GRATs and GRUTs: Estate Planning Trusts Explained

Q: What was the Walton case?

Walton v. Commissioner, 115 T.C. 589 (2000), is the Tax Court decision that validated the zeroed-out GRAT strategy. Audrey J. Walton—wife of Walmart co-founder James "Bud" Walton—created two GRATs in 1993, each funded with approximately 3.6 million shares of Walmart stock and structured so the retained annuity consumed virtually all of the trust's value over a two-year term. The IRS asserted each gift was worth approximately $3.8 million, arguing the estate's contingent right to annuity payments if Audrey died during the term should not count as a retained interest. The Tax Court sided with Audrey, holding that an individual cannot make a gift to herself or her own estate, so the contingent payments were a retained interest that reduced the taxable gift to near zero. The decision opened the door for widespread use of zeroed-out (or Walton) GRATs.

Key Takeaways

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GRATs pay a fixed annuity — the grantor receives a set dollar amount each year, providing certainty and predictability.
GRUTs pay a percentage of trust value — distributions fluctuate annually, but GRUTs can accept additional contributions that GRATs cannot.
Both reduce gift and estate taxes — by retaining an income interest, the grantor discounts the value of the gift for tax purposes.
Survival is critical — if the grantor dies before the trust term expires, a portion of the trust property is pulled back into the estate under IRC Section 2036(a)(1). Rolling GRATs help mitigate this risk.
Neither faces the GRIT valuation penalty — unlike GRITs, both GRATs and GRUTs may name children or a spouse as beneficiaries without destroying the gift tax discount.

In this post, I discuss grantor retained annuity trusts (GRATs), grantor retained unitrusts (GRUTs), and their potential estate planning benefits.

In a previous post, I discussed grantor retained income trusts, or GRITs. In this post, I will discuss related types of trusts that can also serve as valuable estate-planning tools: grantor retained annuity trusts and grantor retained unitrusts, or GRATs and GRUTs. These are irrevocable trusts more common than GRITs.

Nature of GRATs and GRUTs

GRATs and GRUTs allow the settlor of the trust to transfer property into the trust and retain either an annuity interest—GRATs—or a unitrust interest—GRUTs. (An annuity interest provides payment of a fixed annuity, such as $10,000 per year, whereas a unitrust interest provides a payment equal to a percentage of the trust value, such as 5% of the trust’s value per year.) Distributions are not merely made of the trust’s income. If the trust’s income cannot meet the annuity or unitrust obligations, the trust’s principal must be utilized.

These trusts may be set up for a fixed term of years, for the grantor’s life, or for the shorter of the two. When the trust terminates, the assets remaining in the trust will be paid out to the final beneficiaries of the trust.

A major limitation of GRITs is that naming children, a spouse, or other family members as beneficiaries causes the grantor’s retained interest to be valued at zero under IRC Section 2702, destroying the gift tax discount. Because GRATs and GRUTs hold “qualified interests” under the statute, they do not face this penalty and may freely name family members as remainder beneficiaries.

Understanding Retained Interest

When the grantor creates a GRAT or GRUT, they do not simply give property away outright. Instead, they transfer property into the trust while keeping something back for themselves—an annuity stream (in a GRAT) or a unitrust percentage (in a GRUT). This kept-back portion is the grantor’s “retained interest,” and it is central to the tax benefit these trusts provide.

The IRS values the retained interest using the Section 7520 rate, a discount rate published monthly based on the federal midterm rate. The present value of all expected annuity or unitrust payments is calculated, and that figure represents the retained interest. The taxable gift is simply the difference: the fair market value of the property transferred into the trust minus the present value of the retained interest.

Consider a simple example. Suppose a grantor transfers $1,000,000 in stock into a two-year GRAT and retains an annuity of $515,000 per year. If the Section 7520 rate is 5%, the present value of the two annuity payments—$515,000 discounted back one and two years—comes to roughly $960,000. That means the taxable gift is only about $40,000, even though $1,000,000 in assets entered the trust. If the stock appreciates beyond the 5% hurdle rate during those two years, all of the excess appreciation passes to the beneficiaries free of gift and estate tax.

Now consider the GRIT problem. Under IRC Section 2702, a retained income interest in a trust for the benefit of family members is valued at zero rather than at its actuarial value. If our grantor had used a GRIT instead of a GRAT, the retained interest would be deemed worthless for gift tax purposes—making the entire $1,000,000 transfer a taxable gift. GRATs and GRUTs avoid this result because their annuity and unitrust interests are “qualified interests” that the IRS is required to value using the standard actuarial tables.

Interactions with the Estate and Gift Tax

Just like GRITs, GRATs and GRUTs are valuable tools to lower eventual estate and gift tax liabilities. The value of the gift is usually less than the value that an outright gift would hold, thereby lowering your gift tax bill while removing the property from your estate.

As with GRITs, however, the value of the trust property is only excluded from your estate if you survive the term of the trust. If you die before the trust term expires, a portion of the trust property will be included in your gross estate under IRC Section 2036(a)(1) and subject to the estate tax. This creates a balance of considerations: you may want to retain the annuity or unitrust payments for as long as possible, but a longer trust term increases the risk that you will not survive to the end.

