ABA Members Seek Clarification Under Proposed Regs on Graduated Grantor Retained Annuity Trusts

Docket: IRS-2009-0009

The comments were prepared by members of the Estate and Gift Tax Committee of the Trust and Estate Division of the Section. Principal responsibility was exercised by Thomas M. Sheehan of Hinckley, Allen & Snyder LLP. Also participating in the preparation of the comments were Lisa M. Rico of McCarter & English, LLP, Laurence G. Constable of McCarter & English, LLP, Jeffrey L. Carson of Northern Trust, Bradley W. Lard of Bradley Arant Boult Cummings, LLP, Phillip J. Kenny of The Collins Firm, Anta Cisse-Green of Sullivan & Cromwell, LLP and Brooke A. Everley of Bradley Arant Boult Cummings, LLP. The comments were reviewed by a committee including Carlyn S. McCaffrey of Weil, Gotshal & Manges, LLP, Milford B. Hatcher of Jones Day, Michael Whitty of Vedder Price P.C. and W. Birch Douglass III of McGuireWoods LLP. In addition, these comments were reviewed by Steven B. Gorin of Thompson Coburn, on behalf of the Section's Committee on Governmental Submissions.

Although members of the Section who participated in preparing these comments and recommendations have clients who would be affected by the federal tax principles addressed, or have advised clients on the application of such principles, no such member (or the firm or organization to which such member belongs) has been engaged by a client to make a governmental submission with respect to, or to otherwise influence, the development or the outcome of the subject matter of these comments.

We thank you for your consideration and are available to discuss any matters relating to this project.

Questions should be addressed to Thomas M. Sheehan. His contact information is as follows:

The comments were prepared by members of the Estate and Gift Tax Committee of the Trust and Estate Division of the Section. Principal responsibility was exercised by Thomas M. Sheehan. Also participating in the preparation of the comments were Lisa M. Rico, Laurence G. Constable, Jeffrey L. Carson, Bradley W. Lard, Phillip J. Kenny, Anta Cisse-Green and Brooke A. Everley. The comments were reviewed by a Review Committee of the Section, which Review Committee included Carlyn S. McCaffrey, Milford B. Hatcher, Michael Whitty and W. Birch Douglass III. These comments were reviewed by Steven B. Gorin on behalf of the Section's Committee on Governmental Submissions.

Although the members of the Section who prepared these comments have clients who would be affected by the Federal tax principles addressed, or have advised clients on the application of such principles, no such member (or the firm or organization to which such member belongs) has been engaged by a client to make a submission with respect to, or otherwise influence the development or the outcome of, the specific subject matter of these comments.

                       Table of Contents

By notice of proposed rulemaking in Section 2036 -- Graduated Retained Interests, 74 Fed. Reg. 19913 (April 30, 2009) (hereinafter the "Notice"), the United States Department of the Treasury (hereinafter the "Treasury") issued Proposed Regulations (hereinafter the "Proposed Regulations") that would amend Treasury Regulation Section 20.2036-1 (hereinafter the "Regulation") to address the following three (3) substantive issues:

Our comments are divided into two sections: first, the background on Regulation section 20.2036-1 and how it will be impacted by the Notice; and second, the Section's recommendations, along with a detailed discussion of the recommendations and the suggested amendments necessary to implement the recommendations.

II. Background

On June 7, 2007, the Treasury and Internal Revenue Service (hereinafter the "IRS") caused to be published in the Federal Register at 72 FR 31487 Proposed Regulations (REG-119097-05) providing guidance on the portion of trust corpus includible in a grantor's gross estate pursuant to sections 2036 and 2039. In response to numerous comments, the Treasury and IRS determined that certain comments warranted a reply by separate notice of proposed rulemaking, instead of in the final regulations published on July 14, 2008 (73 FR 40173; as TD 9414).

The Section recognizes that re-proposing regulations is unusual, and appreciates the Treasury's and IRS' willingness to accept additional input.

Consequently, on April 30, 2009, the Treasury and IRS caused to be published in the Federal Register at 74 FR 19913 the Proposed Regulations (REG-119532-08) which more specifically addressed the proper amount includible in a grantor's gross estate if the grantor retained the use of the property, the right to an annuity, unitrust, graduated retained interest, or other payment from such property for life, for any period not ascertainable without reference to the grantor's death, or for a period that does not in fact end before the grantor's death. The Proposed Regulations incorporate the methodology provided in Revenue Ruling 76-273,1976-2 C.B. 268, and Revenue Ruling 82-105, 1982-1 C.B. 133, which provides that the portion of the corpus of a grantor retained trust or a charitable remainder trust includible in the decedent's gross estate under section 2036 is that portion of the trust corpus necessary to generate a return sufficient to pay the decedent's retained annuity, unitrust, or other payment. On June 22, 2009 the IRS issued IRS Announcement 2009-50 (hereinafter the "Announcement") which revised the Proposed Regulations to correct errors in the chart set forth in Proposed Regulation section 20.2036-1(c)(2)(iii) Example 7(iii).

