The Grantor Retained Annuity Trust (GRAT)

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1 WEALTH ADVISORY Esae Planning Sraegies for closely-held, family businesses The Granor Reained Annuiy Trus (GRAT) An efficien wealh ransfer sraegy, paricularly in a low ineres rae environmen Family business owners face unique challenges in managing wealh and preserving legacies for fuure generaions. Wilmingon Trus provides sraegic advice on all aspecs of wealh, personal, and business planning, implemening he righ mix of fiduciary, invesmen managemen, banking, and business services o mee your complex needs. WHAT IS A GRAT? A GRAT is a popular mehod of ransferring propery, such as sock in a closely-held business, o a rus in exchange for an annual paymen (or annuiy) for a erm of years. The amoun of he annuiy is deermined by he erms of he rus, he value of he propery ransferred, and curren ineres raes. When he propery consiss of a minoriy ineres in a closely-held business, he value of such propery is ofen discouned o reflec he inheren lack of conrol and lack of markeabiliy. The annuiy paymen iself may consis of he same propery ransferred o he rus. The primary ax benefi of a GRAT is ha any income or appreciaion earned during he erm, in excess of he saed ineres rae, passes o he remainder beneficiaries (who are ofen children or family russ) free of gif or esae ax. GRATs are popular wih closely-held business owners because here is very lile economic downside and he owner can effecively reain conrol of he propery ransferred. Moreover, GRATs may be designed (under curren law) o pay back o he granor he enire value of propery plus he saed ineres amoun wihou any gif ax consequences (such echnique is ofen referred o as a zeroed-ou GRAT). THE VALUE A GRAT ADDS FOR A CLOSELY-HELD BUSINESS OWNER Wih he appropriae planning sraegy, he granor can ransfer propery o he rus wih a minimal or zero gif ax, wih no addiional gif ax paid laer. Furhermore, by placing non-voing ineres ino he GRAT, he business owner is only ransferring value, no conrol of he company. So long as he granor survives he erm of he GRAT, he appreciaion is removed from his or her esae wih a minimum ax cos, no added economic risk, and no loss of conrol. THE OUTCOME A GRAT COULD DELIVER TO YOU, YOUR FAMILY, AND THE BUSINESS Because here is very lile downside, he GRAT coninues o be a popular planning echnique. The owner is no required o give up conrol of he business, and even if he business value does no appreciae as expeced, he owner is no worse off han he or she would have been wihou a GRAT, because he owner sill owns wha hey had prior o creaing he GRAT. However, if he business value does appreciae as expeced, a significan amoun of ineres in he business can be ransferred free of gif and esae ax o a fuure generaion.

2 Esae Planning Sraegies Granor Reained Annuiy Trus (GRAT) Business Owner funds rus wih company sock or oher business ineress Business Owner (Granor) Annuiy paymen o he Business Owner Granor Reained Annuiy Trus A end of GRAT erm, rus pays ou remainder of rus asses or holds in rus for beneficiaries Designaed Individuals o receive GRAT payou (Remaindermen) page 2

3 Esae Planning Sraegies Granor Reained Annuiy Trus (GRAT) SCENARIO 1: 7520 Rae: 1.4% Toal Annuiy Paymens o Business Owner over 5 years: $5,238,127 Amoun passing o Family: $1,140,674 Taxable Gif: $1.20 SCENARIO 2: 7520 Rae: 3.8% Toal Annuiy Paymens o Business Owner over 5 years: $5,659,781 Amoun passing o Family: $667,195 Taxable Gif: $2.25 ASSUMPTIONS USED FOR BOTH Income Earned by Trus: 6.0% Principal Growh: 1.0% Pre-discouned Value: $5,000,000 Discouned Value: $4,500,000 Term of GRAT: 5 Years # Annuiy Paymens: 5 Increasing Annuiy by 20% each year DIFFERENCE Wih he lower 7520 rae, $473,479 more passes o he family wih no ax difference Dollar amoun passed on o family $1,250,000 $1,000,000 $750,000 $1,140,674 }$473,479 $500,000 $667,195 $250,000 $0 Scenario 1 Scenario 2 page 3

