University of Houston Law Center
Special Research & Writing Assignment
You must receive a minimum grade of “C” to receive credit. Papers must be completed and
submitted to the professor during the semester in which you registered for the course. Students
whose papers are not submitted within this time frame may be administratively withdrawn from
the course: Incompletes (“I”) are not given. The paper must 15 pages plus footnotes for one
credit, 25 pages plus footnotes for two credits, or 40 pages plus footnotes for three credits.
Student: Finis Cowan
Email finis@finiscowan.com
Course No. 5398
No. of Credits:1
Section 18548
Semester/Year Spg 09
Faculty Advisor - Supervising Professor Approval:
__________________________
Ira B. Shepard
Date: ________________________________, 2009.
Form 709 Preparers Ask,
“Why Elect Out of the GST Exemption Automatic Allocation Scheme?”
(Short Answer: Elect out for appreciating property, indirect transfers
including most Crummey ILITs, and trusts less likely to have GSTs.)
© Finis Cowan JD, CPA
LLM Tax Candidate
University of Houston Law Center
fcowan@pratherkalman.com
July 31, 2009
Table of Contents (§ References are to IRC)
1. Purpose and Scope of Article………………………………………………………….4
2. Caveat re: Anticipated Statutory Amendment and Sunset….……………………........4
3. 2009 Planning Opportunities……………………………………………………..........5
4. GST Exemption Allocation Basics
A. Definitions ……………………………………………...…………………...5
B. Exemption § 2631……………………………………………………………6
C. Deemed Allocation § 2632……………………………………………..........7
D. Zero Inclusion Ratio Means No GST Tax § 2642…………………………...7
E. Election Planning, Separate Trusts……………………………………..........8
F. When Do GSTs Occur With Trusts?................................................................9
G. Complete v. Partial Allocation………………………………………….........9
H. Annual Exclusion Only To Direct Skips and Certain Trusts...……………....9
I. Valuation Timing…………………………………………………….............10
i. Automatic Allocations…………………………………............11
ii. Timely 709………………………………………………..........11
iii. Late 709, Electing Out…………………………………............11
iv. Other Returns……………………………………………..........11
v. ETIP……………..………………………………………..........12
J. Irrevocability of Allocations and Elections………………………………….13
5. Deemed Allocation……………………………………………………………….........13
A. Explanation of Statutory Terms § 2632(b)-(c)………………………………....13
B. Form 709 Unnecessary But Good Recordkeeping……………………….........13
C. Order of Deemed Allocation ………………………………………………….14
D. GST Trusts………………………………………………………………..........14
6. Preventing Deemed Allocations…………………………………………………..........15
A. Reasons To Elect Out…………………………………………………………..15
B. How To Elect Out………………………………………………………………16
C. Notice Of Allocation……………………………………………………………16
2
D. Use Formula……………………………………………………………………...19
E. When to Elect…………………………………………………………………….19
F. Five Statutory Allocation Options………………………………………………..19
G. Termination of Election Out……………………………………………………..19
7. Late Affirmative Allocations
A. Relief for late allocations where good faith and no IRS prejudice………………20
B. Substantial Compliance…………………………………………………………..21
C. Intentional Late Elections………………………………………………………...22
D. First Day of Month Value Election, Except Life Insurance and Death………….23
E. Same Day Tie Goes to the Late Allocation………………………………………23
F. Retroactive Allocation If “Unnatural Order of Death”…………………………..23
8. Crummey ILITs – Whether To Allocate Or Not………………………………………..24
A. Term Insurance
(i) Periodic Allocation Is Safest……………………………………………..24
(ii) Wait-and- See May Save Tax……………………………………………25
B. Non-Term…………………………………………………………………………26
(i) Periodic Allocation……………………………………………………….26
(ii) Wait-and-See…………………………………………………………….26
(iii) Expedited Due Date for Late Allocations……………………………….26
Conclusion. Affirmative Allocation for ILITs Recommended……………………………....27



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
Table of Authorities
Appendix A: Checklist For Information and Documents Needed
Appendix B: Checklist For Information and Documents Needed For ILIT Allocation
Appendix C: Checklist for GST Tax Exemption Allocation Analysis
Appendix D: Checklist for GST exemption analysis
Special thanks to Professor Ira Shepard, my colleagues at Prather Kalman PC and my wife Lori
for their kind patience and generous support.
Pursuant to Regulations Governing Practice Before the Internal Revenue Service (Circular 230)
this communication is not intended or written to be used as legal or accounting advice, and it
cannot be used by a taxpayer, for the purpose of avoiding penalties that may be imposed on the
taxpayer.
3
Purpose and Scope of Article:
“A recurring problem is the failure to make an allocation of this (GST) exemption when making
lifetime gifts.”1 First-time preparers of IRS form 7092 are likely to be confused as to whether to
elect to not follow the automatic GST exemption allocation scheme.3 The reasons are not in the
form’s instructions,4 IRC § 2632 or Regs. § 26.2632-1.5 This article is intended to familiarize
the beginner or generalist form 709 return preparer with the rationales for electing out of the
deemed allocation scheme and for affirmatively allocating the exemption for GST transfers
during the transferor’s lifetime.
1.
Caveat Re: Anticipated Legislative Changes:
For individuals dying and transfers made in 2009, the lifetime GST tax exemption (like the estate
tax exemption) is $3.5 million per individual and $7 million per married couple. Absent
probable Congressional amendment,6 there will be no GST or estate tax in 2010 and starting in
2011, the GST tax and exemption will revert to the year 2001 rules, a lifetime exemption of $1
million adjusted for inflation and the 55% GST tax rate will apply again.7 “Total permanent
repeal is doubtful”8 but in case amendment is delayed it would be wise to avoid strategies that
trigger GST taxes payable in 2009 that might be avoided if the transfer is delayed to 2010.
Practitioners should monitor Congressional developments.
1
Streng, Estate Planning Materials 2008, Ch. 11, p. 24.
United States Gift (and Generation-Skipping Transfer) Tax Return: Instructions p. 3: “Caution! Certain transfers,
particularly transfers to a trust, that are not subject to gift tax and are therefore not subject to the GST tax on Form
709 may be subject to the GST tax at a later date . . . you may want to apply a GST exemption amount to the transfer
on this return or on a Notice of Allocation.”
3
The same question arises with Form 706 but post-mortem allocations are outside the scope of this paper. See RIA
Portfolio 850, G. Automatic Allocation of GST Exemption At Death, RIA 7184 Checklist and PPC Key Issues 30D
and 30E. Also excluded from this article are pre-2001 transfers, see PPC Key Issue 30A Grandfathered and Certain
Other Irrevocable Trusts and reverse QTIP elections which should be considered to fully use the GST exemption
available to each spouse or their estates. I.R.C. § 2652(a)(3).
4
http://www.irs.gov/pub/irs-pdf/i709.pdf
5
It is presumed that the reader has ready access to those three sources and every effort has been made to not
unnecessarily duplicate their content in this article without sacrificing comprehensibility. Significant rules from
these sources not having to do with allocation of lifetime transfers are omitted from this article for the sake of focus
and brevity.
2
6
Beth Shapiro Kaufman, Estate Tax Legislation In 2009: Avoiding The Train Wreck, Estate Planning Magazine,
July 2009, http://www.mondaq.com/article.asp?articleid=82182 describes, “what is in play” and suggests that the
most likely consensus is to maintain the status quo of the GST exemption and tax rate at the 2009 levels. “There is
also a reasonable possibility that Congress will enact portability and restore parity between the gift tax and estate tax
exemptions.” Id. The current lifetime gift tax exemption is $1 million.
7
Section 501(b) of the Economic Growth and Tax Relief Reconciliation Act of 2001, P.L. 107-16 (June 7, 2001)
(“EGTRRA”), the generation-skipping transfer (“GST”) tax is repealed effective January 1, 2010; Section 901(a) of
EGTRRA, in order to comply with the Congressional Budget Act, provides that all provisions of EGTRRA
(including the “repeal” of the GST tax) will “sunset” on December 31, 2010 and the provisions of EGTRRA will
then be treated “as if the provisions and amendments...had never been enacted.” See Throw Mama From The
Train….
8
PPC Key Issue 29A, Thompson Reuters/RIA.
4
2.
2009 Planning Opportunities:
“Since the $3.5 million GST exemption available in 2009 may be smaller in the future, it may
make sense to make plans to maximize its use now.”9 For example, a transferor could allocate
up to $3.5 million of one’s remaining GST exemption to property with growth potential in a trust
in 2009 and that trust asset would be GST exempt regardless of future changes in value.
Since it is unclear whether new legislation will allow Qualified Severances (“QS”) which sunsets
at the end of 2010, consider a QS before the end of 2009 if Congress acts this year without
reenacting them and before 2010 if they do not. Consider a QS if a trust’s inclusion ratio
(discussed below) is between zero and one. IRC § 2642(a)(3); Regs. Sec. 26.2642-6.
3. GST Exemption Allocation Basics:10
A. A Few Definitions Translated Into Purportedly Plain English:
Skip Person means (i) a natural person donee who is a generation that is at least two generations
below the transferor’s generation, i.e. a grandchild, great-grandchild, great-niece, etc., (ii) one
statutorily “assigned”11 to such a generation (e.g. beneficiaries 37.5 years younger than the
transferor) or (iii) trusts if all interests in property transferred to the trust are held by skip
persons. I.R.C. § 2613(a).
One can affirmatively allocate GST exemption for unborn skip persons.12 GST exemption
allocations where there is no potential for GST taxation are void13 so if no skip persons ever
exist, there can be no GST tax and allocation has no effect. However, a “trust will also be a skip
person if there are no interests in the property transferred to the trust held by any person, and
future distributions of terminations from the trust can be made only to skip persons.” (709
instructions, p. 7 and I.R.C. § 2613(a)).14
Three types of transfers are subject to the GST tax: direct skips, terminations and distributions.
I.R.C. § 2611(a)
9
Linas Sudzius, Take Advantage Of The GST Exemption Today, 4/6/2009,
http://www.lifeandhealthinsurancenews.com/Issues/2009/April%206%202009/Pages/Take-Advantage-Of-.aspx
10
GST definitions are in IRC Sec. 2632(c)(3)(indirect skip, GST trust), (Reg. Sec. 26.6212-.1, PPC Key Issue 29B:
Generation-Skipping Transfer Tax Terms and Mickey R. Davis, Allocating The Generation-Skipping Transfer Tax
Exemption - All You Need To Know To Fill Out The Forms, Thirty-Fifth Annual Southern Federal Tax Institute,
2000, hereafter “Davis.” This article has sample returns that demonstrate GST allocations
11
Form 709 instructions, p. 7, Determining the Generation of a Donee; Regs. § 26.2651-1.
12
Layne Rushforth, http://rushforth.net/answers1.html submits that, “You may allocate your GST exemption to any
trust . . . (but if) you have no living grandchildren, there can be no automatic GST exemption allocation . . .”
However, the automatic allocation rule for indirect transfers and definition of GST trust are not dependent on the
existence of existing skip persons. IRC Sec. 2632(c).
13
Regs. §26.2632-1(b)(4).
14
Periodically advise transferor clients (a) without skip person beneficiaries and (b) whose trusts provide for future
skip persons, to notify you or their transfer tax adviser of recent family “arrivals and departures” so that GST tax
planning can be updated, e.g., creation of separate GST exempt and GST trusts.
5
Direct Skip means a transfer subject to gift or estate tax made to a skip person including a trust if
all trust beneficiaries are skip persons. IRC § 2612(c)(1). Transfers to trusts having both non-skip
and skip persons as beneficiaries are not direct skips.
Indirect Skip means any transfer of property (other than a direct skip) subject to gift tax made to
a GST trust.
A GST trust is any trust that may incur GST tax unless any of six alternative exceptions apply
that indicate significant benefits will go to non-skip persons, (e.g., grantor’s children rather than
her grandchildren) or certain charitable trusts. IRC § 2632(c)(3)(B).
Taxable distribution ”means any distribution from a trust to a skip person (other than a taxable
termination or a direct skip).” IRC Sec. 2612(b). Exemptions and exclusions aside, payment
from a trust to a grandchild would be a taxable distribution.
