Grantor Retained Annuity Trusts: Tax Efficient Estate Planning Techniques Using GRATs to Preserve and Transfer Assets

Transcription

1 Presenting a live 90 minute teleconference with interactive Q&A Grantor Retained Annuity Trusts: Tax Efficient Estate Planning Techniques Using GRATs to Preserve and Transfer Assets WEDNESDAY, FEBRUARY 9, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Kristin T. Abati, Partner, Choate Hall & Stewart, Boston Christopher D. Perry, Senior Vice President, Northern Trust, Boston Attendees seeking CPE credit must listen to the audio over the telephone. Please refer to the instructions ed to registrants for dial-in information. Attendees can still view the presentation slides online. If you have any questions, please contact Customer Service at ext. 10.

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4 GRATs: Still the Best Deal Around Kristin T. Abati, Partner by any measure CHOATE HALL & STEWART LLP

5 Overview. Estate Freeze. A grantor retained annuity trust or GRAT is an estate freeze technique. It allows the donor/grantor to transfer the future appreciation on an asset to his or her chosen beneficiaries gift tax free. Mechanics. It works like this: The grantor transfers assets to the GRAT in exchange for a stream of annuity payments sufficient to return rn his or her initial contribution, tion plus statutory tor interest at the IRC 7520 rate, back to him or her. Because the grantor will receive back everything he or she initially contributed, plus statutory interest, there is no gift. Interest Rate Senstivity. When interest rates are low, as they are now, a GRAT is more likely to succeed. This is so since the GRAT assets are more likely to appreciate at a rate greater than the 7520 rate (sometimes called the hurdle rate). When the GRAT term ends, the remainder beneficiaries will receive the difference between the actual appreciation and the 7520 rate, tax free. Mortality Risk. In order for the GRAT to succeed, however, the grantor must survive the term. CHOATE HALL & STEWART LLP 5

6 Grantor Retained Annuity Trust ( GRAT ) GRAT NO GIFT TAX Remainder CLIENT S DESCENDANTS (outright or in trust) CHOATE HALL & STEWART LLP Annuity Payment Year 1 Annuity Payment Year 2 NO GIFT TAX Donor ADVANTAGES No gift tax cost If the GRAT assets appreciate at a higher rate than the statutory interest rate, the donor may transfer significant assets to children and others at no gift tax cost Estate tax savings Any appreciation on the GRAT assets in excess of the statutory rate of interest is removed from the donor s taxable estate Limited risk If the assets do not appreciate, the donor has not wasted any gift tax exemption. Furthermore, if the donor dies during the GRAT term, the GRAT assets are included in the donor s estate as if the GRAT was never funded, but no other adverse tax consequences. LIMITATION May not allocate GST tax exemption until end of term CHARACTERISTICS OF A GRAT Assets 1. A GRAT is an irrevocable trust for a fixed expected to term, generally between 2 and 10 years, appreciate funded by the donor. o 2. During the GRAT term, the GRAT makes annuity payments back to the donor at a rate designed to return the entire value of the donor s original contribution to him or her, plus statutory interest. Because the donor will receive back from the GRAT everything he or she originally contributed, plus interest, there is no gift upon funding the GRAT. 3. At the expiration of the GRAT term, if the GRAT assets have appreciated at a higher rate than the statutory interest rate which is more likely in a low interest rate environment the remaining trust property will be paid to the donor s chosen beneficiaries, again free of gift tax. 6

7 Creature of Statute. GRATs are creatures of statute. See IRC 2702 and Treas. Reg They are an exception to the general rule governing the valuation of gifts of remainder interests in trusts that any interest retained by a donor/grantor will be valued at zero. See IRC 2702(a). The fact that GRATs are explicitly blessed by the Internal Revenue Code makes them an extremely safe technique. CHOATE HALL & STEWART LLP 7

