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GRAT

Under current federal transfer tax law, you can transfer up to a combined total of $11,400,000 during life or at death without incurring federal estate or gift tax.(1)  If you transfer assets in excess of this exemption amount, there will be a transfer tax of 40% on the excess assets payable by the grantor.   If you are at risk of a transfer tax liability and own appreciating assets, a grantor retained annuity trust (“GRAT”) can be a useful tool to pass assets beyond your exemption amount free of tax.  Based on the tax savings that GRATs can provide and the fact that the usefulness of GRATs may diminish in the not-too-distant future, it is well worth your time to learn about this planning technique now.

A GRAT, at its most basic level, is an irrevocable trust.  In most cases, creating and funding an irrevocable trust will reduce your federal estate and gift tax exemption amount by the value of the contributed assets.  If you have already fully utilized your estate and gift tax exemption amount, there will be a gift tax equal to 40% of the additionally contributed .  However, a GRAT can be structured so that a gift to it has a net present value of zero and will not reduce your exemption amount or otherwise trigger tax.

A net present value of zero is obtained by retaining a right to receive a stream of annual payments, an annuity of sorts, from the GRAT that offsets the value of the gift.  For example, if you make a gift of $1,000,000 to a GRAT, you could retain the right to receive payments back totaling $1,000,000, plus interest, over a 10-year term.  Assuming the correct interest rate is used, the annuity payments have a net present value equal to $1,000,000.  In other words, the annuity payments offset the value of the gift.

Once the annuity payments have all been paid, the remaining GRAT assets can be distributed to your selected beneficiaries free of estate and gift tax.  In most cases, the beneficiaries are children or trusts for their benefit.  The beneficiary should not be a charity.  There are much more tax-efficient strategies than GRATs for charitable gifts.

The key for a GRAT is the spread between the interest rate used to structure the annuity payments and the actual growth rate of the assets contributed to the GRAT.  As the spread of the actual growth rate of the GRAT assets over the interest rate used to structure the annuity payments increases, the larger the remainder passing to your beneficiaries is free of estate and gift tax.  However, you cannot select the interest rate to be used.  The IRS calculates and