Day 1 August 23, 2018:

Transcription

1 PLANNING WITH THE GENERATION SKIPPING TRANSFER TAX, PART 1 & PART 2 First Run Broadcast: October 26 & 27, 2017 Live Replay: August 23 & 24, :00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes each day) The Generation Skipping Transfer Tax (GSTT) imposes a tax on property transfers among generations of a family and is intended to prevent tax reduction when a senior generation skips over transfers to their children in favor of grandchildren. The tax is one of the most complex elements of trust and estate planning, involving skip and non-skip persons, generation assignments, and determining which transfers are taxable and which are not. Planning has been further complicated with revisions of the federal estate and gift tax regime, including expiration of the GSTT safe harbor. Understanding and planning for this tax is an essential part of planning for client estates, including those less than $5 million. This program will provide you with a framework for understanding and planning with the GSTT, including testamentary and inter vivos exemption planning, and compliance trips and traps. Day 1 August 23, 2018: Framework of how the Generation Skipping Transfer Tax works GSTT vocabulary skip and non-skip persons, taxable events, generation assignments Inclusion ratios sand effective minimum tax Exemption planning for maximum tax and financial benefit Relationship of GST regime to new estate and gift tax law Day 2 August 24, 2018: Speaker: Planning for estates below $5 million Predeceased parent exemption Testamentary use of exemptions Non-portability of exemptions Use of less wealthy spouse s exemption Inter vivos dynasty trusts Predeceased parent exemption Sophisticated planning techniques using dynasty trusts and HEET s Daniel L. Daniels is a partner in the Greenwich, Connecticut office of Wiggin and Dana, LLP, where his practice focuses on representing business owners, corporate executives and other wealthy individuals and their families. A Fellow of the American College of Trust and Estate Counsel, he is listed in The Best Lawyers in America, and has been named by Worth magazine as one of the Top 100 Lawyers in the United States representing affluent individuals. Mr. Daniels is co-author of a monthly column in Trusts and Estates magazine. Mr. Daniels received his A.B., summa cum laude, from Dartmouth College and received his J.D., with honors, from Harvard Law School.

2 VT Bar Association Continuing Legal Education Registration Form Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT Fax: (802) PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name Middle Initial Last Name Firm/Organization Address City State ZIP Code Phone # Fax # Address Planning with the Generation Skipping Transfer Tax, Part 1 Teleseminar August 23, :00PM 2:00PM 1.0 MCLE GENERAL CREDITS VBA Members $75 Non-VBA Members $115 NO REFUNDS AFTER August 16, 2018 PAYMENT METHOD: Check enclosed (made payable to Vermont Bar Association) Amount: Credit Card (American Express, Discover, Visa or Mastercard) Credit Card # Exp. Date Cardholder:

3 VT Bar Association Continuing Legal Education Registration Form Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT Fax: (802) PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name Middle Initial Last Name Firm/Organization Address City State ZIP Code Phone # Fax # Address Planning with the Generation Skipping Transfer Tax, Part 2 Teleseminar August 24, :00PM 2:00PM 1.0 MCLE GENERAL CREDITS VBA Members $75 Non-VBA Members $115 NO REFUNDS AFTER August 17, 2018 PAYMENT METHOD: Check enclosed (made payable to Vermont Bar Association) Amount: Credit Card (American Express, Discover, Visa or Mastercard) Credit Card # Exp. Date Cardholder:

4 Vermont Bar Association CERTIFICATE OF ATTENDANCE Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: August 23, 2018 Seminar Title: Planning with the Generation Skipping Transfer Tax, Part 1 Location: Credits: Program Minutes: Teleseminar - LIVE 1.0 MCLE General Credit 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

5 Vermont Bar Association CERTIFICATE OF ATTENDANCE Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: August 24, 2018 Seminar Title: Planning with the Generation Skipping Transfer Tax, Part 2 Location: Credits: Program Minutes: Teleseminar - LIVE 1.0 MCLE General Credit 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

6 GST Fundamentals Daniel L. Daniels Wiggin & Dana, LLP - Greenwich, Connecticut (o) ddaniels@wiggin.com 2017 Wiggin and Dana LLP -

7 Daniel L. Daniels is a partner in Wiggin and Dana LLP. Dan divides his time between the firm s Greenwich and New York offices. Dan focuses his practice representing business owners, corporate executives and other wealthy individuals and their families. Dan is included on Worth magazine s list of the top 100 trust lawyers in the United States. He is a Fellow of the American College of Trust and Estate Counsel and is listed in The Best Lawyers in America. Dan received his A.B. degree, summa cum laude, from Dartmouth College in 1984 and his J.D., cum laude, from Harvard Law School in Wiggin and Dana LLP is a full-service law firm of approximately 135 lawyers with six offices in the Northeast, including Greenwich, Stamford, New Haven and Hartford, Connecticut, as well as New York and Philadelphia. Since its founding in 1934, the Firm has served the legal needs of entrepreneurs, corporate executives and other wealthy individuals and their families, as well as charitable and educational institutions, emerging companies, middle market business organizations and Fortune 500 corporations Wiggin and Dana LLP 2

8 Introduction to the GST Tax Purpose of Tax Need to learn GST vocabulary Skip person and non-skip person Taxable Termination Direct Skip Taxable Distribution Tax Rate Inclusion ratio GST exemption 2017 Wiggin and Dana LLP 3

9 Name That Transfer T makes a gift of property to his grandchild, GC T transfers property to a trust to pay income his child, C, for life, with the remainder to pass to C s children T makes a gift to a sprinkle trust for the benefit of his children and grandchildren Trustee of that trust makes distributions to grandchildren 2017 Wiggin and Dana LLP 4

