A Tax-Saving Gift

A Tax-Saving Gift with Strings Attached
by: Bonfiglio & Asterita, LLC.
Bonfiglio and Asterita, LLC NY Attorneys at Law
Bonfiglio and Asterita, LLC NJ Attorneys at Law

Suppose you own a profitable business or a large amount of high-yielding assets. You’d like to give them to your children before you die. But if you do, you’ll pass up years of potential earnings, and you’re liable to pay a small fortune in federal gift taxes.

One possible solution: Place your closely held business or other assets in a grantor retained annuity trust (GRAT).
A GRAT allows you to transfer ownership of assets to your heirs through a short-term trust — usually 10 to 15 years. During that time, you draw income or annuity payments from the assets in the trust. So you receive a tidy annual sum, retain an interest in the assets and move them out of your taxable estate.

Meanwhile, you pay gift tax on only a portion of the assets’ value. The gift tax is reduced because of the way the IRS determines the value of the gift. A deferred gift is worth a lot less, for tax purposes, than a current gift. The exact value of the gift is determined by a number of factors, including the current interest rate set by the IRS and the amount of the annuity payments made to you.

When the trust expires, the beneficiaries — typically, your children — end up with the assets, including the appreciated value.

For all these reasons, a GRAT can be a important succession planning tool for the owner of a closely held business because it allows the company to be passed on to the children while keeping gift and estate taxes low.

A bonus: When you place your business or other assets in a GRAT, they avoid going through probate so you keep the transfer of ownership and other details from becoming public. The trust can also protect assets from creditors.

Here’s how it works. Let’s say you place $100,000 worth of stock in a 10-year GRAT, and draw income every year at 6 percent, or $6,000. Over 10 years, you’d receive $60,000. But let’s assume the IRS sets the present value of that income at $50,000. So the value of your assets for gift tax purposes is $50,000 ($100,000 in assets less $50,000 present value of income). As a result, you move $100,000 out of your taxable estate and you use up only $50,000 of your lifetime federal gift tax exemption (which for 2015 is $5.43 million, up from $5.34 million for 2014).

In a GRAT, the taxable value of the gift is basically the value of the assets when you set up the trust, minus the present value of the income you receive over the life of the trust.

Presumably, the assets will continue to appreciate during the term of the trust because you don’t want to overdraw the account. If the income from the GRAT assets isn’t enough to make the annuity payments, the trust’s principal must be used.

You want to make sure that the value of the assets your children receive exceeds the original value, less the income you draw. That’s why the best assets to place in a GRAT are income-producing.

There are some drawbacks. A GRAT is an irrevocable trust, meaning that it can’t be changed. And if you die before the end of the trust term, the assets wind up back in your taxable estate.

A GRAT is only one of the estate planning trusts available to you. For more information about which option is right for your situation, consult with your estate planning adviser for details.5

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