Generation-skipping transfer tax rules affect nonresident aliens.

• Author: Jackel, Monte A.

The Tax Reform Act of 1986 enacted Chapter 13 of the U.S. Internal Revenue Code, dealing with the generation-skipping transfer tax (GST). The law directed the IRS to write regulations necessary or appropriate to carry out Chapter 13, including regulations providing for its application to transferors who are nonresidents and not U.S. citizens (i.e., nonresident aliens (NRAs)).

On Dec. 23, 1992, the Service issued Prop. Regs. Sec. 26.2663-2, dealing with the application of the GST to transfers by NRAs. The proposed regulations would have taxed NRAs under Chapter 13 in essentially two separate ways: 1. Transfers of U.S.-situs property by an NRA would have been subject to GST to the same extent those transfers were subject to estate and gift tax. 2. The GST would have applied to transfers by NRAs of foreign-situs property to or for the benefit of grandchildren or more remote descendants, if the grandchild was a U.S. resident or citizen at the time of the generation-skipping transfer and the parent of that grandchild was also a U.S. citizen or resident at the time of the initial transfer to the grandchild or into the trust for that grandchild.

Thus, for example, under the proposed regulations, a bequest of stock in a foreign corporation by a nonresident alien to a U.S. grandchild would have been subject to the tax if the parent of that U.S. grandchild was also a U.S. citizen or resident at the time of the transfer.

The proposed regulations were highly controversial. Commentators objected mainly to subjecting foreign-situs property to the GST rules.

Final Regulations Limit

Application of the Tax

In response to those comments, final Regs. Sec. 26.2663-2 limits the application of the GST to NRAs solely to transfers of property subject to U.S. gift or estate tax on the part of the NRA donor or decedent. The regulations essentially treat the portion of the trust property at the time of the transfer into the trust that was subject to U.S. estate or gift tax as the taxable portion of the trust, and the balance of the trust is treated as the exempt portion of the trust.

Therefore, an allocation of the $1 million statutory GST exemption available to all taxpayers is required under the final regulations only to the extent the value of the property at the time that the allocation is made is not nonexempt property.

Example 1: A NRA decedent transfers $500,000 of U.S.-situs property and $500,000 of foreign-situs property to a generation-skipping trust...