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Generation-Skipping Transfer Tax (Portfolio 850)

Product Code: TPOR42
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Generation-Skipping Transfer Tax discusses the generation-skipping transfer tax, enacted as chapter 13 of the Internal Revenue Code by the Tax Reform Act of 1986.

Written by Carol A. Harrington, Esq., McDermott, Will & Emery LLP, this Portfolio analyzes the generation-skipping transfer tax that is imposed on transfers, whether outright or in trust, to a transferee who is at least two generations below the transferor's generation. The tax is a flat rate equal to the maximum estate tax rate at the time of the transfer, subject to the allocation of the GST exemption available for each transferor.

This Portfolio explains the background of chapter 13, key terms, rules for allocating GST exemption, rules for separate shares and trusts, tax computation and liability rules, administration of the tax, and the coordination of the tax with other Code provisions. Generation-Skipping Transfer Tax also discusses the history of the tax and the effective date and transitional rules. Examples are used to illustrate and discuss various issues.

The 2001 Tax Relief Act repealed the generation-skipping transfer tax for generation-skipping transfers made in 2010, although it is widely expected that this repeal will be reversed. After 2003, the GST exemption amount increased in tandem with the estate tax exemption amount and, beginning in 2002, the GST tax rates gradually decreased, making planning more challenging during this transition period.

Generation-Skipping Transfer Tax allows you to benefit from:

  • Hundreds of hours of original research on specific tax planning topics from leading practitioners in this area
  • Invaluable practice documents including tables, charts and lists
  • Plain-English guidance from world-class experts
  • Real-world and in-depth analysis that lets you explore various options
  • Time-saving access to relevant sections of tax laws, regulations, court cases, IRS documents and more
  • Alternative approaches to both common and unique tax scenarios

This Portfolio is part of the Estates, Gifts and Trusts Portfolios Library, a comprehensive series containing more than 80 Portfolios, which covers critical transactions in estate, gifts and trusts planning. This highly-regarded resource library offers commentary on a wide range of estate planning topics including: Generation Skipping Tax, Family Limited Partnerships, Charitable Remainder Trusts, Estate Planning for Closely-Held Businesses, Exempt Organizations and Private Foundations, Life Insurance, Valuation, and more.

