By JULIA S. WEAVER, J.D., LL.M., Chief Wealth Planning Officer & Family Office Fellow and KARA J. TALBOTT, CPA/PFS, CFP®, Senior Wealth Strategist & Family Office Fellow

In our article, The 2020 Estate Planning Trifecta, we discussed the perfect storm of elements that should drive clients to consider estate planning strategies, to wit:

1. Historically low interest rates
2. Highly favorable tax laws
3. Volatility in the valuation of not only marketable securities, but also many closely held businesses

In this second article of our series, we dig deeper into key 2020 planning strategies, as well as the practical considerations that should shape our thinking today. Planning in our current environment should focus on: avoiding the burn of a sprint, good planning is a marathon and low hurdles are easier to jump.

Sprint – A run over a short distance in a limited period of time.
The current tax law provides for all-time high estate/gift and GST exemptions of $11,580,000. All wealth in excess of these amounts will at some point be subject to wealth transfer tax, currently at the rate of 40%. However, the period to use these high exemptions is time-stamped with a sunset date of 2025 at the latest and could be reduced earlier (perhaps as early as 2021) under a potential Biden administration and a change of control in the Senate. As such, a common theme for exemption planning in 2020 is “Use It or Lose It.”

We are fortunate to have a historical perspective from 2012, when it was highly speculated the exemption amounts would fall off the fiscal cliff. Families who took a wait and see approach were left doing Hail Mary planning without time to tailor trust documents to their unique situation. The available margin of our estate planning brethren was nearly zero, and many assembly-line trust documents were generated out of sheer necessity.

We find ourselves in a time that may feel like impending 2012 deja vu, and families who procrastinate planning until the end of 2020 may feel the burn of the sprint.

Marathon – A lasting effort highly rewarded by endurance.
Sound planning and creating a thoughtful trust structure is the proverbial “marathon, not a sprint.” The rewards for this effort are many, including:

  • The thoughtful selection of trustees and other fiduciaries
  • Maximizing options to enhance flexibility
  • Consideration of appropriate distributions for current descendants and generational lines
  • Enhancing provisions that maximize tax advantages
  • Creating entities that may entitle some assets to valuation discounts prior to a gift
  • Ensuring sufficient time to avoid certain IRS risks associated with some strategies
  • Determining the optimal state trust situs for particular goals and objective
  • Selecting the optimal assets for trust funding, including time to consider and structure gifts of business interest and other non-marketable securities

For those who may be ‘on pause’ at the notion of moving remaining exemption amounts off their balance sheets, several types of trusts are uniquely tailored to:

  1. Enhance flexibility
  2. Provide some contingent access to the trust income

A Spousal Lifetime Access Trust (SLAT) is a trust that is created by one spouse for the benefit of the other spouse, as well as children and potentially grandchildren and beyond. By including the spouse as a beneficiary, the marital unit can maintain access to trust income and assets if circumstances later require. The spouse’s interest may cease upon divorce, or may continue. The beneficiary spouse may also hold a Limited Power of Appointment to redirect the trust assets at his/her passing to adapt for any changing family dynamics. See the April 2019 e.Insight, The Adaptable Spousal Lifetime Access Trust.

Another type of trust, sometimes referred to as a Contingent Access Trust (CAT), can give an independent Trust Protector the power to add beneficiaries from a class which could include a current or future spouse, or even the grantor provided the trust is created in a jurisdiction whose trust laws include the appropriate statutes. A CAT can be ideal for a currently single individual, or a couple who may be concerned about the impact of divorce or the death of the beneficiary spouse.

A few significant notes to self:

  1. A trust need not be funded immediately. It can be structured now, and then funded at a later date when there is more clarity around potential political shifts or proposed changes to tax laws.
  2. Families who already have irrevocable trusts should review them with their advisors to see if the provisions currently meet (or can be modified to meet) the goals of the family, thereby avoiding the added complexity and administration of additional trusts.

By starting early to structure a new trust or modify an existing trust, families can run the first leg of the marathon now and enjoy the fruits of thoughtful planning for generations to come.

Hurdle – The act of clearing an obstacle to be successful.
An estate freezing strategy is designed to freeze the taxable value of an asset, allowing future growth to occur outside of the taxable estate. Many estate freezing strategies require a certain amount of trust income or assets to be paid back to the grantor. This amount is referred to as the ‘hurdle rate,’ and is defined by the IRS as either the applicable federal rate or the Section 7520 rate.

