• Now Is the Time to Consider a GRAT
  • December 14, 2003 | Author: J. Eric Taylor
  • Law Firm: Trenam, Kemker, Scharf, Barkin, Frye, O'Neill & Mullis Professional Association - Tampa Office
  • The debate continues over whether Congress actually will repeal the estate tax. A one-year repeal is scheduled for the year 2010, but many seasoned observers believe that additional changes in the law will be forthcoming before then. Because of the possibility of repeal, however, many clients have put off plans to effect transfers of wealth during their lifetimes. Ironically, the present environment of low interest rates, together with a recent Tax Court decision, creates a unique opportunity to effect significant transfers of wealth with little or no estate or gift tax consequences by the use of a grantor retained annuity trust (or "GRAT").

    A GRAT is an irrevocable trust to which an individual transfers property and receives in exchange a right to receive annuity payments for a term of years. At the end the annuity term, the trust assets remaining after paying all of the required annuity payments passes to the beneficiaries named in the trust.

    Normally, the value of the gift resulting from a transfer of property to an irrevocable trust is the fair market value of the transferred property. With a GRAT, however, the donor's gift is equal to the value of the property transferred to the trust reduced by the present value of the donor's annuity right over the term of the trust.

    The actuarial calculation that must be performed to arrive at the present value of the donor's annuity right is based in part on an interest rate published monthly by the Internal Revenue Service that assumes how quickly the trust assets will appreciate. For transfers occurring the month of June, the IRS interest rate is only 3.6%, an historical low. Thus, if an individual transfers assets to a GRAT during June that appreciate at a rate higher than 3.6%, additional assets will pass tax-free to the trust beneficiaries at the end of the term of the GRAT.

    For example, assume a 50-year old contributes $1 million of publicly-traded stock to a 5-year GRAT that requires the donor to receive an annuity of $200,000, and that the stock appreciates at an annualized rate of 10%. The present value of the donor's 5-year, $200,000 annuity right is $888,520, which means that the value of the gift to the trust beneficiaries is equal to $1 million less $888,520, or $111,480. However, at the end of the 5-year annuity period, the value of the assets passing to the trust beneficiaries is $389,490. Thus, by using a GRAT, the donor passes an additional $278,010 of assets to the trust beneficiaries free of gift taxes.

    In a recent case involving a member of the Walton Family (the founders of Wal-Mart), the United States Tax Court ruled that it is possible for an individual to create a GRAT and pay no gift tax by making the present value of the retained annuity right equal to the fair market value of the property originally contributed to the GRAT. Returning to the example cited above, assume the 50-year old individual who contributes $1 million of publicly-traded stock to a 5-year GRAT retains a right to an annuity of $222,108.50 rather than $200,000. Assuming the stock contributed to the GRAT appreciates at a 10% annualized rate, the trust beneficiaries will receive $254,515 at the end of the 5-year term, and the individual creating the GRAT will be deemed to have made a gift of less than $1.

    This example underscores the potential power of a GRAT as a wealth-transfer technique for assets that are expected to appreciate rapidly in the near term. Perhaps as important is the fact that, in situations where the trust assets do not appreciate faster than the assumed IRS rate -- or even decline in value -- the individual simply receives back all of the property contributed to the GRAT and is in a position to create another GRAT with the same property. Thus, the risks of using a GRAT are relatively modest. Indeed, the primary risk of using a GRAT is that the individual who creates the GRAT could die during the annuity term. In that case, the assets of the GRAT are includible in the individual's gross estate for federal estate tax purposes. However, this risk can be addressed by using short-term GRATs that exist only for two to five years.