Sec. 2632 Prop. Regs. on Electing Out of Deemed GST Allocations

The Economic Growth and Tax Relief Reconciliation Act of 2001 amended Sec. 2632 to allow for deemed allocations of certain lifetime transfers to generation-skipping transfer (GST) trusts. Proposed regulations issued on July 13, 2004 (REG-153841-02) address how to elect out of these deemed allocations.

Background

The deemed-allocation rules applicable to indirect skips were designed to simplify the process, by removing the affirmative election to allocate the GST tax exemption, especially in instances in which the allocation was intended to be made, but inadvertently omitted. For indirect skips made during life after 2000, the transferor’s GST tax allocation is automatically applied as of the date of the transfer (for transfers subject to an estate tax inclusion period, as of the close of such period).

However, there are several instances in which a transferor would not want to allocate his or her GST exemption. For example, a transferor may (1) want to conserve it for other gifts; or (2) not want to allocate when the gift is made to an irrevocable life insurance trust to purchase term life insurance (for details, see Hills, Tax Clinic, “Wait and See GST Tax Planning,” TTA, September 2003), or when the gift’s value has decreased after the transfer, but before the gift tax return is filed.

Definitions

Which transfers are subject to the Sec. 2632(c) deemed-allocation rules? Indirect skips made during the transferor’s life qualify. Sec. 2632(c)(3)(A) defines an indirect skip as any transfer of property, other than a direct skip, that is subject to gift tax and made to a GST trust. Sec. 2632(c)(3)(B) defines a GST trust as a trust that could have a GST with respect to the transferor; it also details several types of trusts that are not GST trusts.

Prop. Regs.

Prop. Regs. Sec. 26.2632-1(b)(2) and (3) address three separate elections that can be made—to elect to (1) not have the automatic allocation rules apply to current transfers to the trust; (2) not have the automatic allocation rules apply to both current and future transfers to the trust; and (3) treat any trust as a GST trust (and, thus, subject to the deemed-allocation rules).

Making the election: Each election is made by attaching a statement to a timely filed Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, that identifies the trust and describes the transfer. If the transferor is electing out under #1 or #2 above, the statement must specifically provide that the transferor is electing, pursuant to Sec. 2632(c)(5)(A), to have the automatic allocation rules contained in Sec. 2632(c)(1) not apply to the described transfer to the trust (or, to the current transfer and all future transfers, under #2 above). This election can also apply to indirect skips to one or more separate shares treated as separate trusts under Regs. Sec. 26.2654-1(a)(1). Further, in the case of a split-gift transfer with a spouse, the statement must be attached to both the transferor’s and the spouse’s Forms 709.

Terminating an election: Prop. Regs. Sec. 26.2632-1(b)(2)(iii)(B) provides that an election to opt out of all future deemed-allocation transfers to the trust (#2 above) can be terminated, by filing a statement with a timely filed Form 709 for the calendar year in which the first transfer to which the election shall not apply was made.

Electing out of the deemed allocation rules does not prevent a transferor from allocating his or her available GST exemption, such as when making a partial allocation on a timely filed Form 709 or by making a late allocation under Regs. Sec. 26.2632-1(b)(4).

Treatment as GST trust: If the transferor wants to elect to treat a trust as a GST trust (#3 above), Prop. Regs. Sec. 26.2632-1(b)(3)(i) indicates that the statement must specifically provide that, pursuant to Sec. 2632(c)(5)(A)(ii), the transferor is electing to have the trust treated as a GST trust as defined in Sec. 2632(c)(3)(B). This election will treat all current and future transfers to the trust as indirect skips to which the GST exemption will be automatically allocated.

The transferor can terminate the election, according to Prop. Regs. Sec. 26.2632-1(b)(3)(ii), by filing a statement with a timely filed Form 709 for the calendar year in which the first transfer to which the election shall not apply was made. This termination will apply to all future transfers, so they will not be treated as indirect skips, but the GST allocation will not be made automatically unless again elected.

To help facilitate the election out, Form 709 was revised (for details, see Smith, “Navigating the Revised Gift Tax Return” TTA, December 2003, p.738). Schedule A is now separated into three parts: (1) gifts subject only to gift tax, (2) direct skips and (3) indirect skips. Part three, column (c), “2632(c) election out,” allows the tax preparer to check a box to elect out of the deemed-allocation rules. However, the proposed regulations’ statement requirements must still be followed.

Observations

Sec. 2632(c) was enacted to simplify the allocation of the GST exemption process and prevent situations in which the allocation was intended to be made, but was not. Now, more than ever, tax preparers, attorneys and trustees must review each gift made to determine whether or not to opt out of the deemed-allocation rules. The proposed regulations provide a simplified procedure and permit great flexibility in allowing a transferor to make an election, terminate it and make it again in subsequent years, without needing IRS approval.

However, the deemed-allocation rules make it harder to keep track of the exemption amount used because, in some instances, returns are no longer required to allocate the GST exemption. This can occur when a gift is made to a GST trust that qualifies for the gift tax annual exclusion, but not the GST tax annual exclusion. It may be advisable to prepare gift tax returns (even when not otherwise required) to keep track of the GST exemption for future estate and gift tax planning and administration.

From Heather J. Leggiero, CPA, J.D., Dorfman-Robbie, CPAs, P.C., Albany, NY