Depending on the extent of your assets, one of the things that you have to take into consideration when you are planning your estate is the harsh bite of the estate tax. It would be logical to think that you could simply make gifts to your loved ones who would otherwise be inheriting these resources while you are still alive, and, of course, you can, but this too comes with a cost. There is a gift tax in place that carries the same 35% rate as the estate tax at the present time.

Though there is a $5 million lifetime gift tax exemption, it is unified with the $5 million estate tax exclusion. What this means is that the total exempt amount for both gifts and the transfer of estate assets totals $5 million. So if you were to use your exemption to give $5 million in tax-free gifts throughout your lifetime the entirety of your estate would be subject to the estate tax.

The good news is that there are some strategies that can be employed that enable tax-free gift giving, and one of these involves the creation of a grantor retained annuity trust or GRAT. After funding the trust you set a term during which you will receive annual annuity payments from it, and you also name a beneficiary. The act of funding the trust constitutes a taxable gift, and the IRS uses 120% of the federal midterm rate that was in place when the trust was created to calculate anticipated appreciation to determine the overall taxable value of the gift.

The strategy here is to “zero out” the GRAT, so you schedule your combined annuity payments to be equal to the entire estimated value of the trust. In this manner you incur no gift tax liability because you retain all the interest in the trust. However, if the assets that were placed into the trust appreciate beyond the IRS estimate, ownership of that remainder is received by your beneficiary, free of further taxation.

Larry Parman
Founding Attorney