2012 Estate Planning. Martin Inc. Shenkman
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Some basic definitions must be explained in order to understand the complicated GST tax. These include the three events that can cause the GST tax to apply. These events are a “direct skip,” a “taxable distribution,” and a “taxable termination.” These concepts all have applicability to 2012 planning.
Direct Skip
EXAMPLE: In 2012 you have not already used up all of your $5.12 million gift and GST exemption amounts. You may benefit most from shifting as much wealth as your remaining GST exemption will allow into a multi-generational GST exempt trust for the benefit of your children, grandchildren, and more remote descendants. This provides maximum flexibility. But if children, who are not skip persons, are included as beneficiaries, the trust involved is nota “skip person” and the gift to the trust is nota “direct skip.” If instead no children were included as beneficiaries in this trust, the trust itself will be a “skip person” and the gift to the trust will be a “direct skip.”
Some important definitions:
•A skip person is a person who is two or more generations below the generation of the person making the gift (e.g., a grandchild or a trust for the sole benefit of a grandchild). A trust is also considered a skip person when no distributions can be made currently to non-skip persons (e.g., children). This concept is critical to understanding 2012 tax planning since it may be essential for you to file a gift tax return and affirmatively allocate GST exemption to transfers made to many types of trusts that receive 2012 gift transfers (e.g., DAPTs, discussed in Chapter 5). A proper and timely allocation to your GST exemption on a federal gift tax return (Form 709) is often required to assure that the recipient trust is in fact GST exempt.
•Anon-skip person is a person who is less than two generations below the generation of the person making the gift (e.g., a child or sibling). In certain instances, the premature death of a child will allow the deceased child’s children to avoid treatment as a skip person (i.e., the deceased child’s children move up a generation for GST tax purposes). This means that transfers to such grandchildren won’t trigger the GST tax. A direct skip requires a transfer of an interest in property, which is subject to the estate or gift tax (even if protected by an exclusion or exemption from estate and gift tax), to a skip person. The person making the transfer pays the GST tax on a direct skip.
Once it has been determined that a gift is subject to the GST tax, the GST tax must be calculated. For GST tax purposes, a taxable transfer of property is generally valued at the time the generation-skipping transfer occurs and is based on the same valuation rules that apply to gifts.
PLANNING NOTE: Special rules apply when a late allocation of GST exemption is made, (e.g., GST exemption is allocated to a trust years after the initial gift transfer). This might have important planning applicability if you have to make a transfer to an existing insurance trust near the end of the year and there is insufficient time to create anew trust before year end. If a large gift is made to an existing insurance trust to which GST exemption was not previously allocated, then it may be wise to make a late allocation of GST exemption to that trust to exempt prior gifts from GST tax, in addition to allocating GST exemption to cover the 2012 gift. But the amount of GST exemption allocated must be equal to the current value of those gifts, not the 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