SEPT. 18, 2000

Tax Tid-Bits
Final Regs: GRATs & GRUTs May Not Use Notes as Annuity or Unitrust Payments

The IRS has issued final regulations concerning the use of debt obligations to satisfy annuity or unitrust payments for grantor retained annuity trusts (GRATs) and grantor retained unitrusts (GRUTs). These final regulations adopt, with some modifications, proposed regulations published on June 22, 1999, and state that GRATs and GRUTs that use notes, other debt instruments, options, or similar financial arrangements to satisfy payment obligations to the grantor do not meet the requirements of § 2702(b).

Some commentators on the proposed regulations suggested that short-term notes as payments should be permitted as long as they bear interest at the §7520 rate. But the IRS rejected that suggestion, explaining that any deferment of the required payment, even by short-term note, fails to satisfy the payment obligation under § 2702(b). The amount must be paid with cash or other trust assets.

The final regulations do allow the trust to make the required payments with funds borrowed from an unrelated party. However, the IRS points out that the step transaction doctrine will apply where a series of transactions achieves a result that is inconsistent with the regulations.

Trusts established before September 20, 1999 need not include a provision expressly prohibiting the use of notes. However, a retained interest of a GRAT or GRUT will not be treated as a qualified interest if the trust uses notes to satisfy payment obligations after September 20, 1999 or if the trust has not paid in full by December 31, 1999 any such notes issued on or before September 20, 1999.