Essentially, hurdle rates are wealth that must be paid back into the grantor’s taxable estate. Thus, the lower the hurdle rate, the greater the amount of appreciation that remains in trust, free of wealth transfer tax.

The historically low hurdle rates in the current environment are barely a speed bump.

Key Estate Planning Techniques for 2020
In order to utilize the exemption amounts, something must be gifted. However, a “gift” need not necessarily be an outright gift of assets to a trust, such as the gift to a SLAT as described above. The following are additional strategies to utilize the current exemptions and transfer wealth to heirs.

Sale Strategies
A common strategy to freeze the value of assets in the taxable estate is a sale to an irrevocable grantor trust. Such a trust may be referred to broadly as a ‘Defective Grantor Trust’ or ‘Irrevocable Grantor Trust.’ A SLAT is a type of such a trust.

The trust is created and funded with seed capital, which is a gift to the trust. Thus, a ‘third party’ is created. When properly structured, the trust becomes a legitimate borrower, which can later purchase assets from the grantor. However, unlike a sale to a traditional third party, whereupon capital gains are recognized, the trust is designed to utilize provisions in the income tax code which render it a “grantor trust.”

What is the significance? The trust is then deemed one-in-the-same with the grantor for income tax purposes and there is no recognition of gain upon the sale of assets to such a trust.

Further, by complying with the provisions of the Gift and Estate Tax Code, the trust is structured as an irrevocable trust. Hence, when successful, the non-appreciating note is in the Grantor’s estate and the appreciating assets are held in the trust, free of wealth transfer tax on future appreciation.

The Grantor, in return for this sale of assets, takes back a promissory note from the new Trust. In the present environment, a nine-year interest-only note with balloon principal payment would require a minimum AFR of .41% for August, 2020.

Forgiveness of Promissory Notes
Note forgiveness is a gift. When properly structured, it is a gift that utilizes exemption. In the case of the sale of assets to an irrevocable grantor trust, the value of the trust is improved by no longer owing this debt to grantor.

The ability to structure such a sale in return for a note affords the grantor some ‘wait and see’ margin. The note can be held for its full term, or, if the political tides shift to the blue and a reduction in exemptions is deemed inevitable, the grantor may forgive the note at that time, thereby utilizing gift and estate tax exemption.

Grantor Retained Annuity Trusts (GRATs)
A GRAT is similar to a sales strategy. However, the annual payments required to be paid to the grantor are structured as annuity payments. The hurdle rate is the section 7520 rate, which is .4% for August, 2020. All appreciation over and above this historically low rate accrues to the benefit of the trust beneficiaries.

Longer term GRATs (for example, terms of 5 to 15 years) provide an opportunity to lock in the low hurdle rate for a more substantial period. Because the grantor must outlive the GRAT to avoid assets being pulled back into their estate, longer term GRATs are beneficial for clients with lower mortality risk, and are also well-aligned with assets that provide higher cash flow such as higher dividend yielding stocks and certain business interests. Another way to potentially minimize the mortality risk is to play into it. A 99 year GRAT may, especially if the 7520 rate increases, not require that all of the assets be pulled back into the Grantor’s estate at passing; thus leaving some assets to pass to the remainder beneficiaries transfer tax free.

Lastly, GRATs can be structured with either, (1) a gift component in order to utilize gift and estate tax exemption, or (2) as a zeroed-out gift, which would be beneficial as a freezing strategy for families that have already used their full exemptions.

As noted, thoughtful estate planning is a marathon. For many affluent families, the use of their full estate/gift and GST exemptions is just the start. Estate freezing strategies and enhancing trust structures should continue to be explored as long as assets are appreciating and there is remaining estate tax exposure.

As always, a review of your entire balance sheet will enable a full analysis of the pros and cons of each potential strategy. Your Oxford team will collaborate with your other trusted advisors to evaluate these potential strategies in light of your family’s unique situation.

Oxford Financial Group, Ltd. is an investment adviser registered with the U.S Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about Oxford Financial Group Ltd.’s investment advisory services can be found in its Form ADV Part 2, which is available upon request.

The opinions expressed are those of Oxford Financial Group Ltd.’s Investment Team. The opinions referenced are as of the date of the publication and are subject to change due to changes in the market or economic conditions may not necessarily come to pass. The information in this presentation is for educational purposes only and does not constitute investment, tax or legal advice. Tax and legal counsel should be engaged before taking any action. Forward-looking statements cannot be guaranteed. OFG-2008-11

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