After clients with multimillion dollar estates have used Unified Credit Shelter Trusts, Life Insurance Trusts, annual exclusion gifts, etc. to reduce their estate taxes, they are faced with the reality that they still have a substantial estate tax liability to pay on their death or their spouses death if they are married.
Married clients can shelter shelter $3,000,000 from estate taxes with the current $1,500,000 Federal Unified Credit. A single client can shelter $1,500,000 from estate taxes.
But what if a married client has an estate that exceeds $3,000,000 or $1,500,000 if they are single? What if that estate is destined to be even larger because of added earnings prior to death or appreciation in the value of the client's assets such as stock or real estate.
The federal estate alone on estates over $1,500,000 is as follows:
| Over $1,500,000, but not over $2,000,000 | $555,800, plus 45 percent of the excess of such amount over $1,500,000. |
| Over $2,000,001, but not over $2,500,000 | $780,800, plus 48 percent of the excess of such amount over $2,500,000. |
Please note the above rates are federal rates only and do not even take into consideration any state estate taxes which may be payable by the client's estate. What is a client to do? Assume a client has an estate that is over $1,500,000 and is single or $3,000,000 and is married and the estate can reasonably be expected to appreciate in value prior to the client's death. I recently had a conversation with a client's broker who indicated that the client's investments were doubling every 10 years. For example, if we took $500,000 of the stock in the client's portfolio, and assumed it doubled in 10 years, that $500,000 will be worth approximately $1,000,000 in ten years and 2,000,000 in 20 years. The estate tax on that $500,000 of growth would been approximately $250,000 assuming a 50% combined federal and state estate rate. The estate tax on the $1,500,000 of growth would have been approximately $750,000. While these are only estimated numbers and it is impossible for any of us to predict what the stock market will do over the next 10 or 20 years, I think we can be pretty assured that the $500,000 worth of stock will appreciate in value and that over 50% of that appreciation, what ever it is, will be paid in Federal and state estate taxes. I would like to suggest a common estate planning strategy to totally avoid federal and state estate taxes on all of the future appreciation on that $500,000 on the death of either the client or their spouse, while still retaining the income from the stock for 10 years. The strategy used in this type of situation is referred to as a Grantor Retained Annuity Trust or a "GRAT". There is a statute which allows the use of a GRAT and as long as you follow all the rules, the estate tax savings that can be achieved are astronomical. The basic premise of a GRAT is that the $500,000 of stock is transferred to an irrevocable trust with the client (the Grantor) retaining the right to receive an annuity (a fixed payment of the income of the GRAT), for a period of years. I have run some annuity computations for a 54 year old client which illustrates the use of a GRAT. I have used a Section 7520 Rate of 6.8 %; an annuity factor of 0.517950 from Table B of Treasury Regulation 20.2031-7 and a 10 year term of years annuity calculation under Treasury Regulation 20.2031- 7 (d) (iv) of 7.0889 (1-.517950 = .48205/.068 = 7.0889). The value of a 10 year retained annuity will be 7.0889 x the value of the annual annuity payment. The value of the gift will be the value of the annuity subtracted from the $500,000 placed into the trust. If we use the 2% rate of return on the stocks, the value of the annuity is $70,889 ($10,000 x 7.0889). For example, if the client transfers $500,000 of stock to a GRAT, and retained the right to the income from the $500,000, (approximately $10,000 per year), the client would have made a gift of the $500,000 of stock for gift tax purposes of $429,111 ($500,000 - $70,889). The value of the client's retained annuity for 10 years would be $70,889. There would be no federal or New York State gift taxes on the $429,111 gift because we can use the federal and state unified credits to offset any gift tax. At the end of 10 years, if the $500,000 of stock was worth $1,000,000 and the client were to die after the expiration of the 10 years, there would be approximately $1,000,000 of stock in the GRAT that would pass free of estate taxes saving approximately $285,000 in estate taxes. If the stock was worth $2,000,000 there would be approximately $2,000,000 of stock in the GRAT that would pass free of estate taxes saving approximately $785,000 in estate taxes. Of course, if less money was placed into the GRAT, the estate tax savings would be less or if more money was placed into the GRAT the estate tax savings would be more. If your rate of return were smaller or larger the tax savings would vary, but the concept still holds that all future appreciation escapes estate taxation. Also please note that this does not reduce the current estate taxes on the client's death, but eliminates the estate taxes that would be due on the growth of the $500,000 ($1,000,000 - $2,000,000) over the next 10 years or 20 years on the $500,000 that could be placed in the GRAT now. Of course, we are using part of your unified credit in the process. This is obviously a technique that should be given serious consideration. I strongly suggest that you consider the use of a GRAT for your estate plan if you have an estate in excess of $1,500,000 if you are single, or $3,000,000 if you are married. While the use of a GRAT is a rather complex estate planning tool, the GRAT produces significant estate tax savings.
I have tried to take some of the mystery out of the use of a GRAT in your estate plan in this short letter, but if you would like some more information, I am pleased to offer you a free office conference to discuss the entire Estate Planning process as well as the use of a GRAT and how I can help you plan your estate. Please feel free to give me a call. D. Victor Pellegrino Email: 
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