Author: Jeffrey Gehring

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Graduated GRATs

One traditional estate planning technique that has become increasingly popular in recent months is the Grantor Retained Annuity Trust (GRAT). Simply stated, a GRAT is an irrevocable trust where the grantor contributes property to the GRAT and retains the right to receive a percentage of the assets back over a designated period of years; any property remaining in the GRAT at the end of the designated term passes to the remainder beneficiaries of the GRAT. The percentage selected is often tied to actuarial calculations to approximately equal the value of the grantor’s original contribution to the GRAT. For gift tax purposes, the actuarial value received back is deducted from the value of the property originally contributed to the GRAT, often resulting in a nominal taxable gift to the remainder beneficiaries. This can be an effective transfer tax technique for a donor who has already used his or her lifetime gift tax exemption amount.

Where the remainder interest gift is “zeroed out”, the value transferred to the remainder beneficiaries is essentially the appreciation in the value of the property contributed to the GRAT during the GRAT term. Often, the payments back to the grantor are structured as level percentage payments over the GRAT term. However, IRS regulations permit the annuity percentages to be graduated, increasing by as much as 20% each year over the course of the GRAT term. This means that the percentage of the original contribution paid back to the donor in early years can be substantially lower, thereby allowing the assets remaining in the GRAT to more fully appreciate before the larger percentage payments are made in later years. This graduated GRAT structure can be particularly effective for an entity where exponential growth is expected and/or a liquidity event is anticipated since the percentage payments back to the donor are based on the initial value contributed to the GRAT (rather than the appreciating value over the course of the GRAT term). A graduated GRAT can also be an efficient transfer tax technique for an income-producing asset, where the income produced can be used to pay some or all of the annuity back to the grantor.

If you would like to discuss potential benefits of a graduated GRAT, please contact Jeff Gehring in the Lexington, Kentucky office (859-899-8713) or one of the estate planners in our other offices.

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Final Regulations Confirm No Clawback on Gifting

With the gift/estate tax exemption of $11,580,000 (in 2020) set to expire or “sunset” on December 31, 2025, many advisors have encouraged high net worth clients to make large taxable gifts and “use up” their gift tax exemption during lifetime and shelter future income and appreciation in the gifted assets from estate tax at death. However, some advisors have expressed concern that making a large gift and using the current exemption may trigger additional transfer tax if the estate tax exemption is reduced in the future, effectively allowing the IRS to “claw back” the used exemption in excess of the estate tax exemption in effect at the taxpayer’s death.

On November 22, 2019, the IRS issued final regulations confirming that used gift tax exemption will not be “clawed back” upon a taxpayer’s death, even if the taxpayer made gifts in excess of the estate tax exemption ultimately in effect at the taxpayer’s death. Further, a surviving spouse who received unused estate tax exemption from a predeceased spouse — referred to as the Deceased Spousal Unused Exemption (“DSUE”) — can utilize the DSUE amount during lifetime or at death without fear of a clawback or loss of the DSUE.

Wealthy clients should focus on planning and implementing strategic taxable gifts over the next six years to utilize their gift tax exemption and take advantage of the higher exemption amount while it is in effect. While the law is scheduled to sunset on December 31, 2025, taxpayers should not delay making gifts until this date. Tax laws are subject to change in any year, but with the presidential election looming in 2020 and a possible shift in the makeup of Congress, a reduction in gift and estate tax exemptions could take place prior to the end of 2025. Wealthy taxpayers should be proactive in planning their gifts to maximize long-term tax benefits to their family by making leveraged and/or strategic gifts of income-producing and/or appreciating assets.

If you want to discuss planning options to maximize use of the lifetime gift exemption while it remains at an historic high, contact Jeff Gehring in the Lexington office at 859-899-8713 or another estate planner in one of our Dickinson Wright offices.

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Tax Tip: Generation-Skipping Transfer Trusts

Generation-Skipping Transfer (GST) trusts have long been a popular estate tax planning tool used to defer transfer tax to a future generation. While the estate tax exemption is at a historical high, the GST tax exempt status of existing trusts is still important when planning for a family’s overall tax situation. Trusts established by a parent or grandparent can be qualified as GST exempt or GST non-exempt trusts, depending on whether the creator’s GST tax exemption was allocated to the trust. Any distribution from a GST non-exempt trust to a grandchild (or more remote descendant) will be subject to GST tax at a 40% rate, regardless of whether the distribution is made during the term of the trust or upon the termination of the trust. This GST tax can apply even if the beneficiary’s estate is not otherwise subject to estate tax.

There may be planning opportunities to minimize or avoid GST tax on a distribution to a grandchild from a GST non-exempt trust, either through a late allocation of GST exemption, application of the predeceased ancestor rule, exercise of a special power of appointment or addition of a general power of appointment. Timing is important, as some of these planning opportunities are only available while the trust creator or an older beneficiary is alive.

If you have a trust created by a parent or grandparent and need assistance in determining whether the trust is GST exempt or non-exempt, or if you have a GST non-exempt trust and want to explore what tax saving opportunities may be available, please contact Jeff Gehring at 859-899-8713 or one of the other estate planners in Lexington, Nashville, Phoenix, Detroit, Grand Rapids or Troy.