875 / What is a generation-skipping transfer (GST) on which a generation-skipping transfer tax is imposed?

A generation skipping transfer is a transfer to a person two or more generations younger than the transferor (called a “skip person,” see Q 887 regarding generation assignments), and can take any one of three forms: (1) a taxable distribution; (2) a taxable termination; and (3) a direct skip. A trust is also a skip person if the trust can benefit only persons two or more generations younger than the transferor.¹ The GST tax was zero percent for one year in 2010 with a top 35 percent rate in 2011 and 2012.² ATRA increased the maximum GST tax rate to 40 percent for tax years beginning after 2012.³

Transferor

A “transferor,” in the case of any property subject to the federal estate tax, is the decedent. In the case of any property subject to the federal gift tax, the transferor is the donor.⁴ Thus, to the extent that a lapse of a general power of appointment (including a right of withdrawal) is subject to gift or estate tax, the powerholder becomes the transferor with respect to such lapsed amount.⁵ Thus, a Crummey powerholder should not be treated as a transferor with respect to the lapse of a withdrawal power if the amount lapsing in any year is no greater than (1) $5,000, or (2) 5 percent of the assets out of which exercise of the power could be satisfied.⁶

If there is a generation-skipping transfer of any property and immediately after the transfer such property is held in trust, a different rule (the “multiple skip” rule) applies to subsequent transfers from that trust. In such case, the trust is treated as if the transferor (for purposes of subsequent transfers) were assigned to the first generation above the highest generation of any person having an “interest” (see below) in the trust immediately after the transfer.⁷ If no person holds an interest immediately after the GST, then the transferor is assigned to the first generation above the highest generation of any person in existence at the time of the GST who may subsequently hold an interest in the trust.⁸

For the effect of making a “reverse QTIP election,” see Q 876.

Direct Skip

A direct skip is a transfer subject to federal gift or estate tax to a skip person. However, with respect to transfers before 1998, such a transfer was not a direct skip if the transfer was to a grandchild of the transferor or of the transferor’s spouse or former spouse, and the grandchild’s parent who was the lineal descendant of the transferor or his spouse or former spouse was dead at the time of the transfer. In other words, a person could be stepped-up in generations because a parent who had been in the line of descent predeceased such person. This rule could be reapplied to lineal descendants below that of a grandchild. Persons assigned to a generation under this rule were also assigned to such generation when such persons received transfers from the portion of a trust attributable to property to which the step-up in generation rule applied.⁹ For purposes of this predeceased child rule, a living descendant who died no later than 90 days after a transferor was treated as predeceasing the transferor if he or she was treated as predeceased under the governing instrument or state law.¹⁰ For a discussion of the more expansive predeceased parent rule after 1997, see Q 887.

In some circumstances, whether a step-up in generation was available could depend on whether a QTIP or a reverse QTIP marital election was made for GSTT purposes (see Q 876). If the parent of a grandchild-distributee died after the transfer by a grandparent to a generation-skipping trust, but before the distribution from the trust to the grandchild, and a reverse QTIP election had been made, the distribution was a taxable termination and the “step-up in generation” rule was not available. However, if the reverse QTIP election had not been made, the distribution was eligible for the “step-up in generation” exception from treatment as a direct skip and was not subject to GSTT.¹¹

Also, for purposes of the GST tax, the term “direct skip” did not include any transfer before January 1, 1990 from a transferor to a grandchild of the transferor to the extent that the aggregate transfers from such transferor to such grandchild did not exceed $2 million. This $2 million exemption was available with respect to a transfer in trust only if (1) during the life of such individual no portion of the trust corpus or income could be distributed to or for the benefit of any other person, (2) the trust would be included in such individual’s estate if such individual were to die before the trust terminated, and (3) all of the income of the trust had to be distributed at least annually to the grandchild once he reached 21. Requirement
(3) applied only to transfers after June 10, 1987. However, the Committee Report indicated that this requirement was not satisfied by a Crummey demand power.¹²

The $2 million per grandchild exemption applied to transfers to grandchildren only; the step-up in generation rule for a predeceased parent did not apply. A transfer which would have been a direct skip were it not for the $2 million exemption was likewise exempted from being treated as a taxable termination or taxable distribution. However, the rules which apply to the taxation of multiple skips will apply to subsequent transfers from such trust.

