GRAT (Grantor Retained Annuity Trust) in New York

A GRAT passes the growth on an asset to your children with little or no gift tax and almost no exemption used. This page explains the mechanism, the hurdle rate, the risks, and why the structure suits New York residents.

Some clients own an asset they expect to grow sharply: a concentrated stock position, shares in a company approaching a sale or public offering, or a family business turning the corner. Giving it away outright uses exemption and, in New York, starts a three-year clock. Holding it means the growth lands in a taxable estate. A grantor retained annuity trust, or GRAT, is built for exactly this asset.

The idea is to lend the asset to the next generation for a few years rather than give it. You transfer it to the trust, take back an annuity that returns your principal plus a modest rate of interest, and whatever the asset earns above that rate stays in the trust for your children. With a permanent $15,000,000 federal exemption, the GRAT’s value for most New Yorkers is moving growth past the $7,350,000 state exclusion and the $7,717,500 cliff without a taxable gift that New York could add back.

The mechanism

1. You fund an irrevocable trust

The grantor transfers the chosen asset to a trust with a fixed term, commonly two to ten years. The trust is a grantor trust, so the transfer is not a sale and produces no income tax.

2. You receive an annuity for the term

Each year the trust pays the grantor a fixed amount, or a fixed percentage of the initial value, which the regulations allow to increase modestly from year to year. The annuity is set so that, at the IRS’s assumed rate, the payments add up to everything that went in.

3. The remainder passes to your beneficiaries

Whatever is left when the term ends passes to the children or to a continuing trust for them. Because the retained annuity is a “qualified interest” under IRC § 2702, its value is subtracted from the gift, and the taxable gift is only the present value of the remainder.

In Walton v. Commissioner, 115 T.C. 589 (2000), the Tax Court confirmed that the annuity can be sized to return the entire contribution plus interest, so that the remainder is worth close to nothing on the day of funding. That is a “zeroed-out” or Walton GRAT, and it is the form we use almost exclusively. We describe the structure at more length on our page on using GRAT trusts in New York.

The § 7520 hurdle rate

The IRS publishes a rate each month under IRC § 7520 that it uses to value annuities, term interests and remainders. For a GRAT it is the hurdle: the trust must earn more than the § 7520 rate in effect for the month of funding for anything to be left over. If the asset earns exactly the hurdle, the annuity consumes it all and the children receive nothing, but nothing is lost except the setup cost. If it earns more, the excess passes with no gift tax and no exemption. If it earns less, the trust runs out before the last payment and the grantor is where he or she started.

The rate is fixed for the life of the GRAT at funding, so a GRAT created in a low-rate month keeps its low hurdle even if rates rise. Because the rate moves, we do not quote it on this page; we check it when we plan the funding date.

What assets work in a GRAT

Concentrated public stock

A single stock held in size, with real upside, is the classic GRAT asset. Volatility is a feature: a good year passes wealth, a bad year costs only fees.

Pre-IPO and pre-sale shares

Shares funded into a GRAT before a liquidity event pass the step-up in value to the remainder. The valuation at funding must be supportable, ideally by a qualified appraisal.

Closely held business interests

Non-voting or minority interests in an S corporation, partnership or LLC, valued with lack-of-control and lack-of-marketability discounts. The annuity can be paid in kind with units.

Discounted LLC units

Units of a family LLC combine the discount with the growth transfer. Where the IRS challenges the value, an annuity defined as a percentage of the initial value as finally determined for gift tax purposes adjusts itself rather than creating a taxable gift.

Cash, bonds and assets expected to grow at or below the hurdle rate are poor candidates. So are assets the grantor may need back before the term ends.

Mortality risk and rolling GRATs

The one risk a GRAT cannot design away is the grantor’s death during the term. If that happens, the trust assets are included in the grantor’s gross estate under IRC § 2036 to the extent needed to produce the annuity, which for a zeroed-out GRAT is effectively all of it. The estate is then where it would have been without the GRAT: nothing lost, nothing gained. Federal inclusion flows into the New York gross estate, so the same is true for the state tax.

The answer is to keep terms short and to roll. A two-year GRAT limits mortality exposure to two years. Each annuity payment received can be contributed to a new two-year GRAT, so a series of overlapping GRATs captures the growth in every good period while any single bad period costs nothing. Our page on the rolling GRAT in New York explains how the payments are recycled. A longer term makes sense mainly for an asset with a known future event, such as a sale expected in year three.

Why GRATs fit New York residents

New York has no gift tax, so the GRAT costs nothing at the state level when funded. New York’s only lifetime-transfer rule is the three-year add-back (Tax Law § 954(a)(3)), and it reaches only taxable gifts, the kind reported on a Form 709. A zeroed-out GRAT’s taxable gift is trivial, so even if the grantor dies within three years of funding, the amount added back is trivial too. The growth that passed to the children when the term ended is not a gift at all for New York purposes and never re-enters the state calculation.

The annuity payments, by contrast, come back to the grantor and remain in the estate. A GRAT does not shrink the estate; it caps it. That is precisely what a New York family near the cliff needs. A resident with $7,000,000 who expects an asset to run is at risk of crossing $7,717,500 and paying about $735,000 on an estate that would otherwise pay nothing. A GRAT keeps the principal in the estate and sends the run to the children, without the three-year exposure that a SLAT or an outright gift carries.

