By Mark D. Munson
November 23, 2010
December 2010 may be one of the best times to use a grantor retained annuity trust (or “GRAT”) to transfer assets to children and grandchildren free of gift taxes. The reason is that based on current tax rules, it is assumed that assets transferred to a GRAT in December 2010 will yield an annual return of only 1.8% (which is an historic low). If the actual rate of return on assets transferred to a GRAT is greater than 1.8%, the difference will be effectively transferred to children and grandchildren free of gift taxes. In other words, if you own an appreciating asset, and you think it will increase in value over the next few years at a rate greater than 1.8%, and you want to shift that appreciation to other family members free of tax; a December GRAT may be your best bet.
The gift tax benefits of using a GRAT are best illustrated with an example. John Doe transfers $1 million of assets to a GRAT with a 10-year term in December 2010. The GRAT is drafted so that the amount of the annual annuity paid back to Mr. Doe over the 10-year term is equal to the original transfer of $1 million plus 1.8%. According to the IRS, Mr. Doe’s transfer to the GRAT results in a taxable gift of $0 and successfully avoids any gift tax consequences.
If the assets within Mr. Doe’s GRAT grow at a rate that is greater than 1.8% over the course of the 10-year term, the GRAT will have assets remaining after the 10th and final annuity payment is paid back to Mr. Doe. The remaining assets within the GRAT can then be transferred to Mr. Doe’s children free of gift taxes. If the average annual rate of return of Mr. Doe’s assets within the GRAT is 5%, the amount remaining within the GRAT that will be transferred to his children free of gift taxes is $243,252. If the average annual rate of return of Mr. Doe’s assets within the GRAT is 10%, the amount remaining within the GRAT that will be transferred free of gift taxes is $837,998.
Given that the gift and estate tax exemption is currently scheduled to be at only $1 million beginning January 1, 2011, and legislation has been introduced to limit the gift tax benefits of a GRAT, now may be the very best time to consider the GRAT as a wealth transfer strategy. If you believe that your investment or business assets will grow at a rate that is greater than 1.8% and you have concerns about gift and estate taxes, we invite you to contact one of Ruder Ware’s Trusts & Estates Practice Group attorneys to discuss the benefits of establishing a GRAT.
This document provides information of a general nature regarding legislative or other legal developments, and is based on the state of the law at the time of the original publication of this article. None of the information contained herein is intended as legal advice or opinion relative to specific matters, facts, situations, or issues, and additional facts and information or future developments may affect the subjects addressed. You should not act upon the information in this document without discussing your specific situation with legal counsel.
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