The February 2012 applicable federal rates (“AFR”), which is the lowest interest rate the IRS will allow on a debt instrument without imputing interest, has declined from the January 2012 rates. While it was believed that the AFRs could not continue to decline beyond the already historic low rates, the February 2012 AFRs are slightly less than the January 2012 rates. The AFRs for February 2012 are:
- Short-Term Rate (maturity 3 years or less): 0.19%
- Mid-Term Rate (maturity 3 to 9 years): 1.12%
- Long-Term Rate (maturity more than 9 years): 2.58%
The AFRs for February of 2012 increases the ability to transfer wealth to the next generation at greatly reduced costs. One method that can be used to transfer wealth or business interest to children (or other heirs) would be to sell the assets or business interest to the children and receive an installment note in return. This technique freezes the value of the transferred assets or business interest at their current fair market value (principal owed on an installment note does not appreciate in value), with the seller (parent) receiving the interest payments on the installment note, which will hopefully be less than the growth in the value of the transferred assets or business interest. Lower interest rates will allow for an increased spread between the growth in the assets or business interest received by the children and the interest rate paid to the parents.
This technique can be maximized by transferring the assets or business interest into an Intentionally Defective Grantor Trust (“IDGT”) created for the benefit of children, instead of transferring the assets or business interest directly to the children. One of the advantages of transferring the assets or business interest to an IDGT is that the grantor (parent) will continue to pay the income tax liability of the IDGT, thus reducing the size of their taxable estate in the amount of income tax paid, while allowing the IDGT to grow income tax free (which is really a tax free gift to the children). Allowing the IDGT to grow income tax free increases the spread between the growth of the assets or business interest held by the IDGT and the interest rate being paid on the promissory note.
Given the 2012 $5,120,000 federal gift tax exemption ($10,240,00 per couple) and unlimited gifting ability in New York, now is an unprecedented time to lock in advantageous estate planning opportunities. Contact the Pierro Law Group for additional information on how to protect and preserve your assets and maximize these current estate planning strategies.
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