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Detailed Analysis

I. Background and Overview of the Generation-Skipping Transfer Tax

Introductory Material

A. The Law Before the Tax Reform Act of 1986

1. Pre-1976 Attempts at Reform

2. Tax Reform Act of 1976

3. Chapoton's Letter and Subsequent Bills

B. The Tax Reform Act of 1986 and the Law Thereafter

1. Legislation from 1988 to 1998

2. The 2001 Economic Growth and Tax Relief Reconciliation Act

3. Regulations, Revenue Rulings and Procedures

C. Major Differences Between the 1976 and 1986 Chapter 13

D. Overview of Chapter 13

II. Transferor, Interest, Skip and Non-Skip Person, Trust

Introductory Material

A. Transferor

1. Changes in the Transferor

2. Remainder Interests Subject to Transfer Tax

3. Gift-Splitting

4. Transferor of Qualified Domestic Trust Property

5. Transferor and Lapsing Powers of Withdrawal

6. Transferor - Non-Lapsing Powers of Withdrawal, General Powers

7. Multiple Skips - The Transferor Move-Down Rule

8. Exercise of Limited Powers of Appointment

B. Transferor - The Reverse QTIP Election

1. The “No Partial Reverse QTIP” Rule

2. The Necessity of a Separate Reverse QTIP Trust

C. Adverse Effects of Making a Reverse QTIP Election for a Trust with an Inclusion Ratio Greater Than Zero

1. More Tax Paid

2. Predeceased Ancestor Exception Unavailable

3. Splitting a Single QTIP Trust

4. Lifetime Reverse QTIP Trust

5. Making a Late Reverse QTIP Election

D. Interest

1. Charities

2. Future Interests

3. Interests Used to Postpone Tax

4. Powers of Appointment

5. Powers of Withdrawal

6. Discretionary and Conditional Payments

7. Support Obligations

8. Effect of Survivorship Clauses on Interests

E. Skip Persons, Non-Skip Persons

1. Skip Persons

2. Non-Skip Persons

3. Trusts Subject to Powers of Withdrawal in a Skip Person

F. Trusts

1. Definition

2. Survivorship Provisions

3. Trust Arrangements

G. Separate Shares and Separate Trusts

H. Definition of Executor

III. Generation Assignment

Introductory Material

A. Assignments Based on Family Relationships

B. Assignments to More Than One Generation

C. Assignments Based on Age

D. Effect of Adoption

E. Look-Through Rule

F. Certain Charities and Governmental Entities

IV. Taxable Transfers

Introductory Material

A. Taxable Terminations

1. Terminations Subject to Estate or Gift Tax

2. Partial Terminations

3. Simultaneous Terminations of Multiple Interests

4. Contingent Remainder Interests in Skip Persons

B. Taxable Distributions

1. Time That Taxable Distribution Occurs

2. Multiple Skips

3. Payment of Generation-Skipping Tax by Trustee

4. Potential Overlap with Taxable Terminations

C. Direct Skips

1. Transfers to Trusts with Withdrawal Rights in a Skip Person

2. Multiple Skips

3. Payment of Direct Skip Tax Treated as a Gift

D. Loans and Assignments

1. Loans

2. Assignments

E. Survivorship Provisions

F. Taxable Transfer Exceptions and Exclusions

1. Predeceased Ancestor Exception

a. Predeceased Ancestor Exception for GST Transfers Before 1998

b. Predeceased Ancestor Exception for GST Transfers in 1998 and Thereafter

c. Death of Ancestor Within 90 Days of the Transfer

d. Application to Collaterals

2. Exclusion for Certain Medical and Educational Payments

3. “Annual Exclusion” for Generation-Skipping Transfers

a. Outright Direct Skips

b. Direct Skips to Trusts

4. Transfers to 529 Accounts

5. Grandchild Exclusion (Gallo) for Direct Skips

6. Transfers Subject to a Prior Tax

V. GST Exemption and Inclusion Ratio

A. The GST Exemption

B. Inclusion Ratio, Tax Rate

1. Applicable Fraction

2. Effect of Expenses on Applicable Fraction

3. Recomputing the Applicable Fraction and Inclusion Ratio

a. Determining a New Transferor

b. Qualified Severance

c. Additional Transfers to a Trust

d. Allocating Additional GST Exemption

e. Adjustment for Payment of Generation-Skipping Tax

f. Imposition of § 2032A Recapture Tax

4. Changes to a Trust with a Zero Inclusion Ratio

C. Planning to Achieve Inclusion Ratios of Zero and One

D. Time for Allocating

E. Lifetime Automatic Allocation of GST Exemption to Direct Skip Transfers

F. Lifetime Automatic Allocation of GST Exemption to Indirect Skips After 2001 Act

1. In General

2. Definition of GST Trust

3. Electing In or Out of Automatic Allocation

4. Late Allocations During Life and the Automatic Allocation Rules

