Grantor Retained Annuity Trust (GRAT)

[Kathleen Reynolds]

#3896

An estate owner may want to create an irrevocable trust and intentionally retain certain rights in the trust which will cause the trust to be classified as a so-called “grantor trust.” As a grantor trust, the grantor will be taxed on the trust income even though it is not distributed to him. Thus, for income tax purposes, the grantor is treated as though he still owns the trust principal. However, by carefully selecting the appropriate retained powers (IRC Sections 673-677), the trust may be effective for gift and/or estate tax purposes and thus not includable in the grantor’s estate.

There are situations where being taxed on the trust income may be consistent with the grantor’s overall estate objectives. Bear in mind that the grantor may be paying income taxes on trust income that could be accumulated for or distributed to the trust beneficiaries (his heirs). This situation is enhanced because under current law the grantor need not report a gift for the payment of income taxes on trust income. Also, in situations where the grantor sells assets to the trust, the income tax consequences (capital gains, etc.) may be disregarded because the trust does not exist for income tax purposes.

GRITS, GRATS and QPRTS are automatically classified as grantor trusts because of the grantor’s retained interest.

Click the Edit button to set the specifications of the GRAT:

• The name of the GRAT
• The type of calculation
• The year in which the transfer takes place
• The §7520 rate
• To select the asset to use to fund this technique, click the ‘+’ button.
• Enter the principal.
• Enter the Minority Discount rate. What is a minority discount? A minority interest discount may be applicable to the value of the asset being gifted. Generally, due to issues of control, a minority interest in an asset will be worth something less than its proportional share of the overall asset value. For example, a 1/3 interest in a partnership will not be worth 1/3 of the overall value, because someone who owns 1/3 of the partnership lacks control over any investment-related decisions. The discount can be obtained when the asset is gifted to multiple beneficiaries. The system limits any minority discount to 50% or less.
• Enter the Maximum Annuity. What is the maximum annuity GRAT? Under the maximum annuity GRAT the annuity payout is structured to return to the grantor 100% of the initial value of the gifted asset plus interest at the IRS rate. Thus, the annuity is for the maximum amount allowed by the IRS. This arrangement would normally produce a zero-remainder interest value and 1) a minimum reportable gift for a reversionary GRAT or 2) a zero gift for the term certain GRAT. However, for the term certain GRAT the grantor may want to set the annuity payout just below the maximum so there will be a small remainder value, which will in turn cause a very small reportable gift. By filing the required gift tax return for this small gift and providing full disclosure, the 3-year statute of limitations will commence. This will limit the period for the IRS to challenge the gift value and term certain arrangement. Whenever you have a maximum annuity GRAT, you are essentially structuring the GRAT so that the annuity payout is equal to 100 percent of the fair market value of the asset transferred into the GRAT. As a result, in order for the GRAT to produce a positive value for the remainder beneficiary, the return on the asset must be greater than the IRS §7520 rate.
• Enter the years of the term of the trust.
• Verify the amount listed as principal.
• Verify the client’s age.
• If you want to fund the life insurance premiums via a GRAT, check yes, and this adds a new report.
• If you want to include varying Annuity Payments, check the box. This creates an Edit button that will allow you to set the Annual Growth Rate of Annuity Payments, or to define up to 10 years of individual Payout Rates.

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