The aging population of baby boomers has precipitated the need for these people to focus on succession planning at both the personal and business levels. At the personal level, a significant focus on succession planning includes (1) preservation of after tax capital to pass down to their successor generation(s) and (2) providing the liquidity to pay the estate taxes without the need to dispose of non-liquid assets intended for their beneficiaries. At the business level, succession planning encompasses both planning for the human resources necessary to perpetuate a family business into the future as well as protecting the business’ ability to continue after the death of its owners and the ...view middle of the document...
The use of one of these trusts alone or in combination can aid a taxpayer in accomplishing their particular succession and estate planning objectives.
Grantor Retained Annuity Trusts
Overview of GRATS
A Grantor Retained Annuity Trust (GRAT) is an estate planning technique whereby the grantor makes an irrevocable gift of an asset to a trust, while retaining a payment stream from the trust in the form of an annuity usually for the life of the grantor, for a specified term of years, or for the shorter (but not longer) of those periods (1). GRATS are sometimes referred to as split-interest trusts because they are comprised of two forms of interest, the retained interest, which the grantor receives as an annuity, and the remainder interest, which passes on to the beneficiary upon termination of the trust. The gift tax on the transfer of the assets into the GRAT is determined when the GRAT is created based on the fair market value of the remainder interest at the time of the gift, which is the fair market value of the property transferred to the trust minus the value of the retained annuity interest. The retained interest is determined through an actuarial calculation that factors the present value of the annuity the grantor receives using the §7520 rate. §7520 provides, in part, that the value of any annuity is to be determined under the tables prescribed by the Secretary and by using an interest rate equal to 120 percent of the Federal midterm rate in effect under §1274(d)(1) for the month in which the valuation date falls (2).
Calculating the GRAT Remainder Interest
There are three steps involved in calculating the value of the remainder interest. Step 1 is finding the Table B annuity factor for the appropriate trust term and the applicable federal rate for the month during which the transfer to the trust occurs. Table B can be found on the IRS website. Step 2 is computing the value of the grantor’s annuity retained interest by multiplying the factor obtained in Step 1 by the amount of the annual annuity payment. The last step, Step 3, the value of the grantor’s retained annuity interest is subtracted from the full fair market value of the property transferred to the trust to arrive at the value of the remainder gift interest. To demonstrate how the remainder interest is calculated, assume Bob Smith transfers $1,000,000 worth of property to a GRAT for the benefit of his son, while retaining an annuity interest for 10 years. The trust’s governing instrument provides that the annuity payments will be $100,000 per year, and assume for this example that the §7520 rate is 3.4%. Under Table B, the annuity factor for 10 years and a 3.4% interest rate is 8.3587. The value of the annuity interest would be calculated by multiplying the annuity factor (8.3587) by $100,000, which equals $835,870. The value of the remainder interest would then be $164,130, which is calculated by subtracting the value of the annuity interest ($835,970) from the...