Duke Schneider, Esquire
A. Duie Latta, Esquire

This article addresses some of the opportunities presented by various interest rates established by the IRS, which, by historical standards, are currently extremely low. There are few precedents for today's low interest rates, which create favorable conditions for tax-efficient wealth transfers.

Under current law, the federal estate tax applicable exclusion amount (the "Exclusion Amount") is $2,000,000. The Exclusion Amount is scheduled to increase to $3,500,000 in 2009. Although the federal estate tax is scheduled to be repealed in 2010, it is also scheduled to return to $1,000,000 in 2011. While there is some discussion that Congress may freeze the federal estate tax at $3,500,000 in 2009, we still have an uncertain federal estate tax environment. Given the uncertainty concerning the federal estate tax, a federal estate tax rate of 45%, and the fact that more individuals are faced with an estate that will be subject to federal estate tax, people other than just the "mega-wealthy" are thinking about how to transfer wealth between generations without adverse tax consequences. This article will highlight a few techniques that work particularly well in a low interest rate environment.

Family Loans at the Applicable Federal Rate
Today's current low interest rates create an opportunity to transfer wealth by making loans which, although they are at very low interest rates, will nevertheless be treated as fair market rates and not a taxable gift. Such opportunities can serve a useful role in transferring assets between generations without incurring federal gift or estate taxes.

Generally, money is loaned to a family member (or a trust) using a promissory note with an interest rate at the Applicable Federal Rate ("AFR"). The AFR is the rate that the IRS treats as a fair market rate and not a taxable gift. For May 2008, the AFR was between 1.62% and 4.21%, depending on the duration of the loan and the frequency of compounding. The borrower then uses the borrowed funds obtained from the low interest rate loan to make investments that the borrower expects to achieve a higher rate of return than the interest rate of the loan. The borrower repays the loan and retains any returns in excess of the interest rate. Such excess returns are not subject to estate or gift tax. This technique is more effective when there are low interest rates, since the return on the investments does not have to be as high to exceed the AFR, thus increasing the amount that is transferred free of gift tax. Another approach is for the borrower to use the loan at the AFR to pay off higher interest rate debt. The borrower gets the benefit of paying off debt with funds that were borrowed at a lower interest rate.

Grantor Retained Annuity Trust
An additional technique that facilitates tax-efficient transfers of wealth is a Grantor Retained Annuity Trust ("GRAT"). With GRATs, the grantor transfers assets into a trust for a certain period of years (the "Annuity Period"). During the Annuity Period, the Grantor receives an annuity payment at a rate based on the IRS's "7520 Rate" (which is related to the AFR). After the Annuity Period, any remaining assets are distributed to the beneficiaries of the trust. If the appreciation of the GRAT's assets during the Annuity Period exceeds the 7520 Rate, that excess appreciation can be distributed to the beneficiaries at the end of the Annuity Period without being subject to gift or estate tax. When the 7520 Rates are lower, a GRAT's annuity payments will be lower, allowing for the possibility of greater asset appreciation and thus a greater transfer to the beneficiaries.

Charitable Lead Annuity Trust
A Charitable Lead Annuity Trust (a "CLAT") works similarly to a GRAT, except that a charity receives the annuity payments instead of the grantor. In some instances, the grantor can obtain a charitable contribution deduction for the initial transfer to the CLAT. Then, at the end of the term of the CLAT, any assets remaining are distributed to non-charitable beneficiaries such as the grantor's family, without the appreciation of the assets in excess of the 7520 Rate being subject to estate or gift tax.

This article has discussed some of the techniques that can facilitate tax-efficient wealth transfers in a low interest rate environment. The attorneys at MacElree Harvey can assist you with these techniques for estate planning and giving, as well as with structuring an overall plan to accomplish your goals while minimizing estate and gift taxes.

MacElree Harvey
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West Chester, PA 19381–0660
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