PLR 1027034: GST exemption allocations to family trusts were effective despite reporting errors

Plain-English summary

An estate asked how its generation-skipping transfer tax exemption had been allocated among trusts for descendants. The estate had reported the exemption amounts, but it did not properly identify two descendant trusts on Schedule R, and it did not list another family trust for the remaining exemption. The IRS ruled that the allocations to the two descendant trusts substantially complied with the allocation rules and produced zero inclusion ratios, assuming the transfers were properly valued. The IRS also ruled that the remaining exemption was automatically allocated to the other family trust under section 2632(c)(1). The ruling matters because it shows how an estate's demonstrated allocation intent can preserve the intended GST tax treatment despite errors in identifying the trusts on the estate tax return.

Ruling snapshot

• Question: Were the reported GST exemption allocations effective when the estate failed to identify the relevant trusts correctly on Schedule R?
• Outcome: approved
• Key authorities: IRC §§ 2518, 2631, 2632, 2642; Treas. Reg. §§ 26.2632-1 and 26.2654-1

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

                                                         Third Party Communication: None

Number: 201027034 Date of Communication: Not Applicable
Release Date: 7/9/2010 Person To Contact:
-------------------------, ID No. -------------
Index Number: 2642.00-00 Telephone Number:
---------------------
------------------------------------------------------------- Refer Reply To:
-------------------- CC:PSI:B04
-------------------------------------- PLR-148728-09
Date: APRIL 12, 2010

In Re: ------------------------------------

Legend

Decedent = ---------------------------------------------------
Daughter 1 = ---------------------------
Daughter 2 = ----------------------------
Son = -------------------
Granddaughter 1 = --------------------
Granddaughter 2 = --------------------
Grandson 1 = ----------------------
Grandson 2 = ---------------------
Personal
Representative = ----------------------------
Trust = ---------------------------------------
Date 1 = ----------------------
Accountant = -------------------------
Date 2 = ------------------
Date 3 = ---------------------------
V = ---------
W = ---------
X = -------------
Y = -----------
Z = -------------

Dear -------------------:

   This letter responds to your authorized representative’s letter of

October 30, 2009, requesting rulings on the allocation of generation-skipping transfer
(GST) exemption.

Facts
PLR-148728-09 2

   The facts and representations submitted are summarized as follows: Decedent

died testate on Date 1 survived by Daughter 1, Daughter 2, Son and their descendants.
Son is the father of Grandson 1, Grandson 2. Daughter 1 was the mother of
Granddaughter 1 and Granddaughter 2. Daughter 1 died on Date 2.

    Article V of Decedent’s will provides that the residuary of her estate is to be

divided among her three children. Article V, paragraph A provides that two-fifths of
Decedent’s residuary estate is to be placed in Trust for the benefit of Daughter 1.
During Daughter 1’s lifetime the trustee is to distribute $V per year for Daughter,
adjusted for inflation. The trustee is also to purchase medical insurance for Daughter 1
and pay any uncovered medical care as the trustee deems feasible. The trustee is to
pay $W to each of Daughter 1’s children, Granddaughter 1 and Granddaughter 2 for
the cost of their first weddings. At Daughter 1’s death the remaining trust balance is to
be distributed equally to Granddaughter 1 and Granddaughter 2 if they have reached
the age of 35, otherwise the trust assets are to be held in trust for Granddaughter 1
and Granddaughter 2 and distributed when each attains the age of 35. Article V,
paragraph B provides that two-fifths of the residuary estate passes to Daughter 2
outright.

   Article V, paragraph C provides that one-fifth is to pass to Son outright. Son

executed a qualified disclaimer within the meaning of § 2518 with respect to the interest
passing to him under Decedent’s will and as a result the property passed to trusts for the
benefit of Grandson 1 and Grandson 2 until they attain the age of 35.

   Personal Representative of Decedent’s estate hired Accountant to prepare the

Form 706 United States Estate (and Generation-Skipping Transfer) Tax Return for
Decedent’s estate. Decedent had not made any GST transfers during her lifetime and
had her full GST exemption available to allocate on Form 706. The Form 706 was
timely filed with an accompanying Schedule R. The Estate received an Estate Tax
closing letter on Date 3.

   The Schedule R correctly reported that Decedent had $X of unused GST

exemption. Grandson 1 and Grandson 2 were treated as having received two-fifths of
the estate as a result of Son’s disclaimer, and a total of $Y of Decedent’s GST
exemption was allocated to the transfers on Schedule R, Part 1. Since Grandson 1 and
Grandson 2 had not attained the age of 35, the transfers were to be to trusts for their
benefit. The transfers should have been reported on Part 1 of Schedule R, naming the
trusts and showing the allocations to those trusts.

