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Tax Avoidance Series: How to Avoid Estate/Gift Tax with Trusts and Annuities

in Articles, Attorney Advisor Series, Estate Planning, Tax Planning by Greg McIntyre Leave a comment

 

The estate/gift tax is a tax based on the value of the assets an individual owns at the time of death or gave away during their lifetime. Luckily, there is a value threshold and everyone whose assets/gifts are below that threshold, avoids the death tax. This allows for practitioners to implement plans for those who are above the threshold, to bring them under that magic number and avoid unnecessary tax.

One way an individual can avoid the estate/gift tax, is to freeze the value of their estate. Obviously, purely gifting assets can also have adverse tax consequences and can result in a loss of control over the gifted asset. The ideal method would combine retention of assets with tax avoidance.

A threat to crossing the estate/gift tax threshold is appreciating assets. If assets keep increasing in value, they can easily subject someone’s estate to tax at death. What you want to do is freeze the value of your estate (so that it does not appreciate such that your estate will be subject to the high federal tax rates at death) and pass along any appreciation to your beneficiaries.

The method to accomplish this goal and maintain a stream of income, is to utilize a Grantor Retained Annuity Trust (GRAT).

Basics of a GRAT 

In a GRAT, you are placing assets in a trust with two distinct effects. 1. You receive a stream of payments back from the trust; and 2. You are earmarking a certain amount to pass to your beneficiaries free of gift/estate tax.

Here is how it works: The trust maker or Grantor creates an irrevocable trust and funds it with assets. The Grantor retains a right to receive an annuity from the trust (Retained Interest). This annuity must be paid to the grantor at a set rate for a set amount of time. If there is no income generated by the trust assets, the annuity payments will be paid from principle.

The annuity from the trust represents a percentage of the trust, not the full amount. Any amount not paid back to the Grantor over the set amount of time of the annuity, will be paid to the beneficiaries with no further gift tax consequences (remainder interest).

There is an assumption that any assets put into the trust will appreciate at a set rate as set forth by IRC 7520 as of the date of transfer (as of July 2022, that rate is 3.6 percent). If the assets do not appreciate at at least the 7520 rate, they are returned to the Grantor with no adverse tax consequences. If the assets appreciate beyond the 7520 rate, the excess appreciation is passed to the beneficiaries free of gift tax.

Is a GRAT right for Me?

If you have assets that are appreciating at a significant rate, it may be beneficial to consider a GRAT. GRATs are especially useful for stock owned in companies that are going public. However, they can be used for any assets that are increasing in value.

When Should I Implement a GRAT?

Interest rates are still low. That means that the IRC 7520 rate is still low. Remember, any appreciation above that 7520 rate is passed without gift tax. Thus, it is better to implement a GRAT while the rates are low.

Additionally, if you hold assets with a depressed value, a GRAT is a great strategy. When the stock market is underperforming and driving down the relative price of individual stocks, you want to plan for the rebound. A GRAT is a perfect way to manage the appreciation of rebounded equities.

What are the income Tax Consequences of a GRAT?

All the income, gain, and loss will be passed along to the Grantor. The purpose of the trust is to avoid gift/estate tax. The payment of tax by the Grantor will not be considered a further gift to the trust and is, thus, a further benefit to any of the beneficiaries.

Will My Beneficiaries Have Capital Gains on Any Assets They Receive at The End of The Trust Term?

The beneficiaries do not receive a step-up in basis in any of the assets they receive. However, a properly structures GRAT will have “Swap Powers” where the Grantor can swap out low basis assets for higher basis assets.

Conclusion

GRATs are a great way to avoid excess taxation. Now is a great time for a GRAT given that interest rates are low and assets values have been depressed, given the recent performance of the stock market.

 

 

 

 

 

 

Brenton Begley

Estate Planning & Elder Law Attorney

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