Personal Wealth Law News

At the beginning of this year (2010), there was discussion in the press and in legal publications about the ability to convert IRAs and qualified plan accounts to Roth IRAs. This conversion involved paying taxes now and then being free of them thereafter, plus avoiding the necessity of minimum distributions during life. In effect, for those people who really didn’t need the amount being converted, conversion was a very effective multi-generational planning technique. To the extent you believe income tax rates will be higher in the future (a good bet), conversion makes sense. There’s a choice you can make when converting, whether to pay taxes this year at this year’s rates or over the next two years at whatever the rates will be then. Some people prefer to pay this year, because they like knowing what the tax rates will be.

Another advantage of conversion now is that security values are still low. The stock market is still far off its high values of a few years ago, so conversion now, before (we hope) the stock market recovers, is a good idea. Conversion is not for everyone. It requires some thinking about the future and personal planning. But there is still time to begin that process.

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Is it possible that Congress will do nothing for the rest of the year to restore the federal estate tax? Given the other items on its agenda, and the fact that this is an election year, it’s very possible. But then what? At the end of the year, the so-called Bush tax cuts expire. That means that the estate tax will return, at its earlier rates and exemption level: a maximum graduated rate up to 55% and an exemption of only $1,000,000 (as compared to the $3,500,000 that was in effect in 2009). Many more people will be subject to federal estate tax, and that will affect the planning they should be doing now.

In addition, the lower income tax rates that were in effect will expire. Capital gains rates will return to their prior, higher levels, and regular income tax rates will also rise. Congress has the ability to extend the lower rates, but it must take some action to do that. And we have seen that on tax issues, it’s difficult to get changes enacted. What if Congress does nothing, or if efforts to extend the lower tax rates fail? Higher taxes. It’s probably a good idea to start planning with respect to income taxes now, in anticipation of eventual higher tax rates: possibly postponing deductions to next year and accelerating income into this year. All of this could change, but it’s probably wiser to assume that nothing will happen.

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The IRS has announced the rates of interest used in valuing gifts and other transfers for the month of July, and they have fallen again. This means that transfers to the next generation can be made at a lower cost in gift tax exemption. But here’s something else affected by these lower rates: intra-family loans. An individual can lend money to a child or grandchild, for example, for a period up to just under three years, and charge interest at the rate of .61%. That means that a loan at that rate will not be considered a gift. How does this work? The person who receives the loan invests the money and earns some rate of return. To the extent that the rate exceeds the required loan rate of .61%, the borrower gets to keep the difference, and that can be substantial if the loan is big enough. The difference is not considered a gift to the borrower, which makes the intra-family loan an effective technique of transferring assets without worrying about the gift limitations in the Internal Revenue Code.

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A bill has passed the U.S. House making changes in grantor retained annuity trusts (GRATs). The bill would require that GRATs have a term of at least ten years, and would eliminate the zeroed out GRAT. These changes would make GRAT planning a little less advantageous, although transfers of wealth involving GRATs remain an excellent method of minimizing taxes. They are particularly helpful in transferring closely held business interests. With the right kind of assets, GRATs are a valuable planning technique. The change in the law hasn’t been acted upon yet by the U. S. Senate, and they might delay for some time yet. The changes are to take effect when the bill is signed into law, so there is still time to do some effective planning under the existing rules. And, even if the changes are made, GRATs remain a technique to consider in transferring assets while “holding on to them” for a while. 

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