House Bill 4849 –Time May Be Running Out on 2-Year GRATs
House Bill 4849 (the "Bill"), passed by the U.S. House of Representatives on March 24th, would require a Grantor Retained Annuity Trust (“GRAT") to have a ten year term, as opposed to the minimum two year term required under present law. The Bill, which would become effective upon passage by the Senate, responds to the fact that, under present law, GRATs enable taxpayers to benefit from short-term fluctuations in the markets with no downside risk. The Treasury has long considered present law to be a boon for taxpayers, and has long sought changes such as those set forth in the Bill. If passed by the Senate, the Bill would effectively require long term investment performance in excess of the applicable federal rate in order to pass assets tax free to the next generation, rather than just favorable short term market swings.
By way of background, a GRAT is one of several estate planning vehicles which allow an asset's appreciation in excess of a federal assumed rate (presently 3.2%) to pass gift tax free to or for the benefit of a client’s children at the end of a specified term (often, a period of two years). Under a typical GRAT arrangement, a client would make a gift to the GRAT, with the GRAT paying the client an annuity interest for two years. The remaining balance at the end of the term would pass to (or be retained in further trust for) the client’s children. If the client survives the two year term, the remaining balance is not includible in the client's estate for estate tax purposes.
Since the gift tax value of the gift to the children is reduced by the value of the retained annuity, under current law it is possible to “zero-out” a GRAT, meaning the annuity amount is high enough to cause the value of the remainder interest to equal zero, using the IRS mandated assumed interest rates, and completely eliminating any gift. (The Bill, in fact, requires some taxable remainder, but only specifies that the remainder must be greater than zero, seemingly leaving room for a negligible amount as the taxable remainder.) If the assets in the trust increase in value at a higher rate than the rate assumed by the IRS, the excess at the end of the two year term passes to or for the benefit of the client’s children gift tax free ― and without using a client’s gift tax exemption.
The Bill passed the House along party lines, and would require 60 vote approval in the Senate. However, it is part of a stimulus jobs bill that many in Congress want to pass. We cannot predict likelihood of passage in today's Congressional environment, but if you are considering using a GRAT in your estate planning, you may want to act quickly.