Taxable terminations of interests in trusts “occur when there are no more nonskip persons ahead
of the skip person”15 as a result of “termination (by death, lapse of time, release of power, or
otherwise) of an interest in property held in a trust unless—
(A) immediately after such termination, a non-skip person has an interest in such
property, or
(B) at no time after such termination may a distribution (including distributions on
termination) be made from such trust to a skip person. IRC 2612(a)(1); Regs. § 26.26121(b)(1)(iii).
For example, death of a transferor’s only child, which by the terms of a trust terminated the trust
in favor of skip persons, would be a taxable termination.
B. Exemption: Each individual may transfer a maximum cumulative amount of property ($3.5
million in 2009) during life or at death free of the GST tax. This exemption may be allocated by
transferors against their lifetime gifts on Form 709 and by the transferor's executor on Form
706.16 IRC § 2631(a). The allocation is made to transfers or to trusts, not to transferees.17 For
direct skip transfers to a trust, allocations are made to the entire trust rather than to specific
assets. Regs. § 26.2632-1(a).
C. Deemed Allocation rules “represent the IRS’ attempt to alleviate the harsh consequences of
misunderstanding the complex GST tax rules”18 and automatically apply to direct skips and
15
Steve Garner, Tools & Techniques of Life Insurance Planning, App. C, p. C-13 and PPC Key Issue 32A.
16
PPC Key Issue 29D: Timely Allocation of the Lifetime Exemption.
17
Id.
18
PPC Key Issue 31A
6
lifetime indirect skips to GST trusts if the transferor or executor fails to elect otherwise. IRC §
2632(b)-(c)
Reliance on this default rule may result in significant additional taxes. Electing out of the default
rule and affirmatively allocating the exemption can avoid GST tax on future appreciation.19
Timely affirmative use of the exemption can shield more than the nominal ($3.5 million in 2009)
GST exemption from GST tax.20 The following example demonstrates this “leveraging” of the
GST exemption and a disadvantage of the automatic allocation rule: it doesn’t know the most
appropriate property or trust that the exemption should be applied to.
Grandpa has two inter-vivos trusts that were drafted by different lawyers for the benefit of his
kid and grandkids “from which a generation-skipping transfer may occur.”21 In January 2009,
when Grandpa had $3.5 million of GST exemption available, he transferred $3.5 million cash to
Trust A. He did not elect out of the deemed allocation rule and it automatically allocated $3.5
million of his GST tax exemption to Trust A. One month later he transferred a life insurance
policy worth (pre-death) $2 million to Trust B, whose terms made it more likely than Trust A to
result in a GST. Unfortunately, because the deemed allocation rule had already consumed all the
GST exemption, there was none left to allocate to Trust B.22 When Grandpa’s kid reached the
age specified in Trust A for the trust’s termination in 2013, the Trust A cash went to Grandpa’s
kid and thus no GST tax would have been incurred on it regardless of the GST exemption. When
Grandpa died later that year, the insurance policy paid $10 million for the benefit of his
grandkids. All of it was subject to GST tax that would not have been owed had Jake elected out
for the transfer to Trust A and allocated his exemption to Trust B. The exemption automatically
allocated to Trust A was wasted and would have been more profitably allocated to Trust B. Had
Jake’s CPA elected out of the deemed allocation scheme, or at least for transfers to Trust A, on a
Form 709 due on April 15, 2010, Jake could have left $4,500,000 to his offspring instead of to
the U.S. Treasury23 or at least saved a lot on his insurance premiums for the same amount of
after-tax insurance proceeds.
D. Zero Inclusion Ratio Means No GST Tax. The GST exemption “is not a true exemption from
GST tax, nor does it operate as a credit against tax as the applicable (annual) exclusion amount
does. Rather, it is a rate reducer. The effective rate of generation-skipping tax (called the
‘applicable rate,’ I.R.C. § 2641) is determined by multiplying the ‘inclusion ratio’ (I.R.C. §
2642(a)), which essentially is the percentage of the property to which GST exemption has not
been allocated, by the maximum federal estate tax rate (45% in 2009).”24
PPC Key Issue 29D: Timely Allocation of the Lifetime Exemption and PPC’s Guide to Practical Estate
Planning.
20
RIA 1664 Election Not To Allocate GST Tax Exemption To a Direct or Indirect Skip.
21
IRC Sec. 2642(b)(3)
22
Viehman, Generation-Skipping Transfer Tax Planning, 2007 CPE Tax Expo, p. 20: “If multiple indirect skips
occur during the same tax year and there is insufficient GST exemption to cover all of them, the literal language of
the statute suggests that a ‘first in first out’ sort of approach applies to determine how the unused exemption is
allocated among such indirect skips. I.R.C. § 2632(c)(2)(C).”
23
Assuming Congress does not allow the GST tax rate to revert to 55% as it is currently scheduled to do.
24
Blattmachr & Zeydel, “Adventures in Allocating GST Exemption in Different Scenarios,” 35 Estate Planning 3,
3-4 (Apr. 2008) “analyzes the various methods to create GST exempt and non-exempt trusts, as well as the effect on
GST exempt status of consolidating trusts for administrative purposes.”
19
7
IRC § 2632(b) and(c) provide for automatic allocation of an individual’s available GST
exemption to lifetime direct skips and to indirect skips to a GST Trust “to the extent necessary to
produce an inclusion ratio of zero,”25 i.e., to the extent necessary to avoid GST tax.26 The trust’s
inclusion ratio will need to be recalculated when additional GST tax exemption is allocated to
the trust and when additional property is contributed to the trust.27
E. Election Planning: The “goal is to ensure that all trusts are assigned an inclusion ratio of either
zero or one; that is, either wholly exempt or wholly taxable. A fractional inclusion ratio results in
the ‘wasting’ of the transferor's GST tax exemption and the likelihood of unnecessary
taxation.”28
Separate GST-Exempt and Non-Exempt Trusts: The usual practice “when property will be
placed in trust and the generation skipping transfer will occur at a later time, (is) to allocate GST
exemption to one trust (or group of trusts) so that it (or they) will be entirely exempt from the tax
and for the other trust (or trusts) to not be exempt at all, rather than creating partially exempt
trusts.”29 This may be accomplished by specific GST exempt gifts, judicial reformation or use of
a qualified severance.30 IRC §§ 2632, 2642(a).
A trust is made GST tax exempt by allocating a sufficient amount of the exemption to achieve a
zero inclusion ratio, i.e., equal to the value of the transferred property or by only making
transfers to which the GST annual exclusion applies. The exempt trust should be used to (1)
make generation skipping transfers and (2) hold property for younger generation beneficiaries
that has the potential for significant appreciation. “If possible, transfers to which the GST tax
exemption will be allocated should be made during lifetime so that additional appreciation in the
transferred assets will be excluded from the GST tax.”31
A nonexempt trust should (1) have no exemption allocated to it and (2) be used to benefit older
generation beneficiaries by making distributions which are not generation skipping.32
25
Julie K. Kwon, GST Tax Update: Income & Transfer Tax Roundtable, ABA Real Property, Trust Sect., 9/16/05,
p. 1 (“Kwon ’05” hereafter”). https://www.abanet.org/rpte/meetings_cle/2005/fall/Kwon.pdf
26
The inclusion ratio is one minus the “applicable fraction” rounded to the nearest one-thousandth (.001). IRC
2642(a)(1), Reg. 26.2642-1(a). The numerator of the “applicable fraction.” is the amount of the GST exemption
allocated to the trust. The denominator is the value of the property transferred, reduced by the sum of (1) any federal
estate tax or state death tax recovered from the trust attributable to the transfer, and (2) the gift or estate tax
charitable deduction, if any, allowed for the property. IRC § 2642(a)(2), Reg. Section 26.2642-2(a)(1). See PPC
Worksheets W201, Calculation of Inclusion Ratio on a Direct Skip and W202 Calculation of Trust’s Inclusion
Ratio.
27
See Reg. Sec. 26.2642-4, PPC Key Issue 29C and PPC Worksheet W202 for recalculating the inclusion ratio.
28
Daniel S. Rubin, Understanding The Generation-Skipping Transfer Tax, 348 PLI/Est 545, 576, Practicing Law
Institute, 2008.
29
Zeyer, supra, at p 13.
30
PPC Key Issue 32D; RIA Portfolios 527 and 1664; Carol A. Harrington, Lloyd L. Plaine & Howard M. Zaritsky,
GST Tax: Analysis With Forms (2d ed. 2007); GST Tax Update: Income & Transfer Tax Roundtable, Julie K. Kwon,
ABA Real Property, Trust & Estate Law, 19th Ann. Spg. Symposia, May 2, 2008. (“Kwon ‘08” hereafter)
http://www.abanet.org/rppt/meetings_cle/2008/spring/programmaterial/TEmaterial/te62Kwon.pdf
31
Mezzullo, Planning To Avoid The GST Tax (2007), p. 6.
32
RIA 1664, supra.
8
F. When Do GSTs Occur With Trusts?
“A generation-skipping transfer, however, may occur in two instances. First, if
one or more of the children die before the grantor and under the trust agreement
the deceased child’s share passes to the child’s descendants, some of the trust
assets may pass to skip persons (the child’s descendants). (However, IRC
2632(d)(1) may allow retroactive allocation of the GST tax exemption under these
circumstances).33
Second, if the trust agreement provides that a child’s interest does not vest until
the child reaches a certain age and the child dies after the grantor but before the
assets vest in the child, the assets also may pass to skip persons.”34
G. Complete vs. Partial Allocations: Where a trust has been allocated an amount of the
transferor's exemption equal to the entire amount of the trust, “distributions or terminations
therefrom will always be exempt from GST tax, regardless of the amount to which the trust may
have grown in the interim.”35
A partial allocation of the GST tax exemption “will always result in a GST tax.”36 That is, if the
amount of exemption allocated is less than the transfer, GST tax is owed for that year.
Accelerating the tax may still be cheaper in the long run than incurring tax on appreciation, e.g.,
wouldn’t you rather pay tax on the life insurance premiums than the proceeds?
The GST tax exemption may be allocated even if there is no current generation-skipping transfer,
e.g., it is permissible to allocate a portion of the GST exemption upon the funding of a trust for
the benefit of the transferor's child and grandchild.37
H. Annual Exclusions:38 The annual gift and GST exclusions are the same quantitatively
($13,000 for 2009) but not qualitatively. The GST exclusion only applies to direct skips which
are outright transfers directly to skip persons and transfers to certain trusts the beneficiaries of
which are skip persons.39 IRC § 2642(c). No GST exemption allocation or election is necessary
if such direct skip transfers are below the annual exclusion40 or for medical or tuition payments
paid directly to medical providers and qualified educational organizations.41 If the transferor
“Mezzullo, supra, p. 3, “if the parent of the skip person is a descendant of the transferor’s parent but is deceased
at the time a transfer occurs, the skip person will be elevated to the deceased parent’s generation, and will therefore
not be treated as a skip person. Consequently, transfers to that person will not be subject to the GST tax.”
34
Mezzullo, supra,, p. 9.
35
Rubin, supra at 575.
36
Rubin, supra at 576.
37
Rubin, supra at 576.
38
Distinguish lifetime exemptions from annual exclusions.
39
“In the case of a direct skip which is a nontaxable gift, the inclusion ratio of zero,” resulting in no GST tax.
I.R.C. § 2642(c)(1). See PPC Key Issue 1M: GST Tax Reporting Issues.
40
Amy K. Kanyuk, Iceberg Ahead! (2002) Jnl. of Acctcy.,
http://www.journalofaccountancy.com/Issues/2002/Oct/IcebergAhead.htm and
Mickey R. Davis, Allocating The Generation-Skipping Transfer Tax Exemption All You Need To Know To Fill Out
The Forms, supra, Thirty-Fifth Annual Southern Federal Tax Institute, 2000, pp. S-7,8.
41
PPC Key Issue 24G.
