879 / What is the inclusion ratio and how is it used for purposes of the GST tax?
In general, the inclusion ratio with respect to any property transferred in a GST is the excess of one minus (a) the “applicable fraction” for the trust from which the transfer is made, or (b) in the case of a direct skip, the applicable fraction determined for the skip.1The “applicable fraction” is a fraction (a) the numerator of which is the amount of the GST exemption allocated to the trust (or to the property transferred, if a direct skip), and (b) the denominator of which is the value of the property transferred reduced by (i) the sum of any federal estate or state death tax actually recovered from the trust attributable to such property, (ii) any federal gift tax or estate tax charitable deduction allowed with respect to such property, and (iii) with respect to a direct skip, the portion that is a nontaxable gift (see below). The fraction should be rounded to the nearest one-thousandth, with five rounded up (i.e., .2345 is rounded to .235). If the denominator of the applicable fraction is zero, the inclusion ratio is zero.2
Example 1. For illustrative purposes, in the year 2024, G transfers irrevocably in trust for his grandchildren $20 million and allocates all his $13,610,000 GST exemption to the transfer. The applicable fraction is 13,610,000 /20,000,000, or .681. The inclusion ratio is 1 minus .681, or .319. The maximum estate tax rate,
40 percent, is applied against the inclusion ratio, .319. The resulting percentage, 12.76 percent, is applied
against the value of the property transferred, $20,000,000, to produce a GST tax of $2,552,000. The tax is
paid by G, the transferor, because this is a direct skip (other than a direct skip from a trust) (see Q 875).
Example 2. Same facts as in preceding example, except that for federal gift tax purposes G’s spouse consented to a split gift of the $20 million (see Q 888). Thus, for GST tax purposes as well, the gift is considered split between the spouses and the entire gift is sheltered from estate tax by their combined $27.22 million exemption. If tax were owed, it would be paid 1/2 each by G and G’s spouse, the transferors, because each gift is a direct skip (other than a direct skip from a trust) (see Q 875).
Example 3. In 2023, G transfers $100,000 to a trust and allocates $100,000 GST exemption to the trust. The trust has an inclusion ratio of zero, and taxable distributions and taxable terminations can be made free of GST tax.
Example 4. In 2023, G transfers $100,000 to a trust and allocates no GST exemption to the trust. If all the trust beneficiaries are grandchildren of G, G has made a direct skip fully subject to GST tax. The GST tax is $40,000 ($100,000 transfer × 40 percent GST tax rate) and is payable by G. If the trust beneficiaries are children and grandchildren of G, the trust has an inclusion ratio of one, and GST transfers are fully subject to tax at the GST tax rate at the time of any later transfer.
If there is more than one transfer in trust the applicable fraction must be recomputed at the time of each transfer. Thus, if property is transferred to a preexisting trust, the “recomputed applicable fraction” is determined as follows: The numerator of such fraction is the sum of
(1) the amount of the GST exemption allocated to the property involved in such transfer and (2) the nontax portion of the trust immediately before the transfer. (The nontax portion of the trust is the value of the trust immediately before the transfer multiplied by the applicable fraction in effect before such transfer.) The denominator of such fraction is the value of the trust immediately after the transfer reduced by (i) the sum of any federal estate or state death tax actually recovered from the trust attributable to such property, (ii) any federal gift tax or estate tax charitable deduction allowed with respect to such property, and (iii) with respect to a direct skip, the portion that is a nontaxable gift (see below).3
Example 5. In the year 1995, G transfers irrevocably in trust for his children and grandchildren $4 million and allocates all his $1 million GST exemption to the transfer. The applicable fraction is 1,000,000/4,000,000, or .250. The inclusion ratio is 1 minus .250, or .750.
In 2001, the trust makes a taxable distribution to the grandchildren of $100,000. The maximum estate tax rate, 55 percent in 2001, is applied against the inclusion ratio, .750. The resulting percentage, 41.25 percent, is multiplied by the $100,000 transfer, resulting in a GST tax of $41,250. GST taxes in this example are paid by the grandchildren, the transferees, because the transfers are taxable distributions (see Q 891).
In 2024, the trust makes a taxable distribution to the grandchildren of $100,000. The maximum estate tax rate, 40 percent, is applied against the inclusion ratio, .750. The resulting percentage, 30 percent, is multiplied by the $100,000 transfer, resulting in a GST tax of $30,000.
Later in 2024, when the trust property has grown to $6 million, G transfers an additional $15 million to the trust. An additional $12,610,000 of GST exemption is available to G in 2024 ($13,610,000 GST exemption in 2024 minus $1,000,000 exemption already used). The numerator of the recomputed fraction is the value of the nontax portion of the trust immediately before the transfer, or $5.25 million (value of the trust, $21 million, multiplied by the applicable fraction of .250), plus $12,610,000 additional exemption, or $17,860,000. The denominator of the recomputed fraction is $21 million (the sum of the transferred property,
$15 million, and the value of all the property in the trust immediately before the transfer, $6 million). The applicable fraction is 17,860,000/21,000,000, or .850. The inclusion ratio is 1 minus .850, or .15.
Later in 2024, the trust makes a taxable distribution to the grandchildren of $100,000. The maximum estate tax rate, (40 percent), is applied against the inclusion ratio, .15. The resulting percentage, 6 percent, is multiplied by the $100,000 transfer, resulting in a GST tax of $6,000.
Planning Point: Trusts are usually created with an inclusion ratio of either one (GST transfers, if any, with respect to trust are fully taxable) or zero (fully exempt from GST tax). A trust has an inclusion ratio of zero if GST exemption is allocated to any transfer to the trust that is not a nontaxable gift (an allocation of GST exemption is not needed for a direct skip nontaxable gift (see below); it has an inclusion ratio of zero). For information on severing a trust to create separate trusts with inclusion ratios of zero and one, see Q 883.