Current Market Conditions Create Opportunities for Estate Planning Strategies
While the current bear market has crippled many portfolios and
frightened many investors, there is a bright side to the recent economic
anguish. Depressed asset values, illiquid markets and historically
low interest rates present opportunities for you to transfer assets to
The federal estate tax is imposed on taxable estates at the
rate of 45% on amounts in excess of a taxpayer’s exemption amount
(currently $3.5 million in 2009). The federal gift tax is imposed on
a taxpayer during his/her lifetime at rates ranging from 41% to 45%
in excess of a taxpayer’s exemption amount (fi xed at $1,000,000).
Oregon’s inheritance tax is imposed at rates ranging from 6.4% – 16%
on amounts in excess of a taxpayer’s exemption amount (fi xed at $1
million). Oregon does not have a gift tax.
If you have investments you perceive are likely to appreciate,
you may be able to utilize a variety of wealth transfer techniques that
will significantly reduce or eliminate your family’s estate, gift and generation-
skipping transfer (“GST”) taxes. Some of these techniques are
Technique #1 – Annual Exclusion Gifting
Before venturing into sophisticated strategies, the recent market
downturn provides an increased benefi t for basic annual exclusion
gifting. Currently, you can transfer up to $13,000 to any other individual
without incurring any gift tax and without the need to use any portion
of your $1 million lifetime gift tax exemption. If you are married, you
and your spouse together may gift a total of $26,000 to each donee.
Taking maximum advantage of the annual exclusion by making gifts to
your children, their spouses, and your grandchildren (or any other individual)
has always been a worthwhile “core” gifting strategy as it will
reduce your taxable estate in a tax-free manner. Additionally, you also
can exploit the annual exclusion through certain types of trusts, which
may be preferable if your goal is to defer your family’s enjoyment of the
gifted asset (see Technique #3 below).
The recent decline in the value of stocks and other traded securities
presents an opportunity to leverage an annual gifting program by
permitting you to gift low-value securities in lieu of cash, thereby transferring
any future value rebound to your descendants. Care should
be taken before undertaking an annual exclusion gifting program to
ensure that these gifts are coordinated with other wealth transfer techniques
that you may already have in place.
In deciding which stocks to gift, some thought should be given to the basis
in the gifted stock. The IRS provides the basis of a gifted asset to the
recipient is the lower of the market value on the date of the gift or
the basis in the donor’s hands.
Technique #2 – Below-Market Intrafamily Loans in Lieu of Gifting
If you desire to provide liquidity to your children or other family
members without making gifts, you can simply make a loan at a minimum
IRS-sanctioned interest rate. For example, in February 2009, you can lend
an unlimited amount of money to your child at a rate of 0.60% on a loan
with a term shorter than three years. Your child can use the proceeds for
anything such as purchasing a home, starting a business, making opportunistic
investments and paying down higher-interest debt. For loans of more than
three years and up to nine years, the current interest rate is 1.65%; for loans
with terms longer than nine years, the current rate is 2.96%. In each case, this
is a bargain compared to bank loans (if you can get one!) along with avoidance of
the need for stellar credit history or the ability to put up collateral.
With a “gift loan,” there is no requirement to include interest on the loan.
A gift loan is cumulative loan of less than $100,000 to an individual.
Technique #3 – Gifts in Trust
It is often advantageous for a donor to make gifts to benefi ciaries in
trust. Trusts are simple and flexible structures for holding assets that
allow a donor to determine the degree and timing of control the beneficiaries
will have over gifted assets, while removing the assets from the donor’s estate
for estate tax purposes. For example, a donor can determine whether a portion or
all of the gifted assets will be distributed to his or her child outright on
reaching designated ages or educational goals, and whether the trustee will
have discretion to direct assets away from the child to other family members
or to charity. The utilization of certain trusts can have additional tax planning
benefits. A donor can create an “intentionally defective” grantor trust,
which is a trust over which the donor retains specific powers (for example,
the power to substitute assets of equal value for trust assets) that results
in the donor being treated as the owner of the trust assets for income tax
purposes, but not for gift and estate tax purposes.
Since the grantor of a grantor trust is legally responsible to pay the income
taxes on the trust’s income, the payment of such taxes is not deemed a further
gift to the trust, thereby enabling the trust to grow for the beneficiaries on
an income tax-free basis.
