Estate Planning for a Growing Business

The following is excerpted from a Wall Street Journal article published in October 2010:

Grantor Retained Annuity Trust – if you are about to sell a Business or an Sppreciated Stock Portfolio, consider This :

Because this type of trust works best at times when interest rates are low and asset values are depressed—times like these, in other words—estate planners are urging clients to set one up before Congress makes them far less attractive.

Called a grantor-retained annuity trust, or GRAT, it allows people to give a portion of an asset’s future profits to heirs tax-free. Thomas Bentley, a certified financial planner at Truepoint Inc. in Cincinnati, is setting up one for a local entrepreneur who wants to give his three children a stake in his fast-growing business.

The trusts, whose life span can be as short as two years, are popular with families that have assets expected to increase in value, such as a family business or depressed stock.

To raise revenue, Congress is seeking to impose restrictions on GRATs. Most important, it would require that the trusts remain in place for a minimum of 10 years. That would make them less useful for people with shorter life expectancies. The reason: If a GRAT owner dies before the trust expires, its entire value generally becomes subject to the estate tax.

With interest rates as low as they are today, GRATs are especially attractive. That is because to avoid paying a 35% gift tax on the assets put into one, a GRAT’s owner must agree to take back assets of the same value, plus an interest payment, known as the “hurdle rate.”

In October, that rate, calculated monthly by the Internal Revenue Service, fell to a record low of 2%. As a result, if a GRAT’s assets were to appreciate by, say, 10% a year, the owner would have to take only two percentage points of the gain—leaving eight percentage points for the heirs, tax-free.

GRATs also work well with beaten-down assets. Since 2008, parents have been using the trusts to transfer stocks, real estate and other assets they believe are temporarily depressed, potentially reducing the size of their own estates and giving their heirs a chance to cash in on a rebound. (Due to complexities relating to the generation-skipping tax, GRATs are tricky to use for the benefit of grandchildren.)

Shares in family limited partnerships and privately held companies also are good candidates. In part because such investments can’t be easily traded, they can often be put into a GRAT at a discount to their true value, Mr. Bentley says.

Aside from premature death, there is little downside risk to GRATs. In part because the tax code sanctions these trusts, Mr. Weigandt says, there is little risk of an IRS challenge. If the assets inside a GRAT fall in value, the parents would be no worse off than if they hadn’t established it to begin with, though they would be out the fees they paid. The trust would simply pay them back what is left of their investment by the time it expires.

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Estate Planning for a Growing Business