Trusts & Estates Department
December 29, 2000
U.S. Tax Court Approves
Fixed Term GRATs
Grantor Retained Annuity Trusts ("GRATs") are popular estate
planning devices that enable a portion of the future appreciation in the value
of property to be transferred to descendants inexpensively. The expense -- the
gift tax cost of establishing the GRAT -- got cheaper last week thanks to the
U.S. Tax Court's decision in Walton v.
Commissioner, 115 T.C. No. 41 (December 22, 2000). Carter, Ledyard's Dick
Covey and Jerome Caulfield represented the taxpayer in this watershed case.
GRATs are trusts established for a fixed term (typically, two years) under
which the trust grantor retains the right to an annuity payment. To the extent
the property transferred to the trust is worth more than the value of the
retained annuity, the grantor has made a gift.
Mrs. Walton's GRATs provided that the annuities would be payable to her for
two years and that, if she died during that term, the annuities would continue
to be paid to her estate. Covey and Caulfield argued that the retained annuities
should be valued as term annuities that would be payable in all events. The IRS
disagreed, pointing to a regulation that says that the two year term annuity had
to be valued as an annuity for the shorter of two years or Mrs. Walton's earlier
death. Since there is always a chance that an individual will not live two
years, under the IRS approach the annuity would have to be valued by assuming
that it might not be paid for the full two years. This would have the effect of
decreasing the value of the annuity and increasing the taxable gift.
The Tax Court agreed with Carter, Ledyard, holding that the IRS regulation in
question -- Reg. §25.2702-3(e) (Example 5) -- was an invalid interpretation of
the statute enacted by Congress.
Under the Walton decision
GRATs can now be truly "zeroed out" -- created with no gift tax cost
at all -- by structuring the retained annuity as one that is payable in all
events for the entire term. Completely zeroing-out was never possible under
Example 5. The decision should increase the popularity of GRATs even in the face
of the current debate over whether the current estate and gift tax system should
be substantially modified. A taxpayer who is willing to transfer future
appreciation to his descendants can now do so at no gift tax cost whether or not
the gift tax stays on the books.
Questions regarding this advisory may be directed to Jerome Caulfield (caulfield@clm.com,
212-732-3200) or Steve Lappert (lappert@clm.com,
212-238-8717).
Carter, Ledyard & Milburn uses Client
Advisories to inform clients and other interested parties of noteworthy issues,
decisions and legislation which may affect them or their businesses. A Client
Advisory does not constitute legal advice or an opinion.
© 2000 Carter, Ledyard & Milburn.
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