In the world of advanced estate planning there existed a "Perfect Storm" from 2008-2010. A perfect storm in the sense that conditions were ideal for transferring ones estate to the next generation at an incredibly low estate and gift tax rate due to historically low federal interest rates and extraordinary low asset values. At that time, the mid-term AFR (applicable federal rate) dropped below 3%, real estate values were spiraling downward, interest rates and bond values were extraordinary low.
Every month the government establishes what is known as the Applicable Federal Rate (AFR) for the charging of interest rates in related party transactions or intra-family loans. The IRS uses the AFR to determine that the interest you are charging on an intra-family loan is sufficient. Using an interest rate less that the AFR would re-classify the loan as a gift. The AFR is divided into short term rates; for loans less than 3 years, mid-term rates; for loans from 3 to 9 years and long-term rates; for loans over 9 years. This rate is recalculated every month.
This unique mix of economic conditions along with advanced estate planning techniques such as IDGT's (sales to an intentionally defective grantor trust's), GRAT's (grantor retained annuity trust's), CLT's (charitable leads trust's) and Intra Family Loans (as discussed earlier), make it possible to take advantage of enormous tax savings opportunities. IRS Section 7520 is used for calculating the gift and estate taxes for these techniques. Roughly speaking the 7520 rate is equal to 120% of the mid-term AFR rate.
Today, or more specifically during 2011-2012, we have a "New Perfect Storm" and this new perfect storm is even more favorable than the first "Perfect Storm". Conditions that existed before are even better today from an estate planning point of view. Real estate values are still depressed, bond values are still low and the mid-term AFR (applicable federal rate) is now at or below 1%. Unlike 2008-2010, the federal gift tax exemption for 2011-2012, for an individual is $5,000,000, and for a couple is $10,000,000. In 2012 these figures are adjusted for inflation to be $5,120,000 for an individual and $10,240,000 for a couple.
In a perfect estate planning world the time to transfer your assets and to lower estate and gift taxes is now. Why? It is a rare thing that that these favorable conditions all exist at the same time and one by one each of them will disappear. The $5,120,000 gift tax exemption is eliminated at the end of 2012 and as the economy improves, interest rates, the AFR and real estate values will eventually go up. When that happens, depending on the size of your estate and without proper estate planning, the tax obligation to your family could increase by millions of dollars.
In conclusion and without going into great detail, your estate planning goals are many; (1) take advantage of this large exemption while you can, and (2) design an advanced estate planning technique that allows you to lock in the value of your wealth today, in such a way that the IRS does not recognize future appreciation of your assets tomorrow.
The net result with the right mix of techniques will be; (1) lower estate taxes and (2) the ability to enjoy the use of the income from your assets for an extended period of time. How much your family saves will depend on the size of your assets and how long you live. Ultimately, your family will inherit your wealth and not have to pay more estate tax than they are legally required to.
Ed Wollman is a FL Bar board certified wills, trusts and estate's attorney with 26 years' experience practicing in the state of FL.