Wills Insights

Today’s low interest rate environment, coupled with generous gift and estate tax exemptions, has made this an ideal time to effectively transfer wealth to heirs. Under the Internal Revenue Code (the “Code”), Section 7520, the Internal Revenue Service (the “IRS”) uses a rate based on 120 percent of the Midterm Applicable Federal Rate to discount the value of an annuity, an income interest for life or a term of years, or a remainder or reversionary interest in a trust to present value (hereinafter referred to as the “7520 Rate”). The IRS published the 7520 Rate (which varies from month to month) for September 2012 in Revenue Ruling 2012-24: the 7520 Rate is at the historically low rate of 1.0%. This presents attractive estate planning opportunities for those interested in the following techniques: (1) Grantor Retained Annuity Trusts (“GRATs”); (2) Charitable Lead Annuity Trusts (“CLATs”); and (3) Intra-Family Loans.

GRATs allow a person to transfer property with high appreciation potential to an irrevocable trust while also retaining the right to receive a fixed annuity payable at least annually for a chosen number of years. At the end of the annuity term, the remaining trust property passes to the grantor’s beneficiaries. The transfer of the property to the GRAT is a gift for gift tax purposes to the extent that the initial value of the trust property exceeds the present value of the grantor’s retained annuity interest for the month the GRAT is created. The present value of the grantor’s retained annuity interest is determined using the 7520 Rate for the month the GRAT is created. If the trust property appreciates at a rate exceeding the 7520 Rate, the grantor will be successful in passing wealth to the beneficiaries free of estate and gift taxes. The catch is that the grantor must survive the annuity term; otherwise, the trust property is included in the grantor’s estate for estate tax purposes at its date-of-death value. The minimum annuity term of a GRAT is currently two years.

Those with charitable impulses may want to consider using CLATs. Under the terms of a CLAT, a charity receives annuity payments for the term of the trust; at the end of the term, the balance of the property remaining in the CLAT passes to one or more non-charitable beneficiaries (e.g., the children of the donor). The annuity amount is valued by assuming that the charity’s lead interest will earn a rate equal to the 7520 Rate for the month the donor funds the CLAT. Accordingly, donors also benefit from a CLAT in a low interest rate environment because the investment performance must exceed only the 7520 Rate to result in the passing of wealth without estate and gift taxes; while outside the scope of this alert, there are Generation-Skipping Transfer Tax implications if the non-charitable beneficiaries include certain related individuals (e.g., grandchildren of the donor).