1. Generation Skipping Transfer Tax: An Overview Including Discussion of 2010 Issues Presented by: Daniel L. Daniels Wiggin and Dana LLP www.wiggin.com Copyright 2010 by Daniel L. Daniels

2. 2 GST IN 2010 GST tax not in effect for 2010 As of January 1, 2011, tax is reinstated as if EGTRRA “had never been enacted” Copyright 2010 by Daniel L. Daniels

3. 3 GST IN 2010 – What Should Trustees of Existing Trusts Do? Taxable distributions and taxable terminations occurring in 2010 are not GST taxable events unless law is retroactively reinstated –Consider making distributions or terminations of non-exempt trusts this year –Consider disclaimer or formula distribution to avoid application of GST tax if law is retroactively reinstated Copyright 2010 by Daniel L. Daniels

4. 4 GST IN 2010 – Should Clients Create New Trusts? Funding a Dynasty Trust now not subject to GST tax –But transfer will attract a gift tax –Impact of distributions or termination of trust in 2011 and future years? Fund Direct Skip Trust in 2010? –Not a GST transfer in 2010 –In future years, trust may get benefit of “move up” rule to treat grandchildren as non-skip persons –But beware possible retroactive reinstatement of tax or other legislation/regulations treating grandchildren as skip persons Copyright 2010 by Daniel L. Daniels

5. 5 GST IN 2010 – Should Clients Create New Trusts? A testamentary dynasty trust for a client who dies in 2010 has a better chance of escaping GST tax forever because the trust has no “transferor” Copyright 2010 by Daniel L. Daniels

6. 6 GST IN 2010 – Other Issues An outright direct skip gift in 2010 appears to be safely outside the GST tax absent retroactive reinstatement of the law Do the automatic allocation rules and increases in GST exemption that were part of EGTRRA 2001 disappear because EGTRRA is treated as if it “had never been enacted” How to deal with premium payment and other gifts made to GST trusts in 2010 Copyright 2010 by Daniel L. Daniels

7. 7 INTRODUCTION Purpose of Tax Need to learn GST “vocabulary” –Skip person and non-skip person –Taxable Termination –Direct Skip –Taxable Distribution Tax Rate –Inclusion ratio –GST exemption Copyright 2010 by Daniel L. Daniels

8. 8 “NAME THAT TRANSFER” T makes a gift of property to his grandchild, GC T transfers property to a trust to pay income his child, C, for life, with the remainder to pass to C’s children T makes a gift to a sprinkle trust for the benefit of his children and grandchildren Trustee of that trust makes distributions to grandchildren Copyright 2010 by Daniel L. Daniels

9. 9 “NAME THAT TRANSFER” T makes a gift of property to his grandchild, GC DIRECT SKIP T transfers property to a trust to pay income his child, C, for life, with the remainder to pass to C’s children T makes a gift to a sprinkle trust for the benefit of his children and grandchildren Trustee of that trust makes distributions to grandchildren Copyright 2010 by Daniel L. Daniels

10. 10 “NAME THAT TRANSFER” T makes a gift of property to his grandchild, GC DIRECT SKIP T transfers property to a trust to pay income his child, C, for life, with the remainder to pass to C’s children TAXABLE TERMINATION T makes a gift to a sprinkle trust for the benefit of his children and grandchildren Trustee of that trust makes distributions to grandchildren Copyright 2010 by Daniel L. Daniels

11. 11 “NAME THAT TRANSFER” T makes a gift of property to his grandchild, GC DIRECT SKIP T transfers property to a trust to pay income his child, C, for life, with the remainder to pass to C’s children TAXABLE TERMINATION T makes a gift to a sprinkle trust for the benefit of his children and grandchildren NO GST EVENT Trustee of that trust makes distributions to grandchildren Copyright 2010 by Daniel L. Daniels

12. 12 “NAME THAT TRANSFER” T makes a gift of property to his grandchild, GC DIRECT SKIP T transfers property to a trust to pay income his child, C, for life, with the remainder to pass to C’s children TAXABLE TERMINATION T makes a gift to a sprinkle trust for the benefit of his children and grandchildren NO GST EVENT Trustee of that trust makes distributions to grandchildren TAXABLE DISTRIBUTION Copyright 2010 by Daniel L. Daniels

