F. John Williams is an attorney with Fredrikson & Byron in Fargo. He provides sophisticated estate planning, business succession, and trust and probate administration solutions for business owners, farmers, ranchers, executives and professionals. He can be reached at firstname.lastname@example.org
During unsettling times like the ones we’ve experienced over the last six months, you might feel like “planning” is something that is just impossible. In fact, how can you think about one, two or certainly 10 years from now when you don’t have any idea if you’ll be able to go to work, your kids will be in school, or if a loved one won’t be here in a month? The fact of the matter is that all of us are mostly just reacting in times like these.
However, for those precious few of us who can look beyond today, tomorrow, or even this week, opportunities abound. And, for the rest of us who don’t look beyond the present, deep down we know in our heart that opportunities will be lost.
Whether you are a planner or not, please join me for a few minutes here to see what economic opportunities you might have not yet realized during all of this chaos. I promise it will be worth your while.
Interest rates make a huge difference in mortgages and interfamily loans
In my law practice, I’ve spent the last six months refinancing nearly every single interfamily loan that exists. One year ago, the annual interest rate prescribed by the Internal Revenue Service for interfamily loans was 1.85 percent for loans up to three years, and 2.21 percent for loans greater than nine years. Today, those rates are 0.14 percent and 1.00 percent respectively. This means the total interest paid on a 15-year $100,000 loan this year versus last year will cost the borrower approximately $10,400 less over the life of the loan than it did just one year ago. Now, multiply that result by 10, and significant wealth transfer starts to occur.
And, the benefit in interest rate reduction is not just limited to interfamily loans. The 30-year fixed mortgage rate in September of 2019 was about 3.5 percent. Today that same rate is about 2.9 percent. On a $500,000 home with an 80 percent loan-to-value ratio, the savings are over $47,000 over the life of the loan.
The fact of the matter is that interest rates, across the board, have gone down quite dramatically since the Covid-19 pandemic hit. Many businesses took advantage of payment protection loans, but others also took advantage of refinancing to save on longer-term debt, mortgages, and interfamily loans.
Market valuation decline can be a big benefit for interfamily transfers
At first glance, the fact that your business is worth less today than it was one year ago doesn’t sound like an “opportunity.” However, for those who have concerns about gift or estate taxes, the ability to transfer wealth from one generation to the next without incurring a gift or estate tax is a significant concern. One doesn’t need to look much further than at all of the farmers in our community. Like just about all farms, other closely held businesses can’t withstand an additional tax on the transition of the business from one generation to the next. And, like just about all farms, many businesses won’t continue, unless one generation can pass it to the next.
Therefore, when a global pandemic hits the world and uncertainty abounds, it’s really hard for anyone to be too optimistic about the going concern of just about any business or asset. This is the case of the outlook with appraisers, who might appraise real estate, minerals, equipment, or a business itself.
Take for example the value of a business that, per the business appraisal, is worth a million dollars less than it was one year ago. The gift or estate tax reduction of this market decline could equate to over $400,000 in gift or estate tax savings. Now, if you layer the market valuation with the interest rate reduction, the wealth transfer from generation one to generation two gets significant. Since the family will still continue to operate the business, the market decline is never actually realized. By taking advantage of this unique time in history, a family can save potentially millions of dollars.
Laws are changing: Benefits today may not be here tomorrow
When fear and uncertainty are prevalent, our government will also spring into action. Since March of this year, federal and state governments have injected trillions of dollars into the U.S. economy to keep workers paid and companies running. One need not look further than the Paycheck Protection Program, where the government allocated billions of dollars to loan to businesses to provide low-interest loans that may partially or even fully be forgiven. Did you hear that? FREE MONEY!
In the context of the trust and estate planning, laws can also change and change quickly. Those fast-paced laws that I tend to focus on are tax laws. With a major election in the fall, significant federal stimulus, and polarizing viewpoints, I can only expect that the laws in place today may not be around forever. And, in fact, the gift and estate tax laws passed in 2017 are set to expire on Jan. 1, 2026. The point here is that tax benefits identified today may not be available tomorrow.
After you’ve taken advantage of your financial opportunities, you will see another very sober truth about a pandemic. This sober truth is that life is precious and fragile. What we know today about our health and our loved ones is not what we can always expect for tomorrow. It doesn’t have to be Covid-19. It can be a car accident or injury on the job or sobering medical diagnosis. The fact of the matter is that life for all of us ends the same way.
So take care of your business. Don’t leave your family in a fog of uncertainty. Prepare a Will, Power of Attorney and Health Care Directive. Make sure your family knows where the documents are located, and make sure someone knows your wishes. Uncertainty creates fear. While we never know what’s certain about our health and our families, we can know for certain how we will leave our loved ones once we’re gone. Don’t procrastinate. Take action.
Finally, after you’ve taken your last lap around and finished your work, look to your left and to your right. Realize that everyone in your life is on this ride with you. You can’t take advantage of the opportunities or set your affairs in order without affecting someone else; and if you tackle the pandemic with trusted colleagues and advisors, your plans have a better chance of working out the way you hope they will.