Irrevocable Gift Splitting and GST Tax Decisions

Irrevocable Gift Splitting and GST Tax Decisions

Whether a taxpayer can reallocate certain transfers to trusts depends on whether the statute of limitations has expired

In Private Letter Ruling 201523003 (released June 5, 2015), the Internal Revenue Service examined the effect of gift splitting under Internal Revenue Code Section 2513 and the application of the generation-skipping transfer (GST) tax rules under IRC Section 2632(c) to certain transfers made to trusts.  The IRS issued six rulings, some of which disallowed reallocations of certain transfers that were time-barred.

The Terms of the Trusts

On a certain date (Date 1 during Year 1), a husband created a family trust for the benefit of his wife and his descendants.  On a later date that year (Date 2), he transferred funds to the family trust.

On Date 1, he also created and funded for his benefit Trust 1 and Trust 2, both of which were grantor retained annuity trusts (GRATs).  Trust 1’s annuity term ended on a certain date in a different year (during Year 2); Trust 2’s annuity term ended on a certain date in a different year (during Year 3).  At the end of the annuity terms, which represented the close of the estate tax inclusion period (ETIP), the remaining principal of Trust 1 and Trust 2 became payable to the family trust.

The terms of the family trust provided that the trustee, in his discretion, may pay to or use for the benefit of the husband’s descendants and their spouses as much income and principal as the trustee determines to be required for their support, health and education.  The family trust terms also provided that the trustee may pay to or use for the benefit of the wife, the husband’s descendants and their spouses as much income and principal as the trustee determines to be desirable for their welfare and best interests.  Income not used would be added to the principal.

The Tax Returns

The husband and wife each filed a federal gift and GST tax return (Form 709) for Year 1.  On their forms, they each consented to treat the Year 1 gifts to the family trust, Trust 1 and Trust 2, as having been made one-half by each of them under Section 2513.  They both attached statements to their respective Year 1 Forms 709 electing out of the automatic allocation rules of Section 2632(c) with respect to the funds transferred to the family trust.  They also each allocated their individual GST tax exemptions to a certain dollar amount, which represented a portion of the total amount transferred to the family trust.  They didn’t allocate their individual GST tax exemptions to the remaining portion transferred to the family trust.  They also didn’t allocate their individual GST tax exemptions to the transfers to Trust 1 or Trust 2, because those trusts were subject to ETIPs.

On a different date, the husband filed a Year 2 Form 709 and attached a form reporting the transfer of property from Trust 1 to the family trust.  He didn’t allocate his GST tax exemption to this transfer.  His wife didn’t file a Year 2 Form 709; she also didn’t allocate her GST tax exemption to the transfer of property from Trust 1 to the family trust.

Trust 3 and Trust 4

During Year 3, the husband created and funded a new GRAT (Trust 3) for his benefit during the annuity period.  Trust 3’s annuity term ended on a certain date (during Year 4).  When it ended, the remaining principal would become payable to the family trust.

On a different date during Year 3, the husband created and funded another GRAT (Trust  4) for his benefit during the annuity period.  Its annuity term ended on a certain date (during Year 4), and when it ended, its remaining principal would become payable to the family trust.

The husband and his wife each filed Year 3 Forms 709, consenting to treat the gifts to Trust 3 and Trust 4 as having been made one-half by each of them under Section 2513.  They didn’t allocate their individual GST tax exemptions to the transfers to Trust 3 and Trust 4, because both trusts were subject to ETIPs.  They did allocate their respective GST tax exemptions to one-half of the transfer of property from Trust 2 to the family trust.  They also attached a form reporting that their individual GST tax exemption was automatically allocated to one-half of the Year 2 transfer of property from Trust 1 to the family trust under Section 2632(c).

At the time they requested rulings from the IRS, the couple had not yet filed a Form 709 for Year 4 to report the transfer from Trust 3 and Trust 4 to the family trust.

Requested Rulings

The taxpayers requested rulings on six issues:

1) Is the election to split gifts in Year 1 effective with respect to the family trust, Trust 1 and Trust 2?

2) Is the husband and wife’s allocation of their respective GST tax exemptions to the Year 1 transfer to the family trust effective?

3) At the close of the ETIP in Year 2, was the husband’s and wife’s GST tax exemption automatically allocated to one-half of the transfer of property from Trust 1 to the family trust?

4) At the close of the ETIP in Year 3, was the husband’s and wife’s GST tax exemption affirmatively allocated to one-half the transfer of property from Trust 2 to the family trust?

5) Was the election to split gifts in Year 3 ineffective with respect to the transfers to

Trust 3 and Trust 4?

6) May the husband file a Form 709 to allocate his remaining GST tax exemption to the Year 4 transfers of property from Trust 3 and Trust 4 to the family trust?

