10 Year Minimum GRAT Approved by Ways and Means Committee

Pending Legislation

The House Ways and Means Committee has approved H.R. 4849. The “Small Business and Infrastructure Jobs Tax Act of 2010,” which contains a provision instituting a 10 year minimum for Grantor Retained Annuity Trusts (GRATs).  GRATs are commonly used to transfer wealth to younger generations at no or little gift tax costs.  The restriction would be effective upon enactment of the law.
If you are considering a GRAT, now is the time to act!
Click “Continue Reading” for the pertinent text from the report by the staff of the Joint Committee on Taxation.
Require Minimum Term for Grantor Retained Annuity Trusts (GRATs)
Present Law
Present law provides special rules for valuing certain transfers in trust of temporal
interests in property (such as annuity interests and remainder interests). 147 Present law also
provides rules for determining when a grantor of a trust will be treated as the owner of all or part
of the trust for income tax purposes.148 Grantor retained annuity trusts (GRATs) and charitable
lead trusts (CLTs) are two vehicles, often structured as grantor-owned, that are used to make
transfers of temporal interests in property.
Valuation of certain transfers in trust
In the event of a lifetime transfer in trust to (or for the benefit of) a member of the
transferor’s family where the transferor or an applicable family member retains any interest in
the trust, a special rule applies for purposes of determining the value of the transferor’s gift.149
In general, the value of any retained interest that is not a “qualified interest” is treated as zero.150
Therefore, where a transferor retains an interest that is not a qualified interest, the entire amount
transferred to the trust generally is treated as a gift by the transferor to the remainder
beneficiaries, which gift is subject to transfer taxation.151 The value of a retained interest that is
a qualified interest, on the other hand, is determined using rates and procedures described in the
Code for valuing temporal interests in property.152
For these purposes, the term “qualified interest” means: (1) any interest which consists
of the right to receive fixed amounts payable not less frequently than annually (i.e., a qualified
annuity interest); (2) any interest which consists of the right to receive amounts which are
payable not less frequently than annually and are a fixed percentage of the fair market value of
the property in the trust (determined annually) (i.e., a qualified unitrust interest); and (3) any
noncontingent remainder interest if all of the other interests in the trust consist of interests
described in (1) or (2) (i.e., a qualified remainder interest).153
A qualified interest is valued under procedures described in section 7520 using tables
prescribed by the Secretary of the Treasury and an interest rate (rounded to the nearest twotenths
of one percent) equal to 120 percent of the Federal midterm interest rate in effect under
section 1274(d)(1) for the month in which the valuation date falls. The tables and rates described
in section 7520 assume that the assets in a trust will grow at a relatively modest rate.
“Grantor trust” rules
For income tax purposes, a trust generally is a separate taxpayer. Under certain
circumstances, however, a grantor is treated as the owner of all or part of a trust for income tax
purposes.154 When a grantor is treated as owner of a trust, the grantor, when computing his or
her taxable income and credits, generally must include items of income, deductions, and credits
of the trust attributable to the portion of the trust deemed owned by the grantor for income tax
The Code includes a number of rules regarding when a grantor or another person is
treated as the owner of all or part of a trust for income tax purposes.156 A grantor may, for
example, be treated as the owner of a trust for income tax purposes where the grantor has: (1) a
sufficient reversionary interest in the corpus or income of the trust;157 (2) the power to control
beneficial enjoyment of the corpus or income of the trust;158 (3) certain administrative powers;159
(4) the power to revoke all or part of the trust;160 or (5) the power to distribute income to or for
the benefit of the grantor.161
A trust that is structured such that the grantor is treated as the owner for income tax
purposes, but not for gift or estate tax purposes, is sometimes referred to as an “intentionally
defective grantor trust.”
Grantor retained annuity trusts
A GRAT generally is an irrevocable trust in which the grantor retains an annuity interest
structured as a “qualified interest” under section 2702. The annuity interest must be an
irrevocable right to receive a fixed amount at least annually.162 The trustee must be required to
invade the principal of the trust in the event the income is insufficient to pay the qualified
Assuming the transfer of assets to the trust is treated as a completed gift for gift tax
purposes, the gift to the remainder beneficiaries generally will be subject to gift tax as of the time
of the initial transfer of assets to the trust. Therefore, the grantor will be required to use a portion
of his or her gift tax exemption equal to − or, to the extent insufficient exemption remains, to pay
gift tax on − the value of the remainder interest determined as of the time the grantor funds the
trust. The annuity portion of a GRAT is valued using the procedures for valuing qualified
interests outlined in section 7520 (described above). To value the remainder interest in a GRAT,
the value of any qualified interest, as determined under section 7520, is subtracted from the value
of the property transferred to the trust.
When the grantor’s retained annuity interest expires, the trust assets are distributed to one
or more remainder beneficiaries identified in the trust instrument. Because the value of the
transferor’s gift for gift tax purposes is determined at the time of the transfer, if trust property
grows at a rate in excess of the growth rate assumed under section 7520, the excess appreciation
generally will pass to the remainder beneficiaries without further gift tax consequences to the
grantor. If, however, the grantor dies during the trust term, that portion of the trust necessary to
generate the annuity amount will be included in the grantor’s gross estate for estate tax
purposes.163 Such inclusion generally results in the loss of the transfer tax benefit of using a
A GRAT is a grantor trust; therefore, the grantor is treated as owner of the trust during
the term of the annuity interest, and the grantor generally must include in determining his or her
taxable income and credits the income, deductions, and credits of the trust.
Description of Proposal
The proposal adds certain requirements for an annuity interest retained by the transferor
to be treated as a qualified interest for purposes of the special valuations rules applicable to
transfers of a trust interest to a member of the transferor’s family: (1) the retained annuity
interest must have a term not less than 10 years; (2) the annuity (determined on an annual basis)
may not decline during the first 10 years of the annuity term; and (3) the remainder interest must
have a value greater than zero at the time of the transfer.
Effective Date
The proposal applies to transfers made after the date of enactment.
163 Sec. 2036.
147 See sec. 2702.
148 See secs. 671-679.
149 Sec. 2702(a)(1).
150 Sec. 2702(a)(2)(A).
151 The special valuation rule does not apply in certain excepted situations, including: (1) where the
transfer is not a completed gift; and (2) transfers to certain personal residence trusts. See sec. 2702(a)(3).
152 Sec. 2702(a)(2)(B); sec. 7520.
154 See secs. 671-679.
155 See sec. 671.
156 See secs. 673-677.
157 Sec. 673.
158 Sec. 674.
159 Sec. 675.
160 Sec. 676.
161 Sec. 677.
162 Treas. Reg. sec. 25.2702-3(b).153 Sec. 2702(b).
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