What Is a GRAT (Grantor Retained Annuity Trust)?

1. How Does a GRAT Work?

A GRAT works by splitting one asset into two pieces, an annuity you keep and a remainder your family receives. You transfer property, such as shares of a family company or a block of stock, to an irrevocable trust. The trust pays you a fixed dollar amount at least once a year for a term you choose, often two years. When the term ends, the property left in the trust passes to your children, either outright or in a continuing trust for them.

The gift is only the remainder. Federal law measures the gift as the value of the property you put in, minus the value of the annuity you kept. The annuity counts in that subtraction only if it is a qualified interest, meaning a right to fixed amounts paid at least annually (or a fixed percentage of the trust, which is the unitrust version). Any other retained interest is treated as worth zero when the remainder goes to family, which is why the old income-only trusts no longer work for family gifts.

The family wins when the asset grows faster than the IRS assumed. If the property earns more than the IRS rate over the term, the excess stays in the trust after your last payment and passes to your children without using any of your $15,000,000 federal exemption.

2. What Is the 7520 Rate, and Why Does It Decide Everything?

The 7520 rate is the interest rate the IRS uses to value your annuity, and it is the hurdle the trust has to beat. Federal law sets the rate each month at 120% of the federal midterm rate, rounded to the nearest two-tenths of a percent, and a GRAT uses the rate for the month it is funded. The IRS publishes the figure monthly, and we confirm the current number when we design the trust.

A low rate makes a GRAT easier to win. The IRS assumes the trust property grows at exactly the 7520 rate, so when the rate is low, the annuity needed to return your money is smaller and more of the actual growth is left over. When the rate is high, the asset has to perform better before your children receive anything.

A GRAT does not need the asset to grow a great deal. A company whose value rises 20% in one year, measured against a hurdle of about 5%, leaves roughly the difference in the trust for your children, and on a $10,000,000 block of shares that difference is in the range of $1,500,000 passing without gift tax.

3. What Is a Zeroed-Out GRAT?

A zeroed-out GRAT is a GRAT whose annuity is set high enough that the value of the annuity equals, or nearly equals, the property transferred, so the taxable gift is close to zero. The annuity can also rise from year to year, and many designs raise each payment by 20% over the one before, which leaves more property working in the trust in the early years.

Treasury once took the position that an annuity payable to your estate if you die during the term was not part of the qualified interest, which pushed the gift value up. The full Tax Court rejected that position in 2000 in the case retold at the end of this page, and in 2005 Treasury rewrote its own regulation to match. A payment stream for a fixed term, paid to you or to your estate in all events, now counts in full as a qualified interest.

The zeroed-out design is why a failed GRAT costs little. If the asset falls, the annuity payments use up the trust, the property comes back to you, and your children receive nothing, but you used almost none of your exemption to try. The cost of a failure is mostly the drafting, the appraisal and the gift tax return, and the family can try again with a new GRAT.

4. What Happens If You Die During the GRAT Term?

Death during the term is the main risk of a GRAT. If you die before the last annuity payment, federal regulations include in your taxable estate the part of the trust needed to produce your annuity at the 7520 rate, which is often most or all of the property. The estate tax treats the plan roughly as if the GRAT had never been signed, apart from the legal fees.

Short terms are the usual answer. A two-year GRAT exposes you to two years of mortality risk, and a family that wants a longer program sets up a new two-year GRAT each year, funded with the annuity payments from the last one, which is called rolling GRATs. A term longer than your life expectancy defeats the purpose. The regulations also require the term to be for a fixed number of years, for your life, or for the shorter of the two, and never the longer.

Life insurance held in an irrevocable life insurance trust can cover the estate tax a death during the term would cause, and we price that against the GRAT when the grantor is older or in poor health.

