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You Can Benefit from Giving Gifts

Posted by ANGELA RICH HARTMANN | Jan 15, 2025 | 0 Comments

A benefit of working hard is sharing the fruits of your labor with your loved ones. However, gift or estate tax consequences may impact high-net-worth clients when they share their wealth. By crafting a comprehensive estate plan, we can address these concerns and protect high-net-worth clients and their loved ones.  The following three types of trusts may assist high-net-worth clients in sharing their wealth in a tax-advantageous way.

Grantor Retained Annuity Trust

A grantor-retained annuity trust (GRAT) is an irrevocable trust you can use to make large financial gifts to your loved ones while minimizing gift tax liability. These monetary gifts remove future appreciation from your estate, reducing the amount subject to estate tax at your death. However, there may be gift tax liability, which would be owed and paid at the trust's creation. You create a GRAT and then fund it with accounts and property, such as those expected to appreciate in value over the GRAT's term. Then, you receive a fixed annuity based on the trust's original value for a specified period. Once the period has terminated, the remainder of the trust's accounts and property are transferred to your named beneficiary.

The rate of return you receive is based on the specific rate determined by the Internal Revenue Service, known as the Internal Revenue Code (I.R.C.) § 7520 rate. This rate is The key to saving taxes and having money available to be transferred to the beneficiary is for the trust's accounts and property to outperform this rate. To limit or eliminate the gift tax that would be due when making a gift to someone, the value you retain (the amount that is ultimately distributed back to you) is subtracted from the value of what was transferred to the trust. This is also known as the subtraction method. Ultimately, the goal is for this number to be zero (known as a zeroed-out GRAT) or as close to zero as possible. Any appreciation is transferred to your beneficiary at the trust's termination gift-tax-free. 

Let's look at a possible outcome when using a GRAT. In this situation, let's say you make a $1 million gift to a GRAT; at the time this blog was written, the I.R.C. § 7520 rate was 4.2 percent, and we consider an annuity to be paid over five years. If the trust only makes 4.2 percent, then the client will be in roughly the same position as when it was created because everything will be returned to the client. If the trust makes 7.5 percent, then there will be approximately $123,562 remaining that will be transferred to the beneficiaries with no gift tax (assuming a zeroed-out GRAT). If the trust does even better and makes 10 percent over five years, the beneficiaries will receive $231,419.[1]

Grantor Retained Unitrust

A grantor retained unitrust (GRUT) is an irrevocable trust like a GRAT. Accounts and property are transferred to the trust, and you maintain a right to receive an annuity for a fixed time period. Then, at the trust's termination, the trust's remaining accounts and property are given to your named beneficiary. However, with a GRUT, the annuity payment you receive each year is calculated based on a fixed percentage of the trust's value that year. Therefore, since the trust's value can vary from year to year, the annuity amount can vary even though the exact percentage is used each year to calculate the annuity.

Like a GRAT, the gift tax is due when the accounts and property are transferred to the trust, and the liability is based on using the subtraction method. Because the annuity is based on the trust value that year, it is unlikely that the difference between what you give and retain will be zero, which will require that some gift tax be paid.

Qualified Personal Residence Trust

A qualified personal residence trust (QPRT) is an irrevocable trust that you can use to remove your residence from your overall estate. Ownership of the residence is transferred to the trust, and you retain the right to use and enjoy the property for a specified time period. Then, once that time terminates, the residence is transferred to your named beneficiary. You must pay the beneficiary's rent if you want to continue living in or using the residence. You may need to consider your relationship with the beneficiary when evaluating whether this tool would serve your needs.

Although this transfer reduces the amount subject to estate tax at your death, gift tax will still be owed when the property is transferred to the QPRT. The value of what is transferred to the trust (the amount subject to gift tax) is the residence's value, less the value of what you keep (because you have the right to continue using it). This estate planning tool's effectiveness depends on the federal interest rate when the trust is created. The higher the interest rate, the lower the gift value and the lower the potential tax liability. 

You can establish a QPRT for no more than two residences. It can be funded using a principal residence, a vacation home, a secondary residence, or a fractional interest in these types of residences. It is also important to note that if the residence currently has a mortgage, paying off the mortgage before transferring ownership to the QPRT may be advisable to avoid complications in administering the trust.

The important thing to note with all three types of trusts is that you must survive the trust term. When determining the length of the trust, it is important to consider your current age and life expectancy. If you die before the trust terminates, the tax benefits will be undone, and the full value of the account or property will be counted towards your estate tax liability.

Because each transaction is subject to taxation, you must evaluate the gift tax, estate tax, and nontax considerations before deciding.  Jurisdiction will always be a factor, and not all strategies may be available in your state of residence. We are available to meet with you, discuss your unique situation, and craft a plan that leaves your hard-earned wealth to those you care about as you wish. To learn more, please give us a call.

Contact Hartmann Law Today

If you have questions about gift or estate taxes, contact our office to speak to an estate planning attorney.

Take steps to start your Life and Legacy planning today!  Take action to ensure your voice is heard when you are unable to speak for yourself.  Make the decision to protect yourself, your loved ones, your business, your property.   

Schedule a call today with Hartmann Law.

Hartmann Law provides Life and Legacy plans ready for today with an eye on the future.

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[1] Grantor Retained Annuity Trust Calculator, Roger Healey, https://rogerhealy.com/GRATCalculator.aspx (last visited July 24, 2023).

About the Author

ANGELA RICH HARTMANN

Angela Rich Hartmann is a New Jersey attorney serving clients in the areas of estate, business, and real estate law.

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