13. 13 “NAME THAT TRANSFER” - BONUS QUESTION T makes a gift to a sprinkle trust for the benefit of his grandchildren Copyright 2010 by Daniel L. Daniels

14. 14 “NAME THAT TRANSFER” - BONUS QUESTION T makes a gift to a sprinkle trust for the benefit of his grandchildren DIRECT SKIP Copyright 2010 by Daniel L. Daniels

15. 15 TRANSFEROR In general –Transferor is decedent for property transferred at death –Transferor is donor for property transferred by gift Why do we care who is the transferor? –Only the transferor can allocate GST exemption –Identity of transferor provides starting point for determining whether a transferee is a skip person or not Identity of transferor can change over time –Transferor is person who transfers property and with respect to whom the property was most recently subject to estate or gift tax Copyright 2010 by Daniel L. Daniels

16. 16 TRANSFEROR - SPECIAL ISSUES Gift splitting causes each spouse to be deemed transferor of one-half QTIP property –Surviving spouse is deemed transferor –Reverse QTIP election allows first spouse to keep transferor status Why is reverse QTIP election important? Election must be made over entire trust Copyright 2010 by Daniel L. Daniels

17. 17 INTEREST Why do we care about the term “interest”? –Integral part of the definition of certain generation skipping events –A taxable termination occurs when there is A termination of an “interest” in property held in trust Unless immediately thereafter a non-skip person has an interest in the property –A transfer to a trust will be not be a direct skip as long as a non-skip person has an interest in the trust Copyright 2010 by Daniel L. Daniels

18. 18 INTEREST For GST purposes a person has an interest in a trust if the person is not a charity and is a permissible current recipient of trust income or principal A future interest generally is not an “interest” for GST purposes Special rule for charities Copyright 2010 by Daniel L. Daniels

19. 19 INTEREST - SPECIAL RULE FOR CHARITIES A charity may have an interest in a trust for GST tax purposes in two situations: –Charity has a present non-discretionary right to receive income or principal from the trust –Charity is the remainderman of a CRAT, CRUT or pooled income fund Example: T transfers property to a CRT to pay a unitrust percentage to GC for life, remainder to charity. T’s transfer is not a direct skip. Distributions to GC are taxable distributions. Copyright 2010 by Daniel L. Daniels

20. 20 SKIP PERSON/NON-SKIP PERSON A skip person may be a natural person or a trust A natural person is a skip person if she is assigned to the second or lower generation below the transferor A trust is a skip person if either: –all interests in the trust are held by skip persons; or –no person holds an interest in the trust and at no time after the transfer may a distribution be made to a non-skip person A non-skip person is a natural person or trust that is not a skip Copyright 2010 by Daniel L. Daniels

21. 21 SKIP PERSON QUIZ T creates a trust naming his grandchild, GC, as the only permissible income and principal beneficiary, remainder to great-grandchildren – T creates a trust for GC. Trustee directed to accumulate income until GC is 21 then pay income to GC for life, remainder to GGC T creates a sprinkle trust for C and GC for the life of C, remainder to GC T creates a trust to pay all income to GC, remainder to C Copyright 2010 by Daniel L. Daniels

22. 22 SKIP PERSON QUIZ T creates a trust naming his grandchild, GC, as the only permissible income and principal beneficiary, remainder to great-grandchildren – Trust is a skip person T creates a trust for GC. Trustee directed to accumulate income until GC is 21 then pay income to GC for life, remainder to GGC T creates a sprinkle trust for C and GC for the life of C, remainder to GC T creates a trust to pay all income to GC, remainder to C Copyright 2010 by Daniel L. Daniels

23. 23 SKIP PERSON QUIZ T creates a trust naming his grandchild, GC, as the only permissible income and principal beneficiary, remainder to great-grandchildren – Trust is a skip person T creates a trust for GC. Trustee directed to accumulate income until GC is 21 then pay income to GC for life, remainder to GGC –Trust is a skip person T creates a sprinkle trust for C and GC for the life of C, remainder to GC T creates a trust to pay all income to GC, remainder to C Copyright 2010 by Daniel L. Daniels

24. 24 SKIP PERSON QUIZ T creates a trust naming his grandchild, GC, as the only permissible income and principal beneficiary, remainder to great-grandchildren – Trust is a skip person T creates a trust for GC. Trustee directed to accumulate income until GC is 21 then pay income to GC for life, remainder to GGC –Trust is a skip person T creates a sprinkle trust for C and GC for the life of C, remainder to GC –Trust is not a skip person T creates a trust to pay all income to GC, remainder to C Copyright 2010 by Daniel L. Daniels

