Grantor Retained Annuity Trust (GRAT): Zeroed-Out Walton GRATs and the §7520 Rate (2026)

The §2702 Framework

IRC §2702 generally requires that a transfer of an interest in trust to or for the benefit of a family member be valued at the full fair market value of the property transferred, treating any retained interest as having zero value (unless the retained interest meets specific qualification requirements). Section 2702 prevents the abuse of GRAT-like structures with retained interests that have no economic substance.

Section 2702(a)(2)(B) provides an exception for retained interests that are "qualified interests," which include qualified annuity interests (the GRAT structure) and qualified unitrust interests (the GRUT structure). A qualified annuity interest is the right to receive a fixed annual amount payable at least annually. The Treasury regulations under Treas. Reg. §25.2702-3 set out detailed drafting requirements for the qualified annuity interest.

Because the retained annuity is a qualified interest, its present value is calculated using the §7520 rate and reduces the value of the taxable gift to the remainder beneficiaries. If structured so that the present value of the annuity equals the value of assets transferred (a "zeroed-out" GRAT), the taxable gift to the remainder beneficiaries is zero.

Walton v. Commissioner: The Zeroed-Out GRAT Validated

Prior to 2000, the IRS took the position that a GRAT could not be fully zeroed out: the IRS argued that the annuity could not include payments after the grantor's death within the term (any "balloon" payment of remaining annuity if the grantor died within the term had zero value because it would only be paid if the grantor died, which is unlikely). Under the IRS's position, the present value of the annuity always fell short of the property transferred, and a small taxable gift always remained.

In Walton v. Commissioner, 115 T.C. 589 (2000), the Tax Court rejected the IRS's position. The court held that the annuity payments could include payments to the grantor's estate (if the grantor died within the term), so that the annuity stream has a guaranteed term regardless of the grantor's survival. Properly structured, this annuity has a present value equal to the property transferred, and the gift can be zeroed out.

Treasury subsequently revised the §25.2702-3 regulations to incorporate the Walton holding (Treasury Decision 9181, 2005). The zeroed-out GRAT is now the standard structure. Pre-2000 GRATs often included a small taxable gift (using some lifetime exemption); post-Walton GRATs typically structure to zero out the gift entirely.

How the §7520 Rate Drives GRAT Outcomes

IRC §7520 provides that the value of an annuity, term-of-years, life estate, or remainder interest is computed using an interest rate equal to 120% of the federal mid-term applicable federal rate (AFR), rounded to the nearest two-tenths of one percent. The IRS publishes the §7520 rate monthly. The grantor selects the month of funding to lock in the rate (using either the funding month's §7520 rate or one of the two preceding months' rates per the regulations).

For GRAT purposes, the §7520 rate is effectively the IRS-assumed rate of return on the trust assets during the annuity term. If the trust assets earn exactly the §7520 rate (no more, no less), the annuity exhausts the trust and the remainder beneficiaries receive nothing. If the trust assets outperform the §7520 rate, the excess passes to the remainder beneficiaries free of gift tax. If the trust assets underperform, the GRAT returns the lower amount and no transfer occurs (no harm to the grantor beyond opportunity cost).

Low §7520 rates produce more favorable GRAT outcomes because the hurdle to "beat" is lower. The §7520 rate hit historical lows of 0.4% in 2020 (peak GRAT planning environment); has since risen with general interest rate increases to 4.6% to 5.2% in 2024-2025. Even at higher §7520 rates, GRATs can be effective for highly volatile or appreciating assets (concentrated stock positions, pre-IPO private equity, hedge fund interests) where the expected return substantially exceeds the §7520 hurdle.

Mortality Risk and the Short-Term Rolling GRAT

The principal risk in GRAT planning is mortality. Under IRC §2036(a) and §2039, if the grantor dies before the end of the GRAT term, a portion of the trust assets sufficient to fund the remaining annuity is pulled back into the grantor's gross estate. The exact amount depends on the §7520 rate and the remaining term; in many cases, the full GRAT assets are pulled back. The transfer-tax planning fails entirely if the grantor dies within the term.

To minimize mortality risk, GRATs are often structured with short terms (2-year, 3-year) and the technique is "rolled" by funding a new GRAT each year. A grantor who funds annual 2-year GRATs over a 10-year period creates 10 overlapping GRATs, each with only 2 years of mortality exposure. The aggregate mortality risk is much lower than a single 10-year GRAT.

Short-term GRATs do require asset appreciation to occur quickly during the 2-3 year window. They work best for assets with high volatility and expected outperformance, where some GRATs may fail (assets don't beat the hurdle) but others will succeed dramatically (assets significantly outperform). The aggregate is profitable: failing GRATs cost only the legal and administrative fees; successful GRATs transfer substantial appreciation gift-tax-free.

Best Assets for GRAT Funding

GRATs work best with assets that have (a) high expected appreciation, (b) some valuation discount available (lack of marketability, minority interest), and (c) volatile or lumpy returns that can produce significant outperformance in some periods. Common GRAT funding assets include:

• Pre-IPO company stock: privately-held shares of a company expected to IPO, with significant lack-of-marketability discount available pre-IPO.
• Concentrated post-IPO stock: a large position in a single newly-public company expected to appreciate significantly.
• Family business interests: minority interests in a closely-held family business with growing earnings and lack-of-marketability discounts.
• Hedge fund and private equity LP interests: with lock-up periods that justify discount and expected outperformance.
• Real estate during a depressed market: when valuations are low and recovery is expected.

GRATs are not effective for low-volatility broadly-diversified portfolios. A 60/40 stock-bond portfolio earning 5-7% per year over the long run is unlikely to dramatically outperform a 5% §7520 hurdle in a 2-3 year window. The technique requires concentration and volatility to succeed.

GRAT Drafting Requirements

The §25.2702-3 regulations impose detailed requirements for the qualified annuity interest:

• The annuity must be a fixed dollar amount or a fixed percentage of the initial fair market value, payable at least annually.
• The trust must prohibit additional contributions after funding.
• The annuity must be paid in cash or in kind from trust assets (the regulations permit in-kind payments).
• The trust instrument must require that any underpayment of the annuity be corrected within a specified period.
• The trust may not allow commutation (acceleration) of the annuity.
• The annuity term must be a fixed period (not for the grantor's life).

Drafting errors that fail any of these requirements void the §2702(a)(2)(B) exception and trigger gift tax on the full value of the property transferred. GRAT drafting is highly technical and should be done by experienced estate planning counsel familiar with the §2702 regulations.

Legislative Risk: Proposed Restrictions on GRATs

Several Congressional proposals over the past two decades have sought to restrict GRAT planning. Common proposals include (a) requiring a minimum 10-year GRAT term (which would increase mortality risk and make the technique less attractive), (b) requiring a minimum 10% remainder gift (preventing zeroed-out structures), (c) limiting GRAT planning to a specific dollar threshold of assets per grantor, and (d) eliminating grantor trust treatment for GRATs.

None of these proposals have been enacted as of the date of this article. GRAT planning remains available under current law. Practitioners typically monitor proposed legislation closely and recommend acceleration of planned GRATs when restrictions appear likely to advance. The 2017 Tax Cuts and Jobs Act and 2025 OBBBA did not restrict GRAT planning; the current high federal estate exemption ($15M for 2026) somewhat reduces the urgency of GRAT planning for estates below the exemption, but GRATs remain valuable for estates above the exemption and for transfer of specific high-appreciation assets.

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