Grantor retained annuity trust

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2021-06-23 02:30:04

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.[1]

A grantor transfers property into an irrevocable trust in exchange for the right to receive fixed payments at least annually, based on original fair market value of the property transferred.[2] At the end of a specified time, any remaining value in the trust is passed on to a beneficiary of the trust as a gift. Beneficiaries are generally close family members of the grantor, such as children or grandchildren, who are prohibited from being named beneficiaries of another estate freeze technique, the grantor retained income trust.[clarification needed ] If a grantor dies before the trust period ends, the assets in the GRAT are included in the grantor's estate by operation of I.R.C. § 2036, eliminating any potential gift tax benefit; this is the GRAT's main weakness as a tax avoidance mechanism.

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 grantor) 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.[3] The rate is set equal to 120% of the federal mid-term rate during the month that the GRAT is established.