By Drew Grey, CPA, Partner

A grantor retained annuity trust (GRAT) is a technique designed by Congress to help parents transfer assets to their heirs at a significantly reduced gift tax cost.  This is accomplished because the parents do not transfer the asset outright to the children.  Instead, the parents retain a stream of income from the asset for a fixed number of years.  Therefore, the value of the gift is the fair market value of the asset minus the value of the retained income stream.  Let’s try an example.

Assume Mom and Dad are 65 and 70.  They own an apartment building worth $1,000,000; subject to no debt, which generates $50,000 per year of cashflow.  They want to transfer the value to their children.  However, they have two additional goals.  First, they do not wish to give up the income stream right away.  They want to at least retain the income from the asset for 20 years.  By the time Mom is 85 and Dad is 90, they will no longer need the income due to their short remaining life expectancy and the availability of other assets.  Also, they want to preserve as much of their gift and estate tax exclusion as possible to use against their other assets.

So, Mom and Dad transfer the building to a 20 year term GRAT and retaining a 5% annuity: 5% of $1,000,000 equals the $50,000 they are currently receiving.  If the income increases in the future, they will not get that increase.  But they are comfortable with the current level of cash flow.  What is the value of the gift?  The value of the right to receive $50,000 per year for 20 years at the current 1% interest rate required by the IRS is $902,280, meaning that the gift to the children is only $97,720.  If both Mom and Dad die before the end of the term, then an amount will be included in their estate that is necessary to generate the $50,000 for the remaining years of the GRAT term.

Shorter term GRATs, of course, is more likely to result in complete estate tax exclusion.  However, the gift for a shorter term GRAT will be larger.  In our example, if Mom and Dad used a 15 year term GRAT instead of a 20 year GRAT, the gift would increase from $97,720 to $306,745.  Is the reduction of 5 years’ worth the extra ($306,745 – $97,720 = ) $209,025 of gift?  At $41,805 per year that is a “cost” that many families would be happy to incur for the chance of complete estate tax exclusion.

GRATs work especially well with stock of “S” corporations.  That is because Mom and Dad can assure themselves of the same total income before, during and after the GRAT has ended.  How?  Through a combination of compensation and dividends before the GRAT; compensation, dividends and annuity payments during the GRAT; and increased compensation and perhaps no dividends after the GRAT ends.


The above is not tax advice for any client or matter; it is provided as a topic of general interest to our readers and should not be used for tax planning purposes.  Each client’s situation contains unique facts.

If you are interested in exploring how these rules could benefit you, please contact Drew Grey at (818) 995-0090 or at  to receive advice on your specific matter. 





October 8, 2012 Posted in Estate Tax Planning, Tax