CHARLESTON -- A Grantor Retained Annuity Trust (GRAT) is one of the most powerful and tax efficient wealth transfer tools available today.
A GRAT is an irrevocable trust that enables a person to share the future appreciation of assets with the next generation while reducing or eliminating gift tax.
GRATs are popular among people who own assets expected to increase in value in the next few years, such as marketable securities. GRATs are used to ensure that any gains realized by a gift to family members of a depressed asset will occur outside the grantor's taxable estate.
A GRAT has a specific life or term, such as 5 years, 8 years, etc. The grantor transfers assets to the GRAT and retains an interest in the trust. The grantor then receives payments through a fixed annuity payable at least annually for life or for a term of years.
In a GRAT, assets need to grow faster than the Federal interest rate in effect at the time the trust is established. The rate, known as the section 7520 rate, is set monthly by the Internal Revenue Service.
If the assets in the trust appreciate beyond the 7520 rate, the excess amount will eventually pass to the beneficiaries tax free. If the GRAT does not produce a return that exceeds the 7520 rate, there will be no excess to transfer and no tax savings will be achieved (the trust may even be depleted).
These trusts have grown in popularity as the 7520 rate has fallen. At present, that rate is 3.4 percent.
Some Advantages of GRATs
Reduced transfer tax cost: A GRAT allows the transfer of property to a family member at a relatively low transfer tax cost, since only the value of the remainder interest on the date of funding is a taxable gift. GRATs can be structured so the value of the remainder interest is at or near zero.
Removal of future appreciation from grantor's estate: Assuming the grantor outlives the term of the trust, none of the transferred property remaining in the trust at the end of the annuity period will be included in the grantor's gross estate.
Benefits of grantor trust status: By paying the income taxes associated with the trust's income that will be accumulated and passed on to the trust beneficiaries, the grantor is effectively paying the beneficiaries' taxes for them and increasing the remainder that passes to the beneficiaries.
Some Disadvantages of GRATs
Assets belong to a trust: As with any irrevocable trust, the assets are not available outright to either the grantor or the beneficiaries during the term of the trust.
Inclusion in the grantor's gross estate: The entire date-of-death value of the trust corpus may be included in the grantor's estate if the grantor dies before the trust terminates.
The variations and complexities of GRATs are far too great to cover in this brief article. It is important to enlist the services of a competent tax attorney when setting up a trust.
Robert Nistendirk is a partner at Woomer, Nistendirk & Associates PLLC, a CPA firm located in Charleston. Bob has extensive experience in accounting, taxation, strategic planning and financial/business consulting. He can be contacted at firstname.lastname@example.org.