A grantor retained annuity trust (GRAT) can be a tax-efficient technique for transferring to children property that the transferor expects to appreciate in value. The transferor (the “grantor” of the trust) creates an irrevocable trust, places property into the trust as a gift, and retains the right to a fixed payment each year until the GRAT term ends. The initial transfer to the GRAT is treated as a taxable gift of the remainder interest, equal to the current value of the property placed in the GRAT minus the calculated present value of the retained annuity payments. That present value is calculated using an interest rate published monthly by the Internal Revenue Service (currently 3.2 percent).
Today, the House of Representatives passed the “Small Business and Infrastructure Jobs Tax Act of 2010” (HR4849). Section 307 of this bill creates restrictions on GRATs. The most important of these changes is a requirement that a GRAT have a minimum term of ten years. The ten-year term is important because the transferor must survive the GRAT term for the desired tax-free transfer to occur. In general, if the transferor dies during the GRAT term, the amount that passes to the transferor’s children will be subject to estate tax. This is the main reason that most GRATs have a very short term, and why the current legislation is premised on raising more taxes because far fewer GRATs will be established.
The GRAT change is estimated to raise approximately $800 million over the first five years and $4.45 billion over ten years. Passage in the Senate, as is often the case with tax legislation, will be more difficult. Nevertheless, reducing the deficit is popular in the current Congress, and this change affects those unsympathetic “rich” that many believe simply deserve to pay more taxes. The possibility that this change will become law is quite real.
GRATs are effective when the rate of return earned by assets in the trust exceeds the present value rate established by the IRS. The residual beneficiaries of the trust keep whatever remains in the trust after required payments are made to the grantors. GRATs are usually set up with terms that provide a minimal gift tax, which limits the downside cost if the GRAT’s assets do not outperform the IRS discount rate.
The GRAT legislation contained in this bill, like the earlier recommendation in the Administration’s budget proposals, states that it will take effect when the President signs it into law. Of course, the effective date could change. For those who would benefit by this wealth transfer technique, there is good reason to act promptly.
Private-company business interests are eligible to be placed into a GRAT. This is a means of more tax-efficiently passing on a family business to the next generation. However, as with any family business transfer that potentially involves estate or gift taxes, it is prudent to obtain a business appraisal of the private company stock. Fulcrum performs such business appraisals.
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