Historically Low AFR For October

Posted on September 26, 2011 by Gary A. Phillips

The IRS recently released the Applicable Federal Rate, or “AFR,” for October, 2011.  The AFR is a key interest rate used in connection with a number of the more sophisticated estate planning techniques, such as grantor retained annuity trusts (“GRATs”), sales to intentionally defective grantor trusts, and qualified personal residence interest trusts (“QPRITs”).

The mid-term AFR for October is 1.4%, which is historically low.  This means that GRATs, sales to grantor trusts, and intra-family loans are even more attractive in October because the amount that is required to be paid back to the donor under these techniques is relatively lower due to the extremely low interest rate. 

On the other hand, techniques in which the value of the gift is dependent upon the value of the income interest retained by the grantor, such as QPRITs or charitable remainder annuity trusts (“CRATs”), are not as attractive.  For these techniques, the low interest rate leads to a lower value for the retained interest and a higher value for the remainder interest, thereby resulting in a larger taxable gift when the technique is implemented.

With the increased lifetime gift exclusion ($5 million in 2011 and 2012) and the possibility that the use of GRATs may be restricted in the future, now may be the time to explore some of the estate planning approaches that have been enhanced by historically low interest rates.

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Intra-Family Loans Offer Estate Planning Opportunities

Posted on June 29, 2009 by Steven M. Saraisky

Intra-family loans offer a conservative way of using interest rate arbitrage to achieve guaranteed estate tax benefits. The technique can be a powerful tool in today’s uncertain economic climate.

Intra-family loans take advantage of the spread between IRS prescribed interest rates and the interest rates available in the capital markets. For example, in July 2009, the “applicable federal rate” prescribed by the IRS for a three year note is 0.82% and a jumbo CD can be found with an interest rate of 4%.

Consider this example: Client creates a new irrevocable, generation-skipping tax exempt grantor trust for the benefit of his family. He makes a gift of $1 million and then loans the trust $9 million in exchange for a three year promissory note bearing interest at the applicable federal rate of 0.82%. The trust takes the $10 million and simply invests it in a jumbo CD as described above. The trust will receive interest income of $400,000 per year and have to pay out $82,000 per year in interest on the promissory note, a net gain of $318,000 per year, which accrues to the trust income, gift and estate tax-free. In three years, the trust will have accumulated $954,000 on a tax-free basis. At that time, the trust can repay (or refinance) the note.

The market downturn of 2008-2009 has wreaked havoc with many estate plans as transferred assets have lost value or failed to meet investment expectations. Intra-family loans are a conservative method for achieving estate tax benefits in today’s economy. Readers who are interested in intra-family loans should contact their tax attorney.
 

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