United States

Applicable rates decline for August—which means what, exactly?

Rates are beckoning a whale of an opportunity in estate planning


The IRS announced in Rev .Rul. 2016-18 that the section 7520 rate for August dropped to 1.4 percent from July’s 1.8 percent rate. Applicable rates for other interest rate-sensitive wealth transfer and charitable planning vehicles also dropped.

On its face, this 40-basis point drop in the section 7520 rate is not particularly newsworthy (unless maybe you had a lot of money riding on rates moving sharply to the upside). However, on a context-adjusted basis, the fact that applicable interest rates for such popular planning techniques as grantor retained annuity trusts (GRATs), sales to defective trusts, charitable lead annuity trusts and intra-family loans are once again near historic lows is indeed worthy of the attention of any individuals who are interested in that kind of planning. Here’s why. Any wealth transfer, whether by gift, GRAT or various forms of sale, will only remove from the transferor’s estate the appreciation in an asset’s value from the date of the transfer. If the transfer is by outright gift, then any and all appreciation will be removed. But if the transfer is by GRAT or sale, only the appreciation in excess of the applicable interest rate assumed in the construct of the transaction for gift tax purposes is removed. That’s why planners are so interested in, well, interest rates.

So, as Julius Caesar’s estate planner might have noted, all wealth transfer planning is divided into three parts:

  1. The interest rate that is, in actuality, the ‘hurdle rate’ or rate of return that the transferred asset has to achieve in order to remove post-transfer appreciation from the transferor’s estate. The hurdle rate for a GRAT is the section 7520 rate. The hurdle rate for a sale to a defective trust is the applicable federal rate for the term of the note under section 1274. Each of these rates is reset and announced monthly. So, for example, if the section 7520 rate is 1.4 percent, then the individual who does a GRAT will get back the value of the transferred asset plus 1.4 percent, which means that the asset has to appreciate by more than 1.4 percent to actually move any appreciation in the asset to the next generation.
  2. The availability of discounts that reduce the value of the transferred asset for gift tax or sale purposes. Discounts may be for lack of marketability, for example. The lower the value, the smaller and more manageable will be any required payment to the transferor, whether in the form of an annuity payable by a GRAT or the purchase price and interest payments associated with a sale to a defective trust.
  3. The availability of attractive transfer techniques in the first place.

As we go to press, all three of these parts are as favorably positioned for wealth transfer as they have ever been. But, each part has its very own sword of Damocles over its head, as it were. For starters, anyone who is not aware of the general consensus that an increase in interest rates is a matter of when, and not if, has probably been living in a cave without Wi-Fi. And if, meaning when, rates rise, a transferred asset will have to generate a correspondingly higher return to make the technique worthwhile.

If discounts are limited, perhaps as we anticipate they might be by forthcoming regulations under section 2704, the value of the asset would be correspondingly increased, thereby increasing the economic burden that any technique will have to bear to be successful.

Finally, even if the most popular transfer techniques remain nominally in place, legislation, regulation or litigation could easily curtail the unfettered flexibility to design those techniques to best suit the characteristics of the asset and/or the transferor. The damage inflicted would be measured on a technique-by-technique basis. For example, if GRATs are required to have a minimum10-year term, the utility of that technique would be sharply reduced. If the tax treatment of grantor trusts is unfavorably altered, the sale to defective trust (and techniques such as loans to defective trusts) would be rendered correspondingly less attractive.

The message is clear, though it is arguably best posed as a question, “If not now, when?” Individuals who are interested in wealth transfer planning now have a strong wind at their backs, but that wind could shift direction at any moment. These individuals should move sooner rather than later to identify the asset(s) they might transfer and the transfer techniques that are best suited for them, all things considered. Otherwise, today’s can do’s could become tomorrow’s should have done’s.


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