This is a difficult time and the challenges faced by families are apparent and felt by us all. We all must do our part to stay home, stay safe and stay healthy. So first and foremost, the Private Client Group at Pryor Cashman hopes you and your families are well and stay that way.

Many are thinking about things that are often pushed aside because of other pressing demands. Estate planning is one of those things. If you have been spending more time thinking about your estate plan and whether it comports with your current wishes and values, you are not alone. We suggest that you review your current plan, in particular to see if named guardians and other fiduciaries, such as executors and trustees, are the individuals you still want to have manage your estate and care for minor children if you could not do so. Powers of attorney and health care proxies should be reviewed as well.

We are here for you, to talk things over and to revise your documents if you wish or if that is advisable. As you probably know, we at Pryor Cashman are fully remote and totally operational in terms of providing estate planning services.

Tax and Estate Planning

Despite the turbulence of these times, there are some actions you can take that are prudent in a down economy. If you have not done so already, plan regular discussions with your investment advisors and review your portfolios to see if you should reallocate assets (further) and whether tax loss harvesting is appropriate to your situation.

With lower values for many assets, a bright spot is that there are significant gift and estate tax planning actions you can take now, that will benefit your family later, when asset values and interest rates rebound:

Gift assets at their current low values. With current high gift and estate tax exemptions (approximately $23 million for a married couple) and depressed values for many assets, coupled with the ability to further discount values if the gift is of a minority interest in an entity, this may be a good time for making a gift. Gifts can take the form of an outright transfer of property to the recipient (referred to as the “donee,” with the person making the gift referred to as the “donor”). Gifts may also  and in many cases should be – made in trust. The trust may be structured to be for the benefit of a single beneficiary or a group of family members (such as a child and her descendants), depending on the family’s needs and your wishes. Trusts can provide flexible access to beneficiaries as well as asset protection in addition to offering various estate and generation-skipping transfer (GST) tax minimization options not always available with an outright gift to a beneficiary.

Basis is always an important factor, and now perhaps more so than ever in recent memory. Donors in this environment will have to pay very close attention to the tax basis of any asset (other than cash) that is the intended subject of a gift. Tax basis is generally synonymous with cost (acquisition cost plus improvements, where that is applicable), and though there are some important exceptions, you can assume that the cost of a security as shown on a brokerage statement, for example, is its tax basis. Basis can also be affected by post-acquisition actions. For example, depreciable real estate may start off with a cost basis, may increase to include the cost of improvements and typically is reduced by depreciation deductions. Your accountant can help you determine the basis of an asset.

When you make a gift of property, the recipient/donee generally takes your basis as his/hers for their own income tax purposes. We generally advise clients to gift assets with a high (cost) basis for just this reason. While this is still true, in these uncertain times, you should consider gifting assets that have a basis not substantially higher than the asset’s current fair market value (FMV). In other words, avoid if possible gifting property that is now in a loss position. Although your donee takes your basis in the gifted asset, in the event your donee later sells the asset at a loss, she will measure her loss for income tax purposes by using the lower of your basis or the FMV of the gift property at the time of the gift.

For example, assume you purchased a security for $100,000 (your cost basis) and it has a current FMV of $80,000 when you gift it to your daughter. She generally takes over your basis of $100,000 (and your holding period for purposes of long or short term capital gain determination). If she later sells the security at a gain (for example, she sells during a market rebound for $200,000), she will measure her gain by the difference between her sales price ($200,000) and your basis ($100,000). However, if she later sells for $70,000, she would have a loss, and for income tax purposes the loss is only $10,000 (the difference between FMV of $80,000 and her sales price) rather than $30,000 (the difference between your basis of $100,000 and her sales price).

The example above illustrates the potential pitfall of making an outright gift of an asset that is now in a loss position (FMV less than basis). In addition to the limitation noted above, the recipient may not be in a position to utilize the tax loss effectively. This is a complex topic beyond the scope of this Alert, and requires consideration of your specific situation, but we note that a gift of property currently in a loss position may still be desirable and the donor can retain the ability to utilize the tax loss in the event of a sale if she transfers such property to a grantor trust.

