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Recent tax law changes have all but eliminated the grantor retained income trust (GRIT) as an effective estate planning vehicle. But these same changes have given birth to the grantor retained annuity trust (GRANT) and the grantor retained unitrust (GRUNT).

This month, Stephan R. Leimberg, JD, CLU, professor of taxation and estate planning, the American College, Bryn Mawr, Pennsylvania, Eric T. Johnson, JD, LLM, an attorney in private practice in Haverford, Pennsylvania, and adjunct professor of taxation at the America College, and Robert J. Doyle Jr., CLU, ChFC, associate professor of finance, the American College, or some insights on the changes.

In the past, closely held business owners used estate-freeze techniques that lent themselves to valuation manipulations. For gift, estate and generation-skipping tax purposes, transfers to trusts normally were valued using the "residual method," in which the transferred interest's value was the entire amount transferred minus the retained interests in the trust.

In other words, a grantor was deemed to make a taxable gift to the extent the amount contributed to a trust exceeded the actuarial value of the retained interest. If more was given away than was kept, the excess was a taxable gift. Since the beneficiary did not have the immediate, unfettered and ascertain legal right to use, possess or enjoy the assets in the trust, in most cases that right was a "future interest" that did not qualify for the $10,000 gift-tax annual exclusion.

A primary purpose of many trust transfers is to delay the beneficiary's enjoyment of income, principal or both. For example, a grantor may create a trust in which he or she retains income for 10 years and, at the end of that time, provide for the trust capital to go to the grantor's child.

By increasing the actuarial value of the retained interest, the value of what was given away has a lower gift-tax cost. A transfer to a trust involves valuing property using a time value-of-money analysis. Congress wanted to limit this technique by imposing new valuation rules, which have had a significant impact on the gift, estate and generation-skipping transfer tax implications of making trust contributions. VALUING TRANSFERS IN TRUST The Revenue Reconciliation Act of 1990 created Internal Revenue Code section 2702 effective for transfers in trust after October 8, 1990. This provision repealed section 2036(c) special "safe harbor" trust valuation provisions and superseded section 7520 general valuation rules in certain circumstances.

Several years ago, Congress created section 7520, which applied to gifts made after April 30, 1989, and to the estates of decedents dying after that date. It was intended to bring actuarial interest assumptions in line with current market rates and conform mortality assumptions to more recent statistical evidence.

The section 7520 rules require valuations to be based on 120% of the applicable federal midterm rate (AFMR), rounded to the nearest .2%, in effect for the month in which the valuation date falls. Section 7520 tables provide a uniform valuation of income interests for life or a term of years and annuity interests. The tables can be accessed by computer through software programs such as NumberCruncher, IRS Factors Calculator and Charitable Giving Sales Solutions.


Under current law, the value of any interest in the trust retained by the transferor (or any applicable family member) is generally treated as zero according to section 2702(a)(2)(a). This applies solely for the purpose of determining whether a transfer in trust to or for the benefit of a member of the transferor's family (1) is a gift and (2) the value of the gift.

Congress really meant to say that if a transfer is made to a trust benefiting a family member, the grantor is considered to have retained none of the cash or other assets and is treated as if he or she has given away the entire amount transferred to the trust. No matter ,hat portion of the trust the grantor claims to have kept, he or she gets no credit unless one of the safe-harbor (qualified interest) rules apply.

Assume a 63-year-old mother contributes 100,0 0 to a trust for her daughter. The mother retains a life estate (the right to all income for as long as she lives). Under the IRC chapter 14 general rule, the life interest has a zero value-making the taxable gift to her daughter $100,000 (rather than about $29,000 under prior law, assuming a federal discount rate of 9%).


There is some hope. A retained qualified interest in the trust by the transferor or applicable family member is, according to section 2702(a)(2)(b), valued at its full value under Internal Revenue Service actuarial tables.

A qualified interest is a right to receive fixed annuity payments at least annually (a GRANT), or a right to receive, at least annually, annuity payments that are a fixed percentage of the trust's assets revalued annually on the anniversary of the trust's creation (a GRUNT), or any noncontingent remainder interest if all other interests in the trust are GRANTS or GRUNTS. GRANTS are valued using section 7520 rules; GRUNTS are valued using IRC section 664 tables.

Regular valuation rules also apply when

* Property is to be used as the personal residence of the person holding a term interest in the trust.

* Exercise or nonexercise of the holder of a term interest in tangible property would not affect valuation of the remainder interests in such property.


