Estate Planning Using GRIT, GRAT, GRUT - Research Paper Example

The growing concern about the economic stability and a wavering financial market in America in the last few years, which is quite unpredictable, has made individuals to look for other ways to save money. One alternative is the reduction of taxes on the income earned and the Grantor Retained Income Trusts (GRITs), Grantor Retained Annuity Trusts (GRATs) Grantor Retained Unitrusts (GRUTs) can be effective measures that can be taken in ensuring the reduction of taxes. The effective use of Grantor Retained Income Trusts (GRITs), Grantor Retained Annuity Trusts (GRATs) and Grantor Retained Unitrusts (GRUTs) can be used as effective methods in estate planning for taxpayers. These trusts can reduce the amounts subject to be taxed. They basically involve transferring of one’s personal residence, and or business using GRITs, GRATs or GRUTs which will reduce the grantors future estate taxes without losing income rights. However, Kramer, 1993) posits that: “However, the IRS Sec 2702 prohibits usage of Grantor Retained Income Trust (GRITs) when making transfers to family members. According to its provisions, this kind of transfer is a gift and is therefore subject to gift taxes. The Internal Revenue Code (IRC) Sec 2702(e)(3) provides an exception to this statute. It states that any transfer of a personal residence is not governed by IRC Sec 2702. Moreover, grantors can simply use either the Grantor Retained Annuity Trust (GRATs) or the Grantor Retained Unitrust (GRUTs)” Therefore, this research paper will seek to establish the benefits of the use of each of the three trusts of estate tax planning. Taxpayers today are always looking for means and ways to gain extra income tax reduction. One of the most effective ways being used by the taxpayers involves the different trusts as a way of gaining income after reduction of taxes. However, as the size of the estate grows, the size of the estate tax will also grow which will eventually need room for planning. The bigger the estate, the higher the tax bracket. One of the trusts that can be used in such planning is the Grantor Retained Income Trust (GRITs), which is an irrevocable trust with a termination date that is a set of a number of years after the death of the grantor. It has been in existence for the past several years, unlike GRATs and GRUTs, which are relatively new estate planning devices. The (IRC sections 2701-2704) came into existence in 1990 and eventually eliminated the use of GRITs in the family planning situation, involving the transfers to family members. With the GRITs, the entire value of the transfer, which includes the retained income interest, is subject to gift tax unless the person who is subject to receive the property after the death of the grantor is not a "family member" of the grantor. Under the GRITs plan, the grantor is subject to receive the full benefit of the income from the trust for a certain period. After such period, the estate as well as any income will pass down to the designated beneficiary. The main purpose of GRITs is that it allows the grantor to give away property at a smaller gift tax rate. Therefore, the longer the time period of the GRITs and the older the grantor gets, the smaller the value of the gift gets. If the grantor survives beyond the time period of the trust, the property will not be included in the estate. However, if the grantor dies within the time period of the trust, the entire value of the property will be included in the estate at the time of death. Although it is not yet completely clear how certain important terms are regulated under Sec. 2036 (c ), it will be interpreted by the IRS, however, GRITs should be designed to meet the designated statutory criteria of the section. Therefore, if a statutory GRITs is not fully established, the full value of the property is treated as a gift at the expiration date of the trust term and additional gift tax will be incurred. Thus according (Rottenstreich,1990). “A statutory GRIT is one for a term of not more than 10 years where the grantor cannot be a trustee. Because of the short term, the amount of property which can be transferred before incurring a gift tax is reduced. It can still, however, provide significant estate tax savings. The future interest is valued at less than whole property, and the future appreciation is also free of estate tax” There are three major advantages of GRITs that are beneficial in estate planning. It includes the following (1)Gift tax on the transfer is based on the future, discounted right to trust assets, (2)Large federal and state estate tax savings, as well as other transfer cost reductions and benefits, are possible if the grantor doesnt die during the trust term, and (3)They can escape the broad reach of the IRS. After the elimination of GRITs, there was the creation of the Grantor Retained Annuity Trust (GRATs). GRATs specify that the grantor retains the right to an annual payment from the trust for a number of years. The retained annuity also reduces the amount of the grantors gift. If a trust is set up as a GRAT, only the remainder is subject to gift tax without regard to the beneficiary’s identity. The benefits of GRATs in estate planning is that (1) it allows a grantor to transfer large amounts of wealth at a significant gift tax discount and (2) upon survival of the term of the trust, the value of the property is removed from the estate and the beneficiary may save a significant amount of money at the time. However, if a grantor dies during the GRATs trust term, the value of that interest for estate tax purposes is the capitalized value of the fixed annuity. The use of GRATs has become one of the most dominant estate-planning techniques since its creation in 1990. Properly executed GRATs will achieve the possible transfer of wealth on a tax-free basis. It would be an admirable technique when the trust assets are likely to appreciate substantially and rapidly. The length of time is a critical concern that needs to be taken into consideration when forming GRATs. GRATs can be formed as short- term or long-term. A short- term GRATs minimizes the possibility that between a year or more of poor performance, assets will negatively impact the overall effectiveness of the GRATs. It is recommended that a series of short-term GRATs be funded with volatile securities which will possibly perform better than single long-term GRATs. On the other hand, there is an advantage that a long- term GRATs is more likely to benefit from is when it is locked in a low interest rate at the beginning of the term. When funding annuity payments is likely to become a problem due to insufficient cash flow, long-term GRATs will be recommended in such scenario. GRUTs were also formed after the elimination of GRITs. It is similar to that of GRATs, except that the retained annuity is expressed as a percentage of the trust property at the beginning of each year during the trusts term. A GRUTs trust pays the grantor a fixed percentage of the annual value of the trust assets each year. More likely, with such assessment, the dollar amount paid out will fluctuate with the fair market value of the stock in the trust. Furthermore, being a fixed percentage, the payout may be more or less than actual income gained each year. Therefore, GRUTs is less enticing than GRATs unless the retained interest percentage is less than the Applicable Federal Rates (AFR). GRUTs would generally be more effective only for an S Corp that holds. “A GRUT should generally only be considered in family situations where the corporation produces low taxable income relative to stock value and the stock is easy to value (generally limited to portfolio or real estate holding companies) an investment portfolio or real estate”. (Tyler, 1998) There are three main benefits to establishing GRUTs which are (1) all future appreciation is removed from the grantors estate, provided he lives longer than the trusts term. If the grantor dies during the trusts term, only the capitalized value of the retained annuity will be able to be included in his estate. (2) If the property transferred is conveyed at a discounted value to reflect the reduction in value attributable to the interest retained by the person who does the transfer and finally (3) any gift tax paid as a result of the transfer is removed from the grantors gross estate, provided he does not die within three years of the tax payment. Thus the effective use of GRUTs can also provide significant transfer tax savings. It can be noted that the GRUTs have more advantages over other forms. Read More