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The Perfect “GRAT” Storm: Record-Breaking Low Interest Rates and Depressed Financial Markets

Record-breaking low interest rates and depressed financial markets have created unique estate planning opportunities. Current conditions make this an opportune time to shift a substantial amount of wealth from one generation to another in a tax-efficient manner. We urge you to review and evaluate these opportunities as soon as practicable before these techniques lose their effectiveness, whether due to legislative enactments or changed economic conditions. If you are general counsel, it is important that you forward this time-sensitive information to the business owners.

2011 Transfers to Grantor Retained Annuity Trusts

Description of Technique. Current law allows taxpayers to structure a short-term (e.g., two year) Grantor Retained Annuity Trust (a “GRAT”) without paying any gift tax. A GRAT is an irrevocable trust that pays its grantor annual annuity payments over a fixed trust term. When the fair market value of the property transferred to the GRAT equals the present value of the annuity returned to the grantor based on the IRS assumed interest rate, then the grantor pays no gift tax as the GRAT has been “zeroed-out.” The grantor must survive the trust term for the GRAT to be effective, and a short two-year term minimizes the risk that the trust assets will be returned to the grantor without any tax savings due to his or her death. This ability to fully zero-out the gift for a two-year term has made GRATs very attractive. 

Historical Low Rates. Low interest rates can substantially enhance the overall effectiveness of a GRAT. The IRS assumed interest rate will be 1.4% for GRATs funded in October 2011, the lowest rate in more than 20 years: 

 

If the appreciation of assets held by a GRAT exceeds the IRS assumed interest rate, the trust assets remaining after payment of the annuity may be transferred to or for the benefit of descendants of the trust creator (the “grantor”) without additional gift tax consequences. The lower the IRS assumed interest rate, the greater the likelihood of having asuccessful GRAT transaction if the grantor survives.

Lock-In Low Rates for 5-10 Years. Clients may wish to lock in these historic low interest rates for a term longer than two years (such as five or 10 years), particularly for an asset with longer-term appreciation potential or a portfolio of marketable securities. Many wealth management advisers believe that the historical performance of the equity markets should far exceed 1.4% on an annual basis in the mid to long term. Although the longer trust term may increase the possibility of losing the tax benefits due to the grantor’s death during the term, it may be a reasonable risk for younger and middle-aged clients.

2011 Transfer of Closely Held Business Interests

Due to difficult business and economic conditions, the values of many closely held businesses have reached all-time lows. Combining GRATs with other planning techniques, which benefit from the historically low interest rate environment, can transfer a significant percentage of interests in a closely held business to family members at the current reduced values. The Obama administration has proposed legislation that would artificially inflate the value of interests in family controlled businesses and other entities over their independently appraised fair-market value when transferred to other family members. While it is unclear whether such legislation will be enacted, those considering the transfer of closely held businesses and other interests may wish to act as soon as practicable.

When to Act

The Obama administration has advanced various proposals to make GRATs less attractive by preventing taxpayers from structuring GRATs in this manner. The U.S. House of Representatives passed several bills last year that would restrict the use of GRATs by requiring (1) a 10-year minimum term and (2) a taxable gift upon formation, and the Obama administration continues to offer these restrictions as potential revenue raisers.

Tax advice disclosure:  Any tax advice contained in this publication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

© 2019 Neal, Gerber & Eisenberg LLP.

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About this Author

Michael C. Diedrich, Senior Counsel, Neal Gerber law firm
Senior Counsel

Michael C. Diedrich has advised high net worth individuals and their families on complex estate, gift, generation-skipping and other tax planning matters. He has also counseled individuals, trustees and entities on tax compliance, foreign trust reporting, insurance transactions and financial planning techniques.

Michael has implemented succession and wealth transfer planning strategies involving closely held businesses as well as publicly traded companies. He has advised trustees on how to satisfy their fiduciary obligations to trust beneficiaries, efficiently administer their...

312-269-5356
Marshall E. Eisenberg, Partner, Neal gerber law firm
Partner

Marshall E. Eisenberg has an extensive background in mergers and acquisitions; real estate transactions; estate planning and probate; federal, state and international taxation, including tax controversy; securities offerings; joint venture formation; and venture capital. He has significant experience in matters relating to real estate investment trusts. He is a member of the firm’s Executive Committee.

Marshall began practicing law in the area of corporate taxation and now focuses on complex tax planning and major corporate merger and acquisition transactions. His estate planning practice is international in scope, and he has advised many of the wealthiest families in the U.S. and abroad on matters of generational structures and wealth preservation. He has been a featured speaker at the University of Chicago Tax Conference. He has handled Initial Public Offerings and has served as lead counsel in complex income and estate tax controversies, as well as in commercial litigation. He has been named one of The Best Lawyers in America by his peers for 24 years, and he serves as trustee for wealthy families and is a director of public and private owned companies. In 2006 he received the American Jewish Committee’s Judge Learned Hand Award.

312-269-8020
Lawrence I. Richman, attorney, neal gerber law firm
Partner

Lawrence I. Richman’s practice involves advising entrepreneurs, tax-exempt organizations, fiduciaries and high net worth families on estate, gift and charitable planning issues, including business succession, tax-efficient ownership structures, sophisticated tax-exempt structures, trust and estate administration, executive benefits, life insurance and international estate planning issues.

Larry has served as chairman of the Trust Law Committee of the Chicago Bar Association, and is a frequently published author and speaker. He is also the Estate and Succession Planning columnist for...

312-269-8070
Scott J. Bakal, attorney, neal gerber law firm, Partner
Partner

Scott J. Bakal, co-chair of Neal Gerber Eisenberg's Taxation practice group, specializes in finding tax-sensitive solutions to complex financial situations, business transactions, and estate planning matters. Scott works primarily with entrepreneurial companies and high net worth individuals. Scott frequently represents commodities and securities traders, family offices, owners of business jets and companies and executives in employment...

312- 269-8022
Martin H. Tish, Private Wealth Services attorney, Neal Gerber law firm
Partner

Martin H. Tish counsels business owners, executives, entrepreneurs, traders, charities, family offices and individuals from virtually every field regarding asset ownership and structure, prenuptial agreements, retirement planning and charitable planning. He has successfully administered estates and trusts ranging in size from $500,000 to more than $100 million, achieving excellent tax results without forgetting the human concerns that are of paramount importance to a sound estate plan.

Marty has lectured on estate planning before the Chicago Bar Association, the American Bar...

312-269-8031