The GRAT

Assume a grantor transfers property with a current value of $500,000 into a five-year GRAT and receives an income stream of $50,000 annually, and that the property grows inside the trust at 8.0% per year. Using the IRS’ Section 7520 rate of 4.20% for August 2008, the present value of his income stream would be $221,345. Subtract this amount from the value of the property transferred ($500,000 – $221,345) and the remainder subject to the federal gift tax would be $278,655. With an 8.0% growth rate, the final value of the trust would be $441,334. Subtract the taxable gift from the final value ($441,334 – $278,655) and the amount transferred free of federal estate and gift tax is $162,679. This is because the property grew at a rate of 8.0%, which is greater than the Section 7520 rate of 4.2%. Even though the $278,655 would be subject to the federal gift tax, a portion of his $1 million lifetime gift tax exemption would be applied and no gift tax would be due.

If the donor has already utilized his entire lifetime gift tax exemption, a variation of the GRAT may still be useful in minimizing the gift tax. This is known as a “zeroed-out” GRAT. Basically, the grantor increases his annual income stream to the point where its present value equals the amount gifted, leaving no taxable gift. Using the same assumptions as before, if the grantor received $112,946 instead of the previously mentioned $50,000 annually, and the property in the trust grew at the same 8.0% rate, the remainder at the end of the trust term would be $72,056 and would pass to the trust beneficiaries free of federal estate and gift tax. In this example, the present value of the grantor’s income stream would equal the value of the property transferred to the trust, so the taxable gift would be $0.