2020 was a year of substantial wealth transfer for many families due in large part to the uncertainty surrounding the election outcome and possibility for tax reform in 2021. In particular, many individuals made large gifts in 2020 to take advantage of the historically high gift and generation-skipping transfer (GST) tax exemptions, concerned that these exemptions could be significantly reduced under a Biden presidency. Although uncertainty surrounding the likelihood of tax reform continues for the moment, there are still several wealth transfer strategies that can be considered by those wanting to make gifts. For those who have already used a significant portion or all of their exemptions, some of those strategies include:
1. Gifts
Even if an individual or couple previously used their gift and GST tax exemptions, they can still make additional gifts outright or in trust using the following types of gifts:
• 2021 inflation adjustment amount. The gift and GST tax exemption amounts are currently indexed for inflation and, for 2021, those exemptions were increased to $11.7 million from $11.58 million in 2020. Accordingly, each individual has an additional $120,000 of gift and GST tax exemption that can be used this year.
• Annual exclusion gifts. Individuals can make certain gifts up to $15,000 per donee ($30,000 for married couples), which do not count towards their gift and estate tax exemptions.
• Direct payments for tuition and medical expenses. Without depleting the annual exclusion or gift and GST tax exemptions, individuals can pay for educational, dental and medical expenses for family members or friends as long as the expense is paid to the provider directly.
2. Grantor Retained Annuity Trust (GRAT)
A GRAT is an irrevocable trust in which the grantor makes a gift of property in trust while retaining a right to an annual payment (annuity) from the trust for a specified term of years. GRATs can be used for a variety of assets, including concentrated positions and assets expected to appreciate significantly. Key characteristics of this strategy include:
• The right to the annuity is a retained interest that has a value; this value is subtracted from the full value of the transferred property when determining the taxable amount of the gift.
• If the grantor survives the annuity term, any amount remaining in the trust at the end of the annuity term passes to its beneficiaries without additional gift or estate taxes.
• If the grantor dies during the annuity term, the entire value of the trust generally will be included in the grantor’s taxable estate as if the GRAT had never been created.
One of the primary benefits of a GRAT is that it can be structured so that the gift tax value is almost zero, meaning that highly appreciating assets can be transferred to the next generation without creating a taxable gift. This can be particularly attractive if clients have already exhausted their gift tax exemption.
3. Sale To Grantor Trust
The sale to grantor trust strategy takes advantage of the significant differences between the income and transfer tax treatment of irrevocable trusts. The goal of this strategy is to transfer anticipated appreciation of assets at a reduced gift tax cost. Key characteristics of this strategy include:
• In return for the transfer of property, the trust gives the grantor a note, which carries a market rate of interest and usually requires a balloon payment of principal at the end of the note’s term.
• In most instances, when a trust is a grantor trust, the grantor and the trust are treated as the same taxpayer for income tax purposes, but two separate entities for transfer tax purposes.
• Because the grantor and trust are the same taxpayer for income tax purposes, neither the sale nor the note payments trigger income tax.
• When the note is repaid, the grantor has transferred the appreciation with no tax liability.
This strategy may be especially timely for those who have funded a trust using their gift tax exemption, as this technique typically requires some “seed” funding of the trust prior to a sale. The ability to lock in current market interest rates, which continue to trend near historical lows, also can significantly benefit the overall transaction.
4. Intra-Family Loans
An individual can make loans to family members at lower rates than commercial lenders without the loan being deemed a gift. Key characteristics of this strategy include:
• An intra-family loan allows an individual to assist family members financially without incurring additional gift tax.
• A bona fide creditor relationship, including the payment of interest, is established.
• Wealth can be shifted if the loan assets are invested by the borrower and earn a higher return than the required interest rate.
• Interest is paid within the family rather than to a third-party lender.
Entering into new intra-family loans or refinancing existing loans remains a timely opportunity as interest rates continue to be very low.
These are just a few of the strategies that may be considered for achieving wealth planning goals. Although it is always important to work with qualified professionals when choosing and implementing planning strategies, it is even more important this year due to the uncertainty of tax reform, retroactive or otherwise, that could impact some of the planning strategies discussed above. To address some of this uncertainty, planners may consider the use of additional techniques—such as disclaimers, formula gifts, and QTIP provisions—to add flexibility and minimize potential gift tax exposure.
Caroline McKay is a senior wealth strategist for CIBC Private Wealth Management in Boston, with 14 years of industry experience. In this role, she is responsible for developing integrated wealth management solutions and providing comprehensive estate and financial planning services to high-net-worth clients.