9th Circuit Affirms Decision Including Entire Value of GRAT in Decedent’s Gross Estate

On April 28, 2020, the U.S. Court of Appeals for the Ninth Circuit issued its opinion in Badgley v. U.S.  In so doing, the Court affirmed a lower court determination that the entire date-of-death value of the assets of a Grantor Retained Annuity Trust (“GRAT”) were includible in the settlor’s gross estate for federal estate tax purposes.

The decedent in Badgley created the GRAT in 1998 for purposes of facilitating the transfer of interests in a family-run partnership (then worth approximately $2.5 Mil.) to the decedent’s children.  The GRAT contemplated a 15 year annuity term, meaning that the assets of the GRAT would not pass to the decedent’s children until the end of the 15 year term or upon the decedent’s passing, whichever occurred earlier.  In the meantime, the decedent retained the right to receive annuity payments from the GRAT.

The decedent died in 2012, just a few months prior to the expiration of the annuity term.  By that time, the assets of the GRAT, net of the annuity payments made to the decedent, had appreciated to approximately $11 Mil.  Had the decedent survived the annuity term, the assets of the GRAT would have been successfully transferred to the decedent’s children free of federal estate taxes.  However, the decedent did not survive the term and, as a result, continued to possess an interest in the GRAT as of the date of the decedent’s passing.

The issue before the Court was the extent to which the decedent’s retained annuity interest caused the assets of the GRAT to be included in the decedent’s gross estate (and thus, subject to estate tax).  The decedent’s personal representative argued that inclusion should be limited to the net present value of unpaid annuity payments.  The IRS, on the other hand, argued that the entire date-of-death value of the GRAT should be included.  Ultimately, the Court sided with the IRS on the basis that the decedent’s retained annuity right constituted a “substantial present economic benefit,” requiring inclusion of the entire GRAT under applicable provisions of the Internal Revenue Code.

GRATs are a powerful tool for transferring wealth with minimal transfer tax consequences, especially in the current environment of historically low interest rates and depressed asset values.  However, the Badgley decision underscores a few of the many variables which should be considered carefully in determining whether a GRAT is an advisable strategy in the context of a particular situation.  This is particularly the case given the availability of alternative strategies such as installment sales.

For more information, please contact Joe Owens in the Troy office at 248-433-7515.