How Do Recent Tax Law Changes Impact Grantor Retained Annuity Trusts?
April 16, 2025
Estate planning often involves sophisticated tools to transfer wealth efficiently, minimize estate taxes, and make sure that assets pass on according to the wishes of the individual (or grantor). One of the most popular vehicles for achieving these goals is a grantor retained annuity trust (GRAT).
GRATs are particularly beneficial for high-net-worth individuals looking to reduce estate taxes while retaining some level of control over their assets. However, with recent changes in federal tax laws, GRATs are being impacted in ways that may affect their structure, effectiveness, and appeal as a wealth transfer strategy.
At Eric H. Light, P.A., I’ve spent nearly 20 years assisting individuals with the estate planning process. I’m here to explain how the recent changes in tax law affect GRATs and what Floridians working on their estate plans should know.
What Is a Grantor Retained Annuity Trust (GRAT)?
A GRAT is a type of irrevocable trust where the grantor (the person establishing the trust) transfers assets into the trust and retains the right to receive an annuity payment from the trust for a specified period. The trust is typically structured so that the value of the annuity payments is based on the IRS's Section 7520 interest rate, which is updated monthly.
At the end of the GRAT term, any remaining assets in the trust (after the annuity payments have been made) are transferred to the beneficiaries, typically the grantor’s heirs. Assuming the trust’s assets appreciate at a rate higher than the IRS’s assumed interest rate, the remainder interest (the amount passing to the heirs) can be transferred without incurring gift or estate tax.
The effectiveness of a GRAT as an estate planning tool relies on the performance of the assets held in the trust. If the assets outperform the IRS’s assumed rate of return, the excess appreciation passes to the beneficiaries without incurring taxes. GRATs are most beneficial when the grantor’s assets are expected to appreciate significantly during the trust term.
Recent Tax Law Changes and Their Impact on GRATs
Several significant tax law changes in recent years have impacted the structure and appeal of GRATs:
Doubling of estate and gift tax exemption: The TCJA increased the estate and gift tax exemption, allowing individuals to transfer more wealth without triggering estate or gift taxes. This could lessen the reliance on GRATs for wealth transfer.
Expiration of the increased exemption in 2025: The increased exemption is set to expire in 2025 unless Congress acts. If it reverts to previous levels, GRATs may regain their attractiveness as a strategy for reducing taxable estates.
Zeroed-out GRAT strategy under scrutiny: Proposals are being considered that would limit or even eliminate the ability to structure GRATs in a way that avoids gift tax liability, particularly the "zeroed-out" GRAT strategy.
Federal Reserve interest rate impact on GRATs: Rising interest rates affect the IRS’s 7520 rate, which in turn influences the annuity payments and the potential for asset appreciation within the GRAT.
Stricter gift tax valuation rules: Recent IRS changes require more stringent valuations for assets transferred to GRATs, particularly for illiquid assets like closely held businesses and real estate, which may complicate GRAT planning.
The most notable changes stem from the Tax Cuts and Jobs Act (TCJA), changes in estate and gift tax exemptions, and new discussions surrounding the elimination of the “zeroed-out” GRAT strategy. I’ll break down how these laws impact GRATs below.
The Tax Cuts and Jobs Act (TCJA) of 2017
The TCJA introduced numerous provisions that affect GRATs, although its impact on wealth transfer strategies has largely been felt through changes in estate and gift taxes.
One of the major provisions of the TCJA was the doubling of the estate and gift tax exemption. For individuals, this exemption increased from $5.49 million (in 2017) to $11.18 million in 2018, and it’s indexed for inflation.
This change has had a significant impact on GRAT planning, as the higher exemption allows individuals to transfer larger amounts of wealth during their lifetimes or at death without incurring estate or gift taxes. For those with estates above the exemption amount, GRATs remain an attractive way to reduce the taxable estate.
However, the doubling of the exemption also has created a shift in strategy for many individuals. Some may now focus less on using GRATs as a primary means of transferring wealth tax-efficiently, opting instead for direct gifts or other strategies that allow them to take advantage of the increased exemption.