G. Automatic Allocation of GST Exemption At Death

H. Time from Which Allocation of GST Exemption Is Effective

1. In General

2. Effective Date for Automatic Allocation at Death to Trusts Not Included in Gross Estate

I. Allocation of GST Exemption to Lifetime Gifts

1. Timely Allocations

2. Late Allocations

3. Late Allocations Treated as if Timely - 9100 Relief and Retroactive Allocations

4. Intentionally Allocating Late to Non-Skip Person Trusts and Non-GST Trusts

J. Lifetime Transfers - Trusts Subject to Lapsing Powers of Withdrawal (Crummey Trusts)

1. Consider GST Exemption Allocation

2. Intentionally Allocating Late to Irrevocable Insurance Trusts

K. Lifetime Transfers - Estate Tax Inclusion Period (ETIP) Rules

L. Lifetime Transfers Regulations' Spousal ETIP Rules

1. Regulations' Definition

2. Exceptions

a. Reverse QTIP Trusts

b. So Remote as to Be Negligible Exception

c. Spouse's Power to Withdraw

3. Spouse's Withdrawal Power That Does Not Qualify for the 5-and-5, 60-Day Exception

4. Split Gifts Subject to an ETIP

M. Allocations at Death

1. Allocation by Executor

2. Automatic Allocation after Death

N. Transfers at Death - Valuation Issues

O. Transfers at Death - Regulations' Special Rules for Valuation Used in Determining the Inclusion Ratio

1. Special Rule for Pecuniary Payments

2. Special Rule for Residual Transfers After Payment of a Pecuniary Amount

3. Appropriate Interest

P. Transfers at Death - Analysis of Various Common Formulas Under the Regulations

1. Appropriate Interest on Pecuniary Gifts

2. Pecuniary GST Exemption Gift with Funding at FET Values

3. Pecuniary GST Exemption Gift Funded at Date of Distribution Values

4. Fractional Share Bequests

5. Residuary GST Exemption Gift Following a Pecuniary Bequest Funded at Date of Distribution Values

6. Minimum Worth Formulas

7. Formula Bequest of a Specific Asset Equal to the Unallocated GST Exemption

Q. Transfers at Death - Payment of Taxes on Reverse QTIP Trust

R. Transfers at Death - Special Use Value

S. Inclusion Ratio of Lifetime Trust Included in the Transferor's Gross Estate

T. Inclusion Ratio for Charitable Split-Interest Trusts

1. In General

2. Charitable Remainder Trusts, Pooled Income Funds

3. Charitable Lead Unitrusts

4. Inclusion Ratio for Charitable Lead Annuity Trusts

U. Grantor Retained Annuity Trusts (GRATs) and Qualified Personal Residence Trusts (QPRTs)

1. Remainder to Living Children

2. Remainder to Deceased Child's Estate

3. Separate Trust for Each Child

4. Revert to the Transferor or Spouse

V. Finality of Value for Chapter 13

1. Values as Finally Determined for Estate and Gift Tax Purposes

2. Regulations Regarding Direct Skips

3. Regulations Regarding Other Generation-Skipping Transfers

W. Perpetual Trusts

1. Choosing Governing Law

2. Exercising Powers of Appointment

VI. Separate Shares and Separate Trusts; Splitting Trusts and Other Restructuring

Introductory Material

A. Background

B. Qualified Severances

1. No Downstream Split Rule

2. Proposed Regulations for Qualified Severance

3. Final Regulations and Additional Proposed Regulations

4. Methods of Severing Trusts for Qualified Severance

C. Separate Shares and Separate Trusts - Regulations Issued Under § 2654

1. Separate Share Rule

a. In General

b. Pecuniary Payments

2. Trusts with Multiple Transferors

3. Separate Trusts Allowed by Regulations

a. Mandatory Severances

b. Discretionary Severances

c. Non Pro Rata Funding Allowed

d. Terms of Severed Trusts

e. Other Requirements

f. Validity of Separate Share Regulations

D. Mechanics of a Trustee Split Under § 2654 Regulations

E. Restructuring Alternatives and Issues

F. When Splitting May Not Be Appropriate

G. Splitting Trusts Included in the Gross Estate

1. Trustee Splits Through Exercise of Discretionary Fiduciary Powers

a. Power to Split Granted in the Governing Instrument

b. Power to Split Granted under Applicable State Statute

2. Reformations

a. Reformations to Split Trusts

b. Reformations for Other Changes

3. Suit for Construction

4. Family Settlement Agreements

5. Splits Without Authority

6. Release of Powers

7. Qualified Disclaimer by a Beneficiary

a. Time Period for Disclaiming

b. No Acceptance of Benefits

c. Passage Without Direction by the Disclaimant to Spouse or Person Other than Disclaimant

