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GRAT becomes invalid due to wrong reliance on valuation

In Chief Counsel Advice 202152018, the Office of the Chief Counsel held that the taxpayer’s reliance on the assessment for seven months prior to funding the Grantor Retained Annuity Trust (GRAT) was not justified, as there was a potential sale of the company at a higher price.

The taxpayer funded GRAT in the middle of the year with shares of stock in a successful company. Late last year, the company explored selling to outside buyers with an investment advisor. On the date GRAT was funded, there were five open offers from other companies. The company continued to consider other offers as several bidders raised their offer prices.

Meanwhile, the funded taxpayer calculates his retained interest based on the assessment received for reporting requirements for GRAT and non-qualified deferred compensation purposes under Internal Revenue Code section 409A (approximately seven months from the date of GRAT funding First).

Ultimately, the company accepted an offer, and the taxpayer tendered a portion of its shares for three times the value determined by the valuation used for GRAT. After a year, the balance amount of the company was sold at four times the valuation.

CCA opinion

The CCA reads the Standard for Valuation of Property for Gift Tax Purposes under IRC Section 2512: The price at which such property changes hands between a willing buyer and a willing seller, without any compulsion to buy or sell Under and have proper knowledge of both the relevant facts. Both parties are assumed to have a reasonable fact-check and “reasonable knowledge” includes facts that would be discovered during the course of negotiations, even if that information is not publicly available. Events occurring after the date of assessment may be considered if they were reasonably anticipated as of that date. Value is a question of fact, and all relevant evidence must be considered.

The taxpayer argued that the assessment was valid as it was only six months old and the business operations had not changed materially during that 6 month period. The lead counsel did not agree and cited several other cases in which mergers and corporate transactions taking place after the valuation date were considered in estimating the value of shares as the interested buyer/seller would be aware of significant interactions.

According to the CCA, the taxpayer’s deliberate reliance on the old valuation of the company, when the company had received purchase offers based on high prices, was misleading at best. GRATs are subject to the special assessment rules laid down in IRC Section 2702. To qualify as GRAT under section 2702, the taxpayer must retain an annuity of a certain amount (either a fraction or a percentage) of the initial fair market value (FMV). The assets are used to fund GRAT.

Typically, taxpayers take comfort in GRAT’s automatically adjusting feature: If there is a change in the value of the initial gift, GRAT automatically adjusts the annuity due to the formula used to calculate the annuity payment, which is called Usually expressed as a percentage. Value contributed to GRAT. However, in this case, due to the massive depreciation of the assets used to fund the GRAT, which ignored important facts affecting the value, the lead counsel determined that the amount of the annuity actually paid GRAT had no relation to the initial FMV. The intentional and forceful nature of the devaluation was so significant that the lead counsel said there was an “operational failure” that was fatal to the GRAT, which clearly stipulated the adjustment. The lead attorney may also be upset by the fact that the taxpayer created a charitable balance trust a few months after the GRAT, for which he or she received a different assessment at a value much higher than the one used for the GRAT, giving the taxpayer a different valuation. A higher tax was granted. cut.

It seems likely that the lead counsel could have reached a less drastic conclusion: that the GRAT was funded with a higher value than the claim, annuity payments were based on a lower value and, as a result, the taxable gift was higher upon creation of the GRAT. Instead, the CCA claims that the annuity contribution was not a fixed percentage of the amount contributed, but was based on a much smaller amount and was, therefore, invalid.

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