Tax Benefits Of Grantor Retained Annuity Trusts
There are many ways to skin a cat as they say, and when you are planning your estate there are a number of different vehicles that can be used to gain estate tax efficiency. In every profession the best tool is going to depend on the specific nature of the job, and this is certainly true of estate planning. One of these tools that is of particular value as a receptacle for volatile assets is the grantor retained annuity trust or GRAT.
The way that the GRAT works is that you place assets into the trust that you would expect to appreciate like stocks and other securities, perhaps some real property, and interests in privately held businesses. You name a beneficiary, you appoint a trustee and you determine the duration of the trust term. When you are doing this you want to consider the fact that this strategy will not succeed and the assets will go back into your estate if you pass away before this term expires.
Creation of the trust effectively removes the assets from your estate for tax purposes, but the donation into the trust is considered to be a taxable gift. The total value of that gift is determined using 120% of the federal midterm rate that was in effect during the month the trust was created.
The strategy here is to “zero out” the GRAT, so you take annuity payments equal to the entire taxable value of the trust as determined by the IRS. Your retained interest is 100%, so no gift tax is due. However, if the assets in the trust appreciate beyond the original taxable value that you used to calculate your annuity payments, that remainder goes to your beneficiary. No gift tax is due on that transfer, and this is what makes the GRAT so appealing if you can execute the zeroed out strategy successfully.