25. 25 SKIP PERSON QUIZ T creates a trust naming his grandchild, GC, as the only permissible income and principal beneficiary, remainder to great-grandchildren – Trust is a skip person T creates a trust for GC. Trustee directed to accumulate income until GC is 21 then pay income to GC for life, remainder to GGC –Trust is a skip person T creates a sprinkle trust for C and GC for the life of C, remainder to GC –Trust is not a skip person T creates a trust to pay all income to GC, remainder to C –Trust is a skip person Copyright 2010 by Daniel L. Daniels

26. 26 SKIP PERSON QUIZ - ADVANCED QUESTIONS T creates a CRT to pay an annuity interest to GC, remainder to charity T creates a sprinkle trust for C and his five GCs for the life of C, remainder to GC; Crummey rights are given to all six beneficiaries Copyright 2010 by Daniel L. Daniels

27. 27 SKIP PERSON QUIZ - ADVANCED QUESTIONS T creates a CRT to pay an annuity interest to GC, remainder to charity –Trust is not a skip person T creates a sprinkle trust for C and his five GCs for the life of C, remainder to GC; Crummey rights are given to all six beneficiaries Copyright 2010 by Daniel L. Daniels

28. 28 SKIP PERSON QUIZ - ADVANCED QUESTIONS T creates a CRT to pay an annuity interest to GC, remainder to charity –Trust is not a skip person T creates a sprinkle trust for C and his five GCs for the life of C, remainder to GC; Crummey rights are given to all six beneficiaries –Trust is not a skip person –The Crummey rights are not direct skips –If a GC makes a withdrawal, it would be a taxable distribution Copyright 2010 by Daniel L. Daniels

29. 29 Based on family relationship or age Family relationship –Grandchild or more remote descendant of the transferor is a skip person Age –Non-family members assigned a generation based on age relative to transferor –T’s generation = anyone not more than 12-1/2 years younger than T –C’s generation = anyone more than 12-1/2 years younger, but not more than 37-1/2 years younger than T –GC’s generation = anyone more than 37-1/2 years younger than T Charities are assigned to T’s generation GENERATION ASSIGNMENT Copyright 2010 by Daniel L. Daniels

30. 30 If: –an individual’s parent –who is a lineal descendant of the parent of the transferor (or of the transferor’s spouse) –is deceased at the time a transfer is subject to estate or gift tax Then the individual is “moved up” one generation for purposes of determining whether a GST transfer has occurred PREDECEASED ANCESTOR EXCEPTION Copyright 2010 by Daniel L. Daniels

31. 31 T’s daughter, C, predeceases T, leaving GC surviving T makes a gift of $1,000,000 to GC The transfer is not a direct skip because GC is “moved up” to C’s generation PREDECEASED ANCESTOR EXCEPTION - EXAMPLE 1 Copyright 2010 by Daniel L. Daniels

32. 32 T’s Will establishes a QTIP trust for the benefit of T’s spouse, S, remainder to T’s child, C After T’s death, but before S’s death, C dies Answer depends on whether or not reverse QTIP election made If no reverse QTIP election is made: –S is deemed the transferor –Since C predeceased S, the exception applies and there is no direct skip at S’s death upon the transfer to GC If reverse QTIP election is made: –T is deemed the transferor –Since C did not predecease T, exception does not apply and there is a taxable termination at S’s death PREDECEASED ANCESTOR EXCEPTION - EXAMPLE 2 Copyright 2010 by Daniel L. Daniels

33. 33 A direct skip to an individual that qualifies for the gift tax annual exclusion also qualifies for the “GST annual exclusion” A direct skip to a trust only qualifies for the exclusion if: –The trust is for the exclusive benefit of one beneficiary during that beneficiary’s lifetime; and –the trust will be includible in that beneficiary’s estate at death GST Annual Exclusion Copyright 2010 by Daniel L. Daniels

34. 34 On January 1, T makes a gift of $13,000 to a sprinkle trust for his children and grandchildren –T’s grandchild, GC, has a $13,000 Crummey withdrawal right On January 2, T makes a second gift of $13,000 outright to GC Does either gift qualify for the GST annual exclusion? GST Annual Exclusion Riddle Copyright 2010 by Daniel L. Daniels

