Joseph Darby
T he BIG p ICTURe
vironment . The mechanics are as follows :
The grantor transfers assets to a trust , but retains the right to be paid back an annuity equal to the value of the property transferred plus an annual economic return equal to the Internal Revenue Code Section 7520 rate , which is an interest rate ( rounded to the nearest twotenths of 1 %) equal to 120 % of the midterm AFR .
Note that the 7520 rate is 20 % higher than the midterm AFR rate , and this will be a factor in choosing strategies as this discussion progresses .
Under the so-called “ Walton GRAT ” that runs for a fixed term with annuity payments reverting back to the donor ’ s estate if the donor dies during the term , the remainder beneficiaries of the trust ( for example , the children ) are deemed to receive a $ 0 gift so long as the annuity payable to the donor is equal to the amount contributed plus the 7520 rate . 3 . An Intentionally Defective Grantor Trust An intriguing alternative to a GRAT , with many important similarities and a few key differences , is an installment sale to an intentionally defective grantor trust .
The transaction involves a sale of property that is expected to generate significant cash flow that can then be used to satisfy the installment sale obligations — properties such as stock in a family-owned S corporation or membership interests in a family-owned LLC . These assets can also be eligible for “ fragmentation ” discounts for those owners who lack control over them or the ability to liquidate or market them .
The tax consequences of an installment sale to an intentionally defective grantor trust are remarkably similar to those of a GRAT : The donor transfers the property into the trust and receives back payments of principal plus interest .
One significant difference is that , in the case of a sale to this type of trust , the required minimum interest rate is the AFR rate and not the Section 7520 rate ( which is 120 % of the midterm AFR rate ). This means that the required interest rate to be charged ( i . e ., the “ hurdle rate ”) is lower when a short-term or midterm AFR loan is used , and therefore the amount of wealth transferred to the beneficiaries will be correspondingly higher .
The second significant difference is that if the grantor dies while the transaction is still open , the assets subject to an intentionally defective grantor trust sale are not “ clawed back ” into the estate of the decedent . Therefore , a defective grantor trust sale is “ permanent ,” whereas the GRAT term depends on the survival of the grantor .
There are valid reasons not to overfund transfers to heirs at the economic expense of the parent generation .
4 . The Charitable Lead Trust
This type of trust is sometimes described as a GRAT in which a charity holds the annuity instead of the grantor . The annuity is paid to a designated charity ( often a family foundation created by the grantor for charitable purposes ), and the beneficiaries enjoy the remainder interest after the annuity has been paid to the charity over what can be a fixed term of years , the lifetime of an individual or the joint lifetime of two or more individuals .
By choosing an appropriate payout rate based on the Section 7520 rate , it is possible to “ zero out ” a charitable lead annuity trust ( CLAT ) in much the same way that a “ Walton GRAT ” can be zeroed out . 5 . Refinanced Residences Given the current low mortgage rates , this is a great time to refinance your mortgage .
Beat Biden To The Punch 6 . Lifetime Unified Credit And Generation-Skipping Transfer Taxes Clients can use up their soon-to-begone lifetime unified credit and generation-skipping transfer exemptions by making transfers in trust … so the gifting of assets into a trust for children , grandchildren and future descendants seems like a good thing to consider starting today , if not sooner .
There are valid reasons not to overfund transfers to heirs at the economic expense of the parent generation . Our recommendation is to protect the parents during their lifetimes first , then worry about the next generation . But be aware that the clock may be ticking loudly on large gifts . 7 . Spousal Lifetime Access Trusts Another thing to strongly consider is spousal lifetime access trusts . These offer a way to use up the full lifetime gifting capacity of a taxpayer without giving it all away to children . Instead , it ’ s a sideways transfer to a donor ’ s spouse and is often accompanied — in a delicate procedure — with a return gift at some point from the spouse in trust for the original donor . The trusts cannot be “ reciprocal ,” but they are often “ not dissimilar .”
Take , for example , a husband who puts stocks and bonds representing his current exemption amount of $ 11.7 million into a trust for the benefit of his wife , daughter and all future descendants . An appropriate number of months later , the wife puts $ 11.7 million of real estate and valuables into a trust for the husband . The terms of these two trusts vary sufficiently in material ways to avoid the reciprocal trust doctrine .
Steering The Titanic
Benjamin Franklin said , “ In this world , nothing can be said to be certain , except death and taxes .” Will Rogers retorted that even if that were true , at least death doesn ’ t get worse every time Congress reconvenes .
Now comes Joe Biden , advocating to make death a taxable event that triggers recognition of all appreciation in taxpayers ’ assets during their lifetimes . So Will Rogers may be proved wrong : Death may actually get worse the next time Congress meets .
Your move .
JoSePh B . DarBy III , eSq ., is an adjunct professor at the Boston University school of law and the founding shareholder of Joseph darby law Pc , a law firm that concentrates on sophisticated tax and estate planning for individuals and businesses .
18 | financial advisor magazine | JUlY / aUgUst 2021 www . fa-mag . com