There was a recent Wall Street Journal article describing an IRS "crackdown" on Grantor Retained Annuity Trusts, or GRATs.

The short version: GRATs remain a valuable planning tool for many investors.

GRATs have long been one of the most effective ways to pass wealth to the next generation, and that hasn't changed. For a refresher on how they work, please see an overview here. 


What the headline misrepresents

The IRS isn't targeting GRATs as a whole. Past administrations, under Presidents Obama and Biden, proposed limiting GRATs, but no such legislation is pending today. In fact, the widely used "zeroed-out" GRAT currently rests on solid footing under the Internal Revenue Code (§2702).


What the IRS appears to be  focused on in this case

The case cited in the article, Elcan, involves a specific and aggressive technique: using promissory notes (essentially IOUs) inside a GRAT arrangement.

Here's what appears to have happened in the Elcan case. The person who created the GRATs bought assets from them using promissory notes. When the GRATs owed her their required annuity payments, the trustee didn't pay her. Instead, it forgave part of what she owed on the notes.

This matters because the rules around GRATs are clear on this point. A GRAT can't use a note to make its required payments, and the trust document itself must prohibit it.  By doing so, the Elcan arrangement achieved indirectly what the rules forbid directly, and other existing regulations aimed at indirect workarounds may support that view.


Our take

Using promissory notes with GRATs is uncommon, and the Elcan case reinforces why. Used as intended, GRATs can be  a highly effective strategy with several approaches that can be utilized while staying well within established rules.

If you have questions about an existing GRAT or want to explore whether one makes sense for your family, we're always happy to talk.