If you are faced with federal estate tax exposure, you are looking at a significant threat to your financial legacy. At the present time, the maximum rate of this tax is 40 percent, and this is a figure that certainly gets your attention.
You can transfer a certain amount of assets before the estate tax would become applicable. This figure is called the federal estate tax credit or exclusion. In 2016, the exclusion is $5.45 million.
The tax man does not want you to give gifts while you are living to sidestep the estate tax. To prevent this, there is a gift tax in place as well. It has been around without interruption since 1932. The gift tax and the estate tax were unified under the tax code in 1976, so they both carry the same 40 percent maximum rate.
Because of this unification, the $5.45 million exclusion is a unified lifetime exclusion. This is the total amount that you can transfer free of taxation, either while you are living or after you pass away.
However, there is an unlimited marital deduction. You can transfer unlimited assets to your spouse tax-free. This is assuming you and your spouse are American citizens. Americans who are married to citizens of other countries cannot utilize the unlimited marital deduction. The federal estate tax and the federal gift tax are only applicable on transfers to others.
Irrevocable trusts of various kinds are often used by people who are faced with estate tax exposure. As the name would indicate, generally speaking, you cannot revoke this type of trust once it has been established.
In a legal sense, you are surrendering incidents of ownership because of this arrangement. As a result, if you fund an irrevocable trust, you are removing the assets from your estate for estate tax purposes.
One irrevocable trust that can be part of an estate tax efficiency strategy is the “zeroed out” grantor retained annuity trust approach.
The nature of the funding is at the core of this strategy. For the strategy to succeed, you must fund the trust with assets that will appreciate considerably over the duration of the term.
After you fund the trust with highly appreciable assets, you name a beneficiary. The beneficiary would assume ownership of anything that may remain in the trust after the expiration of the term.
As the grantor of the trust, you except annuity payments on an annual basis throughout the trust term. To execute this strategy, you “zero out” the grantor retained annuity trust.
Here’s what zeroing out is all about. Because a beneficiary may be inheriting something eventually, the gift tax is potentially applicable on the transfer.
The Internal Revenue Service values the trust for tax purposes using 120 percent of the federal midterm rate to account for anticipated appreciation. This is alternately referred to as the hurdle rate.
To zero out the GRAT, you arrange for your annuity payments to equal the entirety of the taxable value of the trust as it has been calculated by the Internal Revenue Service.
When interest rates are low, the zeroed out grantor retained annuity trust strategy has a great deal of viability. If the assets in the trust perform better than the hurdle rate that was applied by the IRS in the beginning, a remainder will be left in the trust after the expiration of the term.
The beneficiary would assume ownership of this remainder, and there would be no gift tax consequences. Ultimately, a tax-free asset transfer would take place.
Preserve Your Wealth
We practice law in Westchester County, and this is one of the most affluent areas in the country. There are many people in our community who are facing federal estate tax exposure. In New York, there is also a state-level estate tax to contend with if you have been particularly successful from a financial standpoint.
The grantor retained annuity trust is an irrevocable trust that can be useful if you are in possession of highly appreciable assets while interest rates are low. This is one possibility, but there are other irrevocable trusts that can be part of your estate tax efficiency plan.
We have worked with many high net worth families to implement wealth preservation strategies over the years, and we can help you as well. Personalized planning is key, because the ideal approach will depend upon the situation.
If you would like to discuss your objectives with our firm, you can give us a call at 914-939-6565 or send us a message through our contact page to schedule a consultation.