GSTT exemption planning related to life insurance trusts.

• Author: Monroe, Tracy
• Position: Generation-skipping transfer tax

Every taxpayer has a $1 million generation-skipping transfer tax (GSTT) exemption that can be used to offset tax when making gifts to grandchildren, other skip persons or trusts. In order to allocate the GSTT exemption to generation-skipping transfers in trust, the donor must calculate an inclusion ratio. When computing this inclusion ratio, filing a gift tax return late in order to use the valuation on the filing date (instead of the value on the date of the gift) may produce very favorable tax results when used for allocations of the GSTT exemption related to premiums gifted into generation-skipping life insurance trusts. This is because the increase in value of the policy on the filing date will presumably be less than the annual gift to cover the premium cost (because of commissions and other costs).

When a generation-skipping transfer is made to a trust, die donor must make a careful analysis of the amount of the GSTT exemption allocated to the transfer. This analysis is important because of the manner in which the GSTT is computed. For transfers made to a trust, the inclusion ratio is computed as the amount of the transfer not covered by the GSTT exemption allocated to the transfer, divided by the total amount of the transfer. The taxable amount of a generation-skipping transfer is the property's value at the time of the transfer, which often is not the gift tax valuation date. Specifically, when a generation-skipping transfer is made through a trust, the portion of the trust corpus protected by the exemption depends on the value of the property when transferred into trust, while the taxable amount of the unprotected portion is based on the value of the property at the time of the taxable termination or taxable distribution.

Example 1: An individual transfers $4,000,000 into a trust for the benefit of her son, S, and grandchildren, and allocates all of her $1,000,000 exemption to the trust. The inclusion ratio is 75% (1 minus the ratio of the exemption ($1,000,000) to the property's value ($4,000,000)). The GSTT rate for generation-skipping transfers after 1992 is therefore 41.25% (75% of 55%). Assume the trust corpus appreciates to $10,000,000 by the time of S's death. S's death is a taxable termination affecting the entire corpus, as all remaining beneficiaries of the trust are skip persons. The taxable amount is $10,000,000 (the value of the trust corpus at the time of the generation-skipping transfer), and the GSTT is $4,125,000...