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Gregory S. DuPont, JD, CFP Aug. 15, 2023

With America's uncertain economic future, many families want to preserve their wealth and transfer it to loved ones. However, gift and estate tax consequences can threaten this goal of sharing wealth. By crafting a comprehensive estate plan, we can address these concerns and protect high-net-worth clients from excess taxes.

The following three types of trusts may assist high-net-worth clients in sharing their wealth in a tax-advantageous way.

Using a Grantor Retained Annuity Trust to Gift

A Grantor Retained Annuity Trust (GRAT) is an irrevocable trust you can use to make large financial gifts to your loved ones. The main benefit of a GRAT is that it can be used to minimize gift tax liability. The financial gifts you make remove future appreciation from your estate, thus reducing the amount that will be subject to estate tax at your death. However, you may owe gift taxes upon the trust's creation.

To create a GRAT, you should first work with an estate planning attorney to draft the document itself. Next, you'll need to fund it with accounts and property (usually those expected to appreciate over the GRAT's term). Then, you'll receive a fixed annuity payment based on the trust’s original value for a specified time period. Once the period has ended, the rest of the trust’s accounts and property are transferred to your named beneficiary.

The rate of return you'll receive is based on the specific rate determined by the IRS. Legally, this is known as the Internal Revenue Code (I.R.C.) § 7520 rate. The key to saving taxes and having money available to be transferred to the beneficiary is for the trust’s accounts and property to outperform this rate. To reduce the gift tax that would otherwise be due, the value you retain is subtracted from the value of what was transferred to the trust. This is known as the subtraction method. The ultimate goal is for this number to be zero or as close to zero as possible. This means that any appreciation is transferred to your beneficiary at the trust’s termination gift-tax free.

Let's look at an example. Let's say you make a $1 million gift to a GRAT, the current I.R.C. § 7520 rate is 4.2%, and the annuity will be paid over five years. If the trust only makes 4.2 percent, then the client will be in roughly the same position as it was when it was created. So, everything will be returned to the client. If the trust makes 7.5%, then there will be approximately $123,562 remaining that will be transferred to the beneficiaries with no gift tax.

Using a Grantor Retained Unitrust to Make Gifts

A grantor retained unitrust (GRUT) is an irrevocable trust much like a GRAT. Accounts and property are transferred to the trust and you retain a right to receive an annuity for a fixed time period. Then, at the trust’s termination, the trust’s remaining accounts and property are given to your named beneficiary. However, with a GRUT, the annuity payment that you receive each year is calculated based on a fixed percentage of the trust’s value that year. Since the trust’s value can vary from year to year, the annuity amount can vary year to year as well.

Like a GRAT, the gift tax is due at the time the accounts and property are transferred to the trust, and the gift tax liability is based on using the subtraction method. Because the annuity is based on the trust value that year, it's unlikely that the difference between what you give and retain will be zero. So, some gift tax will need to be paid.

Using a Qualified Personal Residence Trust to Gift

A qualified personal residence trust (QPRT) is an irrevocable trust that you can use to remove your home from your overall estate. Ownership of the home is transferred to the trust, but you retain the right to use and enjoy the property for a specified time period. Once that period ends the home is transferred to your named beneficiary. If you would like to continue living in or using the property, you will have to pay the beneficiary rent. You may need to consider your relationship with the beneficiary when evaluating whether this tool would serve your needs.

Although a QPRT reduces the amount subject to estate tax at your death, gift tax will still be owed when the property is transferred to the QPRT. The value of what is transferred to the trust (and subject to gift tax) is the home's value minus the value of what you keep (because you have the right to continue using it). This estate planning tool’s effectiveness depends on current federal interest rates. The higher the interest rate, the lower the gift value and the lower the potential gift tax liability.

You can establish a QPRT for no more than two residences. It can be funded using a principal residence, secondary residence, vacation home, or a fractional interest in these types of residences. It is also important to note that if the property currently has a mortgage, it may be advisable to pay off the mortgage before transferring ownership to the QPRT. This is to avoid complications in administering the trust.

Choosing the Right Way to Gift

The important thing to note with all three types of trusts is that you must survive the trust term. When trying to determine the length of the trust, it is important to consider your current age and life expectancy. If you die before the trust terminates, the tax benefits will be undone and the full value of the account or property will be counted towards your estate tax liability.

Because each transaction is subject to taxation, you should work with an experienced estate planning attorney to evaluate the gift tax, estate tax, and nontax considerations before making a decision. We are available to meet with you, discuss your unique situation, and craft a plan that leaves your hard-earned wealth to those you care about. To make an appointment, please call our office at 614-408-0004.

Attorney Gregory S. DuPont PortraitAbout the Author - Gregory S. DuPont, JD, CFP

Greg has been serving clients as an estate and tax planning attorney in Ohio since graduating from Capital University Law School in 1992. He obtained an accounting and finance degree from The Ohio State University. As a Certified Financial Planner, a designation that requires advanced coursework in a complete range of financial subjects, he is a rare financial professional who can provide cross-disciplinary solutions from the legal, tax and investment perspectives.

Greg is the co-author of the book: Protecting Your Future with Tax-Free Long-Term Care, and is a contributing author in Jack Canfield's best selling book The Recipe for Success.

He has been named one of Ohio's Top 100 lawyers, an invitation-only designation given by The National Advocates.