We have all been involved in situations at various points in our lives when we decided to try to fix something on our own. There are times when you can indeed get out your basic tool kit and get the job done, but there are other instances when you learn an important lesson. As you are engaged in the task you see what is necessary, and then you look in your kit and recognize that you don't have the right tool. Knowing the right tools for each job and having access to them is one of the differences between a professional and a dabbler.
Estate planning is one of those jobs that requires the utilization of the proper tools for each circumstance. The one that we would like to take a look at today is the GRAT or grantor retained annuity trust. These vehicles are useful for gaining estate tax efficiency and gifting appreciating assets free of taxation.
The strategy that is employed to make this happen is called the "zeroed out" GRAT. You fund the trust with appreciable assets like securities, real property, or business interests, appoint a trustee, and name a beneficiary. You also decide on the duration of the trust term and the amount of the annuity payments that you would like to receive out of the trust for the term period.
When you fund the GRAT you remove the assets transferred to the trust from your estate for tax purposes, but the IRS does consider the donation to be a taxable gift. However, the taxable value of the gift is calculated using 120% of the federal midterm rate as it stands during the month the trust is created. So, when you set your annuity payments you want them to equal the total taxable value of the trust according to the IRS' valuation methodology. Because your retained interest is 100% of the taxable value, you owe no gift tax on the contribution into the trust. But, any appreciation that exceeds that valuation passes to your beneficiary at the end of the trust term tax-free.
If you have any questions regarding GRATs or other advanced planning techniques, please do not hesitate to contact our firm at any time.