What Are Rolling GRATs?

What Are Rolling GRATs? What Is a “Zeroed-Out” or “Walton” GRAT?

A Grantor Retained Annuity Trust (GRAT) is an effective tool estate planning and elder law attorneys use to prevent estate and gift taxes from consuming the assets their clients intended for their families and other beneficiaries to receive. Essentially, it is a mechanism to minimize the tax burden on large financial gifts that exceed the annual gift tax exclusion limit.

in this blog post, we’ll explain how a GRAT works to reduce the tax burden your survivors will face, and why a GRAT can produce tax savings with no cost to the person establishing the trust.

As you will see, a Rolling GRAT is one of a series of short-term GRATs used to reduce the risk of missing out on the benefits of the GRAT strategy.

How Does a GRAT Reduce Estate and Gift Taxes?

Whether you accumulated substantial financial assets after decades of hard work, or you received a large inheritance or court settlement, everyone wants to prevent their wealth from being eaten up by taxes. When you die, any assets that you leave behind that are valued above the effective exemption amount can be taxed by the federal government at a rate of up to 40 percent, with additional estate taxes typically assessed at the state level as well.

In 2022, the federal estate and gift tax exemption is $12.06 million for an individual, and twice that amount for a married couple ($24.12 million). But, the 2017 law that raised those exemption amounts to that high level is scheduled to expire or sunset at the end of 2025. Unless Congress acts, 2026 estate and gift tax exemption levels could be cut in half, exposing  estates with lower dollar values to a crushing tax liability.

One of the primary goals of an experienced estate planning or elder law attorney is to prevent the value of assets passing through a client’s estate from exceeding the applicable amount of the tax exemption.

What Is a “Zeroed-Out” or “Walton” GRAT?
By using a GRAT to transfer wealth to family or beneficiaries tax-free, a person whose estate would far exceed the value of the estate tax exclusion amount can reduce the prospective estate’s assets by gifting far more money tax-free during their life than otherwise permitted by the annual gift exclusion.

A GRAT Passes Assets to Grantor’s Beneficiaries Tax Free

A Grantor Retained Annuity Trust (GRAT) is a trust into which a person transfers an asset with the right to receive an annual annuity payment of a particular percentage of the trust corpus (asset), plus interest, over the life of the trust (usually 2 to 10 years).

The assets transferred into GRAT trusts are those most likely to see substantial growth. The reason is that the tax rate for the GRAT asset is determined at the time the trust is created. Pursuant to 26 U.S.C. Section 7520, known as IRS Rule 7520, the tax is determined by what the IRS presumes will be the asset’s growth rate based on 120% of the “applicable federal midterm” rate, or AFM. It is referred to as the 7520 interest rate, and, each year,  it is calculated in valuation tables provided by the IRS.

The grantor’s hope is that the asset grows in value at a rate exceeding the applicable IRS Rule 7520 interest rate. If the GRAT asset grows more than presumed by the IRS Rule 7520 rate, when the grantor is repaid their original contribution and the IRS Rule 7520 interest, any amount of gain in the trust that remains—however large– can be distributed immediately to the trust beneficiaries as a tax-free gift, with no gift tax reporting requirement as well.

Tax-Free GRAT Gift Can Exceed Annual Gift Tax Exclusion Amounts

In 2022, a person may gift up to $16,000 to anyone—family or friend– tax free (with no tax reporting requirement), or $32,000 to a married couple. This is the annual gift tax exclusion limit. If an asset held by a GRAT grows substantially beyond the 7520 interest rate when the GRAT expires, the surplus gain gifted tax-free to the grantor’s beneficiaries is unlimited. The annual gift tax exclusion limit is not applicable.

By using a GRAT to transfer wealth to family or beneficiaries tax-free, a person whose estate would far exceed the value of the estate tax exclusion amount can reduce the prospective estate’s assets by gifting far more money tax-free during their life than otherwise permitted by the annual gift exclusion.

Of course, if the GRAT asset’s growth does not exceed the 7520 rate, then the grantor’s annual annuity payments will equal what they would have been, irrespective of the GRAT.

What Is a Rolling GRAT?

The only risk of a GRAT strategy is the fact that if the grantor dies during the term of the annuity, before they receive the full annuity payout, then the value of the remaining asset will go into their estate, possibly increasing the estate’s value far above the effective exemption (estate tax exclusion) level.

To counter this risk, a series of shorter term GRATs are favored, called Rolling GRATS. If a grantor establishes a 3-year GRAT, when they receive their first annual annuity payment, that money is used to establish a second 3-year GRAT, and the pattern is repeated in successive years. The annuity payments are “rolled-over” into new GRATs.

Why? The shorter life of Rolling GRATs lowers the risk of the grantor dying during the term of the GRAT, thus avoiding the inclusion of the GRAT assets in their estate. A second benefit of the shorter-term Rolling GRAT is that holding what we hope is an asset with high growth potential, the shorter life of the Rolling GRAT lowers the risk of a loss in value from market fluctuations over a longer term. If the asset experienced a period of strong growth over the short-term, the GRAT will mature with a greater likelihood of gifting more tax-free value to the beneficiaries.

“Zeroed-Out” or “Walton” GRATs

When establishing a GRAT and funding it with an asset, the grantor reserves the right to receive an annual annuity of a set percentage of the trust asset. If the value of the annuity payments exceeds the value of the original asset and its projected 7520 anticipated growth, then the corpus of the asset will need to be used to satisfy the annual payment to the grantor, not just the interest or value gained(appreciation) by the investment. In this case, there is no projected gift to beneficiaries, and therefore, no gift to be taxed—the gift to beneficiaries is zero (0).

This was a strategy used by Audrey Walton, the wife of Walmart founder Sam Walton, when she established a number of GRATs with her daughters as beneficiaries of any remainder interest. Mrs. Walton’s GRAT required annuity payments of close to 110% of the value of the original asset. At the end of the 2-year term of the GRATs, the entire asset and value gained were exhausted by the annual annuity payments, leaving a shortfall of unpaid annuity in the last year.

The IRS contested the legitimacy of this strategy claiming that the value of the gift to the beneficiaries was under-reported to the IRS. The Tax Court rejected the IRS claim and ruled that the retained interest of Mrs. Walton left no gift to be taxed. Further, if Mrs. Walton died during the term of the GRAT, the remainder that would be paid to her estate could not be treated as a gift because one cannot gift to themselves.

Estate Planning and Elder Law Attorneys Know When a GRAT Is Right for You

Ely J. Rosenzveig & Associates has been providing wealth preserving and tax effective solutions to clients whose prospective estate and gift tax liability can be effectively reduced or eliminated with appropriate estate planning. Anyone whose wealth may exceed the levels exempted by federal and state estate tax exclusion limits, needs to take prudent steps to protect and preserve those assets for their family and other preferred beneficiaries.

Contact Ely J. Rosenzveig & Associates for Estate & Gift Tax Planning Solutions.
Call: 1 (914) 816-2900 or email us at: [email protected]

Ely J Rosenzveig
Ely Rosenzveig

Ely J. Rosenzveig practices principally in the fields of elder law, trusts & estates, tax planning, employment law, and mediation. He has extensive experience in federal and New York State tax law, and has successfully represented a wide range of clients on FBAR & FATCA compliance issues. Ely also practices employment law, with a particular emphasis on age and disability discrimination, negotiating compensation agreements, and severance issues.

With his extensive background in the law, his experience as a congregational rabbi, and his specialized training in Mediation at Harvard Law School, Ely is also available as a professional mediator to help facilitate optimal solutions in matters ranging from family and estate disputes to multi-party commercial issues.

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