Beth Kaufman Talks to Tax Notes About Grantor Trusts and GRATs
The manager wants to create what is called a completed gift grantor trust (also called an intentionally defective grantor trust). The manager wants to make a completed gift to get property out of his estate and take advantage of the exclusion. He will usually transfer the partnership interest at the time of grant, when its value is low. He continues to be taxable on the income — essentially an annual gift to the ultimate beneficiaries in the amount of the taxes. The trust is irrevocable, which is one factor that makes the gift complete.
No powers can be retained that would pull the trust property back into the estate, so planners are threading the needle between income and transfer taxation in designing the manager’s retained powers. The manager can’t have the power to direct distributions or retain a power of appointment. He may retain the ability to manage investments. The manager usually retains the power to borrow without adequate security (section 675(2)) and the power to swap assets (section 675(4)(C)).
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“Those rights are not those that would cause the assets of the trust to be included in the grantor’s estate for estate tax purposes, but they are sufficient to cause the trust to be a grantor trust for income tax purposes,” Beth Shapiro Kaufman of Caplin & Drysdale explained.
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A GRAT is another species of estate freeze. A manager would use a GRAT to take advantage of the special valuation rule for those trusts (section 2702). The annuity value is set so that the actuarial value of the annuity equals the FMV of the asset contributed plus imputed interest at the gift loan rate (section 7520). Kaufman explained that this is how the grantor avoids paying a gift tax. The actuarial value of the gift of the remainder interest is zero or near zero — called a zeroed-out GRAT. So appreciation in the contributed asset goes to the remaindermen without gift tax.
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