Fiduciary Trust International

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Today's economic landscape, coupled with favorable transfer tax rules, create unprecedented gifting opportunities. Historically generous transfer tax exemptions and rates, as well as unusually low interest rates and asset values, make for some unique planning opportunities. However, this incredible alignment of gifting opportunities will not last. The current $5 million transfer tax exemptions and low transfer tax rates are set to expire on December 31, 2012, and economic conditions could change as well.

You might consider these gifting strategies, designed to leverage today’s unique wealth transfer opportunities.

TAKE ADVANTAGE OF TODAY’S $5 MILLION EXEMPTION BY SETTING UP A DYNASTY TRUST
A number  of states allow individuals to create trusts that exist in perpetuity, called Dynasty Trusts. “A Dynasty Trust is a powerful vehicle, allowing assets to pass from one generation to the next free of estate and generation-skipping transfer tax,” explains Gail Cohen, Vice Chairman and General Trust Counsel at Fiduciary Trust. “Since assets held by the trust are not included in either the grantor’s estate or any of the beneficiaries’ taxable estates, estate, gift and GST taxes are avoided for multiple generations. This allows a Dynasty Trust’s assets to grow tremendously over time.”

Current tax laws make Dynasty Trusts even more attractive, because the exemption for gift and GST taxes is currently $5 million, or $10 million for couples.

“There  is another advantage to a Dynasty Trust,” adds Cohen. “The trust can be designed so that trust assets are shielded from the claims of a beneficiary’s creditors  and protected against claims of a beneficiary’s divorcing spouse.”

IN THIS LOW INTEREST RATE ENVIRONMENT, CONSIDER MAKING AN INTRA-FAMILY LOAN
Intra-family loans generally benefit family members. They are a simple and effective way to freeze the value of the senior generation’s estate, since the loan’s value will not appreciate. Assets purchased with the loaned funds can then appreciate in the hands of younger generations.

“Here’s how intra-family loans work,” explains Warwick Carter, Director of Trust Administration. “According to the IRS, a loan to a family member is not considered a taxable gift, as long as the loan’s rate is equal to or greater than the Applicable Federal Rate (AFR) established by the IRS.” November 2011 annual AFR rates were at historically low levels:

• Short-term rate: 0.19%
• Mid-term rate:   1.20%
• Long-term rate: 2.67%

These rates are significantly below October’s Prime Lending Rate of 3.25%. What’s more, intra-family loans have the added benefit of keeping interest payments within the family, while allowing individuals to avoid fees traditionally charged by banks, such as points, appraisal fees and closing costs. Carter adds that, “Individuals may consider forgiving part of the loan each year through the annual gift tax exclusion, which lowers the principal balance ultimately  paid at the expiration of the loan term.”

To ensure the IRS won’t treat the loan as a gift, it’s essential to observe all formalities. For example, the loan should be evidenced by a promissory note and interest payments should be paid on time. You will need to maintain payment records and the interest income should be reported for tax purposes.

TODAY’S LOW INTEREST RATES MAKE GRANTOR RETAINED ANNUITY TRUSTS MORE ADVANTAGEOUS THAN EVER
A Grantor Retained  Annuity Trust (GRAT) is an irrevocable trust that allows individuals to transfer the appreciation of assets to heirs free of gift tax. Mike Mariani, Director  of Trust and Estate Services, explains, “GRATs are particularly attractive in a low interest rate environment for individuals who have assets they believe will significantly appreciate in value and who wish to remove this potential appreciation from their estate.”

Here’s how this vehicle works: a grantor transfers assets to the GRAT and retains the right to receive a fixed dollar amount (GRAT annuity) for a specified term of years. Generally, GRATs are set up so that their annuity payments equal the amount of assets originally transferred into the GRAT, plus an assumed rate of return  that is established by the Internal Revenue Service, known  as the “hurdle rate” (this technique is called “zeroing  out”). At the end of the GRAT term, the trust’s remaining assets, including appreciation, pass to designated beneficiaries, generally members of the grantor’s family.