8 Statutory and Regulatory Requirements. The GRAT must be for a fixed term of years, or the grantor s life, or the shorter (but not longer) of either. Using a term of years is always advisable as it allows the grantor to zero out the gift. In order to zero out the gift, if the grantor dies during the term, the GRAT must provide that the annuity ypayments will continue to be paid to the grantor s estate for the remainder of the term. See Walton v. Commissioner, 115 TC 589 (2000). The grantor must receive a fixed amount (either a dollar amount or a percentage of the initial fair market value of the trust assets) at least annually. More frequent (i.e., quarterly) payments are possible. The annuity payments can be made from income, or if income is insufficient (which it almost certainly will be), from the stock or other assets held by the GRAT. CHOATE HALL & STEWART LLP 8

9 Statutory and Regulatory Requirements (cont.). The grantor s payments may increase over the term, provided that each year s payment is no greater than 120% of the prior year s payment. (There are no similar limitations on the amount by which the payments may decease over the term.) To allow the trust assets more time to grow within the trust, increasing (or backloading ) the payments is usually advisable. If the IRS determines that the initial fair market value of the trust assets was incorrectly determined, and the payments are based on a percentage of the initial fair market value, the GRAT will not fail as long as it contains provisions requiring, in the case of an undervaluation, the trustee to make a correcting distribution to the grantor, or in the case of an overvaluation, the grantor to make a correcting payment to the GRAT, both within a reasonable time after the correct value is determined. This self-correcting feature of GRATs limits/eliminates any valuation risk that could lead to an unexpected taxable gift. CHOATE HALL & STEWART LLP The grantor should consider filing a gift tax return reporting the GRAT transaction as a zero (or near zero) gift. This will start the 3-year statute of limitations running on the issue of valuation. 9

10 Statutory and Regulatory Requirements (cont.). No additions to the trust property are allowed after the initial funding. Be mindful of the timing of the annuity payments. There is a 105 day grace period for payments tied to the anniversary date of the GRAT. CHOATE HALL & STEWART LLP 10

11 Income Tax Treatment. There will be no income tax consequences associated with the initial transfer of assets to the GRAT, or the annuity payments back to the grantor, provided the GRAT qualifies as a grantor g trust. A grantor trust is a trust that triggers one or more of the grantor trust rules under IRC , with the result that the grantor is treated as the owner, for income tax purposes, of the GRAT property. As long as the GRAT is a grantor trust, transactions between the grantor and the trust he or she owns simply will be disregarded. See Rev. Rul In most cases, a GRAT will qualify as a grantor trust under IRC 677 (regarding the grantor s retained right to income). Since it is theoretically yp possible, however, that the income from the trust assets could exceed the annuity payments (if, for example, the annuity payments are relatively small at the beginning of the term), consider adding another grantor trust trigger (such as the power to substitute assets under IRC 675(4)(C) ) and Rev. Rul ) to ensure grantor trust treatment. CHOATE HALL & STEWART LLP 11

12 Power to Substitute Assets. Apart from ensuring grantor trust treatment, there is another reason to give the grantor the power to substitute the GRAT assets with assets of equivalent value during the GRAT term: If the GRAT assets overperform, and the grantor would prefer to cap the appreciation he or she passes on to his or her children, or the grantor would prefer to share in some of the appreciation, the power to swap assets can be very useful. Giving this power to the grantor is often preferable to relying on the trustees to sell assets between the GRAT and the grantor (which is also possible, and will be disregarded for income tax purposes just like the swap), since the trustees are bound by fiduciary duties to the remainder beneficiaries and may not feel comfortable selling an overperforming asset for another asset with less possibility for growth, even if has the same current value. CHOATE HALL & STEWART LLP 12

13 Death During the Term. If the grantor dies during the GRAT term, it is almost certain (absent a wildly successful GRAT) that the entire GRAT property will be included in his or her estate. This is so because the IRS includes in the grantor s estate the amount of property necessary to generate the remaining annuity payments from income only, using the then-7520 rate. See Treas. Reg (c)(2) ) (regarding g flat annuity payments), and Prop. Treas. Reg (c)(3) (regarding graduated annuity payments). Since, however, it is theoretically possible that less than the entire GRAT property will be included in the grantor s estate if he or she dies during the term, consider insulating the GRAT from estate tax inclusion on other grounds. For example, if the GRAT contains the power to substitute assets, consider naming a trustee other than the grantor who can independently verify the value of the substituted assets under Revenue Ruling (This revenue ruling provides a roadmap for using the power to substitute assets without causing inclusion in the grantor s estate under either IRC 2036 or IRC 2038.) CHOATE HALL & STEWART LLP 13

