Gifting assets during your lifetime is an important component of an effective estate plan. Merely gifting outright ownership of assets to family members fails to utilize advanced planning techniques that allow for the leveraging of gifts through the use of split interest transfers, where a donor retains an interest in gifted property for a period of time. At the end of the time period, the property is no longer included in the donor’s estate for estate tax purposes. The IRS provides discount rates to use when computing the values of the present and future interests in a split interest gift. Assets expected to appreciate significantly in excess of the IRS rate are most effective in split interest gifting. As a result, closely held business interests with a history of consistent returns can work well.
Several types of trusts can be used to leverage these tax benefits, including:
Grantor Retained Annuity Trusts (GRAT)
In this trust, the donor transfers property to a trust, retaining the right to a fixed annuity for a term of years, payable annually.
- Income from the trust’s assets is paid to the donor, unless the assets produce insufficient income, in which case the donor receives a portion of the assets transferred to the trust.
- At the end of the trust’s term, the property passes to the beneficiary, either outright or in trust.
- The key is for the donor to survive the annuity’s term, in which case, the property is excluded from the donor’s taxable estate. Alternatively, if the donor dies during the term, most, if not all, of the property is included in his or her taxable estate.
Grantor Retained Unitrust (GRUT)
Similar in most respects to a GRAT, the donor receives an annual payment determined as a percentage of the value of property in the GRUT each year, known as a unitrust. Where the assets increase in value, a GRUT pays the donor a larger amount based on the increased asset value.
Qualified Personal Residence Trust (QPRT)
In this type of trust, the trust owns a personal residence for a term of years.
- Similar to a GRAT or GRUT, the donor must live beyond the trust’s term; otherwise, the value of the personal residence is included in his or her taxable estate.
- Unlike a GRAT or GRUT, the trust does not make payments to the donor during the trust’s term. If the donor is living at the end of the trust and desires to continue living in the residence, the donor must pay fair-market rent to the trust or purchase the residence.
- A QPRT is particularly effective where the donor anticipates appreciation in the value of the residence, as the future appreciation escapes taxation in the donor’s estate.
- When property located in another state is placed into a QPRT, the trust will also avoid the need for ancillary probate of a will in that state.
Numerous other forms of trusts, including intentionally defective grantor trusts, are designed to achieve various estate planning objectives.