Use It or (Potentially) Lose It: Inflation Hikes Provide Unprecedented Estate Planning Opportunities  

November 23, 2022

There are more estate planning opportunities as a result of inflation-adjusted figures recently released by the IRS. The gift, estate, and generation-skipping transfer (“GST”) tax exemption amounts are each increasing to $12,920,000 per person starting January 1, 2023. These figures are historical highs and reflective of the significant increase in inflation that has also impacted the U.S. economy in 2022. With an increased exemption of $860,000 per person more than the 2022 amount of $12,060,000, such figures present significant opportunities for individuals (and married couples, who may exclude $25,840,000 between them) to make substantial gifts free of transfer tax. Absent a change in legislation, the record-high gift, estate, and GST tax exemption amounts are set to sunset after December 31, 2025. Accordingly, individuals who wish to utilize their present exemptions should begin to think about doing so sooner rather than later.

In addition to these increases, the inflation-adjusted annual exclusion amount—the amount that each person can give to anyone else, gift tax-free, in each year—will increase to $17,000 per person in 2023.1 This is the first time since the gift tax annual exclusion has existed in the U.S. tax code that the gift tax annual exclusion has increased in consecutive years, also having increased from $15,000 per person in 2021 to $16,000 per person in 2022.

In addition to these historically high exclusion amounts, rising inflation has led to significant increases in the applicable federal rate (“AFR”) and Section 7520 rate. These rates are relevant to intra-family transactions such as sales and loans, as well as other planning techniques such as grantor retained annuity trusts (“GRATs”) and charitable lead trusts (“CLTs”). While the past few years have seen unprecedented low rates, the past year has seen markedly increased federal rates. The relevant interest rates affecting estate planning techniques change monthly. The rates applicable to transactions in November, along with some historical rates for comparison purposes, are as follows:

 

November 2022

January 2022

November 2021

Short-term loan (3 years or less)

4.10%

0.44%

0.22%

Mid-term loan (more than 3 and up to 9 years)

3.97%

1.30%

1.08%

Long-term loan (more than 9 years)

3.92%

1.82%

1.86%

Section 7520 rate

4.80%

1.6%

1.4%

Although the recent rise of interest rates may somewhat limit the effectiveness of traditional planning techniques like GRATs and CLTs, they can still be powerful estate planning tools.

GRATs

A GRAT is an irrevocable trust in which the individual who creates the trust retains the right to receive annuity payments for a selected term of years equal to the amount contributed to the GRAT plus an amount equal to a hurdle rate (the Section 7520 rate, referred to above). At the end of the annuity term, the appreciation on the trust property in excess of the hurdle rate of return (4.8% for November 2022) passes tax free to that individual’s family members or trusts for their benefit. Assets expected to increase in value significantly over a short period of time are ideal assets to contribute to a GRAT. As an example, a GRAT funded in November with $5,000,000 for a three-year term whose assets appreciate 7% a year for the 3 years would produce a tax-free remainder of over $250,000. If the same assets appreciate at a rate of 10% per year the tax-free remainder would be over $600,000.

CLTs

For those charitably inclined, consider a CLT, which is similar to a GRAT except that a charity receives the annuity payments instead of the individual who created the trust. Your family members or trusts for their benefit still benefit tax free from any asset appreciation in excess of the hurdle rate.

This environment also presents certain planning opportunities that are more effective when higher interest rates are available, such as qualified personal residence trusts (“QPRTs”) and charitable remainder trusts (“CRTs”).

QPRTs

A QPRT is a means of transferring ownership of your home at a reduced gift tax cost. The trust provides that you retain the right to live in the home for a specified number of years that you select when you create the QPRT. At the end of that period, ownership of your home passes to your beneficiaries or to a trust for their benefit. The longer period of years you select—and the higher the then-applicable Section 7520 rate—the lower the value of the gift.

While QPRTs can potentially present significant transfer tax savings, residential transfers are not without administrative hurdles. Accordingly, care should be taken in making these types of transfers and administering the QPRT during its term.

CRTs

A CRT is a means of producing an income stream for you or your beneficiaries for a period of years, or their lifetime, with the remainder to pass to charity. The donor will receive an immediate income tax charitable deduction when the CRT is funded. Additionally, a CRT can be particularly useful in deferring gain on appreciated assets, as CRTs are exempt from income taxation.

You should consult with one of the members of Dechert’s Private Client team to help you determine if any of these techniques or other estate planning opportunities are appropriate for your situation. Dechert’s Private Client team is always ready to help you make the most of these and other opportunities available to you.

Footnotes

1) For gifts to non-U.S. citizen spouses, taxpayers can gift up to $175,000 in 2023 before utilizing their Estate Tax Exemption. While gifts to U.S. citizen spouses are unlimited, gifts to non-citizen spouses are not.

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