5A: Generation-Skipping Transfer Tax Issues

This chapter1 discusses selected key generation-skipping transfer (GST) tax issues concerning life insurance.

The GST tax is one of the most complicated provisions of the federal transfer tax system, and probably one of the least understood by practitioners who do not practice in the GST tax area on a frequent basis. The application of the GST tax exemption to an ILIT is important because of the insured’s ability to leverage the transferor’s GST exemption through the use of life insurance. The amount of GST tax exemption that generally needs to be allocated to an ILIT is small in comparison to the huge reward that is reaped when the insured dies and the ILIT receives the policy death benefits. This makes the ILIT an attractive candidate for dynasty trust treatment. The GST tax also impacts a beneficiary’s right to withdraw gifts that are made to the ILIT. For example, if the beneficiary dies before the withdrawal right lapses, there may be a GST tax event, which could cause a conflict with the grantor’s structure of the trust for transfer tax purpose. This chapter discusses these potential beneficiary-caused GST tax traps and how to avoid them.

In the ILIT context, there are several key GST tax issues that the advisor should note:

  • The fact that a Crummey withdrawal right gift may qualify for the gift tax annual exclusion does not mean that the gift is automatically GST tax exempt. Because there is a disconnect between the gift tax annual exclusion under IRC section 2503(b) and the GST rules, GST tax exemption may still need to be allocated to the ILIT.
  • If the spouse is a beneficiary of an ILIT, the spouse’s Crummey withdrawal right should be limited to the five-by-five safe harbor amounts of IRC section 2514 and 2041, and the right of withdrawal must lapse no later than 60 days after the date of the transfer that creates the withdrawal right.
  • Every ILIT is possibly subject to the indirect skip rules that came into existence under the 2001 Tax Act. A decision must be made to either opt in or opt out of those rules.

5A.1 BRIEF OVERVIEW OF THE GST TAX

Before the existence of the GST tax, many wealthy families transferred property to their descendants in trust rather than outright. At each subsequent death, the beneficiary’s life estate was not includable in the beneficiary’s gross estate, and for succeeding generations, the family’s wealth went untaxed. The GST tax was designed to stop this tax-free transmission of wealth. The GST tax was initially adopted in 1976 and then replaced in its entirety with a new set of GST tax rules in 1986. The 1976 version of the GST tax was overly complicated. A lack of understanding, inability by the IRS to devise appropriate GST tax reporting forms, and scattered compliance all led to the demise of the original version of the GST tax. The 1986 version of the GST tax (as amended) is still in effect at this time (but will be repealed for calendar year 2010, and then reinstated on January 1, 2011). The GST tax is set forth in Chapter 13 of the Internal Revenue Code of 1986 (as amended), and is structured on a series of defined terms, many of which are discussed below. The purpose of the GST tax is to prevent the dynastic accumulation of inherited wealth that can occur when multiple generations of a transferor’s family are benefited by property transfers that are not subject to additional estate taxation at each succeeding generation. Simply put, Congress wants to ensure that significant wealth transferred to a person’s descendants (or transferees) is eventually taxed, even though the transferred wealth is insulated from successive estate or gift taxation. The imposition of the GST tax occurs at generations that are two or more below that of the transferor, such as the transferor’s grandchildren or more remote descendants.

Example: An individual dies leaving a credit shelter trust for the surviving spouse. After the death of the surviving spouse, the balance of the credit shelter trust, which is not GST tax exempt, is payable outright to the transferor’s descendants, per stirpes. Six months after the transferor’s death, the transferor’s son dies leaving surviving issue. Upon the death of the transferor’s surviving spouse, the trust distribution to the deceased son’s issue will be subject to the GST tax, as a taxable termination.

Example: After the surviving spouse’s death, the balance of the credit shelter trust, which is not GST tax exempt, remains in trust for the benefit of the transferor’s descendants for as long as is permitted under the rule against perpetuities. At the death of each descendant, as his or her interest passes to the next generation, that interest in the trust generally escapes estate tax, but is instead subject to the GST tax.

