closely held business) passes to designated heirs either outright or in further trust. Under the §2702 of the Internal Revenue Code, the value of the gift transfer to the GRAT is determined by subtracting the present value of the retained income right from the fair market value of the property transferred. If the term and the level of retained income interest are sett high enough the value of the retained right to income can be equal to the value of the interest transferred. In that case the value of the gift to zero. Retained interests are generally valued at zero unless they are “qualified interests.” A “retained interest” is an interest retained by the transferor or any “applicable family member,” provided the family member held an interest in the trust before and after the transfer. Section 2702(b) provides that there are three types of qualified interests: (1) an annuity trust interest; (2) a unitrust interest; and (3) any noncontingent remainder interest if all of the other interests in the trust consist of either unitrust or annuity trust interests. Applicable family members are the transferor's spouse, ancestors of the transferor or the transferor's spouse, and the spouses of any such ancestors. §§2702(a)(1), 2701(e)(2). Regs. §25.2702-2(a)(3) provides that “retained” means held by the same individual both before and after the transfer. Thus, an interest can be “retained” by an applicable family member only when property is transferred to an existing trust in which an applicable family member holds an interest both before and after the transfer to the trust. When the transfer creates the term interest, §2702 applies if the transferor holds the term interest immediately after the transfer. Unless the retained interest in the GRIT constitutes a qualified interest under §2702, it will be given a zero value, resulting in a gift to the remainder beneficiaries under the GRIT in an amount equal to the total fair market value of the property transferred. To transfer stock to the next generation at a reduced transfer tax cost, while retaining an interest in the transferred stock for a period of time, the transferor must now use a trust with a qualified interest: a grantor retained annuity trust (“GRAT”) or a grantor retained unitrust (“GRUT”). b.
Excluded Transfers
Section 2702 does not apply to incomplete gifts, including transfers to revocable trusts, 239 or to transfers to a trust qualifying as a personal residence trust or to a qualified personal residence trust 240 under Regs. §25.2702-5. Transfers to charitable remainder trusts and pooled income funds are also not subject to §2702 since the retained interests in such trusts are either annuity or unitrust interests. 241 Another safe harbor (sometimes called the “art” exception) excludes non-income-producing tangible property from application of §2702. c.
Example
Here’s an example of how this works: assume the client’s interest in the closely held business is worth $1,000,000, before it is recapitalized. After the recapitalization the owner now holds a voting interest which is entitled to 1% of the net cash flow and 1% the net proceeds in liquidation but 100% of the vote; the non-voting interest is entitled to 99% of the net cash flow and the net proceeds in liquidation but 100% of
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