d. Partial Disclaimers

e. Using Qualified Disclaimers

8. Nonqualified Disclaimers

H. Special Transitional Rule Treating QTIP Trust as Two Separate Trusts

I. Drafting Documents to Allow Splitting of Trusts

VII. Computation of the Tax and Liability

A. Tax Rate

B. Tax Base and Liability

1. Taxable Terminations

2. Taxable Distributions

3. Direct Skips

4. Direct Skip Tax Paid on Gifts Made Within Three Years of Death

C. Source

D. Valuation

E. State GST Tax Issues

1. Credit for State GST Taxes

2. “Decoupled” State GST Taxes

F. Choosing Direct Skips

1. Planning and Drafting

2. Allocating GST Exemption Between Direct Skips and Taxable Terminations

G. Choosing Chapter 11 or 12 Instead of Chapter 13

1. Rates

2. State Death, GST Taxes

3. Applicable Exclusion Amount, Annual Exclusion

4. Credit for Tax on Prior Transfers

5. Marital Deduction Benefits

6. GST Exemption

7. Transfers to Same or Higher Generations, Double Skips

8. Other Considerations

VIII. Administration, Returns, 9100 Relief and Other Procedural Issues

A. Administration

B. Return Requirements

1. Due Dates in General

2. Special Due Dates

3. Special Rule for Trust Arrangements

4. Place for Filing

C. Return Forms

1. Form 709

2. Form 706

3. Forms 706GS(D), 706GS(D-1), 706GS(T)

D. Mechanics of Preparing Tax Returns

1. Relying on the Automatic Allocation Rules

2. Electing In or Out of the Automatic Allocation Rules on Form 709

3. Reporting a Qualified Severance

4. Formula and Conditional Allocations

5. Payment of Direct Skip Tax Treated as a Gift, Form 709

6. Making the Reverse QTIP Election

7. Dividing Direct Skips Between Schedule R and R-1, Form 706

8. Dividing Direct Skips Between Part 2 and Part 3 of Schedule R, Form 706

9. Allocating GST Exemption to Direct Skips in Trust, Form 706

10. Priority of Allocation, Form 706

11. Mental Disability on October 22, 1986, Form 706

E. 9100 Relief

1. Automatic Six-month Extension for Statutory Elections

2. 9100 Relief for Allocating GST Exemption

3. Requesting a Discretionary Extension for Regulatory Elections

a. Acted Reasonably and in Good Faith

b. No Prejudice to the Government

4. Miscellaneous

5. Simplified Procedures for 9100 Relief

a. Annual Exclusion Transfers-Rev. Proc. 2004-46

b. Reverse QTIP Elections at Death - Rev. Proc. 2004-47

F. Discharge from Personal Liability, Closing Letters

IX. Coordination with Other Code Sections

A. Disclaimers

B. Income Tax Deductions for Generation-Skipping Taxes on Income Distributions

1. Deduction for GST Tax Paid

2. Income in Respect of a Decedent

C. Redemption of Stock to Pay Death Taxes

D. Extension of Time to Pay Tax

E. Basis Adjustment for Property Received from a Decedent for GST Tax Paid

F. Alternate Valuation

G. Special Use Value

H. Payment of Direct Skip Tax Treated as a Gift

I. Definition of Executor

J. Qualified Domestic Trust (QDOT)

K. Chapter 14

X. Application to Nonresident Aliens

A. Statutory Provisions Regarding Nonresident Aliens

1. Chapter 13 Provisions

2. Estate and Gift Tax Principles

B. Regulations

1. Direct Skips

2. Taxable Distributions and Taxable Terminations

3. Trusts Funded with U.S. and Non-U.S. Property

4. ETIP for NRA Transfers

5. Transitional Rule

C. Planning for NRAs

XI. Effective Dates and Transitional Rules

A. Repeal of 1976 Chapter 13

B. Effective Date of Chapter 13

C. Regulations

D. Retroactive Effect

E. Transfers Before the Effective Date

F. Trusts Irrevocable on September 25, 1985 (Effective Date Irrevocable Trusts)

1. Trusts “Revocable” Under § 2038

2. Trusts “Revocable” Under § 2042

3. QTIP Trusts

4. Additions to Irrevocable Trusts

a. Pro Rata Taint

b. What Is an Addition

c. Computation of the “Taint”

