In Silicon Valley, GRATs are an increasingly popular estate planning tool that come with significant potential tax savings. If you are unfamiliar with the grantor retained annuity trust, learn about the basics of how to use it in your estate plan.
What Is a GRAT?
The term GRAT stands for grantor retained annuity trust. Grantor refers to the person who creates the trust. For this type of trust, the grantor receives an annuity payment for a short amount of time after the trust is formed, usually two to five years. After the annuity payments end, the trust gives all remaining trust assets to the beneficiaries. The beneficiaries are usually children or grandchildren.
The IRS may assess taxes on the gift the grantor makes through the GRAT to beneficiaries. Rather than basing taxes on the assets’ value when they were placed in trust or their value at the time the annuities stop, the IRS considers two factors:
- The amount of the annuity that the grantor takes back; and
- The rate of return that the trust is expected to earn while annuities are paid.
The rate of return is known as the 7520 rate, and it is based on what U.S. Treasury bonds are paying when the grantor sets up the GRAT. These two factors help the IRS calculate a “gift value” of the assets that the grantor places in the GRAT. The IRS uses the gift value to determine if taxes are due.
How Can You Use GRATs in Your Estate Plan?
People in tech love to create GRATs to hold startup stock in preparation for an IPO. If you set the total annuity payment amount to equal the amount the grantor originally contributed to the trust plus some interest, then the IRS will set the gift value at zero. As a result, the grantor will not owe gift taxes on the assets placed in the GRAT.
The assets may appreciate in value significantly over the trust term, however. This often happens when startups have their IPOs and stock values rise. As a result, the beneficiaries may receive something of far greater value than zero. But the grantor will not have to pay gift taxes. (See Walton v. Commissioner, 115 T.C. 589 (2000).) If you would like to make a gift of startup stock and already have significant gift tax liability, consider starting a GRAT.
Planning your estate? Look to Janet Brewer, Esq. for thorough and thoughtful estate planning advice. Janet’s more than 20 years of legal experience will give you confidence and peace of mind. To schedule a “Get Acquainted” meeting, visit Janet's website or call her office at (650) 469-8206.