Grantor Retained Annuity Trust

A Grantor Retained Annuity Trust (commonly referred to by the acronym GRAT) , is a financial instrument commonly used in the United States to make large financial gifts to family members without paying a U.S. gift tax. [ [http://www.trustsandestates.net/GRATs/GRATMmClIce.htm Ice, Noel, “What You Should Know About Your GRAT (Grantor Retained Annuity Trust) How To Make LARGE Gifts Without Paying Gift Tax or Using Any Gift Tax Unified Credit”, 2003] ]

Basic Mechanism

A donor sets up a GRAT by making a donation into a trust. The trust is set up as an annuity whereby the donor receives an annual payment from the annuity for a fixed period of time (the term). At the end of the term, any remaining value in the trust is passed on to a beneficiary of the trust as a gift. The beneficiary must be a family member of the donor. If the donor dies before the end of the term, then the value of the trust at that time is passed on to the beneficiary.

The United States Internal Revenue Service has a number of regulations governing how the remaining value of the trust at the end of the term (or at the death of the donor) is taxed. When the GRAT is first set up, a “gift value” of the GRAT is calculated. The gift value is set equal to the initial contribution to the GRAT plus a theoretical interest earned on the principal minus the annuity payments that would be made through the end of the term. The theoretical rate of interest is determined by IRS regulations [Treas. Reg. §25.2702-3(b) and (d)] . The rate is set equal to 120% of the federal mid-term rate during the month that the GRAT is established.

To realize a tax benefit, the sum of the scheduled annuity payments of a GRAT are set to be about equal to the principal plus theoretical interest. Thus, for tax purposes, the initially calculated gift value is zero, since what will be paid back to the donor in annuity payments is anticipated to be about equal to what the donor invested, plus interest. If a GRAT is funded with highly volatile assets, however, it is possible that the actual interest earned on the assets will be substantially higher than the IRS theoretical interest. Thus at the end of the term, the value remaining in the GRAT may still be large, even though the initial IRS calculation suggests that it should have been zero. This remaining value is then passed on to the beneficiary without incurring a gift tax.

Important Legal Cases

*Audrey J. Walton v. Commissioner, 115 T.C. 589 (2000), acq. Notice 2003-72, 2003-44 IRB, 10/15/2003. [ [http://www.ustaxcourt.gov/InOpHistoric/walton.TC.WPD.pdf Audrey J. Walton v. Commissioner, 115 T.C. 589 (2000)] ] This case established the current way that the IRS established a gift value for a GRAT.

Patents

The Wealth Transfer Group owns a patent covering different methods for managing SOGRATs. A SOGRAT is a GRAT that is at least partially funded with stock options. The patent is number is US patent|6567790, and is entitled "Establishing and managing grantor retained annuity trusts funded by nonqualified stock options".

ee also

*Trust law
*SOGRAT

References