Transfers to skip trusts in 2010: not necessarily free from GST tax.

• Author: Ransome, Justin P.
• Position: Generation-skipping transfer

The generation-skipping transfer (GST) tax is imposed on certain transfers that skip generations, to ensure that property is subject to transfer tax at each generational level. The tax is imposed at the rate equal to the highest federal estate tax rate at the time of the transfer. Each individual is allowed a GST exemption that may be allocated to a transfer so that it will be exempt from GST tax.

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Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EG-TRRA), (1) the GST tax was scheduled to be repealed entirely for 2010. The GST tax was retroactively reinstated for 2010 by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the Tax Relief Act), (2) but Congress provided that the GST tax due on GSTs made in 2010 is zero. It did so by making the applicable rate determined under Sec. 2641(a) zero for GSTs made after December 31, 2009, and before January 1,2011. (3)

All generation-skipping transfers are taxed at the "applicable rate" (a flat rate equal to the maximum federal estate tax rate in effect at the time of the generation-skipping transfer) multiplied by the "inclusion ratio." (4) The in- elusion ratio is determined by subtracting the "applicable fraction" from one.5 The applicable fraction is defined as the fraction with:

1. A numerator equal to the GST exemption allocated to the trust; and

2. A denominator equal to the value of the property transferred to the trust less:

   1. Any federal estate tax and state death taxes chargeable to the trust and actually recovered from the trust;

   2. The amount of any charitable deduction allowed under Sec. 2055, Sec. 2106, or Sec. 2522 with respect to the transfer; and

   3. In the case of a direct skip, the value of the portion of the transfer that is a "nontaxable gift." (6) Example 1: In 2009, T transferred $100,000 to a newly created irrevocable trust providing that income is to be accumulated for 10 years. At the end of 10 years, the accumulated income is to be distributed to T's child, C, and the trust principal is to be paid to T's grandchild, GC. Tmade an affirmative allocation of $40,000 of her GST exemption to the trust on a timely filed gift tax return for 2009. The applicable fraction of the trust is 2/5 ($40,000 + $100,000), or 0.40, and the inclusion ratio is 3/5 (1 - 2/5), or 0.60. In 2019, if the maximum federal estate tax rate is 55%, (7) the GST tax rate applicable to the trust is 0.33 (0.55 x 0.60).8

   The applicable fraction for a trust is recomputed when property is added to an existing trust. (9) The numerator of the recomputed applicable fraction generally is the sum of:

1. The amount of GST exemption currently being allocated to the trust (if any), plus

2. The value of the "nontax portion" of the trust.

   The denominator of the recomputed applicable fraction generally is the value of the trust principal immediately after the occurrence of the re-computation event. (10) The nontax portion of the trust is determined by multiplying the value of the trust principal immediately before the re-computation event by the then-applicable fraction. (11)

   Example 2: T transfers $1 million to a newly...