Talk of limiting short term GRATs has been around for a while now, but the discussion seemed to be “back burnered” with the 2010 Estate Tax repeal actually coming into effect, and no signs of life in Congress regarding any Estate Tax reform this year. Well, that seems to have changed with the passing of HR 4849 in the House on 3/24.
Traditionally estate planners use GRATs that last 2 or 3 years to minimize mortality risk (i.e. the chance the grantor dies during the term thereby causing full estate inclusion and defeating the GRATs purpose) and that are “zeroed out” to avoid any gift tax on the transaction (i.e. the remainder interest is calculated to be worth $0 under IRS formulas even though the grantor and his advisors plan for the assets in the GRAT to appreciate significantly and thus have a large actual remainder value).
The House bill would severely curtail the use of low risk GRATs by requiring a minimum 10 year term and a remainder value greater the zero. The latter requirement doesn’t seem too onerous since no specific value is required and smart estate attorneys tend to report a remainder value of ~$1 on the client’s Gift Tax return to start the Statute of Limitations running. The 10 year term, though, would be a much bigger issue. While longer term GRATs actually transfer more value to the remaindermen, the previously mentioned mortality risk is always a concern.
What might this mean? Well, for one thing, sales to irrevocable grantor trusts (“IDGT”) look more attractive. These transactions are traditionally structured for 9 year terms (but can be longer or shorter) and use more favorable interest rates than GRATs. They have far less mortality risk since the technique “freezes” the estate tax value of the transferred asset so if the grantor dies in year 5, only part of the value of the asset is pulled back into his estate, and such value would not include any appreciation on that asset during those five years. Had the grantor died during year 5 of a 10 year GRAT, the entire value (including appreciation) would be pulled back into his estate. Another advantage for Sales to IDGTs is the ability to allocate GST exemption, something not permitted for GRATs – thus making them preferred tools for multi-generational transfers and Dynasty Trust creation.
Sales to IDGTs do have one significant danger: valuation risk. Much like a GRAT, when implementing an IDGT sale, one must value the transferred assets and often will take discounts on that value for various reasons. If the IRS later challenges those values and discounts, the effect can be significant. In a GRAT, a changed value has no effect since most GRATs are drafted using percentage payouts as opposed to fixed dollars amounts. If an asset value changes, this language “captures” it and no adverse effects occur. In contrast, IDGT sales use specific dollar amounts in their provisions which means a change in asset value after the terms are set could cause the transaction to be treated as a part sale / part gift and trigger gift taxes. Furthermore, if GST exemption had been previously allocated, a new asset value might cause the Inclusion Ratio for the IDGT to change, causing a whole host of problems. (New rulings on so called “defined value clauses” can be applied to IDGTs to reduce these risks. Such a discussion is well beyond the scope of this post though)
Of course, all of this discussion may be premature – the Senate still needs to vote on the Bill and the President needs to sign it. However, given the fact these anti-GRAT provisions are specifically designated as ”revenue raisers” for the Jobs Bill, I suspect the likelihood they will be implemented is be better than 50/50.
The current low interest rates and a rebounding economy that is causing assets to appreciate and business to start picking up means we are in a perfect environment for GRATs. If you (or a client, if you are an advisor) are on the verge of a liquidity event (e.g. business sale, IPO, etc) or have assets that are depressed in the current market but are expected to rapidly appreciate in the coming couple of years, now is the time to get moving - there is no way to know how long this window will remain open.
As always, please don’t hesitate to contact us if you have any questions or we can be a resource to you in any way.
All the best,
Joe Donlon
The estate planning law firm of Donlon & Associates, PC provides high quality, focused legal counsel to clients all ages and wealth levels in the following areas:
Wills & Trusts
Asset Protection Planning
Advanced Planning for Business Owners & Professionals
Elder Law
Special Needs Trusts
Probate & Estate Administration
Donlon & Associates, PC provides trusts & estates and asset protection services to clients throughout New York City and Long Island, including Nassau County, Suffolk County, Queens, Brooklyn, Manhattan, and Staten Island.
