Grantor Retained Annuity Trust (GRAT)

A GRAT is a type of trust specifically authorized by the regulations interpreting the Internal Revenue Code. This type of irrevocable trust permits a lifetime transfer of assets to an irrevocable trust in exchange for a payment stream for a specified term of years.

At the end of the terms of years, the balance of the trust property (the “remainder interest”) is transferred to the beneficiaries, typically children or grandchildren. The GRAT reduces estate taxes by removing appreciation on the contributed assets to the extent that the actual appreciation exceeds a relatively low federal rate.

The GRAT is particularly suited for assets that are expected to appreciate in value and property subject to discounts, such as interests in closely held businesses or limited liability companies.

During the term of years of the trust the Grantor must be paid a fixed amount annually or more frequently (for example, quarterly). The term of years and the amount of the payment are fixed at the time the trust is created (the number of years is determined by the Grantor when the trust is created).

During the term of years of the trust the Grantor can be the sole trustee or a co-trustee of the trust.

Because the GRAT is a “grantor trust”, during the initial term of years the Grantor is treated as the owner of the property for income tax purposes. Therefore, all items of income, gain, loss and deduction with respect to the GRAT are treated on the Grantors personal income tax return.

If the Grantor dies during the term of years, the property in a GRAT reverts to the Grantors estate for estate tax purposes, almost as if the transaction never occurred.

Advantages

  • Provides Grantor with payment stream.
  • Effective method to transfer future appreciation on assets above a Federal Rate to beneficiaries in a protected manner.
  • Helps Grantor maintain control during lifetime.
  • May reduce estate and gift taxes.

Disadvantages

  • If the Grantor dies during the trust term the value of the GRAT is included in the Grantor’s estate.
  • Actual appreciation in excess of federal rate may not occur.

For information on how to get started on your estate plan visit our Estate Planning Process page.