GRATs, Estate Planning, and the Elkins Case: Insights from George Riter
Grantor Retained Annuity Trusts (GRATs) have long been one of the most effective wealth transfer tools available to high-net-worth individuals and families. However, a recent tax court case, Estate of Elkins v. Commissioner, has generated significant discussion among estate planning professionals regarding GRAT administration, valuation requirements, and the use of substitution powers.
In this episode of the Newton Knowledge Podcast, George Riter, Senior Partner at Timoney Knox, joins hosts Mark Singer and Steve Target to discuss the fundamentals of GRATs, the facts surrounding the Elkins case, and the potential implications for estate planning strategies moving forward. George also shares insights from decades of experience helping families navigate complex trust, tax, and wealth transfer planning issues.
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Podcast Transcript
George Riter on His Background and Estate Planning Practice
Mark Singer: Tell us about your career path first, becoming a senior partner at Timoney Knox and the resources the firm provides, and then go into your particular practice as well.
George Riter: Well, I actually was a bio major in college thinking I’d go to med school, but organic kind of swayed me away from that. So a good friend of the family was a lawyer, so I followed that path.
When I got out of law school, graduated from law school, I started with a small firm downtown, did mostly trust and estate work. And then in 2001, Tom Timoney, who was one of the named partners who I’d known all my life, convinced me to come out here and so I’ve been here ever since.
And we’re essentially a general practice firm in the fact that the largest group is trust and estate and corporate and tax. We have strong litigation, we do municipal, we do real estate. We don’t do securities, we do very little private equity, but otherwise we can serve most of the needs of our clients.
Mark Singer: And yours is particularly estate planning? Trust and estate, okay. Did you go into the legal profession knowing you were going to be an estate planning attorney?
George Riter: You know, good question. There’s so many areas of law and you think, okay, what do I want to do? It turned out that the firm I started with was essentially a trust and estate group with some litigation insurance defense.
And I just realized that dealing with families, multi-generations, partnerships, real estate, tax, estate documents—you’re really doing so many more things, and becoming a family advisor was really what I like about all this.
Understanding GRATs: The Basics
Mark Singer: Considering this case, can we begin with the basics on what a GRAT is and why is this case getting so much attention?
George Riter: GRAT stands for Grantor Retained Annuity Trust, and it’s permitted under IRS Code Section 2702.
The key, and what makes it so efficient and unique and quite frankly versatile, is the fact that if done properly, a person that’s known as the grantor can transfer funds into this GRAT, this trust, which is irrevocable and usually for a term of years.
You often hear about 2-year GRATs, 3-year GRATs, whatever, but they’re zeroed out. So what that means is you can transfer money, let’s say $1 million, and you would transfer primarily securities or assets that you think would appreciate.
And the grantor gets repaid over the term of that trust. The thing is, it doesn’t use any of your gift tax.
Mark Singer: That’s great.
George Riter: That’s the way it’s usually structured. So think of it more as a loan that will come back to you and hopefully appreciate.
But it has to be administered properly. All too often somebody will draft a GRAT, and you’ve got to be particular. When does it go in? What goes in? How is it valued? What are the key dates? What are the key reporting periods?
Sometimes that’s where, for lack of a better word, the wheels start to fall off.
The Elkins Case and What the IRS Is Challenging
Steve Target: As we’re sitting here today, we’re referencing the Elkins case. What is the IRS challenging in this particular fact pattern?
George Riter: Right now they’re understaffed. So normally if you file a gift tax return for a gift directly to anybody, to a trust or a GRAT, they look at it and it probably just gets accepted without review because it looks good on its face.
This is a very significant case. The Elkins family created three GRATs and transferred an aggregate of $688 million into these GRATs. The annuity payments to come out totaled about $721 million.
First and foremost, you’ve got significant GRATs that are not the norm, and they’re going to look at it more carefully.
Normally they would be looking at the assets and how they are valued. Was there an appraisal? Was it fully supported?
Here, though, they’re saying that there was a substitution of assets. The assets that went in, which were S corporation and real estate interests, came out and were replaced with promissory notes issued by the grantor.
It’s called a swap.
It appears from what you can read that they didn’t value those notes and there was no supporting documentation. So the IRS is claiming that either they were not of equal value or they were worth more, and therefore it was an addition and a gift.
So that’s what they’re focusing on.
Qualified Interests and Valuation Concerns
Steve Target: What’s considered a qualified interest under IRC 2702 and how might taxpayers and the IRS interpret this?
