The Shape of Tax to Come

A Tax & Estate Planning blog for 21st-century Texans

Forbes: Goodbye GRATs?

As detailed in a Forbes article, President Obama would like to reign in the use of Grantor Retained Annuity Trusts (GRATs) as a vehicle to pass wealth in estate planning as part of the 2011 budget process. It certainly does not hurt that the Joint Committee on Taxation thinks that these changes will bring approximately $4.45 billion into the treasury over the next 10 years.

Properly utilized, GRATs allow grantors to pass large sums to future generations without the imposition of either the gift tax or the estate tax. While GRATs provide an income stream for the grantor as well as a freezing the value of the assets that are contributed, they require that the grantor have a plan for other income after the term has run on the GRAT.

GRATs reduce the value of the gifted property because the grantor retains an income interest in the trust in the form of an annuity payment, while the remaindermen receive a future interest in the property. As the remaindermen are receiving a future interest in the property, the transaction is not subject to the gift tax.

As part of H.R. 4849, section 2702 of the Code would be amended to include the following:

(2) ADDITIONAL REQUIREMENTS WITH RESPECT TO GRANTOR RETAINED ANNUITITES – For purposes of subsection (a), in the case of an interest described in paragraph (1)(A) (determined without regard to this paragraph) which is retained by the transferor, such interest shall be treated as described in this paragraph only if –

(A) the right to receive the fixed amounts referred to in such paragraph is for a term not less than 10 years,

(B) such fixed amounts, when determined on an annual basis, do not decrease relative to any prior year during the first 10 years of the term referred to in subparagraph (A), and

(C) the remainder interest has a value greater than zero determined at the time of the transfer.

If signed into law, this language would require that GRATs have a 10-year minimum length before qualifying for the valuation treatment under section 2702. Under current law, there is no minimum length for the term of a GRAT.

Typically, GRATs are set up for terms shorter than ten years, ranging from two to five years. Planners will use longer terms to achieve better tax treatment, though there is always the risk that the grantor will not live long enough to see the end of that term.

An additional result of the legislation is that “zeroed-out” GRATs will not longer be available as a planning technique. The GRAT will have to leave some amount as a gift to the beneficiaries, which will require the grantor to use up some portion of the $1 million lifetime gift tax exemption with the residual gift. Congress has sidestepped making this decision, and will grant Treasury the ability to write legislative regulations to cover the required minimum amounts.

The take-away lesson here is that if you are thinking about setting up GRATs as part of your estate plan, now is the time to get them in place. The current Congress is in the mood to increase taxes, and there is no way of knowing when these changes will be implemented. Even if the law is passed this year, it may well be years before we have regulations indicating what a minimum gift amount might be.

There is an open question remains as to the treatment of the GRAT if the grantor dies during the term. Should the entire trust corpus be included in the gross estate because it was the grantor’s property; should the full amount be excluded from the gross estate because the grantors interest was solely in the annuity, an interest that is now worth zero; or should only a portion be included in the gross estate to reflect that the grantor had less than a complete interest in the trust corpus? There is support for all three positions, though nobody has been willing to take such a case to court yet.

Read the full article here.

March 30, 2010 Posted by | Uncategorized | , , | Leave a comment


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