A “Grantor Retained Annuity Trust”, more commonly known as a “GRAT”, is an irrevocable
trust that can reduce estate tax exposure. GRATs are usually used for large gifts of capital
appreciating assets, as the assets transferred into the GRAT are excluded for estate tax
purposes, making it an attractive option for estate planning in the US for ultra-high net worth
clients with beneficiaries.

GRATs are complex and care needs to be taken when structuring them, and it is imperative
that certain conditions be adhered to.

In summary:

  1. The grantor must receive a “qualified interest” in the trust. Section 2702(b) of the
    US Internal Revenue Code defines a “qualified interest” to be:

    1. “any interest which consists of the right to receive fixed amounts payable not
      less frequently than annually,
    2. any interest which consists of the right to receive amounts which are payable
      not less frequently than annually and are a fixed percentage of the fair market
      value of the property in the trust (determined annually), and
    3. any non-contingent remainder interest if all of the other interests in the trust
      consist of interests described [above]”
  2. The grantor must retain a right to receive the original value of the assets
    contributed to the trust while earning a specified rate of return (of at least 0.4% as
    of November 2020, in accordance with IRC section 7520 – see
    https://www.irs.gov/businesses/small-businesses-self-employed/section-7520-
    interest-rates)
  3. The term of the annuity of the GRAT must be a fixed amount of time equal to
    the life of the annuitant, a specified term of years, or the shorter of those two periods
    (IRC section 2702(c)(3)).

    1. When the GRAT’s term expires, the assets remaining in the GRAT (based on
      any appreciation and the IRS-assumed rate of return), are passed on to the
      grantor’s beneficiaries without any gift tax implications.
    2. If the grantor dies before the GRAT term expires, the assets become part of
      the grantor’s taxable estate for estate tax purposes (in which case, the
      beneficiaries will not receive the remainder of the GRAT assets).

Structuring

The gift tax exposure on the transfer of assets to the GRAT can be limited if the actuarial
value of the annuity retained by the grantor is equivalent to the value of the property
transferred (see IRC section 2702).

A GRAT should ideally be structured as a grantor trust (read our prior blog Is your Australian trust a “grantor trust” for US tax purposes?) for both principal and income purposes, so that any future transactions between the GRAT and the grantor are
ignored for US Federal tax purposes.

 

To find out if a GRAT is right for you, please contact:

Renuka Somers
Head, US-Australia Tax Desk

Prerna Polepally
Intern, US-Australia Tax Desk