MOTHER'S Day is roughly a month and a half away, but it is never too early to start thinking about the perfect gift for the special lady in your life.
While perusing the Bloomberg Businessweek website last Saturday, I found a little tidbit that Mark Zuckerberg or Travis McCoy might find useful come early May. So, all of the future millionaires on Grounds should listen very carefully. If you want to pass large amounts of your wealth on to your parents, mistress or children without incurring the federal gift tax, you should consider using a financial instrument known as a Grantor Retained Annuity Trust.
For most of us, the existence of GRATs means nothing. Unless you are very rich or an embittered, financially aware socialist you probably hold no opinion of this financial instrument. The impact of GRATs on the movement of wealth, however, has real implications on the short-term financial health of the country.
Even more important are the tax policies GRATs highlight. In the past year, GRATs have received increasing media attention because of the instrument's ability to give grantors' assets literally a free ride to the individuals of their choosing through asset appreciation.
Under the Tax Relief, Unemployment Insurance Reauthorization, and Jobs Creation Act of 2010, President Obama increased the amount of wealth transfer that an individual can make from $1 million to $5 million over the course of his lifetime prior to incurring the gift tax. This tax is a 35 percent levy mandated by the federal government on all gifted funds above the legally specified lifetime cap.
President Obama's willingness to allow wealthy families to keep an additional $1.75 million on the first $5 million they transfer to private individuals seems to conflict with his promises to tackle the American budget deficit. Obama's apparent gift to the wealthy will expire in a year, however, unless Congress and the President renew the legislation. If the rich are smart, they will take advantage of the current regulatory environment to set up gifts for their loved ones that can keep on giving for years to come.
Here is a quick overview of how GRATs work. GRATs are a special type of trust fund that can be set up for a period as short as one year or for decades. Investors place securitized assets such as stocks or bonds into the trust and use its terms to designate the percentage of the principal that is to pass on to the designated recipient when the trust expires. At the end of the trust term the principal, along with a return based on the Applicable Federal Rate, is allocated to the recipient and the estate of the grantor based on the provisions of the trust.
In recent years, the AFR has hovered around 3 percent, making the instrument increasingly attractive as a means of funneling the gains from asset appreciation to private individuals without incurring any gift or estate taxes. This can be done when the grantor retains a 100 percent interest in the trust, with all gain in the value of the assets above the AFR going directly to the beneficiary.
GRATs offer the wealthy a wonderful opportunity to bypass paying Uncle Sam when transferring wealth to private individuals. If the government seriously plans on tackling the soaring budget deficit, GRATs in their present form should be a limited time offer that the government allows to expire. There has been much political debate surrounding the current use of GRATs and the increasing of the wealth transfer cap to $5 million. Many individuals view both policies as examples of federal tax policy that benefits the rich at the expense of the nation.
A solution that has been proposed to close the alleged loophole created by GRATS is to require a 10-year minimum trust term on the financial instruments. Requiring a decade-long holding period would decrease significantly the attractiveness of GRATs and eliminate their usefulness to the thousands of Americans who employ the instruments to shelter upstream movements of wealth to their parents. Based on the current political climate, this is probably the last Mother's Day the young rich will be able to pass a short-term GRAT on to their parents.
While the future terms of GRATs remain contested, the debate surrounding the complicated financial instrument is one that should interest every American. The issues at stake are not simply whether or not successful citizens like Zuckerburg can pass on portfolio gains to their parents free of estate and gift taxes, but whether or not they have the right to give their wealth to people of their choosing. It could be argued that estate and gift taxes restrict the liberty of wealthy individuals by imposing penalties on the rich who choose to redistribute their wealth to other private citizens. I suppose the government is trying to teach its successful citizens a lesson: pay your taxes, and leave the wealth redistribution to the professionals.
Ginny Robinson's column appears Wednesdays in The Cavalier Daily. She can be reached at g.robinson@cavalierdaily.com.
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