Grantor Retained Annuity Trust
This is a Great Time for GRATS
(In this Low Interest Rate Environment)
by Edgar Saenz, Esq.
A grantor retained annuity trust or GRAT is a trust made for holding appreciating assets.
A GRAT is an irrevocable trust that holds appreciating assets and pays the grantor annual payments for the life of the trust. The annuity is based on a rate set by the U.S. Treasury called the Section 7520 rate. For the month of February 2012, for example, the Section 7520 rate was 1.4%. This stunningly low rate represents an opportunity for taxpayers.
Two approaches are short-term and long-term GRATs. With longer term investments—for example, shares in a family business passing to children through a GRAT—sturdy souls might opt for longer trust terms. This locks in the Section 7520 rate, which is highly desirable.
Short-term GRATs are used to capture price spikes. The best use of them is where a big liquidity event is happening soon. Under current law, two-year GRATs are permissible. The White House has indicated that it will push for legislation to end short-term GRATs.
GRAT—Goal: All appreciation ends up with the kids (tax free).
GRAT—Discounted Giving: A GRAT is a way of making a gift on a discounted basis, where the full value of the gift will not be taxed either for gift tax or estate tax purposes. Under the GRAT technique, the donor transfers assets to an irrevocable trust which provides for a fixed rate of return on the amount of the transfer to be paid to the donor for a fixed period of time, regardless of the amount of income actually earned by the trust. At the end of that period, the trust terminates and the trust assets are distributed to the remaindermen.
Death: The grantor must outlive the trust term.
GRAT—Annuity: Must be paid at least annually and expressed as a fixed dollar amount or percentage of the fair market value of assets transferred to the GRAT. GRAT payments do not fluctuate but they can increase annually 20% from prior year.
GRAT—Beneficiary: A GRAT can benefit anyone.
GRAT—Examples of assets placed in trust:
• Closely held business. Move it into GRAT before sale.
GRAT—Interest rates: GRATs work best in low interest rate environments.
GRAT—Zeroed-Out: A zeroed-out GRAT is the Holy Grail of solid estate/gift tax planning. The “zero” refers to the value of the gift in the eyes of the IRS. Even though the trust assets might in fact be worth millions of dollars at the end of the trust term, if the annuity “zeroed-out” correctly, the beneficiary receives the assets free of gift taxes.
If the annuity amount is high enough, the value of the remainder interest in the GRAT is zero. The result is commonly known as a “zeroed-out” GRAT.
The present value (as of the date of the gift) of this anticipated future zero- or nominal amount-value becomes the value of the donor’s gift for gift tax purposes. Thus, the donor pays little or no gift tax (or uses up none of his gift tax exemption) on the GRAT gift, because the gift has a value of zero.
GRAT—Short term: Short-term GRATs are used to reduce the risk that the grantor will die during the term.
GRAT—Tax savings: The success of the GRAT as a tax-saving technique depends on the transferred asset’s outperforming the § 7520 rate.
GRATs are the best planning technique around. They’re easy. And they’re ideal for pre-IPO situations. Done properly, they’re free from IRS second-guessing.
Edgar Saenz is a Los Angeles-based estate planning attorney. He is a graduate of Stanford Law School. He is a member of the Trust and Estates sections of the State Bar of California and the Los Angeles County Bar Association and serves on the board of the Culver Marina Bar Association. Telephone: (310) 753-1668; email contact: info@EdgarSaenz.com.