5. Constructive Additions

a. General Rule

b. Exercise of Limited Powers

c. Effective Date Trusts Subject to Lapsing Withdrawal Rights

d. Appreciation and Accumulations of Income

e. Additions from Other Trusts

6. Payment of Liabilities

G. Transitional Rules - Persons Dying Before January 1, 1987

1. No Creation or Increase After October 22, 1986

2. Administrative or Clarifying Changes

3. Net Effect Is Considered

4. Same Transfer Would Have Occurred Under a Grandfathered Document

5. Additions, Treatment of QTIP Trusts

H. Mental Disability on October 22, 1986

1. Definition of Mental Disability

2. Claiming the Exemption

3. Additions to Mental Disability Trusts

I. Disclaimers of Interests in Effective Date Trusts

J. Reformations of and Other Changes to Effective Date Trusts

1. Private Letter Ruling Test

2. Applying the Private Letter Ruling Test

a. Partitions

b. Mergers and Consolidations

c. Resolution of Ambiguities

d. Administrative Changes

e. Change of Trust Situs

3. 2000 Regulations Regarding Changes to Effective Date Trusts

a. Trustee's Discretionary Powers

b. Court-Approved Settlements

c. Judicial Construction

d. Other Changes

(1) Shift of Beneficial Interest

(2) Extending the Time for Vesting of Beneficial Interests

(3) Partition of Discretionary Trust

(4) Shift of Beneficial Interest to Same or Higher Generation

(5) Merger

(6) Administrative Changes

(7) State Law Changes Regarding Principal and Income

e. Change of Trust Situs

f. Failure to Meet Any Safe Harbor

g. Effect of Loss of Exempt Status

h. Effective Date

i. Income Tax Issues

j. Validity of IRS Position Regarding Changes to Effective Date Trusts

K. Grandchild (Gallo) Exclusion for Direct Skips

L. Election to Qualify for Grandchild Exclusion

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Working Papers

Table of Worksheets

Worksheet 1 Husband's Revocable Self-Declaration of Trust with Generation-Skipping Provisions

Worksheet 2 Husband's Pourover Will for Use with Revocable Trust

Worksheet 3 Wife's Revocable Self-Declaration of Trust with Generation-Skipping Provisions

Worksheet 4 Wife's Pourover Will for Use with Revocable Trust

Worksheet 5 Alternate Provision for Single Fund Family GST Exempt Trust

Worksheet 6 Alternate Provision for Trustee's Power to Grant General Power of Appointment over Nonexempt Trust

Worksheet 7 Sample Language Relating to Trustee's Power to Split Trusts

Worksheet 8 Family Generation Assignment Flowchart

Worksheet 9 Examples of Federal Transfer Tax Costs

Worksheet 10 General Explanation of the Tax Reform Act of 1986, prepared by the Staff of the Joint Committee on Taxation (May 4, 1987)

Worksheet 11 House Ways and Means Committee Report to Accompany H.R. 4333, The Technical and Miscellaneous Revenue Act of 1988, H.R. Rep. No. 795, 100th Cong., 2d Sess. (July 26, 1988)

Worksheet 12 Form 706, Schedules R and R–1, Generation–Skipping Transfer Tax (Estate Tax Return)

Worksheet 13 Sample Attachments to Form 706 and Schedule R for Division of Marital Trust, Reverse QTIP Election and Allocation of GST Exemption

Worksheet 14 Form 706-GS(D), Generation-Skipping Transfer Tax Return for Distributions

Worksheet 15 Form 706-GS(D-1), Notification of Distribution From a Generation-Skipping Trust

Worksheet 16 Form 706-GS(T), Generation-Skipping Transfer Tax Return For Terminations

Worksheet 17 Form 709 - Timely Filed Return, Election In

Worksheet 18 Form 709 - Late Allocation, Election Out

Worksheet 19 Form 709 - Late Allocation to Insurance Trust

Worksheet 20 Sample Form 709 - Allocation of GST Exemption at End of ETIP

Worksheet 21 Sample Qualified Severance

Bibliography

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Regulations:

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Treasury Rulings:

Cases:

UNOFFICIAL

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Carol A. Harrington
Carol A. Harrington, B.S., summa cum laude, University of Illinois; J.D., magna cum laude, University of Illinois Law School; Section of Real Property, Probate and Trust Law, American Bar Association: Section Council, 1992–1996, Chair, Committee on Generation-Skipping Transfers: Legislation and Regulations, 1987–1992; Fellow, American College of Trust and Estate Counsel, Board of Regents 1999-2005; member, Illinois State Bar Association; member, Trust Law Committee, Chicago Bar Association; co-author, Harrington, Plaine & Zaritsky, Generation-Skipping Transfer Tax, Warren, Gorham & Lamont (2001); contributor to various legal publications on estate planning matters and lecturer at various tax and estate planning institutes.