Fiduciary allocations of the generation-skipping transfer tax exemption.

• Author: Williams, Robert S.

Every individual has a generation-skipping transfer tax exemption ("GST exemption"), currently $1,100,000 (1) for 2002, which may be allocated by such individual or his personal representative to any property with respect to which such individual is considered the transferor, (2) and any allocation, once made, is irrevocable. (3) A personal representative makes this allocation on Schedule R of IRS Form 706 by the due date for filing IRS Form 706 (including extensions). (4) In the event the decedent failed to timely make an allocation of the GST exemption during his lifetime, the Internal Revenue Code provides for a deemed allocation of GST exemption to any transfers made during his lifetime which are considered direct skips. (5) As a result, a personal representative has the responsibility of allocating a decedent's remaining GST exemption to all transfers where the decedent is considered the transferor, except for direct skips occurring during the decedent's lifetime. In the event a personal representative fails to allocate a decedent's remaining exemption, the code provides for an automatic "deemed" allocation. (6)

Duty to Minimize Taxes

Personal representatives have a general duty to minimize the overall tax burden on an estate and its beneficiaries, which is derived from the duty to conserve estate property and to make the property reasonably productive. (7) This duty runs to the entire group of interested persons, including estate creditors as well as beneficiaries of the estate and any inter-vivos trusts created by the decedent. (8) Personal representatives, in making tax elections, may not generally favor one beneficiary over another; (9) rather, the powers and discretions of personal representatives are to be exercised in a manner consistent with the testator's intention, and act as fairly and impartially as between the beneficiaries of a decedent's estate. (10) In an effort to fulfill their responsibilities to allocate the GST exemption among various transfers, personal representatives should seek to minimize the overall tax burden that will be imposed on all generation-skipping transfers ("GSTs"). By allocating the GST exemption based purely on the expected tax consequences, specifically ignoring the issue of who will be liable for the tax, and thereby minimizing the impact this tax will have on the value of all of the transfers, personal representatives can fulfill their duty to minimize taxes and, at the same time, fulfill their duty to act fairly and impartially as between the interested persons.

Any remaining GST exemption should be allocated to all of a decedent's GSTs using a formula that distributes the exemption to the various types of GSTs on a priority basis which will result in the least amount of GST tax being imposed on all of the GSTs in the aggregate. (11)

Generation-Skipping Transfers

There are some general observations that should be made with respect to the various types of GSTs, which impact how the GST exemption should be allocated. First of all, when the exemption is allocated to a particular GST, the goal is to allocate enough exemption to the transfer so that there will not be any GST tax on that transfer. This is accomplished by allocating a sufficient amount of exemption to produce an inclusion ratio equal to zero. (12) If the inclusion ratio for a particular GST equals zero, there is no GST tax on the transfer, or, in the case of a trust, any subsequent distribution. If the inclusion ratio is greater than zero, then there will be GST tax due on the transfer, or, in the case of a trust, subsequent distributions, relative to the inclusion ratio. (13) If the inclusion ratio is equal to one, then the entire transfer, or, in the case of a trust, subsequent distributions, are subject to the GST tax. As a general matter, trusts should be either wholly exempt or wholly nonexempt, with an inclusion ratio of either zero or one. (14)

There are three types of GSTs under the Internal Revenue Code each having different tax results: 1) direct skips, 2) taxable distributions, and 3) taxable terminations. (15) Direct skips are generally inter-vivos transfers made by a donor, (16) and taxable terminations and taxable distributions involve trust arrangements. (17)

Direct skips are usually capable of being reasonably valued, and the GST exemption may be correspondingly allocated to this value to produce an inclusion ratio of zero. Direct skips do not include transfers to nonskip...