Kathleen ReynoldsKeymasterOctober 7, 2022 at 5:56 pmPost count: 428
This calculation determines the gift tax implications of establishing a grantor-retained income trust (GRIT) or qualified personal residence trust (QPRT). Through this trust, the grantor retains an income interest in irrevocably transferred property, and the remainder interest is passed to the grantor’s beneficiaries. These computations can be used for both residence trusts and qualified residence trusts and for GRITs transferring property to non-family members.
An irrevocable trust is established with the trustee directed to pay to the grantor the income from the trust for a specified number of years. When the grantor’s trust interest terminates, the property in the trust is distributed outright to family members. In some cases, the trust continues for their benefit.
At the time the trust is funded, a future gift is made. The value of that gift is the excess of the value of the property transferred over the value of the interest retained by the grantor. The value of the retained interest is found by multiplying by the present value of an annuity factor for the number of years the trust will run.
For example, assuming a 7.6% discount rate, if the trust will run for 10 years and $100,000 is initially placed into the trust subject to a reversion, the value of the (nontaxable) interest retained by a 65 year old grantor would be $63,458.
The value of the (gift taxable) remainder interest would be the value of the capital place into the trust ($100,000) minus the value of the nontaxable interested retained by the grantor ($63,458). Therefore, the taxable portion of the grantor retained income trust gift would be $36,542. This remainder interest, by definition, is a future interest gift and will not qualify for the annual exclusion. The donor will have to utilize all or part of the remaining unified credit (or if the credit is exhausted, pay the appropriate gift tax). If the grantor’s income interest lasts long enough, however, the value of his or her retained interest would approach actuarially 100 percent. This would essentially eliminate any gift tax liability.
The advantage of the GRIT is that it is possible for an individual to transfer significant value to family members but to incur little or no gift tax. In the example, the cost of removing $100,000 from the gross estate (plus all appreciation from the date of the gift) is the use of $36,542 of unified credit.
The GRIT is a “grantor trust.” This means all income, deductions, and credits are treated as if there was no trust and these items were attributable directly to the grantor.
The entire principal (date of death value) must be included in the estate of a grantor who dies during the term of the GRIT since he has retained an interest for a period which, in fact, will not end before his death. If any gift tax had been paid upon the establishment of the GRIT, it would reduce the estate tax otherwise payable. If the unified credit was used, upon death within the term, the unified credit used in making the gift will be restored to the estate (if the grantor’s spouse consented to the gift, his or her credit will not be restored).
The estate’s beneficiary (possibly through gifts received from the GRIT grantor) could purchase life insurance on the life of the grantor. Then, if the grantor should die during the term of the GRIT, there would be sufficient cash to pay any estate tax.
IRC Code §2702 has severely limited the use of GRITs. Non-family members can use GRITs for any type of asset for any term. Family members will find GRITs useful only when the property transferred is a personal residence or for some tangible property.
IRS regulations allow a QPRT to be converted to an annuity trust if the trust should cease to be a qualified personal residence trust at any time during its term (if the personal residence were sold, for example). The program calculates the annuity that would have to be paid to the grantor under those circumstances. See Treas. Reg. Section 25.2702-5(c)(8)(ii)(C).
- Transfer Date: Enter the month and year that the cash or other asset was transferred to the trust. 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.
- Principal: Enter the value of the capital placed into the trust.
- Grantor’s Current Age: Enter the grantor’s age as of the nearest birthday.
- Second Age (0 if none): Enter a second age if a second life will also be used to determine the income interest.
- Term of Trust: Enter the number of years the trust will provide income to the grantor.
- With Reversion? Select the check box if reversion is to be included. Generally, this should be checked. If reversion is not selected, the age inputs are not used. If the check box is not selected, you may select either Term or Shorter calculation types, and the ‘non-reversion’ values will be based off that selection.
- After-Tax Growth: Enter the after-tax growth rate of the trust assets.
- Comb. Death Tax Bracket: Enter a tax bracket which takes into account both the state and federal death taxes.
The Summary Tab displays the taxable portion of a QPRT. To calculate this value, the calculation determines the value of the interest retained by the grantor (income interest plus reversion). It then subtracts the value of the grantor’s retained interest from the principal placed into the trust. The result is the taxable portion of the QPRT. The Taxable Gift, the Property Value after three years, and the Potential Death Tax Savings (Combined Bracket times [value of Property minus Taxable Gift]) are also shown in the results. Use the Factors tab to view the factors that are used in the calculation.
The “qualified annuity” is the annuity that would be paid to the grantor if allowed or required by the trust document upon the trust ceasing to be a qualified personal residence trust during its term (if the personal residence were sold, for example). See Treas. Reg. Section 25.2702-5(c)(8)(ii)(C).
If the term of the trust is increased, there is a greater discount for gift tax purposes, but also a greater probability of the grantor dying during the term of the trust and the trust being included in the grantor’s estate for federal estate tax purposes. The graph shows the increasing discount for increasing terms of year (the red line showing the “Contingent Remainder”), the decreasing probability of the grantor surviving the term of the trust (the blue line showing “Probability of Survival”), and the product of those two factors, representing the net effective discount (the green line showing the “Probable Remainder”).
Theoretically, the highest point on the green line should show the term of years that balances the increasing gift tax discount with the decreasing chances of surviving the term of the trust.
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