The IRS has issued proposed regulations [Prop. Treas. Reg. ?26.2632-1] that seem to add a little flexibility to making allocations of generation-skipping transfer (GST) tax exemption to trusts. The proposed regulations extend the rules so that a person generally can provide for allocations or nonallocation of GST exemption to trusts in any timely fashion. However, as discussed below, in most cases a simple all-or-nothing approach sticking to trusts with inclusion ratios of zero or one is all that is needed.
In general, the generation-skipping transfer tax applies to transfers to skip persons. A skip person is a person 2 or more generations younger than the transferor (e.g., grandchildren, great-grandchildren). A transfer to a trust is a direct skip if all trust beneficiaries are skip persons. Also, a taxable distribution occurs when distributions from a trust are made to skip persons when there are also nonskip beneficiaries (e.g., distributions to grandchildren while children are still beneficiaries). In addition, a taxable termination occurs when an interest in a trust ends (e.g., child?s income interest for life) and the remaining beneficiaries are all skip persons.
Each person has a GST exemption that can be allocated to transfers. In 2004, the GST exemption is $1,500,000. A married couple effectively has a GST exemption of $3,000,000 in 2004. Each time a contribution is made to a trust, an inclusion ratio is calculated for a trust that generally reflects how much of a trust is protected by GST exemption and how much is not.
The statutes provide for certain automatic allocations of GST exemption to direct skips and to indirect skips to GST trusts. An indirect skip is a transfer (other than a direct skip) subject to gift tax to a GST trust. The definition of a GST trust is a purely arbitrary list of certain trusts that Congress thought might be likely to result in generation-skipping transfers. The statutes also provided for certain elections.
As noted above, the proposed regulations extend those provisions so that a person generally can provide for allocations or nonallocation of GST exemption to trusts in any timely fashion. The regulations generally permit elections to allocate or not allocate GST exemption to individual transfers or to all transfers to a trust. An election with regard to all transfers to a trust can later be revoked with respect to future transfers to the trust. The regulations also permit elections with regard to individual transfers to a trust even where an election is in place with regard to all transfers to a trust.
While it is good that all this flexibility is available, it seems that the best strategy generally remains to make an election with regard to an entire trust to have the trust treated as either (1) a GST trust to which automatic GST exemptions allocations are made, or (2) other than a GST trust and to which GST exemption is not allocated. If need be, the election with regard to all transfers to the trust can be changed at a later time.