A GRAT is an irrevocable trust where a grantor makes a one-time transfer of property and retains an income stream payable to him, at least annually, for a specified number of years. At the end of this period the value of the trust will pass to the remainder beneficiaries, typically the children, or the income may continue to be paid to the estate. Using the IRS’ Section 7520 rate, the annual annuity payment to the grantor is discounted and the present value of this income stream is then deducted from the value of the property transferred to the trust. The difference is the amount of the taxable gift. There are a couple of keys for a GRAT to be successful. First, the grantor must outlive the trust term. If not, all or a portion of the property may be brought back into his estate. Also, the property in the trust must grow faster than the Section 7520 rate. If both of these hold true, then the strategy will succeed. If not, then the grantor will be no worse off than he was prior to the trust except for the cost of establishing the GRAT and any gift tax that he may have paid.
Because of its grantor trust status, the grantor would pay no income tax on the annual annuity payments received. He would, however, pay tax on any income and capital gains generated by the GRAT whether or not distributed to him. The income can be paid out in cash or in kind if the property is not income producing.