33
9
uses the gift tax exclusion for contributions to qualified tuition programs or education savings
accounts, such contributions also qualify for the GST annual exclusion.42 A split gift between
married people for gift tax purposes is also a split gift for GST purposes. “A transfer in trust for
the benefit of both nonskip persons and skip persons (such as a trust for the benefit of one’s
children and grandchildren) may qualify for the annual exclusion for gift tax purposes, but it
cannot qualify for the exclusion for generation-skipping transfer purposes.”43
Transfers to Most GST Trusts are Not Eligible for Annual GST Exclusion
The GST tax annual exclusion does not apply to direct skip transfers in trust for the benefit of an
individual unless the trust provides that:
1. Distributions cannot be made to anyone other than a single skip person beneficiary
during that skip person’s life; and
2. If the skip person dies prior to the termination of the trust, the trust assets must be
included in the skip person’s estate. IRC Sec. 2642(c)
If these two conditions are not met, the annual exclusion will not be available for GST tax
purposes, and the transferor’s lifetime GST tax exemption will have to be allocated to shelter the
transfer from the tax.44 The inapplicability of the GST annual exclusion to most Crummey trusts
is discussed more fully below.45 “(T)his type of trust would not apply to the typical irrevocable
life insurance trust for the benefit of a spouse, children and multiple grandchildren even though
contributions might be sheltered from gift taxation by the gift tax annual exclusion.”46
Form 709 must be filed to elect out of the deemed allocation rule, even if the annual gift tax
exclusion would normally apply. See Form 709 Instructions and Regs. § 26.2632-1.
Whenever a transfer exceeds the annual GST exclusion, consider allocating some of the lifetime
GST tax exemption or making a record of the deemed allocation.47
I. Valuation Timing is the key to maximizing the value of the GST exemption.
“The transferor or his executor may allocate the GST exemption at any time from the date of the
transfer through the date for filing the estate tax return.” Regs. § 26.2632-1(a). However, the
timing (or deemed effective date) of the allocation and the type of transfer determine the amount
of exemption allocated.
(i) Automatic Allocations To Lifetime Direct Skips and GST Trusts48 are “effective as of the
date of the transfer.” Reg. 26.2632-1(b)(ii) and (iii)(2). This means the value of the allocation is
42
Id.
Zaritsky & Leimberg, supra, Sec. 3.04(1)(c) citing IRC Sec. 2642.
44
PPC Key Issue 24E.
45
Mezzullo, supra at p. 8: “(I)n most cases an irrevocable life insurance trust will not be a skip person because there
will be nonskip persons (i.e., the spouse or children of the grantor) who are current beneficiaries.”
46
Jansen, ILIT Planning – Uses And Tax Consequences (2007) p. 49
47
Zaritsky & Leimberg, supra, Sec. 3.04(3).
43
10
the value on the date of the transfer whether or not a Form 709 is filed. Id. Form 709 need not be
filed to report an automatic allocation. “Nevertheless, it is often desirable to do so for record
keeping and to begin the running of the statute of limitations on the valuation of the gift and the
inclusion ratio. IRC § 6501(a).”49
(ii) Timely 709: For allocations made on Form 709 for the year of the transfer (whether
automatic or affirmative), the value of the transfer is also the value on the date of transfer. IRC
Section 2632(c); Reg. Section 26-2642-2(a)(1). Thus, the value at the time of the transfer can be
locked in by filing Form 709.
Subsequent Timely Filed Returns. “The allocation may be modified by a subsequent return if the
subsequent return is also timely filed and clearly identifies the transfer and the
nature and extent of modification.”50 Treas. Reg. § 26.2632-1(b)(2)(ii).
(iii)Late 709: If a Form 709 allocating the exemption was not timely filed for the year of the
GST transfer and the transferor wishes to elect out of the deemed allocation rule, the value of the
transfer for GST exemption allocation purposes is the value on the postmarked filing date of the
allocation on a subsequent Form 709.51 IRC Sec. 2642(b)(3). The consequence of delaying the
Form 709 is to include changes in value.
In Inclusion Ratio terms,
For a timely allocation, the denominator of the applicable fraction is determined
using the value of the transferred property on the date of gift. I.R.C. §§
2642(a)(2)(B), (b)(1). For a late allocation, the denominator is instead determined
using the value of the transferred property (actually of the fractional portion of the
recipient trust attributable to such property) on the date of the allocation. I.R.C. §
2642(b)(3).52
Regs. Sec. 26.2642-2(a)(2) provides that a donor must make any late allocation against current
FMV by actually filing the return in the month the allocation is to be effective.
(iv) Other Returns: “If, however, the allocation is made on any other return,53 it becomes
irrevocable on the date the return making the allocation is filed, and the value of the property for
purposes of using the exemption is generally its value on that later date, including changes in
value.”54 IRC § 2642(b)(1).
48
GST trusts provided that the transfer is subject to gift tax and does not qualify as a direct skip.
Thomas L. Stover, Advising GST Trust Beneficiaries, Boulder County Estate Planning Council, February 17, 2009
http://www.epcsed.org/presentations/Stover%20Advising%20GST%20Trust%20Beneficiaries%20%205%2012%20
09.pdf
50
Davis, supra, p. S-32.
51
Rubin, supra at 578.
52
Viehman, supra, p. 13.
53
E.g., 706, 1041, Schedule R.
54
Ronni G. Davidowitz, Understanding Estate, Personal, Gift & Fiduciary Income Tax Returns 348 PLI/Est 597,
626 (2008).
49
11
(v) ETIP Rules: The automatic allocation rule for property subject to an estate tax inclusion
period (‘ETIP’)55 presents another potential trap. If a transferor or her spouse retains certain
rights or interests in trust assets, transfers and GST exemption allocations will not be effective
(i.e., valued) until the ETIP terminates,56 i.e., termination of the transferor and spouse’s interests
so that the assets are no longer includible in their estates or death. 57 IRC §§ 2632(c)(4),
2642(c)(4) and (f); Reg. § 26.2632-1(b)(2) and 1(c).The delayed automatic allocation can cause
more exemption to have to be expended than if an election out and earlier affirmative allocation
had been made. For transferors with more than one GST trust, not all of which are includable in
the transfers’ estates, the ETIP and deemed allocation rules could also waste GST exemption by
allocating it to trusts that are unlikely to benefit a skip person.
This rule makes it possible to “wait until the termination of the ETIP to make the allocation,
when the exact amount of the property to which the GST exemption will be allocated is known.
If the ETIP terminates during the transferor’s life, an allocation of GST exemption may be made
on a timely gift tax return for the taxable year in which the ETIP terminates, and the allocation
will be effective as of the ETIP termination date. Regs. §26.2632-1(c)(1). If the ETIP terminates
at the transferor’s death, the allocation of GST exemption is made on a timely filed estate tax
return and is effective as of the date of death.”58
A transferor “cannot allocate GST exemption to a grantor retained annuity trust or qualified
personal residence trust—where the trust property is included in her gross estate if she dies
before her retained interest in the trust terminates—until the estate tax inclusion period ends
(when the grantor dies, a generation-skipping transfer occurs with respect to the property, or the
grantor’s retained interest in the trust expires).”59 “A GRAT is included in the grantor's estate if
the grantor dies before the expiration of the term of the grantor's annuity. Thus, the grantor's
GST tax exemption cannot be allocated to the GRAT until the annuity expires.”60
An election out of the automatic allocation must be made on or before the due date (including
extensions actually granted) of Form 709 for the calendar year in which the ETIP closes. Regs.
Sec. 26.2632-1(b)(2)(iii)(c).
J. Irrevocability of Allocations and Elections:
55
Id.
See Regs. §26.2632-1(c)(3) for rules on when the ETIP terminates.
57
Mezzullo, supra at p. 10.
58
Slade, Irrevocable Life Insurance Trusts: Planning Opportunities And Considerations After The Trust Is
Executed, 2003, p. NY2:# 449357521.
59
Kanyuk, supra, http://www.journalofaccountancy.com/Issues/2002/Oct/IcebergAhead.htm
60
Davidowitz, supra: “A GRAT (Guaranteed Retained Annuity Trust) provides the annuitant with an irrevocable
right to receive a fixed amount payable annually for the term of the trust. IRC § 2702(b)(1). GRATs are generally
used in conjunction with property that is expected to appreciate at a greater rate than the IRC § 7520 valuation rate
in effect at the time of the transfer, so that any appreciation in excess of the expected rate of return is transferred to
the remaindermen of the GRAT tax-free. Only if the transferor dies before the GRAT term expires will the property
be included in his gross estate and subject to estate tax.”
56
12
If an election out is not made, the automatic allocation becomes irrevocable after the due date for
reporting the transfer if it was a taxable gift, including extensions actually granted. Elections out
of the automatic allocation must be made by the due date (including extensions) for the filing of
the Form 709 for the year in which the transfer is made. Once made, both allocations and
elections are irrevocable. Regs. § 26.2632-1(b)(1)(ii).
4.
Deemed Allocations
A.
Explanation of Statutory Language:
Unless an election out is made, IRC § 2632(b) provides for deemed allocations of the GST
exemption to certain “direct lifetime skips,” e.g. transfers during grantors’ lifetimes to
grandchildren or others deemed two or more generations (“skip persons”) below the grantors or
trusts all the current beneficiaries of which are skip persons. “(A)ny unused portion of such
individual’s GST exemption shall be allocated to the property transferred to the extent necessary
to make the inclusion ratio for such property zero” means that the default scheme applies the
balance of the exemption to the extent necessary to make the transfer free of GST tax. If there is
not enough GST exemption, it is allocated to the extent necessary to produce the lowest possible
inclusion ratio for the property, i.e., the lowest GST tax possible on that property.
IRC 2632(c) applies the same deemed allocation method to “indirect skips,” i.e., certain lifetime
transfers to GST trusts.
B. Good Recordkeeping To Use Form 709 Even If Automatic Allocation: Although express
allocation of the GST tax exemption allocation is not required if the exemption is automatically
allocated, making a record of deemed allocations on Form 709 is a prudent way to track the use
of the GST tax exemption. Both affirmative allocations and deemed allocations of the exemption
to lifetime direct skips can be made on Form 709. “Whether GST exemption was affirmatively
allocated or whether it was automatically allocated, any filed gift tax returns should show the
amount of GST exemption used for the taxable year of the return and the amount of available
GST exemption remaining at the end of such year.”61 “If no gift tax returns are filed, it is
recommended that a detailed listing be kept of all the gifts made or treated as having been made
to the trust so that there is a running total of the amount of GST exemption deemed to have been
allocated during the client’s lifetime.”62
C. Order of Automatic Application: “(A)n allocation is effective as of the date of any transfer as
to which the Form 709 on which it is made is a timely filed . . . the earlier allocation is modified
only if the later allocation clearly identifies . . . the modification . . .” Regs. Sec. 26.26321(b)(4)(ii). Unless a contrary election has been made, GST exemption is deemed to apply: (a)
first, to all lifetime direct skips or inter-vivos trusts from which a generation-skipping transfer
may occur; (b) second, to testamentary direct skips; and (c) lastly, to other trusts from which a
taxable termination or a taxable distribution may occur.”63 Uncertainties about the effect of the
61
62
63
Stover, supra, p. 15.
Weiner, Estate Planning Opportunities, 2007, LWeinerLaw.com, p. 8.
Davidowitz, supra, pp. 625-26.
13
ordering rules for transferors with multiple trusts encourage electing out and affirmative
allocation.
D. GST Trust. “Whether the automatic allocation rules apply (to an indirect skip) will depend on
whether the trust is a ‘GST trust.”64 A “GST trust” is a trust that could have a generationskipping transfer . . . unless six important exceptions apply. IRC Sec. 2632(c)(3)(B): The
exceptions “are intended to cover those instances where the deemed allocation of GST tax
exemption would be inappropriate because of a reduced likelihood that the trust will ultimately
have a generation-skipping transfer . . .”65 i.e., unless it is likely that …trust assets will be
distributed to nonskip persons.”66 An exception to the six exceptions may apply with regard to
indirect skips if the property transferred to a GST trust will not be includable in the gross estate
of a nonskip person or subject to a right of withdrawal by a nonskip person to the extent such
right is restricted to the gift tax annual exclusion amount. It is presumed for indirect skips that
powers of appointment held by nonskip persons will not be exercised. IRC Sec. 2632(c)(3)(B).
