High Interest Rates Have an Impact on Estate Planning – Annapolis and Towson Estate Planning

The Section 7520 rate has been low for the past 15 years and presented many opportunities for good planning. What happens when inflation has returned and rates are moving up, asks a recent article titled “Estate Planning Techniques in a High—Interest—Rate Environment” from Bloomberg Tax – Annapolis and Towson Estate Planning.

The Section 7520 rate is the interest rate for a particular month as determined by the IRS. It is 120 percent of the applicable federal midterm rate (compounded annually) for the month in which the valuation date falls and rounded to the nearest two-tenths of a percent. It is used for actuarial planning, to discount the value of annuities, life estates and remainders to present value, and is revised monthly.

In January 2022, the 7520 rate was at 1.6%, but as interest rates increased, it shot up and in December 2022 was 5.2%. This was a 225% increase—unprecedented in the history of the 7520 rates. However, there are four key planning concepts which may make 2023 a little brighter for estate planning attorneys and their clients.

Higher inflation equals higher exemptions. Certain inflation adjusted exemptions and exclusions increased on January 1, 2023. The federal transfer tax exemption rose by $860,000 to $12.92 million, and the annual gift tax exclusion increased to $17,000 from $16,000 in 2022.

These increases give wealthy families the opportunity to make generous new gifts to family members without triggering any transfer taxes. Those who have fully used transfer tax exemptions may wish to consider making additional transfers.

Shift charitable giving to CRTs for higher interest rates. People who might have started Charitable Lead Trusts should instead look at Charitable Remainder Trusts. With both CLTs and CRTs, the value of the income and remainder interests are calculated using the 7520 rates. The key difference, for estate planning purposes, is the impact of a rising rate on the amount of the available charitable deduction.

The return of the QPRT. Qualified Personal Residence Trusts have been hibernating for years because of low interest rates. However, the time has come to return them to use for wealth transfer. A QPRT lets a person transfer a residence at a discounted value, while retaining the right to occupy the residence for a number of years. The 7520 rate is used to determine the value of the owner’s retained interest. The higher the rate, the more value retained by the owner and the smaller the amount of the taxable gift to the remainder beneficiaries, usually the owner’s children.

GRATs still have value. A Grantor Remainder Trust should still be considered in estate planning. A GRAT is more appealing in a low interest environment. However, a GRAT can still be useful when rates are rising. The success or failure of the GRAT usually depends on whether the assets transferred to the GRAT appreciate in value at a rate exceeding the 7520 rates, since the excess appreciation is transferred to the remainder beneficiaries’ gift tax-free. A GRAT can also be structured as a zeroed-out GRAT. This means that the transfer of assets to the GRAT doesn’t use any of the grantor’s transfer tax exemption or result in any gift tax due. This is still of value to a person who owns assets with significant growth potential, like securities likely to rebound quickly from depressed 2022 values.  Contact us to review your estate plan with one of our experienced estate planning attorneys.

Reference: Bloomberg Tax (Dec. 23, 2022) “Estate Planning Techniques in a High—Interest—Rate Environment”

 

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys

What Happens to Stock Options when Someone Dies? – Annapolis and Towson Estate Planning

Once your business grows, so does the pressure to make good financial decisions in the short and long term. When you think about the future, estate and succession planning emerge as two major concerns. You are not just considering balance sheets, profits and losses, but your family and what will happen to them and your business when you are not around. This thinking leads to what seems like a great idea: transferring stock or LLC membership units to one or more of your adult children.

There are benefits, especially the ability to avoid a 40% estate tax and other benefits. However, there are also lots of ways this can go sideways, fast.

Executing due diligence and creating an exit plan to minimize taxes and successfully transfer the business takes planning and, even harder, removing emotions from the plan to make a good decision.

An outright transfer of stock or ownership units can expose you and your business to risk. Even if your children are Ivy-league MBA grads, with track records of great decision making and caring for you and your spouse, this transaction offers zero protection and all risk for you. What could go wrong?

  • An in-law (one you may not have even met yet) could try to place a claim on the business and move it away from the family.
  • Creditors could seize assets from the children, entirely likely if their future holds legal or financial problems—or if they have such problems now and have not shared them with you.
  • Assets could go into your children’s estates, which reintroduces exposure to estate taxes.

No family is immune from any of these situations, and if you ask your estate planning attorney, you will hear as many horror stories as you can tolerate.

Trusts are a solution. Thoughtfully crafted for your unique situation, a trust can help avoid exposure to some estate and other taxes, allocating effective ownership to your children, in a protected manner. Your ultimate goal: keeping ownership in the family and minimizing tax exposure.

A Beneficiary Defective Inheritance Trust (BDIT) may be appropriate for you. If you have already executed an outright transfer of the stock, it is not too late to fix things. The BDIT is a grantor trust serving to enable protection of stock and eliminate any “residue” in your children’s estates.

If you have not yet transferred stock to children, do not do it. The risk is very high. If you have already completed the transfer, speak with an experienced estate planning attorney about how to reverse the transfer and create a plan to protect the business and your family.

Bottom line: business interests are better protected when they are held not by individuals, but by trusts for the benefit of individuals. Your estate planning attorney can draft trusts to achieve goals, minimize estate taxes and, in some situations, even minimize state income taxes.

Reference: The Street (June 27, 2022) “Should I Transfer Company Stock to My Kids?”

 

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys