Grantor Retained Annuity Trusts (GRATs) are commonly used to transfer wealth to children or others in a tax efficient manner. A GRAT is an irrevocable trust to which a person (Grantor) transfers property and retains the right to receive fixed annuity payments. The remainder may pass to the Grantor’s family and, as long as the Grantor survives the term, the remainder is removed from the Grantor’s taxable estate. If the value of the assets transferred to the GRAT increases at a rate greater that the IRS assumed rate of return (currently 3.2%), the excess value passes free of tax to the remainder beneficiaries.
To minimize the mortality risk and maximize the potential benefits, short-term GRATs (usually two year terms) with annuity payments that provide a zero remainder (creating a zero gift) have been widely used. The opportunity to use this type of GRAT soon may be eliminated by legislation. The House Ways and Means Committee has approved a bill containing a provision that would place certain restrictions on GRATs making them less attractive. The restrictions include:
- a minimum term of 10 years (creating a greater risk of death during the term),
- a prohibition on decreasing the payments during the first 10 years (increasing payments would still be permitted), and
- the requirement for a remainder greater than zero.
If enacted, the bill as currently drafted would apply to all GRATs established after the enactment date. Therefore, if you are considering creating a GRAT you may want to move quickly.