14 Death During the Term (cont.). Also consider qualifying the GRAT property for the marital deduction to defer any estate taxes that may be due. In the grantor s will, direct that any payments made to the grantor s estate after his or her death be paid to the surviving spouse or a marital trust for his or her benefit. In the GRAT, direct that any property included in the grantor s estate be paid, on the termination of the GRAT term, to the surviving spouse or a marital trust for his or her benefit. CHOATE HALL & STEWART LLP 14

15 Not Ideal for GST Planning. Under the estate tax inclusion period ( ETIP ) rules, it is not possible to allocate generation-skipping transfer ( GST ) tax exemption to a GRAT until after the term expires (or the grantor dies, if earlier). See IRC 2642(f) and Treas. Reg (c). Accordingly, it is not possible to leverage the initial gift (which could be very low or even zero) to exempt the ultimate remainder interest (which could be much more valuable than the assumed remainder interest at initial funding, using the then-7520 rate) from GST tax. CHOATE HALL & STEWART LLP 15

16 Effect of Badly Performing Assets? If the GRAT assets do not perform as expected and there is not sufficient property in the GRAT to make the required annuity payments back to the grantor, there are no bad tax consequences. Nothing will pass to the remainder beneficiaries, but the grantor will not have wasted any gift tax exemption. The only costs are the transaction costs necessary to establish and monitor the GRAT, which are not likely to be substantial. CHOATE HALL & STEWART LLP 16

17 2010 GRAT Legislation. In 2010, the House of Representatives passed a series of bills containing identical language that would have restricted the utility of GRATs. See, e.g. H.R. 4849, Sec. 307, passed by the House on March 24, The bills would have required that: (A) the right to receive the fixed amounts is for a term of not less than 10 years, (B) such fixed amounts, when determined on an annual basis, do not decrease relative to any prior year during the first 10 years of the term referred to in subparagraph (A), and (C) the remainder interest has a value greater than zero determined as of the time of the transfer.. CHOATE HALL & STEWART LLP 17

18 10 Year Minimum Term. Arguably the biggest change wrought by these bills would have been the requirement that a GRAT have a term of at least 10 years. Under current law, many grantors choose shorter term (2 year) GRATs, in order to capture short periods of upside that benefit the remaindermen and to decrease the mortality risk associated with GRATs. Notwithstanding the relative popularity of shorter term GRATs, however, when interest rates are low (as they are now) and are likely to increase (as they are in the near future), choosing a longer term can compound the benefits of the lower rate. Accordingly, in environments like the current one, a 10-year minimum term wouldn t be likely to dissuade younger grantors (who are less worried about mortality) from funding GRATs. A 10-year minimum term likely would, however, make GRATs less attractive for all grantors (regardless of age) in declining interest rate environments, when locking in a relatively higher hurdle rate for a long period of time will make less sense. CHOATE HALL & STEWART LLP 18

19 Other Requirements. The requirement that the annuity payments not decrease year over year would not be likely to affect many grantors, as most choose to increase the annuity ypayments in order to allow the assets more time to grow within the GRAT. Similarly, the requirement that the remainder interest must have a value greater than zero, if read literally, would not be likely to impose too great a burden, since it is possible to construct GRATs with gifts of $1 (which is greater than zero) that would satisfy this requirement. This requirement would, however, require every grantor to file a gift tax return reporting the GRAT transaction, which may have been the intent. CHOATE HALL & STEWART LLP 19

20 No Legislative Changes in The legislation described in the foregoing slides did not ultimately become law as part of the 2010 revisions to the estate, gift and GST taxes. However, they may resurface, and this argues in favor of creating shorter term GRATs now. CHOATE HALL & STEWART LLP 20