Julie Kwon explains that the election scheme obviates the difficulty of determining whether
transfers to a trust are subject to automatic allocation. “Instead of parsing the statutory definition
of ‘GST trust’ each time a transfer to a trust occurs, the advisor can simply elect ‘in’ or ‘out’
with respect to all transfers to the trust . . . no further action would be necessary to prevent
unintended allocations . . . until circumstances change . . .”67
Election to Treat Trust as a GST Trust. A transferor may elect to treat any trust as a GST trust to
effectively rely on the automatic allocation rules.68 IRC Sec. 2632(c) (5)(A)(ii). One could do so
to allow application of the deemed allocation method to trusts that may not otherwise qualify as a
GST trusts, e.g. ones that provide significant benefits to a non-skip person. Reg. 26.26321(3)(iii) This may also be done when gifts to the trust in subsequent years would not otherwise
create a gift tax filing requirement. However, “there will be few trusts that fall outside the
definition of ‘GST trust’ as to which the transferor will want to allocate GST exemption.”69 The
election is terminable.
Check the trust to see if the transferor intended the trust to be a GST trust or if it indicated an
affirmative decision whether or not to permit the automatic allocation rules to apply. “(A) trust
may be treated as a GST trust in many cases even if the transferor’s intent is not to have his or
her GST exemption allocated to transfers to the trust.”70
It is recommended that one “determine (i) which GST trusts are not, in fact, intended to receive a
portion of the client's GST tax exemption, and (ii) which trusts that do not qualify as ‘GST
64
65
66
67
68
69
70
Mezzullo, Planning To Avoid the GST Tax, 2007, p. 9.Mezzullo, supra, p. 9.
Rubin, supra at 581-82.
Mezzullo, supra, p. 9.
Id. p.2.
PPC Election E304.
Viehman, supra, p. 23.
Id.
14
trusts’ are, in fact, intended to receive a portion of the client's GST tax exemption and have the
client ‘opt-in’ or ‘opt-out’ of deemed GST tax exemption allocation . . .”71
“In some cases, the decision of whether to automatically allocate the GST exemption to transfers,
or to affirmatively allocate the GST exemption to a particular transfer to the trust is difficult,
often involves guesswork on the part of the advisor as to the order of deaths and the sizes of the
children’s gross estates.”72
6. Preventing Deemed Allocations
A. Reasons To Elect Out:
1. To be able to offset GST exemption against future transfers, usually future transfers of
property with appreciation potential.
2. To “reallocate the exemption away from a direct skip to a trust with the potential of
accumulating income and appreciating before the occurrence of a taxable distribution or
termination at some future time.”73 This choice (a) can save taxes because of the
difference in the way GST tax is imposed on direct and indirect skips,74 and (b) would be
particularly valuable if the grantor had only a limited amount of remaining GST
exemption available and had to choose between its allocation for cash gifts and gifts with
growth potential.
3. The indirect skip deemed allocation rule “is overly inclusive. It provides for deemed
allocations of the GST exemption whenever a transfer is made to any trust as to which a
subsequent generation-skipping transfer is likely. The rule does not attempt to identify
the trusts where an allocation will be most beneficial. It does not contemplate that the
transferor might want to save the GST exemption to apply to . . . trusts where its use is
more beneficial (if not essential) . . .”75
4. Where “trust property has gone down in value after the transfer was made and there is no
likelihood of recovery.”76 If a later allocation is made before a generation-skipping
71
Rubin, supra at 584.
Mezzullo, supra, at p. 9.
73
RIA 1664 Election Not To Allocate The Generation-Skipping Transfer (GST) Tax Exemption To A Direct Or
Indirect Skip.
74
Direct skips incur less GST tax than taxable distributions and taxable terminations. GST tax on direct skips is “tax
exclusive,” i.e., only the amount received is taxed. In contrast, since skip persons are liable for GST tax on taxable
distributions and terminations, the GST tax is imposed on the full amount (“tax inclusive.”) “Thus allocating GST
exemption to direct skips saves less in GST tax compared to allocating it to ( GST trust) property from which a
taxable distribution or taxable termination will occur.” BNA Portfolio 850-2nd, supra. “The problem of whether
GST exemption should be allocated to avoid an immediate direct skip tax or to a trust from which a taxable
distribution or termination may occur is complex and discussed in VIII, D, 10.”
75
Viehman, supra, p. 22.
76
Id. And Davis, supra, p. S-32: ”(T)his ‘alternate valuation’ period for GST tax purposes can be a significant
period of time, depending on the date of the gift and the length of any extensions obtained. For example, Transferor
makes a gift to a trust on January 1, 2000. She also receives an extension of time to file the gift tax return for this
gift until August 15, 2001. If the value of the property increases between those dates, then Transferor would
allocate the GST exemption and file the return timely. If the property declines in value, the exemption
allocation could be done after August 15, 2001. In either case, Transferor has a 19 ½ month “window”
in which to examine the performance of the transferred property.”
72
15
transfer, the late allocation will consume less of the GST exemption than if a timely
allocation had been made.
5. The BNA Portfolio says “uncertainties in the statute regarding the definition of a GST
trust and the lack of priority rules as to the automatic allocation of GST exemption at
death among trusts from which generation-skipping transfers could occur make
affirmative elections as to whether the automatic allocation rules should apply or
affirmative allocations at death desirable in most cases. “77
Even if some GST tax must be paid now as a result of electing out, “it may be possible to
achieve GST tax savings greatly in excess of the amount (of tax) paid up-front.”78
To preserve the ability to make a late election to a GST trust one must either elect on a yearly
basis not to have the automatic allocation rule apply to that trust or make an election not to have
the automatic allocation rule apply to any future transfers to that trust.
B. How To Elect Out:
The transferor can prevent application of the deemed allocation rules for:
1. direct skips by electing out as to a specific transfer (IRC Sec. (b)(3), and
2. indirect skips by electing out as to a specific transfer (I.R.C. § 2632(c)(5)(A)(i)(I))
or with a blanket election for any future transfer to a specified GST trust (I.R.C. §
2632(c)(5)(A)(i)(II), both on a timely filed Form 709.
For lifetime transfers that are direct skips and lifetime indirect skips to a GST trust, elect out of
the automatic allocation rules by checking Form 709, column C, Schedule A, Part 2, describing
the transfer and the extent to which the automatic allocation is not to apply, timely filing it and
paying any GST tax shown on the return. “(C)learly identify the trust to which the allocation is being
made, the amount of GST exemption allocation to it, the value of the trust principal at the time of the
allocation, and the inclusion ratio of the trust after the allocation.”79 Alternatively, the transferor can
elect out of the automatic allocation rules by attaching a statement to Form 709 describing the
transaction and the extent to which the automatic allocation should not apply and paying the
GST tax. The allocation of the GST tax exemption to lifetime transfers (other than a direct or
indirect skip) is also made on a Notice of Allocation attached to Form 709.80
C. The Notice of Allocation should identify:
1. The trust to which the allocation is made, including the trust’s EIN if known.
2. If applicable, the item number(s) from column A, Schedule A, Part 3 of the transfers,
i.e., the value of the property transferred as of the date of transfer;
77
Carol A. Harrington, Generation-Skipping Transfer Tax, BNA Portfolio 850-2nd, 2009.
Id.
79
Davis, supra, p. S-33.
80
Regs. Sec. 26.2632-1(b)(4)(i), and the Form 709 instructions prescribe the contents of the Notice of Allocation.
Also see PPC Election 301 and Kwon 2005, supra, p.3.
78
16
3. If the allocation is late, the year the transfer was reported on Form 709.
4. The amount of the taxpayer’s unused GST tax exemption at the time the Notice of
Allocation is filed.
5. The amount of GST tax exemption allocated to it (or a statement that the exemption is
being allocated by means of a formula).
6. The value (as shown in column H of Schedule A, Part 3) of the gift or, if the allocation
is late, the value of the assets at the time of allocation.
7. The inclusion ratio of the trust after the allocation.
8. A statement that all of the requirements of section 3.01 of Rev. Proc. 2004-46 have
been met.
The Notice of Allocation is also used to allocate the GST tax exemption to transfers that qualify
for the gift tax annual exclusion but not the GST tax annual exclusion, e.g. transfers to most
Crummey trusts.81 IRC Sec. 2642(c)(2).
The GST tax exemption is allocated on an item by item basis on Form 709, Part 3 (Tax
Computation), column C. Affirmatively electing to allocate the exemption by reporting it on
Form 709, Schedule C, Part 2, line 6 and attaching a Notice of Allocation “provides a clear
record of the taxpayer’s intent to have GST tax exemption allocated to the trust and exactly how
much exemption has been allocated.”82
Form 709, Schedule A, Part 3 tracks the use of the GST tax exemption automatically allocated to
indirect skip transfers and provides a mechanism for electing out of these deemed allocation
rules. The election is made by indicating (on Form 709, Schedule A, Part 3, Column C) each
transfer the transferor wants to exclude from the deemed allocation rules.
Electing Out of the Deemed Allocation Rules for Lifetime Indirect Skips:
The GST definition is so broad “that the term could apply to virtually any trust created for the
benefit of family members unless the trust falls into one of” (the statutory) exceptions . . . the
language used to create these exceptions poses as great an interpretive challenge as any of the
complex provisions of the tax code . . . there remain many trusts to which the automatic
allocation of GST exemption would, in effect, squander it . . . One notable example is the
irrevocable life insurance trust (“ILIT”) . . . (which typically) would likely not be subject to the
GST trust . . . (but) under the new (2001) GST automatic allocation rules, GST exemption would
be allocated to the ILIT . . . even though trust assets may never pass to the grandchildren.”83 For
81
PPC Key Issue 30A
82
PPC Key Issue 29D, Elections E01, E303 and Example 30B-2.
83
New "Generation Skipping" Tax Rules Require Taxpayers to File Gift Tax Returns to Elect Out of Automatic
Allocation of Exemption (2002) www.proskauer.com
17
this reason, various commentators agree that, “The automatic allocation rules never should be
relied upon to determine the inclusion ratio in the case of indirect skip transfers.”84
Thomas W. Abendroth provides an alarming explanation as to the costly consequences of
trustees’ lacking information or expertise who erroneously assume trusts are GST exempt:
The indirect skip rules created another possible problem for other ILITs. The IRS
definition of a trust to which the indirect skip rules apply is very broad. See Treas.
Reg. § 26.2632-1(b)(2). In many cases, the settlor would not want GST exemption
automatically allocated to the trust. If the settlor is not filing a gift tax return for
gifts to the ILIT, or is not making the proper election on the gift tax return to elect
out of the indirect skip rules, his or her GST exemption may be being depleted
unintentionally. These trusts may be fully or partially exempt from GST tax and
the settlor and trustee, again, are unaware of it . . . record-keeping is important
with any irrevocable trust, but the nature of ILITs raises the stakes: ILITs usually
are funded with smaller annual gifts over many years. The gifts are not always
large enough to require gift tax returns, and, over many years, they cross over
several different rules about their tax treatment. For the trustee, the consequences
of lack of information can be costly. If there is a taxable termination in the trust
(for example, the last child of the settlor dies and the trust continues on for
grandchildren or terminates in their favor), the GST tax is paid by the trustee out
of the trust property. IRC § 2603. A trustee who does not pay the tax, operating
on the incorrect assumption that the trust is GST exempt, may face interest and
penalties that beneficiaries will assert should not be borne by the trust. If the trust
indeed has terminated, the trustee will have to seek recovery of the tax from the
beneficiaries, an effort that is often not completely successful. The fact that the
beneficiaries are liable as transferees and the IRS could go directly after them
does not help. The IRS will start with the trust because it is the easiest target. And
more to the point, the trustee may have personal liability for the GST tax under
federal law if the trustee distributed the trust assets when it should have known,
with reasonable inquiry, that a GST tax was due. See 31 U.S.C. § 3713; United
States v. Ayer, 12 F.2d 194 (1st Cir. 1926) . . .
If the trust is liable by its terms, the same issues discussed in the preceding
paragraph exist. If the beneficiary is liable, the trustee has a duty to so
advise him or her. Failure to do so may be actionable. At the very least, it is very
bad for business. It also is possible that the trustee of the ILIT may not be aware
of automatic allocations of GST exemption that occurred during the settlor's life.
