Pre-Transaction Estate Planning Part 2: Grantor Retained Annuity Trusts (GRATs)

Building on the first installment of this series (the simple gift of business units), this second post will discuss the first leveraged gifting option—grantor retained annuity trusts, more commonly known as GRATs. Estate planners love acronyms, so almost every specialized technique will have some kind of acronym associated with it.

A GRAT is an irrevocable trust that is established by the grantor, and the grantor pays all the income taxes associated with the assets held in the trust. The trust is established to last a certain period of years, usually 2-5 years. Right now there are no limitations on the term length, but that is something Congress is considering changing.

The grantor transfers assets to the trust, and then retains the right to get ALL the assets back in annual installments in the form of an annuity. In addition to getting all the assets back, the grantor receives a prescribed interest rate. Any growth the assets have over the initial value plus that interest rate, the trust retains tax free. Generally the lower the rate, the more successful the trust is. After the prescribed term of years, the trust usually continues for the lives of children. Just as in the example in Part 1, if you anticipate your business will grow in value, have a sale event, go public, or experience some other appreciation event, you can capture all of that appreciation tax free.

Example. Business owner transfers $10,000,000 of appraised business assets to a GRAT for a three-year term. The business owner will receive three annual payments of $3,400,200 based on August’s rate of 1.0% (an all-time low), and if the assets grow at 10%, the trust will contain over $2,000,000 after the three years. All tax free. If the assets grow 30%, say in a sale, the remainder left in the trust will grow to $8,400,000 tax free.

If the assets go down in value there is no risk to you as grantor; the assets are treated the same as if you held the assets in your own name. There are no income tax implications to transferring the stock to the trust and there are little to no gift tax implications. This is a great technique if you are expecting an appreciation event, or even have steadily appreciating business assets. The lower the interest rate, the better the technique works, so now is the time to take advantage.