21 Wealth Management Copyright 2011 Kristin T. Abati Information contained herein should not be construed as legal advice or legal opinions on specific facts. The enclosed material is provided for education and information purposes by Choate, Hall & Stewart LLP to those who may be interested in the subject matter. Under regulations of the Treasury Department, we are required to include the following statement: Any advice contained herein regarding federal tax matters was not intended or written to be used, and it cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer. by any measure CHOATE HALL & STEWART LLP

22 PERSONAL FINANCIAL SERVICES Northern Trust GRAT Strategies, February 9, 2011 Hosted by Strafford Publications Exploring the Interplay Between Low-Interest Rate Estate Planning Christopher D. Perry Senior Vice President Senior Fiduciary Officer Ph: (617) Fax: (617) and Market Volatility 2011 Northern Trust Corporation northerntrust.com

23 Disclaimer NOT LEGAL ADVICE: No portion of this presentation is intended to be legal or tax advice nor should it be construed as such. Discuss the contents of this presentation with your legal and tax counsel. IRS CIRCULAR 230 NOTICE: To the extent that this communication or any attachment concerns tax matters, it is not intended to be used, and cannot be used by a taxpayer, for the purpose of avoiding any penalties that may be imposed by law. For more information about this notice, see 23

24 Section 7520 Rates and Estate Planning Feb. 2011: 2.8% 14% 12% High of 11.6% in June 1989 Historical IRC 7520 Rates 10% AFR Rate 8% 6% 4% 2% 0% Jan 89 Jan 90 Jan 91 Jan 92 Jan 93 Jan 94 Jan 95 Jan 96 Jan 97 Jan 98 Jan 99 Low of 1.8% in December, 2010 Jan 00 Jan 01 Jan 02 Jan 03 Jan 04 Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11 The Section 7520 rate (sometimes referred to as an Applicable Federal Rate or AFR ) is used in many estate planning calculations to determine the value of annuities, income interests and remainder interests. While the Section 7520 has been rising recently, it is still very low on a historical basis. Certain estate planning techniques will "work" better in a low interest rate environment. Low Rate Techniques High Rate Techniques No Effect Grantor Retained Annuity Trusts (GRATs) Charitable Remainder Trusts (CRTs) Family Limited Partnerships Charitable Lead Trusts (CLTs) Qualified Personal Residence Trust (QPRT) Insurance Trusts Intra-Family Loans Annual Exclusion Gifts Sale to a Defective Trust Defective Trusts Dynasty Trust 24

25 VIX Index from Inception to Oct US:SPX 25

26 26 VIX Index Over the Last Year

27 27 VIX v. Dow Historic Volatility; Equities Off Historic Highs

28 Tax Relief Act of 2010 Note: The Tax Relief Act of 2010 does not contain a requirement that would limit a GRAT s term to a minimum of 10 years. Unified gift, estate and generation-skipping ( GST ) transfer tax exemption of $5 million. Unified gift, estate and GST tax rate of 35%. 28

29 What is a GRAT? A Grantor Retained Annuity Trust ( GRAT) is an irrevocable statutory trust to which the grantor makes a gift of assets and retains an annuity interest, typically for a term of years. A GRAT can be structured so the value of the gift is nominal and so no gift tax is due. During the term of the trust, the grantor receives an annuity. At the end of the trust term, remaining trust assets pass to beneficiaries. Income (pre-tax due to grantor status) and appreciation in excess of the federal interest t rate pass free of gift tax to the GRAT remainder beneficiaries. To achieve gift tax benefits, the grantor must survive the GRAT term. The following slides illustrate strategies by which a GRAT may be administered. 29

