Partial Interests — GRATs, GRUTs, QPRTs (Section 2702) (Portfolio 836)

Part of Tax

Tax Management Portfolio, Partial Interests — GRATs, GRUTs, QPRTs (Section 2702), No. 836-2nd, addresses transfers of partial interests in property governed by Chapter 14. 

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Tax Management Portfolio, Partial Interests — GRATs, GRUTs, QPRTs (Section 2702), No. 836-2nd, addresses transfers of partial interests in property governed by Chapter 14. The Portfolio analyzes the rules for making transfers that will qualify for an exception to unfavorable valuation under § and thus minimize transfer tax, evaluates planning options, and provides sample forms for effecting qualified transfers.
Section provides special rules to determine the amount of a gift when an individual makes a “transfer in trust” to (or for the benefit of) a “member of the individual's family” and the individual transferor or an “applicable family member” of the transferor retains an interest in the trust. In general, if § applies, the interest retained by the transferor or the family member is valued at zero so that the gift tax value of the transferred interest is equal to the full fair market value of the property. In contrast, if the transfer qualifies for an exception to §, as a general rule, the value of the transferor's retained interest is calculated under regular gift tax rules and subtracted from the full fair market value of the property in determining the gift tax value of the transferred interest. If the transferor survives the retained term, the transferred property is not included in the transferor's gross estate for estate tax purposes. Thus, a properly structured transfer may reduce transfer tax costs.
The Portfolio addresses in detail the forms of transfer that qualify for exceptions to §, including personal residence trusts, qualified personal residence trusts (QPRTs), grantor retained annuity trusts (GRATs), and grantor retained unitrusts (GRUTs). In addition to discussing the statutory and regulatory requirements that must be satisfied to qualify for the exceptions, the Portfolio addresses practical drafting issues and analyzes alternative planning choices that should be examined in choosing the transfer vehicle. For example, the choice between a personal residence trust and a QPRT and between a GRAT and a GRUT are discussed, as are choosing a retained term and deciding whether to obtain grantor trust status. Finally, qualified remainder interests, joint purchases and transfers of split interests, and the special rule for tangible personal property are examined.
Annotated samples of a QPRT, GRAT, GRUT, and grantor retained income trust (GRIT) (which remains effective for nonfamily transfers) appear in the Worksheets.
For detailed treatment of the other components of Chapter 14, see T.M., Transfers of Interests in Family Entities Under Chapter 14: Sections 2701, 2703 and 2704.
This portfolio may be cited as Blattmachr, Slade, and Zeydel, 836-2nd T.M., Partial Interests — GRATs, GRUTs, QPRTs (Section 2702).


Jonathan G. Blattmachr, Esq.

Jonathan G. Blattmachr, partner, Milbank, Tweed, Hadley & McCloy LLP, New York, New York; former chairperson, Trusts & Estates Law Section, New York State Bar Association; member, various committees of the New York State Bar Association and the American Bar Association; member, Alaska Bar, California Bar, and New York Bar. Mr. Blattmachr has served as a lecturer-in-law at the Columbia University School of Law and an Adjunct Professor of Law at New York University Law School. He is a Fellow and former Regent of the American College of Trust and Estate Counsel and past chair of its Estate and Gift Tax Committee. He is the author or co-author of over 250 articles and three books on estate planning topics; former editor of The Chase Review (published by the Chase Manhattan Bank (N.A.)); and a former editor of Probate Notes (published by the American College of Trust and Estate Counsel). He is also co-developer and co-author of Wealth Transfer Planningsm, a computerized estate planning software system offering expert advice and document assembly.

Georgiana J. Slade, Esq.

Georgiana J. Slade, A.B., Duke University (1982); J.D., Harvard Law School (1985); partner, Milbank, Tweed, Hadley & McCloy LLP, New York, New York; member, various committees of the Trusts & Estates Law Section, New York State Bar Association; member, American Bar Association; member, New York State Bar and Pennsylvania Bar; fellow, American College of Trust and Estate Counsel. Ms. Slade is the author of T.M., Personal Life Insurance Trusts, and has written extensively on a variety of estate planning subjects.

