GRANTOR RETAINED ANNUITY TRUST UPDATE – June, 2010

As noted in our last estate tax update, the federal estate tax has been in flux for some time. If you die in 2010, there is no federal estate tax, but your assets will receive only a limited step-up in basis. The federal estate tax is reinstated in 2011 at a 55% marginal rate, and a $1,000,000 exemption per person, unless Congress changes the law. When the estate tax returns in 2011, your heirs will have a date of death tax cost basis equal to the fair market value of your assets on that date. New Jersey has a separate estate tax with a $675,000 exemption.

The taxes your heirs pay can be minimized through effective lifetime planning.

Many clients are engaging in estate tax planning techniques which help them minimize the estate taxes which their heirs will pay.

One of these techniques is a Grantor Retained Annuity Trust, or “GRAT”. A GRAT is an irrevocable trust which provides a fixed annuity payment to you during the term, usually expressed as a fixed percentage of the original value of the assets transferred to the GRAT. If the income earned on the assets is insufficient to cover the annuity payment, the payments will be made from principal. All income and appreciation in excess of the required annuity payment accumulate for the benefit of the remainder beneficiaries (your heirs). Therefore, if the assets appreciate, it may be possible to transfer assets to the beneficiaries when the trust terminates with values that far exceed their original values when transferred to the GRAT and, more importantly, exceed the gift tax value of the transferred assets. The value ascribed to the remainder interest is a function of your ages and the term of the GRAT.

The goal is to fund the GRAT with assets that are appreciating at a rate in excess of the applicable IRS rate, which has been at historic lows. The July, 2010 rate is 2.8%, which makes this an opportune time to establish and fund a GRAT if you expect that the assets you transfer to the GRAT will appreciate annually at a higher rate.

Currently, a GRAT can be established for any term. It is often important to keep the GRAT term as short as possible, because if you die during the term, all of the GRAT property will be taxed in your estate at its appreciated value, and you will not realize any estate tax savings. There is legislation pending in Congress which, if enacted in its present form, will impose a ten year minimum term for GRATs. The draft of the legislation is effective on the date it is enacted, which means that GRATs established before that date can have terms as short as two years, but GRATs drafted on or after the enactment date (if passed by Congress) will be required to last for at least ten years. The significant increase in the mortality risk, along with a greater likelihood that the GRAT will not perform as well over a ten year term, makes it a good time for you to consider establishing a GRAT now, if you believe that the value of your appreciating assets is likely to increase over the next several years at an annual rate in excess of the IRS discount rate.

To find out more about whether establishing a GRAT makes sense for you, or to discuss any other estate planning matters, please contact Jane Brody (973) 232-0600 jlbrody@marcusbrodylaw.com.