883 / When are portions of a severed trust treated as separate trusts for GST tax purposes?

In general, portions of a trust are not to be treated as separate trusts. However, portions attributable to different transferors, substantially separate and independent shares of different beneficiaries of a trust, and trusts treated as separate trusts under state law are to be treated as separate trusts for GST tax purposes.¹ However, treatment of a single trust as separate shares for purposes of the GST tax does not permit treatment as separate trusts for purposes of filing or payment of tax, or for purposes of any other tax. Additions to, or distributions from, such a trust are allocated pro-rata among all shares unless expressly provided otherwise. In general, a separate share is not treated as such unless it exists at all times from and after creation of the trust.

Trusts created from a qualified severance are treated as separate trusts for GST tax purposes, effective for 2001 to 2009 and for tax years beginning after 2010. A qualified severance means the division of a single trust into two or more trusts under the trust document or state law if (1) the single trust is divided on a fractional basis, and (2) in the aggregate, the terms of the new trusts provide for the same succession of interests of beneficiaries as are provided in the original trust. In the case of a trust with a GST inclusion ratio of greater than zero and less than one (i.e., the trust is partially protected from the GST by allocations of the GST exemption), a severance is a qualified severance only if the single trust is divided into two trusts, one of which receives a fractional amount equal to the GST applicable fraction multiplied by the single trust’s assets. The trust receiving the fractional amount receives an inclusion ratio of zero (i.e., it is not subject to GST tax), and the other trust receives an inclusion ratio of one (i.e., it is fully subject to GST tax).²

Otherwise, severance of a trust included in the taxable estate (or created in the transferor’s will) into single shares will be recognized for GST purposes if (1) the trusts are severed pursuant to the governing instrument or state law, (2) such severance occurs (or a reformation proceeding is begun and is indicated on the estate tax return) prior to the date for filing the estate tax return (including extensions actually granted), and (3) the trusts are funded using (a) fractional interests or (b) pecuniary amounts for which appropriate adjustments are made.³

Regulations provide that a qualified severance must be done on a fractional or percentage basis; a severance based on a specific pecuniary amount is not permitted. The terms of the new trusts must provide in the aggregate for the same succession of beneficiaries. With respect to trusts from which discretionary distributions may be made on a non pro rata basis, this requirement can be satisfied even if each permissible beneficiary might be a beneficiary of only one of the separate trusts, but only if no beneficial interest is shifted to a lower generation and the time for vesting of any beneficial interest is not extended.⁴