Grantor Retained Annuity Trust (GRAT): Definition and How It Works in California

By Eric Ridley, attorney, Ridley Law. Updated October 2026.

A grantor retained annuity trust (GRAT) is an irrevocable trust that pays its creator a fixed annuity for a set term, then passes what is left to family. The gift is valued on day one, so any growth above the IRS interest rate reaches the children free of gift tax.

How it works in California

Ridley Law has a full guide to GRATs. The rules are federal. Under 26 U.S.C. § 2702, an interest the grantor keeps in a trust for family is valued at zero unless it’s a “qualified interest,” and a right to fixed payments made at least once a year qualifies. That qualified annuity is valued using the section 7520 rate, so the taxable gift is what goes in minus the present value of the annuity. Each year’s payment can’t be more than 120 percent of the year before (Treas. Reg. § 25.2702-3(b)(1)(ii)(A)).

In Walton v. Commissioner (2000) 115 T.C. 589, the Tax Court held that a two-year annuity payable to the grantor or, if she died, to her estate is valued as a fixed-term annuity, and it struck down the regulation example the IRS relied on. That ruling is what lets a GRAT be “zeroed out,” with the annuity sized so the taxable gift is close to nothing.

Because the annuity is paid to the grantor, a GRAT is generally a grantor trust under 26 U.S.C. § 677(a), and the grantor pays tax on its income. California applies the federal trust income tax rules unless its own code says otherwise (Rev. & Tax. Code, § 17731), so that income goes on the grantor’s California return as well.

Why it matters

A GRAT moves appreciation out of the estate, and the principal comes back to the grantor through the annuity. Take a hypothetical founder who puts $10 million of company stock into a two-year GRAT when the section 7520 rate is 5.6 percent, the October 2026 rate (Rev. Rul. 2026-19). If the stock grows faster than 5.6 percent a year, the excess passes to the children with little or no gift tax. If it grows slower, the annuity hands everything back. The cost is the legal work and the appraisal. That one-sided risk is why families holding concentrated stock before a sale often run short GRATs back to back.

Common mistakes

Dying during the term. If the grantor dies before the last payment, the part of the trust needed to fund the remaining annuity is pulled back into the estate (Treas. Reg. § 20.2036-1(c)(2)). Paying the annuity with a note, which the regulations say doesn’t count as payment (§ 25.2702-3(b)(1)(i)). And forgetting about basis. Assets that stay in a grantor trust outside the estate keep the grantor’s old basis and get no step-up at death (Rev. Rul. 2023-2).

Related terms

• Intentionally Defective Grantor Trust (IDGT): the other main way to move growth out of an estate, by sale instead of an annuity.
• Section 7520 Rate: the interest rate that values the GRAT annuity and sets the hurdle the assets have to beat.
• Charitable Lead Trust: the charitable version, where a charity receives the annuity and family receives the remainder.
• Defined Value Clause: a GRAT annuity stated as a fraction of the value as finally determined works the same way.
• Grantor Trust: a GRAT is generally a grantor trust, so its creator pays the income tax.

Part of the California estate planning glossary. For the full treatment, see GRAT (Grantor Retained Annuity Trust): How It Works, With the California Rules.