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AALU INSIGHTS

In Hunt For Revenue, Congress Aims For Grats

Both President Barack Obama's budget proposals for 2010 and 2011 and a recent version of the "Small Business Jobs Tax Relief Act" (H.R. 5486), which passed the House on June 15 and was merged into the "Small Business Lending Fund Act" (H.R. 5297), contained a proposal to require a minimum 10-year term for grantor retained annuity trusts (GRATs).

The GRAT provision is the primary revenue offset ($5.3 billion over 10 years) in the House's small business jobs measure, which was referred to the Senate Finance Committee on June 18. Having failed to find compromise on the tax extenders and jobs creation bill after three weeks of floor debate, Senate Majority Leader Reid (D-Nev.), indicated on June 24, indicated his intent to pivot to H.R. 5297 and bring it to the Senate floor without going through committee.

It is not expected, however, that the first draft of the Senate's substitute amendment to the small business measure will include the GRAT provision as a revenue offset, which is likely an indication that many in the Senate prefer to reserve estate planning revenue provisions for future estate tax legislation. Although it has been suggested to include an estate tax amendment on the Senate's substitute to H.R. 5297, this is not expected to occur.

The GRAT provision, Section 2702 of the Internal Revenue Code, provides that if an interest in a trust is transferred to a family member, the value of any interest retained by the grantor is zero for purposes of determining the transfer tax value of the gift to the family members. This rule does not apply if the retained interest is a "qualified interest" - i.e., a fixed annuity or unitrust interest, as defined in applicable Treasury regulations. A GRAT is one such qualified interest, and current law prescribes no particular minimum or maximum length of term for a GRAT.

GRATs have proven to be a popular and efficient technique for transferring wealth while minimizing the gift tax cost of transfers, providing that the grantor survives the GRAT term and the trust assets do not depreciate in value. Taxpayers have become adept at maximizing the benefit of this technique, often by minimizing the term of the GRAT (thus reducing the risk of the grantor's death during the term), in many cases to two years, and by retaining annuity interests significant enough to reduce the gift tax value of the remainder interest to zero or to a number small enough to generate only a minimal gift tax liability.

The bill's GRAT provision, which is identical to the provision in H.R. 5486, requires that there be some downside risk in the use of this technique by imposing the requirement that a GRAT have a minimum term of 10 years (a number that appears to have been chosen because it is the same as the 10-year minimum term of so-called "Clifford" trusts that were created before March 2, 1986). The provision also requires that the annuity (determined on an annual basis) does not decline during the first 10 years of the annuity term and that the remainder interest must have a value greater than zero at the time of the transfer (although no minimum value is prescribed).

At the very least, the bill would increase the risk of the grantor's death during the GRAT term resulting in the loss of any anticipated transfer tax benefit. This loss would presumably be the Treasury's gain to the tune of approximately $5.3 billion over the next 10 years. (We note that this revenue estimate is higher than the $4.45 billion revenue estimate in H.R. 5486.) As with previous versions of this provision, it would be effective on "date of enactment." Without a change in the effective date in any final version of the legislation that may be adopted, the new GRAT restrictions would apply to GRATs executed on or after the date of enactment.

As the intense focus on our fiscal dilemma persists, tax policy decisions will continue to be scrutinized, and the hunt for revenue will continue to drive the debate. It is likely that the GRAT provision will ultimately be enacted as a revenue offset to deficit spending legislation. So the time to plan is now, since the provision would grandfather existing GRATs.

In Hunt for Revenue, Congress Targets GRATs [email protected].


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