10 Name That Transfer T makes a gift of property to his grandchild, GC Direct Skip T transfers property to a trust to pay income his child, C, for life, with the remainder to pass to C s children T makes a gift to a sprinkle trust for the benefit of his children and grandchildren Trustee of that trust makes distributions to grandchildren 2017 Wiggin and Dana LLP 5

11 Name That Transfer T makes a gift of property to his grandchild, GC T transfers property to a trust to pay income his child, C, for life, with the remainder to pass to C s children Initial transfer not a GST event; C s death is a taxable termination T makes a gift to a sprinkle trust for the benefit of his children and grandchildren Trustee of that trust makes distributions to grandchildren 2017 Wiggin and Dana LLP 6

12 Name That Transfer T makes a gift of property to his grandchild, GC T transfers property to a trust to pay income his child, C, for life, with the remainder to pass to C s children T makes a gift to a sprinkle trust for the benefit of his children and grandchildren No GST Trustee of that trust makes distributions to grandchildren 2017 Wiggin and Dana LLP 7

13 Name That Transfer T makes a gift of property to his grandchild, GC T transfers property to a trust to pay income his child, C, for life, with the remainder to pass to C s children T makes a gift to a sprinkle trust for the benefit of his children and grandchildren Trustee of that trust makes distributions to grandchildren Taxable Distribution 2017 Wiggin and Dana LLP 8

14 Name that Transfer - Bonus Questions (Hint: Know the transferor move down rule) T makes a gift to a sprinkle trust for the benefit of his grandchildren and great grandchildren Trustee later makes a distribution from the trust to a grandchild Trustee later makes a distribution from the trust to a great grandchild 2017 Wiggin and Dana LLP 9

15 Name that Transfer - Bonus Questions (Hint: Know the transferor move down rule) T makes a gift to a sprinkle trust for the benefit of his grandchildren and great grandchildren Direct Skip Trustee later makes a distribution from the trust to a grandchild Trustee later makes a distribution from the trust to a great grandchild 2017 Wiggin and Dana LLP 10

16 Name that Transfer - Bonus Questions (Hint: Know the transferor move down rule) T makes a gift to a sprinkle trust for the benefit of his grandchildren and great grandchildren Direct Skip Trustee later makes a distribution from the trust to a grandchild No GST (Move-down rule) Trustee later makes a distribution from the trust to a great grandchild 2017 Wiggin and Dana LLP 11

17 Name that Transfer - Bonus Questions (Hint: Know the transferor move down rule) T makes a gift to a sprinkle trust for the benefit of his grandchildren and great grandchildren Direct Skip Trustee later makes a distribution from the trust to a grandchild No GST (Move Down Rule) Trustee later makes a distribution from the trust to a great grandchild Taxable Distribution 2017 Wiggin and Dana LLP 12

18 In general Transferor Transferor is decedent for property transferred at death Transferor is donor for property transferred by gift Why do we care who is the transferor? Only the transferor can allocate GST exemption Identity of transferor provides starting point for determining whether a transferee is a skip person or not The Reverse QTIP election Identity of transferor can change over time Transferor is person who transfers property and with respect to whom the property was most recently subject to estate or gift tax 2017 Wiggin and Dana LLP 13

19 Interest Why do we care about the term interest? Integral part of the definition of certain generation skipping events A taxable termination occurs when there is A termination of an interest in property held in trust Unless immediately thereafter a non-skip person has an interest in the property A transfer to a trust will be not be a direct skip as long as a nonskip person has an interest in the trust 2017 Wiggin and Dana LLP 14

20 Interest Special Rule for Charities A charity may have an interest in a trust for GST tax purposes in two situations: Charity has a present non-discretionary right to receive income or principal from the trust Charity is the remainderman of a CRAT, CRUT or pooled income fund Example: T transfers property to a CRT to pay a unitrust percentage to GC for life, remainder to charity. T s transfer is not a direct skip. Distributions to GC are taxable distributions Wiggin and Dana LLP 15

21 Skip Person/Non-Skip Person A skip person may be a natural person or a trust A natural person is a skip person if she is assigned to the second or lower generation below the transferor A trust is a skip person if either: all interests in the trust are held by skip persons; or no person holds an interest in the trust and at no time after the transfer may a distribution be made to a non-skip person A non-skip person is a natural person or trust that is not a skip 2017 Wiggin and Dana LLP 16

22 Skip Person Quiz T creates a trust naming his grandchild, GC, as the only permissible income and principal beneficiary, remainder to great-grandchildren T creates a trust for GC. Trustee directed to accumulate income until GC is 21 then pay income to GC for life, remainder to GGC T creates a sprinkle trust for C and GC for the life of C, remainder to GC 2017 Wiggin and Dana LLP 17

23 Skip Person Quiz T creates a trust naming his grandchild, GC, as the only permissible income and principal beneficiary, remainder to great-grandchildren - Skip Person T creates a trust for GC. Trustee directed to accumulate income until GC is 21 then pay income to GC for life, remainder to GGC T creates a sprinkle trust for C and GC for the life of C, remainder to GC 2017 Wiggin and Dana LLP 18

24 Skip Person Quiz T creates a trust naming his grandchild, GC, as the only permissible income and principal beneficiary, remainder to great-grandchildren T creates a trust for GC. Trustee directed to accumulate income until GC is 21 then pay income to GC for life, remainder to GGC Skip Person T creates a sprinkle trust for C and GC for the life of C, remainder to GC 2017 Wiggin and Dana LLP 19

