With the current environment in Washington, clients are nervous and seeking our advice and guidance more than ever on what they can do to plan for the uncertain looming changes to the Tax Code. Whether under President Biden’s American Families Plan, the “99.5% Act,” the Sensible Taxation and Equity Promotion (STEP) Act or the sunset of the tax cuts under the Tax Cuts and Jobs Act, changes to the Tax Code are almost certain. However, what those changes will ultimately be is anyone’s guess. This makes it challenging to offer tax planning advice, particularly to those clients who wish to take advantage of the current $11.7 million gift tax exemption but can’t afford to irrevocably give away assets or simply don’t want to. For those clients, you may consider the grantor retained interest partnership (GRIP)—a planning technique that allows clients to lock in today’s gift tax exemption without really giving too much up.
Although the term “GRIP” may be new, the technique isn’t. In fact, it’s not really a technique at all but simply a partnership established with two types of interests—a preferred interest and a common interest—that carefully follows the rules imposed under Internal Revenue Code Section 2701 for the taxpayer’s benefit. IRC Section 2701 is part of Chapter 14 of the IRC, which is titled “Special Valuation Rules” and dictates that in certain circumstances, actual values are ignored and special values are imposed for estate and gift tax purposes. Section 2701 was enacted to regulate certain types of estate-planning transactions that “freeze” the value of a business entity—typically a partnership or limited liability company (LLC). When it applies, Section 2701 treats the taxpayer—or, for purposes of this article, the grantor, as having made a significant taxable gift even when what was actually gifted or transferred was a common interest that had no or minimal value. Instead, the grantor retains the preferred interest that’s actually worth $11.7 mil-lion and continues to hold, enjoy and benefit from it for life. On the grantor’s death, this $11.7 million preferred interest is included in the grantor’s taxable estate. However, because the special valuation rules of Section 2701 had previously attributed $11.7 mil-lion of value to the common interest that the grantor had gifted during life, the IRC and regulations protect the grantor from being taxed twice and direct that the estate be reduced by this $11.7 million amount. The policy behind the reduction is that because the special valuation rules under Section 2701 had already treated the grantor as having gifted the value of the preferred interest during life, it wouldn’t be fair to tax this same $11.7 million again at the grantor’s death.
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