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Positive Planning Strategies in a Post-COVID-19 World

Several techniques that are particularly attractive during challenging times.

As we face challenges on the health, economic and market fronts, we would be remiss not to explore the positive ways your client’s wealth plan can benefit from low interest rates and depressed asset values. Here are several planning strategies that are particularly attractive in this kind of climate.  

Gift Depreciated Assets

Now may be a perfect time to gift assets that have declined in value due to challenging market conditions; the federal estate, gift and generation-skipping transfer (GST) tax exemption (the federal exemption), which is the amount you can transfer tax-free, is at an all-time high of $11.58 million (individuals) and $23.16 million (married). While asset values are low, consider gifting more assets to maximize your federal lifetime gift tax exemption. The amount of exemption used in making a gift is based on the fair market value (FMV) of the asset transferred at the time of the gift. Any future appreciation of these assets would be outside of your estate.

Maximize the High Federal Exemption

The high federal exemption is set to revert to $5 million, adjusted for inflation, on Jan. 1, 2026. Take advantage of the increase now by making larger gifts that use up some or all of your exemption. The earlier a gift is made, the longer it can potentially grow outside of your estate. According to the Internal Revenue Service, if the exemption decreases in the future, gifts made prior to the decrease won’t be retroactively taxed.

There’s a possibility that before 2026, the exemption could revert to previous levels or go lower. There’s also been discussion among the presidential candidates of changing the current estate and gift tax laws and potentially adding new wealth taxes. This is another reason why it may be best to make larger gifts now while the exemption remains high and there’s  some certainty about the taxation of these gifts.

Gift to a Trust

When considering large gifts, you may wish to use a  trust rather than an outright gift. A trust may be structured as a grantor trust, which is disregarded for income tax purposes, and the grantor continues to be responsible for the income tax associated with the trust assets. Therefore, the basis of the property remains unchanged in the hands of the trust. If the grantor trust sells the assets, the grantor would recognize a gain or a loss as if he’d held the assets in his individual name. Thus, the income tax the grantor pays on behalf of the trust is effectively another “gift” to the trust that doesn’t use the grantor’s federal gift tax exemption.

Take Advantage of Low Interest Rates

Certain estate planning strategies are advantageous in a low interest rate environment. They don’t need to use the federal gift tax exemption, so if you don’t wish to use your exemption or have used it already, these would be good strategies to consider.

Grantor retained annuity trust (GRAT). A GRAT allows you to transfer the growth on assets to future generations at a reduced gift and estate tax cost. With this irrevocable trust, you transfer assets expected to appreciate and retain an annuity stream for a fixed term. At the end of the period, the remaining assets pass to family members outright or in further trust. Although the transfer of assets to the trust is considered a gift, the gift amount is reduced by the actuarial value of the annuity retained by you, so the amount of the taxable gift may be small compared to the value of the assets transferred. If the asset growth outperforms the IRS statutory (Internal Revenue Code Section 7520) rate used to value the remainder interest, the additional growth is transferred free of gift and estate taxes to the trust’s remainder beneficiaries. When the Section 7520 rate is low, GRATs can be very effective, as appreciation of the asset above that rate passes to your family free of gift and estate tax.

Intrafamily loans. This loan allows a family member to provide low-cost capital to another family member. Properly structured, an intrafamily loan can provide attractive lending rates without gift tax consequences. Intrafamily loans have no limitations on how a borrower uses the proceeds. They can provide credit opportunities to family members who might not be able to obtain credit and at lower rates than commercially available. This is particularly attractive in today’s low interest rate environment.

To avoid treatment as a gift, an intrafamily loan must be properly structured and must bear interest at least equal to the applicable federal rate (AFR) set by the IRS. This rate is currently at very low levels, so there’s a higher possibility that the rate of return earned on an investment made with the borrowed funds will exceed the AFR, and all those earnings will be effectively transferred wealth-tax-free.

Sale to an intentionally defective grantor trust (IDGT). A sophisticated strategy that leverages both low valuation and interest rate environments is a sale of assets to an IDGT, which offers multigenerational planning.

Make Roth IRA Conversion

A Roth individual retirement account can be a very effective planning tool given the threat of higher tax rates. By preserving a Roth IRA for as long as possible, you provide the opportunity for maximum growth to an account that can be 100% income-tax-free. While assets in a traditional IRA benefit from tax-deferred growth, future distributions are taxed at ordinary income rates. Alternatively, a Roth IRA can grow tax-free while in the account, and distributions are income-tax-free. There are no required minimum distributions from Roth accounts unless they’re inherited accounts.

Given the long-term benefits of Roths, conversions from traditional IRAs to Roth IRAs should be evaluated in the scope of your overall income tax and estate planning. Converting to a Roth IRA is a taxable event—tax is based on FMV of the traditional IRA at the time of conversion. However, if the traditional IRA is currently undervalued, the resulting conversion tax would also be lower. Once converted, any rebound of value inside the Roth IRA would be income-tax-free. A Roth conversion has many variables, and a detailed analysis of these factors is highly recommended.

Use Tax-loss Harvesting

During challenging market conditions, consider harvesting portfolio losses, allowing you to use your harvested losses against any future gains. This offers taxpayers a way to ease the pain of a losing stock investment: Sell the security to offset capital gains incurred on redeemed “winning” securities. However, there’s a caveat: If you buy back the same or substantially the same stock 30 days before or 30 days after, you’ll  trigger the “wash sale rule,” and the loss will be disallowed.

You can also harvest losses for individual bonds, which may be important going forward as bond prices typically decline when interest rates rise. Remember that for income tax purposes, the assets in your grantor trust are treated the same as the assets held in your individual name. Therefore, also evaluate the assets in your grantor trust.

Move assets to mitigate state income taxes. While personal trusts have been used most commonly as estate and gift tax planning tools, they now have increased importance as vehicles for minimizing a family’s state income tax liability.

Those in high-tax states may have opportunities to reduce or eliminate state taxes on some income by establishing a new trust or moving an existing trust to a tax-friendly jurisdiction, such as Delaware. Using Delaware as a trust planning jurisdiction is similar to using states that don’t have any income tax for a well-structured trust. Regardless of a taxpayer’s state of residence, a new trut may be created in Delaware, and an existing irrevocable trust may be moved into Delaware for ongoing administration. Moving your trust to a tax-friendly jurisdiction may enhance any future gains on the trust once the market rebounds. This strategy is very state-law specific and must be examined on an individual basis.

Reexamine existing trusts. If you have an existing grantor trust that has a swap power, you may wish to exercise it during this time of low valuation and interest rates. As grantor of the trust, you can substitute or swap assets of equal value with the trust. If your trust has highly volatile assets, you may wish to swap cash into the trust and remove those assets. This would allow you to effectively “freeze” the assets inside your trust so that the trust is protected from any future downturn in value. Similarly, if you have low-basis assets inside your trust, you may wish to swap cash or high-basis assets with the trust. This would allow you to take back the low-basis assets into your estate so that they may benefit from a step-up in basis on your death. The trust will get the benefit of the higher basis and hence lower capital gains in the future.  A similar strategy can be deployed to swap assets with an underperforming GRAT and “reset” the assets with a new GRAT. 

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