Is a Grantor Retained Annuity Trust Right For You?

What is a GRAT?

Grantor Retained Annuity Trusts (GRATs) ­are a mechanism by which wealthier individuals and couples can transfer appreciating assets to their heirs and minimize gift or estate taxes. High-net-worth individuals and couples can use GRATs to freeze the value of their estates and transfer any increase in the value of their assets to their heirs, with minimal tax consequences.

Understanding the Basics

GRATs are irrevocable trusts permitted by the Internal Revenue Code. A client (grantor) transfers an asset or assets to the trust. The grantor (and only the grantor) retains a right to receive an annuity income from the GRAT over a certain period of time. The GRAT is required to pay this annuity stream no less than annually, and it must be a dollar amount or percentage of the value of the asset put into the trust. Any annuity income received is not subject to income tax due to special tax rules.

The asset that is transferred is considered a gift equal to its value reduced by how much of an annuity the grantor receives, along with any interest, as set forth in IRS guidance. Once the trust terminates, the assets transfer to beneficiaries such as a client’s children or a trust for their children.

A GRAT can be designed to result in no taxable gift and, therefore, no gift tax. However, if a GRAT cannot be set up this way, then the grantor can use any of his or her lifetime gifting exclusion to offset any gift tax.

If the grantor does not pass away during the GRAT’s term, then any assets or appreciation that pass to beneficiaries are not subject to gift tax or estate tax upon the grantor’s death. If the grantor dies during the term, then the value of the assets needed to pay the remaining annuity payments to the grantor would be included in his or her estate for tax purposes. The rest of the assets would pass without being included in the grantor’s estate.

Let’s Look at An Example

Let us say you have a stock account worth $1 million and transfer it to a GRAT. The terms of the GRAT provide that you receive 10 annual payments of $100,000, plus interest, at a rate set by the IRS from the income of the trust. If designed to be a zeroed-out GRAT, the total payments should equal the asset's present value at the date of transfer. If the stock account is appreciating, this works out very well. The trust can pay you the annuity without invading the principal, and any appreciation in value transfers to the beneficiaries of the trust, with no gift or estate tax consequences, once its term ends.

Why Consider a GRAT?

A GRAT may be especially prudent for clients that gift money regularly and may use up their federal estate and gift tax exemption. The total lifetime exclusion as of 2022 is $12.06 million ($24.12 million for married couples). A GRAT is also a helpful planning device for clients with high-value estates who may suffer serious tax consequences when the federal exemption reduces by half in 2026.

Furthermore, many states have less favorable estate tax exclusion amounts and gifting rules. New York, for example, has an exclusion of $6.11 million as of 2022. In New York, the consequences of exceeding this threshold can be harsh. If an estate is more than 5% over the exemption, the estate loses the exemption entirely, and the total value of the estate’s assets is subject to estate tax. New York also has a three-year clawback rule for gifts. So, when a person passes away, the state includes the last three years of gifts that person made in calculating the total value of their estate for tax purposes.

GRATs can help avoid many of these issues. So why not plan ahead now? Contact your attorney to determine whether a GRAT is a good fit for you. 

How You Can Help Your Loved Ones by Planning Your Funeral Arrangements

When an individual passes away without a funeral plan, responsibility for arranging the funeral often falls on the deceased’s close family members, such as surviving spouses and children. Planning your own funeral arrangements can assist your loved ones in an emotionally challenging time, while also protecting them from incurring extraneous costs.

According to the National Funeral Directors Association, in 2021, the average cost of a full-service burial was $7,848, and the average cost of full-service cremation was $6,971. When an individual dies without having outlined a funeral plan, surviving family members may be unsure of their loved one’s wishes. As a result, they may choose more expensive funeral options or feel pressure to overspend to demonstrate their love. Yet you can shield your family from these costs by prearranging the funeral and, in some cases, prepaying for funeral arrangements. (Always do your research before prepaying.)

Without a plan in place, grieving family members often face time constraints in making decisions. For instance, they may not have time to visit multiple funeral homes and compare their values after their loved one’s death. Often, they choose the first funeral home they see rather than exploring various options to find the best fit and value.

When individuals prearrange their funerals, they have time to research funeral homes and carefully decide the details of their end-of-life arrangements, ensuring that the services will follow their wishes.

