IRS Challenge to GRAT Strategy Raises Questions for Estate Planners

The IRS is challenging a technique commonly used in Grantor Retained Annuity Trust (GRAT) planning, raising questions about the future of a popular estate planning strategy. A pending $736 million tax dispute offers important lessons for families and advisors using GRATs to transfer wealth to the next generation.

A pending federal tax court case involving a $736 million gift tax dispute is drawing attention to one of the most widely used strategies in advanced estate planning: the Grantor Retained Annuity Trust, or GRAT.

A September 21, 2026, Wall Street Journal headline captured the controversy: “The IRS Is Cracking Down on a Favorite Way the Ultrawealthy Pass Money.” The article examines a dispute involving Chuck and Trisha Elcan of Nashville, Tennessee, whose use of GRATs has prompted the IRS to challenge a technique historically considered effective for transferring wealth to the next generation.

Understanding GRATs

A GRAT is an irrevocable trust that allows a donor to transfer future asset appreciation to beneficiaries while minimizing gift tax consequences. The donor transfers assets to the trust but retains the right to receive annuity payments over a specified term. Those payments are calculated using the IRS Section 7520 interest rate, commonly called the “hurdle rate.” In October 2026, that rate was 5.6%.

If the assets appreciate faster than the hurdle rate, the excess appreciation passes to beneficiaries at the end of the trust term, generally free of additional gift tax.

GRATs are particularly effective for appreciating investments and closely held business interests. The Wall Street Journal cites modeling showing that a $1 million transfer of Amazon stock to a GRAT ten years ago could have resulted in approximately $4.5 million passing to descendants free of gift tax.

Typically lasting two to ten years, GRATs have historically been considered relatively low-risk. If assets fail to outperform the hurdle rate, little or no wealth passes to beneficiaries, and the donor generally receives the assets back through annuity payments.

The Elcan Case: A Dispute Over Promissory Notes

The Elcan case centers on a technique known as promissory note substitution, which can be used to capture appreciation in assets held by a GRAT.

The Elcans established two GRATs and transferred Subchapter S corporation stock and general partnership interests into them. After the assets appreciated, they purchased them back at their appreciated values in exchange for promissory notes bearing interest at the prime rate plus one percentage point. The repurchased assets were then transferred to a third GRAT.

The remaining annuity payments owed by the original GRATs were to be satisfied through cancellation of payments due on the promissory notes.

The IRS contends that this transaction retroactively invalidated the original GRATs, resulting in a taxable gift rather than a transfer in exchange for a qualified annuity interest.

Under Section 2702(b) of the Internal Revenue Code, a GRAT’s retained annuity interest must qualify as a “qualified interest” for gift tax valuation purposes. The related regulations generally prohibit satisfying a GRAT’s annuity obligation through the issuance of a note or other debt instrument.

The Elcans disagree. In their motion for partial summary judgment, they argue that Section 2512 requires the value of a gift to be determined when the gift is made and that Treasury Regulation Section 25.2702-3 cannot invalidate an otherwise valid GRAT based on subsequent events.

They further argue that the regulation does not apply because the GRAT trustees did not issue the promissory notes. Rather, the Elcans issued the notes in connection with their purchase of the trust assets. Their position relies on estate planning commentary recognizing a distinction between a note issued by a GRAT trustee to satisfy an annuity obligation and a note issued by another party that the trustee acquires through a sale of trust assets.

Implications for Estate Planning

Regardless of the outcome, the IRS challenge has already had a chilling effect on GRAT planning. Many practitioners are putting promissory note substitution transactions on hold or reducing their use of GRATs until the Tax Court provides additional guidance.

In my opinion, the taxpayers will ultimately prevail in Elcan. The dispute brings to mind Walton v. Commissioner, a 2000 Tax Court decision rejecting the IRS’s position that a GRAT could not have a zero-value remainder interest for gift tax purposes. Following Walton, so-called “zeroed-out GRATs” became commonplace, and the IRS subsequently conceded the issue in Notice 2003-72.

Until Elcan is resolved, practitioners may want to consider alternatives to promissory note substitution. Steve R. Akers, Senior Fiduciary Counsel for Bessemer Trust, has suggested substituting other property for GRAT assets and receiving the remaining annuity payments in property rather than notes. Another option is for the grantor to obtain a bank loan, purchase the GRAT assets with the proceeds and allow the trustee to use the cash to satisfy the annuity obligation.

Akers also suggests that the interest rate used in the Elcan transaction—prime plus one percent—may have attracted IRS attention. Using the applicable federal rate (AFR) in a substitution transaction may help avoid an argument that an above-market interest rate itself constitutes an additional gift.

Sales to intentionally defective grantor trusts (IDGTs) are another alternative worth considering during this period of uncertainty.

For families continuing to use traditional GRATs, proper valuation remains essential. The IRS has also focused on the valuation of closely held business interests transferred to GRATs, although initial valuation is not at issue in Elcan. A qualified, independent appraisal should accompany any transfer of closely held business interests.

GRATs remain an important estate planning tool, but the Elcan case is a reminder that even well-established strategies can attract increased IRS scrutiny. Until greater clarity emerges, careful structuring, proper documentation and consideration of alternative strategies are essential.

This article was written by firm partner Kent Endacott and will also appear in an upcoming issue of Nebraska CPA magazine.