84
Rubin, supra at 581citing uncertainty regarding the definition of a GST trust and the ordering rules; Sharon
Goodman, Beware the GST Tax When Preparing Gift Tax Returns, The Tax Advisor (2005) “Reliance on the
automatic allocation rules does not allow clients and their advisers to trace readily the amount of the used
exemption. The affirmative ongoing tabulation of the used and available exemption on Schedule C gives clients and
their advisers the information needed for future GST planning.” This article contains common examples of
unintended GST trusts to which automatic allocation “result(s) in wasting the GST exemption, by automatically
allocating it to trusts not intended to benefit skip persons.”
http://www.aicpa.org/pubs/taxadv/online/apr2005/clinic3.htm
18
In this situation, the trustee could refuse to make distributions to skip persons
because of the perceived GST tax cost, or,
worse, make distributions and pay a GST tax that is not due. If, in either case, it
later is discovered that the trust is GST exempt or is partially exempt, the trustee
will face potential liability. 85
D. Trusts Should Use Formula: The affirmative allocation of the transferor’s GST tax exemption
may be made by specific dollar amount but should be made by a formula. A formula allocation
avoids the risk that insufficient exemption will be allocated to a transfer in the event the value of
the transferred asset is changed on audit. The formula may express the allocation as “an amount
necessary to produce an inclusion ratio of zero.” Reg. 26.2632-1(b)(4)(i).
E. When to Elect: The election will be considered to be timely if filed on a timely-filed
(including extensions actually granted) gift tax return for the calendar year in which:
1. the first transfer to be covered by the election out was made, or
2. the ETIP closes, for transfers subject to an ETIP. IRC Sec. 2632(c)(5).
“With respect to future transfers, the transferor may choose to elect out even if a current-year
transfer has not yet been made and even if the transferor is not otherwise required to file a gift
tax return.” T.D. 9208, Internal Revenue Bulletin: 2005-31 (August 1, 2005).”86
F. Allocation Options: The five separate elections regarding prior, current and future transfers
provide considerable flexibility. Transferors are permitted to elect out of the automatic
allocation rules with respect to: (a) a current transfer, (b) a current-year transfer and all future
transfers to the same trust, (c) certain designated future transfers to a trust, or (d) all future
transfers made by the transferor to any trust (regardless of whether the trust exists at the time of
the election). Reg. 26.2632-1(b)(2)(iii)(A). “With respect to future transfers, the transferor may
choose to elect out even if a current-year transfer has not yet been made and even if the
transferor is not otherwise required to file a gift tax return.”87 T.D. 9208, Internal Revenue
Bulletin: 2005-31 (August 1, 2005).
G. Termination of Election Out. Elections are terminable but not revocable, i.e., only prospective
changes are allowed. If circumstances change or as more facts become known, the election out
of the deemed allocation rule can be terminated in a subsequent year “to the extent the election
out applied to future transfers or to a transfer subject to an ETIP. The termination of this election
is prospective only and will not change an automatic (or affirmative) allocation made in a prior
year.”88 Terminate an election by attaching a statement to a timely filed Form 709 for the year
for which the first transfer was made to which the election out is lifted (even if a gift tax return
would not otherwise be required). Reg. 26.2632-1(b)(2)(iii)(E). For example if a transferor had
85
Thomas W. Abendroth, Ticking Time Bombs in Irrevocable Life Insurance Trusts, Trusts & Investments, March
2008.
86
Davidowitz,supra, p. 626.
87
Id.
88
Reg. Sec 26.2632-1(b)(2)(iii)(E); PPC Key Issue 29D and PPC Election E306
19
earlier elected to not have the exemption apply to any future transfers but later decided to
transfer property with upside potential, he should terminate the earlier election and make an
affirmative allocation for the new transfer.
7. Late Affirmative Allocations
A. Relief for Late Allocations
The 2001 Tax Act provided relief for inadvertently missed GST tax exemption allocations. IRC
Sec. 2642(g). Transferors falling under these relief provisions get to allocate exemptions based
on the date of transfer values. “Generally, for transfers subject to estate or gift tax made after
2000, the IRS is directed to grant extensions of time to make the election to allocate the GST tax
exemption or to elect out of the automatic allocation rules and to grant exceptions to the time
requirement without regard to whether any limitation period has expired.”89 There are numerous
PLRs granting extensions of time to make GST exemption allocations under Reg. 301.9100.90
Prop. Reg. §26.2642-791 provides specific guidance for seeking an extension of time through a
PLR to make late allocations/elections. It applies to taxpayers seeking to:



make an affirmative allocation,
elect out of the deemed allocation rule, or
elect to treat a trust as a §2632(c) GST trust
Requests for relief will be granted when the taxpayer establishes that the transferor acted
reasonably and in good faith and the grant of relief will not prejudice the interests of the
government.92 In most of the numerous PLRs, the taxpayer relied on a tax practitioner. “The
usual grounds for relief is the failure of the return preparer to allocate exemption or a lawyer's
failure to properly advise the client of the need to allocate GST exemption.”93
89
90
PPC Key Issue 29E.
E.g., PLR 200927015, see BNA Portfolio Secs. 2642, 850 T.M., VIII.E., pp. A-88-91.
91
Beth Shapiro Kaufman, Checking In With The Guidance Department, Washington Watch 03 July 2009,
http://www.mondaq.com/article.asp?articleid=82238 “The (April 2008) Proposed Regulations under section
2642(g) regarding extensions of time to make allocations of the generation-skipping transfer tax exemption “are far
more detailed and demanding than the 9100 Regulations.” Reg. §301.9100-3 and Notice 2001-50, 2001-2 C.B. 189
will be obsolete.
92
BNA Portfolio 850, E. 9100 Relief details what is prejudice and what is not good faith, e.g., informed choice not
to make election, hindsight and changed circumstances, lower tax and limitations expiration negate g good faith.
Kwon ’08, supra.
http://www.abanet.org/rppt/meetings_cle/2008/spring/programmaterial/TEmaterial/te62Kwon.pdf
Harrington, et al., Generation-Skipping Transfer Tax Planning After the 2001 Act: Mostly Good News, (2001)
ESTATES, TRUSTS, & GIFTS , Fn. 60: “This affidavit must describe the engagement and the responsibilities of
the professional, as well as the advice that the professional provided to the taxpayer. In addition, each affidavit must
include the name, current address, and taxpayer identification number of the affiant and must be signed and
accompanied by a dated declaration stating that, under penalties of perjury, the contents of the affidavit are true,
correct, and complete to the best of the affiant's knowledge and belief. Regs. 301.9100-3(e)(2) (last sentence) and
(e)(3) (last sentence).”
93
20
Granting this relief effectively transforms an otherwise late allocation into a
timely one. It is used for a transfer in trust when the time for filing the gift tax
return covering the period in which such transfer occurred has already passed . . .
use of this relief provision is much more likely for pre-EGTRRA transfers (i.e.
transfers made before January 1, 2001) because deemed allocations under the
indirect skip rule will now generally cover most situations where the taxpayer
might fail to make a voluntary GST allocation even though one was intended.94
Simplified Method for Relief:95 Rev. Proc. 2004-46 provides an alternative to the PLR process to
obtain an extension of time to timely allocate the GST tax exemption for taxpayers meets the
following requirements:
1. on or before December 31, 2000, the taxpayer made or was deemed to have made a
transfer by gift to a trust from which a GST may be made;
2. no taxable distributions have been made and no taxable terminations have occurred;
3. the transfer qualified for the annual exclusion under IRC Sec. 2503(b) and the transfer,
when added to the value of the other gifts to that donee in the same year, did not exceed
the annual exclusion for the year;
4. no GST tax exemption was allocated to the transfer; and
5. the taxpayer has an unused GST tax exemption available to allocate to the transfer.
In order to obtain the extension under these simplified procedures, the taxpayer must:
1. file a Form 709 for the year of the transfer (regardless of whether they have previously
filed for that year) indicating at the top of the form that it is “FILED PURSUANT TO
REV. PROC. 2004-46”;
2. report on the Form 709 the value of the transferred property as of the date of transfer;
3. allocate the GST tax exemption to the trust by attaching a Notice of Allocation to the
Form 709.
B. Substantial Compliance with the GST Tax Exemption Allocation Requirements with the
requirements for allocating the GST tax exemption will suffice to establish that the exemption
was allocated to a particular transfer or a particular trust. Include sufficient information with the
return for determining the taxpayer’s intent to make the allocation of the GST tax exemption. If
substantial compliance is shown, unused GST tax exemption will be allocated to the extent it
produces the lowest possible inclusion ratio. All trust or transfer instruments will be considered
and may need to be amended or supplemented.
94
95
Viehman, supra p. 24.
http://www.irs.gov/irb/2004-31_IRB/ar20.html
21
C. Intentional Late Allocation of the GST Tax Exemption
If one did not file a timely 709 allocating GST exemption and does not qualify for an extension,
the remaining option is to make a late allocation of the GST tax exemption. If a portion of the
exemption was automatically allocated to previous transfers, “the current inclusion ratio of the
trust must be determined at each of the previous transfer dates. To determine the inclusion ratio,
the (trust’s) value immediately before each of the transfers and . . . at the time of the late
allocation must be obtained . . . The trust’s inclusion ratio must be calculated each time an
allocation of the GST tax exemption is made.”96 Attach a copy of the calculation of the
applicable fractions and inclusion ratios to the Form 709 in addition to a Notice of Allocation.
The allocation should be reported on Form 709, Schedule C, Part 2, line 6.97
The risks of a late allocation of the GST tax exemption are (a) appreciation of trust assets
consuming more of the exemption and (b) if the transferor dies before the allocation is made, a
larger amount of exemption may be needed to get a zero inclusion ratio and possibly subjecting
the entire value of the trust, e.g., the proceeds of a life insurance policy, to GST tax.
A late allocation may also be useful if the value of the property transferred declined since the
transfer because it will be use less than of the exemption. This
“would probably be limited to situations where the property has declined
significantly in value by the time the gift tax return for the year of transfer is due
to be filed. In that case, the transferor can opt out of any deemed
allocation on a timely-filed gift tax return, then make a late allocation of GST
exemption based on the decreased date of filing value. This late allocation would
normally be made on an amended (but untimely) gift return for the year of
transfer.”98
A “late allocation . . . made with respect to a trust as to which prior GST allocations occurred . .
. is more complicated because it requires a recomputation of the trust's applicable fraction for the
first gift that was not fully covered by an allocation of GST exemption and each gift thereafter
(even ones covered by timely allocations). Since these recomputations are based in part on the
value of the trust's assets on the dates of such gifts, information regarding those values must be
compiled.”99
D. First day of month value election, except if life insurance and death: “If a transferor makes a
late allocation of GST exemption to a trust, the transferor may, solely for purposes of
determining the fair market value of the trust assets, elect to treat the allocation as having been
made on the first day of the month during which the late allocation is made -- such first day of
96
See PPC Example 29E-2: Late allocation of the GST exemption.
97
Id.
Viehman, supra at p. 25.
99
Id. at p. 26, which includes “Sample Form C reflects a late allocation that shows the recomputations
needed when there has been a prior GST exemption allocation.”
98
22
the month to be known as the ‘valuation date.’ . . This election, however, is not effective with
respect to life insurance or a trust holding a life insurance policy if the insured individual has
died . . . Nevertheless, this special rule appears to apply whether or not the transferor has
died."100 Regs. § 26.2642-2(a)(2).
E. Tie Goes to the Late Allocation: A late allocation is deemed to precede any taxable event
occurring on the effective date of the allocation. Regs. Sec. 26.2632-1(b)(4)(ii).
F. Retroactive Allocation If “Unnatural Order of Death”: If a child dies before the transferor, a
trust might terminate in favor of the grandchild, unexpectedly imposing GST tax even though the
transferor had some unused GST exemption. IRC 2632(d)(1) allows retroactive allocation of the
GST tax exemption under these circumstances but it is scheduled to sunset 12/31/10.101
8. Crummey Irrevocable Life Insurance Trusts (“ILIT”) - To Allocate or Not To Allocate
“Use of an ILIT as a generation-skipping trust, or so-called dynasty trust, is an extremely
efficient technique to leverage the transferor’s GST tax exemption and applicable exclusion
amounts,102 assuming the ILIT is properly drafted.103 “The major problem in this area is the
increasing complexity and uncertainty of the tax laws in relation to irrevocable life insurance
trusts — particularly in the Crummey power withdrawal area where the rules are quite often
inconsistent for income, gift, estate and GST purposes.104
Query: Should ILIT transferors wanting to make their ILITs GST tax exempt (1) rely on the
automatic exemption allocation method, (2) affirmatively allocate on periodic timely Form 709s,
(3) elect out and allocate in the year the transferor dies,105 or (3) let the executor handle it postmortem on Form 706 or Schedule R?106 (Short answer: Number two is the safest and simplest
but not necessarily the most tax efficient).
