United States

Section 7520 rate ticks up, will proposals trump sound planning?

If Hippocrates had been an estate planner, what would he advise today?


The IRS announced in Rev. Rul. 2017-4 that the section 7520 rate for February 2017 will rise to 2.6 percent from January’s rate of 2.4 percent. Applicable rates used in the construct of other interest rate-sensitive wealth transfer and charitable planning vehicles rose in lock step.

Needless to say, with the section 7520 and other ‘hurdle’ rates on a seemingly inexorable uptrend, the knee-jerk reaction would be to press ahead with those grantor-retained annuity trusts (GRATs) and, circumstances permitting, certain other interest-sensitive planning vehicles now while the pressing is good. Of course, with repeal of the estate tax (but apparently not the gift tax) on the agenda of President Trump and his Republican colleagues, estate planners are uniformly advising individuals to avoid transactions that will or even could potentially trigger a gift tax. For this reason, GRATs have become the preferred wealth transfer vehicle because they can be done without creating anything more than a negligible taxable gift.

So why the reference to Hippocrates? Of his many quotes, two seem particularly applicable nigh these 2500 years later. The first is, ‘To do nothing is also a good remedy.’ The second is, ‘Make a habit of two things: to help; or at least to do no harm.’ Let’s apply each in turn to estate tax planning in today’s environment.

To the notion that the uptrend in the section 7520 rate should spur prompt implementation of GRATs (and other interest-sensitive planning vehicles), Hippocrates might ask, “What’s the hurry? Is the need to transfer appreciation out of your estate so great, so urgent, that it’s worth parting with control over the asset and its income before you know how your income will be taxed in the years ahead?” He’d have a point, because wealth transfer planning should only be done when and to the extent that an individual’s current and projected capacity to accommodate such transfers is clear. We suspect that ‘clear’ would not accurately describe most individuals’ take on what the world will look like a year from now. As we have advised in previous alerts, one way for individuals to get a reasonably good look at their financial future and, therefore, their capacity to make large gifts, is to do a long-range projection of their cash flow and net worth through life expectancy.

But now let’s consider a situation where taxpayers could have some very legitimate reasons to do some wealth transfer planning. Assume that a couple owns a successful business that they fully intend to pass on to their son and daughter. Even before the election, they had been thinking that, for a host of personal, tax and business reasons, it would make sense to get started on the transition, soon. Of course, their children agree wholeheartedly! Then came the election. With the estate tax now in play, maybe transition could be put off for a while. But the parents’ advisors point out that they might want to stay on track for an earlier transition because, unlike the estate tax, there are no indications that the gift tax will be repealed. So, if transition is truly a matter of when and not if, now would be a good time to get started. After all, if the business just continues to become more valuable, then the gift tax cost of a lifetime transfer will correspondingly increase over time. What’s more, if the estate tax, once repealed, is reinstated, a transition more closely proximate to the parents’ own transition could cause some significant tax and liquidity problems. Coupled with the reminders from the children about how they (and their parents) are not getting any younger, the parents realize that there is a pretty strong case for transition now. In other words, doing nothing would not be a good remedy in this case. Of course, the parents will work with their advisors to structure the transition though GRATs, gifts and other techniques carefully, not just to avoid gift tax, but also to further the family’s business and personal objectives while protecting against such vicissitudes of life as the children getting divorced.

All of which brings us to Hippocrates’ second quote about doing no harm. So far, with the advisors already designing the plan so that no element of the transition will trigger gift tax, there’s no harm likely to be done, at least from a tax standpoint. But there could be more to the story. Remember that then-candidate Trump’s tax proposals included a capital gains tax at death. In the absence of further detail, some advisors read this proposal literally as imposing a capital gains tax at death on appreciated property. Others take the view that even if such a tax is not imposed, then there would be a carryover basis at death rather than a stepped-up basis for such property as we have today. Importantly, the plans put forward by the rest of the GOP include no such proposal. Yet, many advisors are taking the position that the proposal is ‘baked in’ as a budgetary quid-pro-quo for repeal of the estate tax and are using it as great fodder for ‘incremental’ wealth transfer planning as well as incremental life insurance sales.

We are not predicting the future of that proposal one way or another. We are saying, and Hippocrates would agree we think, that any incremental planning solely for the purpose of addressing the implications of the proposal could easily take these parents trekking to where no parents have gone before or likely need to go now. In other words, if the first level of transition planning that is appropriate and will do no harm also conveniently addresses the planning and liquidity implications of the proposal, then fine. But if a second level of planning designed solely to address those implications would impose further constraints on the parents’ financial flexibility, then there could be the potential for significant harm in the form of misspent costs and needless complexity.

The bottom line is there should be no reason why parents (or grandparents) who want to make large gifts today should not do so, with the aforementioned caveats applying. But there may be good reason to be skeptical about any incremental planning that, as described, would be predicated on and driven by candidate Trump’s ambiguous proposal. That kind of planning could needlessly snatch complexity from the jaws of simplicity, which would not be what the doctor ordered.


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