EFTA01088640.pdf

FOR PENALTY THIS ARTICLE MAY NOT BE RELIED UPON PROTECTION a Walton GRAT or Six Steps to a Marital Deduction for How I Learned to Love the Bomb By tachaei t Giaharn and )29pmda.Q„IY.olmrgt,! 0 2005. All Rights Reserved. Introduction which sets forth how The Walton case (Walton v. Corn., (2000) 115 T.C. 589), Annu ity Trust (a -GRAT" to reduce the gift element of a Grantor Retained the IRS as tance thereo f by herein) to near zero, and the subsequent accep 964, added a powe rful tool to the announced in Notice 2003-72, 2003-2 CB movie with all due respe ct to the 1960s estate planner's toolbox. However, an estate GRAT for a marrie d grant or can create "Dr. Strangelove," a Walton prior to the termination of the tax bomb, waiting to explode if the grantor dies to compare such a result term of the GRAT. It is, perhaps, an overstatement a bucki ng bronco to its final to the sight of Slim Pickens riding the bomb like the loss of the plann ing attorn eys, destination. However, for most estate held in the GRAT would be an unpleasant marital deduction for all properties siona l liability in the need to notify one's profes experience, sure to result insurance carrier of a potential claim. standard Walton-style If the grantor dies during the term of the GRAT, the of all of the GRAT provisions will almost always result in (i) inclusion ses, and (ii) a situation properties in the grantor's estate for estate tax purpo qualif y for the marital deduction. in which that included GRAT property cannot grantor's death. Walton requires that the GRAT not terminate upon the wheth er or not the grantor Rather, the GRAT must continue for the full term, the GRAT contin ues, the property dies during the term of the trust. Since the grantor's estate , where it could pass under cannot return to the grantor's to qualif for the all y other estate planning documents in a manner designed important marital deduction. Walton GRAT trust There are, however, six modifications to the standard allow the GRAT to continue for agreement which, if implemented correctly, will emen ts) and qualify, if the full term (complying with the Walton requir the grant or's estate . necessary, for the marital deduction in Step 1: Continuation for the Entire Term treatment (after all, the To be sure that the GRAT qualifies for Walton-type grantor will probably not die) the GRAT paym ent langu age must provide that and that the paym ent of the GRAT the GRAT continues for the entire term, during that term. It term, even if the grant or dies Annuity continues the entire payments will be is critical that one be clear that the GRAT will continue, and the GRAT term, to the made, to the grantor, and if the grantor dies during y that any that you specif estate of the grantor. You will also want to be sure EFTA01088640  payees payment made after the grantor's death will be prorated between the (the grantor and the grantor's estate on a daily basis). is to Step 2: Restate the Payment Formula to Provide that All Income be Distributed income must A basic requirement for marital deduction qualification is that all be paid, at least annually, to the surviving spouse. To comply with this requirement and still qualify for Walton type treatment, the payment formula contained in the GRAT must provide for the distribution of the greater of the (i) GRAT payment previously specified and (ii) the income of the GRAT. Of course, the payment must still be made to the estate of the grantor, as set forth in Step 1. In consequent steps, we will assure that such income is paid to the surviving spouse. Some estate planning lawyers have expressed concern that changing the payment upon the death of the grantor to the greater of (i) the GRAT payment, normally calculated, and (ii) the income of the trust, would violate the 20% increase rule set forth in Reg. 25.2702-3(b)(1)(ii). However, that provision does not limit how much the payment to the grantor (or the grantor's estate) can increase in any one year. Rather, that provision limits the extent to which any such increase in GRAT payment can be taken into account in valuing the payments reserved to the grantor. The payments to the grantor can increase more than 20% in any one year, but only increases up to 20% can be taken into account for valuation purposes. Step 3: Include Boilerplate Marital Trust Qualification Provision and Make them Applicable during the Term of the GRAT Estate planners are accustomed to including certain standard "boilerplate" provisions for any marital deduction trust, such as the provision that the surviving spouse may direct the Trustee to make the properties productive of income. Upon the death of the grantor, the goal is to be sure that the trust terms applicable to the property held by the GRAT trustee are consistent with the allowance of a marital deduction. Thus, provisions such as the productive property language must be included and must be made expressly applicable to the GRAT during the remainder of