Tax Changes to Estate Plans Still Need to Be Scrutinized

FLPs are often created to reduce estate taxes, but the doubled estate tax exemption from 2018-2025 may mean that these clients will no longer be subject to the estate tax at all. Unfortunately, use of the FLP structure will require the client to forego the step-up in basis that the assets transferred to the FLP would otherwise receive upon his or her death. If the client who formed the FLP no longer anticipates being subject to the estate tax, he or she may wish to dissolve the FLP in order to obtain that step-up in basis and allow his or her heirs to realize the income tax savings that the step-up can generate.

Of course, the value of this strategy will depend upon the overall health (i.e., life expectancy) of the client and whether the estate tax exemption eventually reverts to its pre-reform levels. Clients interested in dissolving their existing FLPs should also be aware of the potential for taxation under IRC Section 731 if the FLP distributes cash or marketable securities in excess of basis, in which case the distribution will be treated as ordinary income in some cases.

Evaluating GRAT Assets and Rising Interest Rates

Clients who have contributed assets to a grantor retained annuity trust (GRAT) should evaluate the basis of those assets and consider exchanging those assets if necessary. A GRAT combines a trust that is established for a certain predetermined period of time with an annuity that pays the grantor a set value each year of the trust’s existence. This annuity payout is the client’s retained interest. The remaining value passes to the client’s beneficiaries, and out of his or her estate.

The value of the taxable gift to the GRAT beneficiaries is equal to the fair market value of the GRAT property minus the client’s retained interest. The retained interest is the actuarially calculated value of the annuity stream the client will retain over the GRAT’s life based on the Section 7520 rate in effect for the month when the GRAT is created.

For the GRAT to succeed, tax-wise, the assets placed into the trust only need to outperform that locked-in Section 7520 rate. If a client’s assets are locked into the GRAT at today’s low interest rates, the probability of the assets appreciating at a more rapid rate as interest rates increase also increases. Generally, a client is able to exchange or buy-back GRAT assets for fair market value, so a year-end checkup of the assets placed in the GRAT and potential tax value of exchanging those assets can be valuable to clients who have employed this planning strategy.

Conclusion

Clients who regularly engage in estate planning “check-ups” may think that there is no need to “rush” any of the strategies that can be employed based on the currently high estate tax exemption or rising interest rates, but they should be advised that tax laws can change at any moment—making flexibility key to any estate plan’s ability to maximize the value of the tax law changes over the long term.

• Read previous coverage of planning under the new tax law in Advisor’s Journal.
• Read in-depth analysis of the rules governing GRATs see Advisor’s Main Library.
• Your questions and comments are always welcome. Please post them at our blog, AdvisorFYI, or call the Panel of Experts.