25 Skip Person Quiz T creates a trust naming his grandchild, GC, as the only permissible income and principal beneficiary, remainder to great-grandchildren T creates a trust for GC. Trustee directed to accumulate income until GC is 21 then pay income to GC for life, remainder to GGC T creates a sprinkle trust for C and GC for the life of C, remainder to GC Skip Person 2017 Wiggin and Dana LLP 20

26 Skip Person Quiz Advanced Questions T creates a CRT to pay an annuity interest to GC, remainder to charity T creates a sprinkle trust for C and his five GCs for the life of C, remainder to GC; Crummey rights are given to all six beneficiaries 2017 Wiggin and Dana LLP 21

27 Skip Person Quiz Advanced Questions T creates a CRT to pay an annuity interest to GC, remainder to charity Nonskip Person T creates a sprinkle trust for C and his five GCs for the life of C, remainder to GC; Crummey rights are given to all six beneficiaries 2017 Wiggin and Dana LLP 22

28 Skip Person Quiz Advanced Questions T creates a CRT to pay an annuity interest to GC, remainder to charity T creates a sprinkle trust for C and his five GCs for the life of C, remainder to GC; Crummey rights are given to all six beneficiaries Nonskip Person Crummey rights are ignored 2017 Wiggin and Dana LLP 23

29 Inclusion Ratio What is it? Essentially, the proportion of the trust that is subject to GST tax More correctly, it s a factor in determining the GST Tax Rate Tax rate = (Top Estate Tax Rate) X Inclusion Ratio 2017 Wiggin and Dana LLP 24

30 Determining Inclusion Ratio Inclusion ratio equals 1 - applicable fraction Applicable Fraction Amount of GST Exemption allocated/value of property in the trust 2017 Wiggin and Dana LLP 25

31 Inclusion Ratio Example T transfers $100,000 to trust T allocates $40,000 of GST Exemption Applicable fraction equals $40,000/$100,000, or.40 Inclusion ratio equals , or.60 Tax rate equals.60 x.40% = 24% 2017 Wiggin and Dana LLP 26

32 GST Exclusions GST Annual Exclusion Outright Gifts Special Rule for Trusts Impact on Crummey Gifts GST Med-Ed Exclusion 2017 Wiggin and Dana LLP 27

33 GOAL IS AN INCLUSION RATIO OF EITHER ZERO OR ONE Mixed inclusion ratio wastes GST exemption when distributions from a trust are made to children Mixed inclusion ratio causes unnecessary GST tax when distributions from a trust are made to grandchildren A trust with a zero inclusion ratio will be invested differently from a trust with a one inclusion ratio 2017 Wiggin and Dana LLP 28

34 Achieving a Zero Inclusion Ratio Allocate GST exemption to each transfer to the trust Timely allocation permits use of date-of-gift value for purposes of allocation Late allocation requires use of values as of date return is filed Special first of the month rule Planning pointers: Be sure trust agreement includes power for trustee to split into zero and one inclusion ratio trusts Use intentional late allocation for life insurance in trust? 2017 Wiggin and Dana LLP 29

35 Automatic Allocation Rules Lifetime Direct Skips Automatic Allocation at Death Rules on Automatic Allocation to Indirect Skips An Indirect Skip is a transfer that is not a direct skip which is made to a GST Trust A GST Trust is any trust that could have a taxable termination or taxable distribution unless one of six exceptions applies 2017 Wiggin and Dana LLP 30

36 Exceptions 1. More than 25% of corpus must be distributed or may be withdrawn by non-skip persons before they attain age More than 25% of corpus must be distributed or may be withdrawn by non-skip persons who are living on the date of death of a person identified in the trust agreement who is more than 10 years older than such non-skip persons 2017 Wiggin and Dana LLP 31

37 Exceptions 3. Under the trust agreement, if a non-skip person dies on or before an event described in Exception 1 or Exception 2, more than 25% of the trust corpus must be distributed to such person s estate is subject to a GPA held by such person 4. The trust is a trust any portion of which would be included in the estate of a non-skip person if such person died immediately after the transfer to the trust 2017 Wiggin and Dana LLP 32

38 Exceptions 5. The trust is a CLAT, CRAT or CRUT 6. The trust is a CLUT and is required to pay the remainder interest to a non-skip person if the person is alive at the termination of the lead interest 2017 Wiggin and Dana LLP 33

39 Unintended Consequences of the Automatic Allocation Rules? Straightforward ILIT is a GST Trust? Sprinkle trust for spouse and children Upon death of last to die of grantor and spouse, division into per stirpes shares for descendants, with each descendant s share held in trust until age 40 Exceptions 3, 4, 5 and 6 clearly don t apply Exceptions 1 and 2 seem like they were intended to apply but, under a close inspection, may not apply Result is an automatic allocation to a trust that the grantor likely did not intend to have exemption applied to Opt out 2017 Wiggin and Dana LLP 34

40 Unintended Consequences of the Automatic Allocation Rules? Termination of an ETIP in a GRAT or QPRT Suppose GRAT or QPRT provides for distribution to an ILIT-like trust upon expiration of the trust term None of the exceptions would appear to apply; therefore, the trust probably is a GST trust An allocation of GST exemption to property subject to an ETIP is not effective until the close of the ETIP Result is an automatic allocation to the trust, utilizing GST exemption in an amount equal to the full value of the trust property at the close of the ETIP This could cause a waste of the grantor s entire exemption Opt out 2017 Wiggin and Dana LLP 35

