The Grantor Retained Annuity Trust (GRAT): What Is It?
To reduce taxes on substantial financial contributions to family members, grantor retained annuity trusts (GRATs) are a financial tool used in estate planning. These strategies create an irreversible trust for a predetermined tenure or duration. A gift value is decided upon by the person creating the trust at the time of creation. After assets are transferred into the trust, the grantor receives an annual annuity payment. The recipient obtains the assets and pays little to no gift taxes when the trust expires and the final annuity payment is issued.
Grantor Retained Annuity Trusts: An Overview (GRATs)
A type of irrevocable gifting trust known as a grantor retained annuity trust enables a grantor or trustmaker to potentially convey large wealth to the next generation with little to no gift tax burden. GRATs are set up for a specified period of time.
When establishing a GRAT, a grantor contributes assets in trust but keeps the right to receive (over the course of the GRAT) the assets’ original worth while earning a rate of return determined by the IRS (known as the 7520 rate). The remaining assets (basically any increase in the initial assets less the IRS-assumed return rate) are distributed to the grantor’s beneficiaries at the end of the GRAT’s tenure.
A GRAT pays annuity payments either as a percentage of the overall asset value or from interest accrued on the assets supporting the trust. If the person who creates the trust passes away before it expires, the assets become a part of their taxable estate, and the beneficiary gets nothing.
Uses of GRAT
GRATs are especially helpful to wealthy people who will have a sizable estate tax obligation when they pass away. In this situation, a GRAT might be used to transfer some or all of the appreciation to the beneficiaries of their estate, so capping the value of their estate. A person might transmit the difference to their children tax-free, for instance, if they held an asset worth $10 million but anticipated that it would increase to $12 million during the following two years.
GRATs are particularly well-liked by people who own stock in young companies since the stock price growth for IPO shares typically outpaces the IRS projected rate of return. As a result, additional funds can be left to the next generation without reducing the grantor’s lifetime exemption from inheritance and gift taxes.
History of GRAT
The Walton family of Walmart Inc. renown received a favorable judgement in the U.S. Tax Court in 2000, which led to a significant increase in the use of GRATs. The court ruled in favor of Audrey J. Walton’s use of two GRATs, where annuity payments were designed to return all of the original assets to the grantor and leave only the appreciated value to beneficiaries. Audrey J. Walton v. Commissioner of Internal Revenue saw this decision.
This arrangement reduces the value of the gift that was initially placed in trust to zero and transfers any residual value to the beneficiary tax-free. A “zeroed-out GRAT” or “Walton GRAT” is a GRAT used in this manner.
Figure of a GRAT
Before Facebook went public, its creator Mark Zuckerberg invested pre-IPO stock in a GRAT. The worth of Zuckerberg’s stock was estimated by Forbes magazine to be $37,315,513, despite the fact that the precise figures are unknown.
