By: Randall A. Denha, Esq.***
Buried deep into a large tax relief bill are new restrictions on a popular estate planning strategy that has been used by wealthy families, among others, the billionaire Walton family that founded Wal-Mart. The technique, known as a grantor retained annuity trust, or GRAT, allows families to pass on wealth while dramatically cutting their estate and gift tax bills.
President Obama in his fiscal 2010 budget proposal last year and again this year in his 2011 budget proposal, suggested reigning in GRATS. But many estate planners didn’t take the threat too seriously. Things have now changed. Many planners have changed their tune and now are urging those that can establish a GRAT to do so immediately before it becomes law.
The new GRAT restrictions would likely be effective when the bill is signed, which means there is a window of opportunity to set up GRATs under the old rules. With a GRAT, a grantor puts assets into a trust and takes back an annuity payout for typically two to three years. At the end of the period, anything left in the trust goes to the grantor’s children or other trust beneficiaries. The value of the annuity is calculated based on a government set rate of interest–currently a very low 3.4% (May 2010.) Often, the payout is set so that if the assets grow at only 3.4%, all the assets will be paid out as an annuity–what’s known as a “zeroed out” GRAT. Since, in theory, nothing is left for the beneficiaries, no gift tax is owed. If the value of the assets in the trust grows at more than 3.4% a year, the children or other trust beneficiaries get that excess appreciation, free of estate and gift tax. If the assets don’t appreciate beyond the set rate of interest, the grantor is no worse off than having tried the technique. Put another way, the grantor has simply paid back to himself as an annuity the assets put in the trust.
But this technique isn’t a sure thing. If the grantor dies during the term of the trust, the assets put in the GRAT, plus any appreciation, are included in his or her estate. The House bill would require a GRAT to last a minimum of 10 years. That increases the risk the person setting it up will die during the term of the GRAT, making GRATs less attractive for the older folks who typically set them up.
A second restriction on GRATs in the legislation essentially bars zeroed-out GRATs, requiring that at the time a grantor puts assets into the trust, he set the annuity so that the remainder gift is greater than zero. Exactly how much more than zero would be left to be spelled out in Treasury regulations. It’s possible, for example, that $1 million in assets placed in a GRAT could require a 10% gift of $100,000. If a minimum gift is required, the person setting up the trust would have to use up some of his or her $1 million lifetime gift tax exemption. If that exemption has already been used up, the grantor would have to pay gift tax, even if the strategy fails because the asset doesn’t appreciate or because the grantor dies before the end of 10 years
In the meantime, planners are recommending setting up multiple short-term GRATs, each with different asset classes. For example, a wealthy investor might put all his emerging market stocks in one trust, all junk bonds in another. The GRAT assets that go up enough save the family estate taxes; the ones that don’t exceed a 3.2% return collapse back into the estate, and no harm is done–except for lawyer’s fees.
The timing of the current GRAT rush is a bit ironic. Under the Bush tax cuts, the federal estate tax at the start of 2010. But the tax is set to come back to life in 2011 with only a $1 million per person exemption from tax. Acting House Ways & Means Chair Sander Levin, D-Mich., has said that Congress will attempt to restore the tax retroactively to its 2009 state. That means there would be a $3.5 million per person exemption per estate, making GRATs appropriate for couples who have, or anticipate eventually having, combined assets of more than $7 million and singles worth more than $3.5 million.
Also being proposed but not currently in the bill before the House, the Obama budget is also proposing the elimination of certain valuation discounts on passing property from one generation to the next. Often assets put in GRATs are assigned a discounted value. Eliminating discounts would make GRATs even less attractive.
***Randall A. Denha, j.d,, ll.m., principal and founder of the law firm of Denha & Associates, PLLC with offices in Birmingham, MI and West Bloomfield, MI, attended Wayne State University and graduated with a degree in Corporate Finance. After college, Mr. Denha then went to University of Detroit School of Law where he obtained his law degree. He then attended the University of Miami School of Law and completed a masters in law (LL.M.) in estate planning. The University of Miami is regarded as the premier school in the country for its program in estate planning. Throughout his career he continues to lecture extensively for many local groups some of which are the AICPA, State Bar of Michigan, Michigan State Medical Society, Detroit Medical Society, UBS Financial and its affiliates to name a few. Randy is frequently called upon by both local and state publications to render an opinion or provide insight into planning techniques. Randy has hosted a radio program and has authored many articles in the estate planning arena on the importance of planning. Additionally, he is a former adjunct Professor at Oakland University’s Personal Financial Planning Program where he taught estate planning for those wishing to obtain a Certified Financial Planning (CFP) degree. Mr. Denha also serves as General Counsel for both local and national organizations. Mr. Denha is also a member of the Bank of Michigan’s Board of Directors and volunteers his time to several community organizations. Mr. Denha can be reached at 248-265-4100 or by email at firstname.lastname@example.org