Inclusion of Annuity Trusts and Unitrusts (GRATs, CRATs, CRUTs, and GRUTs)

Under § 2036 of the Internal Revenue Code, the property that is included in the gross estate for federal estate tax purposes and so subject to federal estate tax at a person's death includes not only the property that they own but also any property that they have given away but retained the right to the income or use of the property. (States that have their own death taxes have similar rules for the purpose of their taxes.)

When the grantor has retained not the right to the "income" of the trust, but an annuity amount or unitrust percentage payout, the same principle applies, but a different calculation must be performed to determine the portion of the trust that included in the gross estate and so subject to federal estate tax because the annuity or unitrust might be less than the income of the trust.

Annuity Trusts and Unitrusts

The kinds of annuity trusts and unitrusts that will most often be subject to these inclusion rules are GRATs, CRATs, CRUTs, and GRUTs:

• A grantor retained annuity trust, or “GRAT,” is an irrevocable trust from which the grantor (i.e., the creator or settlor) of the trust has retained the right to receive an annuity of a fixed (or determinable) amount during the term of the trust, which can be for life or a term of years, but which is almost always for a term of years. At the end of the term of the trust, the remaining assets of the trust go to the beneficiaries (such as children or grandchildren of the grantor) that are specified in the trust document, but if the grantor dies during the term of the trust then all or a part of the trust will be included in the grantor's taxable estate regardless of whether the trust ends or continues.
• A charitable remainder annuity trust, or “CRAT,” is an irrevocable trust which distributes an annuity of a fixed amount to one or more individuals. When the trust ends, either because the trust was for a term of years or because the indiviudal beneficiaries have died, the remaining assets of the trust go to one or more charitable beneficiaries. If the grantor has retained the right to all or part of the annuity distributions and the grantor dies before the trust ends, then all or a part of the trust will be included in the grantor's taxable estate regardless of whether the trust ends or continues.
• A charitable remainder unitrust, or “CRUT,” is an irrevocable trust which distributes a fixed percentage of the value of the trust (redetermined each year) to the grantor (i.e., the creator or settlor) or other individuals. When the trust ends, the remaining assets of the trust go to one or more charitable beneficiaries. If the grantor has retained the right to all or part of the unitrust distributions and the grantor dies before the trust ends, then all or a part of the trust will be included in the grantor's taxable estate regardless of whether the trust ends or continues.
• A grantor retained unitrust, or “GRUT,” is an irrevocable trust from which the grantor (i.e., the creator or settlor) of the trust has retained the right to receive an annual distribution of a fixed percentage of the value of the trust (redetermined each year) during the term of the trust. GRUTs are therefore similar to GRATs, but are rarely used because the way they are valued and make distributions will usually produce no tax benefit to the grantor or the grantor's beneficiaries.

Why Use It?

An inclusion calculation is needed when the grantor (creator or settlor) of an annuity trust or unitrust has died and a federal estate tax return (or state death tax return) is required, so the portion of the trust that is subject to federal estate tax or (or state death tax) must be determined.

How Does It Work?

As will be explained below, the general approach is to treat the annuity amount or unitrust distribution as an income, and then compare that income to the interest rate determined under I.R.C. §7520 for the month of the death of the grantor.

The §7520 rate is used for this purpose because it is the rate used to determine the present value of the income from a trust for a life or a term of years years. (The §7520 rate is 120% of the average yield on federal securities with maturities of more than three years but not more than nine years.)

Annuity Interests

Simple (Ungraduated) Annuity Interests

When the grantor has retained an annuity (such as an annuity from a charitable remainder trust) that is a fixed amount each year, and does not increase, the annualized annuity is treated as an income stream and divided by the §7520 rate to determine the amount of principal needed to produce that income. That principal amount is the portion of the trust that is included in the grantor's gross estate (but not in excess of the actual value of the trust, of course).

The "annualized annuity" is the total annuity amount payable each year, multiplied by an adjustment factor if the annuity amount is payable in installments that are more frequent than annual.

Increasing (Graduated) Annuity Interests

When the decedent has retained an annuity interst that is scheduled to increase in value each year (which is commonly done in GRATs), the calculation of the portion of the trust to be included in the grantor's gross estate is somewhat more complicated, because it is necessary to calculate the increasing amounts of principal needed to provide the income for the increasing annuity amounts and then discount those future principal amounts back to present value.

Unitrust Interests

When the grantor has retained a unitrust interest (such as a unitrust interest in a charitable remainder unitrust), the adjusted payout rate is converted to an equivalent income interest rate by dividing the adjusted payout rate by one minus the adjusted payout rate. The "adjusted payout rate" is the unitrust payout percentage multiplied by a factor when the unitrust distributions are not annual or are not made immediately after the annual valuation.

The equivalent interest rate is then divided by the §7520 rate to determine the percentage of the trust principal that would be needed to produce the income to pay the unitrust distributions without distributing any principal. That percentage of the trust principal (but not more than 100%, of course) is included in the grantor's gross estate.