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Grantor Retained Income Trust (GRIT)

July 29, 2011

John Jastremski Presents:

 

Grantor Retained Income Trust (GRIT)

 

A grantor retained interest trust (GRIT) is an irrevocable trust into which a grantor makes a one-time transfer of property, and in which the grantor retains the right to receive all of the trust’s net income at least annually for a specified term of years. At the end of the retained interest period or upon the grantor’s death, whichever is earlier, all the property in the trust passes to the remainder beneficiaries or remains in trust for their benefit.

A successful GRIT transfers, federal gift tax free, appreciation produced by the GRIT property during the term of years that is in excess of the rate of return assumed by the IRS (known as the Section 7520 rate, hurdle rate, or discount rate) when determining the value of the gift to the remainder beneficiaries.

With a GRIT, the remainder beneficiaries cannot be “members of the grantor’s family” (i.e., the grantor’s spouse, any lineal descendants of the grantor or the grantor’s spouse, any sibling of the grantor or the grantor’s spouse, or a spouse of any sibling of the grantor or the grantor’s spouse). Remainder beneficiaries can be lineal descendants of siblings (e.g., nieces and nephews) or more distant relatives, or unrelated persons. A GRIT, therefore, can be a useful tool in planning for a grantor’s domestic partner or friends.

For a GRIT to be successful:

  • The remainder beneficiaries cannot be “members of the grantor’s family”
  • The grantor must outlive the term of years
  • The GRIT property must outperform the Section 7520 rate
  • The GRIT document must be properly drafted

Potential tax advantages of a GRIT include:

  • Because of the retained interest, the value of the transfer for federal gift tax purposes may be discounted
  • Principal remaining in the GRIT at the end of the term of years is removed from the grantor’s gross estate for federal estate tax purposes
  • Appreciation produced by the GRIT property during the term of years passes to the remainder beneficiaries free of federal gift tax

Key Tradeoffs 

  • If the grantor does not outlive the term of years, property in the GRIT is includable in the grantor’s gross estate for federal estate tax purposes
  • If the GRIT is unsuccessful, the costs to create the GRIT will be wasted

How Is It Implemented?

  • Hire an experienced attorney to draft the GRIT document
  • Have property that is transferred to the GRIT professionally appraised
  • Transfer property to GRIT (i.e., retitle assets)
  • File gift tax returns

What is it?

A grantor retained income trust (GRIT) is an irrevocable trust into which a grantor makes a one-time transfer of property, and in which the grantor retains the right to receive all of the trust’s net income at least annually for a specified term of years. At the end of the term of years or upon the death of the grantor, whichever is earlier, all the property in the GRIT passes to the remainder beneficiaries named in the trust or is held in trust for their benefit.

A GRIT is a way for a grantor to transfer property to certain loved ones, but it also has the potential to minimize federal gift and estate tax (explained further below). However, to establish an effective GRIT, the remainder beneficiaries cannot be “members of the grantor’s family,” defined as the grantor’s spouse, any lineal descendants of the grantor or the grantor’s spouse, or any sibling (or a sibling’s spouse) of the grantor or the grantor’s spouse. Remainder beneficiaries can be lineal descendants of siblings (e.g., nieces and nephews) or more distant relatives, or unrelated persons. A GRIT, therefore, can be a useful tool in planning for a grantor’s domestic partner or friends.

One exception to the “no family member” rule is a GRIT that is funded with a personal residence. This type of GRIT is otherwise known as a qualified personal residence trust (QPRT). To achieve tax benefits similar to a GRIT with any other type of property, and if the grantor wishes to name family members as remainder beneficiaries, the trust must be structured as a grantor retained annuity trust (GRAT) or grantor retained unitrust (GRUT).