Beyond choosing the funeral home, planning such arrangements ahead of time can include:

• Deciding what happens to the remains, including burial or cremation

• Determining the burial location, such as next to a loved one

• Letting loved ones know where to spread or keep ashes

• Deciding whether to donate organs or remains to scientific research

• Selecting the type of funeral or memorial service (For instance, a traditional funeral ceremony may be held in a religious institution and include viewing and burial, whereas direct burials happen soon after death and do not include a viewing)

How to plan your funeral arrangements

Often, planning funeral arrangements entails writing down your wishes in detail. You may wish to give your family members copies of your written wishes. Additionally, people with a reasonable idea of where they will pass away can prepay a funeral home for services, ensuring family members do not need to take on the cost.

Advance directives can document your desires regarding end-of-life care and what happens to your remains after death. You can choose a person to act as your healthcare agent and help you with healthcare decisions. Although your agent’s authority often terminates upon your death, you may provide your agent with your funeral wishes, along with the power to oversee the arrangements.

Wills may contain sections describing desired funeral arrangements. However, wills are not the best place for funeral arrangements, as family members often read wills after the funeral. Instead, a separate document, such as a prepaid funeral or burial contract, can describe funeral arrangements and end-of-life wishes.

Deciding funeral arrangements in advance and providing instructions to your loved ones makes your wishes clear, avoiding arguments within your family and giving them more peace of mind after you pass away.

How Changes to Portability of the Estate Tax Exemption May Impact You

On July 8, 2022, the Internal Revenue Service issued new guidance that allows a deceased person’s estate to elect “portability” of their unused gift and estate tax exemption for up to five years after their death. So, if your spouse passed away less than five years ago, you may be able to file an estate tax return to transfer their unused estate tax exclusion to yourself.

What Is Portability, and How Does One Get It?

Portability is a way of transferring the amount of the gift and estate tax exemption that a deceased spouse did not use to the surviving spouse. It is only available to married couples.

To get the benefit of portability, the executor of an estate must file a federal estate tax return. Previously, this return had to be filed within two years of a person’s date of death, assuming an estate tax return was not required sooner. Because so many estates kept missing this window, the IRS decided to extend it to five years.

Let’s say your spouse has passed away, and you are the executor of their estate. If the total value of your spouse’s assets in their estate is below the threshold for federal estate taxation, you may assume that no estate tax return needs to be filed. While this is technically correct, if you do not file an estate tax return, there is no way to transfer over your spouse’s unused estate tax exclusion for your benefit.

The federal gift and estate tax exclusion as of 2022 is $12.06 million per person ($24.12 million for married couples). A person can give away — either during their lifetime or at death — up to this amount, tax-free.

In the above example, if your spouse’s estate were worth $2 million, that would leave an unused exemption of $10.06 million, which you could add to your own $12.06 million exemption, should you ever need it. But you must file an estate tax return for your spouse and complete the section of Form 706 currently entitled “portability of deceased spousal unused exclusion.”

Now Is a Good Time to Consider If You Could Benefit From Portability

The current federal gift and estate tax exemption will be reduced by half in 2026. So, if you have a spouse who died in the past five years, you should consider as soon as possible whether electing portability makes sense.

To be eligible, the deceased spouse must have been a U.S. citizen or permanent resident on the date of their death, and the executor must not have been otherwise required to file an estate tax return based on the value of the total estate and any taxable gifts. If an estate tax return was filed within nine months after the spouse’s death or an extended filing deadline, the portability option may also not be available.

For families with some wealth, this option could result in hundreds of thousands of dollars or more in tax savings. Many families might not have an estate tax problem now, under the gift and estate tax exclusion of 2022. However, if the second spouse dies after 2026, that spouse’s estate could owe hefty taxes. Portability allows you to plan ahead to avoid this problem. Reach out to your attorney to learn more. 

Using a Roth IRA as an Estate Planning Tool

A Roth IRA does not have to be used as just a retirement plan; it can also be a way to transfer assets tax-free to the next generation. 

Unlike a traditional IRA, contributions to a Roth IRA are taxed, which means that the distributions are tax-free. Also, unlike a traditional IRA, you are also not required to take any distributions on a Roth IRA, regardless of your age. If you don’t need the money for retirement, you can leave all of it in the IRA to grow tax-free and eventually pass on to your heirs. 