30 Grantor Retained Annuity Trust A Typical Example Example Assumptions: Stock Transferred to Trust : $10,000,000 Assumed Valuation Discount: 0.00% Value Transferred to Trust: $10,000, ,000 Value of Gift for Gift Tax Purposes: $0 IRC Sec Rate: 4.20% 2-Year GRAT Payout Rate % Term (Years) 2 Assumed Annual Return $ Thousands 12,000 10,000 8,000 4,000 2, % -12% -4% 4% 12% 20% 28% 36% GRAT Remainder Value of Annuity Payments Results Assuming 9.00% Appreciation Capital Income Balance Annual 38.90% Appreciation Yield Before Payout Year - End Income Year Balance 9.00% 0.00% Payout to Grantor Balance Taxes 1 $10,000, , ,900,000 (5,317,167) 5,582, ,582, , ,085,288 (5,317,167) 768,

31 Pitfalls When Assuming A Constant Rate of Return Three Options for Returns on a 5 Year Zeroed-Out GRAT* Year Average Return Option #1 Option # % 25.00% -4.00% % 11.00% -0.01% % 5.00% 11.00% % -1.00% 14.60% % 0.00% 18.41% Compound Annual Return 8.00% 8.00% 8.00% Standard Deviation 0% 9.51% 8.59% GRAT REMAINDER $ 1,612,184 $ 2,671,634 $0 (Failure) Take Away: Early performance of the asset has a disproportionate impact on effectiveness of GRAT. *Assumes GRAT is funded with $10 million, the IRC 7520 Rate is 4.2%, and the annual annuity payment growth rate is 20%. 31

32 Short-Term Rolling GRATs Rolling GRATs are a series of GRATs funded with the annuity amounts from an existing GRAT (also called Cascading GRATs ) Provided d the assets or their dividends id d are not needed d for current support, almost unlimited amounts can be committed. With short-term GRATs (2 years), the client retains flexibility to stop the strategy or commit fewer er or more assets to the GRAT strategy. A GRAT funded with a diversified pool of publicly traded securities succeeds at passing wealth to the remainder beneficiaries only about 55-60% of the time. Research has shown, however, that the odds are about 95% that the rolling GRAT strategy will move at least some wealth out of a client s estate in five years. See David L. Weinreb & Julie Franck, The Three Gs, Trusts & Estates Magazine, Penton Media Publication, March, 2008, p. 16,

33 Short-Term Rolling GRATs Cont. Assessing Interest Rate Risk 7520 Rate Percentage Payout in First Year Percentage increase in Percentage increase first year payout based in first year payout on 1% increase in 7520 based on 3% increase Rate in 7520 Rate 3.80% 48.14% 4.80% 48.86% 0.71% 5.80% 49.57% 0.71% 6.80% 50.29% 0.72% 2.15% Assumptions: Two-year zeroed-out GRAT in which the annuity payout increases by 20% each year. A longer-term GRAT that locks in a low interest rate may be preferable if funded with low-volatility assets. A rolling GRAT strategy using short-term GRATs may be preferable if using higher-volatility h assets See 2.15% differential in first year payout rate versus VIX. 33

34 Portfolio GRATs Concentrated positions increase volatility Modern Portfolio Theory - A bundle of assets each with a high standard deviation when combined may have a lower standard deviation because of the effects of negative correlation Portfolio GRATs The higher standard deviation for each asset may increase the likelihood that each GRAT will succeed. -See Jonathan G. Blattmachr, Drafting and Administration to Maximize GRAT Performance, Probate & Property Journal, Volume 20, Number 6, November/December 2006, American Bar Association, p

35 Asset Classes, Ranges of Returns and Standard Deviations* Description Return Assumptions Standard d Dev Proxy Large Cap 7.5% 15.7% U.S. S&P 500 Mid Cap 6.3% 17.5% Russell Mid Cap Small Cap 6.5% 20.4% Russell 2000 Index International Dev 7.2% 17.6% MSCI-EAFE Emerging 13.20% 23.00% MSCI - Emerging Tax Exempt 3.2% 7.3% Lehman - Muni Bond High Yield 6.6% 8.9% Lehman - US High Yield Hedge 8.1% 6.0% HFR Fund of Funds Private Equity 10.0% 22.7% Cambridge PE Index Real Estate 9.4% 19.4% FTSE EPRA/NAREIT Commodities 5.0% 13.6% DJ AIG Comm Tot Rtn Fund Index Cash 1.5% 1.0% 90 Day T-Bill * Assumptions of potential returns provided by Northern Trust Investment Policy Committee do not reflect actual investment results and are not guarantees of future returns. 35

