A grantor retained annuity trust (“GRAT”) can be an effective means for an individual to transfer property to a desired beneficiary with minimal gift or estate tax consequences. A GRAT may be particularly useful for individuals who have assets that are likely to achieve a return at above market interest rates.

Creation of a GRAT
A GRAT is created when a person (the grantor) transfers one or more potentially high-yield assets into an irrevocable trust, retaining the right to an annuity interest, generally for a fixed term of years. When the term of years ends, the assets remaining in the trust are distributed to the named beneficiary.

Taxable Gift
The IRS values the reportable taxable gift by subtracting the present value of the retained annuity from the fair market value of the asset that went into the GRAT. The result of the IRS method of valuation is that the appreciation in the GRAT in excess of the interest rate used in calculating the present value of the retained annuity is effectively shifted to the beneficiary without gift tax consequences to the grantor. When interest rates are low, as they are now (historically low), this GRAT technique works extremely well.

Income Tax Effects
The GRAT is treated as a grantor trust for income tax purposes. This means that the grantor is treated as the owner of the assets, together with all of their income and other income tax attributes. The grantor, therefore, is taxed on income and realized gains on trust assets even if these amounts are not required to be distributed to the grantor. This feature further enhances the GRAT’s effectiveness as a family wealth-shifting and estate-tax-saving device. In essence the grantor is allowed to pay the taxes on income accruing to the benefit of the beneficiary.

Contact
If you would like to discuss a GRAT or other estate or gift tax planning strategies that may be right for you, please contact David Spence, who leads Royse Law Firm’s Trust, Estate & Wealth Strategies Practice at 650-813-9700 ext. 211, or by email at dspence@rroyselaw.com.