The dismal economic forecasts due to the COVID-19 pandemic represent a unique opportunity for gift and estate tax planning. Business owners and high-net-worth individuals can take advantage of low valuations during this time to minimize gift and estate taxes. In addition, devalued assets of the recently deceased need to be valued at this time for estate tax compliance purposes.
Lower values create a unique planning opportunity by allowing business owners to transfer a greater portion of their business assets and reduce their taxable estate. The recent decline in market valuations provides an opportunity to gift at lower values, potentially allowing you to gift assets using your lifetime exemption that would have otherwise resulted in a taxable event before the pandemic. Given the additional uncertainty surrounding the U.S. presidential election and what might happen to the gift and estate tax exemption level, now may be the best time to do some gifting.
With the recent COVID-19 pandemic, the stock market’s major indices have lost about one-third of their value over the past several weeks. It also seems that real estate, marketable securities, closely held businesses and other assets have declined or may decline in the coming weeks. Except for a few industries, such as healthcare and grocery stores, business values have dwindled due to:
- lower actual or projected revenues and earnings due to business closures;
- increased interest-bearing debt to pay employees and other fixed expenses;
- decrease in the value of tangible assets such as inventory, machinery, equipment and real property due to changes in market demand and occupancy rates; and
- increase in discount for lack of control and marketability due to liquidity issues in the market.
In the present scenario, with the decrease in the value of business assets, those who are subject to federal or state estate tax or state inheritance tax should consider transferring the reduced-value assets in a tax-advantaged fashion.
With proper planning, the post-transfer growth in the assets potentially can escape estate, gift and generation-skipping transfer (GST) taxes. Since assets are worthless now because of the pandemic situation, post-transfer growth will occur even if the asset values simply return to pre-virus levels. Any additional longer-term growth will also avoid transfer taxes.
Another economic development also makes transfer tax planning especially beneficial in the current scenario. Interest rates are currently very low, in part a result of the government’s efforts to support the economy. There are certain planning techniques such as grantor-retained annuity trusts (GRATs), sales to grantor trusts, charitable lead annuity trusts (CLATs) and intra-family loans that are particularly effective in low-interest-rate environments.
Loss harvesting—The financial markets have been very low over the past several weeks. Hence, if there is an unrealized loss in some of the investments, an individual should consider selling those assets and realizing the losses (a process known as “loss harvesting”). Assuming the unrealized gains on other assets, you can realize those gains before the end of the year and use the harvested losses to offset those taxable gains.
Roth Individual Retirement Account (IRA) conversions—A traditional IRA can be converted into a Roth IRA. The main advantage of a Roth IRA, unlike a traditional IRA, is that individuals will not have to pay income tax on the money they withdraw in retirement. The beneficiaries inherit the same tax benefit if the individual dies. When you convert a traditional IRA to a Roth IRA, income tax must be paid on the value of the converted assets. When, as now, asset values have declined, the tax cost of conversion may be substantially reduced, so now is a good time to consider a Roth IRA conversion.
Following are just a few planning techniques that take advantage of this volatile time where asset values are depressed and interest rates are extremely low:
- grantor-retained annuity trusts (GRATs);
- sales to an intentionally defective grantor trust (IDGT);
- charitable lead annuity trusts (CLATs);
- spousal lifetime access trust (SLATs);
- swapping assets with a grantor trust; and
- intra-family loans.
One of the keys to many of these strategies is to obtain a supportable valuation of the assets involved in the strategy, especially when dealing with closely held businesses or a fractional interest in a business. During these unprecedented times, please contact your tax advisor for assistance with gift and estate valuations and to review your current estate plan to ensure it continues to meet your needs.
Angela Sadang is a Principal in the Advisory Services group at Marks Paneth LLP. Sadang specializes in business valuations and the valuation of intangible assets and has over 20 years of experience providing corporate financial consulting services and performing valuations.