36 Passive v. Active GRAT Administration David & Alice Funding Date 15-Mar-07 Per share funding value $69.38 Number of shares 1,140, Total value of stock concentration $79,093,200 Dividend Rate 0.00% IRC 7520 Rate 580% 5.80% Annuity Percentage 54.39% Value of shares on 7/15/2007 $76.31 Value of shares on 11/15/2007 $78.62 Value of shares on 3/15/2008 $75.15 Value of shares on 9/30/2008 $80.94 Value of shares on 12/31/2008 $86.03 Value of shares on 3/15/2009 $80.94 Payment due date #1 Payment due date #2 15-Mar Mar-09 36

37 Passive Distribution - GRAT Operation & Results On 3/15/2008, David & Alice receive a distribution of 572,568 shares at $75.15 plus a little cash ( FMV $43,029,669) GRAT On 3/15/2009, David & Alice receive a distribution of 531,624 shares at $80.94 plus a little cash ( FMV $43,029,669) Remaining in GRAT: 35,793 shares and a small amount of cash with a FMV of $2,902,005 G 37

38 Active Management Strategy Scenario 2 The Trustee of the GRAT actively manages ages the stock in the GRAT either e selling stock or swapping stock for cash in order to take advantage of volatility in the price of the stock. NOTE: There can be no guarantee that an investment manager will successfully time the market or maximize the returns within the GRAT. 38 DAVID & ALICE GRAT SCENARIO 2 - ON 3/15/2008 Shares swapped for short-term bonds on $ ,000 $17,398,680 7/15/2007 Shares swapped for short-term bonds on $ ,815 $25,615,575 11/15/2007 Stock Concentration, 3/15/2008 $ ,185 $44,051,803 Princ. Cash $12,500 Inc. Cash (interest income from bonds - 1%) $194,451 TOTAL MARKET VALUE $87,273, DAVID & ALICE GRAT SCENARIO 2 - Distribution of Annuity #1, 3/15/2008 Bond Funds $43,014, Income Cash $15, TOTAL $43,029, DAVID & ALICE GRAT SCENARIO 2 - ON 3/15/2009 Shares swapped for short-term bonds on $ ,200 $17,337,348 9/30/2008 Shares swapped for short-term bonds on $ ,499 $25,679,869 12/31/2008 Stock Concentration, 3/15/2009 $ ,486 $5,947,957 Princ. Cash $5,000 Inc. Cash (interest income from bonds - 1%) $329,863 TOTAL MARKET VALUE $49,300, DAVID & ALICE GRAT SCENARIO 2 - Distribution of Annuity #2, 3/15/2009 Bond Funds $43,017, Income Cash $12, TOTAL $43,029,669.48

39 Substitution Strategy Year 1 Swapping Cash for Shares in Year 1: David & Alice swap cash for a total of 553,815 shares of the stock in Invest in short-term interest-bearing vehicles in the GRAT. Freezing $43,014,255 of value in the GRAT. 7/15/2007, 228,000 $76.31, $17,398,680 11/15/2007, $78.62, $25,615, GRAT Annuity in Year 1: The GRAT uses available ailable cash/bond funds to pay the annuity. Cash inflows: $43,014,255 Interest Income: $194,451 Cash Equivalents Available: $43,221,207 Annuity Payment: ($43,029,669) Remaining Cash: $191,538 Note: Need fewer shares to satisfy annuity, having captured upside appreciation in the stock, and because of interest earned on bond fund.

