Navigating the Revised Gift Tax Return

The 2003 Form 709, United States Gift and Generation-Skipping Transfer Tax Return, reflects changes to the generation-skipping transfer tax enacted by the Economic Growth and Tax Relief Reconciliation Act of 2001. This article summarizes the changes and illustrates how to complete the revised schedules.
 

Blake T. Smith, CPA
Executive Editor and Senior Director of Product Development
Practitioners Publishing Co.
Fort Worth, TX
 

Editors note: Mr. Smith chairs the AICPA Tax Divisions Trust, Estate, and Gift Tax Technical Resource Panels (TRPs) Form 709 Task Force. Other members of the Form 709 Task Force are: Carol Barnes, Bob Caplan, Nancy Hyde, David Lajoie, Terri Lawson, Eileen Sherr (Technical Manager) and Evelyn Capassakis (Trust, Estate, and Gift Tax TRP Chair).

For more information about this article, contact Mr. Smith at blake.smith@ppcnet.com.
  

Executive Summary

• Form 709, Schedules A and C, have been modified to facilitate an election out of a deemed allocation of the GST exemption and to track the amount actually used.
• Split gifts made by spouses are now listed separately on Schedule A.
• Schedule A has a new Part 3 for reporting lifetime indirect-skip transfers.

The recently released 2003 Form 709, United States Gift and Generation-Skipping Transfer Tax Return, contains several modifications to help implement the generation-skipping transfer (GST) tax changes enacted by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). The changes are designed to ease electing out of the automatic allocation of GST exemption and simplify tracking a donors unused GST exemption.

In June 2002, the AICPA Tax Divisions Trust, Estate, and Gift Tax Technical Resource Panels Form 709 Task Force met with the IRS and submitted suggested changes to the form to take the new law into account. Many of the AICPAs suggestions have been included in the revisions to the 2003 Form 709.

Reporting GSTs on Form 709

Form 709 is used to compute the gift tax on lifetime transfers. It is also used to calculate the GST tax on lifetime direct-skip transfers and to allocate the donors GST exemption to (1) such transfers and (2) transfers to trusts that may produce a taxable distribution or taxable termination.

Lifetime transfers subject to gift tax are reported on Form 709, Schedule A, Computation of Taxable Gifts. Schedule A has been overhauled to accommodate the deemed (automatic) allocation of GST exemption rules applicable to lifetime indirect skips. It now contains Part 3Indirect Skips, for reporting lifetime indirect skips. In addition, split gifts made by a spouse are now reported separately on Part 1, Gifts Subject Only to Gift Tax; Part 2, Direct Skips; or Part 3, whichever is applicable, to facilitate electing out of the deemed-allocation rules on split gifts that are direct skips or indirect-skip transfers.

Split Gifts

Under Sec. 2513, spouses may elect to treat a gift made by one spouse to a third person as if the gift had been made one-half by each. Treating half of the gift as made by each spouse, regardless of who actually made the gift, allows use of the annual exclusion and applicable credit amount available to each spouse. In addition, because the gift tax rates are graduated, a split gift allows the total taxable gift to be taxed at each spouses lower rate before either spouse moves on to the next bracket.

When a husband and wife elect gift-splitting for gift tax purposes, each spouse is also treated as the transferor of one-half of the gift for GST purposes, under Sec. 2652(a)(2). As a result, the deemed-allocation rules (which automatically allocate a transferors GST exemption to direct skips and lifetime indirect-skip transfers) apply to split-gift transfers as well. Thus, Schedule A is modified to allow the transferor to elect out of the deemed-allocation rules when they apply to split-gift transfers.

In prior years, split gifts were not reported separately on Schedule A; only the transferors gifts were listed on Schedule A, Part 1 or 2. The total split gifts to be reported by the transferors spouse were subtracted out when determining the transferors taxable gifts for the year.