5A.2 GENERATION-SKIPPING TRANSFER DEFINED

The following events constitute a generation-skipping transfer: (1) a taxable termination; (2) a taxable distribution; or (3) a direct skip. IRC section 2611(a). An outright transfer to an individual who is a skip person that qualifies for the gift tax annual exclusion under IRC section 2503(b) does not constitute a GST event. Also, a transfer under IRC section 2503(e) (concerning direct payment of medical expenses and tuition) does not constitute a GST event; nor does any transfer: (1) to the extent the property transferred was subject to a prior GST tax; (2) the transferee in the prior transfer was assigned to the same generation as (or a lower generation than) the generation assignment of the transferee in the current transfer; and (3) the current transfer does not have the effect of avoiding the GST tax with respect to any transfer. IRC section 2611(b).

Practice Point: Certain transfers from trusts or wills that were executed before a certain date are not subject to the GST tax. Treas. Reg. §26.2601-1. See, section 5.24, below. However, a modification of such instrument or an addition (including a constructive addition) to such trust may cause the trust to lose its GST grandfathered status. See, section 5.25, below.

5A.3 TAXABLE TERMINATION DEFINED

A taxable termination is the termination (by death, lapse of time, release of a power, or otherwise) of a beneficiary’s interest in property held in a trust2 (such as a life estate) where immediately after the termination, there is no person who has an interest3 in the trust property other than a skip person, or after the termination, no distribution may be made from the trust to a non-skip person. IRC section 2612(a). A taxable termination does not occur if, at the time of the termination of the beneficiary’s interest, a transfer of the trust property occurs and that transfer is subject to estate or gift tax (such as the trust property’s being includable in the beneficiary’s gross estate because he or she has been granted a testamentary general power of appointment over the non- GST tax-exempt trust property). A taxable termination can occur only from a trust (or a trust arrangement). A taxable termination cannot occur from a probate estate.4 Thus, a taxable termination of a trust is when all interests of non-skip persons come to an end. Because the GST tax is levied on the termination of any interest in trust property, a taxable termination can occur on more than one occasion. For example, if T creates a trust to pay income for life to T’s child (C) for life, then to T’s grandchild (GC) for life, with distribution of the remainder to T’s great grandchild (GGC), two taxable terminations will occur—one when C dies, and one when GC dies. The severity of taxable terminations underscores the need for transferors to allocate GST tax exemption to trusts that are intended to benefit skip persons.

Practice Point: A non-skip person’s interest in a trust that is used primarily to postpone or avoid any GST tax is disregarded for GST tax purposes. IRC section 2652(c)(2). An interest is considered so used if a significant purpose for the creation of the interest is to postpone or avoid the GST tax. Treas. Reg. §26.2612-1(e)(2)(ii). The interest to be disregarded does not have to be nominal.

Practice Point: A charity’s interest in a trust will not avoid a taxable termination if (i) the charity’s interest is discretionary, or (ii) the charity’s interest is a separate share that existed at all times from the creation of the trust (or results from a qualified severance), or (iii) the charity’s interest is used primarily to postpone or avoid the GST tax. Treas. Reg. §§26.2612-1(e)(1)(ii), 26.2612-1(e)(2)(ii), and26.2654-1(a).

5A.3(a) Amount Of GST Tax Attributable To A Taxable Termination

The amount of the taxable termination that is subject to GST tax is described in IRC section 2622. Since the GST tax is paid from the property giving rise to the taxable termination, the tax is similar to the tax-inclusive nature of the estate tax, i.e., the dollars used to pay the GST tax are subject to the GST tax. Because, the GST tax is calculated on a tax-inclusive basis, this has the effect of approximating the result of the property being subject to estate tax in the estate of the skipped person. The trustee of the trust is liable for paying the GST tax, which is paid from the assets giving rise to the taxable termination. IRC section 2603(a)(2); Treas. Reg. §26.2662-1(c)(1)(ii).