the GRAT term. Step 4: Clarification of Priority between the 105 Day Distribution Rule and the Income at Least Annually Distribution Rule The GRAT regulations provide that payment of the GRAT annuity for a calendar year GRAT may be deferred until April 15th of the next year. Similarly, for GRATs which are drafted to provide that payment is to occur on each anniversary of the initial funding, payment may be deferred for up to 105 days after that due date. However, under the marital deduction rules income must be distributed to the surviving spouse at least annually. Care must be taken that the marital deduction rule (annual distribution of income) has priority over the 105-day rule. An abundance of caution dictates an express statement that other provisions of the agreement and the applicable GRAT regulations are subject to the grantor's direction and that the EFTA01088641 provisions of the GRAT qualify for a marital deduction in the event of the grantor's death during the GRAT term. Step 5: Contemporaneous Execution of a Codicil Mandating Immediate Distribution of the GRAT Payment Received By the Estate Steps 1 and 2 provide that if the grantor dies, the GRAT payment will continue but will be made to the grantor's estate rather than the grantor. The payment will be the greater of (i) the GRAT payment, normally calculated under the agreement, and (ii) the income of the GRAT. Step 5 is to contemporaneously execute a Codicil to the Grantor's Will providing that any such payment so received will immediately be distributed to the grantor's surviving spouse. The surviving spouse will then be receiving all of the income of the GRAT on an annual basis, as required by the marital deduction regulations. Some variation upon the amount to be distributed is probably permissible, and may be very advisable to satisfy the grantor. In virtually all short term GRATs, the GRAT payment, as normally calculated, will greatly exceed any income of the trust. Is it necessary that all of the payment received by the grantor's estate be distributed outright to the surviving spouse, or is it permissible to provide that only that the portion of the payment so received which represents income of the GRAT will be distributed outright to the surviving spouse? For example, a two year GRAT created during September of 2005, providing for a 20% increase between the first and second payments, where the first payment is due upon the first anniversary of creation of the GRAT, will have a first anniversary payment of 49.00037% of the value of the property initially contributed to the GRAT. Almost certainly, the income of the trust for that first twelve-month period will be less than that large calculated GRAT payment. While the GRAT must provide that in the event of the death of the grantor, the payment to the grantor's estate must be the larger of (i) the calculated GRAT payment and (ii) the income of the trust, the payment actually made will almost always be the calculated GRAT payment of 49.00037% of the initial value. In that event, the codicil could provide that the personal representative of the grantor's estate would immediately distribute the portion thereof representing income of the GRAT outright to the surviving spouse, and distribute the remainder thereof to a QT1P trust for the benefit of the surviving spouse. Step 6: Provision for the GRAT Remainder in a Manner that Qualifies for a Marital Deduction Finally, the GRAT must provide that at the end of the GRAT term, any assets remaining in the GRAT (after payment of all amounts due to the grantor or the grantor's estate) must be distributed in a manner that otherwise qualifies for a marital deduction. EFTA01088642 That may be in the form of a distribution (i) outright to the surviving spouse, (ii) to a traditional general power of appointment marital deduction trust, or (iii) to a QTIP trust. The distribution would only be made if the grantor died before the end of the GRAT term, survived by a spouse. Of course, if the GRAT provides that the remainder passes to a QTIP trust, care must be exercised to describe the entire arrangement on the grantor's estate tax return and elect QTIP treatment for such arrangement. Conclusion If the above steps are followed, a marital deduction should be allowed in the grantor's estate for the property held in the GRAT (and included in the grantor's estate) if the grantor dies during the term of the GRAT. In Wealth Transfer Planning's SmartContent Lifetime Estate Planning Module, all of these steps are automatically implemented if the drafter simply clicks "yes" to the question about whether a marital deduction is desired in the event of the grantor's death prior to the end of the GRAT term. An excellent demonstration of this is on the Wealth Transfer Planning website in streaming video on the homepage of vrww.vinIthtransferplAnni no .cosp. For those using and modifying their own forms, care should be taken to correctly implement each of these steps. EFTA01088643