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Mark Cornwall: Extolling the Virtues of a GRAT
The topic of this week’s article goes beyond the typical revocable trust, consisting of the usual bypass trust, survivor’s trust, perhaps a QTIP trust, and the option of a disclaimer trust. A disclaimer trust is for the survivor who wants to pick and choose among the assets that best fit his or her survivor’s trust. We have crossed that “typical revocable trust” lexicon, including the “three-way formula split” and the “pourover will.”
We are now poised to enter into the realm of a sophisticated trust that is usually overlooked and underutilized because the gift and marital estate tax exemptions up to the year 2007 have been high enough that 48 percent of the people who died didn’t have an estate large enough to pay estate taxes. However, an estate tax return must be filed on everyone who dies and has paid taxes. That task has to be accomplished within the first nine months after death.
Unless President Obama makes good on his effort to repeal the repeal of estate tax for 2010, the maximum exemption for every single person, or spouse, starting Jan. 1, 2011, reverts to $1 million, with a 55 percent tax on everything over that. That draws into the system 56 percent of American families who will be paying the death tax on estates valued at more than $1 million.
As for when you want to start implementing the grantor-retained annuity trust (GRAT), or the qualified personal residence trust (QPRT), depends on how large your estate is, and how much of the double-dipped taxation of your already taxed earnings you want to pay to the government when you die.
Everyone in estate planning knows the virtues of a GRAT. It allows you to transfer assets into a trust for a set period of time, say five or 10 years. During those years, you will receive annual payments from the trust. The payment is based on the value of the gift you transfer into the trust for the beneficiaries, less the present actuarial value of the retained annuity, as calculated by the IRS. The longer an annuity interest in the GRAT is retained by the donor, the smaller the value of the retainer gift for the beneficiaries.
Technically speaking, the annuity interest is valued using the IRS’ actuarial tables and an assumed interest rate (rounded to the nearest 0.2 percent) equal to 120 percent of the federal midterm rate, compounded annually, for the month in which the gift is made. As a result, the retained annuity from the GRAT may vary from year to year, increasing and decreasing, provided that the increase for one year to the next may not exceed 120 percent.
After the five- or 10-year term of the trust, the trust is “zeroed out,” which means you have been paid back your original investment, plus the IRS rate of interest on it, which is currently 2.4 percent. The remainder of the trust above the IRS interest goes to your children (beneficiaries) tax free, after the term of years.
Therefore, if you have securities or property you expect will gain in value as much as 35, 50 or 100 percent, a GRAT eliminates that added value from your estate upon your death, and your children get it free of estate taxes. Since you can’t take it with you, it’s an excellent way to avoid the tax man twice. First, the money is gifted out of the gross value of your estate; secondly, your children take the gains of the remainder tax free (if less than $1 million).
Of course, there is a big catch for successful utilization of a GRAT, and for how long a term it should be. If you don’t live out the term of the GRAT, all or most of the GRAT corpus will be included back into the deceased donor’s estate, and that will be the end of that, except for the taxes. Thus, a GRAT, the same as a QPRT, is a gamble against time and the IRS actuary tables. Failing to outlive a long-term GRAT could have severe tax consequences by adding more value back into your estate. The term must be long enough to provide a favorable reduced tax cut, but short enough to realistically survive the term.
When this plan comes together, Uncle Sam is doing you a big favor.
— No opinion herein is a “marketed opinion” and no information provided herein can be used to avoid tax penalties for which the taxpayer would otherwise be responsible. Mark S. Cornwall has lived in Santa Barbara for more than 30 years and practiced law here for 25 years. He is accepting new clients. His book, Estate Planning: The Heroes Way for Baby Boomers, can be purchased via his Web site, www.MarkCornwall.com; Amazon.com; or locally at Chaucer’s and Borders bookstores. To schedule an appointment, contact him at .(JavaScript must be enabled to view this email address) or 805.845.7558.
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» on 07.01.09 @ 06:58 AM
Is it true that GRATs are age neutral so even people in their 80’s may want to use it?
» on 07.02.09 @ 02:10 PM
As long as an 80 year old, or a hundred year old has donor capacity, that is the capacity to contract, then a Grat would be available to them. However, an octonegerian may have already outlived the IRS actuary tables. It would have to be a GRAT for a term of years and it would be very interesting to see what the IRS came up with as an annuity payment. But the inability to make over 120% a year would remain the same. Since nothing happens if the donor does not outlive the term or tables, it would be worth a try. It simply is returned to his estate.
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