Similarly, the total split gifts attributable to the transferors spouse were added to the reporting spouses other gifts to arrive at taxable gifts for the year. Because the net split gifts were not listed separately, it was difficult to identify gifts subject only to the gift tax from those potentially subject to both gift and GST taxes. In turn, this made it difficult to identify (1) direct-split transfers subject to the deemed-GST-exemption-allocation rules, complicating the task of electing out and (2) other transfers that might warrant GST-exemption allocation, because they might produce a future taxable distribution or termination.

The inability to identify individual split gifts for purposes of electing out of the deemed-GST-exemption allocation was compounded when the deemed-allocation rules were extended to lifetime indirect-skip transfers. Thus, split gifts made by the transferors spouse are now listed separately in Part 1, 2 or 3 of Schedule A, facilitating the ability to elect out of the deemed-allocation rules for split gifts that are direct skips or lifetime indirect-skip transfers. 

On the 2003 Form 709, the transferors total gifts are reported in the top half of Part 1, 2 or 3 (whichever is applicable) of Schedule A. As with the prior form, the donees name, relationship and a description of the gift are reported in column B. The donors adjusted basis, the gift date and the gifts fair market value (FMV) are listed in the appropriate column. However, the split-gift portion of the transfer to be reported by the transferors spouse is listed in column G; only the net amount of the transfer attributable to the transferor is listed in column H.

Similarly, gifts made by the transferors spouse for which gift-splitting will be elected are reported in the lower half of Part 1, 2 or 3 of Schedule A. The portion of the split gift to be reported by the spouse who made the gift is listed in column G. This amount is subtracted from total gifts, so that only the net amount of the split-gift transfer is listed in column H of the reporting spouses return. This simplifies identifying these gifts should the reporting spouse want to elect out of the GST deemed-allocation rules (if applicable).

Example 1: On Jan. 12, 2003, Bill Gregg gave $60,000 of Texon Corp. stock to his grandson, Brett. On Feb. 23, 2003, Bills wife, Jane, gave her granddaughter, Dot, a car valued at $28,000. Bill and Jane elected gift-splitting on the transfers, so that each was considered the donor of one-half of the gifts for gift tax purposes.

Because the gifts are direct-skip transfers, they are included on Schedule A, Part 2. In Bills case, the Texon stock would be listed in the top half of Part 2; $30,000 of the gift would be included in column G (because it will be reported by Jane), leaving a net transfer of $30,000 in column H. The full amount of the automobile Jane transferred would be listed in the lower portion of Part 2. The half of the gift ($14,000) that will be included on Janes Form 709 is included in column G, leaving a net transfer of $14,000 in column H. Exhibit 1 illustrates Bills completed Schedule A, Part 2.

Reporting Direct Skips

Form 709 is used to compute the gift and GST taxes on lifetime direct-skip transfers and to allocate a transferors GST exemption to these transfers. Direct-skip transfers are reported on Schedule A, Part 2. In addition to the modifications for reporting split gifts (discussed previously), Part 2, Column C2632(b) election, now provides a way to elect out of the deemed allocation of GST exemption.

A direct skip occurs under Sec. 2612(c)(1) when property subject to either the estate or gift tax is transferred to a skip person. Generally, under Sec. 2613, skip persons are individuals two or more generations younger than the transferor (e.g., grandchildren). A transfer to a trust is a direct skip (occurring at the time of the transfer) if all of the beneficiaries with an interest in the trust are skip persons. Direct skips can occur during life or at death. However, only lifetime direct-skip transfers are reported on Form 709.

For a lifetime direct-skip transfer, a portion of the donors unused GST exemption will automatically be allocated to the transfer under the deemed-allocation rules. If the donor wants to allocate GST exemption to a direct-skip transfer (including a split gift made by the donors spouse), column C of Schedule A should be left blank. The value of the transfer listed on Schedule A, Part 2, column H, should be entered on Schedule C, Computation of Generation-Skipping Transfer Tax, Part 1, Generation-Skipping Transfers, in column B (split gifts made by the donors spouse are listed in the lower portion of Schedule C, Part 1). After reducing this amount by the annual GST exclusion (if applicable), the net value of the transfer for GST purposes is entered in column D (and Part 3, column B).