GST inefficiency: GRATs are for children, not grandchildren

A GRAT is a poor vehicle for skipping a generation. Under the estate tax inclusion period (ETIP) rules of IRC § 2632, GST exemption cannot be effectively allocated to a trust while its assets would be included in the grantor’s estate if the grantor died. For a GRAT, that means no allocation until the term ends. By then the remainder has, if the GRAT worked, grown substantially, and the exemption needed to shelter it is the grown value, not the near-zero value at funding.

We therefore draft GRAT remainders for children (or trusts for children that are not skip trusts) and use separate dynasty trusts or a GST trust, funded with direct gifts and a full allocation of the $15,000,000 GST exemption, for grandchildren. If a child dies before the term ends, the trust should vest that child’s share in the child’s estate rather than let it skip to grandchildren.

Form 709 and adequate disclosure

The GRAT gift must be reported on a Form 709 by April 15 of the year after funding, even though the taxable gift is close to zero. A return that meets the adequate-disclosure standard (Treas. Reg. § 301.6501(c)-1(f)), with a description of the asset, the valuation method, and the appraisal for any closely held interest, starts the three-year statute of limitations on the value. Without it the IRS can revisit the value at death with no time limit and argue that the annuity was too small. The Form 709 page lists what an adequate disclosure requires.

Income tax: grantor trust status and no step-up

A GRAT is a grantor trust under IRC §§ 671–679 throughout its term. The grantor reports the trust’s income and gains on his or her own return, the annuity payments are not taxable income, and paying the trust’s tax is not a gift (Rev. Rul. 2004-64). Assets can be paid out in kind to satisfy the annuity without triggering gain.

The cost is basis. The remainder beneficiaries take the grantor’s basis under § 1015, and because the assets are outside the estate they get no § 1014 step-up when the grantor dies (Rev. Rul. 2023-2). For a New York City resident, a later sale can face a combined federal, state and city long-term rate of roughly 38.5% on the built-in gain. Against that, the estate tax avoided is 40% federally on amounts over the exemption and up to 16% in New York, with the cliff making the state cost far worse near $7,350,000. A § 675(4)(C) swap power (Rev. Rul. 2008-22) lets the grantor exchange cash or high-basis assets for low-basis trust assets before the term ends, so the low-basis property can be held until death and stepped up. Our pages on capital gains tax versus estate tax and step-up in basis cover the comparison.

A worked example

A New York resident owns $5,000,000 of a single stock she believes is undervalued. Her other assets are about $6,000,000. She funds a two-year zeroed-out GRAT with the stock.

Without the GRAT, her estate would hold the doubled stock, roughly $16,000,000 in total, and face New York tax well over the $1,386,800 owed on a $12,000,000 estate, plus federal tax on the amount above $15,000,000. With it, the growth is with the children and her New York estate is around $11,000,000, still taxable but by far less. If the stock instead falls, the GRAT unwinds, she gets back whatever is there, and the cost is the drafting and administration. If she dies in the two-year window, the stock is back in her estate under § 2036 and she is no worse off than she started.

Who a GRAT is for, and who it is not for

• Good fit: a New York resident with an asset likely to outperform the hurdle rate, who does not need to give away principal, and whose estate is near or above $7,350,000. Founders, executives with concentrated stock, and owners of appreciating businesses are typical.
• Poor fit: someone whose primary goal is to reduce the estate itself (a GRAT returns the principal), someone in poor health, someone who wants to benefit grandchildren, or someone holding low-growth or low-basis assets where the lost step-up outweighs the transfer tax saved.

Pitfalls

• Missed or late annuity payments. The annuity must be paid on time; the regulations allow a short grace period, but a pattern of late or skipped payments can disqualify the retained interest and make the entire transfer a gift.
• Paying the annuity with a note. The trust may not issue a note to the grantor to satisfy the annuity. Pay in cash or in kind.
• Unsupported valuation. An undervalued contribution shrinks the annuity and creates a gift. Use a qualified appraisal for anything not publicly traded and define the annuity as a percentage of the finally determined value.
• Long terms. Mortality risk grows with the term. Prefer short, rolling GRATs unless a specific event justifies a longer one.
• Grandchildren as remainder beneficiaries. The ETIP rule makes this expensive. Keep GRAT remainders at the children’s level.
• No Form 709. Skipping the return because the gift is “zero” forfeits the statute of limitations.

Related Estate Tax Planning Topics

• SLAT – Moving principal, not just growth, out of the estate while a spouse keeps access.
• Family LLC and Valuation Discounts – Discounted units are an efficient GRAT asset.
• The New York Estate Tax Cliff – Why capping growth matters between $7,350,000 and $7,717,500.
• Tax Basis: Step-Up and Carryover – The cost of taking assets out of the estate before death.
• Generation-Skipping Transfer Tax – Why a GRAT is the wrong tool for grandchildren.

Talk to us about a GRAT

We design GRATs and rolling GRAT programs for New York residents, prepare the Form 709 with adequate disclosure, and coordinate the valuation and the remainder trust. Call Albert Goodwin at 212-233-1233 or email [email protected] to discuss whether a GRAT fits your assets.