Modifying the GRAT rule: This provision would modify the rules for grantor retained annuity trusts (GRATs) by (1) requiring a minimum value for gift tax purposes of the GRAT’s remainder interest. The greater of (a) 25% of the value of the assets transferred to the GRAT, or (b) $500,000; (2) prohibiting any decrease in the annuity during the GRAT term; (3) prohibiting the grantor from acquiring in an exchange an asset held in the trust without recognizing gain or loss; and (4) requiring the GRAT term to be between (a) 10 years and (b) the life expectancy of the annuitant plus 10 years. The minimum-value requirement would eliminate the ability to create a GRAT that does not have gift tax consequences, severely limiting its usefulness in an estate plan.

The prohibition of decreasing annuity payments would eliminate the “frontloading” of GRATs with other assets so that more of the main asset that is the target for using the GRAT is preserved for the remainder beneficiary of the GRAT. The required minimum term of the GRAT would make a GRAT a riskier planning technique because the transfer tax benefits of GRATs are typically achieved when the grantor outlives the GRAT term. The required maximum term of the GRAT would prevent 99-year GRATs that some taxpayers have created so that the amount includible in the grantor’s estate under Sec. 2036 is very small.

Impose income tax on transfers between a grantor and a grantor trust: For a trust that is not fully revocable by a deemed owner, this provision would treat the transfer of an asset for consideration between a grantor trust and its deemed owner as a potentially taxable transaction. The seller would recognize gain on any appreciation in the value of the transferred asset. Further, the proposal would treat the payment of income tax on the income of a grantor trust as a gift occurring on Dec. 31 of the year in which the income tax is paid, unless the trust reimburses the deemed owner during the same year. This provision would supersede Rev. Rul. 85-13 (disregarding sales and exchanges between a grantor and his or her grantor trust for income tax purposes) and make sales and the satisfaction of obligations with appreciated property (including in-kind payments of annuity and unitrust amounts, e.g., GRAT annuity payments) result in the recognition of gain.

Treat payment of income tax by the grantor of a grantor trust as a gift: This provision would treat the payment of income tax on the income of a grantor trust as a gift occurring on Dec. 31 of the year in which the income tax is paid, unless the trust reimburses the deemed owner during the same year.

Under Sec. 671, grantors of a grantor trust must include in their income their grantor trust’s items of income, deductions, and credits; therefore, the tax on the income of the grantor trust is the grantor’s obligation and does not constitute a gift from the grantor to the beneficiaries of the trust. In Rev. Rul. 2004-64, the IRS confirmed that the grantor’s payment of his or her grantor trust’s income tax liability is not a gift. This provision would invalidate this position.