By Wendy M. Greenberg, Esq., Morrison & Foerster LLP
rate used to determine actuarial valuations of certain retained or remainder
interests for purposes of federal gift and estate tax, commonly referred to as
the "7520 rate" and defined as 120% of the applicable federal midterm rate
(compounded annually) for the relevant month, has fallen to a record low of 1.2%
for transfers completed in June, 2012. To put this in some perspective, Section 7520
rates reached as high as 6.2% only five years ago, and hovered around 10% in
the early 1990s.
low interest rates clearly present some estate planning opportunities, but
certain techniques actually benefit from higher interest rates. This article provides a quick reference
resource to determine whether the current interest rate climate is advantageous
for the use of various common estate planning techniques. Interestingly, it appears that certain estate
planning techniques (grantor retained annuity trusts and charitable remainder
trusts, specifically) are minimally affected by interest rates, where others
(qualified personal residence trusts and charitable lead annuity trusts) are
more dramatically affected.
1. Grantor Retained Annuity
Summary: Lower 7520 rates
Reason: Where a GRAT is "zeroed-out" for gift tax
purposes, the grantor's retained annuity is purposefully exactly equal to the
total actuarial value of the GRAT assets, assuming growth at the 7520 rate over
the course of the annuity term. If the
assets of the GRAT outperform the 7520 rate, the excess assets over those
required to pay the annuity amount pass to the remainder beneficiaries free of
transfer tax. The lower the 7520 rate, the
easier it is outperformed, and the higher the potential for excess assets to
remain after payment of the annuity amount.
Example: Assume Donor transfers assets with an initial
value of $3 million to a five-year GRAT:
Retained annuity required to "zero out" the gift and
the gift tax
2. Qualified Personal
Residence Trust (QPRT)
Summary: Higher 7520 rates
Reason: The use (essentially,
the entire income) of the property is retained by the transferor during the
QPRT term. The more the retained use is
worth, taking into account growth over the course of the QPRT term, the less
(actuarially) remains to be transferred to remainder beneficiaries. The higher the 7520 rate, the more the
retained use is worth, and the lower the value of the taxable gift to the
Example: Assume 60-year-old Donor transfers a personal
residence with a value of $3 million to a 10-year QPRT:
Value of retained interest
Gift taxable value of remainder interest
Remainder Unitrust (CRUT)
Reason: The higher the assumed
growth rate, the less the unitrust payments to an individual are presumed to
cut into the income (and principal) of the trust, leaving more for the charitable
beneficiary in the end. Keep in mind
that the minimum unitrust payout allowable is 5% annually.
Example: Assume 60-year-old Donor transfers $3 million
to a CRUT with a retained 5% unitrust interest:
Gift tax value of deductible charitable remainder
4. Charitable Lead Annuity
Reason: Here, the charity receives the lead rather
than the remainder interest, so the CRUT reasoning, above, is expressed
inversely: the lower the presumed growth rate, the more the annuity payments
are presumed to cut into the income (and principal) of the trust, leaving less of
an eventual taxable gift to remainder individual beneficiaries. Thus, like the GRAT, a CLAT need only
outperform the Section 7520 rate to result in a tax-advantaged transfer.
Example: Assume 60-year-old Donor transfers $3 million
to a CLAT paying charity $150,000 annually for Donor's life, residue to Donor's
Gift tax value of deductible charitable interest
Estate taxable value of remainder interest
The results described above are
not necessarily intuitive, and of course it makes sense to run the numbers
before recommending any specific trust strategy.
Additionally, in this interest
rate climate, the simpler estate planning techniques of sales and loans to
family members of lower generations are hard to beat. Any promissory notes remaining in the seller
or lender's estate will bear interest at astoundingly low rates: the mid-term
applicable federal rate for June (for notes with terms between three and nine
years) is 1.07% (compare to 2.27% one year ago, and 4.64% five years ago), and
the short term applicable federal rate (for notes with terms of less than three
years) is just 0.23% (compare to 0.46% one year ago, and 4.84% five years ago). Interest paid on the notes will likely make
little impact on the holder's estate, or may even be forgiven with no or very
little gift tax consequence (depending on the size of the note).
Morrison & Foerster's
Trusts and Estates group provides sophisticated planning and administration
services to a broad variety of clients.
If you would like additional information or assistance, please contact Patrick McCabe at (415) 268-6926 or
© Copyright 2012 Morrison &
Foerster LLP. This article is published
with permission of Morrison & Foerster LLP.
Further duplication without the permission of Morrison & Foerster
LLP is prohibited. All rights reserved. The views expressed in this article are those
of the authors only, are intended to be general in nature, and are not
attributable to Morrison & Foerster LLP or any of its clients. The information provided herein may not be
applicable in all situations and should not be acted upon without specific
legal advice based on particular situations.
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