The ongoing rise in capital markets has likely created significant wealth for many of your high-net-worth clients. Although the estate tax exemption currently stands at a generous $5.43 million per individual, the wealthiest clients continue to seek estate and gift tax mitigation strategies. For clients whose net worth exceeds the exemption threshold, now may be an excellent time to implement estate planning strategies designed to take advantage of today's historically low interest rates.
Section 7520 of the Internal Revenue Code provides for a key interest rate that is used to value certain interests involved in various estate planning strategies, including annuities, life interests, interests for a term of years, and remainder and reversionary interests. Published monthly by the IRS, the Section 7520 rate is based on the midterm applicable federal rate, or AFR. As of May 2015, the Section 7520 rate stands at a low 1.8%, making certain gift and estate tax planning strategies very attractive.
Let's take a brief look at several strategies that may be appropriate for some of your wealthiest clients.
Strategy One: Intrafamily Loans
An intrafamily loan is one of the simplest ways to take advantage of low rates. Simple doesn't mean ineffective, however. With an intrafamily loan, wealthy parents and grandparents can provide their children and family members with access to capital at a very low interest rate compared with loans available through traditional retail banks.
Why would clients charge their family members any interest at all? The answer is gift taxes.
In addition to the Section 7520 rate, the IRS publishes short-term, midterm, and long-term AFRs that represent the minimum interest to be charged on loan instruments in order to avoid triggering gift taxes. The rates as of May 2015 are as follows (compounded annually):
– Short-term rate (for loans with terms of three years or less): 0.48%
– Midterm rate (for loans with terms of between three and nine years): 1.53%
– Long-term rate (for loans with terms over nine years): 2.30%
As long as these minimum interest rates are applied based on the proper loan term, clients can avoid triggering a taxable gift while helping family members buy a home, start a business, or make other investments. If those ventures produce a rate of return that exceeds the rates mentioned above, those proceeds are not considered part of the client's taxable estate.
Strategy Two: Grantor Retained Annuity Trusts (GRATs)