Diana S.C. Zeydel, Esq.

Diana S.C. Zeydel, LL.M., New York University School of Law, 1993; J.D., Yale Law School, 1986; B.A., summa cum laude, Yale University, 1982; Elected to Phi Beta Kappa; shareholder, Greenberg Traurig, P.A., Miami, Florida; American College of Trusts and Estates Counsel (ACTEC): Fellow, Member, International Planning Committee, 2001–present, Member, Estate and Gift Tax Committee, 2005–present, Member, Program Committee, 2002–2004, Member, Nominating Committee, 2001–2002; American Bar Association (ABA): Co-Chair, Generation-Skipping Tax Committee of the Real Property, Probate and Trust Law Section, 2001–present. The Florida Bar: Member, Executive Counsel, Circuit Representative; Miami City Ballet: Member, Community Development Board, Chair, Planned Giving Committee; admitted to practice in Florida and New York.

Table of Contents

Detailed Analysis

I. Background to Enactment of § 2702 and Overview

A. Before § § 2702 and 2036 - Common Law GRITs and Joint Purchases

1. Common Law GRIT

a. Gift Tax Considerations

b. Estate Tax Considerations

2. Joint Purchases

B. Limiting Use of GRITs and Joint Purchases - Former § 2036(c)

II. Overview of § 2702

A. Effective Date

B. Scope of and General Rules Under § 2702

1. Transfer in Trust

2. Member of Transferor's Family

3. Retained Interest in Transferor or Any Applicable Family Member

C. Effect of § 2702

D. Exceptions to Application of § 2702

1. Incomplete Gift

2. Personal Residence Trust

3. Charitable Remainder Trust

4. Pooled Income Fund

5. Charitable Lead Trust

6. Assignment of Remainder Interests in Discretionary Trust

7. Certain Marital Property Settlements

8. Qualified Interest

9. Certain Tangible Property

10. Non-Family Member GRIT

11. Interests Are Substantially Same Before and After Transfer

III. Personal Residence Trust

A. Overview

B. Requirements for Personal Residence Trusts

1. Personal Residence

a. Definition of Personal Residence

b. Additional Property

c. Mortgaged Property

d. Use of Personal Residence

e. Co-Ownership of Residence by Spouses

2. Additional Specific Requirements for Personal Residence Trusts

a. Only Asset Is One Residence Used as Personal Residence

b. Residence May Not Be Sold or Transferred

3. Additional Specific Requirements for Qualified Personal Residence Trust

a. Income of Trust

b. Distributions from Trust to Other Persons

c. Permissible Assets of Trust

(1) Addition of Cash for Payment of Expenses, Etc.

(2) Improvements

(3) Sale Proceeds

(4) Insurance and Insurance Proceeds

d. Commutation

e. Cessation of Use of Residence as Personal Residence

(1) General Rule

(2) Sale of Personal Residence/Prohibition on Sale to Grantor

(3) Damage to or Destruction of Personal Residence

f. Required Disposition of Trust Assets on Cessation of Trust as QPRT

(1) General Rule

(2) Requirements for Conversion to GRAT

C. Gift Tax Considerations

D. Estate Tax Considerations

1. Grantor Dies Before End of Retained Term

2. Grantor Survives Retained Term

a. Right to Trust Income or Corpus

b. Right to Determine Beneficiary

c. Reciprocal Trust Doctrine

E. Income Tax Considerations

1. Income Taxation of Trust During Grantor's Retained Term

2. Income Taxation of Trust After Expiration of Retained Term

3. Advantages of Wholly Grantor Trust

F. Generation-Skipping Transfer Tax Considerations

G. Planning Considerations

1. Disposition of Remainder

2. Who Should Be Trustee?

3. Payment of Expenses

4. Personal Residence Trust vs. Qualified Personal Residence Trust

5. Trust vs. Non-Trust Format

IV. Qualified Annuity Interest and Qualified Unitrust Interest

A. Requirements for Qualified Interest

1. Overview

2. Statutory Requirements for Qualified Annuity and Qualified Unitrust Interests

a. Qualified Interest in All Respects

b. No Distributions Other than to Annuitant or Unitrust Recipient

c. Fixed Term for Annuity or Unitrust Interest

d. Commutation (Prepayment)

