GRATs have been around in their present form for decades, but the reason they have become so popular-and caught the gaze of revenue starved federal legislators-was because they allowed clients to take great advantage of the low valuations that were created by the global financial collapse of 2008.

In the typical scenario, an elderly asset holder could take an undervalued asset, put it in a GRAT for a term of two or three years-a period of time where one would expect values to rise as the economy went into recovery. Under present tax law, the grantor would receive annual annuity payments during the term roughly equal to the original principal and IRS-calculated interest, or the "hurdle rate," which has been running at slightly more than 3%. At the conclusion of the term, any leftover appreciation is passed onto beneficiaries free of gift tax. This is, in effect, what is known as a "zeroed-out" GRAT.

Given the current low hurdle rates, and the great potential for appreciation in recent years, GRATs have been a boon for the wealth transfer industry, virtually assuring clients of passing millions to their heirs without paying gift tax.

Indeed, in the end, they probably worked too well, estate planners acknowledge. "The perception of most taxpayers is that only the very wealthy benefit from this strategy," says Elizabeth Schlueter, head of wealth advisory for J.P.  Morgan Private Wealth Management. "That perception makes them an easy target."

But Schlueter feels GRATs benefit a larger swath of the population than may be realized.

Anyone looking to pass wealth to their children in a tax-efficient way can potentially benefit from GRATs, she notes. The legislation, however, will limit the benefits and, as a result, limit their client suitability. "I think it would change the nature of the person who you talk to about using them," she says.
Elderly clients, for example, would have a harder time making a GRAT fit into their plans for wealth transfers because of the 10-year minimum term requirements. That's because of the mortality risk inherent in a GRAT. If the holder of a GRAT dies during the term of the trust, then all the assets of the trust goes into the person's estate and becomes subject to estate tax. Clients were able to minimize this risk by limiting GRAT terms to just a few years. A 10-year term, however, would be too much risk for many clients to accept, planners say.

In addition to mortality risk, there is also the question of whether assets will appreciate to a level over the 10-year period to make the GRAT a suitable strategy, planners say. This is an issue with clients who, for example, are using GRATs as a way to pass on a concentrated stock position, planners say.
Planners also would no longer be able to pass client wealth through the use of rolling two-year GRATs. This strategy, which funds each successive GRAT with the annuity payments of the previous GRAT, is designed to hedge against the volatility of assets such as publicly traded stocks. Front-loaded GRATs would also become a thing of the past because, under the bill, annuities may not decrease for ten years.

"The economics don't work out so well over a term of 10 years," says Linda B. Hirschon, an estate planning attorney who frequently uses the rolling GRAT strategy at Greenburg Traurig LLP in New York City.

Clients with closely held businesses, and who often place shares of those businesses in a long-term GRAT anyway, stand to be least impacted by the new legislation, according to estate planners. Given today's interest rates, such clients would probably still be good candidates for GRATs, they say.
For such clients, the priority is often to make sure the business is passed onto their children, according to Schlueter. The question of appreciation usually isn't an issue, even over 10 years, and quite often the family prefers the transition to take place over a long period so they can be groomed to take over, she says.

"For a closely held business, even with a modest rate of growth, it's still an attractive way" to pass it on to the next generation, Schlueter says.