Gifting Opportunities During an Economic Downturn

May 2020

While the current COVID-19 environment has depressed stock prices and likely the value of many businesses, there are potential opportunities for those looking to shift assets to the next generation.

In Minnesota, the current state estate tax exemption amount is $3 million per person and the top marginal estate tax rate is 16%. The Minnesota estate tax exemption amount was last revised in 2017, and, at that time, the exemption amount was scheduled to increase each year. As of 2020, the exemption amount is no longer scheduled to increase and will remain at $3 million per person until further changes are made.

As of today, the federal estate tax exemption amount is $11.58 million per person and the top marginal estate tax rate is 40%. The federal estate tax exemption was increased as a result of the 2017 Tax Cuts and Jobs Act (TCJA). Absent legislative action, the increase to the federal estate tax as a result of the TCJA will sunset effective January 1, 2026. Under current law, this means that come 2026, the federal estate tax exemption amount will revert back to 2017 levels, as adjusted for inflation.  

Thus, with the current high federal exemption amount and a potentially temporary decrease in business values, now may be a good time to consider some gifting opportunities.

Taking Advantage of Low-Interest Rates

Parents looking to shift assets to their children could consider making loans to their children with the intention of forgiving the loan over a number of years. The applicable federal rate (AFR) is the minimum interest rate that the IRS allows for private loans. The IRS determines these interest rates using a variety of economic factors. Every month, the IRS publishes a set of interest rates that are considered to be minimum market rates for loans. Generally, any loan with an interest rate that is below the AFR is considered a gift. For loans between 3-9 years (considered a mid-term loan), the AFR rate in May is 0.58%. The mid-term AFR rate for June drops to 0.43%. This means that a parent could lend their child funds at a low-interest rate and could forgive a portion of the loan over the next few years using their annual exclusion amount, which is currently $15,000 in 2020. The annual exclusion amount is the amount of money that any one person may gift to another without having to report that gift to the IRS.

For example, say a couple lends a child $100,000 with an interest rate of 0.43%. The child signs a promissory note agreeing to re-pay the loan over the next five years. Instead of having the child repay the loan, the couple could use their annual exclusion amounts to forgive the interest owed, as well as a portion of the principal. If the parents each used their annual exclusion amounts to forgive the interest and principal, the loan could be fully forgiven in less than five years with the child never having made a payment to the parents.

Taking Advantage of Depressed Business Value

Another opportunity for gifting is available to business owners whose business may have been negatively impacted by COVID-19 and the related market downturn. Many business owners may find that revenue and profits are down. However, a temporary decrease in the value of a business can provide a gifting opportunity. When gifting an interest in a business, the business owner needs to determine the fair market value of the interest they intend to gift. This is typically done by hiring a third party appraisal service to determine the value of the interest to be gifted. If the value of a business has temporarily decreased, the business interest to be gifted may have less value.

Careful consideration will need to be given as to who controls the company and manages the day-to-day operations, how company profits will be distributed, what will happen with the business upon the death of the parents and other such items. 

FMJ’s Trusts & Estates attorneys have worked with numerous families and businesses to design and implement gifting plans. If you have questions or are interested in your gifting options, please contact FMJ’s Trusts & Estates attorneys David Ness at david.ness@fmjlaw.com, Karen Schlotthauer at karen.schlotthauer@fmjlaw.com, Matthew Jensen at matthew.jensen@fmjlaw.com, or Nicole Flaherty Cropper at nicole.flaherty@fmjlaw.com