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Trust Law/Level V · Tax and legacy/5.2 Annuity and unitrust structures/Lesson 1

GRATs: grantor retained annuity trusts

How a grantor retained annuity trust works under IRC §2702, why a ‘zeroed-out’ GRAT can pass growth with little gift tax, and what can go wrong.

Education, not legal advice. Trust law changes from country to country and state to state, and the right structure depends on your situation. Anything you sign should be drafted or reviewed by a qualified lawyer where you live.

The lean path

The cheapest, lowest-tax, simplest and most private route the law allows, best first. Each step names the rule it rests on and the condition that keeps it lawful.

  1. For an estate under the 2026 basic exclusion of $15,000,000, a GRAT saves no federal estate tax, and its assets lose the §1014 step-up at death; annual-exclusion gifts of $19,000 per recipient are cheaper, though state estate taxes start as low as $1,000,000.
  2. A zeroed-out GRAT (Walton, 115 T.C. 589) passes growth above the §7520 rate with almost no gift; the October 2026 rate is 5.6%, so only assets expected to beat that hurdle are worth funding with, and the transfer is still reported on Form 709.
  3. Short rolling 2-year GRATs limit mortality risk, because death during a term returns the trust to the estate under §2036, leaving the grantor roughly where they started minus costs; annuities must be paid on time, never by note, with no additions (Treas. Reg. §25.2702-3).
  4. Because a GRAT is a grantor trust, the grantor’s tax on trust income is not a gift (Rev. Rul. 2004-64) and further shrinks the estate; the catch is that a near-zero gift depends on a defensible value for hard-to-value assets.

MaterialsThe IRS’s current table of §7520 interest rates, free on irs.govThe text of IRC §2702 and Treas. Reg. §25.2702-3, free on law.cornell.eduA copy of the GRAT document you are reading, if you have one, to find its term and annuity amount

Wonder

  1. What happens if the grantor dies before the annuity term ends?
  2. Why does a low §7520 rate make a GRAT more likely to pass value to the remainder beneficiaries?
  3. Why do some families use a series of short GRATs instead of one long one?

Explore

  1. A grantor retained annuity trust (GRAT) is an irrevocable trust used under US federal gift tax law. The grantor transfers assets and keeps the right to a fixed annuity for a term of years; whatever is left at the end passes to the remainder beneficiaries, often children or a trust for them. IRC §2702, enacted in 1990, values a retained interest in a trust for family members at zero unless it is a ‘qualified’ interest, such as an annuity meeting the rules in Treas. Reg. §25.2702-3.
  2. The gift is the value of the assets transferred minus the present value of the retained annuity, computed with the §7520 rate, which the IRS publishes monthly. If the assets earn more than that rate over the term, the excess passes to the remainder beneficiaries without further gift tax, which is why the §7520 rate is often called the ‘hurdle rate’. If they earn less, the annuity payments use up the trust and little or nothing passes. The annuity must be paid at least annually, and each year’s amount can be at most 120% of the year before.
  3. In a ‘zeroed-out’ GRAT, the annuity is set so that its present value nearly equals the value transferred, leaving a gift close to zero. In Walton v. Commissioner, 115 T.C. 589 (2000), the Tax Court held that a 2-year annuity payable to the grantor or, if she died, to her estate should be valued as an annuity for a fixed term, and it struck down a regulation example that valued it differently. The IRS acquiesced in the result in Notice 2003-72 and amended its regulations in 2005.
  4. The main risk is mortality. If the grantor dies during the term, IRC §2036 brings into the gross estate the part of the trust needed to produce the annuity at the §7520 rate in effect at death, up to the whole trust (Treas. Reg. §20.2036-1(c)(2)). That is often most or all of the trust, so the planned transfer largely fails, although the grantor is generally no worse off for estate tax than without the GRAT, apart from costs. A shorter term lowers this risk but gives the assets less time to grow.
  5. Treas. Reg. §25.2702-3 limits how a GRAT is run. The trust document must prohibit additional contributions and prepayment of the annuity, and paying the annuity with a note or similar debt does not count as payment. Some practitioners use ‘rolling’ GRATs: a series of short GRATs, often of 2 years, with each annuity payment put into a new GRAT. A year of strong growth is captured in one GRAT while a weak year affects only that GRAT, but each one must be drafted, funded and tracked.
  6. A GRAT is usually a grantor trust for income tax (IRC §§671–679), because its income can be paid to the grantor. The grantor pays tax on the trust’s income, and Revenue Ruling 2004-64 held that paying that tax is not a gift. Short, zeroed-out and rolling GRATs sit at the aggressive end of accepted planning, and past administrations have proposed limits such as a minimum 10-year term, so check current law. This lesson describes how GRATs work; it does not suggest using one.

Key facts

  • IRC §2702 (1990) values a retained interest in a trust for family members at zero unless it is a qualified interest, such as a fixed annuity.
  • Walton v. Commissioner, 115 T.C. 589 (2000), let a GRAT annuity payable to the grantor or her estate be valued for a fixed term, allowing a near-zero gift; the IRS acquiesced in Notice 2003-72.
  • If the grantor dies during the term, §2036 includes the part of the trust needed to produce the annuity at the §7520 rate at death, up to the whole trust.
  • A GRAT annuity must be paid at least annually, can rise by no more than 120% a year and cannot be paid with a note (Treas. Reg. §25.2702-3).
  • A GRAT’s governing instrument must prohibit additional contributions and prepayment of the annuity (Treas. Reg. §25.2702-3).
  • Growth above the §7520 rate passes to the remainder beneficiaries free of further gift tax; growth below it leaves little or nothing for them.

Exercise nine, six, three, one

9CollectList up to 9 facts about a GRAT you are reading about (some lists are shorter), such as the assets transferred, their value, the term, the annuity amount, the §7520 rate used, the grantor’s age or the remainder beneficiaries.
6ClusterSort them into 6 categories: assets, valuation, annuity terms, term length, people involved, and facts you are unsure about.
3DistillReduce the 6 categories to 3 groups: facts that set the size of the gift, facts that bear on mortality risk, and facts that decide how much may pass to the remainder beneficiaries.
1CrystallizeWrite 1 sentence explaining, in your own words, why a GRAT passes value only if its assets earn more than the §7520 rate.

Fact check

Dates, figures and claims checked against the published sources listed below.

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