Grantor retained annuity trust (GRAT)
A grantor retained annuity trust, or GRAT, is an irrevocable trust into which an owner transfers a business interest in exchange for an annuity for a term. Practitioners describe the gift tax transfer as occurring when the interest moves into the trust. The mechanics involve a retained annuity, a remainder gift valued by formula, and an estate inclusion risk if the owner dies during the term.
How it works
A GRAT works through a transfer and a retained stream of payments. Estate planning practitioners describe the owner moving a business interest into an irrevocable trust and receiving an annuity for a term in return. The gift tax transfer occurs when the interest is transferred to the GRAT.
The gift tax value of the remainder gift follows a formula. Practitioners note that the value equals the business interest transferred less the value of the retained annuity interest. The calculation uses a rate set by the tax code for valuing the annuity.
One condition runs through the practitioner descriptions. Practitioners point to the length of the annuity term as a factor that matters because of the estate inclusion risk described below.
Where it shows up for owners of businesses, real estate and private investments
A GRAT shows up where an owner holds a business interest and places that interest in the trust for an annuity term. The owner receives the annuity, and the trust holds the interest that was transferred.
The annuity term sets how long the owner receives payments from the trust.
The value of the transferred interest is an input to the gift calculation. The other input is the value of the retained annuity, which is measured with the valuation rate used in the calculation.
Points that are easy to confuse
The value of the business interest and the value of the gift are different amounts.
The estate inclusion risk applies when the owner dies before the annuity term ends.
The date of the gift and the end of the annuity term are separate events.
Common questions
When does the gift tax transfer occur in a GRAT?
The owner receives an annuity for a term in exchange, and the remainder gift is valued as the interest's value less the value of the retained annuity interest.
What happens if the owner dies during the annuity term?
Trust and estate practitioners describe GRAT assets as included in the parent's taxable estate to the extent needed to provide the annuity payments.