41 Contact Information Daniel L. Daniels Wiggin and Dana LLP 30 Milbank Avenue Greenwich, CT Wiggin and Dana LLP 36

42 FEDERAL GENERATION SKIPPING TRANSFER TAX: FUNDAMENTALS, THEORY AND ADVANCED APPLICATIONS I. OVERVIEW A. Basic Theory of the GST Tax 1. With the exception of the deemed ownership string sections of of the Internal Revenue Code, the estate tax generally applies only to what the decedent owns at time of death. Accordingly, prior to the enactment of the GST tax, it was possible for an individual to transfer significant value outside the transfer tax system through the creation of trusts. 2. Examples (a) Suppose T bequeaths $100,000,000 to his son, S. For simplicity s sake, assume a flat transfer tax rate of 50 percent and assume no estate tax exemption is available. At T s death, a $50 million estate tax is due, leaving S to inherit $50 million. At S s death a further $25 million in estate tax is due, leaving the grandchildren to inherit $12.5 million. At the level of T s greatgrandchildren, the original $10 million is worth only $6.25 million, the equivalent of a transfer tax rate of percent. (b) Suppose instead that T leaves the $100 million to a trust for S. The trust agreement provides S with an impressive bundle of rights, but just short of enough rights to be deemed the owner of the trust for estate tax purposes. These rights might include any all of the following. S is the sole trustee. S is entitled to income and principal for his health, education and support. He is permitted to withdraw an additional 5 percent of the trust principal each year. S is given the right to appoint an independent trustee who can distribute additional principal to S for any purpose. S is also given the right to remove the independent trustee and appoint a new independent trustee. Finally, S is given a testamentary power of appointment giving him the authority to leave the trust assets remaining at his death to anyone other than himself, his estate, his creditors or the creditors of his estate. At T s death, the trust receives $50 million (the $100 million estate net of estate taxes). And yet, prior to the enactment of the generation skipping transfer tax, at S s death, because he was not granted sufficient rights over the trust to cause inclusion in his estate, the entire $50 million, (plus any growth on it during S s lifetime), passes tax free to S s children. Furthermore, the trust could be designed to continue for the lives of S s children and grandchildren, meaning that the assets can pass free of tax for multiple generations, subject only to any applicable rule against perpetuities period. Assuming a perpetuities period of 90 years, and a compound growth rate of 5 percent, the amount remaining in the trust would be in excess of $8 billion. Given this result, it is perhaps not surprising that Copyright 2017 by Daniel L. Daniels. All rights reserved.

43 2 efforts were made in the Congress to close this generation skipping loophole in the transfer tax system. B. The 1976 GST Tax The first sustained effort to tax generation skipping transfers came as a part of the 1976 Tax Reform Act (TRA 1976) 1. Like the current version of the GST tax, the 1976 GST tax was a tax wholly apart from the estate and gift tax. The idea behind the 1976 tax was to get at the type of transfer described in our example a transfer that would be referred to as a taxable termination in the parlance of the current version of the GST tax. The ideal purpose of a GST tax is to mimic the result that would occur if the trust assets were included in the deceased trust beneficiary s estate at his death. The 1976 GST tax attempted to achieve that ideal result. In practice, however, figuring out how to apply and calculate the tax proved to be dizzyingly complicated. So complicated, in fact, that the tax was repealed in its entirety and retroactively in 1986 by TRA C. Current Law the 1986 GST Tax The 1986 GST Tax was enacted on October 22, 1986 and applies to all generation-skipping transfers after that date. 3 In addition, subject to certain exceptions discussed later in this outline, generation skipping transfers from trusts that became irrevocable after September 25, 1985 are also subject to the tax. D. Modifications to the 1986 GST Tax: EGTRRA 2001, TRA 2010 and ATRA 2012 The Economic Growth and Tax Reconciliation Act of 2001 (popularly referred to as the Bush Tax Cuts ) initiated substantial and positive changes to the 1986 GST Tax. These included: 1 P.L , retroactively in 1433 (c)(1) of the 1986 TRA. 2 TRA 1986, 1433 (c)(1). Interestingly, TRA 1976-which brought us the 1976 version of the GST Tax also ushered in the short-lived idea of carryover basis, a concept that also proved so complex that it, too, was retroactively repealed. 3 3 P.L (1986)

44 3 1. The advent of the automatic allocation rules and the concepts of a GST Trust and an indirect skip. 2. The extension of the substantial compliance doctrine and 9100-style relief for errors in complying with Chapter The law also increased the GST exemption and reduced the nominal GST tax rate. As originally enacted, EGTRRA 2001 was to sunset (expire) retroactively as of January 1, The retroactivity provision left many practitioners to wonder whether actions taken in reliance on the Act would become null on that date. Fortunately, those concerns were alleviated by TRA 2010, which extended the GST provisions of EGTRRA 2001 for two years and ATRA 2012, which extended them permanently. 4 E. Quick Review of GST Tax Vocabulary The GST Tax employs a sometimes bewildering number of defined terms. For purposes of an introduction to the tax, the most important of these terms are taxable termination, taxable distribution, direct skip, skip person, non-skip person, transferor and inclusion ratio. 1. Skip Person; Non-Skip Person. A skip person is a person assigned to the second generation or more below the transferor, e.g., a grandchild. A non-skip person is any person who is not a skip person. 2. Taxable Termination, Taxable Distribution and Direct Skip. These terms refer to the three types of transfers to which the GST Tax applies. Although the definitions of these terms contained in the Code are predictably opaque, they are fairly easily understood by example. (a) Taxable Termination. The Code defines a taxable termination as the termination of an interest in property held in trust unless immediately thereafter a nonskip person has an interest in the property or unless thereafter no distributions may be made to a skip person. IRC 2612(a). Example: T creates a lifetime trust for C, remainder to GC. A taxable termination occurs on C s death. (b) Direct Skip. A direct skip is a transfer subject to estate or gift tax of an interest in property to a skip person. IRC 2612(c). Example: T transfers $100,000 outright to GC. (c) Taxable Distribution. A taxable distribution is any distribution from a trust to a skip person other than a taxable termination or a direct skip. IRC 2612(b). 4 P.L , 301(a) and 302(c); ATRA 2012, 101(a).

