In the event you anticipate to obtain several million remaining in your property, organize to transfer some wealth while living in a manner that triggers little or no gift tax and have your family enjoy the estate tax planning. You may use a grantor retained annuity trust (GRAT) to achieve exactly that. A GRAT is an irrevocable trust setup for just particular term of years and made to move the appreciation on possessions contributed to it with little or no gift-tax implications.
It is important to know this fundamental estate tax planning concept: IRS views each resource as having 2 components: the value today and also the long term value. You possibly can split any asset into those two parts for estate tax planning and that is the aim of the GRAT.
You fund your GRAT, receive back annuity payments from it during its term, and what ever is left in the GRAT at the end of its period is now out of your 'estate' which will go to your designated beneficiaries (or a holding trust) gift tax free. In case you die during the term, though, the funds go to your beneficiaries yet stays in your 'estate' for estate and gift tax purposes . The concept here is that any appreciation on the asset happens out of your estate for estate tax planning.
How do you steer clear of gift tax for funding the GRAT?
The IRS assigns an interest rate that a trust is anticipated to earn during the time of its funding. The gift worth is set equal to the preliminary contribution to the GRAT along with a theoretical interest earned on the principal without the annuity payments that would be produced through the end of the period. So if you assign this particular IRS rate to find out your annuity payments, than the net gift you have produced to your GRAT may be 'zero' - great estate tax planning!
What you fund your GRAT with would appear to qualify like a gift subject to gift tax. However since the GRAT returns to you annuity payments made up of these funds and some of their income over the term of the trust, the precise gift is your funding quantity less the present worth of these annuity payments.
You deposit $1 million in your GRAT
The GRAT is to pay you $50,000 yearly for twenty years
The present value of those payments is $682,000
Therefore, you've produced a gift not of $1 million but of $318,000 ($1 million less $682,000)
Obviously in case your GRAT funds only earned the IRS rate, you'd deplete your GRAT at the end of its term leaving nothing for your beneficiaries. So, you're planning on GRAT investments to develop at a substantially greater rate compared to the designated IRS rate of earnings. And that is why a reduced rate of interest environment - as in a economic downturn - with the anticipated recovery throughout the GRAT term makes it a very low or zero gift tax savings transfer vehicle.
Note that since the GRAT is a grantor trust, you must pay out income tax on all taxable trust earnings throughout its time period. However having to pay these taxes does not constitute additional gifts to the GRAT