How IRS Interest Rates Affect Your Transfer Tax Planning

The Section 7520 rate for November 2009 will remain unchanged at 3.2%. While the rates have been trending upward since bottoming out back in February, the economic climate is still too volatile to confidently project where rates will go in the coming months. Keep in mind that the November rate is still low compared to historic rates. Download a table of Section 7520 rates since inception here and a graphic chart here.

 

If an income, estate, or gift tax charitable contribution is allowable for any part of the property transferred, you can elect to use the 7520 rate for the current month or either of the two months preceding the month in which the valuation date falls. The Section 7520 rate for August (can only be elected if completed in October) was 3.4%, the rate for September was 3.4%, and the rate for October was 3.2%. Remember, the use of a preceding month's Section 7520 rate requires an affirmative election that must be included.

 

 

Although higher rates are detrimental for defective grantor trusts and intra-family loans, rates remain the same for November. We would normally advise you to delay the transaction until the December rates are announced on or about November 18, 2009. However, since there is proposed legislation that would be detrimental to this technique, you may instead want to complete the transaction as soon as possible.

 

Note that a sale to a Defective Grantor Trust is able to use the Applicable Federal Rate (AFR) as described in Section 1274. The Section 7520 rate is determined by taking 120% of the mid-term AFR. Therefore, the Section 7520 rate, which is required to be used for GRATs, will always be higher than the AFR allowed to be used for a Defective Grantor Trust. While this results in an extra benefit by using a Defective Grantor Trust, all other advantages and disadvantages in comparing the use of a GRAT or Defective Grantor Trust should also be considered.

 

Next month's AFR amounts are as follows: Short-term rates (applicable to instruments with terms of 3 years or less) were .75% for October and are .71% for November – a .04% decrease. Mid-term instruments (over 3, but not over 9 years) were 2.66% for October and are 2.59% for November – a .07% decrease. Long-term instruments (over 9 years) were 4.10% for October and are 4.01% for November – a .09% decrease.

 

 

While a higher rate reduces the benefits of a GRAT, next month's rate will remain the same. We would normally advise you to delay the transaction until the December rates are announced on or about November 18, 2009. However, since there is proposed legislation that would be detrimental to this technique, you may instead want to complete the transaction as soon as possible. A term certain GRAT generally can be zeroed out. The recently released US Government's fiscal year 2010 budget proposals include requiring a minimum 10-year term for GRATs, which would significantly reduce the possible benefits and applicability of this technique. Thus, it is very important to discus GRAT opportunities with your clients immediately.

 

 

Higher rates are beneficial for QPRTs. We would normally advise you to delay the transaction until the December rates are announced on or about November 18, 2009. However, since there is proposed legislation that would be detrimental to this technique, you may instead want to complete the transaction as soon as possible. Assuming you include a reversionary feature in the QPRT, this could be a very valuable strategy in the event the client will be considered a year older by reference to his or her nearest birthday in November. It is important to note that, unlike a technique involving in part an income, gift or estate charitable deduction, you cannot elect to use the Section 7520 rate in effect for either of the previous two months.

 

 

Higher rates are detrimental for private annuities. However, on October 17, 2006, the IRS issued proposed regulations that would eliminate (retroactive generally to 10/17/06) the tax benefits of using a private annuity to sell appreciated property between family members. Under the proposed regs, gain on the sale of property in exchange for a private annuity no longer could be deferred and recognized as the annuity payments are received. Instead, the amount realized on the date of the transaction is deemed to be the fair market value of the annuity (as determined under the appropriate interest rate under Section 7520). Thus, the entire gain will be recognized at the time of the exchange, regardless of the taxpayer's method of accounting. The IRS has not acted on the Proposed Regulations as of October 18, 2009; however, a change in position in Final Regulations is not expected.

 

 

Higher rates are beneficial to charitable remainder annuity trusts. If you have a pending CRAT transaction, you should wait until on or about November 18, 2009 to see if the December rate increases, since you have until the end of November to otherwise elect to use September's rate of 3.4%. If the CRAT is based on the life or lives of the grantor(s), allowing one or more of the grantors to add an additional year to their age (measured to the nearest birthday), will further increase the tax benefits of the transaction.

 

 

Higher rates are beneficial to charitable remainder unitrusts. However, the impact of changes in the section 7520 rate is less pronounced than in the case of a CRAT. If you have a pending CRUT transaction, you will derive a slight benefit if you wait for higher rates, so it would be best, if possible, to wait for the December rate to be announced to see if it increases. If it does not, you will still be able to elect to use September's rate of 3.4% if you complete the transaction by the end of November. If the CRUT is based on the life or lives of the grantor(s), allowing one or more of the grantors to add an additional year to their age (measured to the nearest birthday), will further increase the tax benefits of the transaction.

 

 

Higher rates are detrimental for charitable lead annuity trusts. Section 7520 permits the use of either the rate of the current month or either of the two preceding months if an income, estate or gift tax charitable contribution is allowable for any part of the property transferred. However, in this case there is no advantage in electing a prior month's rate. If possible, consider delaying the transaction until the December rates are announced on or about November 18, 2009. If the CLAT is based on the life or lives of the grantor(s), allowing one or more of the grantors to add an additional year to their age (measured to the nearest birthday), will reduce the tax benefits of the transaction.

 

Charitable Lead Unitrusts – CLUTs – Higher rate is Detrimental

 

Higher rates are detrimental for charitable lead unitrusts. However, the impact of changes in the section 7520 rate is less pronounced than in the case of a CLAT. Nevertheless, there is a small benefit to using smaller rates. However, in this case there is no advantage in electing a prior month's rate. If possible, consider delaying the transaction until the December rates are announced on or about November 18, 2009. If the CLUT is based on the life or lives of the grantor(s), allowing one or more of the grantors to add an additional year to their age (measured to the nearest birthday), will reduce the tax benefits of the transaction.

 

 

Self-canceling installment notes warrant additional consideration in light of the elimination of the benefits of using private annuities to defer gain on the sale of property between family members. Higher rates are detrimental for SCINs. If possible, consider delaying your transaction until the December rates are announced on or about November 18, 2009 to see if the rates decrease (although we do not expect any large rate decreases). Adding a year to the age of a measuring life will generally further decrease the tax benefits of the transactions assuming actual life expectancy is unchanged (i.e., the individual on whose life the SCIN is based lives to the same date). SCINs pose some significant issues, most importantly, the triggering of all unrecognized gain (and where that gain is triggered) upon death. Careful up-front planning can increase the likelihood that your clients ultimately will enjoy the tax benefits that are anticipated at the outset of the transaction.

 

Special thanks goes to Mark Albers in our Green Bay Office for his assistance issuing these monthly observations to our professionals.