5. Which Assets Work Best in a GRAT?

The assets that work best in a GRAT are the ones with the most room to rise over a short term. Shares of a business before a sale or a financing round, stock in a company expected to grow, and interests in a family partnership valued with a discount are the common choices. Cash and bonds rarely beat the hurdle by enough to matter.

Each asset should have its own GRAT. A trust holding two stocks lets the loser cancel the winner, while two separate trusts let the winner pass its growth to your children and the loser simply return to you. Hard-to-value assets need a qualified appraisal, and the annuity terms should include a formula so that a later IRS change to the value adjusts the annuity rather than creating a gift.

A home is a poor fit. A residence goes in a different trust built for it, the qualified personal residence trust, and a Florida homestead has restrictions of its own on who can receive it at death, covered in our guide to the homestead and a surviving spouse.

6. Who Pays the Income Tax on a GRAT?

The grantor pays the income tax on a GRAT during the term. Trust income that is payable to the grantor makes the trust a grantor trust, so the IRS treats you as the owner, and the dividends, interest and gains are reported on your own return. The annuity payments back to you are generally not a separate taxable event, because for income tax you are paying yourself.

Paying that tax helps your family. Every dollar of tax you pay on the trust’s income is a dollar that stays in the trust for your children without being counted as a gift. Florida law also lets a trustee reimburse the grantor for that income tax in the trustee’s discretion, unless the trust elects out, and our page on the grantor trust reimbursement rule explains who can make that call. Many GRATs are drafted to shut the reimbursement off, so the tax payment keeps working for the family.

Florida adds no gift tax and no state income tax, so a Florida resident’s GRAT has only the federal rules to satisfy. A beneficiary’s tax on later trust distributions is a separate question once the GRAT has ended and the remainder trust begins.

7. Can a GRAT Benefit Grandchildren?

A GRAT is a poor vehicle for grandchildren. Federal law does not let you apply your generation-skipping transfer exemption to property that would be in your estate if you died, and during a GRAT term the property would be. The exemption can only be applied when the term ends, measured by the value at that point, which is after the growth has already happened.

Families who want the growth to reach grandchildren usually pay the GRAT remainder to the children, or to a trust for them, and use a different trust for the generation-skipping piece. Our guide to the generation-skipping transfer trust covers that design, and the Florida dynasty trust page covers how long Florida lets one last.

How Does a GRAT Compare With a SLAT or a Bypass Trust?

A GRAT uses almost none of your exemption and moves only the growth, while a spousal lifetime access trust uses your exemption now to move the whole asset and its future growth, with your spouse able to receive distributions. A bypass trust is created at the first spouse’s death rather than during life. Many families above the exemption use a GRAT and a SLAT together, and every one of these trusts sits beside the revocable living trust that handles everything else.

What Does a GRAT Cost?

Designing and funding a GRAT is a flat fee quoted at consult, because the work depends on the asset, whether an appraisal is needed and how many GRATs the plan uses. The fee includes the trust, the funding documents and the instructions for paying the annuity on time. Appraisal fees and other third-party costs are additional and passed through at cost. Advertised fees are honored for 90 days from the posted date.

Frequently Asked Questions

Common Situations

The founder before a sale. A founder holds shares worth $4,000,000 in a company that may be sold within two years at a much higher price. She funds a two-year GRAT with the shares at today’s appraised value. If the sale closes at three times the value, most of the gain above the IRS rate passes to her children’s trust after the second annuity payment, and she used almost none of her exemption.

The investor who rolls them. A retired executive funds a new two-year GRAT every year with a concentrated stock position. The years the stock falls, the trust simply pays him back. The years it rises, the excess passes to his children, and no single death during a term puts more than one trust back in his estate.

