One of the objectives that many people have when they are engaged in the process of estate planning is to enable a transfer of assets to their loved ones in a tax efficient manner. You might think this can be accomplished through gift giving while you are still alive to see your family members enjoy the gifts. Unfortunately the IRS is well aware of this possibility so there is a gift tax in place that carries the same rate as the estate tax.
There is a $5 million lifetime gift tax exemption, but it is unified with the estate tax exclusion. So, for example, if you were to give $3 million in gifts using this exemption you would only have $2 million left to apply to your estate.
You can however transfer funds to your loved ones while you are still alive in a tax-free manner through the utilization of tax efficiency strategies, and one of these is the “zeroed out” GRAT strategy.
A GRAT is a grantor retained annuity trust, and with these trusts you set a term during which you will receive annuity payments and name a beneficiary who would assume ownership of any remainder left in the trust after the term has expired. Funding the trust does equate to a taxable gift in the eyes of the IRS, and they account for anticipated appreciation using 120% of the federal midterm rate. The idea is to arrange for the annuity payments to equal the entirety of this taxable value so that you retain all the interest and owe no gift tax as a result.
The key to successfully executing the zeroed out GRAT strategy is to fund the trust with highly appreciable assets. If they do wind up appreciating beyond that original IRS valuation there will be a remainder at the end of the trust term, and this remainder would pass to your beneficiary free of the gift tax.
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