We respectfully suggest that the Treasury and IRS have not sufficiently clarified expectations the Proposed Regulations place on the taxpayer to ensure compliance with regard to calculation of the retained interest includible in the grantor's gross estate. We do believe the Proposed Regulations support and properly reference a consistent application of the existing methodology as established in the referenced revenue rulings. The greatest area for improvement to assist taxpayer compliance would be in the content and format of the existing explanatory provisions of the Proposed Regulations. Therefore, it is recommended greater emphasis be given to providing clear and consistent, step-by-step analysis and application of the existing methodology.

Further, we believe that the Proposed Regulations fail to take into account the depletion of trust principal that occurs when an annuitant receives an amount that is higher than that that would be earned if the trust assets were invested to produce a return equal to the section 7520 rate. The result is an attribution to the grantor of a greater portion of the value of the trust property. As such, we recommend this issue be addressed in the final regulations.

Finally, we recommend that guidance be provided in the Regulation that would preclude the potential inclusion under section 2033 of a retained interest in property that continues past the death of the grantor and the property that is subject to inclusion as a retained interest under section 2036. If both sections applied under these circumstances, more than 100% of a property would be included in the gross estate. When a decedent has transferred property and has retained an interest in that property that continues past death, section 2033 should not apply to the value of the retained post-death interest (e.g., the right to receive post-death payments of income or annuities) if section 2036 applies to the transferred property itself.

The Section believes implementation of these recommendations will simplify the rules, thus making it easier for taxpayers to follow.

III. Recommendations

This section contains a description and detailed analysis of the Section's recommendations and suggests textual changes to the Proposed Regulations that would implement these recommendations.

A. Summary

1. Revise Regulation section 20.2036-1(b). Regulation section 20.2036-1(b) should be limited to its definitional purpose. The explanation of the application of the methodology outlined in romanette (ii) should be moved to Regulation section 20.2036-1(c) where the includibility of other retained interests is handled.

2. Revise Regulation section 20.2036-1(c)(1). Regulation section 20.2036-1(c)(1) should be revised to delete the "(i)" following "Example 1" while retaining the text of the example, and the example under romanette (ii) of the same section should be moved to Regulation section 20.2036-1(c)(2). This will achieve organizational consistency.

3. Revise Regulation section 20.2036-1(c)(2). Regulation section 20.2036-1 (c)(2) should be revised to delete references to retained income or use interests. Again, this will achieve organizational consistency.

4. Revise Regulation section 20.2036-1(b)(1)(ii). Regulation section 20.2036-1(b)(1)(ii) should be revised to delete the current steps implementing its computational methodology and add the steps detailed below. Again, this example should be moved to Regulation section 20.2036-1(c) for purposes of internal consistency.

5. Clarify Proposed Regulation section 20.2036-1(c)(2)(ii). Proposed Regulation section 20.2036-1(c)(2)(ii) should be revised to clarify the explanation of the methodology used to calculate the retained annuity of a graduated retained annuity.

6. Clarify Proposed Regulation section 20.2036-1(c)(2)(iii) Example 7. Proposed Regulation section 20.2036-1(c)(2)(iii) Example 7 should be revised to provide consistent headings in the charts and clarify the discrepancy in the amounts used in subsections (ii) and (iii) of the example.

B. Advantages

The recommendations included herein are intended to: 1) clarify the methodology meant to be employed by the Proposed Regulations; 2) provide a consistent internal structure, and 3) provide examples that properly reflect the computational methodology.

C. Detailed Discussion of Recommendations

The definitional statement in Regulation section 20.2036-1(b)(ii) refers to a decedent who reserved an income interest. The Proposed Regulations appropriately expand this statement to include a decedent who "reserved the right to receive the income, annuity, or other payment from transferred property at the time of the decedent's death."

In addition to the expanded definition, the Proposed Regulations provide a description as to how to determine the portion of the transferred property that should be included in the case of a reserved annuity interest that follows an annuity interest held by another. This is an awkward position for this description because the more basic description of the method of determining portion includibility in the case of a reserved annuity interest that the decedent was entitled to receive at the time of death appears later in the Regulations. We suggest that this inclusion description be moved to Regulation section 20.2036-1(c), which describes how to determine the portion of the transferred property that should be included in a decedent's gross estate in the case of all other reserved interests.

