Rolling GRATs

A GRAT is a grantor trust for a term of years in which the grantor retains a fixed annuity interest and makes a gift of the remainder interest. The present value of the remainder interest is the amount of the taxable gift. The taxable gift is computed by subtracting the fixed annuity from the principal. A higher value for the fixed annuity leads to a lower taxable gift. The value of the fixed annuity is calculated by reference to IRS actuarial tables issued pursuant to Code Sec. 7520. The Section 7520 rate for December 2001 is 4.8%. The annuity for purposes of a GRAT equals 120% of the Section 7520 rate. Even so, if the grantor can achieve rates of return over ten percent, the taxable gift will not reflect a substantial amount of the appreciation which will pass to beneficiaries. The greater the difference between the Section 7520 rate and the expected rate of return, the greater the attractiveness of GRATs.

Utilizing successive short-term (rolling) GRATs in a high annuity payout results in a small taxable gift, yet can remove substantial assets from the grantor’s estate, especially if the assets appreciate rapidly. Other techniques used in combination such as the transfer of an LLC interest to a GRAT, can further leverage the gift tax savings. (Please see the enclosed spreadsheet which illustrates the relative advantages of a two-year GRAT.)

The use of short-term GRATs also reduces the likelihood that the grantor will die during the trust terms. Recall that the premature death of the grantor of a GRAT will cause inclusion of the entire trust in the grantor’s estate under Code Sec. 2036 or 2039. Thus, with a ten-year GRAT, all of appreciation of the first nine years will be included in the grantor’s estate. With four two-year GRATs, all of the appreciation occuring during the first three trust terms will be removed from the grantor’s gross estate. (Even in the event of premature death, any GRAT entails little risk since even if trust assets are ultimately included in the grantor’s estate, any unified credit exhausted at the beginning of the trust term is reinstated.)

A rolling GRAT is also much less sensitive to poor investment returns than are longer-term GRATs. For example, if an investment in a ten-year GRAT produces low rates of return in the initial years, requiring the trustee to dip into principal to pay the annuity, the investment may never recover enough to achieve significant estate tax savings. Conversely, if a two-year rolling GRAT yields a poor investment return in the first year, the loss of estate tax-savings is contained; investments in the second GRAT in a series of rollings GRATs may fare better and achieve the desired estate tax freeze.

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