Grantor Retained Income Trusts

A grantor retained income trust (GRIT), also know as a grantor retained interest trust, is an estate planning vehicle to transfer appreciating assets into an irrevocable trust for a term of years, retaining an income or other interest while naming others, preferably not "members of the family," as remainder beneficiaries at the end of the trust term. This has the potential of moving wealth and future appreciation from the grantor's estate, while still providing the grantor with income for the trust term. The Revenue Reconciliation Act of 1990 effectively eliminated the use of GRITs for transfers to a "member of the family," however. The term "member of the family" means the grantor's spouse, any ancestor or lineal descendent of the grantor or the grantor's spouse, the grantor's brothers or sisters, and any spouse of any individual described above. Essentially the same benefits of a GRIT for family gifts can be obtained by using a grantor retained annuity trust (GRAT) or a grantor retained unitrust (GRUT) discussed elsewhere on this website. One exception to the "member of the family" rule permits a personal residence to be transferred to a member of a family. See the discussion of qualified personal residence trusts (QPRT) elsewhere on this website.

With an irrevocable trust, a taxable gift to the remainder beneficiaries occurs at the time the trust is created. Since the remainderman will not have beneficial enjoyment of the trust assets until the end of the trust term, the gift is of a future interest in property and does not qualify for the annual gift tax exclusion.

The taxable value of the gift to the remaindermen is the value of the assets placed in trust, reduced by the present value of the interest retained by the grantor, discounted by prescribed monthly IRS interest rates for the term of the trust. The law provides that for gifts to a member of the family, the retained interest is valued at zero and the entire contribution to the trust is a taxable gift to the family member. This negates one of the primary purposes of a retained income trust.

Consider an example. Grantor transfers one million dollars of income producing assets into a 10-year trust for the remainder benefit of Nephew (a nephew is not "a member of the family") while retaining an income interest for the term of the trust. Assume that the IRS rates for a 10-year trust value the retained interest at sixty-percent. Grantor has made a taxable gift to Nephew in the amount of $400,000 rather than $1 million. The grantor may use her lifetime gift tax exclusion amount to eliminate the tax due on the discounted gift, or pay gift tax on that amount if she has already used her gift tax exclusion. Had the remainderman of this trust been the grantor's son, the taxable amount of the gift would have been the full $1 million. The favorable valuation benefits of a retained income trust for family gifts can be obtained by using a grantor retained annuity trust (GRAT) or a grantor retained unitrust (GRUT) discussed elsewhere on this website.

If the grantor survives the term of the trust (10-years in the example above), the trust terminates, the trust corpus, including appreciation, passes to the nephew free of further transfer tax, and the value of the trust assets will not be included in the grantor's gross estate. If, however, the grantor fails to survive the term of the trust, the trust assets will be included in his gross estate at date of death fair market value, but still pass to the nephew. If the grantor dies within three years of establishing the trust, any gift tax paid on the taxable transfer to the remainderman will also be included in the grantor's gross estate. If the grantor fails to survive the trust term, the GRIT will have provided little tax benefit. If the grantor survives the trust term, however, the GRIT can transfer considerable accumulated wealth and all future appreciation non-family remaindermen at significantly reduced transfer tax costs.

Passing assets to beneficiaries through a trust such as this removes those assets from the grantor's probate estate which should reduce costs of administering the grantor's estate, and provides a measure of confidentiality since a trust is generally not a public document as is a will.

GRITs are not for every estate plan. They are a poor choice for wealth transfers within a family. They are but another tool to fill a specified need. GRITs should be drafted only by well qualified estate planning attorneys.

©2011 Ronnie C. McClure, PhD, CPA