Legislation Update
Grantor Retained Annuity Trusts
In 2008, we described the "perfect storm" of conditions existing at the time that increased the likelihood of success for a grantor retained annuity trust ("GRAT"). Although much has changed since 2008, most of the circumstances promoting the consideration of a GRAT still prevail. The "perfect storm" will likely be stilled if the Senate passes a pending bill. The legislation, called the Small Business and Infrastructure Jobs Tax Act of 2010 (HR 4849), was passed by the House of Representatives on March 24, 2010.
Lawmakers designed the bill to provide incentives for small business and infrastructure job creation, but such incentives require "Revenue Provisions" necessary to offset spending and tax cuts. Section 307 of the bill acts as one of those revenue generators by expanding the rules on GRATs, which in turn increases the transfer tax income to the federal government. The Congress Joint Committee on Taxation estimates that $4.45 billion in revenue will be generated over ten years by this provision.
HOW DOES A GRAT TRANSFER WEALTH?
Under certain conditions, a GRAT can result in the transfer of wealth to family members without gift tax. First, a quick overview of how GRATs work. The grantor transfers assets into an irrevocable trust, which is established for a set term, and an annuity is paid back to the grantor during each year of that term. For gift tax assessment, the IRS assumes an expected level of asset appreciation, called the Section 7520 rate. The amount of the taxable gift is the fair market value of the property when it is transferred to the trust less the present value of the grantor's annuity interest, using the Section 7520 rate as the discount rate. This difference is often referred to as the remainder interest.
The figure below shows a five-year GRAT with the annuity set up such that the remainder interest equals zero, assuming $10 million of assets are placed into the trust with a Section 7520 rate of 3.4%.