Category: GRAT

GRATs are used to Reduce Taxes

GRATs are used to Reduce Taxes

Estate planning includes using various methods to reduce gift and estate taxes, as described in a recent article titled “Grantor Retained Annuity Trust Questions Answered” from Entrepreneur. GRATs are one type of irrevocable annuity trust used by estate planning attorneys to reduce taxes.

An annuity is a financial product, often sold by insurance companies, where you contribute funds or assets to an account, referred to as premiums. The trust distributes payments to a beneficiary on a regular basis. If you have a Grantor-Retained Annuity Trust (GRAT), the person establishing the trust is the Grantor, who receives the annuities from the trust.

The GRAT payments are typically made annually or near the anniversary of the funding date. However, they can be made any time within 105 days after the annuity date. Payments to the GRAT may not be made in advance, so consider your cash flow before determining how to fund a GRAT. For this to work, the grantor must receive assets equal in value to what they put into the GRAT. If the assets appreciate at a rate higher than the interest rate, it’s a win. At the end of the GRAT term, all appreciation in the assets is gifted to the named remainder beneficiaries, with no gift or estate tax.

Here is a step-by-step look at how a GRAT is set up.

  • First, an individual transfers assets into an irrevocable trust for a certain amount of time. It’s best if those assets have a high appreciation potential.
  • Two parts of the GRAT value are the annuity stream and the remainder interest. An estate planning attorney will know how to calculate these values.
  • Annuity payments are received by the grantor. The trust must produce a minimum return at least equal to the IRS Section 7520 interest rate, or the trust will use the principal to pay the annuity. In this case, the GRAT has failed, reverting the trust assets back to the grantor.
  • Once the final annuity payment is made, all remaining assets and asset growth are gifted to beneficiaries, if the GRAT returns meet the IRS Section 7520 interest rate requirements.

The best candidates for GRATS are those who face significant estate tax liabilities at death. An estate freeze can be achieved by shifting all or some of the appreciation to heirs through a GRAT.

A GRAT can also be used to permit an S-Corporation owner to preserve control of the business, while freezing the asset’s value and taking it out of the owner’s taxable estate. Caution is required here, because if the owner of the business dies during the term of the GRAT, the current stock value is returned to the owner’s estate and becomes taxable.

GRATs are used most often in transferring large amounts of money to beneficiaries, helping to reduce taxes. A GRAT allows you to give a beneficiary more than $16,000 without triggering a gift tax, which is especially useful for wealthy individuals with healthy estates.

There are some downsides to GRATs. When the trust term is over, remaining assets become the property of the beneficiaries. Setting a term must be done mindfully. If you have a long-term GRAT of 20 years, it is more likely that you may experience serious health challenges as you age, and possibly die before the term is over. If the assets in the GRAT depreciate below the IRS’s assumed return rate, any benefits of the GRAT are lost. If you would like to learn more about GRATs, please visit our previous posts. 

Reference: Entrepreneur (March 17, 2022) “Grantor Retained Annuity Trust Questions Answered”

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Consider Gifting to Loved Ones before Tax changes

With all of the talk about changes to estate taxes, estate planning attorneys have been watching and waiting as changes were added, then removed, then changed again, in pending legislation. The passage of the infrastructure bill in early November may mark the start of a calmer period, but there are still estate planning moves to consider, says a recent article “Gift money now, before estate tax laws sunset in 2025” from The Press-Enterprise. It is wise to consider gifting to loved ones before tax changes arrive.

Gifts are used to decrease the taxes due on an estate but require thoughtful planning with an eye to avoiding any unintended consequences.

The first gift tax exemption is the annual exemption. Basically, anyone can give anyone else a gift of up to $15,000 every year. If giving together, spouses may gift $30,000 a year. After these amounts, the gift is subject to gift tax. However, there’s another exemption: the lifetime exemption.

For now, the estate and gift tax exemption is $11.7 million per person. Anyone can gift up to that amount during life or at death, or some combination, tax-free. The exemption amount is adjusted every year. If no changes to the law are made, this will increase to roughly $12,060,000 in 2022.

However, the current estate and gift tax exemption law sunsets in 2025. This will bring the exemption down from historically high levels to the prior level of $5 million. Even with an adjustment for inflation, this would make the exemption about $6.2 million. This will dramatically increase the number of estates required to pay federal estate taxes.

For households with net worth below $6 million for an individual and $12 million for a married couple, federal estate taxes may be less of a worry. However, there are state estate taxes, and some are tied to federal estate tax rates. Planning is necessary, especially as some in Congress would like to see those levels set even lower.

Let’s look at a fictional couple with a combined net worth of $30 million. Without any estate planning or gifting, if they live past 2025, they may have a taxable estate of $18 million: $30 million minus $12 million. At a taxable rate of 40%, their tax bill will be $7.2 million.

