A grantor retained annuity trust or GRAT can potentially be of value if you are exposed to the federal estate tax. Before we explain the details, we should provide some background information about the federal estate tax so you can determine whether or not you are exposed.
Death Tax
The federal death tax carries a 40 percent maximum rate, and the amount of the exclusion for the rest of 2015 is $5.43 million. If your estate is valued in excess of $5.43 million, you are in taxable territory.
We should point out the fact that the estate tax is applicable on asset transfers to anyone other than your spouse. You can transfer unlimited assets to your spouse free of taxation, because there is an unlimited marital deduction.
Gift Tax
In addition to the federal estate tax, there is also a gift tax. This tax is unified with the estate tax, and it exists to stop people from giving gifts so that they can avoid the estate tax.
The $5.43 million is a unified exclusion that applies to gift giving while you are living along with the value of the estate that you are passing on to your heirs. So, if you give $5.43 million in tax-free gifts throughout your life using this exclusion, there would be nothing left to apply to your estate.
Grantor Retained Annuity Trusts
If you are looking for ways to transfer assets at a tax discount, you could potentially implement the “zeroed out” grantor retained annuity trust strategy. This involves funding the trust with assets that you would expect to appreciate considerably.
You fund the trust, and you accept distributions throughout its term. When you create the trust declaration, you also name a beneficiary who would assume ownership of anything that remains in the trust after the expiration of the term.
Since the beneficiary could potentially be receiving a gift, the Internal Revenue Service calculates the taxable value of the trust by adding anticipated interest. This is done through the utilization of the hurdle rate, which is 120 percent of the federal midterm rate.
To zero out the grantor retained annuity trust, you calculate the total amount of the annuity payments that you receive to be equal to the entire taxable value of the trust. If the assets in the trust performed better than the hurdle rate, there would be a remainder, even though you incrementally assumed ownership of the entire taxable value of the trust without incurring any transfer tax responsibilities.
The beneficiary would assume ownership of the remainder, and there would be no gift tax consequences.
Free Estate Tax Report
To learn more about the estate tax, download our special report. This report is free, and you can visit this page to access your copy: Free Report on Federal Estate Tax.
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Attorney Caprice L. Collins is a top rated Harvard Law School graduate. She has 34 years of legal experience with a successful law practice devoted exclusively to Estate/Business Planning and Trust Administration. Attorney Collins is a well-respected keynote speaker on Wills, Living Trusts, Estate Planning, Business Planning and Trust Administration. She has appeared on California’s Real Estate Radio Station KTLK AM 1150 as a legal expert on Estate Planning and Living Trusts among many other notable media appearances.