5A.3(a)(1) Meaning Of Tax-Inclusive Basis

Being on a “tax-inclusive” basis means that GST tax is paid not only on the transfer giving rise to the GST tax but also on the GST tax actually paid as a result of the transfer—a tax on a tax. In other words, the dollars used to pay the GST tax are subject to the GST tax and are part of the transferred property’s tax base. At the 50% tax rate, the cost in transfer taxes (gift tax and GST tax) for an intervolves direct skip is “only” 125% of the amount actually received by the skip person, which is the least costly method of making taxable GSTs (see, example below). This is because an intervolves direct skip is taxed on a tax- exclusive basis, with the transferor responsible for paying the tax. Being on a tax-exclusive basis means that the GST tax is paid only on the transferred property and not on the dollars used to pay the GST tax. However, because of the tax-inclusive nature of the federal estate tax, direct skips at the transferor’s death, direct skips from a trust, taxable distributions, and taxable terminations from trusts created during the transferor’s lifetime generally result in transfer taxes of 200% of the amount actually received by the skip person. The most expensive forms of GST transfers are taxable terminations or taxable distributions occurring from trusts established at the transferor’s death that are subject to federal estate tax. In those instances, the total transfer tax cost (at a 50% GST and 50% federal estate tax rate) to transfer $1 million to a skip person is 300% of the amount actually received by the skip person, to wit, $4 million devise X .50 (FET Rate) = $2 million X .50 (GST Rate) = $1 million net to skip person. Example (Direct Skip During Transferor’s Lifetime): Grandfather makes an inter vivos transfer gift of $1 million to his grandchild. No applicable exclusion amount credit and no GST tax exemption are available for allocation to the gift. The total cost of the transfer will be $2.25 million. Transfer taxes will total $1.25 million, computed as follows:

Gift tax on $1 million gift = $500,000 (Paid by grandfather)
GST tax on $1 million gift = $500,000 (Paid by grandfather)
Gift tax on $500,000 GST tax = $250,000 (Paid by grandfather)
Total transfer taxes = $1,250,000

Total transfer taxes ($1.25 million) amount to 125% of the amount ($1 million) gifted to the skip person. Thus, it will take $2.25 million to transfer $1 million to the grandchild. (The GST tax paid by grandfather will be removed from the grandfather’s death-time taxable estate, as will the gift tax paid by the grandfather [assuming he lives for more than 3 years after the gift (IRC section 2035(b))], ultimately saving 50% of the lifetime transfer taxes paid.)

Example (Direct Skip At Transferor’s Death): Grandfather devises $1 million to his grandchild. No applicable exclusion amount credit and no GST tax exemption is available for allocation to the devise. The total cost of the transfer will be $3 million. The formula is: [$1 million (devise) + $500,000 (GST tax)]/1-.50 (where .50 is the applicable federal estate tax rate) = $3 million (in other words, to be able to pay $1 million plus the $500,00 GST tax ($1.5 million), it is necessary to start with twice that amount because of the 50% estate tax). Transfer taxes (estate and GST taxes) will total $2 million, which amounts to 200% of the amount ($1 million) transferred to the grandchild. Thus, it will take $3 million to transfer $1 million to the grandchild.

Example (Taxable Termination From Trust Established During Transferor’s Lifetime): Grandfather gifts $2 million in trust with income only to his only son and remainder to his sole grandchild. The grandfather desires the grandchild to receive $1 million net of all transfer taxes. No applicable exclusion amount credit and no GST tax exemption are available for allocation to the intervolves gift. The total cost of the transfer taxes will be 200% of the $1 million amount received by the grandchild. The total cost of the transfer will be $3 million. Transfer taxes will total $2 mil- lion, computed as follows:

Gift tax on $2 million gift = $1,000,000 (Paid by grandfather)
GST tax on $2 million termination = $1,000,000 (Paid from the gifted funds)
Total transfer taxes = $ 2,000,000

Total transfer taxes ($2 million) amount to 200% of the amount ($1 million) received by the skip person. Thus, it will take $3 million to transfer $1 million to the grand- child. (The gift tax paid by the grandfather (assuming he lives for more than 3 years after the gift [IRC section 2035(b))], will be also removed from the death-time taxable estate, ultimately saving 50% of the gift tax paid.)

Example (Taxable Termination From Trust Established At Transferor’s Death): Grandfather devises $2 million in trust with income only to his only son and remainder to his sole grandchild. No applicable exclusion amount cred- it and no GST tax exemption are available for allocation to the devise. Estate tax of $2 million will be paid at death on the $4 million needed to pay the tax, leaving a $2 million bequest. Another 50% GST tax ($1 million) is due at the taxable termination, leaving $1 million to the grandchild. The total cost of the transfer taxes will be 300% of the remaining amount received by the grandchild. The formula is: [$1 million (remaining devise) + $1 million (GST tax)]/1-.50 (where .50 is the applicable federal estate tax rate) = $4 million. Transfer taxes (estate and GST taxes) will total $3 million, which amount to 300% of the amount ($1 million) transferred to the skip person. The total amount transferred is $4 million for a $1 million distribution to the grandchild.

