The grantor retained annuity trust (GRAT) is an estate planning technique that can be used to transferfuture appreciation to family members, or others, free of gift and estate taxes provided the grantor survives the trust term.
TRUST ESTABLISHED. In order to implement a GRAT, the grantor creates an irrevocable trust for a specified number of years, names his children as trust beneficiaries, and transfers to the trust property that has a potential for substantial appreciation. The grantor retains the right to receive, for the term of the GRAT, a “qualified annuity interest” based on either a specified sum or fixed percentage of the initial value of the property transferred to the trust. This annuity is mandatory and must be paid at least annually. The annual payment may be increased, provided the increase is not greater than 120 percent of the prior year’s payment. Additional contributions to the GRAT are not permitted.
Only the value of the remainder interest payable to the trust beneficiaries is subject to the gift tax. This value is determined by subtracting from the fair market value of the property transferred to the trust the present value of the annuity retained by the grantor. The value of this annuity is increased by a longer-term trust, larger annuity payments, and lower assumed interest rate used to make the present value calculation. To summarize, gift tax exposure is reduced if the present value of the retained annuity is increased and the value of the remainder interest is decreased:
Exposure to Gift Tax Value of Retained Annuity Value of Remainder Interest
DURING TRUST TERM. Tax-free annuity payments are made to the grantor. Trust assets may be used to make these payments. For federal tax purposes the GRAT is considered a grantor trust, meaning that the grantor pays taxes on all trust income. Should the grantor die before the end of the trust term, the annuity payments continue to be made to the Grantor’s Estate and the property is subject to estate taxes.
AT END OF TRUST TERM. Any property remaining in the trust, including appreciation and earnings, is paid to the trust beneficiaries (i.e., the remainder interest). Provided the grantor lives to the end of the trust term (and does not die within 3 years of the transfer), this property is not subject to estate taxes.
Information required for analysis & proposal
1. Fair market value of property transferred to trust (provide appropriate appraisals).
2. Term of trust (in years).
3. Annuity to be paid (as dollar amount or percent of initial trust value).
4. Payment frequency (annually, semiannually, quarterly, or monthly).
5. Increase in annuity as a percent, if any (not to exceed 120 percent of prior year).
6. Age of grantor (if grantor retains reversion).
7. Date of transfer to trust (needed to set payment dates and determine Section 7520 interest rate as published monthly by IRS).