Grantor Retained Annuity Trust
Encyclopedia
A grantor retained annuity
trust
(commonly referred to by the acronym GRAT), is a financial instrument commonly used in the United States to make large financial gifts to family members without paying a U.S. gift tax
.
whereby the donor receives an annual payment from the annuity for a fixed period of time. At the end of the term, any remaining value in the trust is passed on to a beneficiary
of the trust as a gift. The beneficiary must be a family member of the donor. If the donor dies before the end of the term, then the value of the trust at that time is passed on to the beneficiary.
The United States Internal Revenue Service
has a number of regulations governing how the remaining value of the trust at the end of the term (or at the death of the donor) is taxed. When the GRAT is first set up, a “gift value” of the GRAT is calculated. The gift value is set equal to the initial contribution to the GRAT plus a theoretical interest earned on the principal
minus the annuity payments that would be made through the end of the term. The theoretical rate of interest is determined by IRS regulations. The rate is set equal to 120% of the federal mid-term rate during the month that the GRAT is established.***
To realize a tax benefit, the sum of the scheduled annuity payments of a GRAT is set to be about equal to the principal plus theoretical interest. Thus, for tax purposes, the initially calculated gift value is zero, since what will be paid back to the donor in annuity payments is anticipated to be about equal to what the donor invested, plus interest. If a GRAT is funded with highly volatile assets, however, it is possible that the actual interest earned on the assets will be substantially higher than the IRS theoretical interest. Thus at the end of the term, the value remaining in the GRAT may still be large, even though the initial IRS calculation suggests that it should have been zero. This remaining value is then passed on to the beneficiary without incurring a gift tax.
owns a patent
covering different methods for managing SOGRATs. A SOGRAT is a GRAT that is at least partially funded with stock options. The patent number is , and is entitled "Establishing and managing grantor retained annuity trusts funded by nonqualified stock options". On January 12, 2011, the director of the USPTO initiated a reexamination
of US patent 6,567,790. The reexamination serial number is 90/009,868.
Annuity (US financial products)
In the United States an annuity contract is created when an insured party, usually an individual, pays a life insurance company a single premium that will later be distributed back to the insured party over time...
trust
Trust law
In common law legal systems, a trust is a relationship whereby property is held by one party for the benefit of another...
(commonly referred to by the acronym GRAT), is a financial instrument commonly used in the United States to make large financial gifts to family members without paying a U.S. gift tax
Gift tax
A gift tax is a tax imposed on the gratuitous transfer of ownership of property. The United States Internal Revenue Service says a gift is "Any transfer to an individual, either directly or indirectly, where full consideration is not received in return."When a taxable gift in the form of cash,...
.
Basic Mechanism
A donor sets up a GRAT by making a donation into a trust. The trust is set up as an annuityAnnuity (US financial products)
In the United States an annuity contract is created when an insured party, usually an individual, pays a life insurance company a single premium that will later be distributed back to the insured party over time...
whereby the donor receives an annual payment from the annuity for a fixed period of time. At the end of the term, any remaining value in the trust is passed on to a beneficiary
Beneficiary
A beneficiary in the broadest sense is a natural person or other legal entity who receives money or other benefits from a benefactor. For example: The beneficiary of a life insurance policy, is the person who receives the payment of the amount of insurance after the death of the insured...
of the trust as a gift. The beneficiary must be a family member of the donor. If the donor dies before the end of the term, then the value of the trust at that time is passed on to the beneficiary.
The United States Internal Revenue Service
Internal Revenue Service
The Internal Revenue Service is the revenue service of the United States federal government. The agency is a bureau of the Department of the Treasury, and is under the immediate direction of the Commissioner of Internal Revenue...
has a number of regulations governing how the remaining value of the trust at the end of the term (or at the death of the donor) is taxed. When the GRAT is first set up, a “gift value” of the GRAT is calculated. The gift value is set equal to the initial contribution to the GRAT plus a theoretical interest earned on the principal
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
minus the annuity payments that would be made through the end of the term. The theoretical rate of interest is determined by IRS regulations. The rate is set equal to 120% of the federal mid-term rate during the month that the GRAT is established.***
To realize a tax benefit, the sum of the scheduled annuity payments of a GRAT is set to be about equal to the principal plus theoretical interest. Thus, for tax purposes, the initially calculated gift value is zero, since what will be paid back to the donor in annuity payments is anticipated to be about equal to what the donor invested, plus interest. If a GRAT is funded with highly volatile assets, however, it is possible that the actual interest earned on the assets will be substantially higher than the IRS theoretical interest. Thus at the end of the term, the value remaining in the GRAT may still be large, even though the initial IRS calculation suggests that it should have been zero. This remaining value is then passed on to the beneficiary without incurring a gift tax.
Important Legal Cases
- Audrey J. Walton v. CommissionerWalton v. CommissionerWalton v. Commissioner, 115 T.C. 589 , a decision of the United States Tax Court in favor of taxpayer Audrey J. Walton, "ruled that a grantor's right to receive a fixed amount for a term of years, if that right is a qualified interest within the meaning of Section , is valued for gift tax purposes...
, 115 T.C. 589 (2000), acq. Notice 2003-72, 2003-44 IRB, 15 October 2003. This case established the current way that the IRS established a gift value for a GRAT.
Patents
The Wealth Transfer GroupWealth Transfer Group
The Wealth Transfer Group is a consulting firm that provides estate planning services. They serve only clients with estates worth more than US$ 10,000,000.In 2006, the Wealth Transfer Group sued former Aetna CEO John W. Rowe for infringement of a tax patent...
owns a patent
Patent
A patent is a form of intellectual property. It consists of a set of exclusive rights granted by a sovereign state to an inventor or their assignee for a limited period of time in exchange for the public disclosure of an invention....
covering different methods for managing SOGRATs. A SOGRAT is a GRAT that is at least partially funded with stock options. The patent number is , and is entitled "Establishing and managing grantor retained annuity trusts funded by nonqualified stock options". On January 12, 2011, the director of the USPTO initiated a reexamination
Reexamination
In United States patent law, a reexamination is a process whereby a third party or inventor can have a patent reexamined by a patent examiner to verify that the subject matter it claims is patentable...
of US patent 6,567,790. The reexamination serial number is 90/009,868.