Software De Procesamiento

New GRAT.

1. The Technique.

The grantor of a GRAT could purchase the assets of an underwater GRAT, or purchase the assets of a GRAT that is extremely successful in which the grantor wishes to lock in the gains, for a note that pays the applicable federal rate. The purchased assets could then be contributed to a new GRAT. In that manner, the appreciation of those assets would then be captured in the new GRAT, assuming appreciation exceeds the Statutory Rate of that new GRAT. The grantor‘s retained annuity in the ―old‖ GRAT would be satisfied with the principle and interest on the note as the grantor makes those principle and interest payments. The note should not run afoul of Treas. Reg. Section 25.2702-3(d)(6), because the note will not be issued by the trustee of the current GRAT in satisfaction of the annuity.

Example 9: Grantor Purchases Assets Out of GRATs and Creates New GRATs With Purchased Assets

Val Volatile creates two three year GRATs in year one. One GRAT (GRAT #1) holds Stock A. The other GRAT (GRAT #2) holds Stock B. Each stock is worth $1,000,000 upon creation of the GRATs. At the end of year two, Stock A is worth $500,000. At the end of year two, Stock B is worth $2,000,000. Val purchases the stock from each GRAT for a one year note and creates new GRATs (GRAT #3 and GRAT #4) at the end of year two as illustrated below:

GRAT #1 Stock A Val Volatile $500,000 Note GRAT #3 Stock A Annuity Based on $500,000 Value GRAT #2 Stock B Val Volatile $2,000,000 Note GRAT #4 Stock B Annuity Based on $2,000,000 Value 2. Advantages.

The advantages of this technique are that it is very simple and can be utilized in almost any situation, if the correct purchase price of the GRAT assets can be ascertained.

3. Considerations.

If the technique is used to lock in a gain on a particular asset in a successful GRAT and if that asset continues to increase in value, the technique will produce a lower amount being transferred to a grantor‘s beneficiaries in comparison to just keeping the asset in the original GRAT because a new Statutory Rate in the new GRAT needs to be satisfied.

The technique may not work with a hard to value asset because the purchase price that is assumed with the purchase transaction may not be accurate. If the purchase price is not accurate the sale for a note may be treated as a prohibited additional contribution63 _{by the grantor (if the}

purchase price is too high) or as a prohibited commutation64 _{of the grantor‘s retained annuity}

interest (because the purchase price is too low). In either event, the Internal Revenue Service could take the position that the purchase disqualifies the GRAT and the retained interest by the grantor is no longer a qualified interest under the Atkinson case rationale.65

Another consideration is that the purchase of GRAT assets by a note issued by the annuitant of the GRAT with the GRAT then satisfying the annuity owed to the annuitant with cash flow from the annuitant may lead the IRS to take the position that the transaction is circular and lacks economic substance and, as a consequence, should be a deemed commutation.

Even if the principal amount of the note is equal to the value of the asset, another consideration is that the Internal Revenue Service could take the position that using an interest

63_{See Treas. Reg. Section 25.2702-3(b)(4).} 64

See Treas. Reg. Section 25.2702-3(d)(5).

rate equal to the applicable federal rate is inadequate for purposes of purchasing assets from the current GRAT. The Internal Revenue Service could take the position that the public policy allowing a GRAT safe harbor requires a Statutory Rate that is equal to 120% of the mid-term applicable federal rate and that a purchase using any interest rate below that rate is a disguised commutation based on the public policy inherent in the Statutory Rate of a GRAT.

The proponents of the above note purchase technique argue that if such a deemed commutation argument is brought by the IRS it would be unsuccessful. Assuming the principal amount of the note is equal in value to the GRAT asset that is purchased and the interest rate of the note is equal to the applicable federal rate, there is a clear congressional mandate that the note is full and adequate consideration for the GRAT asset.

Secondly, proponents of the technique argue that under federal estate tax and gift tax law the courts are first to determine the state law property rights of the transaction and then apply the federal estate tax and gift tax to that transaction.66

Under state law, a fair market value purchase of a GRAT asset does not commute or terminate the GRAT or the GRAT term. If under state property law there should be no commutation, then under federal gift tax law there should be no commutation.

C. Second Technique: Grantor Substitutes the Assets of the GRAT For Another