For multigenerational families, a grantor retained annuity trust, or GRAT, has long been one of the most dependable tools for moving wealth to the next generation without triggering a large gift tax bill. It is flexible, well established and, when properly administered, effective. That reliability is now being tested in a closely watched Tax Court case.
The IRS has assessed a Nashville, Tennessee, couple, Chuck and Trisha Elcan, with a gift tax bill of about $736 million, disputing three GRATs the family used in 2018 to transfer wealth to their three daughters. The case, Elcan v. Commissioner (Tax Court Docket No. 3405-25), is pending in the U.S. Tax Court, and it raises questions every family with an existing or planned GRAT should be asking now, not after the fact.
A Familiar Structure, Built on Careful Administration
A GRAT works by having a family member contribute assets, often marketable securities or interests in a family business, to an irrevocable trust for a fixed term of years, while retaining the right to annuity payments during that term. Whatever growth remains in the trust when the term ends passes to the family's chosen beneficiaries, largely free of additional gift tax.
The gift tax value at the trust's creation depends on the IRS's published Section 7520 rate for that month. Families have relied on this structure for decades because, done correctly, it allows appreciation above that rate to move to the next generation at minimal tax cost. But “done correctly” is doing a great deal of work in that sentence, and the Elcan case shows exactly why.
What Went Wrong in the Elcan Family's GRATs
The Elcans funded three GRATs with roughly $1.5 billion in business and securities interests. The trusts, like most GRATs, allowed Trisha Elcan to substitute personal assets of equal value for trust property. She used that power and substituted GRAT assets for promissory notes issued by her and payable to the GRAT. Then, the GRAT used the promissory notes to satisfy part of the annuity payments owed back to her rather than cash or in-kind property by canceling or forgiving an equivalent amount of principal and interest due by Trisha Elcan to the GRAT.
The IRS's position is that paying an annuity with promissory notes issued to the GRAT by the grantor means the trust never operated as a “qualified annuity interest” required under the Treasury regulations. Relying on Atkinson v. Commissioner, a case involving a charitable trust that lost its tax status because it failed to function as designed from the outset, the IRS argues the same result applies here: if a GRAT's administration deviates from what its own terms require, the entire trust can be disqualified retroactively, turning the full contribution, not just the excess growth, into a taxable gift.
Why This Matters Beyond One Family's Tax Bill
The Elcan dispute follows an earlier IRS challenge to a GRAT funded shortly before a company sale, addressed in a 2021 ruling where the agency again reached for this “failure to function” theory rather than simply adjusting a valuation. Taken together, these cases signal that the IRS is treating GRAT administration, not just the trust document, as fair game for audit. For a family office or multigenerational family managing several trusts across generations, that shift in emphasis means the people executing a GRAT day-to-day matter as much as the attorney who drafted it.
Planning Recommendations for Families and Family Offices
Even though the Internal Revenue Code regulations do not support the position taken by the IRS in the Elcan case, this is still a good reminder to families and family offices to pay close attention to the proper administration of the GRAT, as follows:
- Pay required annuity amounts using GRAT assets other than promissory notes owned by the GRAT that are issued by the grantor to avoid the exact issue raised in Elcan.
- Support every substitution of trust assets with a current, qualified appraisal showing the exchanged property is genuinely of equal value.
- Keep a single, consistent valuation for a given asset across related transactions in the same period, rather than different values for different purposes.
- Build an annual administration checklist for each GRAT, confirming payment amounts, timing and form match the trust instrument exactly and make payments on time.
- Loop in counsel for a periodic health check of existing GRATs, not only when they are drafted, since ongoing operation is now the IRS's focus.
Many of the families I work with hold family business interests inside their GRATs and other trusts. When that is the case, Warner's corporate and tax attorneys can help make sure valuations and ownership documentation used for a GRAT stay consistent with the family's broader succession and governance planning, closing the kind of gap the IRS is now pursuing in Elcan.
I have spent my career listening closely to multigenerational families and family offices to design wealth transfer and trust administration strategies that hold up over time, including GRATs, trust modifications and gift and estate tax audit defense. If your family has a GRAT in place, or you are considering one, contact Laura Jeltema or Warner attorney.
