GRATs Are Great and Not Just As a Tax Tool

GRATsA GRAT is a trust that is typically created by a Trustmaker (aka, Grantor) who transfers assets, like stock or closely-held business interests, to the GRAT for a specific period of time—usually between five and ten years or as little as two years.

When gifting assets to a GRAT (Grantor Retained Annuity Trust), the language of the GRAT can provide annual fixed payments (an annuity) to the Trustmaker of up to 100% of the initial fair market value of the assets transferred to the GRAT.  

The Trustmaker will also receive a rate of return on those assets based upon the IRS-prescribed interest rate, known as the “7520 rate,” after Internal Revenue Code Section 7520. Section 7520 specifies the way in which this rate is to be calculated. For example, the IRS’s 7520 rate for November 2016 is 1.6%.

An excellent feature of a GRAT is that any asset remaining in the GRAT at the end of the trust’s term, will pass to the named beneficiaries without any additional gift tax. The named beneficiaries, in many cases, will be the Trustmaker’s children. This type of GRAT is often called a “zeroed-out GRAT” because it doesn’t end up with the grantor making a taxable gift due to the retention of an annuity equal to 100% of the assets contributed to the GRAT.

To illustrate this further, the stock of a family business is placed into a GRAT for a term of ten years, and the value of that stock is $500,000. (Note: if you put the stock of an S corporation into a GRAT, you are required to refile the S-election under the QSub rules.) The term of the GRAT is 10 years, and the 7520 rate is 1.6%. Based on these assumptions, you would pay the Trustmaker an annuity payment of $50,000 a year, plus 1.6% in interest in addition to any salary he was entitled to.

What a GRAT does in this example is freeze the asset—so in ten years, after the GRAT has zeroed out, all of the appreciated value would remain in the GRAT and pass to the beneficiaries, gift-tax free. Great way to pay along an asset that you know will highly appreciate such as a family business.  The only problem is that the Trustmaker must outlive the term of the GRAT, otherwise the assets of the GRAT remain a part of the deceased Trustmaker's taxable estate.

The GRAT can be used as an effective way to remove assets from an estate or if estate and gift taxes is not the issue, a great business succession plan. Speak with an experienced estate planning attorney to learn if a GRAT should be considered for your estate plan. We have thoughtfully made the process of requesting a complimentary consultation as easy as possible. 

Reference: AccountingWeb (November 18, 2016) “The Beauty of Grantor Retained Annuity Trusts”


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