The following message about Grantor Retained Annuity Trusts (GRAT) is important for clients (and advisors who have clients) who think it likely that their estates will be subject to estate tax. Inasmuch as the estate tax “exemption” is scheduled to return to only $1,000,000 per person in January, that is a lot more people than it would have been in 2009, when the “exemption” was $3,500,000.
If you have an asset which you think will generate income and/or capital appreciation in excess of what the IRS thinks it will generate, a Grantor Retained Annuity Trust (or “GRAT”) is a technique to shift the excess return to a spouse and/or descendants with no transfer tax. This is a “no-lose” technique. If you’re right, then the desired result is achieved. If the asset does not perform as you hoped and expected, then you’re simply back at square one. There is no penalty for trying.
There are two reasons to do a GRAT right now: (1) the bar set by the IRS is extremely low (only 2.8% per year for GRATs established in July); (2) the House of Representatives has passed proposed legislation (which has yet to be approved by the Senate) requiring that all GRATs involve a taxable gift, and that all GRATs last a minimum of 10 years. The minimum taxable gift hasn’t been specified, and this may prove to be only a minor irritant. However, the minimum 10 year term could be a significant hurdle for some.
The reason is that for a GRAT to work, the person who establishes it must survive for whatever term is selected. Obviously, there is a greater chance that a person will die within ten years than that the same person will die within two years or five years. Another factor is that if the event that is expected to sharply increase the rate of return on the asset is likely to happen in a year or two (e.g. sale of a family business), having to continue the GRAT for an additional eight or nine years runs the risk of giving back some of benefit that would have been locked-in if the GRAT had ended shortly after the anticipated event.
There are other techniques that are similar to GRATs, but none is as generally accepted and relatively risk-free. If you think that you might be a candidate for this planning, now is the time to act.
Please contact your Varnum Estate Planning attorney for more information.