The most-recognized victim of the new valuation rules is the GRIT, in which an individual places cash or other assets in trust for remainder men, such as children, but retains the income from trust assets for a specified period of time, such as 10 years. Before the 1990 act, in virtually all cases the gift-tax cost of creating the trust was based on the actuarial value of the remainder interest. The remainder interest was valued without considering potential appreciation; GRITS presented the opportunity to transfer assets with substantial appreciation potential at a gift value less than their future economic value.

However, the 1990 act effectively eliminated GRITS as viable tools in family situations in most circumstances. When a GRIT is used, the retained income interest is valued at zero for gift-tax purposes if a member of the grantor's family is a trust beneficiary. In such a situation, the gift-tax value of the remainder interest would be considered equal to the entire value of the property transferred to the trust, not just the (reduced) actuarial value of the remainder interest.

The amount of the gift tax is the same as it would be if the grantor made an immediate gift of all cash or other property placed in the GRIT, no discount is allowed even though remaindermen must wait many years to obtain the principal. GRITS still can be useful in limited situations. Normal valuation rules apply if the transfer of property does not involve family members and in two special family situations:

* If the property is to be used as the personal residence of the person holding the term interest, the remainder interest will be valued in the regular manner, even if a family member holds the remainder interest.

* When exercise or nonexercise of rights by the holder of a term interest in tangible property (such as artwork) does not affect the valuation of the remainder interest in such property, the term interest is not valued at zero for gift-tax purposes, even if the remainder interests are held by family members. However, the term interest in the property must be valued at the amount the transfer or would obtain on its sale to an unrelated third party.

For example, artwork's trust value might be obtained by first finding the rate at which the artwork could be rented for display in a commercial setting. The term interest is then computed by discounting the rental payments over the trust term by the section 7520 rate.

GRANTS. GRANTS allow grantors to shift potential appreciation and growth in income on trust assets without recognizing it for gift-tax purposes. A GRANT is an irrevocable trust in which the grantor retains a right to receive fixed payments (such as a fixed annuity) payable at least annually for his or her life (or the joint lives of the grantor and one or more life tenants) or for a term of years (a GRANT is actuarially identical to a charitable remainder annuity trust).

At the end of the term or life interest, the remaining trust corpus is paid to designated beneficiaries. The annuity interest is valued under section 7520 rules and the gift value of the remainder is determined by subtracting the value of the annuity interest from the total value of the principal placed in trust.

For example, a father, age 65, places $100,000 in trust. He retains the right to a fixed annuity of 7% of the initial value of the trust for 10 years. Because this arrangement qualifies for favorable tax treatment under section 2702's safe-harbor rules, the acturarial value of what the father retains $48,967, assuming a 9% discount rate) can be used to reduce the value of what the father gave away. Under the residual valuation method, the gift would be $51,033 ($100,000 - 48,967).

GRUNTS. While the GRANT is a fixed-annuity trust, the GRUNT is essentially a variable-annuity trust. A GRUNT is an irrevocable trust in which the grantor retains the light to receive, at least annually, annuity payments that are a fixed percentage of the trust's assets, as revalued each year. The GRUNT is actuarially identical to a charitable remainder unitrust.

The term of the trust may be based on the life expectancy of the annuitant (or the joint lives of two or more annuitants; or a specified term of years. At the end of the term, all remaining trust assets pass to the designated remaindermen.

Assume a father, age 65, places $100,000 in trust and retains the right to a lifetime annual income of 7% of the trust's value-as revalued annually. In the first year the father receives 7,000 (7% of $100,000). In the second year, the trust s assets grow to $200,000. The father still receives 7%, or $14,000. In the third year, trust assets decrease to $50,000, and the father receives only $3,500 of income.

Because this arrangement qualifies for safe-harbor treatment, the actuarial value of what the father retains, $51,602 (based on section 664 tables for annual payments), can be used to reduce the value of what the father gave away. Under the residual valuation method, the taxable gift would be $48,398 ($100,000$51,602).

SHIFTING WEALTH GRITS have been dealt a serious blow by the new tax law. But they are still useful for family members in limited situations and should be considered in certain nonfamily transfers, such as between close friends. On the other hand, GRANTS and GRUNTS are viable new tools for shifting wealth among family members. CPAS should make their clients aware of how these arrangements can yield significant tax savings.
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Title Annotation:estate planning
Author:Doyle, Robert J., Jr.
Publication:Journal of Accountancy
Date:Mar 1, 1992
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