That GRAT: A down equity market and low interest rates make the Grantor Retained Annuity Trust an even more attractive tool for reducing federal estate and gift taxes

A GRAT is an irrevocable trust formed and used for the purpose of transferring wealth from an individual – the “grantor” – to a beneficiary without generating any federal estate or gift tax liability for the grantor and in most cases without using the grantor’s federal estate or gift tax credit. The basic idea upon which the GRAT is based is that the grantor forms the trust and then transfers certain assets or property towards it. Once the property is transferred and the trust is “funded,” the grantor then receives a portion of the property in the form of annuity payments over a period of time – the “GRAT term” – specified on the GRAT instrument. These annuity payments are based on original cost basis of the GRAT property plus a rate which is periodically set by the IRS and referred to as the “IRS Section 7520 rate”. If the grantor survives the GRAT term, then at the end of such term the portion of the GRAT property – including appreciation in the value of such property net of the IRS Section 7520 rate – is then transferred to the beneficiary either in trust or outright. If the GRAT property has appreciated in value since the time it was transferred and the IRS Section 7520 rate is low, then at the end of the GRAT term the grantor will have succeeded in transferring property of significant value to the beneficiary without federal gift tax liability and also succeeded in removing the property from the taxable estate.

The greatest potential for wealth transfer using a GRAT occurs when two factors are present. First, the grantor has a low basis property which they believe will appreciate in value and, second, when the IRS Section 7520 rate for the month in which the GRAT was funded is low. On March 13, 2020, the IRS released Internal Revenue Bulletin 2020-12 which, among other things, set the IRS Section 7520 rate for June 2020 at 0.6 percent.

In addition to the foregoing, many are concerned that the federal estate and gift tax credit may be reduced in the near term. If the credit is reduced, then there will be an additional reason for having already incorporated a GRAT into your estate planning.

Please contact the Tax Planning & Controversy practice group to schedule a time to discuss how a GRAT might assist you in preserving your wealth.

Frank L. Leffingwell is a tax attorney in the firm’s Tax Planning & Controversy, Estate Planning, Probate & Trusts, and Real Estate sections.