Recent developments in estate planning: Part 3.

• Author: Ransome, Justin

This article is the third installment of an annual update on recent developments in trust, estate, and gift taxation. The first two installments appeared in the November and December issues, respectively. The update covers developments in estate and gift tax returns and planning during July 2021 through July 2022.

Generation-skipping transfer tax

Automatic allocation of GST exemption to GST trust allowed

In IRS Letter Ruling 202210010 released on March 11, 2022, the IRS ruled that an individual's generation-skipping transfer (GST) exemption was automatically allocated to a transfer to a trust even though the individual improperly reported the transfer on her gift tax return.

The taxpayer established an irrevocable trust for the benefit of her descendants. During the taxpayer's lifetime, the trustee could distribute the income and principal of the trust to her descendants in the trustee's discretion to provide for their health, education, maintenance, and support. Upon the taxpayer's death, the trust would divide into separate shares for the benefit of each of her children and his or her descendants. During each child's life, the trustee could distribute principal and income in the trustee's discretion to the child and his or her descendants to provide for their health, education, maintenance, and support.

At the death of a child, he or she would have a limited power to appoint the remainder of his or her trust to any person or entity other than the child's estate, the child's creditors, or the creditors of the child's estate. Each child also would have a general power to appoint to the creditors of his or her estate an amount with a value equal to the greatest amount that produces the lowest sum of: (1) the transfer taxes payable with respect to the child's estate and (2) the GST tax payable with respect to the trust. Any unappointed assets of a child's separate trust would continue in trust for the benefit of his or her descendants.

The taxpayer transferred nonvoting partnership units in a limited partnership to the trust. The taxpayer reported the transfers to the trust on her Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, for the year of the transfers. However, the transfers to the trust were incorrectly reported on Form 709, Schedule A, Part 1, Gifts Subject Only to Gift Tax, instead of on Schedule A, Part 3, Indirect Skips and Other Transfers in Trust. Furthermore, the automatic allocation of the GST exemption was not reported on Schedule D, Computation of Generation-Skipping Transfer Tax.

The taxpayer requested a ruling that GST exemption was automatically allocated to the transfers of the partnership units.

The IRS first addressed whether the trust was a "GST trust" to which GST exemption is automatically allocated. Sec. 2632(c)(3)(B) defines a "GST trust" as a trust that could have a generation-skipping transfer with respect to the transferor. However, this provision also lists six exceptions to the definition. In particular, Sec. 2632(c)(3)(B)(ii) provides an exception if more than 25% of the trust corpus must be distributed to, or may be withdrawn by, nonskip persons who are living on the date of death of another person identified in the trust who is more than 10 years older than such person. Sec. 2632(c)(3)(B)(iii) provides an exception if the trust instrument provides that if one or more skip persons die on or before a date described in Sec. 2632(c)(3)(B)(ii), more than 25% of the trust corpus either must be distributed to the estate or estates of one or more of such individuals or is subject to a general power of appointment exercisable by one or more such persons.

The IRS concluded that more than 25% of the trust would be subject to a general power of appointment held by the children (nonskip persons) if GST exemption was not allocated to more than 25% of the trust. It then concluded, however, that the general power of appointment contingent upon the inclusion ratio of the trust did not, in this case, prevent the trust from being a GST trust at the time of the transfer to the trust.

The IRS next addressed the failure to correctly report the transfers on the taxpayer's gift tax return. The IRS concluded that the failure to correctly report the transfers did not amount to an election out of the GST exemption automatic allocation rules to a GST trust because no election statement making the election was attached to the gift tax return. Because the trust met the definition of a GST trust, the IRS ruled that GST exemption was automatically allocated to the transfers to the trust even though the gift tax return failed to properly account for the automatic allocation.

The key to the IRS's ruling is that the testamentary general power of appointment was a "contingent" power that had not yet manifested at the time of the transfers to the trust. Therefore, the testamentary general power of appointment at the time of the transfers was not an absolute right to withdraw more than 25% of the trust corpus.

Late allocation to CRUT allowed

In IRS Letter Ruling 202134005 released Aug. 27, 2021, the taxpayer requested an extension of time to allocate GST exemption to a charitable remainder unitrust (CRUT).

The donor created and funded the CRUT sometime after Sept. 24, 1985, and before July 29, 1997. The CRUT instrument provided for the annual payment of a unitrust amount for life to the taxpayer's grandchild. At the grandchild's death, the remainder of the CRUT would be paid to a charity. The donor and the donor's spouse elected to split gifts in the year the CRUT was created and hired an accounting firm to prepare their gift tax returns for that year. The accounting firm failed to allocate GST exemption to the CRUT.

The donor died, and the executor of the donor's estate and the donor's spouse were made aware of the GST tax consequences of the unitrust payments from the CRUT as the donor's estate tax return was being prepared. Upon realization of the error, the executor of the taxpayer's estate and the donor's spouse requested an extension of time pursuant to Sec. 2642(g) and Regs. Sec. 301.9100-3 to allocate the donor's and his spouse's GST exemption to the transfers to the CRUT and requested that the GST exemption allocated to the transfer would be effective on the date of the transfers.

Requests for relief under Regs. Sec. 301.9100-3 will be granted when the taxpayer provides evidence to establish to the IRS's satisfaction that the taxpayer acted reasonably and in good faith and that granting relief will not prejudice the interests of the government. A taxpayer is considered to have acted reasonably and in good faith if the taxpayer reasonably relied on a qualified tax professional, including a tax professional employed by the taxpayer, and the tax professional failed to make, or advise the taxpayer to make, a regulatory election. (1)

Based on the facts submitted and the representations made by the taxpayer, the IRS concluded that the requirements of Regs. Sec. 301.9100-3 were satisfied. As a result, the donor's executor and spouse were granted an extension of 120 days from the date of the ruling to allocate their available GST exemption to the transfer to the CRUT.

This CRUT was created before the automatic allocation rules for GST trusts came into existence in 2001; (2) otherwise, the taxpayers would not have had to make these requests, as GST exemption would have been automatically allocated to the CRUT. The transfer to the CRUT is not a direct skip because the charity is always considered a nonskip person. Had the IRS not granted the taxpayers an extension of time to allocate GST exemption to the CRUT, the unitrust payments to the grandchild would have been taxable distributions, which would have required the grandchild to pay GST tax from the distribution he or she received from the CRUT.

Trusts

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