GRATs in 2010: still a viable estate and gift tax planning option.

• Author: Donchess, John P.
• Position: Grantor-retained annuity trusts

The grantor-retained annuity trust (GRAT) is the Dirty Harry of estate and gift planning. It is complicated, unconventional, and politicians in charge hate having it around. Yet the GRAT has so far successfully resisted efforts to rein it in. And, like the fictional San Francisco homicide inspector, it continues to be very effective in the right situations.

A GRAT is designed to transfer wealth to the next generation without paying estate tax to do it. It is a bet that the client will live to the end of the term of the GRAT, which may be two years or longer. The major disadvantage is that the grantor must survive the trust term for all of the trust's remaining property to be excluded from the grantor's estate. Therefore, planners often create multiple GRATs and vary the terms of the trusts to balance the risk of the grantor's untimely demise with the potential benefits that GRAT planning provides.

A GRAT is also a bet that the assets the client places into the trust will appreciate in value at a rate that is greater than an IRS-prescribed interest rate. Therefore, GRATs typically are funded with property expected to appreciate in value. The trust is required to pay an annuity back to the grantor during the trust's term, which is what makes the trust a GRAT. The annuity that is paid back to the grantor is determined by reference to the so-called Sec. 7520 rate, which ranged from 2.4% to 3.4% in 2010.

At the end of the GRAT's term, whatever assets are left in the trust are distributed to the trust's beneficiaries and the GRAT is terminated. The end result is that the grantor has transferred to the GRAT's beneficiaries any growth in the value of the trust's property that exceeds the Sec. 7520 rate. Clearly, a GRAT is worth considering today because lower interest rates reduce the amount of the annuity that the GRAT must pay.

A client could be a candidate for GRAT consideration if he or she has:

* Real estate that is currently at a much lower value than the client believes it will be when the real estate market recovers;

* A securities portfolio that is currently at a much lower value than the client believes it will be when the market rebounds;

* A business that is currently at a much lower value than the client believes it will be when the economy improves; or

* Assets, of any kind, that the client expects to greatly appreciate in value over the next several years, whether because of increased demand for...