PLANNING IN THE AGE OF CORONAVIRUS
March 24, 2020
We hope everyone who receives this bulletin is safe and healthy, and if you have fallen ill, we send our best wishes for a speedy and full recovery. While this situation is still in its early days and will likely stretch on for some time, we wanted to share with you some initial thoughts and news. We will continue to provide updates as developments arise.
Summary of Key Points
- In addition to the guidance previously released by Seward & Kissel regarding Federal income tax deadlines being extended to July 15, 2020, New York State and Connecticut have extended the due date for 2019 taxes to July 15, 2020. New Jersey has not yet extended the due date.
- The recent stock market decline has created an opportunity for substantial wealth transfer, even with respect to previous estate planning transactions that appear to be failing.
- Given that the coronavirus can strike anyone and with varying degrees of severity, it is important to make sure your Living Will, Health Care Proxy and Power of Attorney are up to date.
Tax Payment Deadline Extension
As noted in guidance released yesterday by Seward & Kissel, the Federal government has extended the deadline for the filing of income tax returns and the payment of income taxes (both 2019 taxes and Q1 2020 estimated taxes) to July 15th. No interest or penalties will begin to accrue until July 16, 2020.
On March 20th, Governor Cuomo gave a speech indicating that New York State would follow the Federal government and extend the April 15th deadline for filing tax returns for 2019 to July 15, 2020. It is not yet clear whether state income taxes due for 2019 will be extended through July 15th, but based on comments made by the Governor, the payment deadline appears to be extended as well.
On March 21st, Connecticut also extended the deadline for the filing of income tax returns and the payment of income taxes, including estimated taxes for the first and second quarters of 2020, to July 15th.
New Jersey has not yet extended the due date for either payment of income taxes or the filing of income tax returns.
Gifts, GRATs and Sales
The current stock market decline, while undoubtedly causing many of you considerable consternation, has led to reduced asset values and low interest rates, creating an historic opportunity to transfer significant wealth to descendants. Most estate planning transactions are effective when appreciation in an asset occurs outside of the donor’s estate. This is generally accomplished by (i) making a gift to a multi-generational trust, (ii) using a type of trust known as a Grantor-Retained Annuity Trust (a “GRAT”) for transfers to the generation below the transferor, or (iii) selling assets to a multi-generational trust in exchange for a promissory note. All of these techniques benefit from low asset values at the time of the transfer, and the latter two of these techniques are more effective in a low interest rate environment. Given the recent reductions in asset values and interest rates, now may be an opportune time to consider transferring wealth to your descendants.
If you gift an asset worth $1 million, and it doubles in value, you have moved $1 million of appreciation out of your estate. If you gift that asset to a multi-generational trust for your descendants, you have moved that asset out of not only your own estate, but also your children’s and grandchildren’s estates. Under current law, every individual has a lifetime Federal gift and estate tax exemption of $11,580,000 ($23,160,000 for a married couple). Should Democrats regain control of the Presidency and Congress next year, it is possible that the exemption could be reduced, perhaps to as low as $3.5 million, effective as early as January 1, 2021. (The Coronavirus has likely delayed 2021 income tax reform, but it is unlikely to substantially change the outlook for estate tax reform in the event of a Democratic win.) Therefore, clients planning to use their current exemptions should do so prior to the end of this year, particularly if Democrats win broadly in the November election; and you may want to consider doing so prior to the election in order to take advantage of depressed valuations.
If you have already used up all of your lifetime exemption, or if you are worried that ongoing market volatility could further reduce the value of any gifted assets, a GRAT may be worth considering. In a GRAT, the Settlor transfers assets worth $X to a trust. The trust is required to pay back to the Settlor the $X over a term of years (usually 2-10 years), along with interest at an IRS-determined rate (currently 1.8%, but dropping to 1.2% in April and likely even further in the next few months). Because the Settlor is considered to have received back what he or she contributed, no taxable gift is made to the trust. Any appreciation in the assets in the trust above the amount required to be returned to the Settlor would pass to the Settlor’s descendants (or other chosen beneficiaries) free of gift and estate tax. GRATs are particularly useful in a volatile market, since failure of the GRAT (i.e., the GRAT’s assets decline or do not grow in value, and so nothing passes to descendants) has no tax consequence. As a result, it is possible to create multiple successive GRATs funded with a single asset, or multiple GRATs with different assets. The GRATs funded with appreciating assets will succeed (and thereby pass wealth to chosen beneficiaries), while the GRATs funded with poorly-performing assets will fail (at no tax cost to the Settlor).
As an alternative or complement to a GRAT, if you have already used your lifetime exemption by funding a multi-generational trust for your descendants (or if you are planning to do so now), you may want to consider selling additional assets to that trust in exchange for a promissory note. The promissory note can be structured as a long-term note at an extremely low interest rate (currently 1.53% for a 9-year note and dropping to 0.99% next month) that pays interest only on an annual basis, with a balloon payment of the principal at the end of the note. Unlike in the case of a GRAT, the prior gift made to the trust is at risk if the asset sold to the trust declines in value, but the interest-only nature of the note (in contrast to GRATs, which must amortize principal) can allow for a substantially greater transfer of wealth over time.
Many reading this bulletin will likely have done estate planning transactions (such as GRATs and leveraged sales) over the past few years and are now discovering that the structures are under water. While there is no way to directly rescue the transaction short of a dramatic and sudden increase in equity prices (a sale 5 years ago at $50 in return for a promissory note is not going to result in a wealth transfer if the current price is $20), it nevertheless may be possible to re-use the assets that were previously transferred in new transactions which will capture any future increase in assets prices.
Updating Living Wills, Health Care Proxies and Powers of Attorney
Now is the time to review your Living Wills, Health Care Proxies and Powers of Attorney to ensure that (i) they have been properly executed and (ii) the agents named in your Health Care Proxies and Powers of Attorney are the people you would currently wish to act for you in case of a medical disability. Living Wills generally permit you to state your wishes and instructions concerning life-sustaining treatment should you be unable to make your own health care decisions and should the likelihood of your continued survival be questionable, and can also permit you to indicate whether you would like to be an organ donor after death. Health Care Proxies permit you to name an agent to make medical decisions for you if you are unable to do so; and Powers of Attorney permit you to name an agent to control your finances if you are unable to do so. All are important documents, and in light of recent events they have become all the more important.
Again, we wish you and your families good health during this difficult time.
Seward & Kissel has established a COVID-19 Resource Center on our web site to access all relevant alerts that we distribute.