Potential tax advantages of a GRIT include:

  • The tax value of the gift is reduced. The present value of the grantor’s retained interest is subtracted from the total value of the transferred property when determining the amount of the gift to the remainder beneficiaries for gift tax purposes. The gift is “discounted” using a calculation based on the IRS’ assumed rate of return in effect during the month the gift is made (this is known as the Section 7520 rate, hurdle rate, or discount rate). Any gift tax due can be offset to the extent of the grantor’s available lifetime gift and estate tax exemption ($5 million in 2011).
  • Property transferred to a GRIT will not be included in the grantor’s gross estate as long as he or she outlives the term of the retained interest. If the grantor dies before the term of the retained interest ends, however, the full value of the property in the trust on date of death will be included in the grantor’s gross estate for estate tax purposes.
  • Appreciation in the property after being transferred to the GRIT will also not be included in the grantor’s gross estate. This tax benefit is most advantageous for GRITs funded with rapidly appreciating property

Example(s): Joe transfers property valued at $100,000 into a GRIT with a 15-year term. Joe names his domestic partner as the remainder beneficiary. The Section 7520 rate at the time is 5.4 percent (i.e., the IRS anticipates that the property will grow at this rate). The GRIT specifically provides that Joe will receive all of the trust’s net income each year for 15 years. According to the IRS valuation tables, Joe’s retained interest is valued at $54,565. Therefore, the value of the remainder interest, and the taxable gift, is approximately $100,000 minus $54,565, or $45,435. The federal gift tax on that $45,435 is totally offset by a portion of Joe’s lifetime gift and estate tax exemption. After the 15-year period ends, the property plus all appreciation passes to Joe’s remainder beneficiary free of any additional gift or estate tax consequences.

As explained above, a GRIT can minimize gift and estate tax, but only if it is successful. For a GRIT to be successful at all, the grantor must outlive the term of the GRIT. If the grantor dies before the term of years ends, all the property in the trust is included in the grantor’s gross estate for estate tax purposes, just as it would have been had the GRIT not been created. Therefore, the only risk associated with an unsuccessful GRIT is any costs incurred to create and maintain the trust.

For maximum tax benefit, the property in the GRIT must appreciate greater than the Section 7520 rate (and/or the income paid must be less than the Section 7520 rate). If the property transferred to the GRIT does not appreciate greater than the Section 7520 rate, the result is merely that no additional value is transferred gift tax free.

Tip: Using a short-term GRIT can reduce the risk of the grantor dying before the term of years ends. This, however, will increase the amount of the taxable gift.
When can it be used?

A GRIT generally works best for people who are expected to outlive the specified term of years, and who have enough other property to maintain their lifestyle when the net income payments stop. Further, a GRIT should be considered if the grantor has property that is growth oriented (as opposed to income oriented) and is expected to appreciate significantly over the term of the GRIT.

A GRIT can be particularly advantageous to unmarried couples because the income stream and the remainder interest stays with the couple as one economic unit. Also, because the unlimited marital deduction is not available to unmarried couples, a GRIT can be an excellent way for one partner to transfer wealth to the less wealthy partner, equalizing their estates and allowing each partner to fully use his or her estate tax applicable exclusion amount.
Strengths
Use of GRIT may allow transfer of property to beneficiaries to be discounted for federal gift tax purposes

Transferring property to a GRIT is considered a taxable gift to the remainder beneficiaries. However, since the grantor retains a valuable interest and the remainder beneficiaries of the GRIT will not receive the remaining trust property until some time in the future, the IRS generally allows the grantor to discount the value of the gift for gift tax purposes. The size of the discount depends on the length of the term of years and the applicable Section 7520 rate. The longer the term of years and the higher the Section 7520 rate, the more the value of the gift may be discounted.

The gift tax due, however, may be offset by the grantor’s lifetime gift and estate tax exemption, to the extent it has not already been used up.

Caution: If the grantor lives in one of the handful of states that impose their own gift tax, state gift tax may also be due.
Value of property remaining in GRIT will not be included in grantor’s gross estate as long as grantor outlives the term of years

As long as the grantor outlives the term of years set out in the trust document, the property (principal and appreciation) remaining in the trust will not be included in the gross estate of the grantor for estate tax purposes. The grantor need only outlive the term of years for one day. Thus, a GRIT can be an excellent vehicle for transferring future appreciation gift and estate tax free. A GRIT can be especially valuable to a grantor who has property that is expected to rapidly appreciate.
Use of GRIT may prevent will contest, public scrutiny of assets

Property transferred to a GRIT will not be part of the grantor’s probate estate. The property will be distributed to the remainder beneficiaries named by the grantor according to the terms of the trust. The grantor’s legal heirs would have no claim to them, and this may discourage a will contest. Furthermore, a will is a public document. Anyone can go to the probate court and view the contents of a will. A trust, however, is a private document that is not subject to public scrutiny.
Tradeoffs
Property in GRIT will not escape estate taxation if grantor does not outlive the term of years

Failing to outlive the term of years throws the GRIT property back into the grantor’s estate, and the advantages of the GRIT will be lost.