A. Term Insurance:
(i) Periodic Allocation Is Safest: The safest and simplest way to make ILIT transfers and life
insurance proceeds exempt from GST tax is to document the allocation (affirmatively or
automatically) on a timely Form 709 and Notice of Allocation. The price for this simplicity and
security is use of more of the GST exemption. The other downside to periodically allocating
GST exemption to life insurance premiums is that if the insured outlives the policy (as with the
100
Slade, supra, p. NY2:# 449357518.
PPC Key Issue 32A and PPC Sample Election E305. The retroactive allocation provisions are currently
scheduled to expire at the end of 2010.
102
Sebastian V. Grassi, A Practical Guide to Drafting Irrevocable Life Insurance Trusts, p. 91,
https://www.ali.aba.org/aliaba/BK28.htm..
103
See Sudzius, supra, §8.4 Benefits of ILIT •, 91 which contains a list of potential defects to look for in the ILIT
instrument.
104
Shenkman, The Practical Planner: Insurance Trusts (ILIT) Not So Simple, February 2, 2009
http://www.wealthstrategiesjournal.com/articles/2009/02/the-practical-planner-insuranc.html
105
Marvin D. Hills, Wait and See GST Tax Planning, 2006,
http://www.aicpa.org/pubs/taxadv/online/sep2003/clinic5.htm
106
See Appendix B for information and documents needed to analyze allocation with ILITs.
101
23
vast majority of term life insurance policies) the exemption allocated has been used
unnecessarily. If the transferor has ample remaining GST and no GST transfers of assets with
greater appreciation potential, this is the safest alternative.
Automatic Allocation and Allocation of Exemption on Timely Filed Return. The “value of the
premium gift to the trust for GST purposes is the value on the date of transfer. IRC Section
2632(c). Reg. Section 26-2642-2(a)(1).”107
Allocation of Exemption on Untimely Filed Return. “If the GST exemption is not automatic and
if a gift tax return is not timely filed, the value of the premium gift for GST exemption allocation
purposes is the value of the premium gift at the date the allocation is filed with the Secretary (on
a subsequent gift tax return).” 108
(ii) Wait-and- See Approach May Save Tax: More adventurous advisers use a wait and see
approach, electing out and either making a late allocation or waiting until the transferor’s death
to see if there is still insurance in effect.109 If there is, the executor can make an allocation110
against the (a) ILIT’s value at the time of the allocation and (b) “dollar-for-dollar” against “all
subsequent trust contributions”111
Marvin D. Hills warns that delaying allocation “is extremely effective if a client is cooperative
enough to die relatively suddenly, (but) this plan can be a trap if the client develops health
problems in the calendar year before death . . . that make him or her uninsurable or highly
rated.”112 The fair market value of the policy would go up and the increased value would
consume far more of the exemption than periodic allocation.
IRC Sec. 2642(d) provides that where multiple contributions to a trust are made, the amount of
the nontaxable portion is based upon relative values immediately before the transfers, “indicating
that later transfers (e.g., those made in a later year, although before the allocation is actually
made on the late-filed return) are not considered. Hence, one-day late returns may be
appropriate.“113
For a late filed Form 709, the amount of GST exemption required to be allocated to protect the
entire trust from the GST tax equals, as a general rule, the value of the property at the time of the
allocation. Regs. Sec. 26.2642-2(a)(2).114 For insureds dying with term-life-insurance-onlyILITs, a late filed Form 709 would only have to allocate GST exemption to the value of the paid
but unexpired premium on the date of the allocation / death. The policy proceeds would be
exempt.
107
108
109
110
Jansen, supra, p. 46.
Id.
Id. and PPC Key Issue 29D.
On Form 706 or Schedule R.
111
Presumably unused or subsequent premium payments. See Hills, supra.
112
Id. pp. 1, 3.
Slade, supra, p. NY2:# 449357525.
Jansen, supra, p. 46.
113
114
24
For a “term life insurance policy that pays premiums monthly, the policy’s value (and, thus, the
trust’s value) is arguably zero at the end of each month (when a premium becomes due again).
As long as the trust’s FMV is zero as of the date of the gift(s) to the trust each year, one could
wait (almost indefinitely) to make the allocation, because a timely allocation (even after the
insured’s death115) should still result in a fully exempt trust.”116
“(T)o prevent the coverage period extending beyond the filing date of the gift tax return,
anniversary dates for term policies should be before April 15th.”117
“This is because the timely allocation against the current-year premiums would equal 100% of
the combination of (1) the policy’s value immediately before the gift (which is zero), plus (2)
$10,000, the current-year gift(s). If multiple gifts are made to the trust during the year (for
instance, monthly premium payments), a timely allocation against that first premium for the year
would produce a zero inclusion ratio, as long as the policy’s FMV was zero immediately before
that gift. Exempt status would then be maintained via the timely allocations to the other
subsequent gifts to the trust during the year.”118
Not allocating against the premiums when they are contributed to the ILIT and waiting to
allocate later against the diminished value of the ILIT maximizes leverage of the exemption (as
long as it is allocated before the ILIT value goes up). Delayed allocation requires only enough
exemption to cover the ILIT’s current value, if any, plus the current premium.119
If this more risky wait-and-see approach is used, Hill recommends “maintaining good
communication with the client . . . to ensure proper allocation of the GST exemption if the client
develops health problems . . . or an illness that causes the policy’s FMV to be greater than zero,
he or she should promptly file a form 709120 and allocate exemption against that year’s premiums
and begin filing gift returns annually thereafter.
B. Non-Term Insurance Policies
“The general rule is that the value of a gift of life insurance is deemed to be equal to the cost of
replacing the policy on the date of the gift. See Guggenheim v. Rasquin, 312 U.S. 254 (1941).
See also GCM 38110 (September 25, 1979). Regs. §25.2512-6(a) . . . a life insurance policy on
which no further payments are to be made to the company (e.g., a single premium policy or paidup policy) makes a gift of the contract to an irrevocable trust. The value of the gift is the amount
Hills, supra p. 3, “(S)imply let the executor file a timely allocation against the premiums paid during the year of
death.”
116
Hills, supra p. 2.
117
Jansen, supra, p. 47, who also cautions that whether the IRS will agree with this approach is unclear and that, “A
cautious approach would be to claim a full premium gift value of GST exemption on a timely filed gift tax return
even though a term or split-dollar policy or a policy with a cash value increase of less than the premium payment is
involved.”
118
Id.
119
Hills, supra, E.g., 1.
120
Ideally the same month and elect the first-day-of-the-month valuation option.
115
25
which the company would charge for a single premium contract of the same specified amount on
the life of a person of D's age. Regs. §25.2512-6(a), Example 3.”121
(i) Periodic Allocation: If allocation is made on a timely filed Form 709, the amount of GST
exemption needed to exempt the ILIT will generally be a “policy’s cash value plus any unused
(or remaining) premium already paid. For premiums paid later, the gift will equal the amount of
the premium, unless a special valuation rule is prescribed. Where the premiums are paid by the
trust and the grantor makes contributions to the trust, the gift will equal the fair market value of
the property transferred to the trust by the grantor.”122
Valuation of non-term insurance gets rather technical, “the value of the policy is measured by the
sum of the interpolated terminal reserve and the unexpired portion of the most recent
premium.”123 For this reason, it is probably more cost-effective to periodically affirmatively
allocate based on the premiums for most clients. Larger GST trusts for transferors that may be
liable for substantial GST tax may benefit from the more sophisticated approach that follows.
(ii) Wait-and-See: For non-term insurance the potential benefit of late allocation of GST tax
exemption after electing out of any automatic allocation, “lies in the fact that the value of the
trust is generally lower after the premium has been paid, rather than on the date of trust funding;
thus, a late allocation may use less GST tax exemption. The value of the trust decreases by the
amount of the premium payment, while increasing only by the addition to the policy’s cash
surrender value.” 124
Hills explains the crucial difference between treatment of timely and late allocations. Regardless
of when premiums are paid, IRC Sec. 2642(b)(1) treats exemptions as allocated to the trust as of
the transfer date if (1) Form 709 is filed before the extended due date for that year or (2) there is
an automatic allocation. IRC Sec. 2642(b)(c)
(iii) Expedited Due Date for Late Allocations: “In contrast, Regs. Sec. 26.2642-2(a)(2) provides
that a donor must make any late allocation against current FMV by actually filing the return in
the month the allocation is to be effective. For example, to allocate against the CSV (cash
surrender value) as of July 1, 2004, the donor must file a (709) return in July 2004.”125 Waiting
to file Form 709s for late allocations until the following April 15 risks the insured’s dying during
the interval and exposing the entire ILIT to GST tax.
For a late filed Form 709, “the amount of GST exemption required to be allocated to protect the
entire trust from the GST tax equals, as a general rule, the value of the property at the time of the
allocation. Although the regulations provide no specific guidance as to how a policy of
insurance would be valued for purposes of a late allocation of GST exemption to it, presumably
121
Slade, supra at NY2:# 449357513.
Slade, supra at NY2:# 449357524.
123
Slade, supra at NY2:# 449357513, Zaritsky & Leimberg, Tax Planning with Life Insurance: Analysis with
Forms (2009) RIA Tax Plan. Life Ins. Ch. 3, 1999 WL 1031889 (W.G. & L.) citing Regs. Secs. 20.2031-(8)(a)(2),
25.2512-6(a).
124
PPC Key Issue 30B, electing out Example 30B-2 and accompanying Caution for risk of death before allocation
and imposition of avoidable GST tax.
122
125
Hills, supra, p.2.
26
its value will be the same value as would apply for gift tax purposes if a gift of the policy were
being made at that time . . . value at least equal to the unexpired insurance premium for the year
in which the exemption is allocated . . . a late-filed allocation will apply only to that part of the
trust attributable to” the preceding year in which the premium has already been consumed.126
Since IRC Sec. 2642(d) provides that where multiple contributions to a trust are made, the
amount of the nontaxable portion is based upon relative values immediately before the transfer,
“indicating that later transfers (e.g., those made in a later year, although before the allocation is
actually made on the late-filed return) are not considered.”127
If a portion of the exemption was automatically allocated to transfers after 2000, “the current
inclusion ratio of the trust must be determined at each of the previous transfer dates. To
determine the inclusion ratio, the policy’s value immediately before each of the transfers and the
value of the policy at the time of the late allocation must be obtained. Generally, this information
can be obtained from the life insurance company that carries the policy. The trust’s inclusion
ratio must be calculated each time allocation of the GST tax exemption is made.”128
“The insurance company should provide the interpolated terminal reserve value as of the date the
policy is transferred to the trust (and on subsequent allocation dates) on Form 712, Life
Insurance Statement, which CPAs should attach to the gift tax return. Don’t rely on verbal
assurances by the insurance agent or the agent’s in-force ledger regarding the policy’s value.
Incorrectly valuing a policy for gift tax purposes will result in an incorrect allocation of the
generation-skipping transfer exemption to the trust . . . incorrect gift values will make it
impossible for accountants to determine the donor’s remaining GST exemption.”129
If the insured died “after the date of timely allocation has passed and before the late allocation is
made . . . (this would subject) the entire value of the trust to GST tax . . .the authors urge caution
when considering this technique.”130
Hill and Slade seem to agree that (1)“for a one-year term policy, the value at the time of the late
allocation arguably should be nil” because the periodic premium is used up and the value of the
policy and inclusion rate are zero and (2) “if the insured dies during the term, a timely allocation
of GST exemption should be made based upon the amount of the premium, because that timely
allocation should exempt the entire policy proceeds from GST taxation.”131
126
Slade, supra at NY2:# 449357524.
Slade, supra at NY2:# 449357525, see discussion for policies with cash value.
128
PPC Example 29E-2.
129 Amy K. Kanyuk, supra.
http://www.journalofaccountancy.com/Issues/2002/Oct/IcebergAhead.htm
“For whole life insurance, the gift tax value equals the policy’s “interpolated terminal reserve value” plus any
premiums the donor paid before making the gift that cover the period extending past the gift date. (See example 4 in
Treasury regulations section 25.2512-6(a)). Thus, if the donor pays the premium annually and transfers the policy to
the trust nine months later, 25% of the premium is added to the interpolated terminal reserve amount to determine
the policy’s value for gift tax purposes.”
