Larry Athan has been practicing law for more than 30 years in the areas of tax, trusts and estates, and employee benefits as a managing partner at Posternak Blankstein & Lund LLP.
A member of the Boston and Massachusetts Bar Associations, and the Boston Estate Planning Council, Larry has been named a Massachusetts Super Lawyer in both 2010 and 2011.
PBN: What is a Grantor Retained Annuity Trust and how does it work?
ATHAN: A grantor retained annuity trust, or GRAT, is a very popular estate planning technique to transfer wealth to children or grandchildren with little to no gift tax. To create a GRAT, the grantor (usually a mother or father) transfers property likely to appreciate in value to a trust with a fixed term of years. During the term, the grantor retains the right to receive a fixed payment each year. At the end of the term, the remaining assets plus all the appreciation on the assets during the term pass to the beneficiaries. Beneficiaries’ shares can either be given to them outright or kept in trust. The Internal Revenue Code allows the grantor to take a deduction for the value of the retained annuity interest, which reduces the amount of the gift. Many of my clients at Posternak like to make the annuity amount large enough to reduce the taxable gift to zero.
PBN: When is a GRAT advantageous?
ATHAN: This is one of the best times ever to set up a GRAT because interest rates are at historic lows. A GRAT set up in June can lock in a 1.2 percent interest rate no matter how long the term of the GRAT, meaning all appreciation of GRAT assets in excess of 1.2 percent will pass to beneficiaries free of gift tax. Many of my clients at Posternak transfer stock in their family businesses, real estate or marketable securities to GRATs, but almost any asset can be contributed to a GRAT. One of my clients even transferred interest in a racehorse to his GRAT.
PBN: Any other reasons why now is a good time to explore estate and gift tax planning?
ATHAN: In addition to making gifts to GRATs, this year is a great time to make gifts of all kinds. In 2012, the amount that each individual may transfer gift-tax free during his or her lifetime has been increased to $5.12 million. This is a lifetime exemption and is in addition to the $13,000 per donee annual exclusion. The lifetime gift-tax exemption has never been higher and is scheduled to decrease to $1 million next year unless Congress takes action. Furthermore, some members of Congress have proposed legislation restricting the use of GRATS in the future. Because it is unclear what the tax law will be next year, my colleagues and I are advising clients to make substantial gifts before the end of the year.
PBN: How can those of modest means take advantage of gift planning in a manner similar to GRATs?
ATHAN: GRATs are very advantageous because of the discount given to the donor’s retained interest. Many of our clients who do not want to make gifts to GRATs have obtained a substantial discount, and leveraged their lifetime exemptions and annual exclusions by gifting small percentage interests in real estate or closely-held businesses. If these interests are non-controlling minority interests or are illiquid, the IRS will allow a discount to be used in valuing the gift. For example, if a family business is worth $1 million, a 1 percent interest would be worth less than $10,000 because the owner of that 1 percent interest cannot control what the business does and cannot readily sell the 1 percent interest. I always advise clients to have a competent appraiser value such interests.
Those who have most of their wealth tied up in a personal residence can gift their residence to a trust similar to a GRAT. This type of trust is called a qualified personal residence trust, or QPRT. A QPRT is similar to a GRAT in that the grantor retains an interest in the residence for a term of years. During the term, the grantor lives in the residence rent-free and pays all of the expenses. At the end of the term, the residence will pass to the beneficiaries named in the QPRT. The grantor is allowed to take a deduction for the value of the retained interest, thereby reducing the value of the gift.
PBN: Are there other ways to minimize estate and gift tax liability?
ATHAN: A well-drafted will and trust are essential in order to minimize estate tax liability and to maximize the amount of wealth that can be transferred to the next generation. These documents can insure that marital deductions are available for a surviving spouse, and that all state and federal estate tax exemptions are fully utilized.