How Does a Walton GRAT Work?

Question:

I was reading in the Sunday (December 29, 2013) edition of the Washington Post about how Sheldon Adelson has used Grantor Retained Annuity Trusts (GRAT's) to avoid gift and future estate taxes. I don't understand how money can be passed to beneficiaries without any taxes. Can you explain?

Answer:

Sure, it's pretty simple actually. In the end, it's all about the tax code allowing risk-free shots at passing assets to beneficiaries without paying gift or estate taxes. We are allowed as many shots as we want with zero risk or downside (except for lawyer fees to draw up the trusts).

The goal is to "zero out" the value of the property transferred to the trust so that, for tax purposes, no value is transferred even though in reality value may indeed have been transferred to the beneficiaries.

Here's how it works:

"Walton GRATs" (named for one of the heirs of Sam Walton who won a case in tax court over this) last for a term of years, with the annuity payable to the grantor or the grantor's estate if the grantor dies during the annuity term. And, the entire trust is returned to the grantor after a term of years.

So, as an example, Sheldon Adelson could put stock in one of his companies in a trust. The trust could be for say -- 2 years. It would have an annuity payable to him at a market rate and the principle of the trust to be returned to him or his estate after those 2 years.

At this point, for tax purposes, the GRAT is "zeroed out." For tax purposes, the grantor has simply transferred assets into a trust to be returned to him with a "fair" market return (there are many ingenious ways to make that fair market return quite low but that's beyond the scope of this article). Hence, there will be no "gift" for tax purposes since he's just giving something to himself.

But, in reality, there may indeed be a substantial gift. If the value of the stock (including dividends) decreases or stays the same or increases only enough to pay the annuity amount -- then nothing will be transferred to the beneficiaries of the trust.

However, if the value of the stock increases above the annuity amount, then the excess can be received by the beneficiaries free of gift tax. It would also escape any estate tax when Mr. Adelson dies since it would be gone from the estate. It's like magic. Income that is simply not considered income for gift or estate tax purposes. A legal fiction, but "legal" is the operative term.

These types of trusts are especially useful for people who own a business and know the value of its stock is likely to soar. They can put the stock in the trust now, value it at the low current value and when it soars -- that increase can go to the heirs tax free.

So, let's say Mr. Adelson put stock in one of his companies in the trust and valued the stock at 100 million dollars. Say the value of the stock rose to 1 billion dollars in 2 years. At the end of the 2 years, Mr. Adelson would get back 100 million, plus whatever annuity payments were made (maybe $500,000 a year), and the beneficiaries of his trust would receive the gain of 899 million dollars (1 billion, minus 100 million minus 1 million in annuity payments).

So, $899,000,000.00 would be transferred to his beneficiaries gift and estate tax free. That's how it works.

According to the Washington Post article, Adelson has 25 GRAT's now. So, essentially these are just no-lose gambles. If the GRAT stays the same or declines in value he get's it back, nothing is transferred to beneficiaries, no harm, no foul. The only cost is to the lawyers to draft the GRAT.

If the GRAT increases in value -- the increase passes to family members and escapes any gift or estate taxes.

So, the more Walton GRAT's you set up, the more chances you have to "win". And, again, there is no risk of losing. Maybe this is why Sheldon Adelson (a Casino Magnet) is attracted to them.

According to the Post article, wealthy people have avoided paying over $100 billion in gift and estate taxes since 2000 using this maneuver. Which, of course, many think is a good thing.

Undoubtedly, it is a perfectly legal maneuver to avoid gift and estate taxes. So, anyone with more than about $10 million in assets might want to consider setting one (or more) of these up.