Grantor-retained annuity trusts, one of the most powerful and tax efficient wealth transfer tools, could be a lot less attractive for wealthy investors in the future.
Grantor-retained annuity trusts, one of the most powerful and tax efficient wealth transfer tools, could be a lot less attractive for wealthy investors in the future.
A provision in the Small Business and Infrastructure Jobs Tax Act of 2010, which was passed by the House on March 25, would impose a minimum 10-year term for the estate- planning vehicles and would bar “zeroed-out” GRATs.
The Senate Finance Committee is expected to take up the bill next week. Some advisers are so concerned over the potential change in the law that they are urging clients to set up GRATs now while the tax treatment is still favorable.
“This would be a dual strike against GRATs,” said Richard Behrendt, a senior estate planner with Robert W. Baird & Co. Inc. “If it becomes law, GRATs would become less appealing. Why [would you] create a 10-year GRAT when you can capture a burst of appreciation over two or three years, and you minimize the risk that a client dies during the term?”
GRATs are a trust with a specific life or term that allows a wealthy person to transfer more money to heirs than they otherwise could under the “$1 million in a lifetime” rule.
With the strategy, an asset is placed into a trust by a grantor, who then takes back an annuity, which is made up of the asset value plus a variable interest rate.
GRATs work best when the asset appreciates more than the interest rate, a hurdle which has been easy to leap recently because rates have been so low. This month, for example, the rate is 3.2%, and any appreciation beyond that goes to a grantor's heirs when the term of the GRAT ends, as a tax-free gift.
Shorter-term GRATs — typically two or three years — have been most appealing because the asset may appreciate quickly, and the investor is not likely to die over the life of the trust, an event that would force the entire asset back into the taxable estate.
Another restriction under the new law bars zeroed-out GRATs, requiring that the remainder be greater than zero. The Treasury Department would determine how much more, but some estate planners assume it will be 10% of the value of the asset, creating a gift tax liability.
“[The GRAT] has been a very useful technique,” said Matthew Brady, head of wealth advisory services for the Americas at the wealth management division of Barclays Bank PLC. “The structure works well for an asset that appreciates. It's one of the reasons why, at the end of last year, we were saying it's an ideal time to do this. Financial asset values were still reeling. It was a chance to take low-value assets and transfer that value to children.”
WASHINGTON CONCERNED
A little too much value has been transferred for comfort, some people in Washington clearly feel.
Indeed, the House Ways and Means Committee cited the following as the reason for changing the law: “The [new] provision limits opportunities to inappropriately achieve gift tax-free transfers to family members in situations where gifts of remainder interests in fact have substantial value.”
The committee also estimated that the law would raise $4.5 billion in revenue between 2010 and 2020 by raking in the gift tax from the estates of people who died before the end of the 10-year GRAT term. The revenue is intended to offset the costs of the small-business benefits in the broader bill.
Still, with all the estate tax issues that remain unsettled in Washington, observers say they're far from sure that the bill will go through in its present form. Though the jobs part of the bill enjoys bipartisan support, the House vote on HR 4849 was one-sided, pointed out Ronald Aucutt, leader of the private-wealth-services group at McGuireWoods LLP. Only four Republicans voted for it, and only seven Democrats against, he noted.
“Because of the partisan baggage, it's likely to have a pretty hard time in the Senate,” Mr. Aucutt said. “It's certainly possible that the Finance Committee would make some changes. It's also possible that while this is pending, this provision gets stripped out and gets used as an offset for some other legislation. It's the only thing that has to do with the estate tax in that bill. It would not be missed.”
Overall, given the year that Congress has had, especially with regard to estate tax issues, few would be surprised by anything that happens on the Hill.
“Anyone who even thought they knew what was happening in Congress wouldn't say that now,” said Marc Bloostein, a partner in the private-client group at Ropes & Gray LLP. “The GRAT thing is a minor distraction; the larger question is: "What is Congress going to do about the estate tax?'”
“It's a period of significant uncertainty,” said Carol Kroch, managing director of charitable trusts and head of wealth and financial planning at Wilmington Trust Corp. That's why she's been talking to many clients about setting up GRATs — and quickly — before the law changes.
“You can say, "I don't know what's going on with all that,' but if you think you can outperform 3.2%, a GRAT may work for you,” she said. “There are some areas of certainty. They don't answer some of the big questions, but we can't really answer the big questions right now.”
One irony is that the House's revenue projections may not materialize if short-term GRATs go away, Mr. Behrendt said.
“If this is no longer a viable wealth transfer strategy, planners will come up with something else that will accomplish the same objectives,” he said.
He recommends thinking about an intentionally defective grantor trust, the “non-statutory cousin” of GRATs, to achieve the same, or better, tax-free gift on assets likely to appreciate in the short term.
E-mail Hilary Johnson at -hjohnson@investmentnews.com.
