Beware not allocating the GSTT exemption on a gift tax return - a trap for the unwary.

• Author: Sherr, Eileen Reichenberg
• Position: Generation-skipping transfer tax

The AICPA Tax Division's Trust, Estate and Gift Tax Committee has focused on a number of problems and concerns with the current generation-skipping transfer tax (GSTT) exemption that may not have caught the attention of many practitioners. While numerous practitioners prepare gift tax returns for clients, neither practitioners nor taxpayers may realize the importance of considering the impact of using die $1 million GSTT exemption at die time of filing, even for relatively small gifts. Since the result for GSTT purposes varies significantly (depending on whether an allocation is timely or late), there are serious traps in which practitioners may be caught if they do not consider the GSTT exemption at the time of filing the gift tax return. The potential future tax liability that may be avoided by the timely and judicious use of the GSTT exemption could be significant. Preparers and advisers are increasingly being blamed for unexpected results that were not fully explained at the time of the gift (which may have occurred many years prior to the actual generation-skipping transfer (GST) that results in the imposition of the (GSTT).

The IRS is currently examining the GSTT and the exemption allocation much more closely. Therefore, practitioners need to understand the full ramifications of allocating or not allocating the GSTT exemption when a gift tax return is filed.

Background

The GSTT is imposed at die maximum gift and estate tax rate (55%) on outright transfers or transfers in trust to beneficiaries more than one generation below the transferor's generation. To determine the rate applicable to a particular transfer, the 550% rate is multiplied by the inclusion ratio (a fraction based on the amount of exemption allocated to the GST. The GSTT is imposed on every GST (Sec. 2601), which includes taxable terminations, taxable distributions and direct skips. The tax does not apply to lifetime transfers (except for certain transfers in trust) exempt from gift tax because of the annual exclusion or because of the exclusion for certain tuition and medical expense payments (Sec. 2642(c)(3)).

Every individual is allowed a $1 million GSTT exemption, which may be allocated to any property transferred (Sec. 2631). Married couples may treat transfers as made one-half by each spouse, in effect giving them a combined $2 million exemption (Sec. 2652(a)(2)).

If the exemption is allocated on a timely filed gift tax return, it generally is based on the value of the property at the time of the transfer. However, if the allocation is not made on a timely filed gift tax return (i.e., not until death), the GSTT consequences are based on the value of the property at the time of the allocation (generally, a significantly higher value).

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