We suggest, therefore, that Proposed Regulation section 20.2036-1(b)(1)(ii) be changed to read as follows:

The Proposed Regulations would change Regulation section 20.2036-1(c)(1) by adding a two-part example that deals with determining the includible portion in the case of both reserved income interests and reserved annuity interests that follow an income interest or annuity interest held by another. Because we believe that the explanation of the method illustrated in second part of this example should follow the explanation of the method to be used to determine the includible portion in the case of a reserved annuity interest that the decedent was entitled to receive at the time of death, we suggest deleting the "(i)" that follows "Example 1." and adding an example dealing with reserved annuity interests that follow annuity interests held by others to the set of examples in Section 20.2036-(1)(c)(2).

In addition, the Regulation does not address the interaction between sections 2033 and 2036. Many grantor retained annuity trusts and grantor retained unitrusts trusts are established for a term of years, and provide for continuing annuity or unitrust payments to the grantor's estate if the grantor dies during the term, consistent with Regulation section 25.2702-3(e) Example 5, and Walton v. Comm'r, 115 T.C. 589 (2000), acq. IRS Notice 2003-72, 2003-44 I.R.B. 964. The actuarial value of the right to receive post-death annuity or unitrust payments is includible in the grantor's gross estate under section 2033. The interest retained by the grantor would also be includible in the grantor's estate under section 2036(a)(1). We believe the amount includible in the grantor's gross estate under section 2036(a)(1) should be the same whether or not the annuity or unitrust payments terminate at the death of the grantor. This is so because the amount includible in the grantor's gross estate under section 2036(a)(1), as computed under the Regulation, would be that portion of the trust corpus necessary to generate the annuity or unitrust payment in perpetuity as if those payments constituted an income interest in the trust. Accordingly, whether the payments terminate upon the grantor's death or terminate a period of years later should not affect the amount of property included in the grantor's estate under section 2036(a)(1).

For that reason, the Proposed Regulations should include a provision, similar to the provision in Regulation section 20.2039-1(e), providing that, in the case of a retained interest that continues past death of the grantor, section 2033 would not apply to the value of future payments if the retained interest is includible in the grantor's gross estate under section 2036. The application of two different inclusion sections to the same property interests should not result in a double estate tax. In order to avoid this result, and because the amount of trust corpus that is necessary to yield the annual annuity payment to the grantor must always be greater than the actuarial value of the post-death annuity payments, the amount includible should be limited to the value determined pursuant to Section 2036(a)(1).

For organizational clarity and to preclude possible double inclusion under sections 2033 and 2036, we also suggest that Regulation section 20.2036-1(c)(1) be changed to read as follows:

D creates an irrevocable trust the terms of which require the trustee to pay C an annuity of $10,000 per year at the end of each year for 12 years. If C dies before the 12 year period is over, the payments will be made to C's estate. At the termination of the 12-year period, the annuity is to be paid to D for the rest of D's life. D dies immediately after C has received her second annuity payment. The trust property is worth $100,000; the Section 7520 rate is 7%.

The Proposed Regulation would require D to include $72,621 of the trust's value in her gross estate calculated as follows:

The portion of the corpus included in D's gross estate should be no greater than the present value of the amount of trust property that will remain after paying C's annuity, calculated in a manner consistent with section 7520.

If, at the time of the decedent's death, decedent is receiving an annuity from a trust fund that will pay her an additional annuity after the termination of an annuity being paid to another, before calculating the amount of the trust to be included as a result of the deferred annuity, the trust fund should be bifurcated into two parts, the first part consisting of the portion of the trust corpus needed to provide the decedent's current annuity and the second part consisting of the balance of the trust corpus. The calculation of the includibility portion with respect to the deferred annuity should be done with reference to the second portion.

We suggest, therefore, adding the following section 20.2036-1(c)(2)(ii):

The following steps implement this computation.

First, we recommend that column G of the chart in (ii) of Example 7 should refer to the Base Amount, as well as the Corpus Amount. We recommend this because the amount set forth for GRAT Year 3 in column G is the Base Amount as defined under Proposed Regulations section 20.2036-1 (c)(1)(ii)(B)(1).

Further, we believe that the numbers in the corrected chart in Proposed Regulation section 20.2036-1(c)(2)(iii), Example 7(iii) as set forth in the Announcement should be consistent with the numbers set forth in the chart in Proposed Regulation Section 20.2036-1(c)(2)(iii) Example 7(ii). As corrected by the Announcement subsection (ii) and subsection (iii) of Example 7 have different Corpus Amounts for GRAT Years 4 and 5. This discrepancy should be clarified. Also, we recommend for clarity purposes the label "Additional Annuity" in the corrected chart in section (iii) of Example 7 should be re-labeled as "Periodic Addition" to be consistent with the definition terms used in paragraph (c)(1)(2).