130
PPC Key Issue 29E: Late Allocation of the Lifetime Exemption.
131
Slade, supra at NY2:# 449357524.
127
27
Conclusion: Most ILITs should elect out and periodically allocate GST exemption on Form 709.
For most indirect transfers to ILITs, election out of the deemed allocation rules for all
prospective transfers and affirmative allocations are important to avoid costly and contentious
erroneous assumptions that trusts are GST tax exempt and to create a clear record of the
exemption allocation history and remaining balance.
© 2009 Finis Cowan. All rights reserved.
TABLE OF AUTHORITIES
Statutes:
Internal Revenue Code,
U.S.C. Title 26, Subtitle B, Chapter 13:
§ 2611. Generation-skipping transfer defined
§ 2612. Taxable termination; taxable distribution; direct skip
§ 2613. Skip person and non-skip person defined
§ 2621. Taxable amount in case of taxable distribution
§ 2622. Taxable amount in case of taxable termination
§ 2623. Taxable amount in case of direct skip
§ 2624. Valuation
§ 2631. GST exemption
§ 2632. Special rules for allocation of GST exemption
§ 2641. Applicable rate
§ 2642. Inclusion ratio
§ 2651. Generation assignment
§ 2652. Other definitions
§ 2653. Taxation of multiple skips
§ 2654. Special rules
§ 2661. Administration
§ 2662. Return requirements
§ 2663. Regulations
§ 2664. Termination
Treasury Regulations:
Title 26, Chapter I, Part 26--Generation-Skipping Transfer Tax Regulations Under The Tax
Reform Act Of 1986
§ 26.2600-1 Table of contents.
§ 26.2601-1 Effective dates.
§ 26.2611-1 Generation-skipping transfer defined.
§ 26.2612-1 Definitions.
§ 26.2613-1 Skip person.
§ 26.2632-1 Allocation of GST exemption.
§ 26.2641-1 Applicable rate of tax.
§ 26.2642-1 Inclusion ratio.
28
§ 26.2642-2 Valuation.
§ 26.2642-3 Special rule for charitable lead annuity trusts.
§ 26.2642-4 Redetermination of applicable fraction.
§ 26.2642-5 Finality of inclusion ratio.
§ 26.2642-6 Qualified severance.
§ 26.2651-1 Generation assignment.
§ 26.2651-2 Individual assigned to more than 1 generation.
§ 26.2651-3 Effective dates.
§ 26.2652-1 Transferor defined; other definitions.
§ 26.2652-2 Special election for qualified terminable interest property.
§ 26.2653-1 Taxation of multiple skips.
§ 26.2654-1 Certain trusts treated as separate trusts.
§ 26.2662-1 Generation-skipping transfer tax return requirements.
§ 26.2663-1 Recapture tax under section 2032A.
§ 26.2663-2 Application of chapter 13 to transfers by nonresidents not citizens of the United
States.
§26.6081-1T Automatic extension of time for filing generation-skipping transfer tax returns
(temporary).
Recent Treatises and Articles Not Cited In Footnotes:
Catherine Grevers Schmidt, Estate Planning For The Surviving Spouse, 35 Estate Planning 3
(Dec. 2008)
Shenkman, The Practical Planner: Insurance Trusts (ILIT) Not So Simple (February 2, 2009)
http://www.wealthstrategiesjournal.com/articles/2009/02/the-practical-planner-insuranc.html
Alexander A. Bove Jr, Powers of Appointment: Special GST Tax Drafting and Exercise Issues,
ABA Section of Real Property, Trust & Estate Law, 20th Annual Spring Symposia (April 30, 2009)
Howard M. Zaritsky, Stephan R. Leimberg, Tax Planning with Life Insurance: Analysis with
Forms (2009) 1999 WL 1031889 (W.G. &.L.)
BNA Portfolio 807, Personal Life Insurance Trusts IV. Generation-Skipping Transfer Tax
Concerns in Structuring a Life Insurance Trust (2006)
29
APPENDIX A
List of Information Needed To Analyze Allocation of GST Exemption on Form 709132
Documents:
1. All prior forms 709s and 706s (and variations, e.g., 706-GS(D) and (T)) filed by the
transferor and executor and attachments.
2. If any forms 709s or 706s (and variations) has been, or is being, audited,, obtain a copy of
the line adjustments.
3. Any amended returns.
4. Trust instruments (or documentation of arrangements treated as trusts133) and any
amendments and supplements.
5. Trusts created by another in which the decedent possessed a beneficial interest, over which
he held any power, or of which he was a trustee.
6. Notifications and documentation of trust distributions and terminations.
7. Any estate and transfer tax planning documentation.
8. Life insurance policies.
9. Documentation of transfers and their values on the dates made, such as appraisals, receipts,
cancelled checks, check registers, bank and brokerage statements.
10. If the gift was of securities, its CUSIP number.
11. If the gift was an interest in a closely held entity, its EIN.
12. For late and retroactive allocations, documentation of value of the trust assets at the effective
date of the allocation.
13. Proof that payments were from separate property.
14. Crummey letters.
15. Disclaimers. IRC Sec. 2518.
16. Wills and any codicils.
17. Engagement letter. See PPC Resources R102 and R202.
18. Permanent file.
19. Death certificates.
20. Powers of attorney, IRS Forms 2848.
132
Stover, supra, is the source of many of these questions and his article explains their significance.
PPC Key Issue 31B Nonexplicit Trusts: “A nonexplicit trust is a ‘trust arrangement’ treated as a trust for GST
purposes only. In general, a transfer of property in which the identity of the transferee is conditioned on the
occurrence of an event is a transfer in trust (although there may not be an official trust instrument that calls such an
arrangement a trust). Examples of nonexplicit trusts include life estates and remainders, estates for years, and
insurance and annuity contracts [IRC Sec. 2652(b)(3)]. The trustee of such a trust arrangement is the person in
actual or constructive possession of the property [IRC Sec. 2652(b)(2)]. Preparation Pointer: A nonexplicit trust
must have an employer identification number (EIN) . . . the (form 709) box on Part III, line 4, must be checked. In
addition, a statement describing the trust arrangement must be attached to the return.
133
”
30
Facts Needed:
1. Was the trust intended to benefit skip persons? If so and there is potential GST tax, most
commentators say elect out.
2. Whether Forms 709, 706 or Schedule R were filed
3. A general understanding of the transferor’s assets and their potential for appreciation.
4. What, by whom, to whom and when gifts were made. IRC § 2652(a)(transferor).
5. Donees’ relationships to transferor.
6. Source of gifts? Community property or separate property? Split gifts?
7. Dates and amounts of gifts and payments of life insurance premiums.
8. Type of policy and values on dates of transfers and late allocation?
9. Charitable deduction allowed on the current transfer to the trust? (See PPC Worksheet W202:
Calculation of Trust’s Inclusion Ratio)
10. Transferor, spouse, trusts and beneficiaries’ EINs.
11. Identify gifts that are not subject to gift taxes or GST or are treated specially, e.g., direct medical
payments and 529 Education Plans.
12. Any nontaxable gifts? (Reg. 26.2642-1(c)(3) (distributed only to or for the benefit of the
individual and trust assets will be includible in gross estate of the individual if he dies B4 trust
termination).
13. Any direct skips subject to both gift and GST tax? See PPC Resource R502.
14. Any indirect skips that are currently subject to gift tax and may later be subject to GST tax? See
PPC Resource R503 and PPC Example 30B-1.
15. Are there multiple transferors? Treas. Reg. § 26.2654-1(a)(2) (Separate-share rule)
16. Did the client become the transferor because of a lapsed Crummey power?
17. Relationships among the Settlor, Trustee and Beneficiaries of the Trust?
18. Does the transferor contemplate making additional transfers that are potentially subject to the
GST tax? If so, of what property?
19. Is there a QTIP trust and is a reverse QTIP trust election available? IRC § 2652(a)(3).
20. Identify all beneficiaries, dates of birth and determine whether they are skip persons or nonskip persons? IRC §§ 2613, 2651. See Stovall Exhibit A.
21. Is generation assignment determined by lineage or age? IRC § 2651.
22. Transferor and spouse’s dates of birth.
23. Are nonskip persons (e.g., the grantor’s spouse, siblings or children) current beneficiaries?
24. Is the trust a skip person? IRC § 2613.
25. Who has an interest in the trust? IRC § 2652(c).
26. Have withdrawal powers lapsed making the client a transferor? Treas. Reg. § 26.26521(a)(5).
13. Does the predeceased ancestor exception apply? IRC § 2651(e).
14. Have any skip persons’ parents died? Can a retroactive allocation of GST exemption be
made? IRC § 2632(d)
15. Identify any births, deaths, adoptions, marriages and divorces in your family or among your
potential beneficiaries and heirs that occurred or are anticipated in 20__.
16. Previously Taxed Property? “Transfers of property that were previously subject to the GST
tax are excluded to the extent the transferee in the prior GST was in the same or younger
generation as the current transferee.”134 IRC Sec. 2611(b)(2).
134
PPC Key Issue 1M.
31
17. Was any expense incurred by the recipient in connection with the determination, collection,
or refund of the GST tax imposed on the distribution? IRC Sec. 2621(a) allows a deduction in
determining the amount of a taxable distribution.
18. Was GST tax incurred or paid in 20__? Who paid and how much?135 (avoids automatic
allocation
19. For purposes of reducing the denominator of the inclusion ratio, were any (1) federal estate
tax or state death tax recovered from the trust attributable to the transfer, or (2) gift or estate tax
charitable deductions allowed for the property? IRC Sec. 2642(a)(2).
20. Transferor’s adjusted basis of property transferred.
21. Farm and ranch land eligible for “special use” valuation? IRC Sec. 2032A and PPC Key
Issue 33A.
Facts To Ascertain From Form 706 and Prior Forms 709:
1. Amount of GST exemption available.
2. Prior transfers to the trust and prior GST allocations made. (Page 3, Schedule B)
3. Was a reverse QTIP trust election made? IRC § 2652(a)(3).
4. Inclusion ratios.
5. Prior GST tax paid.
6. Elections out and decisions reflected on Notices of Allocation.
7. If elected out or non-GST trust, has adequate GST exemption has been allocated?
8. Was all of the information required to meet the safe harbor for adequate disclosure provided
in Regs Sec. 301.6501(c)-1(f)(2) attached to those returns? (for finality under limitations).
9. Do the past returns indicate whether a GST allocation is intended and, if so, whether a zero
inclusion ratio is intended (or that no allocation is intended)?
Facts To Ascertain From Trust Instrument:
1.
2.
3.
4.
5.
6.
7.
What happens to the trust when the transferor dies?
Will there be a taxable termination when the client dies? IRC § 2612(a).
Will distributions be taxable distributions? IRC § 2612(b).
Will distributions be direct skips? IRC § 2612(c).
GST trust or not? IRC § 2632(c)(3)(B). (See GST trust questions below).
Are all interests in the trust held by skip persons? Regs. 26.2612-1(d)(2).
Is the trust a skip-person trust under sections 2613 (2), 2642(c) or 2503(c)? If not, “the initial
transfer by the grantor into the trust will not be GST exempt and GST tax exemption will
have to be allocated to obtain a zero inclusion ratio.”136
8. Does no person holds an interest in the trust, and at no time after the transfer may a
distribution (including distributions on termination) be made to a nonskip person? IRC
Sec. 2613(a)(2)
(Yes answers to #6 and #7 indicate the annual GST exclusion applies).
9. During the lifetime of a sole skip person beneficiary, may distributions be to no one other
than the beneficiary?
PPC Key Issues 17L: “The recipient of a distribution is liable for the GST tax on includable taxable distributions
[IRC Sec. 2603(a)]. If the trust pays any of the GST tax, the tax payment is treated as an additional taxable
distribution [IRC Sec. 2621(b)]” and PPC 31A. Reg. 26.2612-1(c)(1) has timing rules.
136
Grassi, supra at p. 92.
135
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10. If the beneficiary dies before the termination of the trust, will the assets of the trust be
included in the gross estate of the beneficiary. Form 709 Instructions, p. 6, col. 3. and Regs.
