How grantor retained annuity trusts work

The gift valuation and investment assumptions

For a completed family trust transfer subject to Section 2702, the gift equals the transferred property's value minus the value of interests retained by the transferor or an applicable family member.

This rule applies when an individual transfers property in trust to or for a family member and the individual or an applicable family member retains an interest. A retained interest that is not qualified generally has zero value.

A wholly incomplete gift is excepted, including a wholly incomplete undivided share. Other transactions excepted by the family trust valuation regulation are outside this explanation.

The statutory actuarial valuation uses prescribed tables and 120 percent of the federal midterm rate for the valuation month, rounded to the nearest two tenths of one percentage point.

An election to use either of the two preceding months requires an allowable income, estate or gift tax charitable contribution for part of the transferred property. These are valuation assumptions, not actual investment returns.

The retained annuity and trust terms

A qualified annuity is an irrevocable right to a fixed amount payable at least annually. It can be stated in dollars or as a fixed fraction or percentage of initial fair market value.

A percentage annuity uses initial value as finally determined for federal tax purposes. Either payment form qualifies only to the extent its amount or percentage does not exceed 120 percent of the preceding year's corresponding amount or percentage.

A withdrawal right does not qualify. A permitted right to excess income is not itself qualified and is excluded from the qualified annuity's value.

The interest must meet the definition of, and function exclusively as, a qualified interest from the trust's creation. The instrument must fix an ascertainable term at creation.

The permitted term is the holder's life, specified years or the shorter of those periods. Successive terms for the same individual are treated as one term.

The instrument must prohibit additional contributions, distributions to anyone other than the qualified interest holder during the term, and commutation through prepayment. A note, debt instrument, option or similar financial arrangement does not constitute an annuity payment.

Payment deadlines and valuation corrections

For payments based on the trust's anniversary, the deadline is 105 days after that anniversary. For payments based on the trust's taxable year, the deadline is its federal income tax return deadline without extensions.

If the trustee uses alternative grantor trust reporting, the taxable year payment deadline is the hypothetical unextended deadline that would apply under the standard trust return reporting method.

Taxable year payments require proration for each short taxable year during the grantor's term. Anniversary payments require proration only for a final period shorter than 12 months.

The prorated amount is the annual annuity multiplied by days in the short period divided by 365. The denominator is 366 when the short period includes the leap day.

A percentage annuity's governing instrument must correct an erroneous initial valuation. Undervaluation requires an additional payment to the recipient, while overvaluation requires repayment to the trust.

The correction equals the difference between the correct payment and the actual payment. It must occur within a reasonable period after the value is finally determined.

Death while the annuity continues

A retained annuity can cause estate inclusion if it lasts for life, a period ascertainable only by reference to death, or a period that does not actually end before death.

The included trust corpus is the amount needed to generate the annuity without invading principal, using applicable statutory actuarial rates and regulatory adjustment factors. Inclusion cannot exceed the trust's fair market value at death.

Graduated annuities use a separate calculation combining a base amount with corpus amounts for periodic additions. Amounts payable before death but paid afterward are separately included as property owned at death.

Payments becoming payable after death are not separately included as property owned at death when already reflected in the retained annuity corpus inclusion.

GST exemption allocation timing

For a GRAT subject to an estate tax inclusion period, an affirmative generation skipping transfer tax exemption allocation becomes effective no earlier than the period's close. If any part of the trust is subject, the entire trust is subject.

For purposes of paragraph (c)(2) of the GST allocation regulation, possible estate inclusion is disregarded when actuarial standards establish a probability below 5 percent. This is the regulation's remote inclusion exception.

An allocation deemed made at the period's close uses the property's value at that time. Do not assume that closing always means the scheduled end of the GRAT.

Form 709 and the valuation record

Report gifts of future interests to beneficiaries other than the spouse on Form 709 regardless of value. Support the gift valuation and attach a certified or verified trust instrument to the return reporting the first transfer.

For Section 2702 disclosure, describe the entire transaction or series, including transactions affecting the transferred interest. Describe transferred and retained interests and the methods used to value each.

Identify the transferor, transferee, other participants and their relationships. Also identify related parties holding equity interests in entities involved in the transaction.

Provide the detailed gift valuation method, including actuarial factors and discount rates. For equity interests that are not actively traded, include the financial and other data used to determine value.

Financial data should generally include balance sheets and statements of net earnings, operating results and dividends paid for each of the five preceding years.

Two related terms

Fair market value: The price at which property would change hands between a willing buyer and willing seller, neither compelled to act and both reasonably informed.

Estate tax inclusion period: The period after a lifetime transfer during which the property would be included in the transferor's gross estate if the transferor died. It ends no later than a generation skipping transfer of the property or the transferor's death.

A perspective on family continuity

One participant described continuity between generations as a purpose of the family office's work. Keep that broader purpose in view when discussing a particular trust structure.

"to provide them a platform to um ensure the proper succession uh and transfer from one generation to the next of the family and and to ensure that continuity"

Common questions