Rothschild says that in addition to making gifts, advisors should be advising clients to use these two estate-planning techniques before the year ends. With asset values slammed by the economic recession, he says it's wise for business owners, investors in real estate, and other asset holders to place assets in a family limited partnership and discount the value of those assets because of the illiquidity of the FLP. The discounting, along with depressed asset prices, can result in huge estate-tax savings, though the strategy is likely to be barred by revenue-seeking legislators aiming to boost the estate-tax exemption.
GRATs, the other estate-tax-saving technique likely to be targeted by reform in 2011, are attractive these days because of the combination of depressed asset values and low interest rates. It's a popular way of passing money to children and grandchildren tax-free. President Obama's fiscal 2010 budget proposal last year and his 2011 budget proposal again this year suggested reining in GRATs. Nothing happened, of course. But GRATs are unlikely to survive 2011 estate-tax reform. If a client has been thinking of a GRAT, now is the time to act.
With a GRAT, a grantor puts assets into a trust and gets an annuity payout. After two to three years, typically, anything left in the trust goes to the grantor's children or other trust beneficiaries. The annuity rate is based on the government's applicable federal rate (AFR), which is low, especially with low prevailing rates. At the end of the annuity payout period, the children receive the excess return above the AFR tax-free.
Another simple year-end technique, says Rothschild, is to simply loan money to a trust. With the current applicable AFR at 1.7%, for example, a wealthy client can loan $5 million for up to nine years to a trust established for the benefit of his children. The trust could pay interest on the loan to the client at the 1.7% AFR, but any earnings beyond that rate can build up tax-free. So if the $5 million loan to the trust earns 400 basis points more annually than the 1.7% AFR, that amounts to $200,000 a year, and at the end of nine years the $1.8 million can pass to the client's child tax-free.
Generation-Skipping Tax Break
Not only is there no estate tax for 2010, but there also is no generation-skipping tax (GST). Next year, assuming Congress does nothing to revise GST rules, grandparents who have exceeded their $1 million lifetime gift tax exemption will face an extra-heavy burden on gifts to their grandchildren-a 55% gift tax rate plus a 55% GST tax rate. Grandparents have between now and the end of the year to consider making a gift to a grandchild to avoid the 55% GST and higher gift tax rate.
Grandparents must, however, be mindful: The grandchildren receiving their gifts should not be minors. Grandparents also have to consider otherwise that they might be giving control of the gifts to adults who are very young.
The reason the grandchild cannot be a minor is that gifts for GST tax purposes must be made directly to an individual. When a gift is made to a child under 18, the vessel holding the assets must be a custodial account or trust so it can be controlled by an adult. When the child turns 18, the money in the custodial account or trust would be distributed to the child and it would then be subject to the 55% GST levy-defeating the purpose of making the gift now.
In addition, grandparents making a gift to a grandchild who is 18 or 19 are giving full control to somebody who may invest it all in a dot-com company, an oxygen bar or a tattoo parlor. But under the right circumstances-where you have an older, more mature grandchild-it's a sensible strategy that will allow you some final days to avoid GST.
Editor-at-large Andrew Gluck, a veteran financial writer, owns Advisor Products Inc., a marketing technology company serving 1,800 advisory firms.