Kathleen ReynoldsKeymasterOctober 24, 2022 at 12:31 amPost count: 428
Calculates the annuity interest retained by the grantor and the gift tax value of the remainder interest for a Grantor Retained Unitrust (GRUT). Through this tool the grantor retains essentially an annuity interest with payments equal to a fixed percentage of the value each year of property transferred to an irrevocable trust. The remainder interest generally passes to the grantor’s designated beneficiaries at the end of a specified term or at the earlier of the end of specified term or the grantor’s death.
A grantor retained unitrust may be an effective means for a wealthy client who wants or needs to retain all or most of the income from a high-yielding and rapidly appreciating property to transfer the property to a child or other person with minimal gift or estate tax. GRUTs are particularly indicated where the client has one or more significant income-producing assets that he or she is willing to part with at some date in the future to save federal and state death taxes, probate costs, to obtain privacy on the transfer, and to protect the asset against the claims of creditors.
A GRUT is created by transferring one or more high-yield assets into an irrevocable trust and retaining the right to an annuity interest for a fixed term of years or for the shorter of fixed term or life. When the retention period ends, assets in the trust (including all appreciation) go to the named “remainder” beneficiary (ies). In some cases other interests, such as the right to have the assets revert back to the transferor’s estate in the event of the transferor’s premature death, may be included.
GRUTs provide an annuity payment equal to a fixed percentage of the current value each year of the assets in trust. In this sense, a GRUT is similar to a variable annuity. The payout rate is fixed, but since the value of the assets can be expected to vary year to year, the dollar annuity payout also varies year to year.
For example, if $100,000 is placed in trust and the annuity payout rate is 5 percent, the trust would pay $5,000 the first year. If the value of the assets in trust increase to $110,000 in the subsequent year, the payout would be $5,200, 5 percent of $110,000. If income earned on the trust assets is insufficient to cover the annuity amount, the shortfall in payments will be made from principal. All income and appreciation in excess of that required to pay the annuity accumulate for the benefit of the remainder beneficiary (ies). Consequently, it may be possible to transfer assets to the beneficiary (ies) when the trust terminates with values that far exceed their original values when transferred into the trust and, more importantly, that far exceed the gift tax value of the transferred assets.
The gift tax value of the transferred assets is determined at the time the trust is created and funded using the “subtraction method.” The gift tax value is determined by subtracting the value of the annuity interest (and, in some cases, other retained interests, such as the right to have the assets revert back to the transferor’s estate if he or she does not live the entire term of the trust) from the fair market value of the assets transferred in trust. How the annuity interest and any other retained interests are valued depends on who the remainder beneficiary (ies) is (are) and who retains the annuity and other interests relative to the transferor. There is a more restrictive and less appealing set of valuation rules when family members are beneficiaries and certain family members retain interests in the property both before and after the trust is created than when unrelated parties are involved.
When unrelated parties are involved, all interests are valued according to their actuarial present values using the valuation rules of IRC §7520. These rules mandate the use of a discount rate based on the 120% Applicable Federal Annual Midterm Rate for the month in which the trust is created and funded. The mortality factors from Table 80CNSMT, Table 90CM, Table 2000CM, or Table 2010CM are also used if the interests have a life contingency (i.e., the calculations are of type “Life” or “Shorter”).
The 120% Applicable Federal Annual Midterm Rate changes monthly and is reported in the IRS’s Cumulative Bulletin, in various tax services, and in various financial news publications such as The Wall Street Journal (See Fed Interest Rates in the Money & Investing section, generally between the 18th and 23rd of the preceding month). The AFR Manager included with this program will track and download the monthly updates to this rate.
If family members are involved, the gift tax valuation rules of IRC §2702 may apply. Under these rules, certain types of retained interests, such as the right to have trust assets revert to the transferor’s estate in the event of the transferor’s premature death, may be valued at zero when computing the gift tax value of the transfer. As a general rule, every retained interest but a “qualified interest” is assigned a value of zero for gift tax valuation purposes. In the case of a GRUT, a qualified interest is the right to receive (1) amounts that are payable annually or more frequently and are a “fixed percentage” (annuity payout rate) of the fair market value of the property in the trust (as revalued annually) or (2) a qualified remainder interest, that is, any non-contingent remainder interest if all other interests in the trust consist of qualified retained interests (qualified annuities).
The annuity must be a fixed percentage of the fair market value of the trust assets as revalued each year rather than merely the income produced by the assets in the trust. Although payments equal to an unchanging “fixed percentage” of the trust assets is the norm, final regulations define the term “fixed percentage” more liberally. They would permit the annuity payout rate to increase or decrease in a systematic manner each year without adverse gift tax consequences. However, the annuity payout rate in any year may not be more than 120 percent of the prior year’s payout rate.
For example, the trust could provide that the annuity payout rate in each subsequent year would equal 120 percent of the prior year’s rate. If the initial annuity payout rate is 5%, it could increase to 6% in the second year, 7.2% in the third year, and so on. If the transferor retains the right each year to the greater of a fixed percentage of the value of trust assets as revalued annually or the trust income for a term of years, the annuity will still be a qualified annuity. However, the right to the trust income, if any, in excess of the fixed percentage of trust assets is valued at zero for gift tax purposes. Thus, the retained interest is valued for gift tax purposes as if it did not include any rights to excess income.
