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Mark W Petro
mark.petro@lakelandinvestors.com
 
 




Family Business Succession Planning

A grantor retained annuity trust (GRAT) allows the value of the property transferred to the trust to be discounted, while removing the trust property from the grantor's gross estate.

 

Grantor Retained Annuity Trust (GRAT)

Definition

A grantor retained annuity trust (GRAT) is an irrevocable trust into which a grantor makes a one-time transfer of property, and in which the grantor retains the right to receive a fixed amount (an annuity) at least annually for a specified term of years. At the end of the retained annuity period, the property remaining in the trust passes to the remainder beneficiaries or remains in trust for their benefit.

A transfer of property to an irrevocable trust is a taxable gift. The value of the gift on which federal gift and estate tax is imposed is generally its fair market value. However, because the grantor retains an interest in a GRAT, the value of the transfer is discounted; transfer tax is imposed only on the remainder interest.

Note:  Any transfer tax due may be sheltered by the grantor's lifetime gift and estate tax applicable exclusion amount ($12,060,000 in 2021, $11,700,000 in 2021).

This taxable value is calculated using an interest rate provided by the IRS (known as the discount rate or Section 7520 rate), which is based on current interest rates and changes monthly. This interest rate assumes the GRAT property will earn a certain rate of return during the annuity period. Any actual return that exceeds the assumed return passes to the remainder beneficiaries transfer tax free. Investment performance, therefore, is central to this strategy.

For a GRAT to be successful:

  • The grantor must outlive the term of years
  • The GRAT property must outperform the Section 7520 rate
  • The GRAT document must be properly drafted

Potential tax advantages of a GRAT include:

  • Because of the retained interest, the value of the transfer for federal gift and estate tax purposes may be discounted
  • Principal remaining in the GRAT at the end of the term of years is removed from the grantor's gross estate for federal gift and estate tax purposes
  • Interest (i.e., appreciation and/or earnings) remaining in the GRAT at the end of the term of years passes to the remainder beneficiaries federal gift and estate tax free

Key tradeoffs

  • If the GRAT property underperforms the Section 7520 rate, no tax savings is achieved (and if the GRAT is depleted, no property is transferred to the remainder beneficiaries)
  • If the GRAT property underperforms the Section 7520 rate, gift taxes paid and/or any applicable exclusion amount used will be wasted (though the amounts would be minimal)
  • If the grantor does not outlive the term of years, any property remaining in the GRAT is includable in the grantor's gross estate for federal gift and estate tax purposes
  • If the GRAT is unsuccessful, any costs incurred to create and maintain the GRAT will have been wasted

How is it implemented?

  • Hire an experienced attorney to draft the GRAT document
  • Have property that is transferred to GRAT professionally appraised
  • Transfer property to GRAT (i.e., retitle assets)
  • File gift tax return(s)


Investments and advisory services are offered through Lakeland Investor Services, Inc., a Registered Investment Advisor. 11873 Oakland Beach Road, Conneaut Lake, PA 16316, (814) 382-6681. Insurance services offered through Lakeland Insurance Services, LLC and Mark W. Petro, an agent licensed in PA, FL, NJ, OH and VA. Neither Lakeland Investor Services, Inc. nor its agents and representatives can provide tax, legal or accounting advice. Clients should consult their own attorney or tax advisor about their specific circumstances.

 

This communication is strictly intended for individuals residing in the state(s) of FL, NJ, OH, PA and VA. No offers may be made or accepted from any resident outside the specific states referenced.
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2022.