In 2000, the United States Tax Court in Walton v. Commission of Revenue, 115 T.C. 589 (U.S. Tax Ct. 2000) gave approval to the Grantor Retained Annuity Trust (“GRAT”), and since that time, the GRAT has saved taxpayers millions but has cost the United States billions according to a recent Bloomberg article.
With the GRAT, a grantor irrevocably transfers assets to a trust but retains the right to receive an annuity payment for a stated term. At the end of the trust term, the assets remaining in the trust are transferred to the named beneficiaries. Although the transfer into the trust is considered a gift, the value of the gift in not the full value of the asset but is instead the full value of the property less the actuarial value of the grantor’s retained annuity interest. Further, the Walton decision condoned “zeroing out” GRATs, which essentially means that the grantor is making no taxable gift to the remainder beneficiaries. In a simplified example, if a grantor transfers assets into a GRAT that are expected to highly appreciate and reserves the right to receive annuity payments that equal the present value of the assets plus a modest amount of interest, he will have made no taxable gift and the appreciated value of the assets will pass to the beneficiaries tax-free.
By transferring assets that outperform the IRS’s assumed rate of return into a series of short-term, rolling GRATs, wealthy taxpayers can transfer significant amounts to their family without any tax consequences. According to Richard Covey, the attorney who developed the technique, this tax shelter may have cost the federal government $100 billion since the 2000 Walton decision. As stated in the Bloomberg article, Sheldon Adelson, mark Zukerberg, and Ralph Lauren have all utilized this estate planning technique and have saved millions. In fact, Adelson has created at least 25 GRATs through which he has passed $7.9 billion to family members while saving $2.8 billion in gift taxes.
Although GRATs are clearly beneficial, taxpayers must be very careful and follow all of the requirements for GRATs provided in the tax laws and regulations in order to reap their benefits.