Never has the lifetime exemption been so high, and current interest rates are at unprecedented lows. Change may be on the horizon which makes planning today so important.
- The 2020 lifetime exemption is $11,580,000 per individual; $23,160,000 for a married couple.
- The 2020 annual gift tax exclusion is $15,000 per individual; $30,000 for a married couple.
An effective wealth transfer option for you to consider is an Intentionally Defective Grantor Trust (IDGT).
An IDGT is an estate planning tool used to transfer wealth to family members during the life of the Grantor.
- “Intentionally Defective” means that the Grantor reports the taxable income earned by the trust on the Grantor’s personal income tax return.
- Assets in the trust continue to appreciate in value and are excluded from the Grantor’s estate for estate tax purposes.
Funding Options – Gift and Installment Sale
- The Grantor makes an irrevocable gift of selected assets to the IDGT.
- Gifting appreciating assets is beneficial since the appreciation can be retained by the trust and passed to the beneficiaries free of estate and gift tax.
- Transfers to an IDGT are taxable gifts that will reduce the Grantor’s remaining lifetime exemption.
- The Grantor may also sell assets to an IDGT.
- The sale is not taxable for income tax purposes because the IDGT is a Grantor trust for income tax purposes. The Grantor is treated as having sold the assets to himself/herself.
- The Grantor receives an interest-bearing promissory note from the trust in exchange for the sale of the assets.
- Interest payments must be made annually.
- Principal can be paid during the term of the note or postponed until the end of the note term.
- The annual interest payments to the Grantor are not taxable.
- The interest rate can be based on the Applicable Federal Rate which is only 0.67 percent for an installment sale created in October 2020.
The beneficiaries of IDGTs are typically children or grandchildren who will receive assets that have been able to grow without reductions for income taxes.
The IDGT can also be created as a Dynasty Trust allowing assets to pass to future generations free of estate tax.
An additional effective wealth transfer option is a Grantor Retained Annuity Trust (GRAT).
A GRAT is created when a donor (the Grantor) contributes assets with appreciation potential to a fixed term, irrevocable trust. A GRAT allows the Grantor to transfer future appreciation to the next generation with little or no gift tax liability.
- Securities, business interests, or real estate with expected appreciation are the ideal assets to use with this technique.
- A GRAT exists for a specified number of years referred to as the term.
- During the term of the trust, the GRAT’s taxable income is reported on the Grantor’s personal income tax return.
- The Grantor receives an annuity payment each year during the term equal to a percentage of the initial fair market value of the GRAT assets plus an interest factor based on the IRS Section 7520 rate.
- The October 2020 Section 720 rate is a very low 0.4 percent.
- The annual annuity payment may be paid in cash or paid with assets held in the GRAT.
- The annuity payment is not taxable to the Grantor.
- At the end of the term, the remaining GRAT assets are distributed to named beneficiaries.
- The value of the assets remaining in the GRAT at the end of the fixed term will not be included in the Grantor’s gross estate and pass to the beneficiaries free of gift tax.
- The Grantor must outlive the term of the GRAT for the planning to be successful.
Please contact our office if you would like to discuss using an IDGT, GRAT or both as a tool(s) for your estate planning.