Monday, April 18, 2011

Use of the Applicable Federal Rate (AFR) in Exit Planning

Over the last few weeks, I have discussed the factors that have made transferring business interests to Insiders very attractive right now.  Many times when we plan with clients, we structure the transfer of business interests as part gift – part sale.  Typically in doing so, the sale part is seller financed.  Therefore, and especially when transferring to a child, we would like to use the lowest interest rate we can.  That rate is the Applicable Federal Rate (“AFR”).

What Does Applicable Federal Rate - AFR Mean?
Generally, this means the interest rate published by the U.S. Treasury to calculate imputed interest charges.  In essence, it is the lowest interest rate that can be charged before the loan would be considered a below-market loan.  If the loan is a below-market loan, there may be additional gift tax consequences.

The federal "short-term rate" isdetermined from a one-month average of the market yields from marketable obligations of the United States with maturities of 3 years or less. The "mid-term rate" is determined from obligations with maturities of more than 3 years but not more than 9 years, and the "long-term rate" is determined from obligations with maturities of more than 9 years.

Currently, the long-term rate for April 2011 is 4.25%.  This is a relatively low interest rate and when combined with the discounting and current gift tax regime, it makes for a powerful way to transfer significant business assets while minimizing the tax liability.

I’ve included the recent AFR rates below:

BridgeBuilder - Plans for Life

Garrett Griffin