George Riter: The key section is 2702 and it basically says that they have a defined calculable interest.
The qualified interest is that you can clearly identify what the grantor is getting back over the term of the trust.
What makes these trusts attractive is the ability to swap assets. If you put in a variety of stocks or shares of a closely held company, you get it valued. Stocks are pretty easy to value if they’re publicly traded. Businesses need a valuation.
Then you attach that to the gift tax return.
Later, if that asset is increasing in value and you want to lock in some of those gains, you may swap out other assets. We usually don’t recommend using a promissory note because it is scrutinized more heavily by the IRS and you’ve got to get it valued.
You can lock in gains and manage the trust, but it has to be identifiable. If you start running afoul of those rules, that’s when you get into trouble.
Best Practices for GRAT Administration
Mark Singer: What do you recommend doing if you’re not utilizing a promissory note?
George Riter: We’ve used promissory notes, but never for the whole amount of the GRAT.
Here, they flushed out all the assets and then put in this note.
What we recommend and what we’ve done a couple times is identify what the client holds and what the client can afford to transfer.
We’ll do 2-year GRATs. We’ve done three-, four-, and five-year GRATs knowing that we can swap out assets if necessary.
We transfer the assets in, identify when we put them in, and then monitor them. If the market has been favorable and values are higher, we may swap out other assets.
We may put in fixed income, cash, or a note—but never for the full amount. And the note is valued by an accountant or another qualified professional.
Does the Elkins Case Change Estate Planning Strategies?
Steve Target: Does this case change the way you might approach GRATs moving forward?
George Riter: For us, it will be business as usual because we don’t push the envelope.
I would say we’re conservatively aggressive.
If you can transfer assets into a trust, have them valued, and you believe there might be a liquidity event during the term of the GRAT, that’s hopefully going to produce a favorable result.
Here, it appears as though they did not get the valuation.
For us, our clients don’t want to become a test case, and we would be a little bit more conservative.
There are firms that do notes all the time, but they do get them valued.
Why Valuation Matters
Steve Target: Let’s talk about valuation. No valuation is not good.
George Riter: Correct.
Steve Target: One valuation is probably enough. Are there circumstances where you have more than one valuation?
George Riter: We have never obtained more than one. But if we did a GRAT or transferred money to an irrevocable trust, we’re going to attach a valuation.
If the IRS comes back and says they believe you’ve taken an unreasonable adjustment, then we get another valuation.
And they usually get their own.
Collaboration Among Advisors
Steve Target: Coming from the insurance world, are there opportunities to have insurance participate to protect some of the exposure or enhance the strategy?
George Riter: On a trust level, absolutely.
We’ve been involved in situations where we created irrevocable trusts for children, obtained significant life insurance on a parent, and then structured loans to support the trust.
The investments in one trust grew from approximately $10 million to over $17 million.
The insurance proceeds will ultimately be added to that, and all the appreciation and all the life insurance are completely outside of the client’s taxable estate.
One thing clients like is the fact that advisors work together as a team.
The best way we can serve the client is by not being silos.
I am an advocate of client meetings and family meetings where you have the investment advisor, the accountant, the insurance professional, and the attorney all working together.
It’s really best for all of us and ultimately best for the client.
Final Thoughts on GRAT Planning
Mark Singer: Is there anything we didn’t touch on that you want to talk about?
George Riter: GRATs are still a great technique.
Interest rates have crept up a little bit. The market’s a little frothy. But if you do them—maybe not two years, maybe three or four years, or perhaps a series of them funded differently—they remain a great technique.
You’ve got to advise clients of the downside, but if they hit, they are incredibly effective.
The money ultimately comes back, so you’re not really giving everything away. You’re removing the appreciation from the estate.
Clients like that, especially with the exemption amount so high.
Speak with George Riter About Estate Planning Strategies
Estate planning tools such as GRATs can provide significant opportunities for wealth transfer when they are properly structured, documented, and administered. Whether you’re evaluating GRATs, irrevocable trusts, business succession planning, or other advanced estate planning strategies, experienced legal guidance can help ensure your plan aligns with your family’s goals and current tax laws.
To learn more about estate planning and trust strategies, contact George Riter and the estate planning team at Timoney Knox.
About The Author(s):
George M. Riter
George M. Riter joined Timoney Knox as a partner in 2001 and served as managing partner from July 2007 through June 2018. His practice of wills, trusts, estates and corporate law focuses on the estate planning needs of individuals, families, business owners, individuals with special needs and non-profit entities and foundations.
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