The Results of the Georgia Senate Runoff Election, Coupled with Depressed Asset Values, Near- Historic Low Interest Rates and Continued Market Volatility Create Unparalleled Estate Planning Opportunities to Save Future Estate and Gift Taxes

A new environment is starting to take shape in 2021, and with it comes additional considerations to factor into one’s estate planning. As a result of the success of Georgia Senate candidates Raphael Warnock and Jon Ossoff in their respective Senate races on January 5, the makeup of the new Senate is 50 representatives per party, with Democratic Vice President Kamala Harris holding a tiebreaking vote. This may indicate a heightened possibility of passing key initiatives in President Joe Biden’s agenda, and a realistic possibility of some measure of estate, gift and generation-skipping transfer (GST) tax reform in 2021. Such tax reform may not only decrease estate, gift and GST tax exemptions and increase tax rates; it also may seek to implement some of the proposals that were included in the Obama administration’s “Green Book” that would limit the availability of the tax benefits to be obtained through such popular estate planning techniques as grantor retained annuity trusts (GRATs) and sales and “swaps” with intentionally defective grantor trusts (IDGTs).  Such tax reform may also reduce or eliminate the availability of discounts for family-controlled entities that do not engage in an active trade or business, and limit the availability of the ”step-up in basis” to fair market value upon death. 

Although it may be possible from a U.S. constitutional standpoint, the likelihood that such tax reform legislation would be made retroactive to January 1, 2021 is generally considered to be remote. Accordingly, there is a potential window for estate planning opportunities in 2021 before new tax legislation may be enacted. And given the continuing health and economic risks posed by coronavirus (COVID-19), there is a continuing need to review and update one’s current estate planning documents to ensure they protect oneself and one’s family’s health and finances and achieve immediate and long-term objectives.   

I. It Is Essential to Review Your Estate Planning Documents

In these unprecedented times, it is more important than ever to review your “fundamental” estate planning documents to ensure that they protect you and your family, and carry out your wishes. By “fundamental” estate planning documents, I refer to your will, including a revocable living trust (“revocable trust”), which may be used as a “will substitute,” healthcare proxy and durable power of attorney. You should also review your beneficiary designations for your life insurance policies and retirement plan benefits.  These designations, which govern the disposition of assets passing outside of your will or revocable trust, should be coordinated with your overall estate plan.           

Healthcare proxies and durable powers of attorney. Under your healthcare proxy, you designate someone to make healthcare decisions for you if you are unable to make them yourself. You may name successor agent(s) to serve one at a time. It is very important to discuss your personal wishes regarding your medical care with your health care agent in advance.  

Under your durable power of attorney, you designate one or more individuals to manage your financial affairs, particularly during periods of disability. In a special rider, you may also authorize your agent(s) to make gifts on your behalf. You should likewise discuss your financial management and gifting objectives with your agent(s). In December 2020, Governor Andrew Cuomo signed into law a New York power of attorney statute that will generally simplify the current New York statutory short form power of attorney, but this new law is subject to further amendments by the New York legislature and, in any event, is not scheduled to go into effect until June 2021.   

Given the pervasiveness of the coronavirus, it is important that all adult family members have healthcare proxies and powers of attorney in place.                                              

Wills and revocable trusts. It is generally a good practice to periodically review the provisions of your will to be certain that they carry out your wishes in light of intervening changes in family circumstances, material assets and tax legislation. The dramatic impact of the COVID-19 crisis continues to make such a review more important than ever before. 

Making changes to an existing estate plan or creating a new plan can now all be done remotely–from in-depth discussions, to the drafting and review of planning documents, and even the witnessing of wills and notarization of trust agreements and other planning documents. All of this can be accomplished while maintaining social distancing.

Revocable trusts take on added significance in the current environment. A primary reason for using a revocable trust is to provide for the continuous and active management of your assets during periods of disability and immediately following your death. Given the current state of intense market volatility, even brief interruptions in the ability to manage assets can have dire consequences.

Importantly, revocable trusts may be fully or partially funded during your lifetime. The advantages of doing this are twofold. First, this will avoid delays associated with probate of a will. Currently, there are longer waits in probating a will and appointing an executor to manage a decedent’s assets. Most of the probate courts are operating at reduced hours. During these delays, a decedent’s assets are “frozen” and subject to market turbulence. 

