On March 24, 2010, the U.S. House passed H.R. 4849, the “Small Business and Infrastructure Jobs Act of 2010,” only eight days after its introduction. If approved by the U.S. Senate and signed by the President, certain provisions of H.R. 4849 would impose important limitations on the current use of Grantor Retained Annuity Trusts (“GRATs”).

A GRAT is an irrevocable trust that pays its grantor annual annuity payments over a fixed trust term. If the fair market value of the property transferred to the GRAT equals the present value of the annuity payments based upon the prevailing IRS assumed rate, then the grantor pays no gift tax as the GRAT has been “zeroed-out.” More importantly, if the rate of appreciation of the GRAT assets exceeds the IRS rate (currently, 3.2% for April, 2010), then at the end of the trust term all remaining trust assets (less the required annuity payments) would pass to or for the benefit of remainder beneficiaries (such as the grantor’s children) with no gift tax consequences. If, however, the rate of appreciation of trust assets is equal to or less than the IRS rate, or if the grantor fails to survive the trust term, then all trust assets may be returned to grantor or the grantor’s estate and no tax savings may result. The mortality risk can be minimized with a short trust term of two years.

H.R. 4849 would make GRATs less attractive by imposing the following limitations:

  1. Short-term GRATs Would be Eliminated. The bill requires that GRATs have a 10-year minimum term, which effectively increases the mortality risk that the strategy will fail as a result of the grantor’s death.
  2. GRATs Would Result in Taxable Gifts. The bill also requires that GRATs result in a federal gift tax by requiring that the remainder be valued greater than zero at the time of funding.
  3. Decreasing GRAT Annuity Payments Would be Prohibited. In addition, the bill precludes any attempt to approximate a short-term GRAT by front-loading the annuity with decreasing payments over the 10-year term.

The Obama administration recommended similar GRAT restrictions in its 2010 and 2011 budget proposals, so it is possible that these restrictions on GRATs will survive Senate debate. Since the U.S. Senate returns from recess on April 12, 2010, there may be a limited amount of time remaining to implement short-term, “zeroed-out” GRATs.