New Twist on GST Exemption Allocations Creates Unintended Problems for Many Insurance Trusts
The IRS has tried to make life a little easier for taxpayers by expanding the rules for automatic allocation of the generation-skipping transfer ("GST") tax exemption. The new rules provide that transfers to certain trusts - defined as "GST trusts" - having certain beneficiary and distribution characteristics will receive automatic allocation of GST exemption unless the transferor elects not to have automatic allocation apply. The new rules could save a transferor from incurring GST tax because he or she forgot to allocate GST exemption to contributions to his or her generation-skipping trust.
Unfortunately, a common form of insurance trust can be the unintended "beneficiary" of the new rule. A trust that holds insurance on the life of one spouse and provides a trust for the benefit of the surviving spouse (or the spouse and children) after the death of the insured and, following the death of the surviving spouse, provides a further trust for the children until complete distribution to them at a specified age, falls within the definition of a GST trust. Therefore, contributions to that trust would be subject to the new automatic allocation rules despite the fact that the children are anticipated to receive the trust assets during their lifetimes, so no taxable GST event is expected to take place. As a result, if automatic allocation occurs, valuable GST exemption could be wasted.
Taxpayers may annually opt out of the automatic allocation rules for contributions to particular trusts by indicating that intent on a timely filed gift tax return. In the alternative, taxpayers may also elect to have all contributions to particular trusts not receive automatic allocations in 2001 and future years, eliminating the need to opt out on a year-by-year basis. That election would also be made on a timely filed gift tax return.
If you have created an insurance trust like the one described above (and many of you have) and are currently funding it on a periodic basis, you should strongly consider making the blanket election out of automatic allocation to that trust on a timely filed 2001 gift tax return. If, on the other hand, you created a "real" GST trust that could benefit from the new rules and are considering taking advantage of automatic allocation by not filing annual gift tax returns (assuming those returns are not required other than to allocate GST exemption), bear in mind that, without annual returns and explicit allocation, there may be no way to document and track use of your GST exemption - which may become all the more important as the exemption increases through 2009.
It is possible that Congress may address this "glitch" before 2001 tax returns are due next April. We will discuss any such change in future UPDATES.