GRATS: Loophole or Blackhole?


Respectfully submitted by Lawrence E. Rafferty (rafflaw)-Guest Blogger

We have all heard the political arguments for and against an Estate Tax, or as some have called it, a Death Tax.  Over the years while I attended several Continuing Legal Education seminars and Trust School presentations, I have often learned about the estate and gift tax avoidance strategy called a Grantor Retained Annuity Trust, or GRAT.  Since these estate reduction strategies are best used with very large estates, I have rarely had the opportunity to recommend it to any of my clients or trust customers. Recently, I read an article that provided some documentation just how prominent and popular the GRATS are with the super wealthy.

Just what is a GRAT and why should any of us be concerned with its use?  In my opinion, it is important to understand that when the über wealthy complain about any tweaking of the estate tax, most of them pay little or no estate or gift taxes due to the use of techniques like the GRAT.  Just how does a GRAT work?

Simply put, the donor transfers money or stock into a trust and if the assets increase in value, any increase in the stocks beyond the principal and the minimum interest rate that must be paid back to the donor, goes directly to the beneficiaries tax-free.  When you are talking assets worth millions and in some cases, billions, huge sums of money can escape the estate and gift tax process entirely. 

To make sure you fully understand how a GRAT works in the real world, please take a look at the linked Bloomberg article which includes a couple of graphs that are easy to understand.

Just how could this process be legal?  The IRS didn’t think it was legal when a Walton family member used it and sued the IRS when they disallowed the trust.  The Walton family member was successful in court and the GRAT was officially validated.

“Three years after the new law took effect, Covey created a pair of $100 million zeroed-out GRATs for Audrey Walton, the former wife of the brother of Wal-Mart Stores Inc. founder Sam Walton. The IRS, which had banned such GRATs through regulation, demanded taxes and took her to court.

In 2000, the U.S. Tax Court found in Walton’s favor, determining the 1990 law didn’t prohibit a “zeroed-out” GRAT. Covey had won a rare prize: an official seal of approval for a tax shelter.” Bloomberg

Needless to say, when the news got out that there was a court sanctioned process to allow the wealthy to avoid millions in estate and gift taxes, the use of the GRAT spread quickly.  In fact, the attorney who first devised the GRAT, Richard Covey, claims that the use of the GRAT technique has cost the United States government billions.  “These tax shelters may have cost the federal government more than $100 billion since 2000, says Richard Covey, the lawyer who pioneered the maneuver. That’s equivalent to about one-third of all estate and gift taxes the U.S. has collected since then.” Bloomberg

This same estate planning pioneer thinks that the use of the GRAT is harming the tax system.  “The popularity of the shelter, known as the Walton grantor retained annuity trust, or GRAT, shows how easy it is for the wealthy to bypass estate and gift taxes. Even Covey says the practice, which involves rapidly churning assets into and out of trusts, makes a mockery of the tax code.

“You can certainly say we can’t let this keep going if we’re going to have a sound system,” he says with a shrug.” Bloomberg

It is arguable that the use of the GRAT is an example of great lawyering that actually works too well.  At least when it comes to the country losing out on $100 Billion in estate and gift taxes in a very short period of time.  You might be thinking that if the GRAT is being used to avoid paying into the taxing system, why hasn’t Congress or President Obama done anything to stop it or curtail it?

The answer to that question is found in the current state of our politics.  Both Republicans and Democrats alike rely on wealthy donors to get reelected and those politicians aren’t likely to bite the hand that feeds them.  Some may consider the use of the GRAT a “loophole”, but with the bite its use has taken out of the tax coffers, I consider it a black hole of tax avoidance.

Since the GRAT is legal, Congress will have to act before the Billions in taxes that are being lost to the black hole can be stopped.  When money is the king when it comes to politics these days, I do not see any Congress member or Presidential administration that both need immense sums of money to be elected and stay elected, taking any substantive steps to curb this procedure.

Do you think the GRAT should be repealed or curbed?  When millions and billions are being cut from programs that benefit the vast majority of this country, it is my opinion that the idea of over $100 billion escaping the tax coffers, just since 2000 is an abomination.  Especially when these tax avoidance strategies can’t be used by 98 or 99 percent of the population.  Let me know if you agree and why you agree or disagree.

Additional Sources:  BB&T;

27 thoughts on “GRATS: Loophole or Blackhole?”

  1. BTW, if anyone needs to fill out a “Form 706” ,I found a blank form here This site also has some tutorials on how to fill it out and a few contract documents.

  2. You know raff Alice Walton has gotten one or two drunk driving a under her belt…. She killed a pedestrian walking in the road at night… In which it was determined that the pedestrian was at fault… Never mind she was drinking…. It was suggested to the family that she leave the state of Arkansas…. So she moved right across the border to bought a big ranch…. She’s been stopped a couple of times….. Finally arrested…. The trooper was later determined to be under investigation for an alleged impropriety… So he was suspended…. A year it so later… Still under investigation… The prosecutor decided that the trooper would not be back in time for the trial and dismissed it… No charges brought… A few weeks later her attorney moved to have the arrest, fingerprints and report expunged…. Motion was granted…. The troopers back at work…. And Alice is still driving drunk….. No one has any outrage about her…. Does she have to kill 4 people and injure others before there’s any outrage….

  3. Raff,

    Little did people know that this particular reg was created exclusively for Sam Walton….. It was in exchange for them being turned down to buy a banking system….. I wonder if the would give cut rate loans to any of its customers or employees…..say if they were able to buy a banking system…..

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