The primary goal of certain trust instruments is to legally transfer assets to the next generation or your designated heirs at your death or before with reduced or no estate tax. The reader should review our basic article Wills and Trusts before reading further. While the estate tax is in constant flux, you can expect that absent appropriate planning, many estates face taxes in excess of thirty percent and often in excess of forty percent, the sums due nine months from date of death. Avoiding those often catastrophic taxes is the goal of numerous complex trust instruments, including the GRAT.

The GRANTOR RETAINER ANNUITY TRUST “GRAT” can allow transfer of inflated assets at a reduced value, at times avoiding any transfer tax entirely. As usual with such techniques, the documents and concepts can be complex and confusing and the structure is not worth considering absent a grantor with significant assets that would result in high estate tax absent use of the GRAT.

This article shall describe the basic theory and structure of the GRAT.



A GRAT is a technique the objective of which is transferring property to members of your family (or any other beneficiary you wish) at a reduced transfer tax cost. The use of GRATs is approved under the special valuation rules of IRS Chapter 14, and can be structured so that you will have little or no gift tax cost when you create the trust. And, if you outlive the term of the trust, the property will escape estate tax on your death.

You, as grantor, create a GRAT by transferring property to a trust and retaining a qualified annuity interest in the trust assets (the right to receive a stated dollar amount from the trust each year). The trust lasts for a specified period of time that you are expected to outlive (the "term"). At the end of the term, the trust property passes to your beneficiaries (the "remainder beneficiaries"), who would normally be the members of your family.

The transfer of the property to the GRAT is a taxable gift to the remainder beneficiaries at the time the GRAT is established. But one is allowed to subtract from the fair market value of the property, the value of your right to receive yearly annuity payments. Thus, the amount of the taxable gift will usually be substantially less than the fair market value of the property transferred to the trust.

Additionally, if the amount of the gift is less than your available life time exclusion from gift tax ($1,000,000, reduced by amounts allowed for life time exclusion gifts in previous years) no gift tax will be due on the creation of the GRAT. In some cases, the GRAT may be "zeroed out," meaning that the value of the annuity interest you retain is so high, that the remainder interest, and thus, the gift to the remainder beneficiaries is valued at almost zero.

The value of the gift is determined using IRS valuation tables and the Internal Revenue Code Section 7520 interest rate in effect for the month in which the GRAT is created.

Use of a GRAT is recommended if you expect the trust assets to produce earnings or appreciationat least equal to the IRC Section 7520 interest rate. This is because the IRS valuation table assumes that the trust assets will grow at that rate for the entire term of your retained interest. If the trust assets, in fact, grow at that rate, the assumption on which the remainder interest is valued will be correct.

If, however, the assets of a GRAT grow at a rate higher than the applicable IRC Section 7520 rate, the remainder interest will be undervalued when the trust is created — that is, the present value of the remainder interest for gift tax purposes will be $X, and the present value of the property the remainder men actually receive when the trust terminates will be greater than $X. The greater the rate by which the trust assets outperform the applicable IRC Section 7520 rate, the greater the value of the property that will be transferred to the remainder men free of transfer tax. That appreciation is transferred tax free to the remainder men.



First, If the assets of a GRAT grow at a rate lower than the applicable IRC Section 7520 rate, the remainder interest will be overvalued when the trust is created. Thus the gift tax paid (or the exclusion used up) by you when you create the trust will be too high when compared with the value of the property actually received by the remainder men. You will have either paid taxes you need not or used up exclusion you need not. The solution is to select the assets to put in most carefully.

Second, the structure is not flexible. To work the transfer must be irrevocable. Yes, you get your annuity payment and yes the remainder men get it eventually…but you cannot “change your mind” and revoke it or try to pull some assets out and put other assets in.



A GRAT’s effectiveness as a transfer tax avoidance device increases as the IRC Section 7520 interest rate decreases. Bad economic times are usually particularly advantageous time to consider a GRAT for you because the IRC Section 7520 interest rate is lowered. For example, in 2009 the rate was at historic lows and decreasing from its current low monthly level of 2.4% for January 2009 to 2.0% for February 2009.

Even when the IRC Section 7520 rate is high, however, a GRAT can be effective if it is funded with higher-yielding assets. The use of discounted assets (such as the Business Interests) makes beating the IRC Section 7520 rate easier, but payment of an annuity with discounted assets is undesirable. It is best, therefore, to transfer appreciating assets with reliable income generation to the GRAT.

Note that the GRAT is a "grantor trust" for income tax purposes. This means that you, as grantor, would be considered to be the owner of the assets transferred to the GRAT. Therefore, all of the net income of the trust would be taxed to you. This is advantageous because the trust assets are growing tax-free. This amounts to a gift to your children (or other remainder men) free of wealth transfer tax.



When the GRAT term ends, the property remaining in the trust passes to the beneficiaries outright or in further trust free of additional gift tax, even if it has appreciated in value since the trust was created. If you are still living when the term ends, the trust property is not includible in your estate for estate tax purposes when you die because you no longer will have any interest in the property. If you die during the term, however, part or all of the trust property will be included in your estate. Therefore, in selecting a term it is prudent not to select a term that is too long.



Estate planners generally have focused on the use of short-term GRATs for assets expected to appreciate in a relatively short period of time. That would normally maximize the possible return given the ability to avoid appreciation taxation in GRATS and the danger of death of the Grantor.

But given the current unprecedented low interest rate environment in 2009 and the relatively depressed value of the Business Interests plus a conservative rate of appreciation, the use of one or more long-term GRATs in that particular period could yield the best results. A 20-year GRAT, for example, would lock in the 2.0% interest rate for the full term of the GRAT. It can reasonably be assumed that the interest rates will not remain this low during the next twenty years. Furthermore, it would not be unreasonable to assume that the values of the Business Interests will increase over the years because the values of the underlying real properties and/or business assets will increase. There is a disadvantage to using your discountable Business Interests in the event that those Business Interests would be needed to pay out your retained annuity right. On the other hand, the Business Interests generate income, which might be sufficient to satisfy the annuity obligation, so that the Business Interests themselves could be retained intact in the GRAT for continued growth.



Some clients, looking over the tax savings possible by the correct use of GRATs wonder if this loop hole is fully authorized. However, since there is statutory and regulatory authority for GRATs, and they have been upheld in court decisions, there is little question that these structures are safe from audit if correctly implemented. In other words, the estate planning community has experience with GRATs and knows how to structure them properly to minimize the risk of the IRS questioning any aspect of the GRAT.

On the other hand, a potential disadvantage of a GRAT is that if you do not survive the term of the GRAT, the structure fails and is treated as if it never had been established. Consequently, if you were to fail to survive the GRAT term, the anticipated estate tax benefit of removing growth from your estate would be defeated. A GRAT term should be selected that is well within your life expectancy so that the risk of this eventuality is minimized.

As with any complex trust arrangement, careful advance planning with the particular family situation that exists keenly in mind must be achieved since once the structure is in place, changes can be impossible or difficult to achieve.