Are you missing a GRAT opportunity?

| Wills & Estate

By:  Matthew C. Zuengler, Attorney at Hager, Dewick & Zuengler, S.C

With the reinstatement of the estate tax in 2011, many individuals will want to revisit their estate plans—and soon.  Gifting through a Grantor Retained Annuity Trust (“GRAT”) is one way parents can transfer significant assets to children with little or no gift tax consequences.

The current historically low interest rate of 1.8 percent makes GRATs an ideal vehicle to transfer wealth.  However, in order to take advantage of this interest rate, the GRAT must be established and funded prior to January 1, 2011.

A GRAT is a trust created by a grantor, who retains the right to receive fixed payments from the trust for a specified term of years.  At the conclusion of the term, any assets left in the trust pass gift tax-free to the remainder beneficiaries.

At the time the GRAT is created, the tax consequences are determined based on the amount of assets contributed to the GRAT, the term of the GRAT, an assumed interest rate and the value of the retained payment to be made to the grantor.

For example, assume that Alex transfers $1,000,000 to a GRAT for a term of three years—at a time when the IRS assumed rate of return is 1.8 percent—and retains the right to receive $345,405 each year.  In this case, he will have made no taxable gift because the value of his retained payment is equal to the amount gifted plus the assumed rate of return.

If, over the course of the three year GRAT term, the assets held by the GRAT grow at 10 percent per year, the GRAT will have effectively transferred $187,710 to Alex’s children on a gift tax free basis.  In this case, Alex will have received $1,036,214 back from the GRAT.

The benefit of the GRAT technique is largely dependent upon the rate of return of the assets contributed.  If the assets contributed fail to produce a rate of return in excess of the assumed rate of return, the GRAT will have failed to produce any benefit. If however, the assets produce a return far in excess of the assumed rate of return, the GRAT can successfully remove significant amounts of assets from the Grantor’s estate free of any gift taxes.

In selecting assets to contribute to a GRAT, obviously those assets that have the greatest likelihood of substantial appreciation should be considered.  This may include stock in a closely held business, S-Corporation stock or publicly traded securities.

Now may be an opportune time to contribute such assets as current economic conditions may allow for the value of closely held interests to be significantly lower than will be the case once the economy returns.  This would further the likelihood of the GRAT being successful.

In this historically low interest rate environment, the use of a GRAT can provide significant opportunities to transfer wealth to the next generation on a gift tax free basis.