Lower interest rates make GRATs and GRUTs and attractive tax planning technique.

With interest rates at their lowest level in nearly 20 years (but expected to increase in the future), now may be the most opportune time to establish a grantor retained annuity trust (GRAT) or a grantor retained unitrust (GRUT). By establishing a GRAT or GRUT now, the gift tax value of the remainder interest is reduced to reflect the increased value of the fixed annuity. Moreover, as interest rates gradually increase, the transferor's potential exposure to estate tax during the GRAT term is decreased to reflect the effect higher interest rates have on the valuation of a fixed annuity.

Overview

A GRAT is a trust to which the grantor transfers income-producing property in exchange for the right to receive a fixed cash annuity for a term of years or for the life of the transferor. A GRUT is identical to a GRAT, except that instead of retaining the right to receive a fixed cash annuity, the grantor retains the right to receive a fixed percentage of the trust value each year. Under Sec. 2702, the value of the gift is determined by subtracting the value of the retained interest, determined by reference to the appropriate Sec. 7520 rate. See Example 1, on page 352.

Benefits of arrangement

There are three main benefits to establishing a GRAT or GRUT: First, all future appreciation is removed from the transferor's estate, provided he outlives the trust's term. If the grantor dies during the trust's term, only the capitalized value of the retained annuity will be includible in his estate (Rev. Rul. 82-105). As a result, that portion of the trust's appreciation in excess of the increase in value attributable to a rise (between the date of transfer and the date of death) in the Sec. 7520 rate (which is based on market interest rates) is not included in the grantor's gross estate. Second, the property transferred is conveyed at a discounted value to reflect the reduction in value attributable to the interest retained by the transferor. Third, any gift tax paid as a result of the transfer is removed from the grantor's gross estate, provided he does not die within three years of the tax payment. See Example 2, on page 352.

Current interest rate

fluctuations increase benefits

The value of the remainder interest is determined by reference to the Sec. 7520 rate. The Sec. 7520 rate is equal to 120% of the Federal midterm rate in effect under Sec. 1274(d)(1), rounded to the nearest two-tenths of 1%, for the month in which the valuation date occurs. The Sec. 1274 rate is based on the average market yield on outstanding marketable U.S. obligations with remaining periods to maturity of more than three, but less than nine, years. As a result, the Sec. 7520 rate reflects increases and decreases in market interest rates.

Interest rates are not expected to remain at their current low level. Moreover, there is some speculation that a further decline in the Tokyo stock market could trigger a banking crisis in Japan, which would reduce the flow of Japanese investment in U.S. equity markets.

Lower interest rates

produce lower taxable gifts

This fluctuation in interest rates provides added incentive to establish a GRAT or GRUT now while interest rates are low. Decreased interest rates mean that the value of the remainder interest is reduced. Any reduction in the value of the remainder interest generates a corresponding reduction in gift tax on the transfer. The table on page 352 illustrates the benefits of a reduction of interest rates on the value of the retained annuity interest. See also Example 3 above.

Higher interest rates

reduce potential exposure

to estate tax

If a transferor dies during the GRAT term, the value of that interest for estate tax purposes is the capitalized value of the fixed annuity. A similar calculation is used to determine the value of a retained interest in a GRUT (Rev. Rul. 76-273). The expected increase in interest rates in the future will reduce a transferor's exposure to estate tax in the event he dies before the GRAT or GRUT term expires; the higher the interest rate, the lower the value of the capitalized annuity. See Example 4 on page 353.

Even without considering the benefits of fluctuations in the Sec. 7520 rate, GRATs and GRUTs can be used to provide clients with significant transfer tax benefits. When these benefits are combined with the current favorable interest rate climate, additional benefits may be generated. This opportunity should not be missed - it may not come around again for another 20 years!