Sec. 26.2632-1.
11. When did the trust become irrevocable? “Grandfathered trusts are trusts that were irrevocable
on September 25, 1985 . . . (and) are exempt from the GST tax to the extent there are no
additions or modifications to the trust after September 25, 1985. Modifications to these trusts
that change the quality, value, or timing of any of the trust powers, beneficial interests, or
rights originally provided under the terms of the trust will cause the trust to lose its
grandfathered status.”137
12. Were subsequent additions made to a trust that was irrevocable on September 25, 1985? If
so, a proportionate amount of distributions from, or terminations of interests in property held
in, such trust are subject to GST tax.138 Regs. Sec. 26.2601-1(b)(1)(iv).
13. Was there an exercise, release, or lapse of a general power of appointment created under a
grandfathered trust?139
14. What Crummey powers were granted?
15. Whether Crummey powers lapsed in a taxable way
16. Is there a Power of Appointment? What are the terms?
17. Is there a special power of appointment that could be exercised for the benefit of non-skip
persons in order to avoid a taxable termination?
18. Is there a power that was exercised or allowed to lapse? IRC § 2041.
19. Was the trust ever merged, divided or reformed?.
20. Who pays the tax and how much? IRC §§ 2603, 2622.
21. Can a unitrust election be made? C.R.S. § 15-1-404.5.
22. Is a power to adjust available? C.R.S. § 15-1-404.
23. Is there a QTIP trust and has there been a reverse QTIP election?140 IRC Sec. 2652(a)(3)
24. What state’s law applies? What is its Rule against Perpetuities or does it authorize Dynasty
Trusts?
25. Any language that should be overridden to prevent the automatic allocation or substantial
compliance doctrine from applying?
ETIP Questions:
1. Does the insured transferor (or spouse) hold or retain any incidents of ownership over the life
insurance policy or possess any powers over the ILIT or its trustee that would result in the
ILIT or the insurance policy being included in the insured-grantor’s gross estate
2. Did the grantor die within three years of the transfer? IRC § 2035
Avoiding GST tax by avoiding inclusion in spouse or beneficiaries’ estates (“If trust property is
included in a beneficiary’s estate, that beneficiary becomes the (new) transferor for GST
137
PPC Key Issue 29A.
Id.
139
Id. (split of authority on whether this causes the powerholder/donee to become the transferor for GST tax
purposes).
140
PPC Key Issues 15J and 30A: The election is “made by checking the box located on Schedule C, Part 2, and
identifying the item number from Schedule A of the gift(s) for which the reverse QTIP election is being made.”
138
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purposes and the original transferor’s previously allocated GST tax exemption is lost and
wasted.”141
1. Are the insured transferor’s spouse or other beneficiaries deemed to hold a retained
interest (due to a taxable release of a Crummey withdrawal right)?
2. Do the spouse and beneficiaries hold any general powers of appointment over the trust
assets, either as a beneficiary or as a trustee?
GST Trust Questions:
If the trust falls within one of the exceptions of IRC Sec. 2632(c), the GST exemption is not
automatically allocated. Does the trust instrument provides that:
1. More than 25% of the trust corpus must be distributed to, or may be withdrawn by, one or
more individuals who are nonskip persons before the date such individual attains age 46, on or
before one or more dates specified in the trust instrument that will occur before the individual
attains age 46, or on the occurrence of an event reasonably expected to occur before the date
such individual reaches that age (Sec. 2632(c)(3)(B)(i)); or
2. More than 25% of the trust corpus must be distributed to, or may be withdrawn by, one or
more individuals who are nonskip persons living on the date of death of another person identified
in the instrument who is more than 10 years older than such individual (Sec. 2632(c)(3)(B)(ii));
or
3. If one or more individuals who are nonskip persons die on or before the date(s) described in
#1 and 2 above, more than 25% of the trust corpus must be distributed to the estate(s) of such
individual(s) or is subject to a general power of appointment exercisable by one or more such
individual(s) (Sec. 2632(c)(3)(B)(iii)); or
4. Any portion of the trust is includible in the gross estate of a nonskip person (other than the
transferor) if such person died immediately after the transfer (Sec. 2632(c)(3)(B)(iv)).
141
Grassi, supra at p. 92.
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Appendix B - Attached Forms
(Viehman’s)
SAMPLE FORM A – Timely Allocation
SAMPLE FORM B – True Late Allocation (No Prior Allocations)
SAMPLE FORM C – True Late Allocation (If Prior Allocations)
(PPC Worksheets)
W201 Calculation of Inclusion Ratio on a Direct Skip
W202 Calculation of Trust’s Inclusion Ratio
E-19 Notice of Election
PPC 706/709 Deskbook
CHECKLIST C301: Donor Interview Checklist,
CHECKLIST C302: Form 709 Preparation Checklist
CHECKLIST C303: Checklist of Gift Descriptions
PPC TABLE T102: Roadmap to Guidance for Completing Form 709, 706/709 Deskbook
RESOURCE R502: Form 709, Schedule A, Part 2—Direct Skips Subject to Both Gift Tax and
Generation-skipping Transfer Tax
RESOURCE R503: Form 709, Schedule A, Part 3, Indirect Skips That Are Currently Subject to
Gift Tax and May Later Be Subject to Generation-skipping Transfer Tax
RIA 186 (2008 Gift (and GST)) Checklist of attachments to Form 709.
RIA 7184 Checklist of information about generation-skipping transfer tax, including relevant
supplemental documents and other attachments required to be filed with Form 706, Tax Desk
Client Letters & Checklists
Thomas Stover’s Exhibit A schematic for determining GST skips and nonskips
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Appendix C
Checklist for GST Tax Exemption Allocation Analysis
1. Does client have GST tax potential?
A. Is it possible for generation skipping transfers during lifetime and at death to
exceed the exemption ($3.5 million per person in 2009)?
B. Is there a credit shelter trust to shelter the first spouse to die’s applicable
exclusion amount from estate tax at the death of the survivor and “the value of the
combined estates of the husband and wife will never exceed the twice the GST
exemption, plus administration expenses, and estate and death taxes at the death
of the survivor”?142 If so, there is no GST tax potential.
C. Has GST tax already been paid on a transfer to a trust or a taxable termination? If
so, it is exempt and not subject to automatic allocation. I.R.C. §§ 2611(b)(2) and
2632.
2. Are trusts GST trusts? (Answering this is not for the faint of heart).
3. Is the GST annual exclusion available?
A. Direct skip to skip persons?
B. Does a transfer to a trust qualify for the exclusion? IRC Sec. 2642(c)
(i)
Does the trust have only one current beneficiary?
(ii)
Is the sole current beneficiary a skip person?
(iii)
Can distributions be made to no one other than the single skip
person beneficiary during that skip person’s life? and
(iv)
Will the trust property be included in beneficiary’s federal gross
estate if she dies before the trust is terminated?
5. Were potential generation skipping transfers made during the year?
6. Was a potential generation skipping trust created or funded during the year?
7. Was there a taxable distribution or termination?
142
Mezzullo, supra at p. 4..
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RIA 186. Checklist of attachments to Form 709.
Don't forget to attach the following to the completed Form 709 (as applicable):
... Extension of time to file return (on Form 4868, 2350 or extension letter)—Page 1, Part
1, Line 9, see ¶ 110.
... Disclosure of gifts not subject to tax, as follows—Page 2, Schedule A, Part 1, see ¶ 133
through ¶ 136.
... Documents required for an adequate explanation in describing the gift and the basis for
valuing it, sufficient to permit ready identification of the property. This may include an
appraisal. Additional identifying documents may be submitted if desired—Page 2,
Schedule A, Part 1, Column B, see ¶ 127.
... Election to take contributions to qualified tuition program into account ratably over a
five-year period, see ¶ 123.
... foreign gift tax credit computation, and evidence of payment—Page 1, Part 2, Line 13,
see ¶ 178.
... Elections available under Chapter 14 which are made by attaching statements to Form
709. For sample forms of election statements, see ¶ 134.
... check or money order for balance of tax due, to the order of “United States Treasury,”
with donor's social security number written on it— Page 1, Part 2, Line 19, see ¶ 184.
Also, don't forget to attach separate attachments, if any, which you needed because there wasn't
sufficient room on the return itself—for example, an attachment for Part 1 of Schedule A, see
¶ 125.
RIA 369. Checklist of attachments to Form 709.
In addition to the items listed in the line-by- line explanation of how to fill in a gift tax return
Form 709 for gifts subject only to gift tax (and not generation-skipping transfer tax) at ¶ 186 ,
don't forget to attach the following to the completed Form 709 (as applicable):
... Generation-skipping transfers tax election out of automatic allocation of lifetime
exemption to transferred property—Schedule C, Part 2, Line 1, see ¶ 329 , and Schedule
C, Part 2, Line 5, see ¶ 333 .
... Notice to allocate generation-skipping tax exemption to trust which isn't involved in
transfer listed on Schedule A or C—Schedule C, Part 2, Line 6, see ¶ 334 .
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RIA 7184. Checklist of information about generation-skipping transfer tax, including
relevant supplemental documents and other attachments required to be filed with Form
706.
Introduction. The following is the fifth of five checklists for the Form 706 preparer to use in
preparing Form 706 for estates of individuals dying in 2008.
The checklists guide the preparer through what information he must gather together for
preparation of the federal estate and generation-skipping transfer tax return. The checklists also
help the preparer compile a complete return by listing all the supplemental documents and other
attachments required to be filed with the Form 706. The other checklists in the section are:
... General information needed for preparation of Form 706, including relevant
supplemental documents and other attachments required to be filed with Form 706, at
¶ 7180 .
... Information about gross estate needed for preparation of Form 706, including relevant
supplemental documents and other attachments required to be filed with Form 706, at
¶ 7181 .
... Information about deductions needed for preparation of Form 706, including relevant
supplemental documents and other attachments required to be filed with Form 706, at
¶ 7182 .
... Information about credits needed for preparation of Form 706, including relevant
supplemental documents and other attachments required to be filed with Form 706, at
¶ 7183 .
Schedules R-Generation-Skipping Transfer Tax
Information:
□ Review of decedent's gift and GST tax returns (Form 709) and notices of allocation to
determine total lifetime allocations of the decedent's generation-skipping transfer (GST) tax
exemption made or deemed made. Consider the election to allocate the decedent's GST tax
exemption and the “reverse QTIP” election.
□ Review of trust agreements (and related tax returns) and other lifetime arrangements such as
life insurance for possible generation-skipping transfers. For possible sources of information
regarding trusts includible in the decedent's estate, see ¶ 7181 (Schedules F, G and H).
Supplemental documents and other attachments:
□ Schedule R-1. See below.
□ Statement about trust with respect to which reverse QTIP election made.
□ Statement about severance of trust.
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□ Copy of court order severing trust or copy of petition used to begin proceeding to sever trust.
□ Special use allocation schedule, for line 10 of Part 1.
□ Schedule of post-death events which might result in later GST tax liability for special use
property and the amount of GST exemption allocated to each for line 10 of Part 1.
□ Copy of trust instrument if decedent created any trust during his lifetime or if there was any
trust created by someone other than the decedent under which decedent possessed any beneficial
interest or any power, or decedent was a trustee.
□ Computation and identification of federal or state GST taxes payable out of property interests
passing to decedent's surviving spouse (shown on line 5c of Schedule M).
□ Certification from qualified physician stating that decedent was mentally incompetent at all
times on and after Oct. 22, '86 and didn't regain competence to modify or revoke will/trust before
his death, or sufficient other evidence demonstrating that decedent was mentally incompetent at
all times on and after Oct. 22, '86 along with statement explaining why no physician's
certification is available, when decedent hasn't been adjudged mentally incompetent by a court.
□ Copy of judgment or decree, and any modification thereof, when decedent has been adjudged
mentally incompetent.
Schedule R-1-Direct Skips From a Trust, Payment Voucher
Information:
□ See Schedule R above. If a Schedule R-1 is attached to the Form 706, check the box on page 1
of the Form 706 (line 10 of Part 1).
Supplemental documents and other attachments:
□ Copy of the will or trust agreement containing terms of trust from which the direct skip was
made.
© 2009 Thomson Reuters/RIA. All rights reserved.
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