Have you spoken to a financial advisor or attorney lately regarding your estate and heard a lot of letters flying around?  Have you heard the terms GRAT and IDGT?  If you have, I imagine your head must be spinning!  What in the world do all those letters mean?  What is a Grantor Retained Annuity Trust?  What is an Intentionally Defective Grantor Trust?  Why do I care?

The truth is, most of us won’t really care.  These types of planning tools are better-suited for high-wealth clients.  What is a high-wealth client?  Currently, that is an individual who will very likely have assets of more than $5.4 million when they die ($10.8m for couples). Why that exact amount?  Mostly because the Federal Estate tax comes into play when someone passes that amount.

There are other considerations, of course, that may make your personal plan a good candidate for this type of planning.  For instance, does your state have estate tax? In Oklahoma, we currently do not.

Grantor Retained Annuity Trust

A GRAT is a way for you to leave large gifts without being subject to the annual gift tax.  Why is that important?  Well, mostly because the estate tax is reduced by annual gifts that you give annually.  The estate tax is tied to the gift tax.  If you give your allotted $14,000 each to your chosen people each year, your limit is $5.4 million.  Then, you have no estate exemption left.  So, we want to minimize those taxes as much as we possibly can.

A GRAT is a way to minimize those taxes without taking the benefits of the asset away from the Grantor (person establishing the trust). The Grantor is able to receive distributions (in the form of an “annuity”) at least annually. Then, the remainder passes to the heirs without estate taxes.  These trusts work best for income-producing and high appreciation assets.

Intentionally Defective Grantor Trust

An IDGT is purposefully drafted to invoke the Grantor trust rules of the Internal Revenue Code.  In this trust, the Grantor retains the power to recover the assets and benefit from the trust’s income.  The trust can be structured in a way where the asset is sold to the trust, or gifted to the trust.  If gifted, the estate tax exemption applies.  This trust works well for a family business.  The Grantor can retain business making decisions in regard to the business by keeping voting stock, but sell non-voting stock of the business to a trust with a promissory note.  Then, the asset is no longer owned by the Grantor for estate tax purposes, but the Grantor can still receive income from the promissory note.

The distributions must be pre-determined, and not related to the income of the business. The note can transfer to the spouse at death, or be self-canceling.

These tools are advanced considerations for an estate.  However, if you own your own, successful business, or assets that will exceed the Estate Tax exclusion, you should consider them for your estate.  Find a trusted advisor to help you in the planning.