An amount of exemption equal to the transfers net value, or, if less, the value of the donors remaining GST exemption, should be entered on Schedule C, Part 3, Tax Computation, column C. The GST exemption allocated to all direct transfers made during the year is then listed on Schedule C, Part 2, GST Exemption Reconciliation (Section 2631) and Section 2652(a)(3) Election, line 4.

Example 2: The facts are the same as in Example 1. Bill would like to allocate a portion of his GST exemption to the transfer.

Under the deemed-allocation rules, Bills GST exemption will automatically be allocated to these transfers. As a result, they will carry to Schedule C, Part 1. Schedule C is then completed, so that the exemption amount used for the transfer can be tracked. Exhibit 2  provides a completed Schedule C for reporting Bills transfers.

If the transferor does not want to allocate GST exemption to the transfer, he or she can irrevocably elect out of the automatic Sec. 2632(b)(3) exemption-allocation rule for direct skips. The election is made by checking column C, in Part 2 of Schedule A and including the transfers net value (from Schedule A, Part 2, column H) on Schedule C, Part 1, column B (split gifts made by the donors spouse are listed in the lower portion of Schedule C, Part 1). Schedule C, Parts 1 and 3, are then completed to determine the GST tax due on the transfer. 

Reporting Indirect Skips

The most obvious change to Schedule A is a new Part 3 for reporting lifetime indirect skips. For transfers after 2000, any unused portion of a transferors GST exemption is automatically allocated under Sec. 2632(a)(1) to lifetime indirect skips to the extent needed to produce the lowest possible inclusion ratio for such property. However, an individual can elect not to have the automatic allocation rules apply. Part 3 was added to help track the GST exemption automatically allocated to indirect-skip transfers and to provide a way to elect out of the deemed-allocation rules.

All indirect-skip transfers should be reported on Schedule A, Part 3. An indirect skip is any transfer of property (other than a direct skip subject to gift tax) to a GST trust. Generally, under Sec. 2632(c)(3)(A), a GST trust is any trust that could produce a taxable distribution or taxable termination as to the transferor. However, under Sec. 2632(c)(3)(B), certain trusts do not qualify as GST trusts, to help ensure the deemed-allocation rules only apply to transfers likely to warrant an allocation of the donors GST exemption. (A discussion of these is beyond the scope of this article.)

The transferors total indirect-skip transfers are reported in the top half of Part 3, Schedule A. As with the prior form, the donees name, relationship and a description of the gift are reported in column B. The donors adjusted basis, the gift date and the gifts FMV are listed in the appropriate columns. If gift-splitting is elected, the split-gift portion of the transfer reported by the transferors spouse is listed in column G; only the net amount of the transfer attributable to the transferor is listed in column H. Similarly, split gifts by the transferors spouse are listed in the lower half of Part 3, Schedule A (see the above discussion on split gifts).

Under the deemed-allocation rules, the donors GST exemption will automatically be allocated to indirect skip-transfers made during the year. If the donor wants to allocate GST exemption to the indirect-skip transfer, column C should be left blank. The lesser of (1) the exemption amount equal to the value of the transfer in column H or (2) the donors remaining GST exemption, should also be entered on Schedule C, Part 2, line 5, enabling the donor to track the amount used.

Example 3: On March 21, 2003, Bob Watts established a trust that will pay all of its income to his son, Dave, for life. The trustee can invade principal for Daves benefit, subject to an ascertainable standard. At Daves death, the trust remainder will pass to Bobs grandson Keith. The trust will be funded with $1 million of highly appreciating closely held stock. The trust is a GST trust under Sec. 2632(c)(3).

