Letters to the Editor

 A Loophole You Could Drive a Truck Through

Michael Whitty’s article in the May/June 2005 issue of Probate & Property argues that the IRS is applying the wrong estate tax inclusion formula to a Walton-type GRAT and that a fixed-term interest should be treated differently from a lifetime interest. This is clearly not the law and should not be the law. Code § 2036 includes in the grantor’s estate any trust in which the grantor retains an income interest for any period which does not in fact end before the grantor’s death. If the grantor retains an annuity which is high enough that it must by definition include all of the income, that trust must also be includable. If, for example, the Code § 7520 rate assumes a 6% income return, then if I retain an annuity of 6% I will be receiving more than the amount of the income and if I die at any time during the trust, whether it is a term trust or a life trust, the trust should be includable in my estate. If I create a term income interest for, say, 15 years and I die the day before the trust term ends, Code
§ 2036 will include the entire trust in my estate. The rule can’t be different if, instead, I retain an annuity as great as or greater than the income would be. Whitty argues for a loophole you could drive a truck through.

Lawrence P. Katzenstein

Thompson Coburn

St. Louis , Missouri

 

Professor Katzenstein was kind enough to correspond with me before writing to Probate & Property to critique my article “Repercussions of Walton” in the May/June 2005 issue. We had to agree to disagree on the extent to which Code § 2036 causes inclusion of a GRAT in the grantor’s estate when death occurs during the annuity term. My position can be summarized as follows:

• Code § 2036(a) causes inclusion of principal only “to the extent” principal is subject to the grantor’s retained “right to the income.”

• In a pure GRAT, the grantor retains no express right to the income, but instead retains an annuity payment right—which is not the same thing.

• A pure GRAT is not simply a GRIT that has been modified to fix the payment. There are significant qualitative differences in the trustee’s ability to amortize principal and the grantor’s inability, in a pure GRAT, to cause the generation of income or the allocation of income to the payment when principal is available.

• Any implied income right contained in an annuity payment right is limited to that amount of income necessary to satisfy the payment right when principal is insufficient.

• The only principal necessary to generate that amount of income is the Annuity NPV, which is already included under Code § 2033.

I am developing an article for submission to Real Property, Probate and Trust Journal to further develop my analysis and to explain how it is supported by statutory and legislative history, relevant cases, and actual practice involving GRATs. In the meantime, I would suggest that planners avoid creating GRATs with the grantor as trustee or with a direction to pay the annuity from income first.

Michael D. Whitty

Winston & Strawn LLP

Chicago , Illinois