What's the Fuss with GRATs?

What's the Fuss with GRATs?
by Michael Crowder, Esq.

On March 28, 2022, the Biden administration released its 2023 budget and tax proposals (referred to each year as “the Greenbook”). This year’s Greenbook includes proposed changes to the rules governing Grantor Retained Annuity Trusts (“GRATs”) that have been on this (and some prior) administration’s wish list for quite some time. These proposals, if ever enacted, would significantly limit the benefit of most GRATs. The proposed changes include:

• GRATs have a minimum term of 10 years and a maximum term of the grantor’s life expectancy plus 10 years; and
   
• GRATs be required to recognize a minimum value for gift tax purposes equal to the greater of 25% of the value of the assets transferred to the GRAT or $500,000 (but not more than the value of the assets transferred).

So, what is a GRAT?

In short, a GRAT is a wealth transfer tool that can provide a host of benefits with minimal risk. Specifically, a GRAT is an irrevocable trust to which the grantor transfers assets in exchange for a fixed payment, or annuity, for a term of years chosen by the grantor. The term is typically measured by a fixed number of years, but it may also be measured by the grantor’s life or the shorter (but not longer) of a fixed number of years or grantor’s life. Upon completion of the annuity payment term, the GRAT’s remaining assets pass to the named beneficiaries, either outright or in a further trust. GRATs have several advantages, including:

• GRATs can be structured such that no taxable gift or corresponding gift tax liability results from the ultimate transfer of assets to the named beneficiaries. If the annuity amount and term are high enough or long enough, or both, the value of the grantor’s retained annuity for gift tax purposes could equal 100% of the value of the assets transferred. Thus, when subtracting the grantor’s retained annuity value from the value of the assets transferred to the GRAT, the resulting gift tax liability is zero. This type of a GRAT is known as a “zeroed out GRAT.”
   
• GRATs can be structured to have minimal downside risk other than any applicable legal and administrative costs.
   
• GRATs are currently sanctioned by the Internal Revenue Code (IRC Section 2702).

For now, GRATs remain an effective estate planning strategy. And although interest rates are rising, they remain relatively low—which magnifies the potential wealth transfer opportunity with GRATs. Generally, if the overall investment rate of return on the GRAT assets exceeds the Section 7520 rate, the GRAT will be successful.

If you are interested in GRATs or other wealth transfer strategies, we’d be happy to help. Give us a call at (865) 546-7311.