Smart Ways to Transfer Assets Before Taxes Spike
Business + Economy

Smart Ways to Transfer Assets Before Taxes Spike


It’s easy to gripe about the rich manipulating the rules to lower their tax rates, but sometimes it's better to simply borrow a few pages from their playbook. Finagling a low tax rate on income – as Warren Buffett talks freely about – might be difficult for regular salaried workers, but there’s another area where modest taxpayers have something to learn from the wealthy: minimizing estate taxes.

With the IRS’s monthly interest rate at its lowest level on record at 1.4 percent, a down stock market and depressed housing values, this is a prime time to maximize tax-savings wealth transfer strategies.

“The effectiveness of many strategies depends on being able to get a higher rate of return than the IRS interest rate – now, with the rate so low, and values depressed, that shouldn’t be hard to do,” says Alan Augulis, an estate planning attorney in Warren Township, N.J.

People of modest wealth shouldn’t assume they won’t be affected by estate taxes. Even though the current federal 35 percent estate tax kicks in on estates larger than $5 million (or $10 million for couples), in 2013 the federate estate tax exemption is scheduled to drop to $1 million, and the tax rate will jump to 55 percent, unless Congress intervenes.

What’s more, 17 states and Washington, D.C., have their own estate taxes. In Washington, D.C., and most states such as Maryland, New York, Massachusetts and Oregon, the tax kicks in on estates valued at more than $1 million. But only $675,000 is exempt from the estate tax in New Jersey, $338,444 in Ohio, and $850,000 in Rhode Island. Most states with estate taxes charge a top rate of 16 percent. Washington DC’s is the highest, at 19 percent.

When you consider everything included in an estate – your home, car, retirement accounts – it can all add up pretty quickly beyond those exemption levels. “Yet you would be amazed at how many people don’t plan for the estate tax,” says Steve Lewit, CEO of Wealth Financial Group in Chicago.

One of the simplest ways to pass on assets is through piecemeal gifting. Every year you can give away $13,000 to as many individuals as you like, tax free. So if you and your spouse have three children, you can combine your exclusion to give $26,000 to each.

But unless you’re super wealthy, you may be hesitant to give money away, in light of the uncertainties of the economy and the markets. “Even wealthy people are concerned about outliving their money these days,” says Robert Katz, partner in charge of wealth strategies at Bainco International Investors in Boston.

As an alternative, there are a number of ways to enable your assets to appreciate in your children’s names, without actually giving them up.

Intra-family loans are the most basic example. Just as with any loan, an intra-family loan must be repaid with interest after a specified period of time. The interest can be paid regularly or as a balloon payment at the end of the loan term.

Loans, so as not to be subject to the gift tax, must be arranged with interest. Each month the IRS sets the interest rates called the Applicable Federal Rates. For October, the rate used in many wealth-transfer maneuvers is 1.4 percent, but for intra-family loans they can be even lower, depending on the term: The rate is .16 percent for short-term loans of three years or less, 1.19 percent for loan terms of four to nine years, and 2.95 percent for 10 years or more.

While these loans can be a terrific way to help a relative pay for college, buy a house, pay down high-interest debt or other expenses, you can also use the loans as a simple tool to transfer wealth. If you loan your son $100,000 for nine years, and he invests the money and earns 5 percent, at the end of the term the money will have grown to $155,132. He will have to return $111,234 to you, which is the loan plus interest. But the gain – $43,898 – is his to keep. It would be subject to capital gains taxes, but no gift or estate tax.

“With rates bottomed out, this is a huge arbitrage opportunity,” says Dave Reinecke, chair of the tax practice group at Foley & Lardner in Madison, Wisc. “And you can set this up in 15 minutes with a one-paragraph promissory note, if you want. It couldn’t be easier.”

Transferring wealth using a trust takes some more planning, but the pay-off can be big.

One of the more common is the so-called GRAT (grantor retained annuity trust). Don’t let that mouthful scare you. It’s really quite simple: You set up a trust with invested assets and a specified term, usually between three and 10 years.

At the end of the term, the trust dissolves, the original amount put into the trust plus interest stays in your name, and any gain on the investment above the IRS rate goes to your beneficiaries.

If you’re ready for an even bigger step toward minimizing estate taxes, consider the benefits of transferring ownership of your home to your children now, rather than waiting until after your death.

With the lifetime gift tax exemption at $5 million until 2013, you can transfer title to your home with no gift tax consequence as long as it is valued at $5 million or less. And with housing values still deeply depressed, when the market recovers the appreciation will occur in your beneficiary’s name, rather than in your estate.

If you’re not prepared to give up use and control of the house, you can set up the transfer using a Qualifed Personal Residence Trust (Qpert). This enables you to specify a term under which you manage and live in the home.

Once the term expires, you can pay rent to your beneficiaries – yet another way to gradually transfer wealth free of gift and estate taxes. And when a pipe bursts or the furnace conks out, you get to pick up the phone and call the landlord.