Revocable trusts can be used as “will substitutes” and provide continuous management of assets immediately following death, provided that they are funded during your lifetime. Your trustees will be able to immediately implement the terms of your estate plan, including making assets available to your heirs.

Second, fully or partially funding a revocable trust provides a mechanism for management of assets during one’s lifetime should this be necessary, such as in the event of future incapacity.  This option avoids having to rely exclusively on a durable power of attorney. Many financial institutions can be slow in giving effect to instructions by the attorney-in-fact under current law (although the New York power of attorney statute scheduled to take effect in June 2021 would change that), leaving the assets vulnerable to market shifts. 

All of these problems can be avoided to the extent that a revocable trust has been funded during your lifetime. (It may also be possible to avoid these difficulties by using financial accounts that are payable upon death to a particular individual, such as joint accounts with right of survivorship, “Totten trusts,”  “payable on death” or “transferable on death” accounts, or by creating and funding limited liability companies that designate successor managers.) 

II. Depressed Asset Values, Coupled With Near-Historic Low Interest Rates, Intense Market Volatility and High Estate, Gift and GST Tax Exemptions Create Unprecedented Estate Planning Opportunities for Affluent Individuals

The COVID-19 crisis had a swift and stunning impact on the valuation of almost all classes of assets, ranging from stock in public companies to closely held businesses. Although the public equity markets have generally recovered, the long-lasting impact of this crisis on private equity and real estate holdings, coupled with the current state of market uncertainty, creates unprecedented estate planning opportunities for wealthy individuals to transfer wealth to children and more remote descendants with minimum gift tax and estate tax exposure.

There may be reasons to act sooner than later in deploying any of these planning strategies.  You may wish to secure the use of your federal gift and GST tax exemptions before the gifted assets may recover value, or Congress may act to cut back the size of these exemptions.  Currently, the federal estate, gift and GST exemptions are unified at the highest historical level of $11,700,000 per individual or $23,400,000 for a married couple. These exemptions are scheduled to “sunset” to roughly one-half of these amounts (as indexed for inflation) on January 1, 2026. In light of the 2020 election, there is some concern that given the huge Federal deficits that have been amassed to pay for the federal stimulus programs, these exemptions could be scaled back sooner. It is also possible that the current New York estate tax exemption of $5,930,000 for New York residents who die in 2021 may be reduced by the New York state legislature, given the massive costs to the state in responding to the COVID-19 crisis and looming deficits.  

Although it is currently difficult for many appraisers to quantify the impact of the COVID-19 disaster on the valuation of many types of assets, it may be important to implement these strategies before assets regain value and/or the federal or state estate tax exemptions may be scaled back. Even if the exemptions are not reduced, it is better to implement gifts sooner rather than later to keep future appreciation and subsequent income out of your estate. Please also bear in mind that New York adds back certain taxable gifts made within three years of death for estate tax purposes. New York residents may wish to embark upon gifting or leverage transfer programs to start the three-year risk period running and to permanently reduce their New York taxable estate to avoid the New York estate tax cliff. This cliff, which is built into the New York estate tax calculation, effectively wipes out the New York estate tax exclusion for wealthy residents whose estates exceed 105% of the exclusion amount in effect at the time of their death.                       

Taking advantage of depressed asset values and valuation discounts. The COVID-19 crisis has significantly impacted the value of many asset classes including real estate, closely held business interests, and art. Furthermore, discounts for minority interests and lack of marketability are running higher due to current market conditions. These factors can create a unique opportunity to transfer assets to trusts for the benefit of lower-generation family members while their valuation is extraordinarily low. 

There are certain trusts to which assets having depressed values can be transferred to maximize the use of the federal gift and GST tax exemptions before they revert to lower levels. Trusts that are attractive include dynasty trusts or GST trusts. Through coordinated use of federal gift and GST tax exemptions, individuals can create trusts with an aggregate value up to $11,700,000 per individual ($23,400,000 for married couples) which may benefit several generations of descendants while insulating the assets from gift, estate, and GST taxes. 

Dynasty trusts can be structured to give the grantor’s spouse access to trust assets as a discretionary beneficiary. Such trusts, which are sometimes referred to as “spousal lifetime access trusts” (SLATs), can also include children and grandchildren as discretionary beneficiaries.  

