Unprecedented Wealth Transfer Opportunities Using 'GRATs'December 2010
The Internal Revenue Service released a historically low 7520 interest rate for December 2010, creating an unprecedented opportunity for tax-efficient wealth transfers using Grantor Retained Annuity Trusts (“GRATs”).
But this opportunity might fade away, not just because interest rates could rise but also because there are a number of bills currently circulating in Congress which could limit a GRAT’s tax benefits.
HERE’S HOW GRATS MINIMIZE OR EVEN ELIMINATE GIFT TAXES
A GRAT is an irrevocable trust into which you transfer assets, but retain the right to receive a payment of a fixed amount (the annuity) on at least a yearly basis. At the end of the GRAT’s term (typically 2-6 years) the trust’s remaining assets pass to your designated beneficiary(ies) tax free.
The IRS predicts the future value of a GRAT’s assets using its 7520 rate in effect at the time of the transfer; a new 7520 rate is released each month. Since the IRS does not look at a GRAT’s actual rate of return, any growth in excess of the 7520 rate (also called the “hurdle rate,” because the goal is to beat that rate) is ignored and ultimately passes onto trust beneficiaries free of tax. The December 2010 7520 interest rate is at a historic low of only 1.8%.
The creation of a GRAT triggers a taxable gift, but GRATs are generally structured so that little or no gift tax is due; this is often called “zeroing out” a GRAT. Here’s how:
For gift tax purposes, the goal is to set your total annuity payments to equal or almost equal the IRS’s presumed future value of the trust. Then, any growth in trust assets surpassing the IRS’s assumed rate of return passes to your beneficiary(ies) tax free.
Since December’s 7520 rate is at an historic low, there is a greater chance GRAT assets will surpass the hurdle rate. The opportunities for tax-free transfers have never been better.
THE TIME TO ACT MAY BE NOW—AND NOT JUST BECAUSE INTEREST RATES ARE LOW
Congress has introduced a number of bills this year, designed to curtail the benefits of a GRAT. All of the bills propose a 10-year minimum term for GRATs. This, of course, lowers the chance that a GRAT will outperform the IRS’s 7520 rate. The bills also propose GRATs have a remainder interest with a value greater than zero, meaning a GRAT could not be zeroed-out. This would trigger a taxable gift. These bills provide for an immediate effective date.
By acting before the enactment of any pending legislation, you can still take advantage of short-term and zeroed-out GRATs.
FIDUCIARY TRUST IS HERE TO HELP
Your trust or tax professional is a valuable resource for wealth transfer information. Or, feel free to reach out to Fiduciary Trust at any time.
This communication is intended to provide general information. It is not intended to provide specific advice. Please consult your personal adviser to determine whether information in this newsletter may be appropriate for you. IRS Circular Notice: Pursuant to relevant U.S. Treasury regulations, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (II) promoting or recommending to another party any transaction or matter addressed herein.
Fiduciary Trust Company International is a member of the Franklin Templeton Investments family of companies.
About the Author
Erin Gilmore Smith
Assistant Vice President
Erin Gilmore Smith is responsible for the administration of complex estates and trusts, including pre and post mortem planning, and tax and succession planning at Fiduciary Trust. Ms. Smith earned a Bachelor of Arts degree from Texas A&M University and a Juris Doctor, cum laude, from Seton Hall University School of Law. Ms. Smith is a member of the bars of New York, New Jersey and Connecticut.
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