The recent downturn in energy prices has given consumers a welcomed break at the gasoline pump. The people producing the energy, however, from landowners, to oil companies, to oil field service providers, have felt the full negative effects of the steep price decline. Those producers are seeing price pressure at every turn, reducing their net incomes and eroding their enterprise valuations. Things aren’t always as bad as they seem though. Today’s mix of low energy prices, low interest rates, and the recent rise in the federal estate tax rate make estate freeze transactions particularly attractive to those people in the oil and gas industry.
While this significant price drop is painful for those in the oil and gas industry, it presents a significant estate planning opportunity. For people lucky enough to be concerned about federal estate taxes (those with a net worth in excess of $5.45 million dollars individually or $10.9 million for a married couple) the 40% tax rate presents a significant threat to their family wealth. Therefore, these taxpayers try to minimize the value of their taxable estate, thereby minimizing their exposure to the federal estate tax. Taxpayers often use discount entities and other tax strategies to reduce the taxable value of their estates.
The recent energy price dip, however, has done much of the work of minimizing asset values already. The taxpayer’s current goal is freezing the current low values of their oil and gas assets in anticipation of a recovery in energy prices later. Several estate planning strategies can effectively freeze the current value of assets in a taxpayer’s estate. When energy prices eventually recover, the value of the taxpayer’s taxable estate is frozen at today’s values, being a function of today’s lower prices. The value of the assets grows with the subsequent increase in energy prices, but outside of the taxpayer’s taxable estate.
An example will illustrate the point. Assume Martin, a single man, has oil and gas holdings currently worth $10 million when the price of crude is $30 a barrel. Martin engages in an estate freeze transaction at current prices. Two years later, Martin dies. At that time, oil prices are at $60 a barrel and Martin’s former holdings are worth $20 million. The $10 million increase in value from the price jump is excluded from Martin’s taxable estate because Martin engaged in an estate freeze transaction when oil was at $30 a barrel. For federal estate tax purposes, Martin only has his $10 million frozen estate. The freeze transaction has avoided inclusion of the additional $10 million in Martin’s taxable estate and saved Martin’s estate $4 million in additional federal estate taxes!
Freeze transactions take a variety of forms. They include grantor retained annuity trusts or unitrusts in which the taxpayer transfers assets to a trust in return for a stream of payments that the trust promises to pay the taxpayer over time. Some taxpayers prefer a sale to a special type of trust called an “intentionally defective grantor trust.” Certain of these transactions allow for a freeze in estate tax values, but still allow the taxpayer to share in the appreciation of the sold asset through variable repayments that can increase as the value of the assets sold increase.
These transactions work best when interest rates are low. Historically, we are still in a low interest rate environment, a further incentive to consider a freeze transaction.
The attractiveness of these transactions won’t last forever. Oil prices will eventually recovery. Additionally, interest rates were hiked by the Federal Reserve last year and are forecasted to rise again in the near future.
For those in the oil and gas industry, today is a challenging business environment. But, this environment presents an exceptionally good opportunity to implement an effective estate planning strategy to save future federal estate tax liabilities.
Kyle McInnis is a partner in the Shreveport office of Kean Miller and practices in the estate planning, tax, and business and corporate practice groups. He represents business clients in entity formations, corporate acquisitions and dispositions, and all matters pertaining to closely held businesses. He represents individuals and families in all aspects of the estate planning process, including devising and implementing transfer tax minimization strategies. Kyle is a Tax Law Specialist and an Estate Planning and Administration Specialist certified under the Louisiana Board of Legal Specialization. He was named the Best Lawyers’ 2013 and 2015 Shreveport Trusts and Estates “Lawyer of the Year” and the 2016 Shreveport Tax “Lawyer of the Year.”