With a Grantor Retained Annuity Trust (GRAT), you can avoid gift-tax consequences while temporarily freezing the value of an asset that will be worth more later.
The asset can be shares in a company that is likely to go public or beaten down shares of stock that are likely to appreciate.
Like loans, GRATs mature within a specified number of years and you get back any money you put in when the trust expires.
How Does It Work?
A GRAT is an irrevocable trust and can be designed in a variety of ways to benefit you and your family. In general, it involves transferring an asset, such as stock, with a retained right to receive fixed income, at least annually.
The GRAT permits the value of the grantor’s retained interest to be subtracted from the value of the property transferred in order to arrive at a net gift amount.
While it can be structured in many creative ways, it is typically used in the following way:
1. The grantor has an asset that he believes will appreciate and that he wants to remove from his estate for tax purposes. (With stocks and real estate at a low, this is a powerful tool, assuming the grantor believes that values will appreciate.)
2. The grantor receives a defined income stream, which reduces the value of the principle.
3. The beneficiaries receive the appreciation, whatever that may be.
For example, Dad places $500,000 of company stock into a GRAT. He receives a certain sum in income, pays tax on it, but allows all of the stock’s appreciation to transfer to his children, gift tax free.
What Are the Benefits?
There are many non-tax benefits to a GRAT, as well. For example, if you wants a specific asset to go to one child over another, or you don’t want a former spouse or creditor who might contest your will to obtain it, a GRAT makes it less likely that the asset will be lost if your estate is embroiled in a lawsuit.
Be aware that if you die before the trust ends, then it’s as if the GRAT never existed. The trust’s entire value – including its returns – will be included in your estate and subject to the estate tax.
Another good planning approach is to create separate GRATs for each asset. If you combine two or more unstable assets into one GRAT, then the losses on one might offset the gains on another.
A well-designed GRAT is a powerful way to avoid gift-tax consequences while providing your family a significant portion of an asset’s income.
I hope this information helps you and your family. If you have a specific case or a question, don’t hesitate to call our office. As always, feel free to call me for further advice or to share your ideas.
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