1. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company1 –Irrevocable trust –Grantor transfers assets to trust –Grantor retains an interest for a fixed period of years –Income taxed to grantor during term –At the end of the period, the remaining principal will pass to a noncharitable beneficiary, such as a child or grandchild of the grantor –Grantor must survive the specified term to achieve transfer cost reductions What Are GRATs, GRUTs, and QPRTs?

2. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company2 GRAT Grantor Retained Annuity Trust GRUT Grantor Retained Unitrust GRIT Grantor Retained Income Trust QPRT Qualified Personal Residence Trust Grantor retains right to: Fixed amount for fixed period Grantor retains right to: Fixed percentage of the value* of the trust for fixed period *Determined annually Limited now to transfers of personal residences or certain tangible property like a painting Grantor retains right to: Use of the property during the term of the trust Special type of GRIT What Are GRATs, GRUTs, and QPRTs? (cont’d)

3. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company3 Rapidly appreciating assets or large rapidly appreciating estate Client is single and has a substantial estate upon which estate taxes are certain to be paid Used as a “marital deduction substitute” by: –Wealthy widow or widower –Divorced individuals –Unmarried persons When is Use of a GRAT, GRUT, or QPRT Appropriate?

4. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company4 Married couple with an estate in excess of the couple’s combined unified credit equivalent –Eliminate or reduce taxes on death of second spouse to die Protect assets from a will contest, public scrutiny, or election against the will if grantor survives term of trust When Is Use Of A GRAT, GRUT, Or QPRT Appropriate? (cont’d)

5. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company5 Income producing property is located in more than one state –Unification –Probate savings –Avoidance of ancillary administration A GRIT can still be used where the grantor wishes to benefit a niece, nephew, or unrelated person (someone other than a member of the family under IRC Section 2702) When Is Use Of A GRAT, GRUT, Or QPRT Appropriate? (cont’d)

6. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company6 Client wishes to freeze the value of an asset for gift tax purposes and remove future appreciation from their estate –Use in conjunction with a recapitalization for added gift tax leverage When Is Use Of A GRAT, GRUT, Or QPRT Appropriate? (cont’d)

7. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company7 High probability that the client will outlive the trust term –Consider a series of short-term rolling GRATs Client has substantial assets and can commit a significant portion to a remainder beneficiary without compromising personal financial security Client has a high risk tolerance and strong incentive to achieve gift and estate tax savings When Is Use Of A GRAT, GRUT, Or QPRT Appropriate? (cont’d)

8. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company8 Irrevocable trust Assets should be appraised shortly before being placed in the trust Recommend someone other than the grantor or grantor’s spouse act as trustee to avoid additional income tax or estate tax exposure after the grantor’s retained interest has ended What Are The Requirements?

9. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company9 Grantor retains right to annuity or unitrust payment for specified number of years (GRAT, GRUT) –Longer trust term means greater retained interest and a lower taxable gift value –Grantor must outlive the term of the trust –Trustee has no discretion to withhold payments from grantor –Trustee has no discretion to withhold trust property from a remainder person What Are The Requirements? (cont’d)

10. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company10 Grantor retains right to reside in home for a specified number of years (QPRT) –Written lease should be executed requiring grantor to pay fair market rent after specified term expires –Remember rent payments further reduce the grantor’s estate without using any gift tax exemption or exclusion –Rent is taxable income to the remainder person What Are The Requirements? (cont’d)

11. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company11 Gift taxes are based on the discounted value of the gift using the: –IRC Section 7520 Rate, and the –Waiting period to receive the gift (Trust term) Longer waiting period (term)  Greater discount Can calculate time and discount to create a “zeroed out GRAT” using no gift tax exemption If grantor outlives the term of the trust, the gift plus appreciation will escape estate taxation in the grantor’s estate Advantages

12. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company12 It is essentially a “no lose” estate freeze technique –If grantor dies during the term of the GRAT, GRUT, or QPRT, the property plus any appreciation will be includable in his estate, as if he had done nothing Advantages (cont’d)

13. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company13 Attorney fees, appraisal fees, property titling costs, and other transaction fees Other gift opportunity costs Liquidity issues if grantor dies during trust term –Estate tax on GRAT, GRUT, QPRT due, but assets are not available to pay tax Property does not receive a “step up” in basis at transferor’s death Disadvantages

14. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company14 –Widow, 35% gift tax bracket, IRC Section 7520 Rate 2.4% –10 Year QPRT –Transfer $300,000 FMV personal residence to QPRT –PV of life estate = $63,342 ($.211139 x $300,000) –PV of remainder = $236,658 ($300,000 - $63,342) –FV of residence = $380,295 (10 years, 2.4%) How It Is Done – An Example

15. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company15 –Assuming Widow’s exemption used: Gift Tax (35% x $236,658) = $82,830 –Savings if estate tax at 50% rate after 10 years [(35% x 380,295) - $82,830] = $50,273 –Probate costs would also be avoided, since gift would be out of widow’s estate How It Is Done – An Example (cont’d)

16. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company16 Cannot apply annual exclusion to gift of future interest May apply available exemption to gift Taxable portion of gift considered an “adjusted taxable gift” for the estate tax calculation If grantor outlives trust term: –no further transfer tax on gifted asset –future appreciation of gifted assets out of grantor’s estate, a key advantage General Tax Implications

17. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company17 No step-up in basis at grantor’s death Capital gain on appreciated property will eventually be paid by the grantor, the trust, or the beneficiaries If grantor dies before trust term ends, date of death value of property includable in grantor’s estate Beneficiary may purchase life insurance on grantor’s life to cover possible estate tax exposure and provide a source of liquidity during trust term General Tax Implications (cont’d)

18. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company18 Applies To transfers in trust for the benefit of “family members” including: –Spouse of individual –Ancestor or lineal descendant of individual or individual’s spouse –Brother or sister of individual and their spouse Interests retained by “applicable family members” including: –Spouse of individual –Ancestor of individual or individual’s spouse –Spouse of ancestor Section 2702

19. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company19 General Rule: All retained interests in trusts that are not “qualified interests” are valued at zero Does not apply to transfers in trust resulting from: –Exercise of power of appointment not constituting taxable gift –Lapse of Crummey power not exceeding 5 or 5 limit –Disclaimers –Assignment of remainder interest, if only retained interest is discretionary distribution of income by independent trustee Section 2702 (cont’d)

20. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company20 Does not apply to (cont’d): –Incomplete gifts –QPRT –CRAT –PIF –Certain CRUTs –CLT Section 2702 (cont’d)

21. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company21 “Qualified interests” are valued using the Section 7520 interest rate –Qualified annuity interest –Qualified unitrust interest –Qualified remainder interest Section 2702 (cont’d)

22. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company22 Irrevocable right to receive: –A fixed amount –At least annually –Payable to or for the benefit of the holder of the term interest –For a specified period Fixed amount determined as a percentage of the initial value of the trust or a fixed dollar amount Subsequent contributions are prohibited Does not apply to a withdrawal right Qualified Annuity Interests (GRATs)

23. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company23 Irrevocable right to receive: –A fixed percentage of the net FMV of trust assets –Determined annually –Payable to or for the benefit of the holder of the term interest –For a specified period Qualified Unitrust Interests (GRUTs)

24. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company24 Right to receive: –All or a fractional share of trust –Upon termination of all or fractional share of trust Includes reversion Must be noncontingent –Payable to beneficiary or beneficiary’s estate in all events Qualified Remainder Interests

25. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company25 All other payments must be annuity or unitrust payments (with no excess income distributions) Grantor taxed on income –Unless reversion is less than 5% of value of the transferred property Qualified Remainder Interests (cont’d)

26. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company26 Trust must contain a personal residence, second residence, or vacation home The residence can be sold during the term of the trust, unlike a plain vanilla personal residence trust Involuntary conversion proceeds from a fire or condemnation of the property may be held by the trust for a limited period of time Any trust income must be distributed to the term holder Trust must prohibit holding of property other than the personal residence Qualified Personal Residence Trusts (QPRTs)

27. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company27 Trust must contain the following provisions: –No distributions to other persons are permitted –Cash can be held for three months for purchase of initial or replacement residence –Cash can be held up to six months for payment of trust expenses, including mortgage payments or improvements –If property is sold or insurance proceeds received, a two year replacement period is permitted –If property no longer used as personal residence, trust must terminate and assets distributed within 30 days, unless converted to qualified annuity trust QPRTs (cont’d)

28. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company28 Husband and wife may each reserve a right to payment for the trust term as to his or her respective community property interest in a GRAT or GRUT Spouses can transfer community interests in one or two personal residences to a PRT or QPRT and retain a right to live in the residence for its term Issues In Community Property States

29. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company29 If either dies during the term, the value of that spouse’s community interest in the trust would be included in his or her taxable estate If either or both spouses survive the trust term, his or her community property interest in the trust will not be included in his or her estate Issues In Community Property States (cont’d)

30. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company30 Valuation for transfer to a GRAT or GRUT can be a problem Risk of additional gift tax, penalties, interest, or use of more unified credit for improper valuation or disclosure Issues With Closely Held Stock

31. Grantor Retained Interest Trusts (GRAT, GRUT, QPRT) Chapter 26 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company31 Usually a GRAT or GRUT does not qualify to hold S stock because not all of the trust income is payable to the beneficiary See Chapter 27 “Defective Trust” exception where grantor treated as owner for income tax purposes Issues With S Corp Stock