45 4 Example: T creates a sprinkle trust for the benefit of C and GC for the life of C, remainder to GC. Any distribution to GC during C s life is a taxable distribution. At C s death, there is a taxable termination. If the trust continues for GC after C s death, further distributions from the trust to GC are not taxable distributions. It is important to note that for taxable terminations and taxable distributions, the GST Tax is imposed on a tax inclusive basis, similar to the estate tax, in that the taxable amount includes the GST Tax itself. For direct skips, on the other hand, the tax is imposed only on the amount actually received, similar to the gift tax. However, any GST Tax paid by the donor upon a direct skip is treated as an additional taxable gift. 3. Inclusion Ratio. The GST Tax rate is the top estate tax rate then in effect multiplied by the inclusion ratio, if any. IRC The inclusion ratio is a fraction representing, in essence, the excess value of the property transferred over the amount of the transferor s generation-skipping tax exemption ( GST Exemption ) applied to the transfer. Example: T transfers $1,000,000 to a trust for C, remainder to GC. At the time of the gift, T allocates $1,000,000 of his GST Exemption to the trust. Therefore, the trust has an inclusion ratio of zero. Although there will be a taxable termination at C s death, no GST Tax would be imposed because the trust has a zero inclusion ratio. If in the above example T had allocated only $600,000 of his GST Exemption to the $1,000,000 transfer, the trust s inclusion ratio would have been 0.4 (i.e., the difference between the amount of the transfer [$1,000,000] and the amount of GST Exemption applied [$600,000], divided by the total value of the transfer [$1,000,000], equals $400,000/$1,000,000 equals 0.4). Accordingly, assuming a top estate rate of 40%, the tax rate applied at the time of the taxable termination would be 40% x 0.4). II. BASIC DEFINED TERMS: TRANSFEROR, INTEREST, SKIP PERSON, NON-SKIP PERSON, AND TRUST A. Transferor 1. In general. In general, the transferor of property for GST Tax purposes is (a) the decedent as to any property subject to the federal estate tax and (b) the donor as to any property subject to the federal gift tax. IRC 2652(a)(1). However, if property is the subject of a QTIP election under IRC 2056 or 2523, the transferor s spouse is deemed to be the transferor of the property for GST Tax purposes unless a special reverse QTIP election is made. The identity of the transferor is important in determining (and planning for) whose GST Exemption is used and in determining generation assignments. 2. Change in Transferor Upon a Chapter 11 or 12 Event. The transferor is the person who transfers property and with respect to whom the property was most recently

46 5 subject to federal estate or gift tax. IRC 2652(a)(1); Treas. Regs (a)(1) 5. Therefore, the identity of the transferor can change over time. Example: T transfers property to a trust for C in which C has an unlimited right of withdrawal after attaining age 30. If C dies prior to age 30, remainder to GC. At the date of the transfer, T is the GST transferor. If C dies prior to age 30, T remains the GST transferor. If C dies after age 30, C becomes the transferor because the property is includible in C s estate at that time for federal estate tax purposes. 3. Transferor Move-Down Rule. Under IRC 2653(a), if property continues to be held in a trust after a generation skipping transfer, the transferor is treated as having been moved down to the first generation above the highest generation of trust beneficiaries. Example: T has used all of her GST exemption. She transfers $1,000,000 to a trust for the benefit of her grandchildren and more remote descendants. T s transfer is a direct skip resulting in GST tax. Distributions to T s grandchildren from the trust will not be treated as taxable distributions because they are no longer skip persons with respect to T. However, a distribution to a great grandchild would be a taxable distribution. Similarly, the death of all of T s grandchildren, leaving only great grandchildren as trust beneficiaries, would be a taxable termination. 4. Gift Splitting. Gift splitting between husband and wife causes each to be the GST transferor of one-half of the property. IRC 2513, 2652(a)(2). 5. Reverse QTIP Election. Recall that the GST transferor changes each time property is subject to estate or gift tax. Accordingly, if H leaves property in a QTIP trust for W, H is the transferor of the property at his death, but W becomes the transferor at her death because the property is includible in her estate. With respect to QTIP property only, the creator of the QTIP trust may elect to treat the trust as if no QTIP election had been made for purposes of determining the GST transferor. IRC 2652(a)(3). In other words, in the example above, H s executor could elect to have H treated as the transferor of the QTIP trust for GST purposes notwithstanding the fact that the QTIP property later will be included in W s estate. This election is commonly referred to as the reverse QTIP election. The election must be made over the entire QTIP trust. Treas. Regs (a). Planning pointer: Properly drafted QTIP trusts should always allow for a division into QTIP and reverse QTIP shares to avoid creating a trust which is only partially GST-Exempt The inclusion of an insurance trust in the transferor s estate by reason of IRC 2035 does not result in a new transferor for GST purposes nor does it change the trust s inclusion ratio. See Treas. Regs (a)(3). Under a transition rule, if a reverse QTIP election was made with respect to a trust prior to December 27, 1995, the transferor (or his executor) may elect to treat the trust as two trusts, one with a zero inclusion ratio and one with a one inclusion ratio. The reverse QTIP election is treated as applying only to the trust with the zero inclusion ratio. In order to be eligible for this transition rule, a statement must be attached to a copy of the return on which the reverse QTIP election was made (i) indicating that an