3. Specific Requirements for Qualified Annuity Interest

a. Payment of Fixed Amount

b. Annuity Amount Payable to Term Holder

c. Payment of Annuity Amount

d. Incorrect Valuations of Trust Property

e. Computation of Annuity Amount in Short Taxable Year and Last Taxable Year

f. Additional Contributions Prohibited

4. Specific Requirements for Qualified Unitrust Interest

a. Payment of Fixed Percentage

b. Unitrust Amount Payable to Term Holder

c. Payment of Unitrust Amount

d. Incorrect Valuations of Trust Property

e. Computation of Unitrust Amount in Short Taxable Year and Last Taxable Year

B. Gift Tax Considerations

1. Interest Retained by Grantor's Estate

2. Minimum Value of Annuity or Unitrust Interest

3. Qualified Interest of Grantor's Spouse

C. Estate Tax Considerations

1. Grantor Does Not Survive Retained Term

a. Section 2039

b. Section 2036(a)(1)

c. Section 2033

d. Sections 2036(a)(2) and 2038

e. Credit for Gift Tax Paid

f. Sale or Purchase of Interest in GRAT or GRUT

2. Grantor Survives Retained Term

D. Income Tax Considerations

1. During Retained Term

a. Advantages of Wholly Grantor Trust

b. Grantor Trust Status for GRAT

(1) Reversionary Interest Under § 673

(2) Distributions of Income to Grantor or Spouse Under § 677

(3) Power to Reacquire Trust Corpus Under § 675(4)(C)

(4) Grantor Trust Status During Spouse's Successor Interest If Grantor Predeceases Spouse

(5) Section 674 Power to Control Beneficial Enjoyment

c. Grantor Trust Status for GRUT

2. Grantor Trust Status After Retained Annuity or Unitrust Interest

a. Power to Add to Class of Beneficiaries

b. Authority to Distribute Trust Property to Grantor's Spouse

E. Generation-Skipping Transfer Tax Considerations

F. Planning Considerations

1. GRATs vs. GRUTs

2. When GRATs Make Sense

a. Death of Grantor During Retained Term

b. GRAT's Growth vs. § 7520 Rate

c. Disproportionate Value Factors

3. Zeroed-Out GRATs

a. Is Zeroed-Out GRAT Desirable?

b. Is Zeroed-Out GRAT Possible?

4. Short-Term vs. Long-Term GRAT

a. Advantages and Disadvantages

b. How Short Can Term of GRAT Be?

5. Increasing and Decreasing Qualified Payments

6. Disposition of Remainder

7. Fiscal Year vs. Calendar Year

8. Payment of Trust's Income Tax Liability as Gift

9. Appointment of Trustee

10. Payment of Annuity or Unitrust Interest with Note

11. Reciprocal GRATs or GRUTs

V. Qualified Remainder Interest

Introductory Material

A. Requirements for Qualified Remainder Interest

B. Planning Considerations

VI. Joint Purchases and Transfers of Split Interests

A. Overview

B. Joint Purchase Through Personal Residence Trust

1. Does Joint Purchase of Personal Residence Make Sense?

2. Joint Purchase Trust vs. Personal Residence Trust

a. Estate Tax Considerations

(1) Section 2036(a)(1)

