New Grantor Retained Annuity Trust Legislation

On March 24th, H.R. 4849, which significantly impacts the wealth transfer taxation of grantor retained annuity trusts (GRATs), passed the U.S. House of Representatives. This bill mandates a minimum annuity period of ten years for all future GRATs, and requires that at least some portion of the initial gift be taxable (i.e. no more zeroed-out GRATs).

A GRAT is a trust formed by a grantor for the specific purpose of establishing a private annuity. It is generally used in connection with rapidly appreciating property, to capture appreciation inside the trust, which is not part of the grantor's taxable estate. The amount of the taxable gift to the trust is limited to the amount of the initial gift that will remain in the trust after the final annuity payment (taking into account the payment of a modest interest rate).

Example: For example, a trust is formed, and a gift of $1M is made to the trust. While inside the trust, the property appreciates in value. Over then next five years (the annuity term) the trust makes annual annuity payments back to the grantor. The total value of the annuity payments equal the full amount of the initial gift, plus a modest rate of return (7520 rate). At the end of the annuity term, the grantor has received his initial gift back, plus a little extra, but most of the appreciation in the asset remains in the trust. In some instances the value of the annuity payments will exceed the value of the initial gift - often called a "zeroed-out GRAT."

Required 10 Year Term: Under current law, there are no restrictions on the length or term of a GRAT. Thus, short term rolling GRATs are often used to capture the full benefit of years where property appreciates in value. These short term GRATs can be a very powerful tool in limiting the grantor's future estate tax liability by essentially freezing the estate tax liability at its current levels. H.R. 4849 changes this result by requiring that all GRATs have a term of at least 10 years. Thus, significant appreciation in some years can be eliminated by a decline in value in subsequent years. Additionally, the mortality risk associated with a GRAT becomes much more significant.

Required Gift: Using a zeroed-out GRAT (also called a Walton GRAT), a grantor can transfer appreciation out of their estate without using any gift tax exemption. H.R. 4849 changes this result by requiring the amount of the taxable gift to be greater than zero.

What's next: While H.R. 4849 passed in the House of Representatives, it must still pass through the Senate, and then be signed by the President, in order to become law. It appears unlikely that this bill will pass without significant revision. Perhaps the greatest importance of this bill is the insight that it gives as to Congress' intentions on this issue. In short, the golden years of GRAT planning may shortly be coming to an end.