Personal Finance


December 18, 2009


Estate trust strategy may save taxes on asset gains

Wealthy individuals who would rather give money to their children than the government may have a limited opportunity to put some assets in trusts that let them transfer wealth tax-free.

Grantor-retained annuity trusts, known as GRATs, or irrevocable, intentionally defective grantor trusts allow the appreciation of certain assets to pass to heirs free of estate and gift taxes, said Brittney Saks, a partner in New York-based PriceWaterhouseCoopers’s Private Company Services.

Stock and real estate values “have taken a pounding,” interest rates are low and Congress may soon change tax laws, said Stan Miller, senior shareholder at Miller & Schrader, a law firm based in Little Rock, Ark. “Those three factors combined have created what we think is the perfect storm for estate planning,” Miller said.

Current federal law taxes estates exceeding $3.5 million for an individual or $7 million for a married couple, at as much as 45 percent. Any gift to an individual above $13,000 this year may also be taxed as much as 45 percent with a $1 million lifetime limit per donor, according to the Internal Revenue Service.

Next year the estate tax is scheduled to disappear under a phase-out Congress approved in 2001. It’s due to reappear in 2011 taxing estates valued at more than $1 million at 55 percent.

Wealthy taxpayers are anticipating higher taxes and worrying that their children will have less opportunity to accumulate money, said Roy Ballentine, president and chief executive officer of Ballentine Finn, a wealth management firm with offices in Wolfeboro, N.H., and Waltham, Mass. That’s created a sense of urgency to take advantage of opportunities now to transfer a lot of money with minimal tax consequences.

Here’s how a GRAT works. Taxpayers transfer assets such as stock to the trust and the value of the assets are repaid to them over a set period of time through a fixed annuity. Appreciation of the initial contribution above an interest rate set by the IRS transfers to beneficiaries tax-free.

As an example, an employee with a stake in social- networking site Facebook Inc. could transfer $200,000 -- 10,000 shares valued at $20 -- to a two-year GRAT, with his children as beneficiaries, said Jonathan Mintz, chief executive officer of WealthCounsel, an organization based in Madison, Wisc., that advises estate planning attorneys. If the company went public and the shares rose to $100 by the end of the two-year term, the value transferred to the GRAT would total $1 million.

10-Year Term

The shareholder would get back the initial $200,000 plus 3.2 percent interest in annuity payments over the two years. The interest rate for a GRAT created in December is 3.2 percent, according to the IRS. The IRS rates are low because they are tied to the federal funds rate, which is near zero.

The remaining appreciation of about $800,000 would transfer to his children estate and gift tax-free, said Mintz.

Those who want to dictate how the appreciated assets are spent can keep them in the trust instead of distributing them when the GRAT’s term ends, said Mintz. They can specify the conditions for how the money can be used, such as for college or a first home, he said.

President Barack Obama’s 2010 revenue proposals include requiring a minimum 10-year term for GRATs. That limit may make these wealth-transfer tools less beneficial, said Scott Ditman, a tax partner specializing in trust and estates at New York-based Berdon LLP.

$10,000 cost

That’s because a longer-term GRAT means a better chance of the trust’s creator dying before the term’s end, Ditman said. If the person who created the trust dies before the term ends, assets revert back to the estate.

GRATs may be inappropriate for investors who have a net worth less than $10 million because of the $10,000 or more cost associated with setting them up, according to Deborah L. Jacobs, author of “Estate Planning Smarts: A Practical, User-Friendly, Action-Oriented Guide." The trusts are irrevocable and creators should only set up GRATs if they don’t need to use the money locked up in the trust immediately and can afford to give away the appreciation on the assets in the trust, she said.

An irrevocable, intentionally defective grantor trust may appeal to taxpayers with family businesses or depreciated assets such as real estate, said Miller, of the Arkansas law firm whose clients range from Wal-Mart investors to family business owners.

Upswing in value

“You’re taking an asset value at a time when it’s depressed and shifting that asset to a trust for a family member so that when the value rebounds, all of that upswing in value is not included in the client’s estate when the client dies,” he said.

These trusts are more flexible than GRATs on the timing of the original investment repayment and may avoid another tax the IRS levies on wealth transfers to grandchildren, said Ballentine of Ballentine Finn.

With this strategy you may sell an asset to a trust, unlike with a GRAT, so it’s important to consider the consequences if the assets don’t appreciate, said Ballentine, whose clients have on average $66 million in assets.

“If assets in a GRAT fail to appreciate as expected, the GRAT automatically unwinds and you simply start over,” he said. With a defective trust, which is often financed by taking on debt, if the assets don’t appreciate, additional money put in the trust may be subject to the gift tax, Ballentine said.

Tax proceeds from estates this year will generate an estimated $11.8 billion, according to the Joint Committee on Taxation, a Washington-based, nonpartisan congressional committee.


December 18, 2009