Accounting 815

Taxation of Transfers and Fiduciaries

Week 14: Generation Skipping Transfers

1. SKIPS

 Basic concept of a Skip

G in TR, Y to C for life, Rem to GC

Gift or estate tax for G, but not on C's death

mere income interest not includible property
unless also general power of appointment, etc

Result: avoid transfer tax on big multigenerational fortunes

eg. Rockefeller V-Pres confirmation hearings

How long a tie up? : Rule against perpetuities

Can't exceed "life in being" plus 21 years

1976 tax act tried to tax the shifting interest

unworkable, retroactively repealed in 1986
led Tp's to try direct skips as an alternative
Big rich could avoid better than small rich

2. The Generation Skipping Transfer Tax

Tightly and abstractly drafted w/ many defined terms

3 cases so far; few rulings except on grandfathering

drastic planning implications:

GST Tax stacked on regular transfer tax

What is a "generation"

Sec. 2651 generation assignment

if lineal descendent of Transferor's grandparent
  count the generations

similar generation count for spouse
  Spouse is assigned to transferor's generation

Non-lineal descendants classified by age.
  A generation is 25 years long
  Transferor is at the midpoint

If multiple assignments, assign to youngest generation

Look thru entities

Charities are in transferor's generation

What is a "skip"

"Transfer" to a "skip person": Sec. 2613

person 2 or more generations below the transferor
or a trust if all interests are held by skip persons

What is a "Transfer": Sec. 2611, 2612

Direct Skip

A gift or inheritance-taxable transfer to a skip person
Generation lift-up rule if child is deceased

Taxable termination

any termination of an interest in property held in trust

unless: non-skip person still has an interest
  or, at no time any distribution to a skip person

Taxable Distribution

Residual category

Any distribution to a skip person, other than termination or direct skip

3. Calculating the tax: Sec. 2602

"Taxable amount" times "Applicable rate"

Applicable rate: highest estate tax rate (55%)

Times: "inclusion ratio": Sec. 2642

An adjustment for amounts exempt from tax:
  1- (GST exemption/ property transferred)

eg. 1.5 mm to trust, 1 mm exemption: so 1/3 is included.

Inclusion ratio determined at time of funding -- even if property subsequently increases in value

Times the "taxable amount"

If Distribution

 FMV received less cost of determining GST tax
 tax inclusive, transferee to pay (Sec. 2603

If Termination

Value of property less expenses, debts, taxes
tax inclusive, trustee to pay (Sec. 2603

If Direct Skip

Value of property received: Sec. 2623
Tax exclusive: transferor to pay

"Receipt" means GSTT is on amount left after any estate tax imposed

4. Exceptions, illustrations and interactions

Pre-1986 transfers are grandfathered

The Rockefellers still pay no tax

Petersen v. CIR: is lapse of a power of appointment a post '86 "addition"?

Gift tax exclusion 10K, medical and tutition

$ 1 mm exemption per transferor

Allocation: Sec. 2632

first lifetime direct skips, then to GST trusts

unless different allocation made when estate tax return is filed

The price of direct testamentary skips

Example: a $3mm estate: all to GC: 706 Sched R

First calculate estate tax: 1,088,750

Then apply exemption: GC gets 1,911,250 w/ $1 mm exempt

Then need to solve for GST amount
  X plus GST on X = 1.55X = 911,250
  X = 587,903, GST = 323,347

Generally, GST = .55/1.55 or 35.48%, or 1/2.81818181

Income tax interaction

 Basis adjustment for GST paid, analogous to gift increase or death stepup

Income tax: trust distributions may be of taxable income, and also be "taxable distributions"

The GST Horror Story

"I leave $5,000,000 to my son, $1,000,000 free of generation skippng transfer tax to my grandson, and my $1,000,000 rollover IRA account to my granddaughter."

GD cashes in the IRA for $1 mm

Estate tax re GD is $550,000. GST is $247,500.

Income of $1mm less itemized deduction of about $670K times 40% is $132,000

GD keeps about $71,000 of the $1mm

5. GSTT Planning issues

Now or later

value of deferral. vs more tax on the deferred amount.

 Eg. direct skip or taxable termination?

tax inclusive vs tax exclusive

Preventing dilution of the $1mm exemption

want inclusion ratio of 0

G might want 2 trusts: 1 for C and 1 for GC, with C not to draw out of GC's (and thus not waste the exclusion on a non-skip person)

  

 Build Date 5/12/98 /