Estate and Gift Tax Exemptions and Sunset Provisions
One of the most important provisions in the TCJA was that the increased estate and gift tax exemption amount is set to expire in 2025, returning to the pre-2018 levels unless Congress enacts new legislation. This means GRATs and other strategies used to reduce taxable estates may be less appealing in the future if the exemption amount reverts to a lower threshold.
If the exemption reverts to a lower amount, individuals who have used the increased exemption to make large gifts may find themselves facing higher estate taxes when they pass away. In that case, GRATs may once again become a key tool for reducing estate taxes, especially for those who have already made substantial lifetime gifts.
Additionally, the carryover basis rule also impacts GRATs. Under current law, if a person gifts property to a GRAT, the property retains its original cost basis. If the assets appreciated during the GRAT term, the beneficiaries may be liable for capital gains taxes upon selling the assets.
This means that GRATs must be structured with consideration for both the tax benefits and the tax liabilities that the beneficiaries may face when they eventually sell appreciated assets.
The “Zeroed-Out” GRAT Strategy Under Scrutiny
A zeroed-out GRAT is a strategy in which the grantor structures the GRAT so that the present value of the annuity payments is equal to the value of the assets contributed to the trust.
Essentially, this means the grantor is making a gift equal to the present value of the remainder interest. Because the value of the annuity payments is set to the IRS’s assumed interest rate (using the 7520 rate), this allows the GRAT to effectively transfer wealth with little to no gift tax consequences.
However, the zeroed-out GRAT strategy has come under increasing scrutiny from lawmakers. There have been discussions about changes to the tax code that would make it more difficult to use this strategy.
For example, some proposals suggest limiting the ability to “zero out” GRATs by introducing a minimum term length or eliminating the ability to structure a GRAT in such a way that there is no gift tax liability at all.
If these proposals are enacted, individuals seeking to use GRATs as a wealth transfer tool may need to structure them differently or face higher tax consequences.
Impact of the Federal Reserve’s Interest Rate Policy on GRATs
The IRS’s 7520 rate, which is used to calculate the present value of annuity payments in a GRAT, has a significant impact on the effectiveness of this tool. The 7520 rate is based on a monthly average of long-term Treasury bond rates, which can fluctuate in response to changes in the Federal Reserve's interest rate policy.
As interest rates have been rising in response to inflationary pressures, the 7520 rate has increased, which can have a direct effect on the annuity payments in a GRAT.
A higher 7520 rate means that the annuity payments will be larger, which could reduce the amount of wealth ultimately passed to beneficiaries. However, higher interest rates also increase the potential for asset appreciation, which could benefit the remainder beneficiaries of the GRAT if the assets outperform the IRS’s assumed rate.
It’s essential to monitor the Federal Reserve’s actions and the corresponding effects on the 7520 rate, as these can significantly affect GRAT planning. The current environment of rising interest rates may make GRATs less attractive for certain individuals, but they could still be useful for others depending on their asset portfolio and estate planning goals.
Changes to the Gift Tax Valuation Rules
Recent changes to the IRS's valuation rules have also impacted GRATs. The IRS has introduced more stringent rules for valuing interests in closely held businesses, real estate, and other illiquid assets when they are transferred into a GRAT. These changes were implemented to curb abuses related to the valuation of these assets, which had allowed for significant discounts to be applied, potentially reducing the gift tax liability.
In light of these changes, individuals considering using a GRAT to transfer interests in closely held businesses or real estate must be aware of the new valuation rules to avoid pitfalls. It’s essential to work closely with an estate planning attorney and a qualified appraiser to make sure you comply with these regulations.
Contact an Estate Planning Attorney Today
Understanding the nuances of GRATs in the context of the latest tax developments is critical for making sure your estate plan achieves its goals. This is where experienced legal counsel comes in. If you need assistance with estate planning in Boca Raton, Florida, contact Eric H. Light, P.A. today.