Sources of Law

• 26 U.S.C. §2702(a),(b) (retained interests in trusts for family members valued at zero unless a qualified annuity, unitrust or remainder interest; qualified interests valued under §7520), law.cornell.edu; 26 U.S.C. §7520(a) (120% of the federal midterm rate, rounded to the nearest 0.2%, for the month of the valuation date).
• Treas. Reg. §25.2702-3(d)(4) (term fixed for life, a term of years, or the shorter of the two) and (e) Examples 5 and 6 (an interest paid to the grantor or the grantor’s estate for a fixed term in all events is qualified), as amended by T.D. 9181, 70 Fed. Reg. 9224 (Feb. 25, 2005); Treas. Reg. §20.2036-1(c)(2)(i) (inclusion of a GRAT in the grantor’s gross estate on death during the term).
• 26 U.S.C. §2010(c)(3)(A) (basic exclusion amount of $15,000,000); 26 U.S.C. §2642(f) (no allocation of GST exemption before the close of the estate tax inclusion period); 26 U.S.C. §§671, 677(a) (grantor trust status where income may be distributed to the grantor).
• Fla. Stat. §736.08145 (trustee may reimburse the grantor for income tax on grantor trust income unless the trust elects out); Fla. Stat. §736.0814 (annotated)(2) (limits on a trustee who is also a beneficiary).
• Case retold below: Walton v. Commissioner, 115 T.C. 589 (2000) (reviewed by the Court). Opinion read in full; retrieved September 30, 2026.

What a Failed GRAT Taught the IRS

I have come across a case where two GRATs did everything wrong for the family on paper and still settled the rule every GRAT drafted since relies on.

In April 1993 a Missouri woman owned about 7.2 million shares of Wal-Mart stock. She split them between two GRATs of about $100,000,000 each, with a term of two years. Each trust paid her 49.35% of its starting value in the first year and 59.22% in the second, and if she died during the term the payments went to her estate. One daughter was the remainder beneficiary of the first trust, the other daughter of the second, and each daughter served as a trustee with her mother. The stock fell. By June 1995 the payments had used up both trusts entirely, each trust came up about $14,500,000 short of the payments it promised, and the daughters received nothing. On her gift tax return she valued the gifts at zero. The IRS said her retained interest ran only for her life, because the regulation then treated the payments to her estate as unqualified, and it valued each gift at about $3,800,000 and assessed a gift tax deficiency of about $4,500,000. She conceded a gift of about $6,200 per trust. The full Tax Court sided with her in December 2000, held the regulation’s example invalid, and treated her retained interest as an annuity for a fixed two-year term payable to her or her estate. Treasury rewrote the example in 2005.

My reading of that case is that it proves the downside of a GRAT is small. She transferred $200,000,000 of stock, the market went against her, and the fight was over a gift of about $12,000. In reviewing GRAT planning and the regulations since, I have a few take-home points.

The first is the estate clause. The annuity has to run for a fixed term and be paid to you or to your estate in all events, which is the language the 2005 regulation now approves. A GRAT that stops payments at death reopens the argument she won.

The second is the term. She chose two years, and two years is still the usual choice because the mortality risk grows with every year of the term.

The third is one asset per trust. Both of her trusts held the same stock, so they rose and fell together. Avoid putting several assets in one GRAT, because a loss on one quietly cancels the gain on another that would otherwise have passed to your children.

An owner can set these terms at the drafting stage and roll a new GRAT each year so no single bad market decides the plan. One limit is worth stating plainly. The Tax Court sent the actuarial arithmetic back for a separate computation, so the opinion does not report the final gift tax she paid.

Kevin D. Klagge, Esq., admitted in Florida since 2012. The case described above is a decision of the United States Tax Court rather than a matter handled by this firm. Past results do not guarantee a similar outcome.

Updated on September 30, 2026. Reviewed by Kevin D. Klagge, Esq., Fla. Bar No. 99502. Attorney Kevin Klagge represents families, businesses, and international clients in estate and tax planning, business structuring, and international law, with a focus on Florida legal tools. He litigates estate and business issues in court. General information about federal and Florida law, not legal or tax advice, and no attorney-client relationship is created. Do not send confidential information until we have agreed to represent you.