Tax avoidance tools and strategies should be part of your estate plan to ensure that your estate doesn’t lose a significant portion of its assets to federal gift and estate taxes. At your death, your estate assets will be inventoried and valued. If the value of your probate assets exceeds the current lifetime exemption amount, your estate could owe gift and estate taxes at the staggering rate of 40 percent at the federal level and 16 percent to the State of Maryland. One estate planning tool that can provide tax avoidance benefits is a Grantor Retained Income Trust. If you are unfamiliar with a GRIT, our estate planning attorney, Richard L. Gershberg, explains what you need to know.
What Is a GRIT?
A Grantor Retained Income Trust is a specialized type of irrevocable trust that allows the Grantor (creator of the trust, also referred to as the “Settlor”) to transfer assets into the trust while retaining the right to receive all of the net income from the trust assets for a fixed term of years, referred to as the “initial term.” Income from the trust is distributed to the Grantor at least annually during the initial term. At the end of the initial term, the remaining principal is either distributed to the trust beneficiaries or remains in the trust for the benefit of those beneficiaries. The primary benefit of a GRIT is that if (this condition is important) the Grantor survives the initial term, the value of the principal held in the GRIT is excluded from the Grantor’s estate for federal gift and estate tax purposes.
What Makes a GRIT Such a Valuable Tax Avoidance Tool?
The tax avoidance benefit of a GRIT is found in how the value of the trust principal is determined because those assets are valued at a discount. The value of the discount depends on the length of the initial term of the GRIT, and the applicable federal rate in effect at the time the GRIT is established. The transfer of assets to a GRIT constitutes a gift equal to the total value of the assets transferred to the GRIT, less the present value of the retained income interest held by the Grantor for the initial term. If the Grantor survives the initial term, the assets comprising the GRIT will pass to the designated remainder beneficiaries at a reduced gift tax value.
An Important Note about Beneficiaries
Section 2702 of the Internal Revenue Code determines who you cannot name as a beneficiary in a GRIT. Excluded beneficiaries include your spouse, your ancestors or the ancestors of your spouse, any lineal descendant of yours or your spouse, any sibling of yours or your spouse, or the spouses of any of the foregoing persons. You can name lineal descendants of siblings, (nieces and nephews) relatives even more distant than nieces and nephews, or friends of yours or your spouse as beneficiaries of a GRIT.
Understanding How a GRIT Works in the Real World
Imagine that you establish a 15-year GRIT and transfer $100,000 of assets into the trust and that the applicable federal rate is five percent. As the Grantor, you will receive the income from the GRIT during the initial term. The present value of the retained income interest is $66,007, making the value of the gift $33,993. If you survive until the end of the initial term, however, the remainder beneficiaries will receive $100,0000 plus all capital growth. Your estate, however, will only need to acknowledge a lifetime gift in the amount of $33,993 (the applicable value of the gift at the time it was made)
What Else Do I Need to Know about a GRIT?
Just like most tax savings tools and strategies, there are some disadvantages to relying on a GRIT. First, it is an irrevocable trust, meaning if your personal circumstances change, you cannot make corresponding changes to the trust. Second, if you do not survive the initial term the advantages gained by creating a GRIT do not apply.
Contact Our Owings Mills Estate Planning Attorney
For more information, or if you have additional questions or concerns about estate planning or about incorporating a Grantor Retained Income Trust into your estate plan, contact our experienced Owings Mills estate planning attorney at Gershberg & Associates, LLC by calling 410-654-3850 to schedule an appointment.