Taxable Termination

A taxable termination occurs when an “interest in property” (see below) held in trust (or some arrangement having substantially the same effect as a trust) for a skip person is terminated by an individual’s death, lapse of time, release of a power, or otherwise, unless either (1) a non-skip person has an interest in the trust immediately after such termination, or (2) at no time after the termination may a distribution be made from the trust to a skip person, other than a distribution the probability of which occurring is so remote as to be negligible (i.e., less than a 5 percent actuarial probability). If upon the termination of an interest in a trust by reason of the death of a lineal descendant of the transferor, a portion of the trust is distributed to skip persons (or to trusts for such persons), such partial termination is treated as taxable. If a transfer subject to estate or gift tax occurs at the time of the termination, the transfer is not a taxable termination (but it may be a direct skip).¹³

Taxable Distribution

A taxable distribution is any distribution from a trust to a skip person (other than a taxable termination or a direct skip).¹⁴

Generation-Skipping Transfer Exceptions

However, the following are not considered generation-skipping transfers:

(1)     Any transfer which, if made during life by an individual, would be a “qualified transfer” (see Q 905); and

(2)     Any transfer to the extent (a) the property transferred was subject to a prior GST tax, (b) the transferee in the prior transfer was in the same generation as the current transferee or a younger generation, and (c) the transfers do not have the effect of avoiding the GST tax.¹⁵

Interest in Property

A person has an “interest in property” held in trust if (at the time the determination is made) such person–

(1)     has a present right to receive income or corpus from the trust (for example, a life income interest);

(2)     is a permissible current recipient of income or corpus from the trust (for example, a beneficiary entitled to distribution of income or corpus, but only in the discretion of the trustee) and is not a charitable organization (specifically, one described in IRC Section 2055(a)); or

(3)     is such a charitable organization and the trust is a charitable remainder annuity trust (see Q 8087), a charitable remainder unitrust (see Q 8088), or a pooled income fund (see Q 8096).

In determining whether a person has an interest in a trust, the fact that income or corpus may be used to satisfy a support obligation is disregarded if such use is discretionary or made pursuant to the Uniform Gifts to Minors Act (or similar state statute). In other words, a parent is not treated as having an interest in a trust merely because the parent acts as guardian for a child. However, a parent would be treated as having an interest in the trust if support obligations are mandatory.¹⁶

An interest may be disregarded if it is used primarily to postpone or avoid the GST tax.¹⁷ The regulations provide that an interest is disregarded if a significant purpose for the creation of the interest is the postponement or avoidance of the GST tax.¹⁸

Effective Date and Transitional Rules

The rules explained here and in the succeeding questions apply generally to any generation-skipping transfer (GST) made after October 22, 1986. Also, any lifetime transfer after September 25, 1985, and on or before October 22, 1986, is treated as if made on October 23, 1986. These rules will not, however, apply to the following:

(1)     Any GST under a trust that was irrevocable on September 25, 1985, but only to the extent that such transfer is not made out of corpus (or income attributable to such corpus) added to the trust after September 25, 1985;

(2)     Any GST under a will or revocable trust executed before October 22, 1986, if the decedent died before January 1, 1987; and

(3)     Any GST–

(a)  under a trust to the extent such trust consists of property included in the gross estate of a decedent (other than property transferred by the decedent during his life after October 22, 1986), or reinvestments thereof, or

(b)  which is a direct skip that occurs by reason of the death of any decedent;

but only if such decedent was, on October 22, 1986, under a mental disability to change the disposition of his property and did not regain his competence to dispose of such property before the date of his death.¹⁹ It appears that Congress does not intend for the third grandfathering rule to apply with respect to property transferred after August 3, 1990 to an incompetent person, or to a trust of such a person.²⁰