The district court decision in Badgley v U.S. (ND Cal, May 17, 2018, No. 17–cv-00877–HSG) 2018 US Dist Lexis 83537 confirms what we have long believed: The value of a grantor retained annuity trust (GRAT) is included in the grantor’s estate if the grantor dies during the term of the retained annuity interest.
We believed it even before the IRS issued the GRAT because it’s provided in the regulations. See Treas Reg §20.2036–1(c)(2), providing for a calculation that generally results in the inclusion of the entire trust corpus in the grantor’s gross estate.
But like Mike Mulligan and his steam shovel, which he claimed could dig as much in a day as a hundred men could dig in a week, we’ve never been sure this was true. There seems to be no prior case law on this point.
In Badgley, Settlor was entitled to receive annual payments from a trust funded with partnership interests for the lesser of 15 years or until her prior death equal to 12.5 percent of the date-of-gift value of the property transferred to the GRAT. Settlor died 3 months short of the 15 years. Executor asserted that IRC §2036 didn’t apply to the GRAT and that the regulation was invalid.
Citing case law in which the Supreme Court articulated its pragmatic approach to the statutory language, the district court held that Settlor’s right to a fixed-annuity payment brought her transferred property within the meaning of that section. The court also cited as persuasive the decision in McNichol’s Estate v Commissioner (3d Cir 1959) 265 F2d 667, 673 (reserved life interest property included in gross estate).
The district court concluded that the regulation was a reasonable interpretation of IRC §2036 under the standards of deference articulated in Chevron, U.S.A., Inc. v Natural Res. Defense Council, Inc. (1984) 4578 US 837, 104 S Ct 2778 (so-called Chevron deference), as applied to tax regulations issued by the Treasury Department under Mayo Found. for Med. Educ. & Research (2011) 562 US 44, 131 S Ct 704.
The district court found that the proffered explanation that the IRS’s formula “looks to the amount of property needed, given the interest rate at the time of death, to fund the annuity” was persuasive and well-reasoned. The district court noted that the lower interest rate in effect on the date of death in the present case increased the value of the annuity under the formula.
As this case illustrates, a lengthy GRAT term is risky. In contemporary estate planning, a GRAT term longer than 10 years is unusual because of the increased risk of inclusion. More common is a 2-year zeroed-out so-called Walton GRAT that results in no taxable gift. See Audrey J. Walton (2000) 115 TC 589, acq 2003-44 Int Rev Bull 964 (yes, the Walmart Walton family).
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