17 May 2012

An effective estate planning method for transferring assets to family members with little to no gift tax consequences may be achieved through the use of a Grantor Retained Annuity Trust (a “GRAT”).

What is a GRAT? A GRAT is an irrevocable trust established by a grantor (the creator of the GRAT) in accordance with Internal Revenue Code (“IRC”) Section 2702(b). The grantor transfers assets to the GRAT and retains the right to receive an annual annuity payment from the GRAT for a fixed term of years. The annual annuity amount is determined upon the creation of the GRAT based on the IRC Section 7520 rate (which is 120% of the federal midterm rate) in existence in the month the GRAT is created. At the end of the grantor’s retained term in the GRAT, all assets remaining in the GRAT that were not distributed as an annuity to the grantor (i.e., income generated by the GRAT’s assets in excess of the required annuity payments and appreciation in the GRAT’s assets) will pass as a gift to the GRAT’s remainder beneficiaries. The transfer of the GRAT’s assets to the remainder beneficiaries effectively removes these assets from the grantor’s estate and they will not be subject to estate taxes on the grantor’s death. If, however, the grantor dies during the retained annuity term, the GRAT’s assets will be included in the grantor’s estate for estate tax purposes.

How is the Gift of the Remainder Interest in the GRAT valued for Gift Tax Purposes? The value of the gift to the GRAT remainder beneficiaries is determined by subtracting the value of the grantor’s retained annuity interest in the GRAT from the fair market value of the GRAT’s assets valued on the date the GRAT is created. If the grantor’s retained annuity period is long enough, it is possible to “zero out” the GRAT so that the gift to the remainder beneficiaries equals zero and no gift taxes are due.

If the GRAT is “Zeroed Out,” Do the Remainder Beneficiaries Receive Any Assets Upon the Termination of the Grantor’s Retained Annuity Term? The IRS assumes that the grantor’s retained annuity in the GRAT will equal the assets transferred to the GRAT based on the term of the trust and the assumed growth rate determined by the IRC Section 7520 rate in effect in the month the GRAT is created.  After the grantor is paid the proper annuity amounts (based on the IRC Section 7520 rate) during the grantor’s retained annuity term, all remaining assets in the GRAT pass to the remainder beneficiaries with no further gift tax liability.  Therefore, if the GRAT’s assets appreciate more than the IRC Section 7520 rate in effect in the month the GRAT was created, that appreciation will pass to the remainder beneficiaries free of gift tax.  As such, a GRAT works well when interest rates are low and the appreciation in the GRAT’s assets exceeds the value of the grantor’s retained annuity interest.

If you would like to discuss this or other trusts and estates issues, please contact the attorneys at Drucker Law Offices, 468 North Camden Drive, 2nd Floor, Beverly Hills, CA 90210, 310.285.5375 Tel, 310.444.9754 Fax, www.druckerlaw.com

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