Grantor trusts and the zero valuation rules.

• Author: Depies, Keith

In the estate planning process, many clients run into the conflicting goals of transferring assets to reduce their estate tax liability while retaining control of both the asset and its cash flow. Grantor trusts can provide a solution.

The ultimate goal in estate planning is to provide an individual with sufficient cash flow to support his chosen lifestyle, without his assets ending up being taxed in his estate at death. The zero valuation ruses of Sec. 2702, effective for transfers after Oct. 9, 1990, were designed to prevent this. The primary victim was the grantor retained income trust (GRIT).

Using a GRIT, an individual would transfer assets to a trust, retaining the income for life with the remainder going to a beneficiary. Prior to Oct. 9, 1990, the value of the gift of the remainder interest would have been reduced by the retained income interest. After Oct. 8, 1990, the zero valuation rules state that the value of the income interest is zero and the gift is the current value of the transferred asset. Although the GRIT will still remove the appreciation of the asset from the individual's estate, the current gift tax is typically large enough to make this vehicle impractical for most people.

Exceptions to the Zero Valuation Rules

However, there are some exceptions to the zero valuation rules: the charitable remainder trust and the nonfamily member transferee exception.

* Charitable remainder annuity trust (CRAT) or charitable remainder unitrust (CRUT): A CRAT or CRUT allows a taxpayer to provide annual income to a specified beneficiary for a specific number of years and a charitable contribution to the specified charitable organization(s). The grantor receives a current-year charitable deduction on his tax return.

Example: Taxpayer G contributes $1,000,000 to a charitable remainder trust. The trust provides that G will receive an annual annuity payment of $25,000 for the next 10 years. At the end of the trust term, the remaining trust assets will be distributed to four of G's favorite charities. Assuming the present value of the retained interest by G is $200,000 (using the appropriate IRS valuation table), the gift of the remaining interest would be $800,000. G is allowed a charitable contribution of $800,000 on his individual return.

* The nonfamily member transferee exception: If the beneficiary of the trust is the transferor, his spouse, ancestors, descendants or siblings, the transferor will not be allowed a present value...