5A.3(b) Simultaneous Terminations

Simultaneous termination of two or more interests creates only one taxable termination. Treas. Reg. §26.2612-1(b)(3), (f ), Example 8.

5A.3(c) Change In Identity Of Transferor

Because the estate tax and gift tax supersede the GST tax and determine the identity of the transferor, a transfer from a trust that would otherwise be a taxable termination is not subject to GST tax if the transfer is subject to estate or gift tax. Treas. Reg. §26.2612-1(b)(1)(i).

5A.3(d) Death Of A Lineal Descendant

If a portion of a trust is distributed outright to a skip person because of the death of a lineal descendant of the transferor, the distribution to the skip person is a taxable termination (and not a taxable distribution) because there has been a termination of a portion of the trust estate. IRC section 2612(a)(2); Treas. Reg. §26.2612-1(b)(2), (f ), Example 9.

5A.3(e) IRS Reporting Requirements For A Taxable Termination

Taxable terminations must be reported by the trustee, even if the taxable termination has an inclusion ratio of zero and does not generate any GST tax. The trustee must file IRS Form 706-GS(T) (Generation-Skipping Transfer Tax Return For Terminations) and pay any GST tax that may be owed. Treas. Reg. §26.2662-1(b)(2).

5A.4 BASIS ADJUSTMENT FOR GST TAX PAID

 The basis of property for which a GST tax has been paid is increased (but not above fair market value). IRC section 2654(a). The property’s basis is increased by the amount of the GST tax paid (computed with- out regard to the IRC section 2604 credit for state GST taxes5) on the property’s unrealized gain, and the adjustment is made after any basis adjustment to the property is made under IRC section 1015 (concerning gift tax paid). The property’s unrealized gain is the excess of the property’s fair market value over its adjusted basis immediately before the transfer that gives rise to the GST tax. Thus, an intervivos direct skip with an increase in basis for gift tax paid and an increase in basis for GST tax paid may result in a basis increase close to the transferred property’s fair market value. This will not be the case in a taxable distribution or a taxable termination. However, if the property is transferred in a taxable termination that occurs at the same time and as a result of the death of an individual, the basis of such property is adjusted as provided under IRC section 1014(a) (concerning basis of property acquired from a decedent); except that, if the inclusion ratio of the transferred property is less than one, any increase or decrease in basis is limited by multiplying such increase or decrease (as the case may be) by the inclusion ratio. IRC section 2654(a). Property transferred in a direct skip at death has a basis equal to its federal estate tax value–no basis adjustment for the GST tax is made.

5A.5 TAXABLE DISTRIBUTION DEFINED 

A taxable distribution is any distribution from a trust (other than a direct skip or taxable termination) to a skip person when non-skip per- sons are also beneficiaries of the trust. IRC section 2612(b). A taxable distribution can occur only from a trust (or a trust arrangement). A taxable distribution cannot occur from a probate estate.6 If the distribution is of taxable income, the GST tax paid is deductible for income tax purposes. IRC section 164(a)(4). Taxable distributions do not include distributions described under IRC section 2503(e) (concerning direct payment of medical expenses and tuition). IRC section 2611(b)(1); Pvt. Letter Rul. 9823006. For example, in a spray trust from which income or principal can be paid to the grantor’s children and more remote descendants, any distribution to a grandchild (who is a skip person) is a taxable distribution. However, if the trustee pays the grandchild’s tuition or medical expenses directly from the trust (rather than reimbursing the grandchild), there is no taxable distribution. Taxable distributions do not include distributions that meet the definitional requirements of taxable terminations or direct skips. IRC section 2612(b). A skip person’s exercise of a power of withdrawal (such as a five-by-five power or a Crummey withdrawal right) in a trust that does not have a zero inclusion ratio (i.e., a non-GST tax exempt trust or a non-IRC section 2642(c)(2) trust7), is a taxable distribution if the beneficiary has a continuing interest in the trust. Treas. Reg. §26.2612-1(f ), Example 13. When a GST transfer meets the definitional requirements of both a taxable distribution and taxable termination, IRC section 2612 provides that the GST transfer is classified as a taxable termination.

5A.5(a) Amount Of GST Tax Attributable To A Taxable Distribution

The amount of the taxable distribution that is subject to GST tax is described in IRC section 2621(a). The distributee is liable for paying the GST tax, which causes the GST tax to be calculated on a tax-inclusive basis because the distributee pays the GST tax out of the distributed property. IRC section 2603(a)(1); Treas. Reg. §26.2662- 1(c)(1)(i). This has the effect of approximating the result of the property being subject to estate tax in the estate of the skipped person.

