Estate and Gift Giving

Working on your estate and gift-giving plans? 

You might be thinking of using a GRAT… Grantor Retained Annuity Trust. If done right, a GRAT can freeze the value of appreciated assets while transferring appreciation to the next generation with little to no estate or gift tax. The individual who establishes the trust, known as the grantor, transfers assets into an irrevocable trust for a set term, while retaining the right to an annual stream of income plus interest based on IRS’s applicable federal rate. At the end of the term, the assets are distributed to whomever the grantor named at the trust’s creation. 

Lower interest rates favor GRATs by tamping down the amount of the gift. 

The actuarial value of the leftover assets in the GRAT is a taxable gift up front, but when interest rates are low, as they have been for years, it reduces the gift amount. This is especially true for trusts that are established as “zeroed-out” GRATs, which is typical nowadays. With a zeroed-out GRAT, the present value of the annuity to the grantor is set at the value of the assets placed into the trust, so the gift is zero. Let’s look at other key tax benefits. If the assets appreciate at a higher rate than the federal interest rate at the time the GRAT is funded, the trust beneficiaries will receive the value of the extra growth tax-free when the trust expires and the assets are out of the grantor’s estate. The potential estate tax savings can be enormous if the GRAT’s assets appreciate significantly during the fixed term of the GRAT. But if the grantor dies during the GRAT’s term, the assets are in the grantor’s estate. If considering setting up a GRAT, do it before interest rates rise significantly. A higher rate tarnishes GRATs by cutting the estate- and gift-tax savings. 

President Biden wants to curb the use of GRATs to freeze estate tax values. 

He proposes a required 10-year minimum term on all newly created GRATs. It’s common estate planning to set up a GRAT for a term of two to five or seven years. The risk of the grantor dying during the GRAT term and triggering a big estate tax bill is higher the longer the trust term, which is why Biden is calling for at least 10 years. He would also target zeroed-out GRATs by requiring that the value of the remainder interest at the time of the GRAT’s creation would be no less than the greater of 25% of the value of the assets transferred to the GRAT or $500,000. This would increase the gift amount from zero under zeroed-out GRATs and lead to a gift tax bill. Existing trusts would be exempted from this rule. 

Biden’s proposals won’t likely be enacted anytime soon.

Tax increases aren’t at the top of Congress’s to-do list. And, if the GOP gains control of both chambers in the Nov. elections, the chances of tax hikes are slim to none through at least 2024. It’s up to Treasury and IRS to crack down on GRATs they view as abusive. For example, in a 2021 legal memo, IRS lawyers disregarded a taxpayer’s GRAT because the valuation of the business assets put into the GRAT was shockingly low. IRS treated the entire transfer of the assets to the trust as an upfront taxable gift.