47 6 B. Interest 1. In general. It is important to know who has an interest in a trust for GST Tax purposes because: (1) no taxable termination can occur as long as a non-skip person has an interest in the trust; and (2) a trust will not be a skip person for purposes of determining whether a direct skip has occurred as long as a non-skip person has an interest in the trust. In general, a person has an interest in trust property for GST Tax purposes if the person has a present right to receive income or principal from the trust. IRC 2652(c)(1)(A). In addition, a person has an interest in the trust if the person is not a charity and is a permissible current recipient of the trust income or principal. IRC 2652(c)(1)(B). Generally, a future interest is not an interest for GST Tax purposes except for certain future interests in charities, as discussed below. 2. Charities. Special rules apply to determine whether a charity has an interest in a trust for GST Tax purposes. A charity may have an interest in a trust for GST Tax purposes in two situations: (a) Charity has a present nondiscretionary right to receive income or principal from the trust. IRC 2652(c)(1)(A). Example: Charitable lead trust or a nonqualified charitable income trust. (b) Charity is the remainderman of a CRAT, CRUT or pooled income fund. Example: T creates a CRUT to pay a unitrust amount of 8% per year to GC, remainder to charity. The initial transfer to the trust is not a direct skip because the trust is not a skip person. However, the annual unitrust payments to GC will be taxable distributions. 3. Future interests are not interests for GST Tax purposes. IRC 2652(c)(1)(C). (Except the interest of a charity as remainderman of a CRAT, CRUT or pooled income fund.) 4. Interests inserted in the trust primarily to postpone or avoid tax will be disregarded. IRC 2652(c)(2). An interest is considered as used to postpone or avoid the GST tax if a significant purpose for the creation of the interest is to postpone or avoid the tax. Treas. Reg (f). 5. Support Obligations. Suppose T creates a trust for the benefit of GC, a minor. Trust principal can be used to discharge C s support obligation to GC. Before the GST final regulations were issued, there was a concern that C has an interest in the trust for GST Tax purposes, with the result that T s transfer to the trust is not a direct skip and no tax will be assessed until C s support obligation ceases. However, the final regulations clarify that an individual does not have an "interest" in a trust for GST Tax election is being made to treat the trust as two separate trusts and (ii) identifying the values of the two separate trusts. The statement must have been filed at the IRS office where the return was filed before June 24, 1996.

48 7 purposes merely because a support obligation of that individual may be satisfied by a distribution that is either within the discretion of a fiduciary or pursuant to a Uniform Gifts to Minors Act or equivalent statute. Treas. Regs (e)(2)(i). 6. Interest under a power of appointment. Suppose T creates a trust of which GC is the only permissible income and principal beneficiary but GC has a power to appoint the trust property among T s other descendants. Do the possible takers under the power of appointment have interests in the trust for GST Tax purposes? If the power of appointment is exercisable inter vivos, the answer may be yes. Possible takers under a testamentary power of appointment would not have an interest until the power was actually exercised. C. Skip Person; Non-Skip Person. 1. Skip Person. (a) In general. A skip person may be either a natural person or a trust. A natural person is a skip person if assigned to the second or more remote generation below the transferor. IRC 2613(a)(1). A trust is a skip person if either (a) all interests in the trust are held by skip persons or (b) no person holds an interest (for GST Tax purposes) in the trust and at no time after the transfer may a distribution be made to a non-skip person. IRC 2613(a)(2). (b) Examples. 1. T creates a trust of which his grandchild, GC, is the only permissible income and principal beneficiary, remainder to T s great-grandchildren. The trust is a skip person. 2. T creates a trust for GC in which the Trustee is directed to accumulate the income until age 21 and, thereafter, to pay the income to GC, remainder to GGC. At the time the trust is created, GC is age 20. The trust is a skip person because at the time of the transfer no person holds an interest in the trust for GST Tax purposes and at no time after the transfer may a distribution be made to a non-skip person. 3. Same as the trust in example (2), except that on GC s death, the trust property passes to GC s then living descendants or, if none, to T s then living descendants. The trust will not be treated as a skip person if the probability that a distribution may be made to a non-skip person (i.e., if GC dies without descendants) is 5% or more. See Treas. Regs (d)(2)(ii). 2. Non-Skip Person. (a) In general. A non-skip person is a person or trust which is not a skip person, that is, either (1) a natural person who is not assigned to the second or more

49 8 remote generation below the transferor or (2) a trust in which either (A) not all of the interests are held by skip persons or (B) no person holds an interest but in which a distribution may be made to a non-skip person. IRC 2613(b). (b) Examples. 1. T creates a sprinkle accumulation trust for C and C s descendants for the life of C, remainder to GC. The trust is not a skip person because not all interests in the trust are held by skip persons. 2. T creates a trust for C in which the Trustee is directed to accumulate the income until C attains age 30. At age 30, the entire trust principal is to be distributed to C. If C dies before attaining age 30, remainder to GC. The trust is a non-skip person because no person hold an interest in the trust at the time of the transfer but a distribution may be made to a non-skip person, C, if C survives to age T creates a trust to pay all income to GC, remainder to C. The trust is a skip person because C s remainder is not an interest for GST Tax purposes. 4. Same as example (3), except the remainderman is X Charity. The trust is a skip person because X Charity s remainder interest is not an interest for GST Tax purposes. 5. Same as example (4), except that GC s interest is a qualified annuity or unitrust interest. Under a special rule applicable to CRATs, CRUTs and pooled income funds, X Charity s remainder interest is a GST Tax interest and, therefore, the trust is a non-skip person. However, the annuity or unitrust distributions to GC will be treated as taxable distributions for GST Tax purposes. 3. Crummey Trusts. Suppose T establishes a trust for the benefit of his children and grandchildren in which he gives Crummey withdrawal rights to each of five grandchildren. An early Technical Advice Memorandum held that T s transfers to the trust constituted direct skips to the grandchildren holding Crummey withdrawal powers. TAM However, the regulations clarify that (a) a transfer to a trust subject to a right of withdrawal is treated as a transfer to the trust and not as a transfer to the holders of the withdrawal rights and (b) a transfer to a trust is only a direct skip if all interests in the trust are held by skip persons. Treas. Regs (f), Example 3. D. Trust 1. In general. The regulations provide that a trust includes any arrangement (other than an estate) that has substantially the same effect as a trust. Treas. Regs (b)(1). Therefore, a trust can include not only the traditional trust agreement but also arrangements involving life estates and remainders, estates for years and insurance and annuity contracts if the identity of the transferee is contingent upon the occurrence of an event. Id.