If your spouse is the beneficiary on your Roth IRA, your spouse can become the owner of the account. Your spouse can either put the IRA in his or her name or roll it over into a new IRA, and the IRS will treat the IRA as if your spouse had always owned it. Just like you, your spouse does not need to take any distributions from the IRA if they are not needed.

The rules for a child or grandchild (or other non-spouse) who inherits an IRA are different than those for a spouse. They must withdraw all of the assets in the inherited account within 10 years. There are no required distributions during those 10 years, but it must all be distributed by the 10th year. 

Certain non-spouse beneficiaries are treated like spouses, which means they can treat the IRA as their own:

• Disabled or chronically ill individuals

• Individuals who are not more than 10 years younger than the account owner

• Minor children. Once the child reaches the age of majority, he or she has 10 years to withdraw the money from the account.

The benefit of a Roth IRA for your heirs is that the assets will be distributed tax-free. As long as you opened and began making contributions to the Roth IRA more than five years before you died, the distributions will not be taxed when the beneficiary takes distributions. 

Another consideration is that money you leave your heirs in a Roth IRA does not go through the probate process. This can make it easier for your beneficiaries to access the funds quickly. But make sure that you name a beneficiary on your account. If no beneficiary is named, the account will go to your estate and will then have to go through probate. Also, be sure to regularly check that your beneficiary designations are up to date.

Leaving your heirs a tax-free Roth IRA may not always be the best plan. In figuring out the best type of IRA to leave to your beneficiaries, you need to consider whether your beneficiary's tax rate will be higher or lower than your tax rate when you fund the IRA. In general, if your beneficiary's tax rate is higher than your tax rate, then you should leave your beneficiary a Roth IRA. Because the funds in a Roth IRA are taxed before they are put into the IRA, it makes sense to fund it when your tax rate is lower. On the other hand, if your beneficiary's tax rate is lower than your tax rate, a traditional IRA might make more sense. That way, you won't pay the taxes at your higher rate; instead, your beneficiary will pay at their lower tax rate.

To determine if a Roth IRA should be a part of your estate plan, consult with your attorney. Find an attorney near you.

Learn more about inheritied IRAs.

How Long Does an Executor’s Job Take?

Being the executor of an estate can be a time-consuming job, depending on the size and complexity of the estate. While a simple estate can take a few months and not require a huge time commitment, if there are problems, the job can drag on for years. 

An executor is the person responsible for managing the administration of a deceased individual's estate. Although the time and effort involved will vary with the size of the estate, even if you are the executor of a small estate you will have important duties that must be performed correctly or you may be liable to the estate or the beneficiaries.

The first thing an executor should do is to consult with an attorney to learn the deadlines in the state where the decedent lived. To start the probate process, the executor must file the will for probate. Some states have strict time limits on how long after a decedent dies the executor has to file the will with the court, while others have no time limits. In addition, there may be deadlines for the executor to prepare a list of all of the deceased's assets and file this inventory with the court. It is important that the executor to understand what is required and when. 

How much actual time an executor will have to devote to the job can range widely. Settling an estate takes an average of 16 months, according the software company EstateExec, and the settlement process requires an average of roughly 570 hours of work on the part of the executor. Average compensation for executors was $18,000. 

While executors must adhere to deadlines set by the state, other factors can make the estate administration go faster or slower. The following are the issues that can add or subtract time:

• Debts. The executor must notify potential creditors about the decedent’s death. Usually, the executor must inform all known creditors by letter and publish a notice in a local paper for unknown creditors. Each state gives creditors a certain amount of time, which can range from a few months to a year, to file claims against the estate. The executor must wait for the deadline to pass and then settle all the debts before distributing assets to the beneficiaries of the estate.

• Location. The location of the executor and the beneficiaries can affect the time it takes to settle the estate. If the executor does not live in the same state as the decedent and the beneficiaries, it can take more time to send documents back and forth.

• Assets. The more complicated the assets, the longer it will take the executor to sort everything out. If the estate consists of just a house and bank account, things will go more quickly than if the estate consists of multiple bank accounts, stocks, brokerage accounts, valuables, and/or a family business.

