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IRS GRAT ruling raises planning concerns.

The IRS has issued Letter Ruling (TAM) 9604005, which calls into question a technique that has been used to make payments out of grantor retained annuity trusts (GRATs) when there is not sufficient cash to meet the obligation. Notes have been used to make the required annual annuity payments rather than distributing property out of the GRAT. The TAM concludes that the GRATs that were the subject of the ruling did not meet the requirements of Sec. 2702 because the annuity payments were to be made with funds borrowed from the grantors.

A GRAT is a grantor trust in which the grantor transfers property and retains a qualified interest in the property. This retained income interest, in the form of a fixed annual annuity payment, results in a lesser gift tax value for the remainder interest. Sec. 2702 and the regulations thereunder require that the payments must be a qualified annuity interest. Regs. Sec. 25.2702-3 (b) (1) sets forth the requirements that must be satisfied in order for an interest to be a qualified annuity interest. A qualified annuity interest is the right to receive a fixed amount. The annuity amount must be payable to or for the benefit of the holder of the annuity interest for each tax year of the term. A fixed amount means either a stated dollar amount payable periodically (but not less frequently than annually) or a fixed fraction or percentage of the property's initial fair market value.

The Service took the position that qualified interests were not present "in substance" because they could not be readily valued, and because the retained right was essentially the right to receive notes that were neither fixed amounts nor annual payments. The IRS reached these conclusions even though the form of the trusts was entirely consistent with the requirements of Sec. 2702. The Service concluded that the facts indicated that the parties to the transaction anticipated that the GRATs would not have sufficient cash flow to pay the annuities and that the loan mechanism would be implemented to pay the annuities.

This ruling is of particular concern to GRATs funded with interests such as shares of closely held corporate stock that have a history of paying little or no dividends. It is also of concern in the case of short-term, high-payout GRATs in which the annuity amount cannot normally be satisfied with income.
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Title Annotation:grantor retained annuity trust
Author:Gardner, John
Publication:The Tax Adviser
Article Type:Brief Article
Date:Apr 1, 1996
Words:396
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