written by Brenda Logsdon

A GRAT is an estate planning technique that minimizes the tax liability existing when inter-generational transfers of estate assets occur. Under these plans, an irrevocable trust is created for a certain term or period of time. Assets are placed under the trust and then an annuity is paid out every year. When the trust expires the beneficiary receives the assets tax free. Definition found here at Investopedia

A GRAT is also an intentionally defective trust for tax purposes, so that the grantor is taxed on the income and capital gains that the trust produces. This technique works in a low interest rate environment with the asset appreciating well above the interest rate.

For example, let’s assume the taxpayer set up a 2-year GRAT and contributed 10,000 shares of publicly traded stock worth $100 per share and that the applicable federal interest rate is 1.6%. At the end of the first year, the annuity payment due the grantor would be $512,033 including interest. The second year, the annuity payment would also be $512,033. Let’s assume the stock appreciates 20% per year to $120 at the end of year one and to $144 at the end of year two. At the end of year one, 4,267 shares of the stock is distributed to the grantor for the annuity payment, 4,267 x $120 = $512,040.

At the end of year two, 3,556 shares of the stock is distributed to the grantor for the annuity payment, 3,556 x $144 = $512,064. At the end of year two, the trust terminates and distributes the remaining shares totaling 2,177 shares to the grantor’s children. The value of the shares that the children receive is $313,488 (2,177 x $144 = $313,488). The grantor effectively made a $313,488 gift without paying any gift tax and the grantor does not pay any income tax on the transactions.

The disadvantage to the zeroed-out GRAT is that the children receive a carryover basis of the stock. Also, if the grantor dies within the trust term, the value of the assets are including in the grantor’s estate. There is no downside of a zeroed-out GRAT, since no gift tax was paid or estate tax exemption used at the formation of the GRAT. From a gift tax point of view, the zeroed-out GRAT is a heads you win, tails you don’t lose estate planning technique.

To maximize the benefits of any estate planning technique, whether a GRAT or otherwise, one must take into account the age and health of the grantor, the value of the assets involved, current interest rates and overall tax and financial position, and consult a tax professional prior to implementing any plan. Additional tips from Forbes

If you have any questions about this estate planning technique, please contact us at 417-881-0145 or www.whitlockco.com

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