Example of GRAT valuation:
$1,000,000 trust with grantor receiving a $50,000 annuity for 10 years. If the section 7520 rate is 3.2%, the value of the grantor’s retained interest is $396,260 and the remainder is valued at $609,740.
- So the right to receive the $50,000 annuity for 10 years is worth $396,260 and the right to receive the remainder at the end of the 10 years is worth $603,740.
- The value of the remainder interest ($603,740) would be subject to gift tax upon creation of the GRAT.
Example of a qualified payment in a GRAT:
Grantor transfers 100 shares of X Company to a 3 year GRAT. The terms of the trust stipulate that the trustee must pay the grantor an annuity equal to 10% of the initial value of the trust in the first year with the annuity payment increasing 20% in the second year and 20% third year. After the third year the trustee is to distribute the remaining trust to the beneficiary.
Example of how a valuation formula will reduce the risk of unexpected gift tax consequences when dealing with hard to value assets:
Grantor transfers 100 shares of X Company to a GRAT, X Company has 200 shares outstanding and a company value of $1,000,000. Under terms of the GRAT, grantor retains an annuity of 15%, increasing by 20% annually, for 5 years, with the remainder interest going to his beneficiaries. Grantor files a gift tax return showing a transfer of $300,000 to the GRAT ($1,000,000 x 50% ownership minus 40% discount), with a gift of $44,872.50 to 3 beneficiaries. If on audit the IRS only allows a 20% discount, the taxable gift would be $59,830. Thus, an increase in the amount transferred by $100,000 increases the taxable gift by approx. $15,000.