As the new year begins, there are a number of unique estate/gift tax planning opportunities as a result of the IRS cutting interest rates. These rates are now extremely low, which may provide a small silver lining to the credit economic crisis for individuals or businesses in need of estate planning or succession planning. What do estate and succession planning have to do with the IRS's interest rate? The federal government's desire to drive down interest rates has produced the ancillary benefit that the interest rates used to make loans between family members and other transfer techniques (or trusts and entities for their benefit) are at or approaching historic lows.

For example, interest rates on short-term loans (up to 3 years) to family members are as low as 81 hundredths of a percent (.81%). Simply stated, a parent can loan a child money at .81% and if the child reinvests with a greater rate of return, the arbitrage benefits the child. Rates are also very low for longer term loans, and consequently, there are strategies to exploit the low interest rates, particularly in succession planning and/or estate planning. These strategies can have the effect of freezing the value of an individual's estate. Even better, in certain circumstances and structures where S corporation stock, LLC interests or partnership interests that regularly distribute income are sold to a trust, the ultimate result may be a sale of the entity interest for a low interest note. This strategy could result in the seller ultimately transferring the interest without making a gift and receiving only note payments equal to the income the seller would have received anyway if he had continued to own the entity interest.

Another rate published by the IRS that is used in other types of gift strategies is at an all-time low of 2.4% in January. This low interest rate offers an opportunity to make a significant gift to beneficiaries, practically free of gift tax, while also freezing the value of your estate for estate tax purposes. Consider the following example:

Assume Parent wants to maintain the value of his estate but is willing to allow his son to receive the benefit of appreciation on Parent's assets. Parent transfers stock worth $10,000,000 to a trust and retains the right to receive annuity payments from the trust for two years. At the end of the two-year term, any remaining trust assets will be distributed to the Son. The present value of the two annuity payments retained by Parent are equal to $10,000,000, calculated using the 2.4% interest rate. Because the value of the payments retained by Parent are equal in value to the stock transferred by Parent to the trust, the value of Parent's gift is equal to or nearly zero.

The 2.4% interest rate used to calculate the annuity payments is commonly referred to as the "hurdle rate" because, to the extent the stock grows at a rate in excess of the hurdle rate, the Son will receive the benefit. Assume, for example, that the stock grows in value at a rate equal to 5% per year - Son will receive approximately $416,000 at no gift tax cost! If we assume the stock grows in value at 7%, Son receives an even greater benefit equal to $746,000; but do not forget that Parent also received his $10,000,000 back plus 2.4%.

In comparison, if Parent used S corporation stock to fund the trust and the combined taxable income and growth of the S corporation was equal to 11% of the stock value, then Son would receive assets approximately equal to $1,455,000 at the end of the 2-year term. Again, the value of Parent's gift is equal to or nearly zero.

With the hurdle rate historically low, it is much easier for the trust's investments to outperform the rate, therefore transferring more assets to beneficiaries free of gift tax. This technique is only one of many that become more effective in a low interest rate environment. For individuals interested in effective ways to transfer property to descendants with little or no gift tax, now may be the time to act.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.