Leveraged Estate Planning in a Down Economy

With market declines, an economy that shows no signs of a quick recovery, and the estate tax applicable exclusion amount increasing to $3.5 million, many clients and potential clients have little or no interest in transferring wealth to the next generation. That response overlooks the huge opportunities currently available: the biggest stock market gains in any business cycle typically occur between the worst part of a recession and one year later. As this article is submitted for publication, stock prices are artificially depressed by investors' fears.

With stocks attractively priced, consider suggesting that your clients use one or more of the following strategies:

• Maximizing annual exclusion gifts. The IRS has announced that the gift tax annual exclusion is increasing from $12,000 in 2008 to $13,000 in 2009.
• Using gift tax applicable exclusion amount. The gift tax applicable exclusion is staying at $1.0 million even though the estate tax applicable exclusion amount and gift tax annual exclusion are increasing.
• Creating new GRATs. Two year, rolling, asset-splitting GRATs are becoming more popular and promoted by sophisticated financial planners. “Rolling” refers to the fact that each annuity payment can be reinvested in a new GRAT. “Asset-splitting” refers to the idea that GRATs are best funded with volatile assets, and one should place in each GRAT assets that move in a different (or possibly just uncorrelated) direction than the other GRATs. When a GRAT's assets reach a “high” value, one can swap more stable assets to lock in the gains.

Suppose a GRAT is underwater — its assets have declined in value so much that it is very unlikely that the GRAT will be successful. 1 If the assets have great potential to rebound, the grantor might swap more other assets with less growth potential into the GRAT and place the low-value assets into a new GRAT to capture the upward potential. If the grantor has no other assets to swap, the grantor could transfer the GRAT payments (which presumably are worth much less than face value because the GRAT's assets are insufficient to support the payments) to a new GRAT to capture the upward potential. Similar principles might apply to a sale to an irrevocable grantor trust.

Note that the Joint Committee on Taxation has recommended requiring a 10% remainder interest for GRATs. At some point, one might consider extending the length of new GRATs to lock in the ability to have a near-zero remainder.

1 Much of the analysis in this paragraph comes from the creativity of Mil Hatcher and Ed Manigault, partners in Jones Day's Atlanta office.