5A.5(b) Payment Of GST Tax By Trustee

If the trustee pays the GST tax on the taxable distribution, the trustee’s payment constitutes an additional taxable distribution to the skip person, for which GST tax must be paid. IRC section 2621(b).

5A.5(c) Multiple Simultaneous Skips

Taxable distributions are subject to GST tax only once, even though multiple generations may be simultaneously skipped. For example, a non-GST-tax-exempt trust makes a distribution to great grandchild (skipping a grandchild). The distribution to the great grandchild is taxed only once, even though the grandchild’s generation was skipped.

5A.5(d) IRS Reporting Requirements For A Taxable Distribution

Taxable distributions must be reported by the trustee, even if the taxable distribution has an inclusion ratio of zero and does not generate any GST tax. The trustee must file IRS Form 706-GS(D-1) (Notification of Distribution From a Generation-Skipping Trust) for each skip person who receives a distribution. A copy of the filed Form 706-GS(D-1) must also be sent to each skip person who received a distribution from the trust. The skip person uses the information on IRS Form 706-GS(D-1) to complete IRS Form 706-GS(D) (Generation Skipping Transfer Tax For Distributions) and pay any GST tax that may be owing. Treas. Reg. §26.2662-1(b).

5A.6 INCOME TAX DEDUCTION FOR GST TAX PAID

IRC section 164(a)(4) provides for a special income tax deduction for the payment of GST tax on income distributions. IRC section 691(c)(3) provides for a special income tax deduction for the payment of GST tax on income in respect of a decedent with regard to a taxable termination or a direct skip that occurs as a result of the transferor’s death.

5A.7 DIRECT SKIP DEFINED

A direct skip (in contrast to an “indirect skip,” which is dis- cussed in section 5.29(b), below) is any transfer to a skip person that is subject to federal estate or gift tax. IRC section 2612(c). For example, an intervivos taxable gift or a testamentary bequest to a grand- child (who is a skip person) under the transferor’s will or a trust included in the transferor’s gross estate is a direct skip. A transfer to a trust solely for the benefit of skip persons is also a direct skip. IRC section 2613(a). A direct skip can occur from a probate estate or from a trust (or trust arrangement).

5A.7(a) Amount Of GST Tax Attributable To A Direct Skip

The amount of the direct skip that is subject to GST tax is described in IRC section 2623. If the direct skip occurs at the death of the transferor, the GST tax is in addition to any estate tax that may be owed on property transferred to the skip person.

5A.7(b) Payment Of GST Tax Attributable To A Direct Skip

By definition, a direct skip is always subject to gift tax (which is a tax-exclusive computation) or estate tax (which is a tax-inclusive computation). A direct skip results in the simultaneous imposition of the GST tax and estate or gift tax. The transferor is liable for the GST tax regarding an intervivos direct skip (other than a direct skip from a trust). IRC section 2603(a)(3); Treas. Reg. §26.2662-1(c)(1)(iii). The payment of the GST tax by the transferor on an intervivos direct skip (other than a direct skip from a trust) causes the GST tax to be calculated on a tax-exclusive basis, similar to the gift tax. This means the GST tax is paid only on the transferred property and not on the dol- lars used to pay the GST tax. However, the GST tax paid by the transferor on an intervivos direct skip is an additional taxable gift. IRC sections 2623 and 2515. The trustee is liable for the GST tax regarding a direct skip from a trust or with respect to property that continues to be held in trust. IRC section 2603(a)(2); Treas. Reg. §26.2662- 1(c)(1)(iv). The executor is liable for the GST tax regarding a direct skip (other than a direct skip from a trust or with respect to property that continues to be held in trust) if the transfer is subject to estate tax. Treas. Reg. §26.2662-1(c)(1)(v). The payment of the GST tax by the trustee or the executor also causes the GST tax to be calculated on a tax-exclusive basis. However, a direct skip at death is more expensive than an intervivos direct skip. This is because the dollars used to pay the GST tax on the direct skip occurring at death are subject to federal estate tax (but not GST tax).

