May 20, 2018


A grantor creates an irrevocable trust. He or she directs the trustee to pay the grantor the income from the trust for a specified number of years or allow him or her possession of the trust’s property. When the grantor’s interest terminates at the end of the years selected, the property in the trust is distributed to family members or the other individuals specified in the trust. In some cases, the trust continues for their benefit.

When the grantor puts cash or assets into the trust, a “future interest” gift has been made. The value of that gift is the excess of the value of the property transferred over the value of the interest kept. The value of the retained interest is found by multiplying the principal by the present value of an annuity factor for the number of years the trust will run.

For example, assuming a 7.6% federal discount rate, if the trust will run for ten years and $100,000 is initially placed into the trust subject to a reversion, the value of the (nontaxable) interest retained by a 65-year-old would be $64,590.

The value of the (gift taxable) remainder interest would be the value of the capital placed into the trust ($100,000) minus the value of the nontaxable interested retained by the grantor ($64,590). Therefore, the taxable portion of the grantor retained income trust gift would be $35,410. This remainder interest, by definition, is a future interest gift and will not qualify for the annual exclusion. The grantor will have to utilize all or part of the reaming unified credit (or if the credit is exhausted, pay the appropriate gift tax).

The advantage of the GRIT is that it is possible for the grantor to transfer assets of significant value to family members but to incur little or no gift tax as a result. In the example above, the cost of removing $100,000 from the gross estate (plus all appreciation from the date of the gift) is the use of $35,410 of your constantly growing unified credit.

The GRIT is a “grantor trust.” This means all income, deductions, and credits are treated as if there was no trust and these items were attributable directly to the grantor.

The longer term specified the larger the value of the interest the grantor retains–and the lower the value of the gift made. However, the longer the term of the trust, the greater the probability that the grantor’s death will occur during the term of the trust, and the entire principal (date of death value) must be included in the estate of a grantor who dies during the term of the GRIT since he or she has retained an interest for a period which, in fact, did not end before his or her death. If any gift tax had been paid upon the establishment of the GRIT, it would reduce the estate tax otherwise payable. If the unified credit was used, upon death within the term, the unified credit used in making the gift will be restored to the estate (if the grantor’s spouse consented to the gift, his or her credit will not be restored). So the trick is to select a term of the trust that the grantor is likely to outlive.

Quite often, the estate’s beneficiary (possibly through gifts made by the grantor) will purchase life insurance on grantor’s life. Then, if he or she should die during the term of the GRIT, the tax savings he or she tried to achieve will be met through the life insurance and there would be sufficient cash to pay any estate tax.

IRC Code §2702 has severely limited the use of GRITs. Non-family members can use GRITs for any type of asset for any term. Family members will find GRITs useful only when the property transferred is a personal residence or for certain tangible property.

The regulations under §2702 allow two different kinds of trust to hold personal residences, a “personal residence trust” (PRT) and a Aqualified personal residence trust (QPRT). A PRT is very limited and inflexible, because it must not hold any assets other than the residence and must no allow the sale of the residence. A QPRT can hold limited amounts of cash for expenses or improvements to the residence, and can allow the residence to be sold (but not to the grantor or the grantor’s spouse). However, if the residence is sold, or if the QPRT ceases to qualify as a QPRT for any other reason, either all of the trust property must be returned to the grantor or the QPRT must begin paying a “qualified annuity” to the grantor (much like a grantor-retained annuity trust, or GRAT).