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Estate Tax Planning in a Pandemic Doesn’t Have to Be Complicated

Posted on Sep. 15, 2020

Historically low interest rates and simple, common-sense tax planning techniques are giving estate planners plenty of options to help clients reduce their taxable estates, as long as they take adequate care.

“Interest rates are the lowest they have ever been — really!” wealth planning consultant Blanche Lark Christerson said September 14. And with interest rates so low, simple intra-family loans are more attractive than ever.

The IRS’s monthly applicable federal rates (AFR) under section 7872 establish the minimum amount of interest that can be charged on a loan without it being deemed a gift. Using the September AFR (Rev. Rul. 2020-16, 2020-37 IRB 1), if a parent wants to lend her son money and does a three-year note with annual payments, that would use the short-term AFR and have an interest rate of just 0.14 percent, Christerson said at the Practising Law Institute’s 51st estate planning institute.

Such low interest rates could make this a good time to revisit demand loans, in which an individual makes a loan and retains the right to decide when they will be paid back, according to Christerson. Demand loans use a blended AFR that’s published each year by the IRS in June, but with interest rates so low now, “why not just fix the payment so that you’re locked in?” she said.

However, Sanford J. Schlesinger of Schlesinger Lazetera & Auchincloss LLP cautioned that promissory notes are “very, very contentious with the IRS.”

Taxpayers using notes need to ensure they’re structured properly, Schlesinger said, noting that if there’s interest payable, it must be collected. There also must be a written note: “I’ve had too many clients come to me and say, ‘Well, we kept a ledger.’ That’s not an enforceable note,” he said.

Christerson also warned of some potential pitfalls related to loans, such as when a parent tries to use some of her annual exclusion to forgive part of the loan principal. “That looks as if Mom never intended to be repaid, and so maybe this was really a disguised gift” in the eyes of the IRS, she said.

Taxpayers might also want to refinance an existing loan. According to Christerson, nothing in the code says a taxpayer can’t do that, but “prudence dictates that you get something in exchange.” With the uncertainty related to the COVID-19 pandemic, simply lowering the interest rate makes it more likely that the person repaying the loan will be able to repay it, she said, but “a lot of this is optics, and I think you want to be careful.”

Even Easier

One oft-overlooked planning technique is for an individual to make a direct payment for someone’s tuition or medical expenses, which don’t affect the payer’s annual exclusion amount or overall applicable exclusion amount.

“Keep in mind that direct means direct,” Christerson said, noting that the payment must actually be made directly to the school, healthcare provider, or health insurer if insurance premiums are what’s being paid.

Schlesinger said it’s “unbelievable” how many clients and potential clients are unaware of that option.

“I’ve had this experience: Your clients come in; they want an intentionally defective grant trust; they want a grantor-retained annuity trust; they want a charitable remainder trust — and somewhere in the conversation, it comes out they’ve never heard of the fact that they can pay tuition for anybody,” Schlesinger said.

“It can be anybody in the world as long as you draw the check directly to the university,” according to Schlesinger, who noted that there are no restrictions on whom the payments can be on behalf of, nor are there limits on the number of people or the number of years for which the payments can be made.

Follow Jonathan Curry (@jtcurry005) on Twitter for real-time updates.

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