In Badgley v. United States, the 9th Circuit upheld summary judgment in favor of the IRS in a case regarding the legality of including the entire grantor-retained annuity trust (GRAT) value in a decedent’s estate for purposes of the estate tax under 26 U.S.C. § 2036(a)(1).
A GRAT is an irrevocable trust that meets the requirements of 26 U.S. Code § 2702. A GRAT is usually used to transfer appreciating assets to the next generation with minimal taxes due. When property is transferred to the GRAT, then such property is subject to gift taxes on the present value of the GRAT’s remainder interest, in accordance with 26 U.S. Code § 7520. A reduction in the gift value of trust property is permitted if the grantor retains an annuity interest in the trust. However, if the beneficiary is a family member, then the annuity interest must be a qualified interest under §2702. Trust property can be transferred to the beneficiary without gift tax implications by modifying the trust term and annuity amount in a way as to zero out any remainder. But what about estate taxes if the grantor dies during the annuity payout period?