Tip: To provide for this contingency, many estate planners recommend that the remainder beneficiaries purchase a life insurance policy on the grantor for the term of years. Then, if the grantor dies too early, the beneficiaries will have the funds to pay the estate taxes.
Transfer of property to GRIT is a taxable gift

Since a GRIT is an irrevocable trust (i.e., it cannot be changed or ended), a transfer of property to the GRIT is considered a taxable gift to the remainder beneficiaries. Therefore, gift tax may have to be paid if the amount of the taxable gift is above the $1 million lifetime exemption from gift tax or if the grantor’s gift tax exemption has been previously used.
Transfer of property to GRIT does not qualify for annual gift tax exclusion

A transfer of property to a GRIT does not qualify for the annual gift tax exclusion. To qualify for the annual gift tax exclusion, the donees (i.e., recipients) must have a present interest in the gift (i.e., the donees must be able to currently possess, use, and enjoy the gift). However, with a GRIT, the remainder beneficiaries will not have a present interest in the property until the grantor’s retained interest ends at some point in the future.
Property in GRIT will not be available to the grantor during the term of years

As with any other irrevocable trust, once property is transferred to a GRIT, the grantor gives up control over it. If circumstances change during the term of the trust, and the grantor finds that he or she needs more than the trust’s net income, he or she will be unable to access the property in the GRIT. (The QPRT is a limited exception to this rule, since the “income” retained by the grantor is the right to live in the residence.)
Grantor will lose income from GRIT at end of specified term

Once the specified term of years ends, the grantor’s retained interest ends and the trust property passes to the remainder beneficiaries (or it can remain in trust for their benefit). If the grantor outlives the specified term and still needs the income, he or she will be unable to access the property in the GRIT.
Cost of creating GRIT may be wasted if GRIT is unsuccessful

There may be costs incurred in creating and maintaining a GRIT. First, a competent and experienced estate planning attorney will be needed to draft the trust document. Second, the attorney will have to transfer and retitle the transferred property in the name of the GRIT. Finally, the transfer of property to a GRIT is considered a taxable gift. Gift tax returns will need to be prepared and filed, and gift taxes may need to be paid. If the GRIT is unsuccessful (because the grantor does not outlive the GRIT term of years or the rate of return earned by the GRIT property does not exceed the Section 7520 rate), these costs may be incurred for nothing.
GRIT not generally appropriate for generation-skipping transfers

The federal generation-skipping transfer tax (GSTT) (and perhaps state GSTT as well) will apply to transfers of assets made to a GRIT if some or all of the remainder beneficiaries are two or more generations below the grantor (these are known as skip persons). However, the transfer does not occur until the grantor’s retained interest ends. Thus, the grantor cannot allocate his or her GSTT exemption to the transfer until the end of his or her retained interest (or estate tax inclusion) period (this is known as the estate tax inclusion period or “ETIP” rule). Allocating the GSTT exemption when the trust property has already appreciated fails to leverage the exemption. Thus, a GRIT may not be an appropriate device for making transfers to skip persons.

Tip: A grantor may be able to circumvent these generation-skipping transfer limitations if the remainder beneficiaries sell the remainder equivalent to a dynasty trust. This remainder sale strategy is a sophisticated estate planning technique and beyond the scope of this discussion. An experienced estate planning attorney should be consulted.
Income tax consequences of GRIT
GRIT considered a grantor trust for income tax purposes

For income tax purposes, a GRIT should be a grantor trust. Being classified as a grantor trust means that all items of income and deductions flow through to the grantor. The grantor should have enough income or property available to meet this liability.
Remainder beneficiaries do not receive a step-up in basis

Unlike property received because of the death of the transferor, property transferred to the remainder beneficiaries does not receive a step-up (or step-down) in basis. However, this situation can be averted if the grantor buys the trust property at the end of the retained interest period. The remainder beneficiaries get the cash instead, and the property will receive the step-up in basis at the grantor’s death.

This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of John Jastremski, Jeremy Keating, Erik J Larsen, Frank Esposito, Patrick Ray, Robert Welsch, Michael Reese, Brent Wolf, Andy Starostecki and The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com,  access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that specializes in transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.

John Jastremski is a Representative with FSC Securities and may be reached at www.theretirementgroup.com.

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