by Sandra B. Price, Partner

A GRAT may be an ideal gifting vehicle at the moment because of the current low interest rate environment and the fact that assets may have temporarily depreciated in value relative to long term growth potential. But Congress has before it several bills that would substantially weaken — if not eliminate altogether — the effectiveness of this planning tool. On a "use it or lose it" basis, is now the time to act?

I. What Is A GRAT?

A GRAT is a "Grantor Retained Annuity Trust", a particular type of irrevocable trust authorized by Internal Revenue Code Section 2702 that allows an individual to make deferred gifts to family members with minimal or no estate and gift tax on the transfer.

Simplistically, a typical GRAT functions as follows:

• An individual (the grantor) transfers property to the GRAT and retains the right to receive a fixed annuity for a period of years ("GRAT Term"). For example, if a grantor transfers $1,000,000 to a GRAT by which the grantor retains the right to a 5% annuity payout, then during each year of the GRAT Term, the grantor receives $50,000. The grantor selects the annuity payout rate and the GRAT Term.
• At the end of the GRAT Term, the remaining property passes (outright or in trust) to the remainder beneficiaries, who are one or more family members.
• If the grantor survives the GRAT Term, the assets that remain in the GRAT and pass to the remainder beneficiaries have been removed from the grantor's taxable estate for estate tax purposes. (If the grantor does not survive the GRAT Term, assets are "pulled back" into the Grantor's taxable estate).
• If the assets in the GRAT grow in excess of a rate set by the government reflecting the expected growth of the assets (the "7250 Rate"), the “excess” value passes, free of gift tax, to the family members at the end of the GRAT Term. The 7250 Rate changes monthly and is driven by overall economic conditions. A low interest rate (which we are now — and have been — experiencing) makes it more likely that the 7250 Rate will be exceeded and that the GRAT will work most advantageously.
• The value of the gift to the GRAT at inception is NOT the full value of the property transferred to the GRAT: the value of the gift is calculated using a number of factors including the Internal Revenue Service tables for present and remainder interests, the selected annuity payout rate and the 7250 Rate (in some types of GRATs the Grantor's age will also be a factor). A GRAT can be structured so that there is no gift tax payable at the establishment of the GRAT (commonly known as a "zeroed out GRAT").

Consider the following example:

On July 1, 2010, Mother transfers a part of her share of the family business, valued at $2 million, to a zeroed-out GRAT. The business recently entered into a business relationship that promises to provide initial and continued exceptional growth. Assuming the following factors, at the end of the GRAT Term Mother will have transferred $725,000 to her son with no estate or gift tax liability to Mother. Continued growth is also out of her taxable estate. (And, in this particular scenario, the transfer will be of an interest in the family business, which Mother is in the process of transitioning to her son in any event):

Term of GRAT:	2 years
July 7520 Rate:	2.8%
Projected Income:	8.00% per year
Projected Growth:	15.00% per year
Req'd annuity percent to achieve zero gift:	52.11047%
Value of gift:	$0.16
Remainder in two years that passes to son:	$725,011.78

(Note, because the required annuity payments are so large, part of the business will need to be returned to Mother as part of the annuity payment).

Caveat: In spite of the apparent simplicity of the above overview, GRATs are technical and sophisticated estate planning tools that require careful attention to ensure that, among other things: (i) the GRAT is drafted to and functions as required by the Internal Revenue Code and regulations so that it will be respected by the Internal Revenue Service for estate and gift tax purposes; (ii) the optimal GRAT Term and annuity payout rate are selected; (iii) the appropriate assets are selected for transfer to the GRAT; (iv) the valuation at the time of gift can be and is properly substantiated.

II. Why The Restrictions?

As part of its revenue raising efforts, Congress is seeking to eliminate the use of two features of GRATs that typically provide the most dramatic and desirable results:

• "short term" GRATs (those with a GRAT Term of less than 10 years); and
• "zeroed out" GRATs (structuring the GRAT term and the annuity payout to result in a gift of no value at the time the GRAT is created)

Various bills before Congress estimate savings of BILLIONS of dollars will result from the above eliminations.

III. Current Status?

The following developments suggest that GRATs as we know them may, indeed, be endangered species:

• President Obama's Fiscal Year 2010 Budget first introduced the concept of restricting GRATs. And President Obama's Fiscal Year 2011 Budget again included GRAT restrictions, with an estimated savings of $2.959 billion from these provisions.
• H.R. 4849 (the "Small Business and Infrastructure Jobs Tax Act of 2010") was approved by the House of Representatives on March 25, 2010. H.R. 4849 contained a provision instituting a 10 year minimum term for GRATs and a requirement that the remainder interest for GRATs be greater than zero.
  
  As proposed, the GRAT limits in H.R. 4849 would be effective for transfers after the date of enactment, i.e. they would be effective for transfers after the date that the President signs the bill into law. This provision is estimated to raise approximately $800 million over the first five years and $4.45 billion over ten years.
  
  On June 26, 2010, the Senate considered the House’s version of the Small Business Jobs Tax Relief Act of 2010. The Senate’s version of the House Bill currently does not contain the GRAT restrictions, so for now, short term GRATs may remain a viable technique.
  
  The House bill and the Senate version of the bill will ultimately have to reconciled and it is unclear whether the GRAT restrictions will be included.
• H.R. 5297 (introduced May 13, 2010) has GRAT restrictions identical to those of H.R. 4849 and the voting has been similar. Although the provisions are identical to H.R. 4849 the GRAT provisions in this bill are estimated to raise approximately $5.297 billion over ten years.
• H.R.5486 (introduced June 9, 2010) passed the House on June 15, 2010; it includes similar restrictions.
• S. 5353 (introduced June 24, 2010) is a comprehensive "estate tax" bill dealing with reinstatement of estate and generation skipping transfer taxes but it also includes provisions eliminating short term GRATs and the zeroed-out GRAT.
• H.R. 4899 (the Disaster Relief and Summer Jobs Act of 2010) was amended to include a GRAT restriction that would eliminate short term GRATs, with the amended bill passing the House on July 1, 2010

IV. Conclusion

Given the uncertainty of the legislation, a window of opportunity may well exist at this particular time. If you have been considering implementing a GRAT, it may be the time to move forward — quickly — before it is too late. In particular, note that the effective date will be the date of TRANSFER to the GRAT: in other words, it will not be enough to have the GRAT trust instrument signed by that date; it will be necessary for the asset to be formally re-titled in the name of the GRAT.

This publication is for informational purposes only and is not intended to provide legal or tax advice, or to create an attorney-client relationship.

Pursuant to IRS Circular 230, unless expressly stated to the contrary, any tax advice is not intended and cannot be used to (i) avoid penalties under the Internal Revenue Code or (ii) promote, market or recommend any transaction or matter to another party.