Monday, July 5, 2010

Grantor Retained Annuity Trust ("GRAT")

The Grantor Retained Annuity Trust (often referred to as a "GRAT") is a long favored technique for those with substantial estates who find themselves staring at a 55% estate tax rate starting January 1, 2011. By setting up a GRAT one can legally pass wealth down to the next generation on a tax favored basis. In essence, a donor sets up an Irrevocable Trust and retains the right to receive an annuity paid to the donor over a specified term of years. At the end of the annuity term, if there is anything left over for the beneficiaries, known as "remaindermen", the amount of increase in the trust's investments that exceeds a specified rate set by the IRS, passes tax free to the remaindermen.

The IRS hates this technique even though it is sanctioned by the current tax Code. Clients often set up revolving GRATS that rollover at the end of the term as a way to leverage their transfers to younger beneficiaries. Typically, we use GRATS that have a term of two, three or sometimes five years.

On July 1, 2010 the House of Representatives voted 215 to 210 to pass an amendment to H.R. 4899 ( a supplemental spending bill) that would now require all GRATS to have a minimum ten year term. If the donor who sets up a GRAT dies during the term, the bulk of the GRAT is includable in the estate of the donor for Federal Estate Tax purposes. Thus, for older donors this may well be the death knell of the use of the GRATS. The Senate is expected to take the measure up in the next few days.

For anyone interested in setting up GRATS, now is the time to do so! The effective date of the legislation will be the date the Act is enacted. Due to the very low interest rates now in play, if anyone has ever considered this technique, they should rush to get this accomplished post haste to avoid the application of the ten year minimum term rule. It looks like the clock will be ticking down soon.

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