One of the most widely-utilized tools by high net worth individuals to avoid U.S. estate and gift taxes, namely, “zeroed out GRATs,” remains available. This is due to the failure of Congress to adopt pending proposals to shut it down. “GRAT” stands for “grantor retained annuity trust.” GRATs have a long history of use to reduce estate and gift taxes. The “zeroed out” aspect, as explained below, is the variation that Congress is targeting, and qualifying taxpayers are well advised to act quickly to take advantage of the opportunity before Congress adopts tax reform legislation.
Traditionally, a GRAT is utilized to allow a trust grantor, i.e., transferor of property, to retain income from property transferred to a trust by the retention of an annuity, while giving away future appreciation to beneficiaries (the remainder interest). The value of the remainder is a taxable gift, but future appreciation is removed from the grantor’s taxable estate.
The stakes are high, because estate and gift rates are currently both at 40% for estates in excess of $5.34 million ($10.68 million for couples).
Since the mid-1980’s, the basic GRAT technique has evolved into a more aggressive technique, the zeroed out GRAT, which attracted the ire of the Internal Revenue Service. The Service’s challenge of this practice was rejected by the U.S. Tax Court in 2000.
The zeroed out GRAT technique, in simplified terms, involves transferring money or appreciating property (e.g., low-dividend growth stocks) to a trust, with instructions to return the entire amount to the grantor at the end of a short fixed term, for example, two years. Because the value of the retained annuity is equal, or nearly equal, to the value transferred to the trust, the value of the taxable remainder interest is effectively reduced to zero at the time of the taxable transfer to the trust. Any appreciation of the trust asset during the term of the trust, in excess of the applicable federal interest rate, will pass to the beneficiaries without any tax at the end of the term. Any appreciation of the assets after the term of the transfer is removed from the trust grantor’s estate. If the assets do not appreciate, the only costs are attorney’s and accountant’s fees.
This technique has become so popular that it has been employed by hundreds of the wealthiest and highest profile individuals in the U.S., as determined by filings with the Securities and Exchange Commission. Many of these individuals have churned assets into and out of numerous trusts, with one reportedly having implemented nearly 100 zeroed out GRATs. This technique has reportedly cost the U.S. Treasury more than $100 billion, and illustrates why the estate and gift tax is essentially voluntary, for wealthy individuals.