Couple substantially complied with GST allocation elections

Plain-English summary

A married couple created trusts for their children and descendants, dividing each child's trust into an exempt and a non-exempt subtrust. They split gifts between themselves and intended to opt out of automatic generation-skipping transfer exemption allocation while affirmatively allocating exemption to the exempt subtrusts. Their accountant attached election and allocation documents but failed to check the election-out column and described the intended exempt trusts inadequately. The IRS concluded that the returns, attached statements, and trust instrument together showed the required intent and substantially complied with both election requirements. The couple's opt-out and affirmative GST exemption allocations were therefore treated as timely.

Ruling snapshot

• Question: Did the couple substantially comply with the rules for opting out of automatic GST allocation and allocating exemption to the exempt subtrusts?
• Outcome: Approved, both sets of elections were treated as substantially compliant
• Key authorities: IRC §§ 2632(c) and 2642(g)(2); Treas. Reg. §§ 26.2632-1 and 26.2654-1

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201628013                                              Third Party Communication: None
Release Date: 7/8/2016                                         Date of Communication: Not Applicable
Index Number: 2642.00-00
                                                               Person To Contact:
---------------------                                          --------------------, ID No. ----------------
----------------------------                                   Telephone Number:
--------------------------------------                         --------------------
                                                               Refer Reply To:
                                                               CC:PSI:B04
                                                               PLR-135076-15
Re: -------------------------------------                      Date:
                                                               March 25, 2016




Legend

Husband           =        ---------------------
Wife              =        ---------------------------
Trust             =        -------------------------------------------
Trust 1           =        -----------------------------------------------
Trust 2           =        -------------------------------------------
Trust 3           =        ----------------------------------------------------
Date              =        --------------------------
Year              =        ------
x                 =        -------------
y                 =        ----------
Accountant        =        -------------------
Year              =        ------



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

       This letter responds to your letter dated October 5, 2015, requesting rulings that,
for purposes of § 2642(g)(2) of the Internal Revenue Code, taxpayers substantially
complied with the requirements to elect out of the automatic GST allocation rules under
§ 2632(c) and to affirmatively allocate their GST exemption to transfers to certain trusts.

         The facts and representations are as follows:

      On Date, Husband and Wife established Trust, an irrevocable trust. Trust
provides that, upon creation, Trust would be divided into three separate trusts, Trust 1,
PLR-135076-15                               2

Trust 2, and Trust 3, each trust benefiting one of their children and that child’s
descendants. Trust also provides that the trustee may further divide Trust 1, Trust 2,
and Trust 3 into two or more trusts to allocate different inclusion ratios for GST
purposes.

       Pursuant to Trust, each of Trust 1, Trust 2, and Trust 3 was divided into two
subtrusts, an Exempt Trust and a Non-Exempt Trust, resulting in six trusts: Trust 1
Exempt Trust, Trust 1 Non-Exempt Trust, Trust 2 Exempt Trust, Trust 2 Non-Exempt
Trust, Trust 3 Exempt Trust, and Trust 3 Non-Exempt Trust.

       In Year, Husband and Wife each transferred $x to each of the exempt trusts and
$y to each of the non-exempt trusts. Specifically, Husband gifted $x to Trust 1 Exempt
Trust, $x to Trust 2 Exempt Trust, and $x to Trust 3 Exempt Trust. Husband also gifted
$y to Trust 1 Non-Exempt Trust, $y to Trust 2 Non-Exempt Trust, and $y to Trust 3
Non-Exempt Trust. Wife did the same.

       Husband and Wife retained Accountant to prepare his and her respective Year
Forms 709, United States Gift (and Generation-Skipping Transfer) Tax Return.
Husband and Wife elected to split the gifts to the trusts pursuant to § 2513. Accountant,
in preparing the Forms 709, properly reported the gifts to each of the exempt trusts and
the non-exempt trusts on Part 3 of Schedule A, but failed to check Column C on Part 3
of Schedule A (§ 2632(c) election) to indicate that Husband and Wife elected out of the
automatic allocation rules. Accountant prepared an election out statement to be
attached to each return, but in preparing the Notice of Allocation, Accountant
inadequately described the trusts to which GST exemption was to be allocated.
Accountant timely filed the Forms 706 and attached a copy of Trust to each return.

