Right now may be the best time in a generation for significant family wealth transfers. The combination of a difficult recession, a low interest rate environment, the very real probability of future legislative change, and perhaps most importantly, a deep need for shared family wealth has created a perfect opportunity for families to transfer significant wealth.
Although the stock market has generally recovered most of its value, business and real estate values in many sections of the country remain depressed due to COVID-19. The stock market could repeat its initial reaction to the shutdown if businesses are once again forced to pull back on reopening to combat COVID-19. Regardless, the recession has negatively impacted many businesses. An artificially low valuation of an asset means that less of the gift tax exemption is used when the asset is transferred. If a business with an artificially low value is transferred out of a client’s estate, and management is able to recover value in future years, the result is a tax-efficient wealth transfer.
Many of the sophisticated planning techniques used to transfer such businesses are sensitive to interest rates. The Internal Revenue Code Section 7520 rate is used for grantor retained annuity trusts, charitable lead trusts, and private annuities. The applicable federal rate is used when businesses are sold to intentionally defective grantor trusts. I have been practicing for twenty-six years, and I do not remember ever seeing the long-term federal rate as low as it is now (1.01 percent as of June 2020, 1.12 percent for August 2020).
When a transfer is made relying on these low interest rates, rates are locked in. If rates increase in the future as expected, the transfer is subject to or calculated using these very favorable rates, even if the note or retained interest lasts many years.
We certainly cannot guarantee that interest rates will increase, but historically, when the federal government takes on debt, there is a subsequent increase in interest rates as money becomes more scarce in the future. Thus, as the economy recovers and government debt service represents a disproportionate amount of the available money supply, we can expect interest rates to increase.
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We may see legislative change in the coming years, perhaps as early as 2021, regardless of which party is in power. At the end of the Obama administration, the Department of the Treasury promulgated new regulations that would have eliminated valuation adjustments or discounts on intrafamily wealth transfers. For years, the Treasury has been trying to eliminate the grantor trust. In addition, estate tax exemptions are at historical highs. Exemptions are not only at absolute highs historically, but the percentage of Americans subject to estate tax has probably never been lower. Except for the few short periods of time when this country had no estate tax, we have never been in a situation where the estate tax affected fewer Americans.
Our national response to COVID-19 included the commitment of trillions of dollars, all in the form of debt, to help bail out businesses and individuals, and to prevent more significant layoffs from occurring. There is a growing call for additional stimulus, and in the coming months, we could see a second very significant set of stimulus packages. Regardless of whether Congress initiates additional stimulus, the deficit hawks are already beginning to circle, and some are calling for significant changes in the estate tax.
Some see the estate tax as social engineering, while others see it as an opportunity for revenue generation. The New York Times article cited above indicates that $74 trillion of wealth will exchange hands from one generation to the next as the baby boomers die. Whether one is a deficit hawk seeking to reduce the national debt or a proponent of avoiding a wealth class in this country, it is reasonable to believe that there will be an outcry for either increased estate taxes or a decrease of estate tax exemptions, or both, in the coming years. Transfers made today will likely be grandfathered and protected from such future legislative change.
Perhaps most importantly, the COVID-19 recession has significantly impacted individual family members, even in the wealthiest families. Tens of millions of Americans have been laid off, and perhaps as many more are underemployed. Many people are taking on debt, businesses are struggling to remain afloat, and employers are delaying promotions. These issues affect both the wealthy and the poor. For families who are fortunate enough to have underutilized wealth (often held by parents or grandparents), making a transfer now could be very important to an economically displaced family member. We define underutilized wealth as wealth held by one person — again, often a parent or grandparent — that is in excess of what that person reasonably can expect to need during a lifetime. Transferring such wealth today could help a daughter who is a struggling business owner, or a laid-off son or grandson, preventing those family members from taking on new debt or perhaps even losing their livelihood.
Families often struggle with the questions of how much is enough, the circumstances under which to transfer, or whether helping one child will obligate them to help the others. Confident estate planners know that a well-structured trust can often help to answer many of these questions.
I have heard from many business appraisers that they are already overwhelmed and will struggle to complete the valuations necessary for some of these transfers before year-end. Good planning requires time, careful thought, thorough explanation, and coordination of and with coprofessionals. Carpe diem: seize the day. The time to act is now. We may never see a better time for intrafamily wealth transfers.
This article comes from our fall issue of the WealthCounsel Quarterly -- the premier legal magazine for trusts and estates and business law attorneys. Read the entire issue for free here.