Grantor Retained Annuity Trusts "GRAT"- An Estate Planning Golden Opportunity - for NYSBA'S Elder Law Attorney - MSEK

by Meyer, Suozzi, English & Klein, P.C.


An Estate Planning Golden Opportunity

October 1, 2010

Publication Source: New York State Bar Association Elder Law Attorney

Written By: Patricia Galteri, Nathaniel L. Corwin and Carmela T. Montesano

For the first time since its original enactment in 1916 there is, at least as of the date of this writing, no Federal estate tax. Pursuant to the provisions of EGTRRA, adopted in 2001, the tax has been repealed for a one year period commencing January 1, 2010.1 In light of current economic conditions and the growing Federal budget deficit, permanent repeal of the Federal estate tax is unlikely and the tax will, if not addressed by the President and Congress this year, return with a vengeance on January 1, 2011 with a $1 million exemption amount and graduated rates topping out at 55%. The Federal gift tax, however, remains in place for 2010 with a $1 million exemption amount and graduated rates maxing out at 35%, the lowest gift tax rate in many years. As of January 1, 2011, the top gift tax rate is scheduled to rise to 55%.

“In light of current economic conditions and the growing Federal budget deficit, permanent repeal of the Federal estate tax is unlikely and the tax will, if not addressed by the President and Congress this year, return with a vengeance on January 1, 2011…”

This article addresses one of several estate planning vehicles appropriate for the current low interest rate environment: the inter vivos trust commonly known as a “grantor retained annuity trust” (“GRAT”). Use of a GRAT is specifically authorized under the Internal Revenue Code and the regulations thereunder. 2 Despite the current legislative uncertainty, GRATs continue to provide a golden opportunity for taxpayers to transfer wealth to their beneficiaries with potentially minimal transfer tax consequences and should be considered by taxpayers as a potential part of their estate plans.

A. What Is a GRAT?

A GRAT is a trust to which a taxpayer irrevocably transfers assets in exchange for an annuity payable to the taxpayer for a fixed term of years selected by the taxpayer (“Fixed Term”). The annuity payments received by the taxpayer may be expressed either as a specific dollar amount or as a percentage of the initial fair market value of the trust. If the taxpayer survives the Fixed Term, any remaining trust assets will pass to the taxpayer’s selected beneficiaries free of gift tax. The taxpayer receives back through the annuity payments the initial property he or she transferred to the GRAT and thus retains control and enjoyment of the assets. The transfer of property to a GRAT is a taxable transfer for gift tax purposes. The value of the gift is equal to the fair market value of the property transferred to the GRAT minus the value of the annuity retained by the taxpayer. To value the annuity interest, the IRS uses the interest rate determined under §7520 of the Internal Revenue Code in effect for the month of the transfer of the property to the GRAT.3 The §7520 rate for July 2010 is 2.8%, historically a very low rate. The IRS assumes the assets in the GRAT will grow at a rate equal to the §7520 rate. The §7520 rate is known as the “hurdle rate” because the assets contributed to the GRAT must appreciate in value above that key rate to pass wealth to the taxpayer’s selected beneficiaries. As of this writing, a GRAT may be structured so that the value of the annuity interest equals the original contribution, thereby causing the value of the gift to be minimal (if not zero) with no gift tax due on the transfer to the GRAT. Such a GRAT is often referred to as a “zeroed-out GRAT.”4

B. Objectives

The primary objective of a GRAT is to transfer to the taxpayer’s beneficiaries any appreciation in the GRAT property over the applicable §7520 interest rate, with minimal or no gift tax cost. In a near zero GRAT, if the property grows faster than the applicable §7520 interest rate (2.8% in July 2010), any appreciation in the GRAT assets over the applicable §7520 interest rate passes to the taxpayer’s beneficiaries gift tax free, provided the taxpayer survives the Fixed Term of the GRAT. With applicable interest rates near historic lows, the chances of a successful GRAT are substantially increased.

C. Estate Tax Consequences

If the taxpayer does not survive the Fixed Term, the property transferred to the GRAT is includible in the taxpayer’s gross estate, which is the same result as if the property had not been transferred to the GRAT. Accordingly, other than legal, accounting and possibly appraisal costs, there is essentially no estate planning risk, as a taxpayer who does not survive the Fixed Term is in the same position as if he or she had not created the GRAT. If the taxpayer does survive the Fixed Term, any appreciation in the GRAT property over the hurdle rate is removed from the taxpayer’s gross estate. A GRAT can thus...

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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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