For husbands and wives with more than $4 million of assets, additional estate planning measures beyond marital and bypass trusts are necessary to reduce the federal 45% estate tax rate. A tool of choice is a Grantor Retained Annuity Trust ("GRAT"). GRAT'S can be used to transfer public securities, closely held stock, LLC interests, or real estate. Although the GRAT design differs depending on the asset to be transferred, the concept is the same: (1) the donor transfers assets to a GRAT for a period of time; (2) the donor receives an annual annuity during that time period, consisting of the GRAT income or assets; and (3) if the appreciation in the assets exceeds the applicable federal interest rate, then the appreciation passes to family members estate tax free with virtually no gift tax.
The following example assumes Dad transfers public securities into a GRAT for a 2-year period. The GRAT assets are managed by Dad exactly as he managed them before the transfer. If the growth in the assets exceeds the IRS interest rate (4.40% in January), the excess appreciation passes to Dad's children estate and gift tax free. If the assets do not exceed the IRS rate, or if Dad dies before the expiration of the 2-year period, then it is if the GRAT transaction never occurred and the assets are back in Dad's estate. For example
a) Dad transfers $10 million to a 2-year GRAT.
b) the assets appreciate 10% annually over the 2-year period.
c) at the end of two years, the appreciation (10% growth exceeding 4.40%) passes outside of Dad's estate to his children, roughly $930,000.00. The gift tax is less than $40.00.
d) the assets equal to the initial $10 million, plus 4.40%, are returned to Dad.
e) Dad would then take those assets and roll them into another 2-year GRAT and repeat the process.
The GRAT is an IRS sanctioned estate and gift tax planning tool, and should be automatically considered by affluent taxpayers looking to leave more to their children and less to the government.