The CPA Journal

Declining Interest Rates Enhance Grantor Retained Annuity Trusts

By John A. Gacinski, CPA, Managing Director, Rose Associates, Inc.

When interest rates decline, grantor retained annuity trusts (GRAT) become attractive vehicles for transferring assets to beneficiaries. A GRAT operates by paying an annuity to its grantor; the trust’s beneficiaries receive the remaining assets when the GRAT matures without any additional transfer taxes beyond the minimal gift tax paid upon the initial transfer of assets to the GRAT.

The computation of the annuity is based on the rate specified by IRC section 7520. The rate to value remainder interests is determined by the midterm applicable federal rate for the month in which the valuation date occurs. The underlying Treasury Regulations mandate that this rate is 120 percent of the midterm applicable federal rate, using annual compounding, rounded to the nearest two-tenths of one percent. In May 2001, the section 7520 rate was 5.8%, two percent lower than the 7.8% rate in May 2000.

The drop in the IRC section 7520 rate allows for a smaller annuity, potentially allowing more assets to pass to the beneficiaries when the GRAT matures. The Exhibit shows the difference in assets passing through to the beneficiaries when comparing a GRAT using the May 2001 section 7520 rate to the May 2000 rate.

The lower section 7520 rate results in a smaller annuity payment to the grantor, thereby leaving additional assets in the GRAT to appreciate and transfer to the beneficiaries upon its maturity. This lower rate should also allow grantors to consider the transfer to the GRAT of assets whose cash flow would not have been able to satisfy the annuity under higher rates. For example, a real estate partnership interest could become an ideal asset for a GRAT if interest rates decline sufficiently. Because GRAT annuities are often funded with the income and sales proceeds of marketable securities, stock market fluctuations may adversely affect grantors’ intentions [recently seen in A.J. Walton v. Comm’r 115 T.C. No. 41 (12-22-2000)]. Real estate partnership interests become an attractive alternative when the 7520 rates are low enough, because their cash flow may be sufficient to fund the annuity without selling any of the underlying asset. In addition, the value of a real estate partnership interest may be subject to a discount for lack of control and lack of marketability, which would further reduce the annuity amount.

Even with the reform of the gift and estate tax law on the horizon, the decreasing interest rate environment offers a compelling reason to implement a GRAT. Under the fully implemented reforms, the only cost of the GRAT would be the minimal gift taxes due upon its formation. During the phase-in period, establishing the GRAT takes advantage of the lower interest rates and puts into motion a plan that could allow substantial assets to pass to the next generation.

Editors:
Lawrence M. Lipoff, CPA
Deloitte & Touche LLP

Susan R. Schoenfeld, JD, LLM, CPA
Bessemer Trust Company, N.A.

Contributing Editors:
Jerome Landau, CPA

Debra M. Simon, MST, CPA
The Videre Group, LLP

Richard H. Sonet, JD, CPA
Marks Paneth & Shron LLP

Peter Brizard, CPA

Ellen G. Gordon, CPA
Margolin Winer & Evens LLP

Jeffrey S. Gold, CPA
Joseph R. Beyda & Company P.C.

Harriet B. Salupsky, CPA
Weinick Sanders Leventhal & Company LLP

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