Prior posts have discussed the estate and gift tax advantages of Grantor Retained Annuity Trusts (GRAT) to transfer family assets to beneficiaries. Reprinted below are my January 28, 2008 and April 21, 2008 posts, which discuss GRATs in detail. The dismal economy presents a unique opportunity to leverage GRATs by funding them with low value marketable securities and real estate. Another advantage is the applicable IRS interest rate, which is only 3.4% for December.
In fact, several clients are now creating new GRATs ("GRAT 2") to hold assets that within the last year had been transferred into GRATs ("GRAT 1"). Because the current values in GRAT 1 are unlikely to exceed the hurdle rate, those assets are being purchased by the client from GRAT 1 and then transferred into GRAT 2. These GRAT "rescue plans" are a highly desirable strategy in the current environment.
January 28, 2008 Grantor Retainer Annuity Trusts
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. April 21, 2008 Taking Advantage of Low Interest Rates and a Declining Market
The January 28, 2008 Post explained why 2-year GRAT’s (Grantor Retained Annuity Trusts) are an essential estate planning tool for affluent taxpayers looking to pass wealth to children and other beneficiaries with little or no gift or estate tax consequences. No other tax strategy is as straight forward, effective and IRS sanctioned. What was a wonderful idea in January 2008 is even a better idea in Spring 2008 for the following two reasons: First, the interest rate applicable to GRAT’s is now one percent lower than in January: the rate has decreased from 4.4% to 3.4%. Therefore, if assets transferred to a GRAT appreciate at greater than 3.4%, the excess appreciation passes to beneficiaries chosen by the taxpayer estate tax free. Perhaps this interest rate will decline even further in coming months, however, at 3.4% the rate is attractive regardless of future fluctuations. Second, although nobody can time the stock market, many believe it has bottomed out. (Note, GRAT’s also can be used with real estate and closely held businesses, but this Post assumes taxpayers hold marketable securities.) For example, if in April a taxpayer transferred $1 million to a 2-year GRAT, when the applicable rate is 3.4%, and the assets appreciated at 10% over a 2-year period, approximately $106,000 would pass to beneficiaries tax free. The taxpayer would have received from the GRAT approximately $1,050,000. The taxpayer would then roll the $1,050,000 into the next GRAT. The combination of low interest rates and declining asset values are causing hardship and concern for many investors. A mixed blessing arising from this down market is that, for taxpayers who have estate planning issues, acting now with GRAT’s, sales to Intentionally Defective Trusts, or other estate planning strategies, will preserve substantial wealth for their families and future generations long into the future. When the market turns positive, substantial wealth will already have been removed from the taxable estate.
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