       Husband and Wife request rulings that, for purposes of § 2642(g)(2), they
substantially complied with (1) the requirements under § 2632(c) and
§ 26.2632-1(b)(2)(iii)(B) of the Generation-Skipping Transfer Tax Regulations for
electing out of the automatic allocation rules; and (2) the requirements under
§ 26.2632-1(b)(4) for allocating their GST exemption to the transfers to Trust 1 Exempt
Trust, Trust 2 Exempt Trust, and Trust 3 Exempt Trust.

Law and Analysis

       Section 2601 imposes a tax on every generation-skipping transfer (GST). A
generation-skipping transfer is defined under § 2611(a) as a taxable distribution, a
taxable termination, and 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 the applicable rate as the product of
the maximum Federal estate tax rate and the inclusion ratio with respect to the transfer.
PLR-135076-15                                  3

         Under § 2642(a)(1), in part, 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. Section
2642(a)(2) provides, in part, that the applicable fraction is a fraction (A) the numerator of
which is the amount of the GST exemption allocated to the trust, 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 which 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, is irrevocable.

         Section 2632(a)(1) provides that any allocation by an individual of his GST
exemption under § 2631(a) may be made at any time on or before the date prescribed
for filing the estate tax return for the individual’s estate (determined with regard to
extensions), regardless of whether such a return is required to be filed. Under
§ 26.2632-1(b)(4)(i) of the Generation-Skipping Transfer Tax Regulations, 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 the amount of GST exemption allocated to it. The allocation should also
state the inclusion ratio of the trust after the allocation.

        Section 2632(c)(1) provides that if an individual makes an indirect skip during
such individual’s lifetime, any unused portion of such individual’s GST exemption shall
be allocated to the property transferred to the extent necessary to make the inclusion
ratio for such property zero. 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 transfer 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)(i)
provides, in part, that the election shall be deemed to be timely if filed on a timely filed
gift tax return for the calendar year in which the transfer was made.

       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
PLR-135076-15                                 4

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
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
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 (election out 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) 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.

       Section 2513(a)(1) provides that a gift made by one spouse to any person other
than his or her spouse shall be considered as made one-half by the donor spouse and
one-half by his or her spouse, but only if at the time of the gift each spouse is a citizen
or resident of the United States. Section 2513(a)(1) shall apply only if both spouses
have signified their consent to the application of paragraph (1) in the case of all such
gifts made during the calendar year by either while married to the other.

      Section 2652(a)(1)(B) provides that in the case of any property subject to the tax
imposed by chapter 12, the donor is the transferor for purposes of chapter 13. Section
2652(a)(2) and § 26.2652-1(a)(4) provide that, if, under § 2513, one-half of a gift is
PLR-135076-15                                 5

treated as made by an individual and one-half is treated as made by the spouse of the
individual, then each spouse is treated as the transferor of one-half of the entire value of
the property transferred by the donor spouse, regardless of the interest the electing
spouse is actually deemed to have transferred under § 2513.

       In the present case, the information on the Year Forms 706, including the Notice
of Allocation and election out statement attached to each return, in combination with the
terms of Trust (a copy of which was attached to each return), provides sufficient
information to constitute substantial compliance under § 2642(g)(2).

       Accordingly, based upon the facts submitted and the representations made, we
conclude that, for purposes of § 2642(g)(2), Husband and Wife substantially complied
with the requirements to elect out of the automatic GST allocation rules under § 2632(c)
with respect to the transfers to Trust 1, Trust 2, and Trust 3. In addition, Husband and
Wife substantially complied with the requirements to timely allocate their GST
exemption to Trust 1 Exempt Trust, Trust 2 Exempt Trust, and Trust 3 Exempt Trust.

       The rulings in this letter pertaining to the federal estate tax apply only to the
extent that the relevant sections of the Code are in effect during the period at issue.

      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.

       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 letter is directed only to the taxpayer requesting it.
Section 6110(k)(3) provides that it may not be used or cited as precedent.


                                       Sincerely,


                                       Leslie H. Finlow
                                       Leslie H. Finlow
                                       Senior Technician Reviewer, Branch 4
                                       Office of Associate Chief Counsel
                                       (Passthroughs & Special Industries)

Enclosures (2)
      Copy for § 6110 purposes
      Copy of this letter