GRATs eligible for grantor trust status.

• Author: Harman, Gregory A.
• Position: Grantor retained annuity trust

An essential requirement of every grantor retained annuity trust (GRAT) is that it be a wholly owned grantor trust under Secs. 671-677. When S stock is transferred to a GRAT, the trust must be a grantor trust in order to be a qualified S shareholder. But regardless of the type of property transferred to the GRAT, grantor trust status is necessary to prevent gain from being triggered when trust property is used to satisfy part or all of the annuity payment requirement. This result flows from Rev. Rul. 85-13, which is cited by the IRS for the principle that gain or loss is not recognized on transactions between a grantor and his own grantor trust.

Early GRAT letter rulings sought a grantor trust ruling under Sec. 675(4), based on a trust provision conferring on the grantor a nonfiduciary power to substitute property of equivalent value for trust property. However, while Letter Ruling 9352017 issued a "clean" Sec. 675(4) ruling, other GRAT rulings issued simultaneously and subsequently under Sec. 675(4) have contained a caveat: Grantor trust status will be dependent on a factual determination by the district director that the grantor's power is actually held in a nonfiduciary capacity; see, e.g., Letter Rulings 9352004 and 9416009. While not enough to stand in the way of the transactions, these factual caveats left many grantors and their advisers with an unsettled feeling.

Fortunately, the Service has begun issuing clean grantor trust rulings under Sec...