value of the gifts when they were made to the trust. The goal of all this is to make the trust entirely exempt from GST tax.
The late allocation rules, in the case of many insurance trusts, are sometimes favorable in that the value of the trust-owned policy at the date the late GST allocation is made may be much less than the prior gifts made to the trust (i.e., cash to fund life insurance premiums paid in those prior years). If this occurs, then less GST exemption need be allocated to make the trust free of GST tax than if allocations were made on time as the gifts were made (see Chapter 10).
When the GST transfer also triggers a gift tax, the amount of GST tax paid by you as the donor is treated as an additional gift subject to the gift tax. Depending upon the effective gift tax rate, this can cause the sum of gift and GST transfer taxes to exceed the amount of the gift.
Taxable Distribution
When there is a distribution of property or money from a trust to a skip person, the GST tax may apply. If the GST tax is paid out of a trust, the amount of tax paid is treated as an additional distribution subject to the tax. The GST tax on a taxable distribution is charged against the property that was given, unless specific provisions are made for a different treatment. The transferee (e.g., grandchild) is liable to pay the GST tax.
PLANNING NOTE: If you are very wealthy but have no GST exemption left, you may opt to create what is referred to as a “sprinkle” or “spray” trust (that is, one where the trustee may make distributions to any descendant or not make any distributions at all) in 2012 that permits but does not require distributions to or for skip persons. In that manner the trustee can exercise control over when and if to incur a GST tax. A common approach is to permit distributions to or for the benefit of a skip person, such as a grandchild, from a GST non-exempt trust so that the trustee can make distributions for qualified tuition and medical expenses that do not trigger GST tax. The trustee can then determine if any further taxable distributions should be made.
For example, if you are an elderly and very wealthy taxpayer who has used all of your GST exemption, you may be willing to fund such a sprinkle trust in 2012 for children and later descendants intentionally incurring some gift tax at the cur-rent low 35 percent rate. However, you may not be willing to also trigger GST tax, which can be deferred or avoided.
Taxable Termination
A taxable termination occurs when the interests of all non-skip persons (e.g., the non-skip person, such as a child, entitled to receive income from a trust) terminate as a result of death, lapse of time, or release of a power (right). For example, if a sprinkle/spray trust were established for your child and all grandchildren, the death of your child would result in a taxable termination of that trust for GST purposes.
The death of a child may avoid being treated as a taxable termination resulting in a GST tax if: (1) Immediately after the termination, another non-skip person (such as a child or sibling of yours) has an interest in the property; or (2) no distribution can be made to a skip person. The trustee of the trust pays the GST tax on a taxable termination. The amount of the tax is calculated based on the value of all property to which the taxable termination applied, reduced by expenses, debts, and taxes.
Exclusions from GST Tax
There are a number of methods to protect transfers that would otherwise be subject to GST tax from the tax.
•GST Annual Exclusion: Although the $13,000 annual gift tax exclusion is available for the GST tax, the requirements are different from those applicable for the gift tax. Thus, a transfer might qualify for the annual $13,000 gift tax exclusion but not for the GST tax exclusion. The $13,000 annual exclusion is only available for GST tax purposes on a direct skip transfer for only one skip person. This is a gift directly to a grandchild (or later generation), or in some instances to a trust for a grandchild. This exclusion doesn’t apply to a taxable termination or a taxable distribution.
•Transfers for Educational and Medical Benefits: An individual can gift an unlimited amount of money to pay for a grandchild’s qualified education or medical expenses. These gifts will not be subject to either gift or GST tax.
•GST Exemption: A lifetime exemption is allowed that permits an individual to transfer up to $5.12 million of cash, or other property, in 2012 to skip persons without triggering a GST tax. In 2013, the GST exemption is scheduled to decline to $1 million as inflation adjusted. This is at the heart of much of your 2012 planning.
PLANNING NOTE: The possible creation of a difference in the amount of (de-unification of) the estate and GST exemptions in 2013, if the law in fact reverts to the pre-2001 law, may require that your will or revocable trust be revised to permit a proper funding of the excess GST exemption amount (e.g., the inflation-adjusted GST exemption over the static $1 million estate exemption) otherwise that excess amount, which could grow in future years free of GST tax, could be wasted.
•Certain Transfers: Transfers that meet the following three requirements are also excluded from GST taxation: (1) the property transferred was previously subject to the GST tax; (2) the transferee (recipient) in that prior transfer was a member of the same generation as the current transferee; and (3) the transfer does not have the effect of avoiding the GST tax.
Inclusion Ratio: The Key to GST Tax Trust Planning in 2012
To understand the use of the GST exemption and President Obama’s proposed changes, another important concept must be introduced: the inclusion ratio. The portion of a trust that is exempt from the GST tax is determined by the trust’s inclusion ratio. (Another way of saying this is that the inclusion ratio determines the portion of the trust that, in effect, is subject to the GST tax.) A trust’s inclusion ratio is established when you as the transferor make a completed gift to the trust and allocate your GST exemption (either under the Code’s automatic allocation rules or using a gift tax return to affirmatively allocate GST exemption) to the trust. The inclusion ratio is: [1 - the applicable fraction]. The applicable fraction, when a transferor makes a gift to a trust, is determined as follows:
One approach to addressing the potential GST tax problems associated with long-term trusts is to allocate your GST exemption to the trust. If you allocate any portion of your GST exemption to the trust, that portion of the exemption is considered used, whether or not a GST tax is ever incurred. However, if you allocate GST exemption to a trust, and the trust property never passes to a skip person, you will have wasted that portion of your exemption. You should analyze all the relevant factors and consider the likelihood of the trust incurring a GST tax in the future before committing to allocate GST exemption. This is especially difficult because of the uncertainty as to what the GST exemption will be after 2012. If it appears likely that the trust will incur a GST tax, then you may benefit your heirs by allocating GST exemption to the trust. If the likelihood of a GST tax appears small, then perhaps GST exemption should be reserved for other planning opportunities.