The IRS assumes that the GRAT will grow at a rate equal to its hurdle rate in effect at the time the trust is established. The rate for October 2011 is a historically low 1.4%, compared to a high rate of almost 12% in 1989. Because the IRS does not look at the actual growth of the GRAT’s assets, a low hurdle rate allows for a greater potential gift to the beneficiaries,  since any growth surpassing the hurdle rate passes to the beneficiaries free of gift and estate taxes.

Mariani points out, “It’s important to understand that if the grantor dies during the GRAT term, assets in the GRAT will then revert back to the estate. To mitigate this risk, GRATs are generally structured for short periods of time, and donors often use successive GRATs.”  Mariani also cautions, “Congress is considering legislation requiring longer GRAT terms, making it more difficult for grantors to outlive the trust. So now it’s even more important to develop and leverage a GRAT strategy with your lawyer.”

USE A CHARITABLE LEAD ANNUITY TRUST FOR WEALTH TRANSFERS TO CHARITIES
A Charitable Lead Trust (CLAT) is similar to a GRAT, except the fixed annuity payments are made to a designated charity. At the end of the trust term, the remaining assets pass to one or more non-charitable beneficiaries (typically family members).

Like the better-known GRAT, CLATs work best in a low interest environment, when investment performance is expected to exceed the IRS’s hurdle rate. This is because assets remaining at the end of the CLAT’s term pass to family members free of gift and GST taxes. Unlike GRATs, however, assets held in CLATs are not included in the taxable estate if the grantor dies during the trust’s term.

When establishing  a CLAT, the grantor can elect to use the hurdle rate in effect during the month of the trust’s creation, or if lower, either of the two preceding months’ rates. In other words, if a CLAT is funded in November, the grantor can choose to use September, October or November’s rate, whichever is lower.

TRANSFER LOWER-VALUED REAL ESTATE INTO A QUALIFIED PERSONAL  RESIDENCE TRUST
Qualified Personal Residence Trusts (QPRTs) enable grantors to transfer a residence out of their estate at a low gift tax value. Today’s lower real estate values could make QPRTs especially attractive, because once the residence is transferred to the QPRT, its value, including any future appreciation, is excluded from the estate.

Craig Richards, Director of Tax Services, explains, “With QPRTs, a grantor transfers a personal residence or vacation home into an irrevocable trust for a term of years, and reserves the right to live there, rent free, during that term. During this period, the grantor continues to pay for the residence’s mortgage, real estate taxes, and other related expenses.” Transferring a home into a QPRT is a taxable gift, but the gift’s value is reduced to reflect the value of the grantor’s right to live in the residence rent free for a fixed term. The amount of the taxable gift will therefore usually be substantially less than the fair market value of the residence. While higher interest rates result in a more sizeable markdown of the gift’s value, today’s lower real estate values make QPRTs unusually attractive.

At the end of the QPRT’s term, ownership of the residence passes to the designated  beneficiaries, typically the grantor’s children or other family members, either outright or in further trust for their benefit. If the grantor wishes to remain in the residence at the end of the trust term, the grantor may rent the residence at fair market rental value. This avoids unintended taxable  gifts from the beneficiaries to the grantor and, more importantly, circumvents the potential adverse tax consequences of having the house’s value included in the grantor’s estate for estate tax purposes.

Richards adds, “To realize a QPRT’s tax benefits, the grantor must survive the trust’s terms. But even if the grantor does not survive this term, aside from fees associated with establishing this trust, he or she is in no worse position than if the trust had never been established.”

FIDUCIARY TRUST IS HERE TO HELP
With tax laws set to expire on December 31, 2012,  now is a good time to review your wealth transfer  strategy.  Your trust or tax professional is a valuable resource for wealth transfer information. Or, feel free to reach out to your Fiduciary Trust representative at any time.

 This communication is intended to provide general information. The information and opinions stated are as of November 2011, unless otherwise indicated, and do not represent a complete analysis of every material fact. Statements  of fact have been obtained from sources deemed reliable, but no representation  is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment  advice or as a recommendation  of any particular security, strategy or investment  product. Please consult your personal advisor to determine whether this information may be appropriate for you. IRS Circular 230 Notice: Pursuant to relevant U.S. Treasury regulations, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
Fiduciary Trust Company International is a member of the Franklin Templeton Investments family of companies.

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