Grantor Retained Annuity Trusts: A Perfect Storm
The current economic crisis will almost certainly have vast and lasting effects on our country's businesses and financial markets alike. Personal retirement and investment accounts have been battered. The world of gift and estate taxation is full of uncertainty due to the scheduled repeal of estate and generation-skipping taxes set for 2010, while the inauguration of a new president in January 2009 only adds to the ambiguity about changes in legislation going forward. Amid all the turmoil, or perhaps because of all the turmoil, we have encountered a "perfect storm" in which all the conditions are right for the success of a specific gift and estate tax planning tool, the grantor retained annuity trust ("GRAT").
According to the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001, the life-time exemption for estate taxes during 2008 is $2 million, with a tax rate of 45% on any assets above this limit. As of now, this exemption is set to rise to $3.5 million during 2009, the taxes will be repealed entirely during 2010, and the exemption will come back during 2011 with a $1 million exemption and a 55% tax rate'. The vast majority of estate planners agree that the legislation regarding these exemptions will change before 2010, but it remains to be determined exactly when and how. Those individuals or married couples who know that the value of their assets at death will far exceed current or projected exemption levels often attempt to pass on some of this wealth to beneficiaries prior to death. Typically, such wealth is subject to gift taxes (at the same estate tax rates mentioned above). However, estate tax planning tools such as the GRAT, when employed effectively, can result in the tax-free passage of some portion of wealth to beneficiaries.
WHAT IS A GRAT?
A GRAT is a irrevocable trust set up by a grantor, or settlor, to pass wealth to beneficiaries, preferably while paying as little gift tax as possible. The grantor transfers assets into the trust, which is established for a set term, and an annuity is paid back to the grantor during each year of the term. There are no restrictions on the type of assets that may be added to the trust: cash, securities, and interests in partnerships or closely-held business, as well as more illiquid assets like real estate, may all be included in a GRAT.