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Thursday, March 30, 2006


Under a properly designed Grantor Retained Annuity Trust (GRAT), a grantor transfers property to a trust, and retains for a period of time an annual annuity payout. The taxable gift on the funding is not equal to 100% of the value of the property transferred to the trust - instead, it is reduced by the value of the annuity interest retained by the transferor.

Such annuity interests often run for the shorter of a fixed period (e.g., 2 years) or the death of the grantor. The longer the retained period of payouts to the grantor, the more valuable the retained grantor interest becomes and thus the taxable gift portion is reduced. In an effort to stretch out the retained periods, some taxpayers established trusts that provided if the grantor died before the end of the fixed term, then the annuity payments would then be paid to a surviving spouse (if the spouse survived) for the remainder of the term or until the death of the surviving spouse. This effectively increases the term and actuarial value of the retained annuity interest (and thus appears to decrease the taxable gift) since now BOTH husband and wife have to die before the fixed term expires (in our example, 2 years) for the annuity to expire before the end of the fixed term. Actuarially, this is less likely to happen than if the early termination occurred if only one person had to die during the term, and thus it is more likely that the 2 year annuity payouts will be made without death cutting them off prematurely - thus increasing the actuarial value of the retained annuity interest.

There is one problem, however, as the taxpayers in Estate of Claude C. Focardi, TC Memo 2006-56, learned from the Tax Court. In the opinion of the Tax Court, the interest of the surviving spouse is too "contingent" to be a "qualified annuity interest" for purposes of the valuation of the gift rules that allow for the subtraction of the retained grantor interest. This means that the surviving spouse’s interest is ignored, and the gift is greater because the retained interest is computed under the 1-life annuity tables instead of the 2-life tables.While there may be other case law to the contrary, the Tax Court further noted the adoption by the IRS of Treasury Regulations that mandate this result (even though they were issued by the IRS after the trusts at issue in the case were created).


Anonymous said...

Thanks for this article. I have a test on Chapter 14 on Monday.

Anonymous said...

Me again. This wasn't on Mezzullo's test.