April 2010

Been Thinking about a GRAT? Act Now … Before Congress Does

Proposed restrictions would likely be effective when the bill is signed, which means there is still a window of opportunity to set up GRATs under the old rules

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An important item appeared in the news recently that, depending on your situation, could affect you and your family. A jobs and small business tax relief bill before the House contains new restrictions on a popular estate planning strategy that allows families to pass on wealth while cutting estate and gift tax bills.

If you have been mulling over the idea of establishing a “grantor retained annuity trust” (GRAT), now might be the time to act on it.

A GRAT is a type of irrevocable trust into which you transfer assets and, in return, take back an annuity payout for a term of years, sometimes as little as two to three years. Anything left at the end of the expiration of the trust goes to your beneficiaries. The value of the annuity is calculated based on a government set rate of interest – currently a very low 3.2%. If the value of the assets grows at more than 3.2% per year, the beneficiaries get that excess appreciation, free of estate and gift tax.

While a GRAT offers certain benefits, it is not without potential drawbacks. For example, if you die during the term of the trust, the assets that are in the GRAT, plus any appreciation, are included in your estate.

Potential Restrictions. In his 2010 and 2011 budget proposals, President Obama suggested reigning in GRATs. Initially, most estate planners didn't take the President’s suggestion too seriously; however, with Congressional action seemingly on the horizon, persons who would benefit from a GRAT should consider acting before the restrictions can become law.

The first restriction would require a GRAT to last a minimum of 10 years, making this technique less attractive for older persons. Another restriction essentially bars zeroed-out GRATs, requiring the trustmaker to set the annuity so that the remainder gift is greater than zero. If a minimum gift is required, the trustmaker would have to use up some of his or her $1 million lifetime gift tax exemption.

Assuming the bill passes the House, it still must go to the Senate. But even if the GRAT restrictions don't end up as part of the current legislation, planners now believe that Congress will use the GRAT crackdown as a "revenue raiser" to fund other spending initiatives or tax breaks.

The restrictions would likely be effective when the bill is signed, which means there is still a window of opportunity to set up GRATs under the old rules.

Short-Term GRATs. In the meantime, planners are recommending setting up multiple short-term GRATs, each with a different asset class. The GRAT assets that go up enough save the family estate taxes; the ones that don't exceed a 3.2% return collapse back into the estate, and no harm is done – except for the legal fees associated with setting up the trust.

Adapted from the Daily Plan-It newsletter

Hoopes, Adams & Alexander, PLC, is a Chandler, Arizona, law firm offering services to Phoenix-area clients in the areas of estate planning, entity formation, commercial and real estate transactions, and civil litigation.