5A.7(c) Certain Direct Skips Are Not Subject To The GST Tax

Certain direct skips are not subject to the GST tax and are automatically assigned a zero inclusion ratio by the Internal Revenue Code. IRC section 2642(c). Outright gifts to an individual who is a skip person that come within the gift tax annual exclusion amount described in IRC section 2503(b), lifetime gifts that qualify for the special medical or tuition unlimited gift tax exclusion under IRC section 2503(e), and gifts that qualify for the annual gift tax exclusion amount that are made to a trust described in IRC section 2642(c)(2) (i.e., gifts to a trust for a single skip-person-beneficiary that come within the annual gift tax exclusion amount, and the trust is included in that beneficiary’s gross estate if he or she dies before the trust terminates, such as an annual exclusion gift to an IRC section 2503(c) minor’s trust for the sole benefit of a skip person8) are not subject to the GST tax.9 See, Priv. Letter Rul. 200519006.

Practice Point: As previously mentioned, although a Crummey withdrawal right over a gift made to a trust results in the gift qualifying for the annual gift tax exclusion under IRC section 2503(b), the gift will not be exempt from GST tax if the withdrawal right is held by a skip person and the trust (or trust share) is other than an IRC section 2642(c)(2) trust. Furthermore, the exercise of the withdrawal right by a skip person in a non-IRC section 2642(c)(2) trust will result in a taxable distribution (or possibly a taxable termination). Treas. Reg. §26.2612- 1(f), Example 13.

5A.7(d) Multiple Simultaneous Direct Skips

A direct skip is taxed only once, regardless of how many generations are simultaneously skipped. For example, grandparent gifts $50,000 to great-grandchild. Only one direct skip occurs, even though grandparent has skipped his or her grandchildren’s generation. Treas. Reg. §26.2612-1(a).

5A.7(e) IRS Reporting Requirements For A Direct Skip

An intervivos direct skip that occurs while the transferor is alive is reported on IRS Form 709 (United States Gift [and Generation- Skipping Transfer] Tax Return). Treas. Reg. §26.2662-1(b)(3)(i). A direct skip that occurs at the same time as and as a result of the death of the transferor is reported on IRS Form 706 (United States Estate [and Generation-Skipping Transfer] Tax Return). Treas. Reg. §26.2662-1(b)(3)(ii).

5A.8 SKIP PERSON DEFINED AND GENERATION ASSIGNMENTS

A skip person may be an individual or a trust. Subject to the “transferor move-down rule” discussed in section 5.11, below, a skip person is an individual assigned to a generation that is two or more generations below that of the transferor (such as a grandchild). A trust is a skip person if either (1) all interests in the trust are held by skip persons; or (2) no person holds an interest in the trust and no future trust distributions—other than a distribution the probability of which occurring is so remote as to be negligible (including distributions at the termination of the trust)—can be made, to anyone, other than to a skip person. A non-skip person is any person (or trust) who is not a skip person. IRC section 2613; Treas. Reg. §26.2612-1(d)(2). A transfer to a trust that is a skip person is a GST. IRC section 2612(c)(2). For GST tax purposes, “trust” includes arrangements analogous to a trust (other than a probate estate). IRC sections 2652(b)(2) and (3). See, Treas. Reg. §26.2652-1(b)(2), Example 1, 2, and 3. For GST tax purposes, a beneficiary’s “interest” in a trust is described in IRC section 2652(c)(1). An individual who is assigned to more than one generation is assigned to the youngest generation. IRC section 2651(f)(1); Treas. Reg. §26.2651-2 (per T.D. 9214 (7/18/2005)).

5A.8(a) Generation Assignments Summarized

Generation assignments (vis-à-vis the transferor) are determined under IRC section 2651, and are summarized in the following chart.

Generation Assignments Family Members Non-Family Members
Transferor’s generation (non-skip person) Transferor, transferor’s

spouse, transferor’s brothers and sisters

 Not more than 121⁄2 years younger than the transferor
First generation younger than transferor (non-skip person) Transferor’s children, nieces, nephews and their spouses More than 121⁄2 but not more than 371⁄2 years younger than the transferor
Second generation younger than transferor (skip person) Transferor’s grand- children, grandnieces, grandnephews and their spouses More than 371⁄2 but not more than 621⁄2 years younger than the transferor