If the couple had gifted the maximum $23.4 million now under the current exemption, their taxable estate would be reduced to $6.6 million, with a tax bill of $2,520,000. Even if they were to die in a year when the exemption is lower than it was at the time of their gift, they’d save nearly $5 million in taxes.

There are a number of estate planning gifting techniques used to leverage giving, including some which provide income streams to the donor, while allowing the donor to maintain control of assets. These include:

Discounted Giving. When assets are transferred into an entity (commonly a limited partnership or limited liability company), a gift of a minority interest in the entity is generally given a discounted value, due to the lack of control and marketability.

Grantor Retained Annuity Trusts. The donor transfers assets to the trust and retains right to a payment over a period of time. At the end of that period, beneficiaries receive the assets and all of the appreciation. The donor pays income tax on the earnings of the assets in the trust, permitting another tax-free transfer of assets.

Intentionally Defective Grantor Trusts. A donor sets up a trust, makes a gift of assets and then sells other assets to the trust in exchange for a promissory note. If this is done correctly, there is a minimal gift, no gain on the sale for tax purposes, the donor pays the income tax and appreciation is moved to the next generation.

These strategies may continue to be scrutinized as Congress searches for funding sources, but in the meantime, they are still available and may be appropriate for your estate. Speak with an experienced estate planning attorney to see if these or other strategies should be put into place. It is time to seriously consider gifting to loved ones before estate tax changes arrive. If you would like to learn more about gifting, and other charitable options in estate planning, please visit our previous posts.

Reference: The Press-Enterprise (Nov. 7, 2021) “Gift money now, before estate tax laws sunset in 2025”

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Strategies to Reduce Estate Taxes

If the federal estate tax exemption is lowered, as is expected, it could go as low as $3 million, reports the article “How Trusts Can Be Used To Counter Tougher Estate Taxes” from Financial Advisor. For Americans who own a home and robust retirement accounts, this change presents an estate planning challenge—but one with several solutions. Trusts, giving and updating estate plans or creating wholly new estate plans should be addressed in the near future. There are strategies to reduce estate taxes.

Not that these topics aren’t challenging for most people. Confronting the future, including death and incapacity, is difficult. Adult children and their parents may find it hard to talk about these matters; emotions, death and money are tough to talk about on their own, but estate planning includes conversations around all three.

Once those hurdles are overcome, an unemotional approach to the business of estate planning can accomplish a great deal, especially when guided by an experienced estate planning attorney. Here are a few suggestions for families to consider.

Estate and gift planning strategies to reduce or avoid estate taxes include Grantor Retained Annuity Trusts (GRATs) and Spousal Limited Access Trusts (SLATs). A SLAT is an irrevocable trust created when one spouse (the donor spouse) makes a gift into a trust to benefit their spouse (the beneficiary spouse), while retaining limited access to the assets at the same time they remove the asset from their combined estate. One spouse is permitted to indirectly benefit, as long as the couple remains married.

The indirect access disappears, if the spouses divorce or if the beneficiary spouse dies before the donor spouse. Be careful about creating SLATs for both spouses; the IRS does not like to see SLATs with the same date of origin and the same amount for both spouses.

The GRAT and sales to an Intentionally Defective Trust (IDGT) are useful tools in a low-interest rate environment. For a GRAT, property is transferred to a trust in exchange for an annual fixed payment. A sale to an IDGT is where property is sold to a trust in exchange for a balloon note.

Gifting is an important part of estate planning at any asset level. For 2020 and 2021, the annual gift-tax exclusion is $15,000 per donor, per recipient. The simple strategy of aggressive lifetime gifting using that $15,000 exclusion is a good way to get money out of a taxable estate.

Protect the estate plan by reviewing it every four or five years, and sooner if there are large changes to the tax law—which is coming soon—and changes in the family’s circumstances.

Thoughtful use of trusts and gifting strategies can avoid the probate of the will and reduce estate taxes, ensuring that assets go directly to heirs. Reviewing the estate plan regularly with an eye to changes in tax law will protect the legacy. If you would like to learn more about estate tax strategies, please visit our previous posts. 

Reference: Financial Advisor (April 19, 2021) “How Trusts Can Be Used To Counter Tougher Estate Taxes”

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Should a GRAT Be Part of Your Estate Plan?

A Grantor-Retained Annuity Trust, or GRAT, is funded by the grantor, the person who creates the trust, in exchange for a stream of annuity payments at a predetermined interest rate—the IRS Section 7520 rate. The interest rate in December 2020 is 0.6%, as reported in the article “Transferring Wealth With This Trust Can Yield Big Tax Advantages” from Financial Advisor. Should a GRAT be part of your estate plan?

