Use A Grat To Save On Gift Taxes To Your Kids

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If you expect to have several million remaining in your estate

, arrange to transfer some wealth while you're living in a way that triggers little or no gift tax. You can use a grantor retained annuity trust (GRAT) to do so. A GRAT is an irrevocable trust set up for only a certain term of years and designed to transfer the appreciation on assets contributed to it with little or no gift-tax consequences.

Simply put, you fund your GRAT and begin receiving back annuity payments from it during its term. Whatever is left in the GRAT at the end of its term is now out of your 'estate' and will go to your assigned beneficiaries (or a holding trust) gift tax free. If you die during the term, though, the funds go to your beneficiaries but remains in your 'estate' for estate and gift tax purposes.

How do you avoid gift tax for funding the GRAT? What you fund your GRAT with would seem to qualify as a gift subject to gift tax. But since the GRAT returns to you annuity payments made up of those funds and some of their earnings over the term of the trust, the actual gift is your funding amount less the present value of all those annuity payments you get during the term of the trust.

The IRS assigns an interest rate that a trust is expected to earn at the time of its funding. 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. So if you assign this IRS rate to determine your annuity payments, than the net gift you've made to your GRAT can be 'zero' - producing no gift tax!
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Of course if your GRAT funds only earned the IRS rate, you'd deplete your GRAT at the end of its term leaving nothing for your beneficiaries. So, you're planning on GRAT investments to grow at a substantially greater rate than the assigned IRS rate of earnings. And that's why a low interest rate environment - as in a recession - with an expected recovery during the GRAT term makes it a low or zero gift tax transfer vehicle.

Note that since the GRAT is a grantor trust, you must pay income tax on all taxable trust earnings during its term. But paying these taxes doesn't constitute additional gifts to the GRAT

Tax Savings for Gifting the remainder to Charity If you're interested in giving away the remainder of your trust to charity - rather than to your children - you should consider setting up a charitable remainder trust (CRT). The CRT can give you substantial tax breaks but you must abide by the Internal Revenue Service's rules when setting it up. The income tax deduction you get depends on the present value of the trust's remainder to charity. It must equal at least 10% of the value of assets transferred into the trust.

The ages of the donor and other income beneficiaries, the annual payout of the trust, and an IRS index rate known as the Applicable Federal Rate (AFR) all determine the amount of tax deduction you'll get. Generally, though, the older the donor (grantor) is, the greater will be the deduction.

by: Shane Flait

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