Trust & Estates: A Good Time for a GRAT


Today's low interest rates may feel like a dark cloud, but they have a silver lining: for many, it's a great time to create a Grantor Retained Annuity Trust (GRAT). A GRAT is an irrevocable trust that pays the person who sets up the trust (the "grantor") a fixed annual amount for a specified term. At the end of the specified term, the remaining assets in the trust pass to the beneficiaries of the trust, as chosen by the grantor.

The transfer of assets to a GRAT is considered a taxable gift for federal gift tax purposes. Currently, an individual is permitted to make cumulative lifetime gifts of up to $5 million without paying gift tax. Assets transferred to a GRAT generally count against the $5 million lifetime limitation. However, the value of the assets is calculated when the assets are transferred to the GRAT, not when the beneficiaries of the GRAT ultimately receive those assets. The amount of the taxable gift is calculated using an interest rate provided by the IRS. This interest rate represents an assumed rate of return that GRAT assets will produce.

As of July 2011, the IRS interest rate is only 2.4%. In other words, if assets are transferred to a GRAT in July of 2011, the IRS assumes the assets will achieve a total rate of return of only 2.4%. If GRAT assets achieve a rate of return higher than 2.4%, the excess amount will pass to the beneficiary free of gift tax obligations. For example, assume Parent contributes $1 million of stock to a five-year GRAT in July 2011. Parent will retain an annuity payment of $100,000 each year for five years, and the remaining assets will be distributed to parent's two children, Son and Daughter. The IRS assumes an interest rate of 2.4%, so the value of the children's remainder interests is $512,000. Therefore, $512,000 will be applied against Parent's $5 million lifetime gift tax exemption. The actual rate of return is irrelevant for gift tax purposes. If the realized rate of return is 5%, the actual value of the children's remainder interests is $525,000, resulting in an additional $13,000 that passes to the beneficiaries free of any gift tax obligation.

GRATs may still be an option even if the grantor has used the entire amount of his or her lifetime gift tax exemption. With a "zeroed-out" GRAT, the grantor retains an annuity interest that is equal in value to the property transferred to the trust. This results in a remainder of zero and, in turn, a gift tax value of zero. However, if the GRAT assets achieve a rate of return higher than 2.4%, the remainder of the assets at the end of the GRAT term will pass to the beneficiary, again, free of any gift tax obligation.

In 2010, the House of Representatives passed H.R. 4849, which would impose a minimum term of 10 years on all GRATs and would effectively eliminate zeroed-out GRATs. The bill was referred to the Senate Committee on Finance but was not put to a vote. However, the possibility always remains that Congress could impose significant limitations on GRATs. If passed, H.R. 4849 would have applied only to GRATs created after the date of enactment. It is anticipated that GRATs created under previous versions of the Internal Revenue Code would be "grandfathered in" under any new legislation, so there may still be time to create short-term zeroed-out GRATs with no gift tax liability.

For many, a GRAT can be an integral part of an estate plan. To learn more about GRATs or to discuss any aspect of your estate plan, feel free to contact any member of the Wealth Management Practice Group at Doerner, Saunders, Daniel & Anderson, L.L.P.

Leah M. Ward
(918) 591-5230

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Rebecca represents clients primarily in labor and employment litigation and counsels clients regarding everyday employment matters. 

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