Grantor trusts are not taxed as separate entities; instead the grantor trust is ignored for income tax purposes. All of the trust’s income, gains, losses and deductions are treated as if the grantor was still the owner of the property. This is so, even though the gift is complete for gift, estate and GST tax purposes. (A grantor trust is beneficial even if the trust has taxable income because the grantor, treated as the owner of the trust property for income tax purposes, is responsible to pay the income tax, rather than the trust or any of its beneficiaries. Consequently, trust assets are not diminished by the income tax payable and can grow income-tax free outside the grantor’s estate). The ability of the grantor to utilize an asset’s built-in capital losses even following its transfer to a trust may warrant structuring the trust as a grantor trust. A properly structured grantor trust can easily convert to a non-grantor trust at a later date, for example after the loss is recognized, which would prevent future gains from being taxed to the grantor, if that is desired.

Selecting assets for gifts also involves consideration of basis “step up” or “step down” if the assets are retained until death and included in the gross estate. An asset included in the decedent’s gross estate gets an adjustment to its basis, corresponding to its FMV at date of death (or the alternative valuation date, discussed below). In an environment where assets have a low basis (e.g., a residence purchased many years ago) and have appreciated or are expected to appreciate, we review the potential income and estate tax consequences and will often tell our older clients to hold onto them to get the “step up” in basis to FMV at death. A step up in basis for an appreciated asset willeliminate or significantly reduce the capital gains upon a sale by the estate or the beneficiaries of the estate. This is particularly relevant for assets such as interests in real estate LLCs and LPs, which have likely taken depreciation deductions for many years and which consequently have a low or zero basis. However, if an asset has a basis that is at or above its current FMV, and if the asset is not expected to appreciate significantly during the owner’s lifetime (or has depreciated significantly recently), the opposite may be true: inclusion in the gross estate will result in a “step-down” of basis to FMV. By giving such an asset away during lifetime, the donee/recipient will be assured of taking over the donor’s current high basis (subject to the loss rule discussed above) and will avoid a step down if death occurs in the current down market.

Swap out low basis assets in grantor trusts, which may have depreciated and replace them with higher basis property you expect to appreciate, particularly in cases where you anticipate it will not be sold by the trust in a down market. This may require an expert valuation to be performed to ensure the values of assets being put in the trust are equivalent to the value of the swapped-out assets.

Rethink or revisit GRATs, which perform very well in a low interest rate environment. If you have planned to take advantage of this technique in the past but have put it off, revisit this now. A GRAT (short for “grantor retained annuity trust”) allows the grantor(donor)to transfer the future appreciation of an asset essentially without using any of her estate and gift tax exemption and without triggering a gift tax. The gift property is transferred to a trust, which pays the grantor/donor an annuity over a number of years. The annuity is valued for federal gift tax purposes in accordance with IRS methods and using the IRS’s published interest rate for this purpose (1.2% for GRATs created in April of this year). The amount of the annuity is set by a formula, which insures that the present value of the series of annuity payments will almost precisely equal the value of the property transferred to the GRAT. (For example, where a $1 million property is transferred to the GRAT, the total value of the annuity payments payable back to the grantor is designed to almost exactly equal $1 million). Since the gift is the delta between the property’s value and the value of the annuity the grantor retained the right to be paid, the taxable gift reportable for gift tax purposes is almost zero (hence the term “zeroed-out GRAT”).

This may not seem like a particularly good planning device, since the grantor gets back almost the entire value she gave away, which would not achieve the objective of reducing the size of the grantor’s estate subject to gift and estate tax. However, this actually is the case only if the property transferred to the GRAT appreciates at a rate equal to or below the low rate assumed by the IRS (e.g. 1.2 % annually for GRATs established in April), which many refer to as the GRAT’s “hurdle rate.” Many assets have experienced a decline in value recently, which one would hope is temporary; it is reasonable to assume that these depressed values will rebound and that the appreciation over the course of the next few months but certainly over the next few years will be better than the hurdle rate. If you take advantage of this downward turn now, the appreciation in excess of the hurdle rate will escape gift and estate taxation provided the grantor outlives the GRAT term. If you do not, no estate tax savings result, but nothing is lost either (other than the transactional costs of setting up the GRAT).

