There are two proposals that would affect the use of Grantor Retained Annuity Trusts (GRATs) and partnership and other entity discounts for estate and gift planning purposes contained in the Obama Administration's 2010 Fiscal Year Revenue Proposals (the "Greenbook"), which was released in May.
GRATs are trusts that can be used to transfer appreciation on a gift tax-free basis to the grantor's beneficiaries, usually those in younger generations. However, there is a mortality risk associated with the GRAT, because if the grantor should die before the end of the annuity period established in the trust, all or substantially all of the trust principal will be added back to the grantor's estate. Practitioners have managed this risk by using short-term GRATs (as short as two years) to limit the possibility that a grantor will die during the GRAT term. A short GRAT term also makes it more likely that gains in volatile positions during the initial years of the GRAT will not be lost by losses in the later years.
The Administration's proposal would require GRATs to have a minimum 10-year term. This would dramatically increase the mortality risk for a GRAT created by an older grantor and might also lead to lessened returns to family members for GRATs holding volatile assets.
Many taxpayers in recent years have taken advantage of valuation discounts for interests in limited partnerships or other entities that are controlled by the taxpayer's family (so-called family limited partnerships or FLPs ). The Administration's proposal would disregard certain restrictions on a taxpayer's interest in an FLP in determining the value of those interests. This would mean higher valuations would have to be used in transferring such interests during the taxpayer's life or at his or her death.
Although the trajectory of any tax proposal is uncertain, the Administration has clearly indicated that it means to limit the future use of these two planning techniques. However, there are still opportunities to engage in these techniques now, before any change in the law is enacted. These proposals are intended to offset in part the cost of the Administration's health care initiative. Therefore, it is likely that they will not be enacted until the fall of 2009 at the earliest. Of course the proposals may be changed or rejected by Congress. No matter what the shape is of any eventual legislation, these techniques can be used now by taking prompt action.