   In addition, the remaining amount of Decedent’s GST exemption, $Z, was shown

on line 8 of Schedule R as GST exemption available to allocate to trusts and § 2032A
interests. The remaining exemption should have been allocated (either affirmatively or
automatically) to Trust for the benefit of Daughter 1 and her descendants.
PLR-148728-09 3

   You have requested the following rulings:

  1. The $Y of Decedent’s unused GST exemption was effectively allocated to the

residuary shares passing for the benefit of Grandson 1 and Grandson 2, regardless of
whether they passed outright or in trust.

   2. That the balance of Decedent’s unused GST exemption, $Z, was effectively

allocated to Daughter 1’s Trust as of the date of D’s death.

Law and Analysis

   Section 2601 of the Internal Revenue Code imposes a tax on every generation-

skipping transfer. A generation-skipping transfer is defined under § 2611(a) as (1) a
taxable distribution, (2) a taxable termination, and (3) a direct skip.

   Section 2602 provides that the amount of the tax is the taxable amount multiplied

by the "applicable rate." Section 2641(a) defines applicable rate as the product of the
maximum Federal estate tax rate and the inclusion ratio with respect to the transfer.

     Under § 2642(a)(1), in general, the inclusion ratio with respect to any property

transferred in a generation-skipping transfer is the excess (if any) of 1 over the
applicable fraction determined for the trust from which such transfer is made, or in the
case of a direct skip, the applicable fraction determined for such transfer. Section
2642(a)(2) provides that the applicable fraction is a fraction (A) the numerator of which
is the amount of the GST exemption allocated to the trust under § 2631(a), and (B) the
denominator of which is (i) the value of the property transferred to the trust, reduced by
(ii) the sum of (I) any Federal estate tax or State death tax actually recovered from the
trust attributable to such property and (II) any charitable deduction allowed under
§§ 2055 or 2522 with respect to such property.

   Section 2631(a) provides that, for purposes of determining the inclusion ratio,

every individual shall be allowed a GST exemption amount that may be allocated by
such individual (or his executor) to any property with respect to which such individual is
the transferor. Section 2631(b) provides that any allocation under § 2631(a), once
made, shall be irrevocable.

   Section 2632(a)(1) provides that any allocation by an individual of his or her GST

exemption may be made at any time on or before the date prescribed for filing the
estate tax return for such individual's estate. Under § 26.2632-1(b)(4)(i) of the
Generation-Skipping Transfer Tax Regulations, generally, an allocation of GST
exemption to property transferred during the transferor's lifetime is made on Form 709.
The allocation must clearly identify the trust to which the allocation is being made and
PLR-148728-09 4

the amount of GST exemption allocated to it. The allocation should also state the
inclusion ratio of the trust after the allocation.

   Under § 2632(b)(1), if an individual makes a direct skip transfer during his or her

lifetime, any unused portion of such individual's GST exemption is automatically
allocated to the property transferred to the extent necessary to make the inclusion ratio
zero. Section 2632(b)(3) provides that an individual may elect out of this automatic
allocation rule with respect to direct skips. Section 26.2632-1(b)(1) provides that if a
direct skip occurs during the transferor's lifetime, the transferor's GST exemption not
previously allocated is automatically allocated to the transferred property. The
transferor may prevent the automatic allocation of GST exemption by describing on a
timely-filed United States Gift (and Generation-Skipping Transfer) Tax Return (Form
709) the transfer and the extent to which the automatic allocation is not to apply.
Section 2632(c)(1) provides that if any individual makes an "indirect skip" during
such individual's lifetime, any unused portion of such individual's GST exemption is
treated as allocated to the property transferred to the extent necessary to make the
inclusion ratio for such property zero. If the amount of the indirect skip exceeds such
unused portion, the entire unused portion shall be allocated to the property transferred.

   Under § 2632(c)(3)(A), the term "indirect skip" means any transfer of property

(other than a direct skip) subject to the tax imposed by chapter 12 made to a GST trust,
as defined in § 2632(c)(3)(B). Under § 2632(c)(3)(B), a GST trust is a trust that could
have GST potential with respect to the transferor unless the trust satisfies any of the
exceptions listed in § 2632(c)(3)(B)(i)-(vi).

   Section 2632(c)(5)(A)(i) provides that an individual may elect to have the

automatic allocation rules of § 2632(c)(1) not apply to an indirect skip, or any or all
transfers made by such individual to a particular trust. Section 2632(c)(5)(B)(ii) provides
that the election may be made on a timely filed gift tax return for the calendar year for
which the election is to become effective.

