105 / How can the generation-skipping transfer (GST) tax exemption be leveraged using an irrevocable life insurance trust?
Leveraging of the GST tax exemption can be accomplished by allocating the exemption against the discounted dollars that the premiums represent when compared with the ultimate value of the insurance proceeds. However, in the case of inter vivos transfers in trust, allocation of the GST exemption is postponed until the end of an estate tax inclusion period (ETIP).1 In general, an ETIP would not end until the termination of the last interest held by either the transferor or the spouse of the transferor during the period in which the property being transferred would have been included in either spouse’s estate if that spouse died.
Of course, the transferor should be given no interest that would cause the trust property to be included in the transferor’s estate. Furthermore, the transferor’s spouse should be given no interest that would cause the trust property to be included in the transferor spouse’s estate if the transferor spouse were to die.
The property is not considered as includable in the estate of the spouse of the transferor by reason of a withdrawal power limited to the greater of $5,000 or 5 percent of the trust corpus if the withdrawal power terminates no later than 60 days after the transfer to the trust.2 Also, the property is not considered as includable in the estate of the transferor or the spouse of the transferor if the possibility of inclusion is so remote as to be negligible (i.e., less than a 5 percent actuarial probability).3 Furthermore, the ETIP rules do not apply if a reverse qualified terminable interest property (QTIP) election is made.4 Otherwise, if proceeds are received during the ETIP, the allocation of the GST exemption must be made against proceeds rather than premiums and the advantage of leveraging is lost.
Example 1. [Twenty years in this example only is based upon the $1 million GST exemption prior to any inflation or other adjustment after 1998.] G creates a trust for the benefit of his children and grandchildren. Each year he transfers to the trust $50,000 (to be used to make premium payments on a $2 million insurance policy on his life) and allocates $50,000 of his GST exemption to each transfer. Assuming G makes no other allocations of his GST exemption, the trust will have a zero inclusion ratio (i.e., it is not subject to GST tax) during its first 20 years. At the end of 20 years, G will have used up his GST exemption and the trust’s inclusion ratio will increase slowly with each additional transfer of $50,000 to the trust. If G died during the 20-year period, the insurance proceeds of $2 million would not be subject to GST tax. Part of the $2 million proceeds may be subject to GST tax if G died in a later year. To ensure that the trust has a zero inclusion ratio, use of a policy that becomes paid-up before the transfers to trust exceed the GST exemption may be indicated. Example 2. Same facts as in Example 1, except that the trust is created for G’s spouse, S, during her lifetime, and then, to benefit children and grandchildren. If the trust is intended to qualify for the marital deduction (apparently, other than if a reverse QTIP election is used), the valuation of property for purpose of the ETIP rule is generally delayed until G or S dies because the property would have been included in S’s estate if she died during the ETIP. Consequently, if the $2 million insurance proceeds are received during the spouse’s lifetime, the GST exemption is allocated against the $2 million proceeds, and a substantial amount of GST tax may be due upon subsequent taxable distributions and taxable terminations from the trust. Because allocation of the exemption must be made against the proceeds if they are received during the ETIP, the advantage of leveraging enjoyed in Example 1 is lost. NOTE: The 2025 OBBB increased the transfer tax exemption to $15 million (this $15 million base amount will be adjusted for inflation in future years). By way of history, the 2011 $5 million GST tax lifetime exemption was inflation-adjusted to $5.12 million in 2012, $5.25 million in 2013, $5.34 million in 2014, $5.43 million in 2015, $5.45 million in 2016, $5.49 million in 2017, $11.18 million in 2018, $11.4 million in 2019, $11.58 million in 2020, $11.7 million in 2021, $12.06 million in 2022, $12.92 million for 2023, $13.61 million in 2024 and $13.99 million in 2025. The 2010 Tax Relief Act also unified the lifetime gift exemption with the estate tax exemption.5 The American Taxpayer Relief Act of 2012 (ATRA 2012) made this unification permanent, so that the $5 million lifetime exemption will continue to be indexed annually for inflation, and the 2017 tax reform legislation doubled the $5 million base to $10 million.
This increased exemption will provide transferors with flexibility in funding life insurance premiums through irrevocable life insurance trusts as it allows the transferor to front-pay premium payments with the unused portion of the $10 million exemption ($20 million for married couples), as indexed. In addition, ATRA 2012 made the portability of unused exemptions between spouses permanent, so that any unused exemption of a spouse who dies in a tax year beginning after 2010 may be used by the surviving spouse.6 (See Q 861.)
1. IRC § 2642(f).
2. Treas. Reg. § 26.2632-1(c)(2)(ii)(B).
3. Treas. Reg. § 26.2632-1(c)(2)(ii)(A).
4. Treas. Reg. § 26.2632-1(c)(2)(ii)(C).
5. Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, Section 302(b)(1), Pub. Law 111-312 (2010), amending 26 U.S.C. § 2505(a). See also The American Taxpayer Relief Act of 2012, Public Law 112-240, Rev. Proc. 2013-15, Rev. Proc. 2014-61, Rev. Proc. 2015-53, Rev. Proc. 2016-55, The 2017 tax reform legislation, Pub. Law No. 115-97, Rev. Proc. 2018-18, Rev. Proc. 2018-57, Rev. Proc. 2019-44, Rev. Proc. 2020-45, Rev. Proc. 2021-45, Rev. Proc. 2022-38, Rev. Proc. 2023-34, Rev. Proc. 2024-40, Rev. Proc. 2025-32.
6. Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, Section 303(b)(1), Pub. Law 111-312 (2010), amending 26 U.S.C. § 2010(c)(4). See also The American Taxpayer Relief Act of 2012, Public Law 112-240, Rev. Proc. 2013-15, Rev. Proc. 2014-61, Rev. Proc. 2015-53, Rev. Proc. 2016-55. The 2017 tax reform legislation, Pub. Law No. 115-97, Rev. Proc. 2018-18, Rev. Proc. 2018-57.