Low-yield Treasuries can benefit estates

Situation: Tax law mandates the use of certain interest rates — called applicable federal rates — in promissory notes between related parties and in valuing the gift portion of certain planning transactions. Because current yields on Treasury obligations are at historic lows, certain estate planning techniques can be very attractive. Here’s how your client can take advantage of current low interest rates by using these techniques. Solution: Applicable federal rates, which are computed and published by the Internal Revenue Service monthly, are based on the weighted average market yield for marketable Treasury obligations. The AFR rates for January 2009 range from 0.81% for short-term securities (those that mature in three years or less) to 2.06% for securities maturing in four to nine years and 3.57% for longer-term debt. These are historically low interest levels for Treasury securities. Intra-family loans and sales to flawed trusts Promissory notes between related parties have to bear market interest rates to avoid the imposition of imputed interest that may be subject to income tax or gift tax. If the notes charge the applicable AFR, the imposition of imputed interest for income or gift tax is avoided. As a result, your client can loan funds to his or her children (or sell assets using a promissory note) at a very low interest cost. By exchanging assets for a note, the client has fixed the value that will be included in his or her estate (since the note does not appreciate). As long as the assets transferred appreciate at a rate higher than the AFR used on the loan, the client has achieved significant estate tax savings, since the appreciation on the assets will not be included in his or her estate. For a sale of assets to an intentionally-defective grantor trust, see Tax INsight, Aug. 5 Other options Other estate planning techniques that benefit from lower interest rates include grantor retained annuity trusts and charitable lead annuity trusts. In a basic GRAT, the grantor of the trust transfers assets to a trust, but retains the right to annuity payments for a fixed number of years. After that, the remainder of the assets in the trust passes to the trust beneficiaries. The amount of the taxable gift of the remainder or successor interest is determined by subtracting the value of the retained annuity stream from the value of the property transferred to the trust. Lower interest rates increase the value of the retained annuity and therefore reduce the amount of the taxable gift.