    Section 26.2632-1(b)(2)(i) provides that in the case of an indirect skip made after

December 31, 2000, to which § 2642(f) (relating to transfers subject to the estate tax
inclusion period or ETIP) does not apply, the transferor's unused GST exemption is
automatically allocated to the property transferred (but not in excess of the fair market
value of the property on the date of the transfer). This automatic allocation is effective
whether or not a Form 709 is filed reporting the transfer, and is effective as of the date
of the transfer to which it relates. An automatic allocation is irrevocable after the due
date of the Form 709 for the calendar year in which the transfer is made.

   Section 26.2632-1(b)(2)(ii) provides that, except as otherwise provided, the

transferor may prevent the automatic allocation of GST exemption with regard to an
indirect skip by making an election as provided in § 26.2632-1(b)(2)(iii). The transferor
may also prevent the automatic allocation of a GST exemption with regard to an indirect
PLR-148728-09 5

skip by making an affirmative allocation of GST exemption on a Form 709 filed at any
time on or before the due date for timely filing of an amount that is less than (but not
equal to) the value of the property transferred as reported on that return.

   Section 26.2632-1(b)(2)(iii)(A) provides that a transferor may prevent the

automatic allocation of GST exemption (elect out) with respect to any transfer or
transfers constituting an indirect skip made to a trust or to one or more separate shares
that are treated as separate trusts under § 26.2654-1(a)(1). In the case of a transfer
treated under § 2513 as made one-half by the transferor and one-half by the transferor's
spouse, each spouse shall be treated as a separate transferor who must satisfy
separately the requirements of § 26.2632-1(b)(2)(iii)(B) to elect out with respect to the
transfer. Under § 26.2632-1(b)(2)(iii)(B), to elect out, the transferor must attach a
statement to a Form 709 that identifies the trust and specifically provides that the
transferor is electing out of the automatic allocation of GST exemption with respect to
the described transfer or transfers. Section 26.2632-1(b)(2)(iii)(D) provides that an
election out does not affect the automatic allocation of GST exemption to any transfer
not covered by the election out statement.

   Section 2642(g)(2) captioned "Substantial Compliance" provides that an

allocation of GST exemption under § 2632 that demonstrates an intent to have the
lowest possible inclusion ratio with respect to a transfer to a trust shall be deemed to be
an allocation of so much of the transferor's unused GST exemption as produces the
lowest possible inclusion ratio. In determining whether there has been substantial
compliance, all relevant circumstances shall be taken into account, including evidence of
intent contained in the trust instrument.

   In this case, Decedent's GST exemption amount was properly allocated to the

transfers of the shares passing for the benefit of Grandson 1 and Grandson 2.
However, the property was not identified and properly recorded on Part 1 of Schedule R
as trusts for the benefit of Grandson 1 and Grandson 2. The allocation of Decedent’s
GST exemption to the transfers to Grandson 1 and Grandson 2 was sufficient to
produce a zero inclusion ratio for both trusts. Under these circumstances, with respect
to Decedent's return, the allocation is sufficient to constitute substantial compliance
under § 2642(g).

    Therefore, we conclude that Decedent is deemed to have made a timely

allocation of Decedent's GST exemption with respect to Decedent's transfers to trusts
for the benefit of Grandson 1 and Grandson 2. As a result, the trusts for the benefit of
Grandson 1 and Grandson 2 will have an inclusion ratio of zero, assuming the transfers
to the trusts are properly valued.

   With respect to the transfers to Trust for the benefit of Daughter 1 and her

descendents, the remaining amount of Decedent’s GST exemption was properly
reported on line 8 of Schedule R, but Trust was not listed on Part 1 of Schedule R and
PLR-148728-09 6

the remaining exemption was not allocated to Trust. Thus, we conclude that under
§ 2632(c)(1), Decedent’s remaining GST exemption was automatically allocated to the
transfer to Trust for the benefit of Daughter 1 and her descendants.

  The rulings contained in this letter are based upon information and

representations submitted by the taxpayer and accompanied by a penalty of perjury
statement executed by an appropriate party. While this office has not verified any of
the material submitted in support of the request for rulings, it is subject to verification on
examination.

   The GST tax rulings in this letter apply only to the extent that the relevant

sections of the Internal Revenue Code are in effect during the period at issue.

   Except as specifically ruled herein, we express or imply no opinion on the federal

tax consequences of the transaction under the cited provisions or under any other
provisions of the Code.

  This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3)

provides that it may not be used or cited as precedent.

                                           Sincerely,



                                           Lorraine E. Gardner
                                           Senior Counsel, Branch 4
                                           Associate Chief Counsel