Effectiveness of the Gift Splitting

To answer questions 1, 2 and 5, the IRS first turned to IRC Section 2501(a)(1), which imposes a tax on gifts of property, whether the transfer is in trust or otherwise.  Treasury Regulations Section 25.2504-2(b) states that if the time has expired under IRC Section 6501 to impose a gift tax for transfers made after Aug. 5, 1997, the amount of the taxable gift is the amount that’s “finally determined” for gift tax purposes and may not be adjusted.  Section 2513(a)(1) provides generally that a gift by one spouse to a person other than the donor’s spouse is considered made one-half by the donor and one-half by his spouse.  And, Treas. Regs. Section 25.2513-1(b)(4) states that consent is effective only if both spouses signify their consent to treat all gifts to third parties as having been made one-half by each spouse.  The IRS also looked to Revenue Ruling 56-439, in which a gift was made to a trust where the trustee was to distribute part of the income or principal to the donor’s spouse and his other descendants.  In that ruling, the value of the right to receive the income or principal to be distributed to the spouse was “not susceptible of determination.”  Accordingly, in that revenue ruling, the gift to the spouse wasn’t severable from the gifts to the other beneficiaries and couldn’t be considered as made one-half by the donor and one-half by his spouse under Section 2513.   

In the instant case, the husband transferred property to the family trust, Trust 1 and Trust 2 in Year 1.  The couple each elected to treat the transfers as split gifts on their Year 1 federal gift tax return.  At the end of the GRATs’ annuity terms, the property was to be transferred to the family trust, of which the wife was a beneficiary.  Under the family trust, the trustee was to use his discretion to pay income and principal to the wife, the husband’s descendants and their spouses, for their welfare and best interests.  As such, the wife’s interests in the family trust were “not susceptible of determination” and thus not severable from the interests of the other beneficiaries in the family trust.  The transfer to the family trust, therefore, didn’t qualify for gift split treatment.  Under Section 2504(c), however, the time for determining whether gift split treatment was effective for Year 1 through Year 3 transfers to the family trust had expired under Section 6501.  Thus, the gift split treatment was irrevocable for the Year 1 transfer to the family trust and the Years 2 and 3 transfers from Trust 1 and Trust 2 to the family trust.

On their federal gift tax returns in Year 3, the couple each elected to gift split the transfers to Trust 3 and Trust 4.  However, the statute of limitations hadn’t expired for Year 3 (Treas. Regs. Section 25.2513-1(b)(4)).  Therefore, the husband can file a supplemental Year 3 Form 709 to report that he solely made the Year 3 transfers to Trust 3 and Trust 4.

GST Determinations

The IRS next analyzed the GST tax exemption to the transfers.  IRC Section 2601 taxes every GST; the amount of the tax is determined by multiplying the maximum federal estate tax rate and the inclusion ratio.  Under Section 2631(a), every individual is allowed a GST tax exemption that he can allocate to property of which he’s the transferor.  Any allocation under Section 2631(a), once made, is irrevocable. 

Under Section 2632(a)(1), an allocation may be made on Form 709 on or before the estate tax return is due.  If an individual makes an indirect skip, any unused portion of the GST tax exemption is allocated to the property to make the inclusion rate zero.   A direct or indirect skip that’s subject to an ETIP is deemed to have been made only at the close of the ETIP (Treas. Regs. Section 26.2632-1(c)(1)(i)).  Treas. Regs. Section 26.2652-1(a)(4) states that for a transfer in which a donor’s spouse makes an election to treat the gift as made one half-by her, the electing spouse is treated as the transferor of one-half of the entire value of the property transferred by the donor, no matter what the interest the electing spouse is actually deemed to have transferred.

In the instant case, the family trust is a GST.  The couple each attached a statement to the Year 1 Form 709 electing not to have the automatic allocation rules under Section 2632(c) apply regarding the monetary transfer to the family trust.  The husband and wife, consistent with gift splitting, affirmatively allocated their respective GST tax exemptions equal to a dollar amount to the transfer to the family trust.  The IRS already determined that the transfer to the family trust didn’t qualify for gift split treatment, due to the wife’s interests found not to be severable from the other beneficiaries.  However, the IRS also found that the time for determining the effectiveness of the gift splitting had expired.  Thus, the IRS ruled that the husband and wife must be treated as the transferors of one-half of the entire property transferred to the family trust in Years 1 through 3.  Thus, their allocations of the GST tax exemptions were effective. 

The IRS also ruled that the automatic exemption rules under Section 2632(c) applied to allocate their GST tax exemption to one-half of the transfer of property from Trust 1 to the family trust in Year 2 at the end of the ETIP.  And, the couple’s affirmative allocation of their GST tax exemption to one-half of the transfer of property from Trust 2 to the family trust in Year 3 at the end of the ETIP was effective for purposes of Chapter 13. 

Given that the statute of limitations hadn’t expired regarding Year 3 Form 709, the husband is permitted to file a supplemental Form 709 reporting the Year 3 transfers to Trust 3 and Trust 4 as being made solely by him, and he may file a Year 4 Form 709 to allocate his GST tax exemption to the Year 4 transfers from Trust 3 and Trust 4 to the family trust at the close of their ETIPs.

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