Alternatively, trusts for the sole lifetime benefit of the spouse can be structured to be eligible for a qualified terminable interest property (QTIP) election on a timely filed federal gift tax return (including extensions) by making the spouse the sole beneficiary of the trust during the spouse’s lifetime and requiring that all of the trust income be paid to the spouse at least annually. By doing this, the grantor would have until she or he files a gift tax return in 2022 (potentially as late as October 15, 2022 via an extension) to determine whether or not, and to what extent, to make a QTIP election. A QTIP election would be made to qualify the property transferred to the trust for the gift tax marital deduction and thereby protect against gift tax in the event that the gift tax exemption were retroactively reduced by subsequent legislation. In the event that there were no retroactive reduction to the gift tax exemption, then the decision could be made to bypass a QTIP election and thereby consume the grantor’s available gift tax exemption to remove property from her or his gross estate before the gift tax exemption is potentially reduced by subsequent prospective legislation. There are other techniques, such as formula clause provisions, that may work to achieve this result, but none of them is statutorily blessed in the Internal Revenue Code and therefore “iron-clad” to the same extent as a QTIP election.  

Gifts or sales to IDGTs can be an extremely effective planning strategy that takes advantage of current market conditions. In the case of a gift or a sale of a minority interest in an entity or a fractional interest in real property, valuation discounts can be used to leverage the gift and GST tax exemptions. Individuals who have previously exhausted their exemptions through prior gifting may wish to enhance their gifting. As discussed below, the interest rates that can be used for these purposes are currently extraordinarily low; there may also be significant income tax advantages.

As mentioned above, it is possible that the Biden administration will seek to revive certain Green Book proposals made during the Obama administration that would limit the ability to use transactions with IDGTs to keep subsequent appreciation outside of one’s estate for estate tax purposes. So there is a potential benefit to planning with IDGTs at this time before any such potential legislation may be enacted.

Taking advantage of the near-historic low interest rates and valuation discounts. The tax rules allow taxpayers to lend money or refinance existing loans at the very low current interest rates. The low interest rate environment also produces a lower hurdle rate for GRATs.

Each month, the IRS publishes interest rate tables that establish the lowest rate that, if properly documented, can be safely used for loans between family members without producing a taxable gift. These interest rates are near-historic lows–for March 2021, the short-term rate for loans of up to three years is 0.11%; the mid-term rate for loans of more than three years and up to nine years is 0.62%; the long-term rate for loans exceeding nine years is 1.62%. Funds that are lent to children, or to a trust for the benefit of children, will grow in the senior family member’s estate at this extraordinarily low interest rate, essentially creating a partial estate freeze plan. Those funds, in turn, can be put to use by the junior family member to purchase a residence or may be invested in a manner that hopefully will beat the hurdle interest rate. Existing loans can be refinanced at the applicable federal rate (AFR). This may also be the perfect time to make new sales to existing or new intentionally defective grantor trusts to take advantage of these near historic low rates. This can produce significant annual savings within the family.

Making a loan to a trust for your children may be even more advantageous than making a loan outright if the trust is intentionally structured as a grantor trust for income tax purposes. Ordinarily, the interest payments on the note must be included in your taxable income, but if the payments are made by a grantor trust, they will have no income tax ramifications to you.

Alternatively, depending upon your circumstances, it may be more advantageous for senior family members to put some of their expanded federal gift and GST tax exemptions to work by making cash gifts to facilitate the prepayment of existing loans to family members, and to trusts established for their benefit.

As mentioned above, it is possible that the Biden administration will seek to reduce or eliminate the availability of discounts for family-controlled entities that do not engage in an active trade or business.

Using GRATs to Take Advantage of Depressed Asset Values, the Near Historic Low Hurdle Rate and the Extreme Market Volatility

Intense market volatility, coupled with the low interest rates and reduced asset values, can produce extraordinary estate planning results through the use of GRATs.

GRATs are a popular technique used to transfer assets to family members without the imposition of any gift tax and with the added benefit of removing the assets transferred to the GRAT from the transferor’s estate (assuming the grantor survives the initial term, which can be as short as two years).

