The interest rate that must be used by taxpayers to calculate the amount of taxable gifts when using certain planning strategies will decline to 2.8% for transfers made during the month of June. This reduction generally benefits taxpayers looking to transfer assets to their junior family members.
The Section 7520 rate for June 2011 will decrease from 3.0% to 2.8%. A decrease in the Section 7520 rate benefits Defective Grantor Trusts, Intra-family Loans, GRATs, Charitable Lead Trusts and SCINS. Conversely, a decrease in the Section 7520 rate adversely impacts QPRTs and Charitable Remainder Trusts. The chart below helps to summarize the current interest rate situation.
Technique | Rate Trend | Impact of Current Rate and Law |
| Defective Grantor Trust | Decreasing | Favorable |
| GRAT | Decreasing | Favorable |
| QPRT | Decreasing | Not Favorable |
| Private annuities | N/A | Not Favorable – Don’t Use |
| CRAT/CRUT | Decreasing | Not Favorable |
| CLAT/CLUT | Decreasing | Favorable |
| SCIN | Decreasing | Favorable |
If an income, estate, or gift tax charitable contribution is allowable for any part of the property transferred, you can elect to use the Section 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 May and April was 3.0%, and the rate for March was also 3.0%. Remember, the use of a preceding month's Section 7520 rate requires an affirmative election that must be included.
Defective Grantor Trusts and Intra-Family Loans - Beneficial - Use June’s Rate
Lower rates are beneficial for defective grantor trusts and intra-family loans. Thus, if you are contemplating either a defective grantor trust or an intra-family loan, consider deferring the transaction to next month to take advantage of lower rates.
Sales to Defective Grantor Trusts 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. Nevertheless, in general, a Defective Grantor Trust will produce a result that is superior to a GRAT.
Next month's AFR amounts are as follows: Short term rates (applicable to instruments with terms of 3 years or less) were 0.56% in May and are 0.46% for June – a 0.10% decrease. Mid-term instruments (over 3, but not over 9 years) were 2.44% in May and are 2.27% for June – a 0.17% decrease. Long-term instruments (over 9 years) were 4.19% in May and are 4.05% for June – a 0.14% decrease.
Because of these historically low interest rates, it generally is advantageous for you to continue existing family split-dollar life insurance arrangements as loans rather than using valuable unified credit to terminate the split-dollar relationship. Split-dollar life insurance is a complicated topic and loans to irrevocable life insurance trusts are not advisable in certain circumstances, especially since inadequate planning could lead to significant problems in the future. However, in certain circumstances, split-dollar loans to irrevocable life insurance trusts may provide significant benefits if you are now supporting policies with large premiums.
Grantor Retained Annuity Trusts – GRATs – Beneficial
Lower rates are beneficial for GRATs. Thus, if you are contemplating a GRAT transaction, you may wish to defer that transaction to next month. A term certain GRAT generally can be zeroed out.
Congress has considered cutting back on the benefits of using GRATs by requiring that they include a minimum term of 10-years. This would significantly reduce the benefits of this technique. Although this provision is included in President Obama’s budget proposal, it is not currently included in pending legislation. We do expect this provision eventually will be enacted. For more information, see the related blog posting at www.wipfli.com/Blog_BlogTax.aspx.
Qualified Personal Residence Trusts – QPRTs - Detrimental
Lower rates are detrimental for QPRTs. If you have a pending QPRT transaction, you may want to accelerate the transaction so it is completed this month. If you include a reversion feature, a reduced gift will result as the client gets older; so waiting has a benefit if the client is considered one year older to his or her nearest birthday. The benefit of waiting to receive the reduced gift should be weighed against the adverse impact from the lower rates. 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.
QPRTS may be a particularly effective way to transfer Florida or Arizona vacation property that has declined significantly in value especially if the market for such property is expected to recover during the QPRT term.
Private Annuities - Proposed Regs Eliminate Income Tax Benefits of Use – Estate Tax Benefit May Remain
Lower rates are beneficial 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 May 26th, 2011; however, a change in position in Final Regulations is not expected.
