The basic purpose of a trust is to reduce estate taxes as much as possible. Another benefit is the chance to avoid the costly and lengthy probate court proceeding. With all of the available options, each trust having its own specific goals or requirements, it may be a little daunting trying to choose. One type of trust you may want to consider is the Grantor Retained Annuity Trust.
What is the purpose of a GRAT?
The purpose of a Grantor Retained Annuity Trust is to allow the donor to transfer property to the trust, while retaining, for a certain period of time, the ability to receive income from that property. The income received is known as the annuity. The primary benefit of a grantor retained annuity trust is seen in the decrease in gift taxes.
How does the GRAT work?
When property is transferred into a trust, the entire property goes to the beneficiaries at the end of the trust term. However, with a GRAT, the amount of the gift taxes is assessed only on the remainder interest, at the time the gift is made, excluding the annuities that have been paid out. This way, the value of the annuity retained by the donor is not included, and the property can be transferred at a fraction of the actual value. The higher the amount of the annuity, the greater the discount will be on the remainder interest that you pass on to your beneficiaries.
Knowing the parties involved in the GRAT
The Grantor can typically serve as the trustee of a Grantor Retained Annuity Trust. The remainder interest is then passed on to a trust for the Grantor’s children, if that is what you wish. Another option is for the remainder to actually pass to a generation skipping trust, which is not taxable at the children’s deaths. Depending on how your estate planning attorney sets up the trust, no third parties need to be involved.
Requirements for the annuity
For purposes of federal tax purposes, the annuity retained by the Grantor must be a “qualifying interest.” If not, the value of the annuity cannot be subtracted from the entire interest of the property, when the gift is determined. For the Grantor Retained Annuity Trust to be effective, there are a few requirements for the qualifying interest.
Term of annuity payments
The annuity must be paid during the year required for filing a trust tax return, or in the subsequent period prior to the regular date. The “fixed amount” of the annuity paid to the Grantor must be a specific dollar amount or a fixed percentage of the initial value of the trust property. The length of the term of annuity payments must be specifically set in the trust. There must not be a later shortening or relinquishing of the retained interest and the trust must prohibit payment to anyone other than the grantor. Finally, any annuity payments that are missed must be caught up with interest.
If you have questions regarding Grantor Retained Annuity Trusts, or any other trust administration needs, please contact the Schomer Law Group either online or by calling us at (301) 337-7696.