Client & Advisor Update - May 03, 2010
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Grantor Retained Annuity Trusts: Here Today, Gone Tomorrow? On March 24, the House of Representatives passed the "Small Business and Infrastructure Jobs Tax Act of 2010". The Act, if passed by the Senate and signed by the President, would significantly limit the future utility of grantor retained annuity trusts by requiring (i) that the annuity payments to the grantor continue for a term of at least ten years, and (ii) that the remainder interest have a value "greater than zero". The effective date of these provisions relating to grantor retained annuity trusts would be the date of enactment of the Act.
By way of brief background, a grantor retained annuity trust or "GRAT" is a statutorily sanctioned trust whereby the grantor transfers property in trust and retains the right to receive a series of payments for a predetermined period of years. Most commonly, the payments are structured such that, after accounting for a federally mandated rate of return on the property transferred into the GRAT (called the "§7520 Rate"), the present value of the payments will equal the value of the property transferred into the GRAT. When the annuity payments are structured in this manner, the GRAT is often referred to as being "zeroed-out" because the remainder interest is valued at zero for gift tax purposes; thus, no gift tax is payable and no gift tax exemption is used in connection with the funding of the GRAT.
To the extent that the investment return within the GRAT exceeds the §7520 Rate, however, value will remain in the GRAT after all annuity payments are made, thereby effecting a tax free gift of the excess return. The annuity payment period of a GRAT will often be fairly short; for example, two or three years. A short annuity payment period is considered advantageous primarily because the grantor's death during the annuity payment period will cause all of the GRAT property to be included in the grantor's estate for tax purposes – a shorter payment period reduces the risk of death during that period. In addition, potential significant appreciation within the shorter term will not be cancelled out by virtue of a longer term normalization or reduction in values.
By requiring a remainder interest with a value greater than zero, the Act would require that the grantor pay gift tax, or at least use some portion of the grantor's $1,000,000 gift tax exemption, when establishing the GRAT. Since the GRAT may or may not actually realize an investment return sufficiently in excess of the §7520 Rate so as to pass property to the GRAT remainder beneficiaries, this can result in a waste of the grantor's gift tax exemption or the payment of gift tax without any purpose. Separately, by requiring that the annuity payments continue for a term of at least ten years, the Act would increase the tax risk to the use of GRATs by older individuals, and will inject increased mortality risk into GRAT planning even for younger individuals.
Although it is impossible to say whether the Act will actually become law, the current confluence of (i) low asset values, (ii) a §7520 Rate near its all time low, and (iii) the real
possibility that GRATs might not remain as viable an estate tax planning technique for much longer, we suggests that now is the time to establish a GRAT.