50 9 2. Example. T transfers cash to an UGMA or UTMA account in the name of T's child, C, as custodian for T's grandchild, GC, a minor. The transfer is treated as a transfer to a trust. Treas. Regs (b)(2), Example 1. The transfer should constitute a direct skip even if C may use the funds to defray a support obligation. See Treas. Regs (e)(2)(i). III. GENERATION ASSIGNMENT A. Purpose Generation assignments determine whether an individual is a skip person or a non-skip person. In turn, the determination of whether an individual is a skip person or a non-skip person determines whether there is a generation-skipping taxable transfer. B. Generation Assignment is based either on family relationship or age 1. Family Relationship. (a) A descendant of a grandparent is assigned to a generation by comparing the number of generations between the descendant and the grandparent and the number of generations between the transferor and the grandparent. IRC 2651(b)(1). (b) A present or former spouse of the transferor is assigned to the same generation as the transferor, regardless of the disparity between their ages. IRC 2651(c)(1). (c) A descendant of a grandparent of a spouse or a former spouse of the transferor is assigned to a generation by comparing the number of generations between the spouse and the grandparent with the number of generations between the descendant and the grandparent. IRC 2651(b)(2). (d) A present or former spouse of a descendant of either a grandparent or a spouse of a grandparent is assigned to the same generation as the descendant. IRC 2651(c)(2). (e) A legally adopted person is treated as a blood relative of the adopting parent. IRC 2651(b)(3)(A). (f) If an individual can be assigned to more than one generation under the above rules, he will be assigned to the youngest generation. IRC 2651(e)(1). 2. Age. Persons not assigned to a generation by family relationship are assigned based on age relative to the transferor. IRC 2651(d).

51 10 (a) Any person not more than 12-1/2 years younger than the transferor is assigned to the transferor s generation. IRC 2651(d)(1). (b) Any person more than 12-1/2 years younger but not more than 37-1/2 years younger is assigned to the first generation below the transferor. IRC 2651(d)(2). (c) Any person more than 37-1/2 years younger than the transferor is assigned to a second or succeeding generation below the transferor and, therefore, will be a skip person relative to the transferor. IRC 2651(d)(3). 3. Charities. Charities and governmental entities are assigned to the transferor s generation. IRC 2651(f)(3).

52 11 4. Chart Summarizing Generational Assignments. Generation Assignment Family Relationship Age Transferor's Generation Transferor; his Spouse; his Siblings and Their Spouses; and his Spouse's Siblings and Their Spouses; Charities and Governmental Entities One Generation Below the Transferor Two or More Generations Below the Transferor Transferor's and spouse's children, nephews, nieces and their spouses Transferor's and spouse's grandchildren, grandnephews, grandnieces and their spouses and more remote descendants and collaterals and their spouses Unrelated person who is not more than 12-1/2 years younger than the transferor Unrelated person who is more than 12-1/2 years younger but not more than 37-1/2 years younger than the transferor Unrelated person who is more than 37-1/2 years younger than the transferor. IV. TAXABLE TRANSFERS A. Taxable Terminations 1. In general. A taxable termination occurs when there is a termination of an interest in property held in trust unless: 1. immediately thereafter a non-skip person has an interest in the trust; or 2. no distribution 7 may thereafter be made to a skip person; or 3. a transfer subject to the federal estate or gift tax occurs at the time of the termination, with the result that there is a new transferor for the trust. IRC 2612(a)(1); Treas. Regs (b)(1). 2. Examples. 7 Other than a distribution the probability of which occurring is so remote as to be negligible, i.e., if there is less than a 5% probability that the distribution will occur. Treas. Reg (b)(1)(iii).

53 12 (a) T creates a trust to pay the income to C for life, remainder to GC. C s death is a taxable termination. See Treas. Regs (f), Examples 4 and 11. (b) T creates a trust to sprinkle income and principal among C, GC and GGC. Upon the death of C, the remaining trust property is to be distributed to GGC. Therefore, at C's death, both C's interest and GC's interest terminate. Before the final regulations were issued, it was unclear whether one or two taxable terminations occurred in this scenario. The final regulations clarify that only one taxable termination occurs. Treas. Regs (f), Example 8. B. Taxable Distributions A taxable distribution is any distribution from a trust to a skip person other than a taxable termination or a direct skip. IRC 2612(b). Example: T creates a trust in which the trustee is authorized to sprinkle the income and principal among C and GC. Any distribution of income or principal to GC during C's lifetime is a taxable distribution. 8 Treas. Regs (f), Example 10. (The distribution to GC at C's death would be a taxable termination.) C. Direct Skips A direct skip is a transfer to a skip person of property subject to the estate or gift tax. IRC 2612(c). Example 1: T gifts $1,000,000 to GC. The transfer is a direct skip subject to both gift and GST Tax. Example 2: T gifts $1,000,000 to a trust in which GC holds the only present interest. The transfer is a direct skip subject to both gift and GST Tax. D. Predeceased Ancestor Exception 1. Pre-1998 Law Prior to the Taxpayer Relief Act of 1997, under IRC 2612(c)(2), if a child of the transferor or of the transferor's spouse predeceased the transferor, that child s descendants are moved up one generation for purposes of determining whether a direct skip has occurred. 2. Post December 31, 1997 Law Under 511 of the Taxpayer Relief Act of 1997, old section 2612(c) was repealed. In its place was enacted 2651(e), which creates an expanded predeceased 8 If the distribution is from income, an income tax deduction is available for the GST Tax paid. IRC 164(a)(4); 164(b)(4).

