Shrunken Asset Values Open Estate Planning Opportunities

The novel “coronavirus” (also called “SARS-CoV-2”) causes the disease “COVID-19.” It first appeared in late 2019 and was reported to the World Health Organization (WHO) on December 31, 2019. Here’s a link to the WHO’s site for the latest global information. At this point, the virus has infected over a million people, including those on every continent except Antarctica, and hundreds of thousands in the United States alone.

The spread of the coronavirus has wreaked havoc on financial markets around the world. While nobody would seek out such a decline, it could provide opportunities for some people. This is the second of a two-part series on strategies to consider under these circumstances. This first article looked at gifting and electing alternate valuation. This second article looks at the Grantor Retained Annuity Trust, or “GRAT,” and how that strategy might be used in these troubling times.

Let’s look at a quick case and how a GRAT could help. John has about $5 million, including his home, some other assets, and $3 million of XYZ company stock. He expects the stock to grow at 20% per year between now and 2026, in part because the value is so low now because of the current crisis. After his death, John wants these assets to go to his daughter, Alice. Let’s assume John will die in 2026, when the amount he can pass free from federal estate tax will be $5 million (adjusted for inflation, but let’s assume there’s no inflation adjustment since we don’t yet know what that will be). If John does nothing, his estate in 2026 would be about $9.5 million, $4.5 million over the amount he could pass free from estate tax. His estate would owe 40% on the overage, or $1.8 million in federal estate tax.

On the other hand, let’s look at what would happen if John gave the $3 million of XYZ stock to a GRAT with a term of 5 years and ending in 2025. If he retains the right to distributions for the term of the trust, he wouldn’t be deemed to have made a taxable gift to that extent because he’s getting it back. If John retains a right to receive $672,000 each year for the 5-year term, then the actuarial value of the remainder interest turns out to be zero. In other words, he would not be using any of his exclusion. To the extent the assets in the trust grow faster than the interest rate assumed, that extra growth is out of the estate. The interest rate assumed for a transaction in April 2020 is a historically low 1.2%. In other words, the IRS is assuming the assets will grow at just 1.2%. If they grow faster than that, the excess goes to the remainder beneficiary, Alice, without using any estate and gift tax exclusion. In this situation, if we assume XYZ stock will grow at 20% per year, there will be more than $2.8 million left in the trust which will pass free of estate and gift tax. John’s estate would still have his house and other assets and the annuity payments from the GRAT over the 5-year term, to the extent John doesn’t spend those during his life. But, the appreciation of the XYZ stock is removed from his estate.

Through the use of the GRAT, John has removed the growth on XYZ stock and mostly solved his estate tax problem. Meanwhile, John has retained a stream of payments during the term of the GRAT. Essentially, all John has given away is the possibility the assets would grow faster than the rate the IRS assumed.

There are many other ways to take advantage of the current low-interest rates and low asset values.

We all need to pull together to do everything we can to minimize the impact of COVID-19. Social distancing and self-quarantining are important to the mitigation of the impact of COVID-19. Here’s an article from Johns Hopkins explaining social distancing and self-quarantining.

However, while we are doing our part to minimize the impact of COVID-19, we can still use legitimate Estate Planning opportunities which take advantage of the depressed asset values and low-interest rates resulting from the pandemic. A GRAT is one of the many ways to take advantage of the current circumstances.

Stephen C. Hartnett, J.D., LL.M.
Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com