Don’t let the chaos of the holiday season prevent you from minimizing federal estate taxes and fine-tuning your estate plan. What better gift for your heirs than avoiding the 40% federal estate tax and making sure your affairs are all in order? Although many of the tips discussed below are not time sensitive, year-end is a good time to revisit and review these matters.
9.) Take Advantage of the Gift Tax Exemption. If you wait until you die to use your gift and estate tax exemption, you may be “wasting” your exemption. By gifting property that has the potential to appreciate in value to your heirs now rather than at death, you are removing both the appreciation and the after-tax income generated by the gifted property from your taxable estate. However, if you will not have a taxable estate, your heirs will be better off inheriting the appreciated property at your death because they will receive a “stepped-up” basis in the property equal to the property’s date-of-death value. Thus, your heirs will pay less or no capital gains when they sell the inherited property.
10.) Take Advantage of Low Interest Rates. A simple and often overlooked transfer technique is an intra-family loan. The loan must bear an interest rate of at least the applicable federal rate (AFR), which is now at all-time lows. The annual rates for December 2015 (semi-annual compounding) are: 0.56% (short-term – less than 3 years); 1.68% (mid-term – between 3 and 9 years); and 2.61% (long-term – more than 9 years). If your child or grandchild can earn more than the AFR that he/she has to pay back to you (the hurdle rate), the child pockets the difference free of gift tax.
11.) Consider Freeze Techniques. If you have a taxable estate, low interest rates can be exploited by “freeze” techniques, such as installment sales to irrevocable grantor trusts and grantor retained annuity trusts (GRATs). A sale to a grantor trust uses the AFR, and a GRAT uses the IRC Section 7520 rate (which is 120% of the mid-term rate – 2% for December 2015). Both techniques remove the appreciation over and above the “hurdle” rate from your estate, but with better leverage than a simple loan.
12.) Basis Step-Up Planning. If you have funded an intentionally-defective grantor trust (IDGT), year-end is a good time to consider swapping cash or high basis assets for low basis assets held in the IDGT. It is better to own the low basis assets at death so that your heirs will receive a basis step-up to the asset’s fair market value at the date of death.
13.) Anticipating New Regulations Under IRC Section 2704. The Treasury Department has indicated that proposed regulations are forthcoming that are intended to place new limits on valuation discounts (e.g., for lack of control and lack of marketability) associated with interests in family limited partnerships (FLPs) and family limited liability companies (FLLCs). Given the uncertainty regarding the scope of the proposed regulations and effective date, it is strongly recommended that planning for interests in FLPs, FLLCs and other family-controlled entities be completed as soon as possible ahead of the issuance of the proposed regulations.
14.) Charitable Gifts. Like annual exclusion gifts, charitable gifts must be made by December 31st to qualify for the 2015 charitable deduction. If you are charitably inclined and you have appreciated stock or mutual fund shares, consider making gifts of the appreciated securities to the charity. This will generally allow you to receive a deduction for the full fair market value of the donated securities, but recognize no tax on the appreciation. If your portfolio generated losses in 2015, consider selling the loss shares, using the losses to offset gains, and then donating the cash from the loss sale to charity.
15.) IRA Charitable Rollover. If extended, as anticipated, federal law will again permit individuals 70 ½ and older to make a tax-neutral distribution of up to $100,000 from their IRAs. A transfer from an IRA under this law (if extended for 2015) is excluded from federal income tax and qualifies toward the mandatory required minimum distribution. This law enables non-itemizers to gift more to charity. But it does not qualify for a charitable income tax deduction. While the transfer to charity may be earmarked for a specific use within a charity, it may not be transferred to a donor-advised fund, supporting foundation, charitable remainder trust or charitable gift annuity. If Congress still has not extended the law by the middle of December, IRA owners must be ready to take their required minimum distributions by December 31st to avoid the 50% penalty tax on the amount that should have been withdrawn.
16.) Consider Having Your Children Make Your Charitable Gifts. If you do not have a taxable estate (under $5.43 million for a single person and $10.86 million for a married couple), leaving money to charity at death results in no tax savings. If you can trust your heirs to use a portion of their inheritance to satisfy your charitable wishes, then your heirs will be entitled to a charitable income tax deduction. For example, if your child contributes cash to a public charity, he/she may deduct up to 50% of his/her adjusted gross income (AGI) in the year the donation is made. If your child is unable to use all of the charitable deduction in a given year, he/she can “carry forward” the unused exemption for use in subsequent years (for up to five years).