To summarize, a GRAT makes good sense if the donor believes their property will appreciate at a rate in excess of the hurdle rate. There is now a perfect storm for the IRS: property values are depressed and hopefully will rebound, and interest rates are very low. Consequently, a GRAT created in the current environment has a very good chance of transferring excess value (the appreciation above the hurdle rate) to the ultimate recipient of the GRAT property, typically another trust. Such a trust can be tailored to your specific family and long term objectives. For example, the trust could be for the benefit of your children and more remote descendants.

Since a married couple can transfer approximately $23,000,000 free of federal gift and estate tax, an outright gift to descendants or trusts for descendants may work fine for many. For clients who have used all or most of their gift and estate tax exemption, or expect to transfer assets which could generate a gift tax, a GRAT is very attractive. Call one of our team to discuss this technique if you think it may be of interest.

Failed GRATs (property did not appreciate above the hurdle rate), which are returning assets to the grantor because of current low values, may be recycled into a new GRAT with more likelihood of success. This is a process often referred to as “re-GRATTing.” If the value of the returned property is low enough, and if the grantor has adequate gift tax exemption, an outright gift of the returned property may be appropriate.

Loans. Plan to make long term loans to trusts and family members, locking in historically low interest rates. Similar to the way a GRAT exploits the arbitrage between the hurdle rate and the true rate of return of the assets, if the family member who borrows from you is able to achieve a rate of return with borrowed funds that exceeds the very low interest rate the IRS requires you to charge the family member, those excess returns in effect constitute a wealth shift to the borrower, without any gift tax consequence to you.Where possible, re-evaluate existing loans and renegotiate a lower rate.

ROTH IRA conversions. The income tax due on a conversion is measured by the value of the assets at the time of conversion. Converting a traditional IRA to a Roth IRA while the values of the holdings in your IRA are down may be a good plan, particularly if you can afford to pay the resulting income tax from other assets. Note that so-calledstretch IRAs (payable over the beneficiary’s life expectancy) were eliminated as of the beginning of this year, and IRAs, 401K plans and other qualified plans must pay to a surviving non-spouse beneficiary over a 10-year period in most circumstances. There are exceptions which may apply in your case.

Estate and Trust Administration

Trust and estate distributions. Deciding whether and when an estate ortrust should make distributions to its beneficiaries is a complicated matter that extends far beyond the tax consequences. Fiduciaries should schedule additional reviews with investment managers and beneficiaries to discuss whether income that might have been accumulated within the estate or trust should be distributed to beneficiaries and vice versa. Consider distributing assets in kind, and take into consideration the trust’s other gains or losses and cash flows for the trust and its beneficiaries in these difficult times. Pay attention to fiscal years where applicable, and the beneficiary’s opportunity to defer payment of income tax on his 2019 income. As of the date of this Alert, estates and trusts do not benefit from the July 15 extension of the date to file and pay income tax.

For taxable estates, consider using alternate valuation dates. Typically the estate tax is based on the values of the decedent’s assets as of the date of the decedent’s death. However, it is possible to utilize the alternate valuation date, which is 6 months after the date of death, if that produces an overall reduction of the estate tax owed. For those decedents who died earlier this year, it will be crucial to look at these values to determine whether estate tax can be saved.

Be aware that administration of estates will be delayed due to court closures to all but essential functions, and a word about some “crisis preparedness.” Having a delay in getting a Will admitted to probate and not having the ability to deal with a decedent’s estate in a volatile market will be frustrating and at times downright frightening for executors and their advisors, as well as for the decedent’s family members. Add to the jitters caused by volatility an actual inability to access the decedent’s assets due to COVID-19 court closures, and you have entered the twilight zone none of us ever planned for. The courts will be doing the best they can, as is true for the entire legal community. The difficulties the pandemic created regarding access to a decedent’s assets for a prolonged period have highlighted just how critical it will be for your loved ones to have some ready access to cash in the event of your death. This could be as simple as opening a TOD (“transfer on death”) account funded with enough to get the family through a prolonged period. Another option would be to establish and fund a revocable trust, which will permit the trustees to access trust assets immediately without waiting for the probate process to be completed.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.