There are things that you can do to potentially transfer assets at a tax discount if your estate is going to be exposed to the federal estate tax. This tax is applicable on transfers that exceed the amount of the federal estate tax exclusion. For the rest of 2015, the exclusion is $5.43 million, but it is going up to $5.45 million in 2016 after an inflation adjustment is applied.
If you are married, you can use the unlimited marital deduction to transfer unlimited assets to your spouse tax-free, assuming you and your spouse are American citizens. The death tax can be applied on transfers to anyone else.
One estate tax efficiency strategy that can be useful if you are in possession of highly appreciable assets is called the “zeroed out” GRAT strategy. The acronym stands for a grantor retained annuity trust.
You fund the trust with these appreciable assets, and you name a beneficiary. The beneficiary would assume ownership of anything that may be left in the trust after the expiration of the term. As the grantor of the trust, you accept annuity payments from the trust, and you set the duration of the trust term.
When you fund the trust, you are removing the assets from your estate for estate tax purposes, but you may be giving a taxable gift to the beneficiary. Since a gift may be given, the Internal Revenue Service places a value on the trust for gift tax purposes. The IRS adds the hurdle rate to account for anticipated interest accrual. This hurdle rate is equal to 120 percent of the federal midterm rate.
To zero out the grantor retained annuity trust, you take annuity payments that are equal to the entire taxable value of the trust over the course of the term. If the assets in the trust appreciate at a rate that is identical to the hurdle rate that was applied by the IRS, there will be nothing left in the trust for the beneficiary after the expiration of the term.
However, federal interest rates have been low for a number of years, so this strategy has been effective. You intentionally funded the trust with highly appreciable assets. If the assets outperform the hurdle rate, there will in fact be a remainder after the expiration of the term. Your beneficiary would assume ownership of the remainder, and the gift tax would not be applicable.
Preserve Your Wealth
The zeroed out GRAT strategy can be part of a wealth preservation plan, but there are other possibilities that can yield benefits. If you would like to discuss tax efficiency with a licensed professional, send us a message through the following link to set up an appointment: Sacramento CA Estate Planning Attorneys.