Tax Alert: GRATs' Days Are Numbered
6/25/2010
On June 15, 2010, in a 247-170 vote, the House passed a small-business tax bill (Small Business Jobs Tax Relief Act of 2010, or H.R. 5486) that supposedly would raise more than $5 billion by revamping grantor-retained annuity trusts (GRAT).
A GRAT is an irrevocable trust into which you can place cash, stocks, mutual funds, real estate, or other income-producing property. You are called the grantor (creator) of the trust. As its name implies, in a GRAT, you, the grantor, retain the right to an annuity for a fixed period of years from assets you’ve placed into a trust. At the end of the period of time you specify when you set up the trust (which can be practically any amount of time from, for example, two to 20 years), the asset you’ve placed into the GRAT will pass to the beneficiary you named – typically a child, grandchild, or other family member or friend.
Key Advantages
Saving estate and gift taxes are the two major objectives. In a nutshell, the GRAT allows you to transfer large amounts of wealth at a significant gift tax discount. If you survive the term of the GRAT – even by only one day – the value of the property in the trust at that time is removed from your estate and your family may save thousands – even millions – of dollars of Federal and state death taxes.
H.R. 5486 would restrict GRATs in the following ways:
(1) Require a minimum 10-year term
(2) Fixed amounts, when determined on an annual basis, cannot decrease relative to any prior year during the first 10 years of the term
(3) The remainder interest must have a value greater than zero determined as of the time of the transfer
(4) The effective date would be for “transfers made after the date of the enactment of this Act”
While this is not law today, we predict it will be law very soon. We believe that time is truly running out on the ability to implement GRATs as we know them.
How do the proposed new requirements impact your planning?
1. 10-YEAR MINIMUM
A Grantor’s required retained annuity interest would have to last at least 10 years. This significantly increases the probability that – during the term of the trust – the client will die and thus expose the assets in the trust to Federal estate tax. Obviously, this diminishes the appeal of a GRAT technique for older or sicker clients. Life insurance to “bullet-proof” the tax savings remains viable for younger and healthier clients, but even for younger, healthier clients, the inability to use short-term rolling GRATs will severely diminish the ability to remove upside volatility and will thus reduce the appeal of GRATs.
2. NO DECLINING PAYMENTS
Because of the second proposed rule, it would not be possible to skirt the 10-year minimum rule by massively front-loading all the GRAT payments (for example, in the first year or two) and thus effectively make 10-year GRATs work economically similar to two-year GRATs.
3. REQUIREMENT OF PRESENT-VALUE-GREATER-THAN-ZERO
A quick calculation shows that right now, you can set up a GRAT so that a transfer to it has an actuarial “zero value” for gift tax purposes. The proposed law would require “a value greater than zero.” How much greater, we don’t yet know. It has long been rumored that the IRS would like to require that the value of the gift be at least 10 percent of the value of the assets transferred to the GRAT. Should the 10 percent rule stick, a transfer of more than $10 million to a GRAT, if 10 percent or $1 million had to be a current taxable gift, would require that gift tax be paid. Also, if some of one’s lifetime gift tax exemption already has been used, it would severely limit the possibility of using a GRAT for any substantial transfer.
Now is the time to act upon this opportunity. As stated in previous GRAT communications, we at J.H. Cohn believe that the GRAT remains an effective estate planning tool that, when implemented properly, can reap significant financial rewards for both the donor and the recipient. For more information about GRATs and the other trust and estate planning issues, please contact Ira Herman, CPA, J.H. Cohn partner and the Firm's Trust and Estate Practice Director, via email or at 973-618-6245.
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