• Contested Estate. If the beneficiaries are fighting amongst themselves or with the executor, the probate process is going to take longer. One way an unhappy family member can hold up probate is by contesting the will, based on mental incapacity, undue influence, fraud, or allegations that it wasn’t executed properly. A beneficiary can also prolong the process by challenging the executor’s actions.

Every family situation is unique, so there is no set time that an executor can expect to work. If you are named as an executor, check with an attorney in the decedent’s state to find out what to expect. To find an attorney near you, click here. 

The Tax Consequences of Selling a House After the Death of a Spouse

If your spouse dies, you may have to decide whether or when to sell your house. There are some tax considerations that go into that decision. 

The biggest concern when selling property is capital gains taxes.  A capital gain is the difference between the "basis" in property and its selling price. The basis is usually the purchase price of property. So, if you purchased a house for $250,000 and sold it for $450,000 you would have $200,000 of gain ($450,000 - $250,000 = $200,000).

Couples who are married and file taxes jointly can sell their main residence and exclude up to $500,000 of the gain from the sale from their gross income. Single individuals can exclude only $250,000. Surviving spouses get the full $500,000 exclusion if they sell their house within two years of the date of the spouse's death, and if other ownership and use requirements have been met. The result is that widows or widowers who sell within two years may not have to pay any capital gains tax on the sale of the home.

If it has been more than two years after the spouse’s death, the surviving spouse can exclude only $250,000 of capital gains. However, the surviving spouse does not automatically owe taxes on the rest of any gain. 

When a property owner dies, the cost basis of the property is "stepped up." This means the current value of the property becomes the basis. When a joint owner dies, half of the value of the property is stepped up. For example, suppose a husband and wife buy property for $200,000, and then the husband dies when the property has a fair market value of $300,000. The new cost basis of the property for the wife will be $250,000 ($100,000 for the wife's original 50 percent interest and $150,000 for the other half passed to her at the husband's death). In community property states, where property acquired during marriage is the community property of both spouses, the property’s entire basis is stepped up when one spouse dies. 

To understand the tax consequences of selling property after the death of a spouse, contact your attorney. Find an attorney near you.

Why Small Business Owners Need an Estate Plan

Running a small business can keep you busy, but it should not keep you from creating an estate plan. Not having a plan in place can cause problems for your business and your family after you are gone.  

While an estate plan is important for everyone, it is especially important for small business owners. Planning allows you to dictate what will happen with your business after you die or are no longer able to manage it. It can help you avoid excess taxes and debts and facilitate your business’s continued success. 

Before sitting down to start the estate planning process, you should think about your goals for the business. What do you want to have happen if you die or become incapacitated? Should the business continue with current partners or be sold to new owners? Should your family take over? Should the business be shut down? Consider your family dynamics when thinking about these questions. Once you have come up with your goals, you can create a plan to meet them. 

The basic building blocks of any estate plan include a will, power of attorney, and medical directives. The will allows you to direct who will receive your property at your death while the power of attorney and medical directives dictate who can act in your place for financial and health care purposes. 

Following are some additional things a small business owner should consider as part of an estate plan: 

• Tax Planning. If your business is not a separate entity, you may want to consider ways to minimize estate taxes. The current estate tax exemption ($12.06 million in 2022) is so high that most estates do not pay any estate tax. However, a small business could put an estate over the limit. Also, the fact that the estate tax exemption is set to be cut in half in 2026 and that states have their own estate taxes means that tax planning is important. You may want to put your business assets into a trust or a separate business entity like a limited liability company to lower your estate tax burden.

• Trust. A trust can be useful not only to reduce estate taxes, but also to ensure the continued running of your business if you die or become incapacitated. Because a trust passes outside of probate, the assets in the trust can be transferred immediately to the person you want to run the business without waiting for the whole estate to go through probate. In addition, if you become incapacitated, the trustee can continue to run your business without court involvement.

• Buy-Sell Agreement. If you own your business with others, a buy-sell agreement can be very useful. Buy-sell agreements are used if one of the owners dies, leaves the company, or becomes incapacitated. It specifies who can buy an owner’s share of the business, under what conditions, and for what price.

• Life Insurance. When you own a business, life insurance takes on new importance. A life insurance policy can ensure that your family continues to receive an income in the event of your death. It can also provide funds to keep the business running and be used to fund a buy-sell agreement.

Your estate planning attorney can help you come up with a plan to meet the needs of your business. Find an attorney near you.