4 Esae Planning Sraegies Implemenaion: A Case Sudy for a Closely-Held Business Owner Abou he Clien Harrison Adler, 50, and his wife Whiney Adler, 48, are he sole owners and operaors of XYZ, Inc., an S Corporaion. Harrison is he sole shareholder of he business, and his wife Whiney is acively working in he company. A he age of 25, Harrison sared XYZ, Inc., and over he pas 15 years he business has grown and appreciaed significanly. The Siuaion Even wih he $5.25 million exempion available o boh of hem under he new ax laws, Harrison and Whiney are sill concerned abou poenial esae ax exposure. They are no ready o reire and would like o coninue o operae he business, bu would like o begin ransferring a porion of he company o heir children (or o a rus for heir benefi). Harrison and Whiney have hree children including Ben, age 23; Gloria, age 21; and Brandon, age 18. Currenly, Ben and Gloria are acively working in he business. Brandon is sill in high school and is no working in he business. Wilmingon Trus s Recommendaion To allow Harrison and Whiney o coninue o conrol and acively work in he business, bu begin ransferring ineress in he company o heir children in a ax-efficien manner, Wilmingon Trus has recommended ha hey implemen a Granor Reained Annuiy Trus (GRAT). A GRAT is an appropriae sraegy for he Adlers for he following reasons: I is no an immediae ransfer of business ineres. The GRAT will have a five-year erm, so ha he children will no receive he business ineress unil he end of he five years. Afer he five years, he GRAT can be srucured so ha he business ineress are held in coninuing rus raher han being disribued ourigh o he children, which provides furher ax and non-ax benefis. The Adlers can ransfer ineres in he business wihou ransferring conrol. By creaing voing and non-voing sock in he business, he Adler s can ransfer he non-voing sock o heir children, hereby allowing Harrison and Whiney o coninue o conrol he business. Since a GRAT is a gifing sraegy, Ben, Gloria, and Brandon do no have o raise capial o purchase he business ineres. seps required o implemen he sraegy: Sep 1: Recapialize he business o creae voing and non-voing sock so ha ownership can be ransferred o he Adler s children wihou affecing conrol. XYZ, Inc. is recapialized ino 10% voing and 90% non-voing sock. coninued page 4

5 Esae Planning Sraegies Sep 2: Creae a GRAT, which is a granor rus for federal income-ax purposes, bu a compleed ransfer for esae ax purposes. Therefore, income is aribued o he Adlers, as he granors, and hey are responsible for paying income axes on he rus s asses. This allows he rus s asses o grow income-ax-free. Sep 3: Conribue XYZ, Inc. non-voing sock, wih a curren marke value of $5,000,000 o a five-year GRAT. For valuaion purposes, he non-voing sock will be assessed a discoun for receiving a minoriy ineres and/or lack of markeabiliy. Based on he April 2012 secion 7520 rae of 1.4% and he 10% discoun for minoriy ineres and lack of markeabiliy, he gif o Ben and Gloria (he remaindermen) is $1.20. Harrison and Whiney will receive oal annuiy paymens over he five-year period oaling $5,238,127. Assuming an annual growh of 1.0% and income of 6%, he GRAT will ransfer $1,140,674 worh of non-voing sock o a rus for he benefi of he hree children a he end of year five. THE BENEFITS/OUTCOME OF IMPLEMENTING A GRAT A he end of five years, a subsanial amoun of non-voing sock will have been gifed from Harrison and Whiney o heir children, Ben, Gloria, and Brandon wihou having o pay any gif ax. Since hey are only ransferring non-voing shares, Harrison will sill conrol he business. IMPORTANT NOTICE ABOUT GRAT PLANNING The American Taxpayer Relief Ac of 2012 did no change he GRAT rules, so ha individuals may currenly esablish GRATs wih shor erms. Fuure change is cerainly possible as Presiden Obama has consisenly included changes o he GRAT requiremens in he Adminisraion s annual revenue proposals. These requiremens include mandaing a minimum 10-year erm for he GRAT, eliminaing he possibiliy of having a zeroed-ou GRAT, hus requiring he remainder ineres o be greaer han zero, and prohibiing he annuiy amoun from decreasing in any year during he annuiy erm. The House of Represenaives has passed GRAT changes several imes in he pas few years, bu o dae, hey have no been passed by he Senae. The possibiliy of fuure change, coupled wih low raes and low marke values, highlighs he imporance of GRAT planning sooner raher han laer. A GRAT should be able o be drafed o address he possibiliy of reroacive change, for example, by permiing a disclaimer by rus beneficiaries. Wilmingon Trus is a regisered service mark of Wilmingon Trus Corporaion, a wholly owned subsidiary of M&T Bank Corporaion. Invesmen managemen and fiduciary services are provided by Wilmingon Trus Company, a Delaware rus company, and Wilmingon Trus, N.A., a naional bank. Loans, reail and business deposis, privae banking services, and oher personal and business banking services and producs are offered by M&T Bank, member FDIC. This publicaion is for informaion purposes only and is no inended as an offer, recommendaion, or soliciaion for he sale of any financial produc or service or as a deerminaion ha any invesmen sraegy is suiable for a specific invesor. Invesors should seek financial advice regarding he suiabiliy of any invesmen sraegy based on heir objecives, financial siuaions, and paricular needs. The federal ineres rae and rae of reurn assumpions used in his calculaion are for illusraion only. Reurns are no derived from Wilmingon Trus s Capial Marke Forecas for Sraegic Planning. This illusraion does no represen ax advice and is presened o demonsrae a gif and esae planning echnique. Please consul your Tax Advisor. CS2003 page 5

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