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AMBRECHT & BRITTAIN, LLPPlanning for the Generation Skipping Transfer TaxBy John W. Ambrecht |
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The following is an outline of an oral presentation given September, 1995, for California Continuing Education of the Bar (CEB). A companion booklet of course materials may stil be available -- check with CEB. "GST" refers to the Generation-Skipping Transfer Tax.
A. Introduction to GST 1. Definitions: a. Transferor b. Is the donee or transferee a skip or non-skip person? Can a trust be a skip person? c. Does a beneficiary have an interest in a Trust? d. The three GST events (1) Direct Skip 2. A mechanical overview of the GST calculations -- denominator rules; note effective date requirements 3. More definitions: When the applicable fraction is calculated: a. Effective date b. Automatic Allocation Rules (1) Life c. ETIP B. Charitable Split Interest Trusts 1. General Rules a. A charitable organization is a non-skip person b. If a charity (non-skip person) is a beneficiary of a trust, it has an interest in the trust c. No automatic allocation of GSTTE to the trust where a charity is a beneficiary for life time gifts since not a direct skip 2. Charitable Remainder Trusts (CRT)-- Three questions: (1) What are the possible GST events? a. What are the possible GST events? (1) Direct skips and taxable terminations will never occur because the trust will always have a non-skip person as a beneficiary, therefore is a skip person is a beneficiary all distributions will be taxable terminations BAD OR GOOD: Tax inclusive versus tax exclusive--direct skips effective rate around 35% versus 55% b. A Transferor can allocate his or her GSTTE to the CRT c. The planning implications of using GSTTE is generally not that helpful because of the risk the skip person will die before the benefits of giving discounted dollars to the skip person are realized 3. Charitable Lead Trusts (CLT) -- Three questions: (1) What are the possible GST events? (2) Implications of allocating a transferor's GST exemption to the CLT? (3) What are planning points? a. Possible GST events: (1) Since a charity (non-skip person), the trust itself is not a skip person, one can have a taxable distribution and taxable terminations b. Allocation of GST exemption to the CLT has some special rules for CLAT but not CLUT where the standard rules are applicable. Internal Revenue Code Section 2642(e) provides for the effective date for the GST exemption allocation will only be at the termination of the charity's interest. But one may allocate GST exemption at the time of the transfer and the numerator is then adjusted for the time period between the time the GST exemption is allocated and the time it becomes effective. The outline gives an example of the calculations. c. What are the planning implications for using GST exemption for CLTs? The outline works through an example comparing a CLAT with a CLUT and also with a direct skip with several variables. The point is that one should consider "doing the math" to see which type of transfer would be the most beneficial for the family. d. Caveat: As everyone knows, if a child of the transferor dies before the transferor, the grandchild steps up the child's generation so there would be no GST tax for gifts by the transferor directly to the grandchild (the predeceased child exemption). However, if the transferor sets up a CLT with a grandchild as the beneficiary, this rule does not apply so the gift to the grandchild on the termination of the charity's interest would still be a taxable termination.
Essentially for GST purposes, one could generalize by saying that there are 4 versions of insurance trusts: (1) Those established before April 1, 1988 We will review these four types of insurance trusts later. First we need to discuss some general considerations applicable to all insurance trusts. A. General Remarks 1. Allocation of GST exemption to insurance trusts--the timing of the allocation is very important for insurance trusts since the effective date determines the denominator the applicable fraction which in turn influences the amount of GSTTE needed to be allocated to keep a zero inclusion ratio. a. If file a timely gift tax return, the effective date is the value of the property transferred on the date of the transfer--e.g., cash to pay the premium. b. If file late, the value is the value of all of the non-exempt assets of the trust on the date the 709 is filed. for example, if the assets have depreciated in value, then would use less than if filed timely. Note some special rules here. c. If transferor-insured fails to file during life, then must file on Form 706 (estate tax return) Schedule R and the value will be the full value of the insurance payout. This could be a problem for the person responsible for filing the return. d. Note, just filing a Form 709 (gift tax return) will not allocate GSTTE to the gift, Schedule C must be completed an a notice of allocation attached otherwise no GSTTE is allocated to the trust, which means that the trust may not have a zero inclusion ratio. Check the 709's, especially the old ones. 2. Gift tax exempt transfers to a Trust not exempt for GSTT purposes if made to a trust. This is a very common mistake especially if an accountant or other tax-preparer says one does not need to file a gift tax return since no gift tax implications. 3. Internal Revenue Code section 2642(c)(2) and vested trust requirements a. The "leaky" insurance trust problem. A big problem for insurance trusts currently in existence --hopefully no one does this after today's discussion. I call this, for simplicity's sake, the "leaky" insurance trust. (1) Define leaky insurance trust problem: beneficiary is the child if survives distribution, and if not, then to his or her issue by right of representation. (2) Do you allocate GST to the trust for the risk that the child will die before the trust is distributed to the child thereby incurring a GSTT? b. Four alternatives and their implications on how to handle the leaky trust problem. (1) Allocate GSTTE to the trust now with the possibility of wasting GSTTE if the child lives. (2) Amend the trust to provide either the trust will not be included in the child's at all or give the child a general power of appointment over the assets on the child's death so the trust will be included in the child's estate. Remember, then the child will be the transferor so transfers to the grandchild will not be to skip persons. (3) Delay allocation--the outline goes through the ramifications of a delay. One risk is the separate share rule where have several children as beneficiaries and only one dies, it will be necessary to allocate the transferor's GSTTE to the whole trust (and thereby waste GSTTE for those children who survive). (4) Terminate the trust and distribute the insurance policy to the beneficiaries now. B. The GST implications for the four versions of insurance trusts. (1) Insurance Trusts established before April 1, 1988. a. That is insurance trusts established before Internal Revenue Code section 2642(e)(2) was effective. Here, the GSTTE was automatically allocated to the trust for non-taxable transfers within the 5/5 power. Caution for any additions to the trust since 4/1/88 because section 2642(e)(2) would then be applicable. 2. Insurance Trusts with no withdrawal powers or for amounts in excess of the withdrawal amounts. a. Is the trust a skip person? If yes, the automatic allocation rules would apply for the amount of the transfer to the trust. b. If the trust is not a skip person, then the transferor must make the GSTTE allocation on the Form 709, Schedule R, and attach the notice of allocation we have already discussed. c. Consider the ETIP rules where the spouse is a beneficiary or even the trustee. Remember that no allocation is effective until the ETIP period expires. 3. Insurance trusts with a withdrawal power limited to 5/5 and also those with the $10,000 limitation.
A. Essentially three questions: 1. Who are the reminder beneficiaries? If a remainder beneficiary is a skip person, then the Trust will be subject to GSTT. 2. What GST events will occur for the GRIT? a. The initial transfer to the GRIT by the grantor will not be subject to GST since the trust will not be a skip person and no other skip persons will receive any benefits. b. When the trust terminates two possibilities occur. (1) If terminates because of the lapse of time, then if the trust is distributed to a skip person then a taxable termination will occur. CAVEAT: same rule for predeceased child exception as discussed for CLT's (2) Termination by death of grantor with distribution to the skip persons-- will be a direct skip since the grantor will have the assets included in his or her estate 3. Allocation of the GSTTE to the GRIT. a. The ETIP rules--effective date not until the ETIP period ends. b. Separate share rule--same as we discussed for leaky life insurance trusts. 4. Planning comments--because of the ETIP and the separate share rule problems, one should not necessarily consider using a GRTI for GST purposes.
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