On March 24, 2010, the House of Representatives approved the Small Business and Infrastructure Jobs Tax Act of 2010 (H.R. 4849) (the “SBIJT Act”), which provides in part for changes to the rules governing grantor retained annuity trusts (“GRATs”) which would require all new GRATs to have a minimum ten year term.  These changes are in line with President Obama’s 2011 budget proposal.  This act has not yet been adopted by the Senate or signed into law by the President.

 

Background

 

As we have previously advised many of our clients, creating a GRAT is a relatively simple way to transfer property to your children at virtually no gift tax cost.  In addition, because of the low interest rate environment and down markets, the advantages of creating a GRAT are magnified.  When properly structured, a GRAT can pass to your children all of the future appreciation of the transferred property and reduce the value of the gift to virtually zero.

 

The most popular use of this device in sophisticated estate plans has been the short-term, “zeroed-out” GRAT, in which the term is limited to two or three years and the annuity amount is maximized in order to produce as small a taxable gift as possible.  In this way, anticipated short-term growth in the trust assets can be availed of without risking longer-term uncertainty, and the risk of depreciation is virtually eliminated.  Additionally, the death of the grantor of the GRAT during the two or three year GRAT term, which causes a GRAT to fail, is minimized through the use of a short-term GRAT.  At the end of the GRAT term, any assets remaining in the GRAT are transferred to your children, either outright or in further trust.

 

New GRAT Rules

 

The SBIJT Act requires a GRAT to have minimum term of ten years.  Prior to this legislation, a shorter term had been more common, in order to minimize the chances of the grantor dying during the GRAT term.  The longer GRAT term required under the SBIJT Act would increase the chance that the grantor’s death occurs during the annuity period, resulting in the GRAT assets being included in the grantor’s estate rather than being transferred to the beneficiaries of the GRAT if the grantor dies after the GRAT term.  Thus, the SBIJT Act requires taxpayers to take on a greater risk that they might die during the GRAT term in order to take advantage of the gift tax benefits of using a GRAT. 

 

The SBIJT Act also requires the value of the remainder interest to be greater than zero, technically eliminating “zeroed-out” GRATs.  This ensures that a taxable gift will result from the establishment of the GRAT and require the grantor to file a gift tax return reporting the transfer to the GRAT.  However, the SBIJT Act does not specify the amount by which the remainder interest must exceed zero, so it is still possible to create and fund a GRAT that results in a minimal taxable gift such as a dollar.

 

Finally, the SBIJT Act provides that the annuity amount must not decrease during the first ten years of the GRAT term.

 

These new provisions would only apply to transfers made after the date of enactment.  Therefore, if you would like to create a short term GRAT, or obtain more information on the benefits of a GRAT, please contact us immediately as the window of opportunity for this effective estate planning technique may be closing.  Additionally, the June 2008 issue of Personal Planning Strategies contained an article entitled “Creating a GRAT: Heads You Win and Tails You Break Even” which is a detailed explanation of the operation of a GRAT.  This article may be found at http://www.proskauer.com/publications/newsletters/personal-planning-strategies-june-2008/.