IRS blesses short-term, high-income GRATs.

• Author: Henderson, Tracie K.
• Position: Grantor retained annuity trusts

In Letter Ruling 9239015, the IRS essentially gave a green light to a valuable transfer tax planning technique that seems almost too good to be true: the use of short-term, high-income grantor retained annuity trusts (GRATs). By using a GRAT to transfer appreciating property to a younger generation, a family can increase its overall net worth, by reducing the gift and estate taxes associated with the transfer and shifting, during the trust's term, the income tax burden to senior family members while the benefits inure to the benefit of the junior family members.

The typical GRAT is structured as a five-year or 10-year term trust that generates a market yield to the grantor over the trust's term. By structuring the arrangement as a short-term, high-income GRAT, significantly greater transfer tax savings may be generated over a shorter period of time. For this technique to work, the grantor must be able to generate a rate of return on the funds transferred to the trust in excess of the Sec. 7520 rate on the date of transfer.

In Letter Ruling 9239015 a donor proposed to contribute stock to a GRAT. The trust's term would be the shorter of two years or the donor's life. The annual annuity payment would be 55.776% of the fair market value (FMV) of the property contributed to the trust at the time of contribution. The donor would be the trust's sole trustee, and would retain the power, in a nonfiduciary capacity, to reacquire the trust corpus by substituting other property of equal value. The trustee would have the power to sell property to the donor or his estate at its FMV, including the power to distribute property in kind to satisfy the annuity payment.

The Service concluded that the donor's annual payment right would be a qualified annuity interest under Regs. Sec. 25.2702-3. Because the donor would retain the power to substitute trust corpus, the trust would be a grantor trust under Sec. 675(4). Rev. Rul. 85-13 provided that a transfer of trust assets to a donor of a grantor trust was not a sale or exchange for tax purposes. Therefore, neither the trust nor the donor would recognize gain or loss on the donor's transfer of stock to the trust, on the transfer of stock from the trust to the donor to satisfy annuity payments or on the donor's "purchase" of the stock from the trust.

Unfortunately, the IRS also concluded that Rev...