While recent estate tax law changes may significantly reduce estate taxes, the estate tax will be with us for several more years. In the meantime, persons with substantial estates should consider taking advantage of every available opportunity to reduce estate taxes. One such opportunity is the grantor retained annuity trust (“GRAT”). GRATs are particularly attractive at this time, given the improvement in stock market conditions, continuing low interest rates, and a recent tax court decision.
A GRAT is an irrevocable trust to which the grantor transfers assets, whether real estate, stock, or other investments, but retains the right to receive payments of a fixed amount – an “annuity” – for a period of years. At the end of the annuity term, the trust terminates and the property is distributed to the remainder beneficiaries – usually the grantor’s immediate family members, such as children or grandchildren, or trusts created for their benefit. The transfer of assets to a GRAT is a taxable gift at the time the trust is established. The amount of the gift is equal to the deemed value of the remainder interest after payment of the annuity to the grantor during the term of the GRAT. Because the value of the gift is based on IRS assumptions of how much the beneficiaries will receive – not how much they actually receive at the termination of the GRAT – significant gift planning opportunities exist with GRATs.
The IRS’s assumptions in determining the amount of the gift are based on prevailing interest rates. The lower the IRS interest rate at the time of the conveyance, the lower the annuity payment to the grantor each year. Assets in the trust grow for the benefit of the remainder beneficiaries at the time of the GRAT’s termination.
Further enhancing the opportunities for planning with GRATs is a recent tax court decision involving the heirs of Sam Walton. Prior to this decision, the IRS took the position that when valuing the amount of the gift to a GRAT, the taxpayer had to take into account the likelihood that the grantor would die during term of the GRAT. For older grantors, the value of the gift would be substantial even if the grantor survived the term and regardless of whether the grantor’s designated beneficiaries actually received substantial assets – or any assets – at the end of the term. In Walton, the Tax Court unanimously held the IRS valuation methodology was incorrect and the life expectancy of the grantor was not a part of the valuation calculation. Now even older grantors, who may have large – or highly concentrated – stock holdings, can establish GRATs on a nearly gift tax-free basis.
GRATs can be particularly beneficial to holders of S corporation shares. While S corporations may not have different classes of shares, they may have voting and non-voting shares. Thus, a shareholder could create non-voting shares for a S corporation, and transfer the non-voting shares to the GRAT. At the end of the annuity term of the GRAT, the grantor’s designated beneficiaries would receive the non-voting shares, thereby allowing the grantor to retain voting control over the corporation while having transferred a significant amount of value.
Properly planned and under the right circumstances, GRATs are an increasingly important estate planning technique for shifting appreciation to younger family members on a tax-free or nearly tax-free basis. Please do not hesitate to telephone us to discuss the inclusion of a GRAT in your estate plan.