House passes H.R. 4849, the Small Business and Infrastructure Jobs Tax Act. Provisions will affect Grantor Retained Annuity Trusts (GRATs)

February 01, 2010

On March 24, 2010, the House passed H.R. 4849, the Small Business and Infrastructure Jobs Tax Act. Included among its provisions are some which would affect a popular planning technique known as Grantor Retained Annuity Trusts, or GRATs. GRATs allow taxpayers to structure a transfer of assets to another individual in such a way that substantial gift taxes may be avoided. A GRAT is generally an irrevocable trust in which the grantor retains an annuity interest and transfers a remainder interest to another person or trust, such as for the grantor's children. For gift tax purposes, in valuing the gift of the remainder interest to the beneficiaries of such a trust, current law allows taxpayers to deduct the value of the retained annuity interest computed using the IRS interest rate for the month in which it is created, from the value of the transferred assets. In some cases, the computed value of the retained interest is so great that the gift tax value of the remainder is 0 or very small. If the property transferred to the GRAT appreciates in value at a rate that is greater than the IRS interest rate applied to the GRAT, the excess appreciation will be transferred tax free to the trust beneficiaries. For example, for a GRAT created in March 2010, the IRS applicable rate is 3.2%, so if the assets appreciate at a greater rate, the value of the remainder at the end of the GRAT will be greater than what it was calculated to be at the beginning of the GRAT and will be passed on to the trust beneficiaries at no additional gift tax cost.

One significant risk to this type of tax planning is that, if the grantor dies during the GRAT term, a significant portion of the GRAT assets (and possibly all of the GRAT assets) is included in the grantor’s gross estate for estate tax purposes. This generally would eliminate the benefit of using a GRAT. As a result, taxpayers have created short-term GRATs to maximize their gift tax planning while minimizing the chances that they might die during the trust term.

The bill as passed by the House requires a minimum 10-year term for GRATs, which would significantly limit this type of planning. The bill also requires that the value of the remainder interest (upon which gift tax is measured) must be greater than zero and that the annuity must not decrease during the first 10 years of the GRAT term. As a result, the House bill requires taxpayers to (i) take on a greater risk that they might die during the GRAT term and (ii) structure the GRAT with potentially less gift tax benefits. The Senate has not yet taken up this bill. If passed, the current form of the proposed legislation includes an effective date as of the date of enactment. While it is not certain that this bill with these GRAT provisions will be enacted, there may only be a small window of time to establish a GRAT with the more favorable terms under current law, so if you would like to do so, you should act immediately. Please check back frequently for updates on the progress of this bill with such potentially significant estate planning effects.

House passes H.R. 4849, the Small Business and Infrastructure Jobs Tax Act. Provisions will affect Grantor Retained Annuity Trusts (GRATs)

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