Taxpayer’s GST Tax Exemption Robotically Allotted to Direct Skips

In Non-public Letter Ruling 201921012 (Could 24, 2019), the Inner Income Service concluded that a taxpayer’s election to choose out of the automated allocation of generation-skipping switch (GST) tax exemption was irrelevant as a result of all the taxpayer’s transfers have been direct skips and the choose out election was incorrectly made with respect to all oblique skips.

Presents to Trusts for Grandchildren

A taxpayer created separate trusts for the advantage of every of his grandchildren and transferred an curiosity in a partnership to every belief. The phrases of every belief have been an identical excluding the beneficiaries and trustees. Every belief supplied the trustee with discretion to make revenue and principal distributions to the beneficiary (that's, the taxpayer’s grandchild) within the trustee’s discretion.  On the beneficiary attaining age 30, that beneficiary’s belief would terminate, and the remaining property can be distributed outright to the beneficiary.  If the beneficiary died earlier than age 30, the remaining property can be distributed to the beneficiary’s descendants (that's, the taxpayer’s great-grandchildren or a extra distant descendant) or, if not one of the beneficiary’s descendants survive the beneficiary, to the taxpayer’s different grandchildren.

The taxpayer and his partner every well timed filed a present tax return reporting these items and signifying their consent to separate the items pursuant to Inner Income Code Part 2513.  Nevertheless, the items to the trusts have been incorrectly reported on Half three of Schedule A of Type 709 as oblique skips, moderately than on Half 2 as direct skips.  Connected to every return was an announcement that the GST computerized allocation guidelines wouldn’t apply to any transfers to the trusts pursuant to IRC Part 2632(c)(5)(A)(i) and Treasury Rules Part 26.2632-1(b)(2)(iii) (the choose out election).  Neither the taxpayer nor his partner paid any GST tax with respect to those items.

Errors on Present Tax Returns

The taxpayer and his partner ought to have reported these items as direct skips on Half 2 of Schedule A of Type 709, not oblique skips on Half three of Schedule A of Type 709.  Direct skips are one in every of three sorts of GST transfers for which GST tax is instantly imposed until GST tax exemption is allotted to the switch, whereas oblique skips are transfers to trusts that might have GST tax imposed at a later date if GST tax exemption isn’t allotted.

Extra particularly, direct skips are outlined in IRC Part 2612(c)(1) as transfers topic to present or property tax of an curiosity in property to a skip particular person. A skip particular person is: (1) any pure particular person assigned to a era that’s two or extra generations beneath the era project of the transferor (for instance, a grandchild or a extra distant descendant of the transferor), or (2) a belief if all pursuits in such belief are held by skip individuals. 

Right here, every belief was a skip particular person, and each switch made by the taxpayer or his spouse to every belief was thought-about a direct skip as a result of all the potential beneficiaries (present and the rest) have been the taxpayer’s grandchildren or extra distant descendants.  Subsequently, each switch by taxpayer or his spouse to every belief would have had GST tax imposed until GST tax exemption was allotted with respect to such switch.

Automated Allocation

At problem for the IRS on this PLR was whether or not the taxpayer’s spouse’s accessible GST tax  exemption was routinely allotted to the transfers to the trusts regardless of the choose out election (the PLR didn’t request an identical ruling concerning the allocation of taxpayer’s accessible GST tax exemption). If GST tax exemption wasn’t allotted to the transfers to the trusts, the GST tax would have been imposed.

The IRS concluded that the taxpayer’s spouse’s GST tax exemption was routinely allotted to the transfers to the trusts as a result of no election to choose out of the automated allocation of GST tax exemption to direct skips was made pursuant to Part 2632(b)(three).  Moreover, the IRS concluded that the choose out election hooked up to the present tax return was irrelevant as a result of it was an choose out of the automated allocation of GST tax exemption to oblique skips pursuant to Part 2632(c)(5)(A)(i).

Part 2632(b)(2) gives that a transferor’s unused GST tax exemption is routinely allotted to a lifetime direct skip until the transferor makes an election pursuant to Part 2632(b)(three) to have the automated allocation rule not apply to a switch. Treas. Regs. Part 26.2632-1(b)(1) gives that a transferor might stop the automated allocation of GST tax exemption by describing on a timely-filed present tax return the switch and the extent to which the automated allocation of GST tax exemption isn’t to use. 

Equally, Part 2632(c)(1) gives that a transferor’s unused GST tax exemption is routinely allotted to any oblique skip until the transferor makes an election pursuant to Part 2632(c)(5)(A)(i).  Treas. Regs. Part 26.2632-1(b)(2)(iii) gives that a transferor might stop the automated allocation of GST tax exemption to any switch constituting an oblique skip by attaching an announcement (election out assertion) to a well timed filed present tax return, which should establish the belief and particularly present that the transferor is electing out of the automated allocation of GST tax exemption with respect to the described switch or transfers.

In figuring out that taxpayer’s spouse’s GST tax exemption was routinely allotted to the transfers to the trusts, the IRS concluded that that the choose out election was irrelevant as a result of all the transfers to the trusts have been direct skips, and the choose out election was made pursuant to Part 2632(c)(5)(A)(i) and Treas. Regs. Part 26.2632-1(b)(2)(iii), which apply solely to oblique skips.  In different phrases, by mistakenly reporting the items on the incorrect a part of the present tax return and referencing the incorrect IRC and Treasury regulation sections within the choose out election, the choose out election was ineffective, and the automated allocation guidelines for direct skips utilized.

Formalistic Method

Whereas the errors on the present tax returns resulted in a good end result for the taxpayer and his spouse on this occasion, the IRS seems to create formalistic method to electing out of the automated allocation of GST tax exemption. To choose out of the automated allocation of GST tax exemption for direct skips, Treas. Regs. Part 26.2632-1(b)(1) merely requires an outline of the switch and the extent to which the automated allocation guidelines aren’t to use.  Right here, the assertion hooked up to the present tax returns filed by taxpayer and his spouse expressly supplied that the automated allocation guidelines weren’t to use to any transfers to the trusts. And but, the IRS nonetheless concluded that this assertion was ineffective for functions of electing out of the automated allocation of GST tax exemption for direct skips as a result of the election was made pursuant to the incorrect IRC and Treasury regulation sections.

Question whether or not the consequence would have been the identical had the choose out election not referenced any IRC and Treasury regulation sections in any respect. Would the failure to have reported the items on the right a part of the present tax return been ample to make the election out irrelevant?