COVID-19 – planning for US citizens
The past few weeks have seen significant turbulence in global stocks due to the economic fallout from COVID-19.
Whilst tax planning is unlikely to be high on the list of priorities for most people, US individuals are nevertheless able to take advantage of certain unique planning opportunities which result from the current depressed asset values.
Opportunity 1 – estate tax planning
Each US citizen is able to transfer $11.58m of assets out of his or her estate during lifetime and on death, without having to pay federal gift or estate taxes.
Now is therefore a good time to consider using this tax-free allowance in order to remove value from the US gift and estate tax net, whilst prices are low.
There are lots of ways of transferring assets out of one’s estate, for example:-
Outright gifts to another individual
It is generally better to make gifts of stock rather than cash whilst stock prices are low, since any subsequent appreciation in the value of the stock will be removed from the individual’s estate.
Individual are also able to make annual tax-free gifts of up to the annual exemption of $15,000 per year without ‘eating into’ their lifetime allowance of $11.58m. These gifts can be made to any number of individuals and, as above, can leveraged by gifting stock, instead of cash, whilst values are low.
Gift into a trust
Alternatively, gifts may be made to a family trust. The trust must be structured in such a way that it is outside of the individual’s estate for US purposes.
Again, whilst stock prices are low, it is generally better to fund the trust with stock, rather than cash, therefore leveraging the value of the gift.
Individuals who have used up their lifetime $11.58m allowance (or who prefer not to ‘eat into’ it) can go a step further and transfer assets into a Grantor Retained Annuity Trust, or ‘GRAT.’
A GRAT is created by transferring assets into a trust in return for the right to annuity payments from the trust for a specified number of years (usually between two and four). The right to the annuity payments reduces the overall value of the initial gift into the trust, usually to zero so that there is no taxable gift. The annuity is based on Internal Revenue Service (‘IRS’) interest rates.
The GRAT is usually funded with assets that have temporarily declined in value, but which are expected to recover and continue to go up in value.
Provided that the property contributed to the trust appreciates at a higher interest rate than the IRS rate on the date of contribution, the remainder interest in the GRAT will be worth more than zero and will result in a gift tax free transfer to the trust beneficiaries, such as family members. To give an example, if you gift a stock into the trust which then appreciates by 20% before the end of the GRAT term, most or all of the increase in value will pass gift tax free.
The current low interest rates combined with low stock prices make GRAT planning particularly attractive at the present time.
Sale to a trust or a family member
Individuals who have used up their lifetime $11.58m gifting allowance could, instead of making gifts, sell assets to a trust or family member.
Whilst the sale proceeds would remain in the individual’s estate for US purposes, any subsequent appreciation and value would belong to the recipient trust or family member.
Opportunity 2 – capital loss harvesting
Individuals with unreleased losses in their investments might also consider selling and realising the losses on those assets, a process known as ‘loss harvesting’. Obviously, they should only do this having taken account of investment considerations.
If the individual has unrealised gains on other investments, those investments could be sold before the end of the year in order to offset the losses against the gains.
· Individuals should seek tax advice specific to their circumstances before undertaking any planning.
· In addition to US taxes, individuals will also need to consider the tax and legal ramifications of any planning in their country of residency and domicile. For example, individuals living in the UK may suffer detrimental UK tax charges if they gift assets to trusts.