One of the most powerful estate and gift tax strategies you can employ is temporarily freezing the value of an asset that will be worth more later with a Grantor Retained Annuity Trust (GRAT). When stocks and real estate are at a low, this can be a powerful tool, assuming you (the grantor) believe the values will appreciate.

Like loans, GRATs mature within a specified number of years and you get back any money you put in when the trust expires.

 
Gift Tax 101

The current annual exclusion for the federal gift tax is $14,000 for individuals and $28,000 for married couples. For instance, if you are single you can give up to $14,000 to any number of people every year, without triggering any gift taxes. Recipients almost never owe income tax on the gifts. In addition to the annual gift amount, you can give away up to $5.45 million in your lifetime before you start owing the gift tax.

How does a GRAT work?

A GRAT is an irrevocable trust that involves transferring an asset, such as stock, with a retained right to receive fixed income, at least annually. It permits the value of the “grantor’s” retained interest to be subtracted from the value of the property transferred in order to arrive at a net gift amount.

GRATs must comply with certain U.S. Treasury Regulations requirements under Section 2702. However, these guidelines don’t define a minimum or maximum term for a GRAT, or whether there’s a minimum rate for a GRAT’s remainder interest.

While it can be structured in many creative ways, a GRAT is typically used in the following way:

•    The grantor has an asset that he believes will appreciate and that he wants to remove from his estate for tax purposes.
•    The grantor receives a defined income stream, which reduces the value of the principle.
•    The beneficiaries receive the appreciation, whatever that may be.

For example: You place $500,000 of company stock into a GRAT. You receive a certain sum in income, pay tax on it, but allow all the stock’s appreciation to transfer to your children, gift tax free.

GRAT benefits

There are many non-tax benefits to a GRAT. For example, if you want a specific asset to go to one child over another, or you don’t want a former spouse or creditor who might contest your will to obtain it, a GRAT makes it less likely that the asset will be lost if the estate is embroiled in a lawsuit.

A well-designed GRAT is a powerful way to avoid gift-tax consequences while providing your family with a significant portion of an asset’s income.

Be aware that if you die before the trust ends, then it’s as if the GRAT never existed. The trust’s entire value – including its returns – will be included in your estate and subject to the estate tax.

We hope this information is useful to you and helps you and your family. If you have a specific case or a question, please don’t hesitate to contact our office.

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