United States

Section 7520 rate ticks up for January, but that's not the big news

The big news is the impact of estate tax repeal on succession planning


The IRS announced in Rev. Rul. 2017-2 that the section 7520 rate for January 2017 will rise to 2.4 percent from December’s rate of 1.8 percent. Applicable rates used in the construct of other interest rate-sensitive wealth transfer and charitable planning vehicles rose in lock step. Given everything else that is happening with tax planning these days, even this 60-basis point bump is probably not going to move the needle all that much, other than to get individuals who are in the midst of doing grantor-retained annuity trusts (GRATs) and other interest-sensitive planning to complete the transactions this month.

Speaking of everything else that is happening and, more specifically, potential repeal of the estate tax, it might be helpful to think about the implications of repeal on business succession planning. Actually, we will take our cue from the proposals by President-elect Trump and the House GOP, respectively, and assume for discussion that the estate tax would be repealed but the gift tax would not.

The broad topic of business succession planning is actually comprised of these fundamental subtopics:

  • Balancing the owner’s plans for retirement versus his or her need for ongoing control and cash flow
  • Providing for the owner’s surviving spouse
  • Assuring retention of key people, especially in transition
  • Identifying successor owners and the most effective ways to transfer the business to them
  • Determining how and when to ‘equalize’ for business versus non-business children
  • Providing estate liquidity in a cost- and tax-efficient manner

Implications of estate tax repeal on the fundamentals

It is arguably fair to say that of all the fundamentals, repeal of the estate tax (but retention of the gift tax) would have greatest impact on providing for the owner’s spouse, equalization, transferring ownership of the business and providing estate liquidity.

Repeal of the estate tax would have no direct bearing on the needs of an owner’s surviving spouse. However, it could enable the owner (and spouse) to refashion ownership of their assets, beneficiary designations, marital and credit shelter trusts and other elements of their estate plan with an eye to simplicity, without the contrivance and complexity associated with an estate tax-driven model. The focus of the ‘new’ plan would be on the spouse as an individual and not as an interested bystander in the passage of the estate to the next generation.

Equalization is a particularly knotty problem, one often fraught with tension among parents, children and siblings. One can only imagine how difficult it must be for an owner of a business that comprises most of his or her estate to figure out how to transfer that business to one child, provide fair and ‘equal’ treatment to another child or children and, all the while, provide enough liquidity to pay estate taxes. While it would be a stretch to suggest that repeal of the estate tax would take all of the emotion, complexity and tension out of this common conundrum, it would certainly make things a whole lot easier! For example, life insurance initially purchased for estate liquidity might be reduced and ‘redeployed’ to provide for the non-business children, with the savings in premiums going towards lifetime gifts to those children. What’s more, the owner will have additional flexibility to plan with assets that in today’s environment are income in respect of a decedent (IRD) if only because the IRD will not also be subject to estate tax.

Owners who, for any number of reasons, are interested in transferring the business to the next generation sooner rather than later will still have to deal with the gift tax and, presumably, such esoterica as section 2701. Yes, the ‘string sections’, meaning sections 2035, 2036 and 2038 will no longer be problematic, but owners will still look for advice on how to minimize the gift tax implications of any major transfers. Thus, such techniques as compensatory transfers, taxable gifts, GRATs and sales to intentionally defective grantor trusts will occupy a seat at the table in any planning discussion. And needless to say, the expertise to help taxpayers select the ‘right’ technique and then design it appropriately will continue to be valued by these taxpayers.

The estate liquidity situation will be transformed in many ways. For example, there would be far less need (and call) for second-to-die life insurance, which is typically used to pay estate tax when the surviving spouse passes away. There would be more focus on serving needs for capital and liquidity at the death of the first spouse to die, e.g., placing the insurance on the owner so that the child(ren) in the business will have the cash to buy out any interest held by the owner’s surviving spouse. Of course, section 6166 deferral of estate tax would no longer be relevant and the often constrictive planning required to qualify for the deferral and stay compliant with it will similarly be a thing of the past.

Perhaps the principal task in the event of repeal will be to determine whether existing life insurance policies should be retained, restructured, redeployed or replaced. This too will be an area where clients will welcome objective advice, especially because repeal will likely cause a significant uptick in proposals for replacement. Finally, if there is no estate tax, the continuing support of irrevocable life insurance trusts and split-dollar arrangements with those trusts will need to be revisited, a visitation that will require the sum of all the planner’s skills.

It will be a whole new day for business owners and their families. It will also be a truly significant paradigm shift for many planners. Here’s to living in interesting times!


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