Do a GRAT - Business Owners' Estate Planning Tool

A GRAT is an often-overlooked gifting technique, but it can yield substantial estate tax savings.

Authored by By Paul Arslanian, Managing Partner, Arlsanian Wells PC

Allen Monroe began his car dealership as a young entrepreneur with little money and big ideas. His ideas for marketing his organization turned his company into a profitable business. His ideas for expanding his services transformed his dealership into a multi-million dollar success. And, perhaps even more important, his ideas for finding a way to enable his family to benefit from his hard work ensured that his estate would pass down to his children in the most constructive way possible.

When his company was growing rapidly, Allen took the time to ask himself some crucial questions. His firm was affording security to him and his family for the days ahead, but what would happen if he didn’t make it to tomorrow? What would become of the company he worked so hard to build? Allen understood the need for an estate plan that would provide for his children, Tom and Lisa, in the way that he wished. Tom worked in the business and Allen wanted to ensure he could transfer the company to Tom in a tax-efficient manner without jeopardizing the security he wanted to provide to Lisa.

Allen chose to set up a Grantor Retained Annuity Trust, or GRAT, to provide tax savings for his estate. A GRAT is an irrevocable trust. This lifetime gifting technique primarily aims to reduce estate tax. To begin, the business owner - the grantor - transfers assets to the GRAT. The grantor then receives an annuity paid with cash or other assets from the GRAT at least annually for the length of the term, which can be a specified number of years or life. GRATs are best when the property contributed has potential for significant appreciation, income, or a combination thereof – like stock in the dealership or other family business. The results are even further enhanced when the assets will be valued with a minority interest discount, such as non-voting stock and limited partnership interests.

To establish his GRAT, Allen Monroe transferred stock in the dealership to the GRAT. This transfer is considered a gift. Allen now receives an annuity payment, which can be paid with cash or other assets from the GRAT at least annually for the length of the term. The value of the annuity payment stream reduces the value of the gift.

Once the term is completed, any leftover assets in the GRAT, presumably the company stock, will be distributed to Allen’s son, Tom, who works in the business. In order to secure ownership of the company in the family beyond even Tom’s lifetime, the stock can instead be held in trust for Tom. If the income and appreciation on the stock during the GRAT term exceeds the applicable Treasury rate (recently as low as 4 percent) the difference results in a tax-free gift to the beneficiaries. Allen’s estate plan can provide for his daughter, Lisa, with other assets or a lien against remaining company stock, which will pass upon Allen’s death.

While many business owners can relate to Allen’s story of "local kid makes good," often they have not considered what can happen to their assets once they die. In these times of fluctuating tax legislation and an unsteady economy, it is increasingly important to find strategies that provide long-term benefit for the business owner and his or her family. The estate planning attorney must balance the owner’s sense of financial security with the business succession and estate planning goals to identify and implement the ideal plan.

A GRAT is an often-overlooked gifting technique, but it can yield substantial estate tax savings. When the gifting plan dovetails with the owner’s long-term objectives, pure tax savings with no hidden downsides can result. In the end, they can produce dramatic savings for the family. The most valid criticism of the GRAT is that its assets will be included in the estate of the grantor if the grantor dies before expiration of the term. Aside from the costs of establishing and maintaining the GRAT, however, the family is not worse off than if nothing had been done.

Numerous factors determine the gift and estate tax implications of a GRAT. Despite its complexity, the GRAT remains a valuable tool for achieving dramatic estate and gift tax savings, and should be taken into consideration when discussing your estate planning needs with your attorney.

For more information on GRATs, please contact Paul Arslanian, managing partner of The Arslanian Law Firm PC at paul@estateplans.com, (248) 540-7500, or visit the Web site, www.estateplans.com.