Eighth Circuit allows exception to GST tax.

• Author: Barton, Peter C.
• Position: U.S. 8th Circuit Court of Appeals; generation-skipping tax

In Simpson, 7/23/99, the Eighth Circuit ruled that a transfer to grandchildren made in 1993 under a trust that was irrevocable on Sept. 25, 1985, was not subject to the 55% generation-skipping transfer (GST) tax. Crucial to this ruling was the exercise (as opposed to the lapse) of a general power of appointment over the entire portion of the trust subject to the power. Therefore, Simpson is important because affected taxpayers must take appropriate action to avoid the GST tax.

First enacted in 1976, the GST tax was repealed retroactive to 1976 by the Tax Reform Act of 1986 (TRA '86). However, the TRA '86 contained a new version of the GST tax, which taxes GSTs at the highest estate and gift tax rate (currently, 55%).The GST tax and the estate or gift tax can apply to the same transfer. Sec. 2611 (a) specifies three types of GSTs--taxable distributions, terminations and direct skips. All three involve "skip persons," who are natural persons two or more generations below the transferor (Sec. 2613(a)(1)). There is a $1 million exemption per transferor, indexed for inflation after 1998 (Sec. 2631). The rationale for the GST tax is to tax transfers that try to avoid estate and gift taxes by skipping a generation.

The GST tax generally applies to transfers made after Oct. 22, 1986. However, under Section 1433(b)(2)(A) of the TRA '86, it does not apply to any transfer under a trust that was irrevocable on Sept. 25, 1985, "but only to the extent that such transfer is not made out of corpus added to the trust after September 25, 1985." This grandfather provision protects the reliance interests of trust settlers who established irrevocable trusts before the legislative introduction of the GST; the prohibition on additions prevents abuses. Temp. Regs. Sec. 26.2601-1(b)(1)(v)(A) also prohibits constructive additions. The regulation states, "where any portion of a trust remains in the trust after the release, exercise, or lapse of a [general] power of appointment over that portion of the trust...the value of the entire portion of the trust subject to the power that was released, exercised, or lapsed will be treated as an addition to the trust." (This does not apply to special powers of appointment; see Temp. Regs. Sec. 26.2601-1 (b) (1) (v) (B).)

Example: In June 1980, H established a $500,000 irrevocable trust, providing income to his wife W for life and the remainder to their grandchild. W has a general power of appointment over half of the trust...