As just about every estate planner knows, the financially ruinous storm clouds of 2008 did contain at least one silver lining: an environment that made the grantor retained annuity trust (GRAT) a virtual foolproof way to pass on assets free of gift tax.
But it appears the opportunity will have been fleeting-meaning advisors need to quickly assess their clients' wealth transfer needs before its too late to get them into a GRAT.
Perhaps paying the price for their wild popularity over the last two years, GRATs are one of the targets of the Small Business and Infrastructure Jobs Tax Act of 2010, tax legislation package wending its way through Congress.
Passed by the House in March, the legislation was before the Senate at press time. Among other things, the legislation would mandate that GRATs have a minimum term of 10 years and prohibit "zeroed-out" GRATs and require a remainder interest, thereby robbing the trusts of two of the main features that have made them so attractive to planners and their clients.
The feeling among those in estate planning circles is that the GRAT regulations will eventually be signed into law by President Obama. "There definitely has been some momentum building on this for over a year," says James H. Cundiff, a partner with McDermott Will & Emery, one of the nation's most prominent estate planning law firms, in Chicago. "With that kind of background, you get the feeling it's inevitable."
How will clients be impacted if the legislation is adopted?
Clients with a desire to pass on assets now and in the near term-namely, elderly clients-will be most affected, planners say. "Generally, it is the elderly client," says Thomas Forrest, president of Charles Schwab Bank personal trust division. "It's difficult to tell a 40-year-old to give up their money."
Clients will still have access to tax-advantaged strategies for passing on assets to children and other beneficiaries, but depending on the situation, they will end up paying more in gift taxes and be more susceptible to challenges from the IRS. Many of the people who use GRATs now, planners say, may have to turn to strategies like sales to defective grantor trusts, which have their own benefits, but at the same time are more cumbersome and prone to more IRS scrutiny.
The elimination of zeroed-out GRATs means that some gift tax will have to be paid on transferred assets, but the legislation is not clear on how this will be accomplished, according to planners.
Estate planners say the new restrictions will mean that GRATs will no longer be the surefire vehicles that they have been for clients to pass assets onto younger generations free of gift tax. This is why planners have been busy in recent months reviewing their clients' existing GRATs and creating GRATs for those clients who have been sitting on the fence. Under the current legislation, the restrictions would take affect upon signing, meaning any GRATs formed up until that time will fall under the old regulations.
"It's an excellent vehicle because there really is no downside," says Bruce J. Bettigole, a partner with Gilmore, Rees & Carlson P.C. in Wellesley Hills, Mass. "The worst that can happen is a GRAT fails and you are back where you started from. "