The 9th U.S. Circuit Court of Appeals addressed whether a Grantor Retained Annuity Trust, or GRAT, should be included as a taxable asset in an estate, where the decedent died during the annuity period. The case, Badgley v. United States, was discussed in an article from Wealth Management titled “A String of Bad Luck: GRAT Assets Included in Taxable Estate.”
In 1988, Patricia Yoder created a GRAT, retaining the right to receive an annual annuity for a 15-year term. On the earlier of the term’s expiration and her death, the remainder interest would transfer to Patricia’s daughters under the terms of the GRAT. She funded the GRAT with a partnership interest valued at approximately $2.4 million. A gift tax return reporting the gift of the GRAT’s remainder interest was filed. She died in November 2012, just before the end of the GRAT term.
The family filed an estate tax return, and the entire date-of-death value of the GRAT was included in the gross estate. The executor of the estate then filed an action for a tax refund, claiming that only the present value of the unpaid annuity payments should have been included. A district court rejected that argument, stating that Patricia’s annuity interest was both a retained right to income and the continued enjoyment of the property, as defined in IRC Section 2036 and, therefore, was wholly includable.
The executor argued that it was not includible, as there is no explicit mention of annuities in Section 2036. The court disagreed, stating that “if the taxpayer does not let the property go, neither will the taxman.”
The court held that Section 2036 includes purportedly transferred property that the taxpayer continues to retain possession and enjoyment of, or a right to income. If there is enough of a connection from the owner to the transferred property, the property is included in the taxable estate.
In this case, the owner of the annuity received a substantial economic benefit from the GRAT, in the form of a 15-year annuity, so it was properly included in her estate.
When planning to minimize taxes during life and death, GRATs are frequently used to transfer appreciation from a person’s taxable estate with minimal or no gift tax, by reducing or zeroing out the value of the remainder interest, through fine-tuning the trust term and annuity amount.
However, there is a risk: there’s no way to know when a person will die. The successful use of the GRAT is predicated on avoiding the estate tax, in addition to the gift tax, and the GRAT success requires the person to survive the GRAT’s term.
An estate planning attorney working closely with the family and their financial professionals will need to explain how the GRAT works to ensure that it works to their estate’s benefit.
Reference: Wealth Management (May 13, 2020) “A String of Bad Luck: GRAT Assets Included in Taxable Estate”