40 Substitution Strategy Year 2 & Results Swapping Cash for Shares Year 2: Again, in year 2 David & Alice receive, via cash substitution. The GRAT trustee invests the cash in a short-term cash equivalent bond fund earning interest. 512,699 shares with a value of $43,017,217: 9/30/2008, 214,200 $80.94, $17,337,348 12/31/2008, $86.03, $25,679,869 GRAT Annuity Year 2: GRAT uses available cash/bond funds to pay the annuity: 40 Available cash equivalents: $191,538 Cash inflows: $43,017,217, Interest Income: $329,863 Cash Available: $43,352,080 Annuity Payment: ($43,029,669) Remaining Cash: $322,411 Remaining in GRAT: 73,486 shares and $322,411 of cash with a FMV of $6,270,367

41 Active Management Strategy Scenario 2 The Trustee of the GRAT actively manages the stock in the GRAT either selling stock or swapping stock for cash in order to take advantage of volatility in the price of the stock. NOTE: A GRAT is a grantor trust for income tax purposes. Therefore, the grantor is responsible for reporting all of the income from the GRAT on the grantor s individual income tax return, including realized capital gains. Year 1 Year 2 Annuity $ (43,029,669.48) $ (43,029,669.48) $79,113, $87,273, $49,300, PROFITT $ 44,243, $ 6,270, DAVID & ALICE GRAT SCENARIO 2 - ON 3/15/ REMAINDER INTEREST Stock Concentration, 3/15/2009 $ ,486 $5,947, Princ. Cash $5,000 Inc. Cash (interest income from bonds - 1%) $317,411 TOTAL MARKET VALUE $6,270,

42 GRAT Enhancement Strategies - Summary Passive Distribution Strategy Active Strategy Remaining in GRAT: 35,793 shares and a small amount of cash with a FMV of $2,902,005 Remaining in GRAT: 73,486 shares and $322,411 of cash with a FMV of $6,270,367 42

43 Selling Covered Call Options Selling a covered call option on a concentrated position in the GRAT Option premium increases with increase implied volatility Premium, interest on the premium, and dividends from the stock enhance the performance of the GRAT Deep-out-of-the-money call option Commission charges Potential loss of appreciation above the option exercise price Passive GRAT strategy produces positive wealth transfer in 55-60% of the cases Covered Call strategy produces positive wealth transfer in about 70% of the cases 43 See Ajay Badlani & Thomas Menham, GRAT Effectiveness, Trusts & Estates Magazine, A Penton Media Publication, May, 2008, p. 56, 57.

44 Important Considerations When Gifting Assets Volatility For assets with lower volatility, longer-term GRATs that lock in a low interest rate may be preferable For assets with higher volatility, shorter-term rolling GRATs may be preferable. Expected return Cash flow and timing of dividends Will the client s cash flow needs be met if the stock s dividend id d is not received until the annuity payment is made? Valuation discounts Funding GRATs with LLC/FLP interests Core Capital 44

45 SCIN GRAT Technique Hedging Mortality Risk Client (1) Seed Gift (2) Sale SCIN Dynasty Trust (IDGT) Settlor (4) Assign LP interest in FLP (5) Annuity (ideally paid in cash) asdf GRAT (3) SCIN transferred into FLP FLP See Steven J. Oshins, The SCIN-GRAT, Trusts & Estates Magazine, Penton Media Publications, June, 2008, p

46 Sale to Intentionally Defective Grantor Trust Cash for seed funding GST exemption allocated Valuation discount on the sale Asset has cash flow to satisfy at least the interest portion of the loan Rolling sales of assets to IDGT 46

47 GRAT Drafting Considerations Flexibility in timing of payments See Treas. Regs (b). 105 Day Rule. Substitution of property of equivalent value. Delaware law for holding concentrations. Delaware Directed Trust. Qualified interest, see IRC 2702(b) and regulations. Adjust annuity on audit. If error in administration, grantor is entitled to properly p calculated annuity. Do not draft a spendthrift clause for the annuity interest, so it can be used as collateral for a loan. 47

48 GST GRATs IDGT is funded with seed funds and GST Exemption is allocated to it GRAT established and the remainder interest passes to a trust for children Trust for children sells the remainder interest at FMV ($2) to the IDGT 48

49 This Concludes the Presentation. Thank You For more information about Northern Trust, please visit 49