Window Closing on Short Term GRATs?
Posted on July 6, 2010 in Advanced Planning
Glen A. Coral, CLU, ChFC
Director, Advanced Markets
The days of the short term Grantor Retained Annuity Trust, made popular by the famed 2 year “Walton” GRAT, may be numbered. Last week the Senate introduced S.3533 – The Responsible Estate Tax Act – which would retroactively reinstate a progressive estate tax, change how assets are valued for various transfers and would change the way the GRAT can be structured. Earlier this year the House passed H.R. 4849, the Small Business and Infrastructure Jobs Tax Act of 2010 which imposed similar rules on GRATs.
A GRAT is a trust established by a Grantor who transfers (gifts) property into the trust in exchange for a stream of income for a fixed period of years. The value of the gift for gift tax purposes is determined by how much of an interest gets transferred to the Trust beneficiaries at the end of the term. The GRAT is often structured so there would be no theoretical value remaining, hence no gift.
The advantage of the strategy to the Grantor is if the assets appreciated at a rate exceeding the income payout rate the appreciated assets would be transferred. If the income distributions exceed the asset appreciation the Grantor would simply take back the asset over time and not be in any different position than when the transaction was first adopted. The other risk is if the Grantor dies prior to the end of the GRAT period. In that event the remaining GRAT assets would be included in the Grantor’s estate for tax purposes. For that reason short term GRATs were often preferred.
Under present law the GRAT could established be for as short a time as two years, and remainder interests could pass with zero gift tax. Both the House bill and the new Senate bill would change the minimum GRAT term to 10 years and would require that the remainder interest transferred to the beneficiary be greater than zero when calculated at inception. The intent of extending the GRAT term is to raise additional tax revenues, an estimated $4.4 billion, over the next 10 years – a mere chip off the estimated $260 billion +/- cost of various estate tax bills being considered.
The primary risk to the Grantor from the longer required term is death prior to the end of the term. Where short term GRATs are efficient asset transfer tools for older individuals who often ladder successive GRATs funded with property with rapid appreciation potential or with property benefiting from valuation discounting, the Senate bill now introduces greater market and mortality risk due to the proposed changes in asset valuation and the 10 year minimum term.
GRATs are also used to provide remainder interests to Irrevocable Life Insurance Trusts (ILITs) for the purpose of transferring income producing assets into the ILIT to pay future premiums or to repay private or third-party financed loans. This strategy is still viable for Grantor/Insureds with longer life expectancies.