Technique #4 – Grantor Retained Annuity Trust
A grantor retained annuity trust (“GRAT”) allows a donor to transfer any
appreciation in the value of property over a fi xed interest rate (2% for
February 2009 and reset monthly by the IRS) at a nominal gift tax cost. A
GRAT is an irrevocable trust to which the grantor contributes property for at
least two years while retaining the right to receive an annuity back from the
trust in cash or in kind at the end of each year. At the expiration of the GRAT
term, any remaining trust assets after payment of the annuities pass to the
trust’s remainderman (typically one or more defective grantor trusts for the benefit of
When the GRAT is created, the grantor is deemed to make a gift of the
remainder interest to the beneficiary. The annuity payments can be fixed,
however, such that the value of the GRAT remainder interest at the time of
the initial transfer is very close to zero, which will eliminate gift tax
exposure. A GRAT works particularly well when the value of the asset at the
funding of the GRAT is low, which may prove to be the case following the recent
decline in stock prices. Also, the interest rate set by the IRS currently is low
by historical standards, making it easier to produce a successful GRAT if such
asset appreciates. The current market is thus particularly attractive for the
creation of GRATs.
A GRAT will not produce benefits if the investment return on the GRAT
assets underperforms the fixed interest rate, or, if the grantor dies during
the GRAT term. Since a GRAT is a grantor trust, all GRAT income is taxable to
the donor, and none of the transfers between the GRAT and the donor is
taxable for income tax purposes.
A GRAT is especially effective for interests in closely held businesses.
For example, assume that under current market conditions
and after taking into account applicable discounts, the value of your
equity in an operating business is $1 million. Assume further that you
contribute that interest to a GRAT, and that during the GRAT term, the
company’s prospects improve to the point where the entire company
is sold. If the GRAT’s share of the (undiscounted) proceeds is $5 million,
almost $4 million will pass to your children free of gift and estate
Comparison of Intrafamily Loan and GRAT
The primary advantage of an intrafamily loan over a GRAT is
the lower interest rate required by the IRS. Therefore, it is easier
to pass value tax-free to your children. Additionally, the grantor is
not required to survive the loan term for this strategy to be successful,
whereas a GRAT requires the grantor to survive the entire GRAT
term, or the entire trust corpus is returned to his or her estate with no
A GRAT’s primary advantage over a loan is that it may be designed
to eliminate the risk of a significant taxable gift if the GRAT
investment is unsuccessful. If GRAT assets do not perform well (i.e.
appreciate) enough to fund in full the required annuity payments to the
grantor, then at the expiration of the GRAT term, the grantor receives
back whatever GRAT assets remain. The remainder beneficiary has
no obligation in respect of the shortfall and no gift tax is payable.
In contrast, if loan proceeds are lost and the loan cannot be repaid,
it would have to be forgiven and a taxable gift would be made with
potential income tax consequences. Another advantage of a GRAT
is that unsuccessful GRATS are essentially disregarded and do not
dilute positive investment performance of winning GRATs. Thus, the
potential to pass value to children using GRATs can be greater than
with a loan.
The aforementioned gifting strategies vary in complexity and,
depending on your situation, other strategies may be available. The
decision about which strategy or strategies to employ hinges upon
your goals and your family’s particular circumstances. It is important
to gain a full understanding of the various options available to you
prior to embarking on a gifting program. We encourage you to contact
Randall L. Duncan, Jonathan D. Mishkin or Doug Chiapuzio at (503)
242-0000, and we will be glad to assist you.
Randall L. Duncan
Direct Line: 541-417-6010
Jonathan D. Mishkin, LL.M.
Direct Line: 503-417-6007
1001 SW Fifth Avenue
Portland, OR 97204-1116
Phone: (503) 242-0000
Fax: (503) 241-1458
360 E. 10th Avenue, Suite 300
Eugene, OR 97401-3273
Phone: (541) 485-0220
Fax: (541) 686-6564
333 High Street, N.E.
Salem, OR 97301-3632
Phone: (503) 371-3330
Fax: (503) 371-5336
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relationship with you, constitutes the provision of legal advice, or creates any legal
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the Closely Held Business Team with the understanding that any attorney-client
relationship would be subsequently established by a specific written agreement
with Harrang Long Gary Rudnick P.C. To maintain confidentiality, you should not
forward any unsolicited information you deem to be confidential until after an attorney-
client relationship has been established.