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Grantor Retained Annuity Trust (GRAT) |
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Each taxpayer has a $1 million dollar lifetime exemption from the federal gift tax for lifetime gifts which exceed or otherwise do not qualify for annual exclusion gifting treatment. Your $1 million dollar lifetime exemption amount may be insufficient if you have a large estate and want to make lifetime transfers of property to your family or to trusts for family members substantially in excess of $1 million dollars. A grantor retained annuity trust (GRAT) may, in the right circumstances, give you the opportunity to make these transfers without the imposition of gift or estate tax which might otherwise be owed in respect to the property transferred.
A GRAT is based upon the concept that the ownership of property may be separated into a current time period during which you retain the right to receive a stream of annuity payments and the future ownership of the property (by your children, grandchildren, or continuing trusts for their benefit) after the GRAT annuity term ends. An actuarial calculation, based upon tables established by the IRS, is used to determine the percentage of the fair market value of the property which represents your retained interest and the percentage which represents the future interest of your family members. That future interest percentage is the gift which will be charged against your $1 million dollar gift tax exclusion. Your gift may be a small percentage of the value of the property you transferred to your GRAT.
The assumption behind the IRS GRAT tables is that you will actually consume the percentage of the GRAT property which represents your retained interest. That will occur if the GRAT’s investment rate of return fails to exceed the presumed rate of return under the IRS tables. The IRS tables are adjusted regularly and reflect rates of return of government bonds. If the GRAT out performs the presumed rate of return under the IRS tables, your family will receive property at the end of the GRAT term having a value substantially in excess of the amount presumed under the IRS table. If the investment return of the GRAT proves to be no better than the return predicted under the IRS tables, most if not all of the GRAT property will be returned to you in the annuity payments and the GRAT will not accomplish its purpose.
You should consider a GRAT if you have property which you expect to appreciate significantly, or property which produces large amounts of cash annually which can be used to pay the annuity amount during the annuity term.
There may be estate tax consequences arising from your creation of a GRAT. If you survive the GRAT term, the fair market value of the GRAT property at the conclusion of the term and all future appreciation of that property will be removed from your gross estate for federal and state estate tax purposes. On the other hand, if you die during the GRAT term, the fair market value of the GRAT property at the time of your death will be included in your estate. As with the investment performance, you bear the mortality risk.
There may be several ways to reduce your mortality risk including the creation of separate GRATs for you and your spouse and reducing the GRAT annuity period. Shortening the GRAT period, however, will reduce the gift tax benefit of the GRAT. Accordingly, your effective use of a GRAT requires detailed planning geared to your particular circumstances.
This article is intended to acquaint the reader with some of the features and planning issues presented by GRATs, and is not intended to convey legal advice with respect to the reader’s specific circumstances. Specific planning opportunities which employ one or more GRATs require detailed legal analysis and drafting techniques and the reader is therefore encouraged to call one of the following attorneys who practice in the Trusts and Estates group at Quinlivan & Hughes, P.A. 320-251-1414.
Kevin A. Spellacy
John H. Wenker
Robert P. Cunningham
W. Benjamin Winger
Bradley W. Hanson
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