Graduated GRATs

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One traditional estate planning technique that has become increasingly popular in recent months is the Grantor Retained Annuity Trust (GRAT). Simply stated, a GRAT is an irrevocable trust where the grantor contributes property to the GRAT and retains the right to receive a percentage of the assets back over a designated period of years; any property remaining in the GRAT at the end of the designated term passes to the remainder beneficiaries of the GRAT. The percentage selected is often tied to actuarial calculations to approximately equal the value of the grantor’s original contribution to the GRAT. For gift tax purposes, the actuarial value received back is deducted from the value of the property originally contributed to the GRAT, often resulting in a nominal taxable gift to the remainder beneficiaries. This can be an effective transfer tax technique for a donor who has already used his or her lifetime gift tax exemption amount.

Where the remainder interest gift is “zeroed out”, the value transferred to the remainder beneficiaries is essentially the appreciation in the value of the property contributed to the GRAT during the GRAT term. Often, the payments back to the grantor are structured as level percentage payments over the GRAT term. However, IRS regulations permit the annuity percentages to be graduated, increasing by as much as 20% each year over the course of the GRAT term. This means that the percentage of the original contribution paid back to the donor in early years can be substantially lower, thereby allowing the assets remaining in the GRAT to more fully appreciate before the larger percentage payments are made in later years. This graduated GRAT structure can be particularly effective for an entity where exponential growth is expected and/or a liquidity event is anticipated since the percentage payments back to the donor are based on the initial value contributed to the GRAT (rather than the appreciating value over the course of the GRAT term). A graduated GRAT can also be an efficient transfer tax technique for an income-producing asset, where the income produced can be used to pay some or all of the annuity back to the grantor.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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