5A.9 PREDECEASED PARENT RULE AND GENERATION ASSIGNMENTS

The predeceased parent rule provides that if a skip person’s ancestor, who is a descendant of the transferor (for GST tax purposes), predeceases the transferor, the skip person moves up in generation assignments (vis-à-vis the transferor). Expanded by the Taxpayer Relief Act of 1997 (“TRA 1997”), the “predeceased parent rule” is now applicable to taxable terminations, taxable distributions, and direct skips. The predeceased parent rules also applies to transfers to collateral heirs, such as grand nieces and grand nephews, provided the transferor has no living descendants at the time of the transfer. Treas. Reg. §26.2651- 1(b) (per T.D. 9214 (7/18/2005)). Furthermore, if a beneficiary who is a descendant of the transferor (for GST tax purposes) dies within 90 days after the date of a GST transfer that occurs because of the death of the transferor, the beneficiary is treated as having predeceased the transferor, and the deceased beneficiary’s child will move up a generation assignment (vis-à-vis the transferor) and be placed in the same generation assignment held by his or her (now deceased) parent vis-à- vis the transferor. IRC section 2651(e); Treas. Reg. §26.2651- 1(a)(2)(iii) (per T.D. 9214 (7/18/2005)). This 90-day survivorship rule expands the “predeceased parent rule” of IRC §2651(e) by allowing a grandchild to move up into his parent’s generation for GST tax purposes if the parent dies within 90 days of a transferor.

On July 18, 2005, the IRS issued amendments to the final regulations concerning the predeceased parent rule under IRC section 2651(e). See, Treas. Reg. §§26.2612-1, 26.2651-1, 26.2651-2, and 26.2651-3 (per T.D. 9214 [7/18/2005]). The amendments to the final regulations discuss the 90-day survival rule (which is now automatic and does not require an express 90-day survival provision in the governing instrument or a state statute that provides for a 90-day survival period. These amendments change the prior Treasury Regulations concerning how to determine the date of a transfer for purposes of applying the predeceased parent rule and determining when certain adopt- ed individuals and those who come within the predeceased parent rule (and their spouses and descendants) are to be reassigned to a different generation for GST tax purposes.

5A.9(a) Disclaimers And The Predeceased Parent Rule

 The predeceased parent rule does not apply to disclaimers, even though under state law the disclaimant is treated as having predeceased the transferor of the disclaimed property. Treas. Reg. §26.2651- 1(a)(2)(iv) (per T.D. 9214 (7/18/2005)).

5A.9(b) Additions To A Trust That Is Subject To The Predeceased Parent Rule 

If the predeceased parent (i.e., the deceased descendant who is the ancestor of the beneficiary) was dead at the time a transferor’s transfer in trust first became subject to estate or gift tax, then the pre- deceased parent rule will apply to post-1997 taxable distributions and taxable terminations, as well as to direct skips. If a transferor makes an addition to an existing trust after the death of a descendant of the transferor in an intervening generation, the additional property is treated as being held in a separate trust for purposes of the GST tax. Treas. Reg. §26.2651-1(a)(4) (per T.D. 9214 [7/18/2005]). The time of the addition (and not the time of the first transfer to the trust) is the relevant time to determine whether the property attributable to the addition qualifies for the predeceased parent rule.

5A.9(c) Unnatural Order Of Death Rule

A corollary to the predeceased parent rule is the unnatural order of death rule added by the 2001 Tax Act and set forth in IRC section 2632(d). That rule allows a transferor to make a retroactive allocation of the transferor’s GST tax exemption to lifetime transfers to an intervivos trust if a non-skip beneficiary of the trust, who is a lineal descendant of the transferor’s grandparents, dies after December 31, 2000, but before the transferor. The rule does not protect against an unnatural order of death that occurs after the transferor’s death. The retroactive allocation of GST tax exemption must be made on the transferor’s United States Gift Tax Return for the calendar year in which the non- skip person died.

5A.9(d) Ninety-Day Survival Rule

The ninety (90)-day survivorship rule provides, “Any individual who dies no later than 90 days after a transfer occurring by reason of the death of the transferor is treated as having predeceased the transferor.” Treas. Reg. §26.2651-1(a)(2)(iii) (per T.D. 9214 (7/18/2005)). This survivorship rule expands the “predeceased parent rule” of IRC section 2651(e), by allowing a grandchild to move up into his parent’s generation for GST tax purposes if the parent dies within 90 days of a GST event that occurs because of the death of the transferor. The 90-day survival rule is now automatic, thus abrogating the requirement that the ninety (90)-day survival period be expressly provided by applicable local law or the governing instrument.

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