While there is no income tax advantage to using a private annuity (as opposed to a normal installment sale), you might still use a private annuity to reduce estate taxes. Because the annuity ends at the owner's death, only amounts received before that date are included in your taxable estate. If the property is not highly appreciated (or your projected estate tax rate is greater than your income tax rate), a private annuity could save overall taxes. Although gain is recognized on the transaction (with any tax paid by the seller), the only amount included in your estate is the value of annuity payments received before you die.
Charitable Remainder Annuity Trusts – CRATs – Detrimental – Elect to Use Previous Rate
Lower rates are detrimental to charitable remainder annuity trusts. Section 7520 permits the use of either the current or either of the two months preceding the month in which the valuation date falls if an income, estate or gift tax charitable contribution is allowable for any part of the property transferred. If you have a pending CRAT transaction, it is beneficial to use May’s rate (3.0%) for the remainder of this month. If the transaction is delayed until June, then make the election to use May’s rate (3.0%). If the CRAT is based on the life or lives of the grantor(s), allowing the one or more of the grantors to add an additional year to their age (measured to the nearest birthday), will increase the tax benefits of the transaction. The benefits of waiting until the attainment of another year of age should be weighed against the adverse impact of possible lower rates. Since age is determined based on the transferor’s nearest birthday, it is possible for one or more months to elapse while the transferor’s age remains the same.
Charitable Remainder Unitrusts – CRUTs – Detrimental – Elect to Use Previous Rate
Lower rates are detrimental to charitable remainder unitrusts. However, the impact of changes in the section 7520 rate is less pronounced than in the case of a CRAT. Section 7520 permits the use of either the current or either of the two months preceding the month in which the valuation date falls if an income, estate or gift tax charitable contribution is allowable for any part of the property transferred. If you have a pending CRUT transaction, it would be most beneficial to use May’s rate (3.0%), which is available for transactions completed in May. If the transaction is delayed until June, then make the election to use May’s rate (3.0%). If the CRUT is based on the life or lives of the grantor(s), allowing the one or more of the grantors to add an additional year to their age (measured to the nearest birthday), will increase the tax benefits of the transaction. The benefits of waiting until the attainment of another year of age should be weighed against the adverse impact of possible lower rates. Since age is determined based on the transferor’s nearest birthday, it is possible for one or more months to elapse while the transferor’s age remains the same.
Charitable Lead Annuity Trusts – CLATs - Beneficial – Use June’s Rate
Lower rates are beneficial for charitable lead annuity trusts. It is beneficial to wait and complete the transaction next month. 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. The benefits of waiting for the lower rate next month should be weighed against the adverse impact of the grantor(s) adding an additional year to their age. Since age is determined based on the transferor’s nearest birthday, it is possible for one or more months to elapse while the transferor’s age remains the same.
Charitable Lead Unitrusts – CLUTs - Beneficial – Use June’s Rate
Lower rates are beneficial for charitable lead annuity trusts. It is beneficial to wait and complete the transaction next month. 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. The benefits of waiting for the lower rate next month should be weighed against the adverse impact of the grantor(s) adding an additional year to their age. Since age is determined based on the transferor’s nearest birthday, it is possible for one or more months to elapse while the transferor’s age remains the same.
Self-Canceling Installment Notes (SCINs) - Beneficial - Use June’s Rate
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. Lower rates are beneficial for SCINs; thus SCIN transaction should be postponed until next month, if possible. However, adding a year to the age of a measuring life will generally 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). The benefits of waiting for the lower rate next month should be weighed against the adverse impact of the grantor(s) adding an additional year to their age. Since age is determined based on the transferor’s nearest birthday, it is possible for one or more months to elapse while the transferor’s age remains the same.
SCINs pose some significant issues, most importantly, the triggering of all unrecognized gain (and where that gain is triggered) upon death. Carefully up front planning can increase the likelihood that your heirs ultimately will enjoy the tax benefits that are anticipated at the outset of the transaction.
Table of Historic Section 7520 Rates from Inception through June 2011
Chart of Historic Section 7520 Rates from Inception through June 2011