Eugene Pollingue, Saul Ewing Arnstein & Lehr, West Palm Beach

The COVID-19 pandemic has created many estate planning issues, the first and foremost of which is, do you have an estate plan? If you do not have an estate plan, state law will determine who receives your property, which may not necessarily be the individuals to whom you wish it to go. Also, without an estate plan and a revocable living trust, your estate may be subject to probate which will cause your heirs to incur additional legal fees and expend time which could have otherwise been avoided. Probate is the legal process which involves the institution of a probate proceeding in court in order to cause the property of a deceased person to be transferred to the person's heirs. This can be avoided with a proper estate plan and a revocable living trust.

The next issue to address is whether your estate is subject to estate tax. Currently, only the largest of estates are subject to federal estate tax. In 2020, there is an exemption from federal estate tax of $11.58 million per person, which is adjusted for inflation annually. As a result a married couple would not currently be subject to federal estate tax unless their combined estates exceed $23.16 million because they would each have the exemption of $11.58 million.  However, if there are no changes in the tax law, in 2026 the exemption as adjusted for inflation will drop to approximately $6 million per person, and even if the law does change there is no guarantee what the minimum amount of the exemption will be in the future. Given the uncertainty of the tax law, many find themselves in the position of not knowing whether or not their estate will be subject to federal estate, which is significant because the federal estate tax is equal to 40% of the portion of the estate that exceeds the exemption.

In the case of an individual who believes that his estate will be subject to federal estate tax, the COVID-19 pandemic has created conditions for reducing one's estate tax liability if he believes the current decline in the value of equities and other assets, and the current decline in interest rates are temporary. One simple technique would be to give away assets which have declined in value, valued for gift tax purposes at the current low value. Since the federal exemption also applies to gifts (one uses the exemption during his lifetime for gift tax and his estate uses any remaining exemption not used for gifts against estate tax at death), the exemption will be utilized at the current depressed values and the post gift appreciation in the assets will escape estate taxation at the donor's death.

There are also techniques for giving away only the future appreciation in assets rather than the assets themselves, which is currently very tax efficient given the current low interest rates. One such technique is the sale to a defective grantor trust in return for a note. For example, assume one has an asset that is worth $1 million and he believes it will double in value. He could sell the asset to a defective grantor trust established for the benefit of his heirs in return for a $1 million note. When the asset doubles in value the note could be repaid and the appreciation would remain in the trust for the donor's heirs. This would be an arm's length sale and there would be no gift or gift tax involved. Because the trust is a defective grantor trust, there would be no income tax consequences to the donor when he sells the asset. The note would be required to pay interest, but the interest rates required by the IRS are currently very low.  For May, 2020, the interest rates, compounded annually, are as follows: 0.25% for a note of three years or less, 0.58% for a note of more than three years and up to nine years, and 1.15% for a note of more than 9 years.

Another technique that is economically similar to the sale to the defective grantor trust is a zeroed out Grantor Retained Annuity Trust, or GRAT. Given the same example of a $1 million asset that will double in value, the donor could place the asset in a GRAT for the benefit of his heirs. The GRAT would pay the donor an annuity for a term of years that has a value equal to the value of the gifted asset. Therefore there would be no gift involved because the donor would receive an annuity having a value equal to the value of the $1 million asset transferred to the GRAT. Although the term of the annuity can be for any number of years, by way of example, if the term of the annuity were two years and we use the May 2020 interest rates published by the IRS for valuing annuities, the donor would have to take back an annuity at the end of year one and the end of year two of $505,969 per year, for a total of $1,011,992 over the term of the GRAT, and all remaining appreciation would remain in the GRAT for the donor's heirs. These numbers illustrate how little the donor has to take back given the current low interest rates.

If one compares the sale to the defective grantor trust with the zeroed out GRAT, although they are both similar from an economic point of view, there are advantages and disadvantages of both. An individual considering one of these techniques would have to consult with his estate planner to determine which is better given his circumstances, but either technique could be very advantageous given the current depressed asset values and low interest rates.

Finally, it should be pointed out that these techniques should be pursued only by those whose estates are subject to estate tax. Otherwise, if there is no estate tax to pay, an individual would be better off holding appreciated assets until death so that his heirs could avoid capital gains tax when they sell the assets. To illustrate this, if one pays $1,000 for an asset that is worth $10,000 at his death, and he retained the asset until death, his heirs would inherit that asset with a date of death cost basis (referred to as a stepped-up basis) of $10,000, and they could then sell the asset for $10,000 and incur no capital gain tax. If assets are gifted before death there is no stepped-up basis. Although the estate tax of 40% is significant and one would want to avoid that tax, if there is no estate tax due he would want to retain appreciated assets in his estate until his death so that his heirs could avoid capital gains tax when they sell those assets.

Eugene Pollingue Jr. is a partner at Saul Ewing Arnstein & Lehr in West Palm Beach. His practice is concentrated in the area of estate planning and asset protection for high net worth clients, probate, and income tax planning for commercial transactions.