These more restrictive rules apply if the transfer is to or for the benefit of a “member of the transferor’s family” and an interest in the trust is “retained” by the transferor or an “applicable family member.” A member of the transferor’s family includes the transferor’s spouse, ancestor, lineal descendent, an ancestor or lineal descendent of the spouse of the transferor, a brother or sister, and the spouse of any of these. A retained interest means a property interest held by the same individual both before and after the transfer in trust. An applicable family member is defined as the transferor’s spouse, an ancestor of the transferor or an ancestor of the transferor’s spouse, and the spouse of any such ancestor.
In summary, if the §2702 rules apply, the annuity must be for a fixed percentage of the value of the trust assets as revalued each year for a specified term. The annuity will be considered for a qualified “fixed percentage” if the scheduled payout rate in any year does not exceed 120 percent of the prior year’s payout rate. The specified term may be the life of the annuitant, a fixed term, or the shorter of a fixed term or the life of the annuitant.
If the transferor-annuitant survives the term of the GRUT, the assets transferred in trust are not included in the transferor’s gross estate and escape estate taxation. Although there is no statutory or regulatory authority on the issue, some experts think the maximum amount the IRS could include is the lesser of the entire trust corpus or the amount of corpus required to provide the promised unitrust amount for the term (without invading principal).
This amount is computed by dividing the adjusted unitrust payout rate, for example, 5%, by the §7520 rate for the month of the transferor-annuitant’s death, say 7.6%, to derive the proportion of the trust’s corpus that is includible for estate tax purposes, in this instance, 65.79 percent. A logical but more aggressive and uncertain argument can be made that the amount included should not exceed the present value of the expected unitrust annuity payments at the scheduled adjusted payout rate over the remaining term of the trust assuming the assets are invested at the §7520 rate. For example, if 3 years remain in the term of the trust, the present value of a unitrust annuity interest with a 5% adjusted payout rate is only 0.142625. In other words, only 14.2625 percent of the trust assets are actually economically required to fund the unitrust annuity payments over the remaining 3-year term. In any event, the risk of inclusion of trust assets should be covered by the purchase of life insurance owned on the transferor’s life by the appropriate beneficiary.
Since the GRUT permits payment of both income and trust principal to satisfy the transferor-annuitant’ unitrust annuity payments, the GRUT should be treated as a grantor trust for income tax purposes. This means the transferor-annuitant is taxed on income and realized gains on trust assets even if these amounts are greater than the trust’s unitrust annuity payments. This further enhances this tool’s effectiveness as a family wealth-shifting and estate-tax-saving device. The transferor-annuitant is effectively allowed to make gift-tax free gifts of the income taxes that are attributable to assets backing the remainder beneficiary’s interest in the trust.
- Transfer Date Enter the month and year. See Transition Period Notes.
- §7520 Rate The program automatically enters the correct §7520 discount rate if you have kept the AFR Rates Manager up-to-date. If the AFR Rates Manager is not up-to-date, the program shows a 30% value for the selected transfer date. The program automatically rounds the rate to the nearest 2/10 of 1% as required under §7520.
- Calculation Type Select a calculation type (Term/Life/Shorter). The Shorter calculation is the one most often used. If you select Life, the Economic Schedule runs from year one until the Life Expectancy or until the remainder is zero (whichever happens first). If you select Term or Shorter, the Economic Schedule runs from year one until the end of the Term or until the remainder is zero (whichever happens first).
- Principal Enter the fair market value of the assets placed into the trust.
- Grantor’s Age (Nearest birthday) Enter the grantor’s (transferor-annuitant’s) current age as of the nearest birthday.
- Term of Trust Enter the number of years the trust will provide income to the grantor.
- Payment Period Select the number of payments that will be made each year to the beneficiary (Annual, Semiannual, Quarterly, Monthly, Quarterly, and Weekly).
- Annual Growth of Annuity Payments Enter the annual growth rate of annuity payments, if any (minimum -99.99%, maximum 20%).
- Months Valuation Precedes Payout Enter the number of full months by which the valuation date (for the assets of the unitrust) precedes the first payout in the first full taxable year of the trust (not the short first year). The program will only allow valid input values according to which Payment Period was selected in the previous entry field. Growth is applied on the payment schedule before payments are calculated unless Months Valuation Precedes Payout is zero. This does not pertain to the planning period before the trust goes into effect.
- Percentage Payout Enter the initial annuity payout rate (expressed as a percentage of the initial capital value of the trust).
- Annual Growth of Principal This value is used for the Economic Schedule only. Enter the annual growth of the principal (positive or negative value).
- Income Earned by Trust This value is used for the Economic Schedule only. Enter the percentage of income earned by the trust.
- With Reversion? Select the check box to show that the assets should revert to the granto’s estate in the event of the grantor’s death during the term of the trust.
- Is Transfer To or For the Benefit of a Member of the Transferor’s Family? Select the check box to show that the transfer is for the benefit of a member of the transferor’s family.
- Is Interest in Trust Retained by Transferor or Applicable Family Member? Select the check box to show that an interest in trust property is retained by the transferor or an applicable family member.
The Summary Tab shows the gift tax values of the component interests of the trust, including the value of the remainder interest, the reversionary interest (if any), and the amount of the taxable gift as a result of the transfer in trust.
In addition, the calculation provides detailed analyses of the selected type of GRUT; showing required annuity factors, adjustment factors, and the “subtraction method” of computing the taxable gift value of the residual interest in trust.
An Economic Schedule is also provided, showing principal, percent growth, percent annual income, annual payment, and remainder for four years. If you select Life as the Calculation Type, the Economic Schedule runs from year one until the Life Expectancy or until the remainder is zero (whichever happens first). If you select Term or Shorter, the Economic Schedule runs from year one until the end of the Term or until the remainder is zero (whichever happens first).Click the Economic Schedule Tab to view this information.
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