In a GRAT, you transfer assets to a trust, while retaining the right to receive a fixed annuity for a specified term. The retained annuity is paid with any cash on hand or, if there is no cash, with in-kind distributions of assets held in the trust. At the end of the term, the remaining trust assets pass to the ultimate beneficiaries of the GRAT (for example, your children and their issue or a trust for their benefit), free of any estate or gift tax.

The GRAT can be funded with any type of property, such as an interest in a closely held business or venture, hedge fund, private equity fund or even marketable securities. The most important consideration is whether the selected assets are likely to appreciate during the GRAT term at a rate that exceeds the hurdle rate (an interest rate published by the IRS every month). The value of the grantor’s retained annuity is calculated based on the IRS hurdle rate–the lower the hurdle rate, the lower the annuity that is required to zero out the GRAT. The hurdle rate is 0.8% for transfers made in March 2021. If the trust’s assets appreciate at a rate greater than the interest rate, the excess appreciation will pass to the ultimate beneficiaries of the GRAT free of any gift tax. Any asset that you think will grow more than 0.8% per year may be a good candidate for funding a GRAT. 

GRATs potentially perform well in times of intense market turbulence, particularly when funded with marketable securities. With the hurdle rate so low and the Dow Jones and S&P 500 gyrating significantly above the hurdle rate within short periods of time, funding GRATs with marketable securities will often be a successful strategy. To enhance the likelihood of success, at any time during the GRAT term, the grantor can swap personal assets (such as cash and bonds) with assets in the trust to “lock in” the tax-free appreciation for the benefit of family members.

Other factors to take into account in selecting the assets to be gifted are whether the assets currently have a low valuation or represent a minority interest (which may qualify the assets for valuation discounts for lack of control and lack of marketability under current law).

Generally, the GRAT is structured so as to produce little or no taxable gift. This is known as a “zeroed-out” GRAT. Under this plan, the annuity is set so that its present value is roughly equal to the fair market value of the property transferred to the GRAT, after taking into account any valuation discounts. There is virtually no gift tax cost associated with creating a zeroed-out GRAT.

Other benefits of a GRAT bear mentioning. The transfer to a GRAT is virtually risk-free from a valuation perspective. If an asset for which there is no readily ascertainable market value is transferred to a GRAT, and the IRS later challenges the value that you report for gift tax purposes, the GRAT annuity automatically increases in order to produce a near-zero gift. Accordingly, there is essentially no gift tax exposure. It should be noted, however, that GRATs generally do not provide the same opportunity for leverage for GST tax purposes that other estate planning techniques can provide in connection with transfers to or for the benefit of grandchildren or more remote descendants.

As previously mentioned, it is possible that the Biden administration will seek to revive certain Green Book proposals made during the Obama administration that would limit the effectiveness of GRATs by requiring a 10-year minimum term and imposing a minimum remainder gift requirement such as 25% of the value of the property transferred to the GRAT.  So there is a potential significant benefit to using GRATs at this time before any such legislation may be enacted.

Income Tax Considerations

GRATs, SLATs (including QTIPs), IDGTs and certain dynasty trusts can also enjoy income tax advantages.  These trusts can be structured as a “grantor trust,” meaning that you must pick up all items of income, credit and deduction attributable to the trust property on your personal income tax return. Being saddled with the income tax liability may seem like a burden, but it is actually a great estate planning advantage, in that it allows the trust property to grow income tax free for the beneficiaries, while reducing your estate gift tax free. 

As noted above, another important feature of a grantor trust is that the trust can permit the grantor to swap personal assets with assets in the trust. This can be a very valuable technique for income tax basis planning to reacquire low basis assets to allow for a step-up in basis upon death for income tax purposes (subject to possible proposals to limit the step-up under subsequent law).

Kevin Matz, Esq., CPA, LLM (Taxation), is a partner in both the private client services group and the family office group at the New York City law firm of Stroock & Stroock & Lavan LLP, where his practice is principally devoted to domestic and international estate and tax planning, family office services, estate administration and related litigation. He earned his JD from Fordham University School of Law, New York, N.Y. and his LLM in taxation from New York University School of Law, New York, NY. He is a Fellow of the American College of Trust and Estate Counsel (ACTEC). He currently serves as a director on the NYSSCPA Board of Directors and on the FAE Board of Trustees. He may be contacted at 212-806-6076 or kmatz@stroock.com.