NEW GRAT LEGISLATION PROPOSED

Yesterday, June 15^th, in a 247-170 vote, the House the Small Business Jobs Tax Relief Act of 2010 (H.R. 5486) that is projected to raise more than $5 billion (a questionable statistic, given recent stock market and real estate, and business performance) by altering the requirements of grantor retained annuity trusts (GRATs).

This piece of legislation would change existing law regarding the structuring of GRATs as follows:
           "(1)     A required minimum 10 Year Term,

(2)     Fixed amounts, when determined on an annual basis, can not decrease relative to any prior year during the first 10 years of the term, 
(3)     the remainder interest must have a value greater than zero determined as of the time of the transfer. 
(4)     The Effective Date would be for “transfers made after the date of the enactment of this Act.”

This is NOT law today, but time is running out on a family’s ability to implement short-term, high pay-out GRATs designed to capture unexpected upside in the financial markets for a concentrated asset position.

Here’s the potential impact of the three proposed new requirements:

1.  10-YEAR MINIMUM.

A Grantor’s required retained annuity interest would have to last at least 10 years. This significantly increases the probability that – during the term of the trust – the client will die and thus expose the assets in the trust to federal estate tax.  Obviously, this diminishes the appeal of a GRAT technique for older or sicker people. (Life insurance to “bullet-proof” the tax savings remains viable for younger and healthier people).  But even for younger healthier people, the inability to use short-term rolling GRATs may diminish the ability to remove short-term upside volatility and will thus reduce the appeal of some GRATs. (We have always counseled that a longer term and an annuity based upon internal cashflow and valuation discounts is a safer, superior design.)

2. NO DECLINING PAYMENTS:

Because of the second proposed rule, it would not be possible to circumvent the 10 year minimum rule by front-loading all the GRAT payments, and thus effectively make 10 year GRATs work economically similar to two year GRATs.

3. REQUIREMENT OF PRESENT VALUE GREATER THAN ZERO:  

Currently, a GRAT transfer can have an actuarial “zero value” for gift tax purposes. The proposed law would require “a value greater than zero.”  How much greater we don’t know.  It is rumored that the IRS would like to require that the value of the gift be at least 10% of the value of the assets transferred to the GRAT, similar to the rules for funding gifts to charitable remainder trusts (i.e., the charity has to have a present value interest at least equal to 10% of the value of the gift).  With a 10% rule, wealthy people would be precluded from using GRATs for large transfers. A transfer of more than $10 million to a GRAT, if 10% or $1 million had to be a current taxable gift, would require that gift tax be paid.