Business Perspectives

Now's the time to think about sharing wealth

The current economic environment is perfect for making gifts of wealth. Due to a marketwide decline in asset values, low interest rates and estate tax increases on the horizon, now is the perfect time to make financial transfers to junior family members. Here's why:

Depressed asset values — World economies have lost trillions of dollars in market values in what has become the largest and longest recession since the Great Depression. Blue chip stocks have lost half of their values, bond prices have dropped and real estate values have plunged. Privately held businesses struggle to compete for smaller cash flows in a shrinking economy.

Depressed asset values create an opportunity to shift a greater amount of wealth. For example, a block of 1,000 shares of stock that was worth $26 a share a year ago may only be worth $13 per share today. Making an outright gift using the $13,000 gift tax annual exclusion, a donor can give 1,000 shares today versus giving only 500 shares a year ago. A 50 percent valuation discount effectively turns a $13,000 gift exclusion into a potential $26,000 exclusion if the value recovers. Or, it converts a $1 million lifetime gift exemption into an effective exemption of $2 million.

Low interest rates — In recent months, we have seen interest rates drop to historic lows. The IRS requires loans between family members to provide a minimum interest rate, which is determined by using rate tables issued by the IRS on a monthly basis. Those tables are referred to as the Applicable Federal Rates, or AFRs. The value of life estates, remainder interests and annual payments for gift, estate and income tax purposes are determined using these same tables. These interest rates are based upon government bond rates, which are considered risk-free investments. For example, the short- (less than three years), mid- (three to nine years) and long-term (greater than nine years) AFR rates for October 2009 are 0.75 percent, 2.66 percent and 4.10 percent, respectively. Therefore, any gift assets such as marketable securities, real estate or equity in a closely held business entity with a total return that exceeds the AFR passes such excess to a junior family member completely free of gift and estate taxes. This differential in actual total returns and assumed AFR rates can be substantial.

In addition, low interest rates create huge opportunities for minimizing the value of future interest gifts, such as grantor retained annuity trusts and charitable lead trusts.

Legislative change — Federal estate tax changes are almost certain to occur in 2009 or 2010. Under current law, the amount an individual can exempt from the federal estate tax at death is $3.5 million. The estate tax is a flat 45 percent tax rate. In 2011, the exemption is scheduled to shrink to $1 million with a top tax rate of 55 percent. Transfers between spouses are generally tax-free.

It is expected that President Obama and Congress will make this year's $3.5 million exemption and the 45 percent tax rate permanent. However, under current government tax deficits, any discussion of permanent tax relief is fleeting. Other estate planning changes that are expected include limitations on valuation discounts and further restrictions on Grantor Retained Annuity Trusts, or GRATs. Any planning with an effective date prior to new legislation will most likely be grandfathered.

Estate planning — The estate tax is easy to avoid with advance planning. Techniques such as lifetime gifts, intra-family loans, transfer to an irrevocable grantor trust, grantor retained annuity trusts and charitable lead annuity trusts can be used to minimize or eliminate the estate tax.