A longer trust term means more annuity or unitrust payments for the grantor, but it also raises the risk of dying before the term ends—which would pull the trust property back into the estate.

Rolling GRATs

Rolling GRATs seek to address this problem. A rolling GRAT strategy uses a series of short-term GRATs—often with two-year terms—where the annuity payments received from one GRAT are used to fund the next GRAT in the series. Because each individual trust term is short, the grantor is more likely to survive each term and avoid estate inclusion. The strategy also allows the grantor to capture gains across multiple market cycles rather than betting on a single long-term trust.

GRATs Explained (Video)

Choosing Between the Two

If you believe either a GRAT or a GRUT would be a good fit in your estate plan, you may need to choose between the two. GRATs offer more certainty, as the amount distributed is fixed and predictable. The distributions from GRUTs, however, have the potential to increase every year—though they have the potential to decrease as well. In addition, GRUTs do not face the same risk of running out of property prior to the expiration of the trust.

One advantage that a GRUT has over a GRAT that is worth considering is the GRUT’s ability to accept additional contributions. GRATs do not share this benefit. Determining which type of trust is right for you, however, can be a complex matter and should be discussed with competent legal or tax counsel. You may also want to consider a qualified personal residence trust if your primary goal is transferring a personal residence.

Frequently Asked Questions

What is a GRAT?

A grantor retained annuity trust (GRAT) is an irrevocable trust that allows the grantor to transfer property into the trust while retaining a fixed annuity payment for a specified term (a term of years, the grantor’s life, or the shorter of the two). When the trust term expires, the remaining assets pass to the beneficiaries. Because the grantor retains an annuity interest, the value of the taxable gift is discounted, often significantly reducing gift tax liability.

What is the difference between a GRAT and a GRUT?

The key difference is how distributions are calculated. A GRAT pays the grantor a fixed dollar amount each year (for example, $10,000 per year), regardless of how the trust’s investments perform. A GRUT pays a fixed percentage of the trust’s value, recalculated annually—so distributions rise and fall with the trust’s performance. GRUTs also accept additional contributions after creation, while GRATs do not.

What happens if the grantor dies during the trust term?

If the grantor dies before the trust term expires, a portion of the trust property is included in the grantor’s gross estate under IRC Section 2036(a)(1). This can substantially negate the estate-planning benefit of the trust. Rolling GRATs—a series of shorter-term GRATs where annuity payments from one GRAT fund the next—help mitigate this risk by reducing the amount of property at stake in any single trust.

What is a zeroed-out GRAT?

A zeroed-out GRAT (also known as a Walton GRAT, after the Tax Court case that validated the strategy) is structured so that the annuity payments have a present value approximately equal to the property transferred, reducing the taxable gift to near zero. If the trust’s assets outperform the IRS Section 7520 rate—the hurdle rate used to value the retained annuity—the excess passes to beneficiaries free of gift and estate tax.

What is the Section 7520 rate and why does it matter?

The Section 7520 rate is set monthly by the IRS at 120% of the applicable federal midterm rate. It serves as the discount rate for valuing annuity and unitrust interests retained by the grantor. A lower 7520 rate makes GRATs more effective because the required annuity payment is smaller, leaving more room for appreciation to pass tax-free to beneficiaries. This rate is a critical factor in determining whether and when to establish a GRAT.

What was the Walton case?

Walton v. Commissioner, 115 T.C. 589 (2000), is the Tax Court decision that validated the zeroed-out GRAT strategy. Audrey J. Walton—wife of Walmart co-founder James “Bud” Walton and sister-in-law of Sam Walton—created two GRATs in 1993, each funded with approximately 3.6 million shares of Walmart stock and structured so that the retained annuity consumed virtually all of the trust’s value over a two-year term. Each GRAT named one of her daughters (Ann Walton Kroenke and Nancy Walton Laurie) as its sole remainder beneficiary. Audrey filed a gift tax return valuing the gifts at zero. The IRS issued a notice of deficiency, asserting that each gift was worth approximately $3.8 million. The central dispute was whether the estate’s contingent right to receive the remaining annuity payments—if Audrey died during the two-year term—counted as part of her retained interest. The Tax Court sided with Audrey, reasoning that an individual cannot make a gift to herself or her own estate, and therefore the contingent payments were a retained interest that reduced the taxable gift to near zero. The decision opened the door for the widespread use of zeroed-out (or “Walton”) GRATs, which have since become one of the most popular estate-planning techniques among high-net-worth families.

Can a GRAT or GRUT name children as beneficiaries?

Yes. Under IRC Section 2702, a GRIT’s retained income interest is valued at zero when family members are named as beneficiaries, destroying the gift tax discount. Because GRATs and GRUTs hold “qualified interests” under the statute, they may freely name lineal descendants, spouses, or siblings as remainder beneficiaries without any valuation penalty. This makes them far more practical for most families’ estate-planning needs.

This article is for informational purposes only and does not constitute legal or tax advice. Estate planning involves complex legal and financial considerations that vary by jurisdiction. Consult a qualified attorney or tax professional before making decisions about your estate plan.