What to Know About the New Bill Targeting GRATs and 'Abusive Trusts'

What’s a GRAT?

Summarized simply, GRATs allow the grantor to freeze the value of their estate while transferring any future appreciation to the beneficiaries. Among estate planning professionals, GRATs are seen as a solid strategy for clients who want to avoid estate taxes and pass these assets to the next generation of children, grandchildren or others.

Generally, GRATs run for a fixed term and then the assets are transferred to the beneficiaries. GRATs also allow the grantor to take annuity income stream from the trust during the term of the trust, hence the name.

What’s in the Getting Rid of Abusive Trusts Act?

The bill would add various additional requirements for the creation and operation of a GRAT, all intended to impose costs on the use of GRATs so that they are less likely to be used entirely for tax avoidance purposes.

The bill adds the requirement, for example, that a GRAT must have a minimum term of 15 years and a maximum term of the life expectancy of the annuitant plus 10 years. Second, the bill prohibits any decrease in the annuity during the GRAT term, and it adds the requirement that the remainder interest in a GRAT at the time of transfer must have a minimum value for gift tax purposes.

Other key provisions dictate that any transfers of property between a trust and the deemed owner of the trust will be treated as a sale or exchange for income tax purposes. This change is intended to address prevalent tax planning methods where a taxpayer’s appreciating assets can be transferred in and out of a GRAT without incurring income tax or capital gains tax, according to Wyden and King.

Crucially, the bill further stipulates that income tax paid on the GRAT’s income is to be designated as a gift for the purposes of the gift tax — unless the owner is reimbursed from the GRAT during the same calendar year. As proposed, the gift amount cannot be reduced through the use of deductions such as the charitable deduction, marital deduction, or deductions for gifts of tuition or medical care.

This change, according to the senators, is intended to address prevalent tax planning methods where a grantor of a GRAT uses the trust to reduce the value of their estate, consequently lowering their estate tax burden while avoiding additional income or gift tax.

Pictured: Sen. Ron Wyden