GRAT assets need only appreciate greater than the Section 7520 rate over the term of the trust, and any excess earnings will pass to beneficiaries, or to an ongoing trust for beneficiaries with no gift or estate tax.

Because the grantor takes back the amount equal to that which was transferred to the trust (often two or three years), which is set by the IRS when the trust is funded, future appreciation over and above the interest rate passes gift-tax free.

There’s little upkeep. Once the trust agreement is in place, a gift tax return needs to be filed once a year. If the trust is set up without a tax ID number, there’s no need to file an income tax return.

The grantor is responsible for the income generated by the asset in the GRAT, but that’s it. If the value of the property is increased following an audit, the gift won’t be increased but the annuity will. If the GRAT property decreases in value, the only out of pocket is the set-up costs.

Assets in a GRAT may be anything from an investment portfolio to shares in a closely held business.

Most GRATs are designed to have the value of the retained annuity be equal to the value of the property that is transferred to the GRAT. If the values are equal, then the amount of the gift for tax purposes is zero, since the value of the transfer less the annuity value is zero.

GRATs are not for everyone. The success of the GRAT depends upon the success of the underlying assets. If they don’t appreciate as expected, then there might not be a significant amount transferred out of the estate after paying for the legal, accounting and appraisal fees. If the grantor dies during the term of the GRAT before payments back to the grantor have ended, the GRAT will be unsuccessful.

Generation skipping transfers cannot utilize GRATS, since the generation skipping tax exemption may not be applied to a GRAT, until the grantor’s death.

Ask your estate planning attorney about whether a GRAT should be a part of your estate plan. If a GRAT is not a good fit, they will know about many other tools available.

If you would like to learn more about how GRATS can play a role in your estate planning, please visit our previous posts. 

Reference: Financial Advisor (Nov. 30, 2020) “Transferring Wealth With This Trust Can Yield Big Tax Advantages”

 

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What is a GRAT and Does Your Family Need One?

What is a GRAT and does your family need one? It is a technique where an individual creates an irrevocable trust and transfers assets into the trust to benefit children or other beneficiaries. However, unlike other irrevocable trusts, the grantor retains an annuity interest for a number of years.

As a result of the low interest rate environment, some families may have a federal estate tax problem and need planning to reduce their tax liability. A Grantor Retained Annuity Trust, known as a GRAT, is one type of planning strategy, as described in the article “Estate planning with grantor retained annuity trust” from This Week Community News.

Here’s an example. Let’s say a person owns a stock of a closely held business worth $800,000. Their estate planning attorney creates a ten-year GRAT for them. The person transfers preferably non-voting stock in the closely held business to the GRAT, in exchange for the GRAT paying the person an annuity amount to the individual who established the GRAT for ten years.

The annuity amount payment means the GRAT pays the individual a set percentage of the amount of the initial assets contributed to the GRAT over the course of the ten-year period.

Let’s say the percentage is a straight ten percent payout every year. The amount paid to the individual would be $80,000. At the end of the five-year period, the grantor would have already received an amount back equal to the entire amount of the initial transfer of assets to the GRAT, plus interest.

At the end of the ten-year term, the asset in the trust transfers to the individual’s beneficiaries. If the GRAT has grown greater than 1%, then the beneficiaries also receive the growth. The GRAT makes the annuity payment with the distribution of earnings received from the closely held business, which is likely to be an S-Corp or a limited liability company taxed as a partnership. Assuming the distribution received is greater than the annuity payment, the GRAT uses cash assets to make the annuity payment. For the planning to work, the business must make enough distributions to the GRAT for it to make the annuity payment, or the GRAT has to return stock to the individual who established the GRAT.

There are pitfalls. If the individual dies before the term of the GRAT ends, the entire value of the assets is includable in the estate’s assets and the technique will not have achieved any tax benefits.

If the plan works, however, the stock and all of the growth of the stock will have been successfully removed out of the individual’s estate and the family could save as much as 40% of the value of the stock, or $320,000, using the example above.

It is possible to structure the entire transaction, so there is no gift tax consequence to the grantor. If the person is concerned about estate taxes or the possible change in the federal estate tax exemption, which is due to sunset in 2026, then a GRAT could be an excellent part of your family’s plan. When the current estate tax exemption ends, it may return from $11.58 million to $5 or $6 million. It could even be lower than that, depending on political and financial circumstances. Planning now for changes in the future is something to consider and discuss with your estate planning attorney.

If you like to learn more about various types of trusts, and how they work, please visit our previous posts.

Reference: This Week Community News (Sep. 6, 2020) “Estate planning with grantor retained annuity trust”

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Information in our blogs is very general in nature and should not be acted upon without first consulting with an attorney. Please feel free to contact Texas Trust Law to schedule a complimentary consultation.
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