“Accidental” Tax Break Could Provide Big Opportunity

By Jason Palmisano

What do Mark Zuckerberg of Facebook and Sheldon Adelson of Las Vegas Sands Corp have in common? For one, they are highlighted on the Forbes “America’s Richest People” list. MSN has also reported that both are taking advantage of a tax loophole called the Grantor Retained Annuity Trust (GRAT) which allows wealthy Americans to direct excess earnings to their heirs without incurring the consequences of the 40 percent federal estate and gift tax.

A GRAT can be an extremely effective means to transfer an asset’s growth or appreciation out of an individual’s estate to his/her children and grandchildren without using a single dollar of his/her lifetime federal gift/estate tax exemption ($5,340,000 in 2014).  And you don’t have to carry the Zuckerberg or Adelson name to take advantage of this and save tens of thousands or even hundreds of thousands in federal estate tax.

In simplified terms, a GRAT works like this:

  • An individual creates a Grantor Retained Annuity Trust (GRAT) for the benefit of his or her children and/or grandchildren;
  • The individual transfers assets to the GRAT with potential for significant appreciation (i.e., depressed real estate, closely held stock, marketable securities, etc.);
  • The trustee of the GRAT returns the original value of assets transferred to GRAT (plus some interest) over a terms of years as decided by the individual in establishing the GRAT.  For example, if the individual transfers $1,000,000 in marketable securities to a GRAT with a 4-year term, then trustee pays back the $1,000,000 (plus some interest) to the individual over a 4-year period;
  • Any appreciation or gain obtained by assets of the GRAT stay in trust for the benefit of the individual’s children and grandchildren.  For example, if over the 4-year period the $1,000,000 grew to $1,400,000, $400,000 would remain in the GRAT for the benefit of the children and grandchildren.
  • Even though the individual receives the value of the assets originally transferred to the GRAT back in his or her estate, the growth and appreciation ($400,000 in our example) is forever removed from the individual’s estate so that it is not subject to federal estate tax at his or her death; all without using any of the individual’s lifetime federal gift tax exemption.  If the individual dies during the term of the GRAT, however, then all of the assets of the GRAT (including appreciation) are included in the individual’s estate subject to federal estate tax.
  • If the individual survives the term of the GRAT then the individual saves paying federal estate tax on the growth and appreciation removed from his or her estate.  In our example, federal estate tax saved on the $400,000 growth and/or appreciation can be as much as $160,000 in 2014.

This strategy has been called an ‘accidental tax break’ by some advisors.  If you are interested in learning more about how a GRAT might be an effective strategy in your estate plan, please contact our Private Wealth Practice Group.

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