Grantor retained annuity trust (GRAT) is an irrevocable trust set up by the donor with a donation to the trust. The said grantor receives income stream from the trust as annuity for a specified term. On the expiry of the term, the remaining property of the trust is passed on as a gift to the beneficiary, who must be a family member of the donor. Even on the death of the donor before the end of the term, the trust assets as on that date pass on to the beneficiary.
The regulations of the Internal Revenue Service provide for the mode and manner of taxing the remaining value of the trust at the end of the trust or on the death of the donor.
When the GRAT is set up a gift value is calculated. The gift value is the excess of the sum of the contribution to the trust and hypothetical interest thereon at the rate determined by the Internal Revenue Service over and above the total annuity payments.
Accordingly the gift value may be rendered zero by making the sum of the annuity payments equal to the donation to the trust plus theoretical interest thereon.
If the GRAT proceeds are invested in highly volatile assets, it is highly likely that the income from there will exceed the fixed annuity payments resulting in surplus funds at the end of the term. The beneficiary receives this remaining value free of gift tax.
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