[This article was updated on April 29 to reflect the IRS’ §7520 for May 2020]
While it is worrisome to watch the value of securities, real estate and businesses dramatically decline, those with long-term assets that are expected to appreciate beyond their current valuations should know that the present climate does open windows of opportunity.
Sometimes long-term tax planning opportunities are missed when a strategy is implemented, or a change of law, such as the Tax Cuts and Jobs Act (TCJA) in 2017, makes a previously sound holding structure less efficient. Suboptimal tax structures often cannot be changed because there is too much built-in gain or excessive transaction costs. However, the current asset valuation dip may represent an opportunity to restructure, gift, or transfer assets to realize greater long-term tax efficiencies for your business and family.
In the following situations, a temporary low valuation may be helpful for you:
1.Transfer of Assets to Family Members – Now may be the time to transfer an interest in the family business to the next generation with reduced gift tax exposure.
2. Transfer of Assets to a Family Trust – Low-asset values in conjunction with the increased Generation Skipping Tax (GST) exemption under TCJA gives donors the opportunity to shield the future appreciation of transferred assets from gift and GST taxes. Donors should consider making current transfers GST exempt. This presents an opportunity to make a late allocation of GST exemption to trusts that may have already been funded, but may be wholly or partially non-exempt from GST tax in the future.
3. Alternate Valuation Date – Executors administering estates should consider whether selecting the alternate valuation date to value the assets in the estate will reduce the overall value of the estate. A reduced estate value could also mean a larger Deceased Spouse’s Unused Exemption (DSUE) amount to transfer to the surviving spouse.
4. Exercise of Substitution Powers – Often grantors of trusts seek to swap cash that would be included in their estate for appreciated assets in trust so those assets receive a stepped-up basis at the grantor’s passing. This may be an opportune time for the grantor to consider reacquiring appreciated assets using less cash.
5. Funding Zero-out Grantor Retained Annuity Trusts (GRATs) – GRATs are still a viable strategy as the Internal Revenue Code (IRC) §7520 rate for May 2020 is 0.8%, even lower than the April 2020 §7520 rate of 1.2%; if the market rebounds during the GRAT term, significant appreciation can be transferred for a very small taxable gift. Even if the GRAT fails, the transfer tax cost would be near zero. Sales to Intentionally Defective Irrevocable Trust (IDITs)should also still be considered. Two year GRATs are particularly efficient for gifts with low valuations.
6. Consider “Upstream Gifting” – Transferring depressed assets to a parent who will not have a taxable estate is a great way to move appreciation out of a donor’s estate and get a fresh basis on those assets included in the estate of their parents. The deceased parent of the donor can then use their available GST exemption at death to move the assets to the donor’s children.
In the following situations a temporary low valuation may be helpful for your business:
1. Corporate Distributions – Corporations may be holding low basis, formerly high-value assets that they would like to distribute to shareholders. This may be an appropriate time to consider distributing such assets.
2. Corporate Restructuring – It may be possible to rearrange ownership of corporate entities or assets given the current climate of depressed valuation. Some long-held assets such as real estate may be more tax efficient if held in flow-through entities. Business divisions may similarly be more easily effected in a depressed value environment.
3. Equity Compensation Plans – Because of the rapid increase in the value of stock and other equity consideration, many employers recently abandoned employee incentive programs as being tax inefficient. Now may be a good time to revisit such plans. For cash-strapped businesses in the current environment, equity-based compensation may be a good way to retain key employees or to provide employees with additional benefits. Specifically, employees would be allowed to elect to recognize the fair market value of the property at the current valuation within 30 days of the issue of the relevant property. Where the valuation is low, the tax cost of such elections would be low or, in some cases, zero.
4. Inbound Asset Transfers – The TCJA created many incentives for U.S. corporations to bring intangible property and certain other assets back to the United States. However, a potential high foreign tax cost may have prevented such a transfer. With uncertainty in the market and subsequent reduced valuations, that tax cost may be substantially reduced.
5. Gain Recognition Elections – In certain circumstances, elections can be made that cause gain to be recognized and then allow future benefits, e.g., a purging election for a passive foreign investment company that would then allow the Passive Foreign Investment Company (PFIC) to be reported on a mark-to-market basis prospectively.
6. Time Sensitive Opportunities – In the case of a foreign corporation holding assets that have dramatically declined in value, there may be a benefit to electing for that corporation to be a pass-through entity, effective prior to the date of the decline, to ensure any loss realized is deductible to the U.S. shareholder of that company. In certain circumstances, elections can be made to treat the entity as a flow through with a retroactive effect of up to 75 days (and more in certain circumstances). If such an election was made by March 31, any loss from January 16 should be attributed to the U.S. shareholder, not the foreign corporation.
There may be other circumstances where a temporary decline in the value of assets may create long term opportunities for the holders of those assets. We are confident that this pandemic will pass and want to ensure that, when that happens, you are structured to move forward efficiently.
Many of the opportunities outlined above are highly technical in nature, requiring professional assistance to analyze in relation to your circumstances and to implement, if appropriate. To explore these and other tax-planning opportunities during these difficult times, speak with a Friedman professional who will assist you in planning and executing these and other strategies.
