The IRS recently announced minimum interest rates that need to be charged to avoid gift, estate, and generation-skipping taxation (“transfer taxes”) on intrafamily obligations. They are extraordinarily low. For those occurring in May, the Applicable Federal Rates (“AFRs”) range from 0.25% for obligations due on demand or within three years, 0.58% for those payable in three years and before nine years, and 1.15% for those payable nine years or later. The IRS interest rate for trusts in which the donor has a retained interest will be 0.80%.
These low interest rates, coupled with depressed asset values (especially publicly traded equities), provide very attractive opportunities for shifting significant amounts of wealth by leveraging the sale of depressed value assets to family members or trusts for their benefit in exchange for AFR compliant promissory notes. Be aware, however, that unless the purchaser of the assets is a “grantor trust”, there will be a taxable gain or, if the purchaser is related to the seller, a nonrecognizable loss for each asset transferred to the extent the asset’s then current value is more or less than its cost basis at the time of sale. Leveraging the current low interest rates and asset values by making gift transfers to grantor retained annuity trusts (GRATs) can also accomplish significant wealth transfers to family members with only a miniscule effect on transfer taxes.
The result of these intrafamily sales and transfers is the shifting of all appreciation and income from the transferred assets and their replacement assets after the sale or transfer to the new owners (i.e., the payees of the notes and the residual beneficiaries of the GRAT upon its termination). Thus, the transferor has frozen his or her estate for transfer tax purposes to the extent of the assets’ values at the time of their sale or transfer except for the small amounts received as promissory note interest or GRAT distributions.
For more information, please contact Bob Joslyn in the Troy office at 248-433-7437 or anyone in the firm’s Tax or Estate Planning Group.