54 13 ancestor exception. Under 2651(e), effective for generation-skipping transfers made after December 31, 1997, for purposes of determining whether any transfer is a GST transfer, if (a) an individual is a descendant of a parent of the transferor or a descendant of a spouse or former spouse of the transferor and (b) such individual s parent who is a descendant of the parent of the transferor or a descendant of a spouse or former spouse of the transferor is dead at the time the transfer is subject to estate or gift tax, then (c) the individual is moved up to the lower of (i) one generation below the transferor or (ii) the generation assignment of the individual s youngest living ancestor who is also a descendant of such parent. This predeceased parent exception does not apply to nieces and nephews of the transferor unless the transferor has no descendants at the time of the transfer. Also, for purposes of the predeceased parent rule, an individual who dies no later than 90 days after a transfer occurring by reason of the death of the transferor will be treated as having predeceased the transferor. Treas. Reg (a)(2)(iii). Example 1: T s daughter, C, predeceases T, leaving GC surviving. Under both old section 2612(c) and new 2651(e), T s gift of $1,000,000 to GC will be treated as a taxable gift for gift tax purposes but will not be treated as a direct skip for GST Tax purposes. Example 2: T establishes an irrevocable trust providing for income to be paid to GC for 5 years. At the end of the 5 year period, the trust terminates and the trust is distributed to GC. T's child, C, who is GC's parent, was deceased at the time of the transfer to the trust. Therefore, under both the old and the new law, GC is treated as a child of T rather than a grandchild and the initial transfer to the trust is not a direct skip. In addition, any distributions from the trust to GC will not be taxable distributions. Treas. Regs (c), Example 1. Example 3: Same facts as Example 2 above, except that T's spouse, S, is also an income beneficiary of the trust. Since S has an interest in the trust, the trust is not a skip person and the transfer is not a direct skip. Under 2651(e), the distribution to GC at the end of the trust term will not be a taxable termination. Example 4: Reverse QTIP Problem: T's Will establishes a reverse QTIP Trust for the benefit of S, remainder to T's child, C, if C is then living, otherwise to T's grandchild, GC. T dies survived by S, C and GC. C later dies and then S dies, with the result that the remainder passes to GC. The regulations provide that the predeceased parent exception does not apply because C was not deceased at the time the trust was subject to estate tax in the estate of the transferor. Treas. Reg (a)(3). If the reverse QTIP election had not been made, the predeceased parent exception would apply. Id. Example 5: Collateral Heirs: T transfers $1,000,000 to his brother's grandchild, GN on January 1, T's brother is deceased. If T has no living descendants on January 1, 2014, the transfer is not a direct skip. If T does have living descendants on January 1, 2014, the transfer is a direct skip.

55 14 Example 6: 90 Day Rule: T s will bequeaths his estate to his child, C, provided that C survives T by 90 days. If C does not survive T by 90 days, T s estate passes to his grandchild, GC. T dies. C dies 89 days later. The bequest to GC is not a direct skip. E. GST Annual Exclusion/ GST Med-Ed Exclusion 1. GST Annual Exclusion. (a) A direct skip to an individual that qualifies for the gift tax annual exclusion, while not technically exempt from the GST Tax, will have an inclusion ratio of zero, with the result that no GST Tax is imposed. IRC 2642(c). (b) A direct skip to a trust that qualifies for the gift tax annual exclusion will not have a zero inclusion ratio unless (i) the trust is exclusively for one beneficiary during that beneficiary s lifetime and (ii) the trust will be includible in the beneficiary s gross estate if he dies before termination of the trust. IRC 2642(c)(2). 2. GST Med-Ed Exclusion. (a) A direct skip transfer which qualifies for the gift tax exclusion for direct payments of certain medical or education expenses, while not technically exempt from the GST Tax, will have an inclusion ratio of zero, with the result that no GST Tax is imposed. IRC 2642(c)(3). (b) Likewise, a transfer from a trust is not a taxable distribution if it would qualify for the gift tax medical/education expense exclusion if made by an individual. IRC 2611(b)(1). i. Example 1: T creates a trust for the benefit of C and GC, remainder to GC. Direct payment to the provider by the Trustee for GC s qualified medical or educational expenses would not be a taxable distribution from the trust. If the Trustee makes the payments to GC to be used for educational or medical expenses, the distributions would be taxable distributions. ii. Example 2: T creates a trust for the sole benefit of his five grandchildren, remainder to great-grandchildren. Although the Trustee s direct payment of qualified educational or medical expenses would qualify for the GST med/ed exclusion, there would be no need to use the exclusion: Because the initial transfer to the trust would be a direct skip, subsequent distributions from the trust to grandchildren would not be taxable distributions under the transferor move-down rule described earlier in this outline. (Under the same principle, however, if distributions to greatgrandchildren were permitted, these would be treated as taxable distributions.) F. Gallo Exclusion- Expired