Not only is a taxpayer subject to the estate tax, the income tax and the gift tax but also a generation skipping transfer tax (“GSTT”). The GSTT is imposed on certain transfers of property by a taxpayer to a grandchild or to an individual 2 or more generations below the taxpayer. The GSTT was enacted to avoid the following plan.
A taxpayer would transfer assets to a trust which would benefit many generations (a child, then grandchild, then great-grandchild, then great great- grandchild, etc.). The trust terms would provide that a beneficiary of the trust could have a right to income and principal for their health, education, maintenance and support. When a beneficiary died, and no matter the size of the trust, the trust assets were not subject to estate tax in the beneficiary’s estate because the beneficiary had no ownership rights in the trust assets which would require inclusion in the beneficiary’s estate. The Internal Revenue Service (“IRS”) was not happy as trust assets and the appreciation of such trust assets would not be subject to estate tax for many generations and the IRS lost tax at each generation.
Even better are trusts that were created and irrevocable prior to September 25, 1985 which are NOT subject to GSTT AT ALL (“GSTT Grandfathered Trust”) . Thus, if you want to amend, reform or otherwise change a GSTT Grandfathered Trust, you must be extremely careful so you do not lose the GSTT exempt status of such a trust.
Fortunately, the IRS has published regulations for determining whether a modification, judicial construction, settlement agreement or trustee action will NOT cause the GSTT Grandfathered Trust to lose its exempt status.
In a recent private letter ruling (“PLR”) 201633022, the trustee of a GSTT Grandfathered Trust wanted to modify such a trust. The trust terms provide that shares are to be created for the original grantor’s great grandchildren. Upon the earlier of the great grandchild reaching age 35 or death, such great grandchild’s share would terminate and would either be paid to the great grandchild, if living, or, if not living, as the great grandchild appoints to certain individuals. If the great grandchild did not exercise the power of appointment, then such property would be distributed to the children of the great grandchildren.
Unfortunately, one of the great grandchildren was born with cognitive deficits and other disabilities and she does not have the capacity to exercise such power of appointment. This incapacity was a circumstance not anticipated by the creator of the trust.
The state court agreed to a proposed modification to the trust which provided that the trust property would stay in trust for the beneficiary and if she died before age of 25 her interest would pass as provided in the original trust, If she died between the ages 25-35, then 1/2 of the property would be includable in her gross estate and the other 1/2 would pass under the original trust terms. If she died after age 35,then her share of the trust would terminate and be includable in her estate. This modification order was contingent on a favorable ruling by the IRS.
The IRS analyzed the modification and determined that the modification would not cause the trust to lose its GSTT exempt status under the regulations.
ADVICE: If you are a trustee proposing to reform, amend or otherwise change any trust, then carefully review the date of the trust and determine whether the trust is a grandfathered exempt GSTT trust. You do NOT want any changes to cause the trust to lose this GSTT exemption.
WORD OF THE WEEK: Res is a Latin term for an object or subject matter or a status against which legal proceedings have been instituted. Generally, an express written trust has a transferor (or a donor or grantor), of the res, the res and a trustee managing the res for the benefit of beneficiaries. At the time the transferor signs the trust, technically there is no res because it is a new trust and it takes time to actually title res into the name of the trust. That is why lawyers may attach a $1.00 or $5.00 bill so that it is clear that, upon inception, property or res is actually in the name of the trust.
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