IRS blesses short-term, high-income GRATs.
The typical GRAT is structured as a five-year or 10-year term trust that generates a market yield to the grantor over the trust's term. By structuring the arrangement as a short-term, high-income GRAT, significantly greater transfer tax savings may be generated over a shorter period of time. For this technique to work, the grantor must be able to generate a rate of return on the funds transferred to the trust in excess of the Sec. 7520 rate on the date of transfer.
In Letter Ruling 9239015 a donor proposed to contribute stock to a GRAT. The trust's term would be the shorter of two years or the donor's life. The annual annuity payment would be 55.776% of the fair market value (FMV) of the property contributed to the trust at the time of contribution. The donor would be the trust's sole trustee, and would retain the power, in a nonfiduciary capacity, to reacquire the trust corpus by substituting other property of equal value. The trustee would have the power to sell property to the donor or his estate at its FMV, including the power to distribute property in kind to satisfy the annuity payment.
The Service concluded that the donor's annual payment right would be a qualified annuity interest under Regs. Sec. 25.2702-3. Because the donor would retain the power to substitute trust corpus, the trust would be a grantor trust under Sec. 675(4). Rev. Rul. 85-13 provided that a transfer of trust assets to a donor of a grantor trust was not a sale or exchange for tax purposes. Therefore, neither the trust nor the donor would recognize gain or loss on the donor's transfer of stock to the trust, on the transfer of stock from the trust to the donor to satisfy annuity payments or on the donor's "purchase" of the stock from the trust.
Unfortunately, the IRS also concluded that Rev. Rul. 77-454 would apply if the annuity amount would exhaust the funds of the trust on or before its termination. In such cases, "the value of the retained interest cannot equal the amount transferred to the trust because of the possibility that the grantor may die before the expiration of the term of the trust." This conclusion seems to make it impossible to "zero out" a GRAT so that no gift results.
Calculating the gift when Rev. Rul. 77-454 applies is a three-step process: (1) Determine the potential annuity payments (assuming that the GRAT earns income at the applicable Sec. 7520 rate), (2) calculate the present value of the potential annuity payments using the shorter of the grantor's life or the trust term and (3) subtract the present value from the value of the total trust property. Short-term, high-income GRATs are valuable despite Rev. Rul. 77-454 (see Example I on page 366) and the " shorter of " rule (see Example 2 on this page).
If the grantor dies during the term without revoking the spouse's interest, that interest will not qualify for the marital deduction because it is not a qualifying for terminal interest fore, it is important that the grantor's will contain a provision revoking the spouse's interest if the grantor dies during the term. As a result, the entire trust will pass directly to those with the remainder interests (presumably the grantor's children). Even though the trust corpus will still be subject to transfer tax, at least it will pass to a second generation. If the grantor's will contains no provision revoking the spouse's interest, the spouse should consider disclaiming the interest so that it will be deemed to pass directly to the remainder-persons.
An even better solution may be to structure the trust so that it terminates and the trust property reverts to the grantor's estate if the spouse's interest is revoked. if the grantor were to die during the trust term, the property would then revert to his estate and could pass outright to the surviving spouse, thus qualifying for the marital deduction.
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|Title Annotation:||grantor retained annuity trusts|
|Author:||Henderson, Tracie K.|
|Publication:||The Tax Adviser|
|Date:||Jun 1, 1993|
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