Usually, IRS has great success in court when taxpayers fight audit results or seek refunds. For example, in Tax Court, the Revenue Service wins or substantially prevails the vast majority of the time. So when IRS loses, tax advisers pay attention. Two taxpayer wins on gift taxes stand out… one on grantor retained annuity trusts and the other on using a formula clause to limit gift tax exposure.
Planners are busy exploiting these victories, which can provide major estate and gift tax savings.
Start with grantor retained annuity trusts, known as GRATs. The person who establishes the trust gets an annuity for a set term. Any balance remaining after the annuity is paid goes to whomever the grantor named when the trust was established, typically a family member. The actuarial value of the remainder interest is a taxable gift up front. The current low IRS interest rate…2.4%…helps trim the value of the remainder, which tamps down the gift tax bill.
The remainder beneficiaries can get a large amount of assets gift-tax free. If the trust’s assets appreciate by more than the IRS interest rate, the beneficiaries get the excess and the grantor doesn’t owe any gift tax or estate tax on that amount. However, if the assets underperform, the beneficiaries do not receive any money. The potential estate tax savings are huge if the GRAT’s assets appreciate significantly. But if the grantor dies during the GRAT’s term, the assets are in the grantor’s estate.