(2) Section 2039

b. Interest of Term Holder

c. Income Tax Considerations

d. Payments of Expenses

e. Practical Reasons to Use Trust to Make Joint Purchase

3. Structure of Joint Purchase

a. Purchase of Personal Residence

b. Trust Agreement

c. Trustees

C. Joint Purchase Through GRAT or GRUT

1. Joint Purchase Annuity Trust or Unitrust vs. GRAT or GRUT

a. Estate and Gift Tax Considerations

b. Income Tax Considerations

2. Structuring Joint Purchase Annuity Trust or Unitrust

D. Transfers of Split Interests

VII. Special Rule for Tangible Property

A. Overview

B. Statutory Requirements

1. Tangible Property Within Scope of Special Rule

2. Conversion Requirement

3. Failure to Exercise Rights

C. Valuation

VIII. Double Taxation Adjustment

A. Overview

B. Reductions for Inter Vivos Transfers

C. Reduction for Testamentary Transfers

D. Amount of Reduction of Taxable Gifts to Mitigate Double Taxation

IX. Evaluating GRATs Against Competing Wealth Transfer Strategies

A. Purpose of Using a GRAT

1. In General

2. When a GRAT Accomplishes Its Goals: Growth Greater than § 7520 Rate

3. Exceptions to GRAT Success if, but Only if, Total Return Exceeds § 7520 Rate

a. Disparate Valuation Factors

b. Experiencing Large Losses Before Even Larger Gains

c. Parallel GRATs

B. Comparisons of GRAT to Installment Sale to Grantor Trust

1. Description of Installment Sale to Grantor Trust

2. Comparing Complexities of Implementation of GRAT vs. Installment Sale

3. Comparing Legal Risks and Certainties

4. Many Questions Remain for Installment Sales

a. Does Either or Both of § 2701 or § 2702 Apply to an Installment Sale to a Grantor Trust?

b. Are the Trust Assets Included in the Grantor's Estate if the Grantor Dies While the Note Is Outstanding?

c. What if the Installment Sale Is Not Administered in Accordance with Its Terms?

d. Is Gain Recognized on an Installment Sale of Appreciated Assets?

5. Some Other Potential Legal Differences Between GRATs and Installment Sales

a. Death During the Term

b. Generation-Skipping Transfer (GST) Taxation

c. Use of Assets with Inherent Discounts in Valuation

d. Risk of Large Inadvertent Taxable Gift

C. Some Conclusions About Complexities and Legal Risks

1. Choosing the "Best" Asset for a GRAT or Installment Sale

2. Introduction to Monte Carlo Simulation

3. Why a Direct Gift May Be Best if an Extraordinarily High Return Is Expected

4. Installment Sale May Produce Better Economic Results for the Beneficiaries than a GRAT if Total Return Exceeds § 7520 Rate

a. Interest Payable to Grantor with Installment Sale Is Lower than for a GRAT

b. Greater Leverage with Installment Sale than a GRAT

c. Why Choosing the Potentially Highest Yielding Asset May Not Be Appropriate

d. Capturing the Outperformance and Mitigating the Effects of Underperformance - Why an Installment Sale Is Superior

e. How the 105-Day GRAT Payment Delay May Make It More Advantageous

f. How a Monte Carlo Simulation May Suggest Using a GRAT Instead of an Installment Sale

g. What One Monte Carlo Simulation Forecast with Respect to a GRAT vs. Installment Sale Comparison

5. Conclusions

Working Papers

Working Papers

Table of Worksheets

Worksheet 1 Sample Qualified Personal Residence Trust

Worksheet 2 Sample Grantor Retained Annuity Trust

Worksheet 3 Sample Grantor Retained Unitrust

Worksheet 4 Sample Grantor Retained Interest Trust

Worksheet 5 Sample Joint Purchase of Personal Residence Trust

Worksheet 6 Excerpt from 1990 Informal Senate Report on Proposed Revision of Estate Freeze Rules, 136 Cong. Rec. S 15679-15683 (Daily Ed. October 18, 1990)

Worksheet 7 Excerpt from H.R. Rep. 964, 101st Cong., 2d Sess. 1130-1138(1990) (Conference Report for Revenue Reconciliation Act of 1990)





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