts for the direct payment of medical
However, on January 1, 2010, the federal assets. Planning for incapacity and the and education expenses do not count
estate tax will be “repealed.” Exactly a year appropriate care for one’s self and assets, against annual exclusion gifts. Taking
later, the federal estate tax rate is scheduled should such situations arise, is also incred- advantage of these freebies avoids the gift
to revert back to prior law and return to a ibly important. For this reason, powers tax and may significantly reduce one’s
confiscatory 55% with a $1 million exemp- of attorney for property and health care, taxable estate over time.
tion (the generation skipping transfer tax as well as health care directives and living
exemption becomes $1.12 million, subject wills, should be reviewed. market losses
to further inflation adjustment). Take note of any increases to exemption offer opportunity
President Obama and the Democratic amounts since your estate plan was last Deep market declines offer a tremen-
majority in Congress agree that new updated. With the increase to the estate dous estate planning opportunity. Several
federal legislation is required. Obama and generation skipping transfer tax (GST) strategies incur little or no gift tax that,
recently proposed freezing the federal exemption, it is particularly important to with a market recovery, can successfully
estate tax exemption at $3.5 million, with review your plan in light of two items: transfer wealth to heirs. Strategies such as
a top estate tax rate of 45%. retirement assets and state estate tax. grantor retained annuity trusts (GRATs),
While the law remains in flux, it is a For individuals whose balance sheet charitable lead annuity trusts (CLATs),
particularly advantageous time for plan- consists predominantly of retirement intrafamily loans, installment sales to
ning wealth transfers. Individuals who assets, it is important to ensure that intentionally defective grantor trusts
have been waiting on the sidelines should these assets aren’t allocated to the estate (IDGTs) and statutory freeze strategies
take action to ensure their estate plans tax exemption and incurring income tax transfer to heirs the appreciation on these
are in order. Determine the disposition unnecessarily. The many recent develop- temporarily depressed asset values above
of the assets in light of current goals ments with retirement plan asset tax rules a statutory interest rate—often referred to
and objectives and in light of life events should not be overlooked. as the “hurdle rate.” In most cases, so long
and recent changes to wealth. Determine For clients who live in one of the as you outlive the term established, the
where assets are distributed based on many states that assess a separate estate appreciation is removed from your estate.
your current balance sheet and asset tax, it is important to consider that state’s With asset values and interest rates at his-
ownership. Assess potential estate tax exemption. Many states have exemptions toric lows, conditions favor implementing
liability and how that might be funded. that are lower than the federal amount. one or more of these strategies.
Further, evaluate whether the planned An estate that is not taxable for federal A GRAT allows taxpayers to transfer
disposition is tax-efficient and incorpo- purposes could be still subject to a state future appreciation to beneficiaries. The
rates current law. Clearly, if the current estate tax. Domicile planning, as part of GRAT returns an annual annuity for a
plan does not represent your objectives, the estate plan, is important. term of years, designed so that the present
make appropriate revisions and be mind- Don’t neglect the benefits of wealth value of those payments, calculated using
ful to make any necessary changes. transfer “gifts” from the IRS. These the hurdle rate, equals the initial funding
Remember, estate planning is not include the annual exclusion amount of amount. The current rates applicable for
private wealth magazine | may / june 2009 www.pw-mag.com
Feature Estate Planning
while the law remains in flux, it is a particularly
advantageous time for planning wealth transfers.
2009 are at historically lowest levels. For the large estate, the “statutory lishment in a low-interest environment.
If the assets appreciate more than freeze,” a complex strategy based on Therefore, QPRTs tend to be used less as
the hurdle rate during the term of the corporate and partnership law, should be interest rates decline. However, given the
trust, at the end of the term the apprecia- considered. The statutory freeze allows likelihood the estate tax will continue to
tion will be transferred to the remainder senior family members to contribute be assessed and in a climate of depressed
beneficiaries, such as your children or a assets in exchange for units with young- home values, a review of its application
family trust, resulting in a wealth transfer er family members participating in the is in order.
with an estate tax savings. investment results. Typically, the senior For individuals whose portfolios have
The CLAT is based upon the same generation retains general management lost significant value, there may be reluc-
principles as the GRAT, except that dur- control over the entity and receives a tance to consider wealth transfers of their
ing the initial term the annuity payments fixed, cumulative annual return and a business or investment assets until they
go to a charity, such as a family founda- fixed value on liquidation with their see market recovery and have comfort
tion, designated by the grantor. Just like managing and preferred units. their lifestyle needs are met. A second res-
the GRAT, at the end of the CLAT term, The junior family members receive idence or vacation home with a depressed
appreciation in excess of the hurdle rate units that provide that the excess return, value may be an asset ripe for wealth
passes tax-free to the designated ben- after satisfying the managing unit’s inter- transfer through a QPRT. Although there
eficiaries. For the charitably inclined, a est and the preferred return, is theirs. is a gift tax assessed, the tax would be paid
CLAT is very advantageous. Although these residual units provide less based on current depressed values. Paying
An intrafamily loan permits loans to security, all capital, income and appre- the tax on today’s lower value is more
family members using statutory inter- ciation above the hurdle rate, which is beneficial than paying the estate tax on the
est rates without gift tax implications. returned to the senior generation trans- future appreciated value.
Assuming the loan principal is invested fers the investment gains to the junior
and appreciates more than the interest family members without incurring gift conclusion
rate charged, currently 1.94% for 9 years, tax and removes this “excess” apprecia- The time is right for a thoughtful
the appreciation above this interest rate tion from the senior generation’s estate. review of clients’ estate plans, including a
is owned by the borrower with no gift tax Low asset values and low interest rates review of health care, property manage-
and generates an estate tax savings. The make this strategy particularly attractive ment and tax issues in light of the current
lender gets back the original principal for the high-net-worth family. economic landscape. Estate plans should
plus the annual interest payments. One often-overlooked strategy be continually monitored and adjusted as
An IDGT is similar to the intrafamily is a qualified personal residence trust life events occur and laws change. Estate
loan except that the loan is made to finance (QPRT), in which a homeowner transfers planning is a dynamic process requiring
the purchase of property from the lend- an interest in a personal residence to a continued attention and diligence to real-
er. Moreover, the note is made between trust and retains the right to live in the ize the best results. Now is an opportune
the lender and a grantor trust structured home for a specified term. The hom- time to act.
to avoid income taxes with the sale of eowner may continue to live in the home
the property. The amount of appreciation after the end of the term pursuant to a Domingo p. Such iii is a partner at mcDermott will &
above the stated interest rate in the note is lease agreement providing for fair market emery llp. he can be reached at firstname.lastname@example.org.
transferred to heirs, the beneficiaries of the rental to the successor owners, who are
grantor trust. This sophisticated strategy typically the children. tina Davis milligan is a wealth advisor at william
requires some homework and compliance Unlike the previous strategies, QPRTs Blair & company llc. She can be reached at tmil-
to yield the favorable tax results. tend to incur a larger gift tax upon estab- email@example.com.
may / june 2009 | private wealth magazine