Because this is an indirect skip to a GST trust, there will be a deemed allocation of Bobs GST exemption to the transfer. Exhibit 3 provides a completed Schedule A, Part 3, for this transfer. Exhibit 4 presents a corresponding Schedule C, Part 2, allocating GST exemption to this transfer. Schedule C, Parts 1 and 3, do not need to be completed, because this is an indirect skip, and not a GST currently subject to tax.

Often, a donor may not want to allocate GST exemption to an indirect-skip transfer to a GST trust (e.g., to preserve the exemption for a planned future transfer). Donors can elect not to have the deemed-allocation rules apply to an indirect-skip transfer to a GST trust, under Sec. 2632(c). The election is made by checking column C of Schedule A for each transfer the donor wants to exclude from the deemed-allocation rules. A statement identifying the transfer and describing the election should also be attached to the return. If the election is made, the transfers net value should not be entered on Schedule C, because no exemption is allocated to the transfer.

Example 4: The facts are the same as in Example 3, except that Bob Watts wants to preserve his GST exemption for a direct-skip transfer to a trust for his grandchildren that he intends to make in 2004. As a result, Bob wants to elect out of the deemed allocation of GST exemption.

Bob should check column C of Part 3, Schedule A, and attach an explanatory statement, to elect out of the deemed-allocation rules. Because this is not a direct-skip transfer, Schedule C need not be completed.

Allocating Exemption to a Non-GST Trust

As discussed previously, many transfers to trusts that may result in future taxable distributions or taxable terminations do not constitute indirect-skip transfers subject to the deemed-allocation rules. Examples include transfers to trusts that do not constitute a GST trust under Sec. 2632(c)(3)(B). These transfers should be reported on Schedule A, Part I. Because these trusts are not subject to the deemed-allocation rules, donors must make an affirmative allocation of GST exemption to these trusts. A Notice of Allocation of GST Exemption should be used in these instances. In addition, the GST exemption allocated to these transfers should be listed on Schedule C, Part 2, line 6.

Example 5: On June 16, 2003, Ann Thomson established a trust that will pay all of its income to her daughter, Elly, for life. One-third of trust corpus will be paid to Elly when she reaches age 35, 45 and 55. At her death, any remaining corpus will be distributed to Anns grandson Rick. The trust was funded with $700,000 of highly appreciating securities.

The trust is not a GST trust, because more than 25% of trust corpus must be distributed to a non-skip person (Elly) before she reaches age 46; thus, the automatic allocation of GST exemption does not apply. If Ann wants to allocate GST exemption to this transfer, she should report it on Schedule A, Part 1, and attach a Notice of Allocation detailing the amount of exemption she wants to allocate to the transfer. Tax advisers may also want to add a footnote in Schedule A, Part 1, column B, referencing the attached Notice of Allocation for the transfer. In addition, the exemption allocated to the transfer should be listed on Schedule C, Part 2, line 6. Exhibits 5, 6 and 7 provide a completed Schedule A, Part 1; Schedule C, Part 2; and Notice of Allocation for this transfer.   

As an alternative to filing a Notice of Allocation, the donor may elect to treat any trust as a GST trust as to any or all transfers made by the individual to the trust under Sec. 2632(c)(5)(A)(ii). In these instances, the deemed-allocation rules apply; the transfer would be reported on Schedule A, Part 3, in the same manner as an indirect skip to a GST trust. The election to be treated as a GST trust is made by attaching an election statement to a timely filed gift tax return for the calendar year for which the election is to become effective; see Sec. 2632(c)(5)(B)(ii).

Conclusion

Revisions to the 2003 Form 709 were in response to the favorable GST tax changes enacted by the EGTRRA. Reporting split gifts by type of transfer, segregating direct- and indirect-skip transfers and providing a simple mechanism for electing out of the deemed allocation of GST exemption highlight GSTs that may warrant an exemption allocation and greatly simplify the task of tracking a donors use of the GST exemption.