35. 35 On January 1, T makes a gift of $13,000 to a sprinkle trust for his children and grandchildren –T’s grandchild, GC, has a $13,000 Crummey withdrawal right On January 2, T makes a second gift of $13,000 outright to GC Does either gift qualify for the GST annual exclusion? Answer is “no”: –The gift to the trust does not qualify because it fails the statutory definition –The outright gift to GC does not qualify because it must first qualify for the annual gift tax exclusion in order for the GST annual exclusion to be available GST Annual Exclusion Riddle Copyright 2010 by Daniel L. Daniels

36. 36 GST MED-ED EXCLUSION A direct skip transfer that qualifies for the gift tax med-ed exclusion is also exempt from GST tax Also, transfers from trusts will not be taxable distributions if the transfers would have qualified for the gift tax med-ed exclusion if made by an individual Copyright 2010 by Daniel L. Daniels

37. 37 INCLUSION RATIO What is it? Essentially, the proportion of the trust that is subject to GST tax More correctly, it’s a factor in determining the GST Tax Rate Tax rate = (Top Estate and Gift Tax Rate) X Inclusion Ratio Copyright 2010 by Daniel L. Daniels

38. 38 DETERMINING INCLUSION RATIO Inclusion ratio equals 1 - “applicable fraction” Applicable Fraction –Amount of GST Exemption allocated/value of property in the trust Copyright 2010 by Daniel L. Daniels

39. 39 INCLUSION RATIO EXAMPLE T transfers $100,000 to trust T allocates $40,000 of GST Exemption Applicable fraction equals $40,000/$100,000, or.40 Inclusion ratio equals 1 -.40, or.60 Tax rate equals.60 x 45% = 27% Copyright 2010 by Daniel L. Daniels

40. 40 GOAL IS AN INCLUSION RATIO OF EITHER ZERO OR ONE Mixed inclusion ratio wastes GST exemption when distributions from a trust are made to children Mixed inclusion ratio causes unnecessary GST tax when distributions from a trust are made to grandchildren A trust with a zero inclusion ratio will be invested differently from a trust with a one inclusion ratio Copyright 2010 by Daniel L. Daniels

41. 41 ACHIEVING A ZERO INCLUSION RATIO Allocate GST exemption to each transfer to the trust Timely allocation permits use of date-of-gift value for purposes of allocation Late allocation requires use of values as of date return is filed –Special first of the month rule Planning pointers: –Be sure trust agreement includes power for trustee to split into zero and one inclusion ratio trusts –Use intentional late allocation for life insurance in trust? Copyright 2010 by Daniel L. Daniels

42. 42 AUTOMATIC ALLOCATION RULES Lifetime Direct Skips Automatic Allocation at Death Rules on Automatic Allocation to “Indirect Skips” (Repealed as of 1/1/2011) An Indirect Skip is a transfer that is not a direct skip which is made to a “GST Trust” A “GST Trust” is any trust that could have a taxable termination or taxable distribution unless one of six exceptions applies Copyright 2010 by Daniel L. Daniels

43. 43 GST TRUST EXCEPTIONS Copyright 2010 by Daniel L. Daniels

44. 44 EXCEPTION 1 The trust agreement provides that more than 25% of the corpus must be distributed to one or more individuals who are non-skip persons –Before the date the individual attains age 46; or –On or before one or more dates specified in the trust instrument that will occur before the date that the individual attains age 46 Copyright 2010 by Daniel L. Daniels

45. 45 MASTER EXAMPLE T creates irrevocable sprinkle trust for spouse, S, and children Upon death of T and S, trust divides into separate shares for T’s then living descendants, with each share held in trust until the descendant reaches age 40 Is this trust subject to Exception 1? Copyright 2010 by Daniel L. Daniels

46. 46 EXCEPTION 1 – EXAMPLE CONTINUED C’s right to the trust principal doesn’t come into being until after T and S die Since that could be a date after C attains age 46, the exception, at least by its literal terms, does not apply Copyright 2010 by Daniel L. Daniels

47. 47 EXCEPTION 2 The trust agreement provides that more than 25% of the trust corpus must be distributed to one or more individuals who are non-skip persons and who are living on the date of death of another person identified in the trust instrument who is more than 10 years older than such individuals Copyright 2010 by Daniel L. Daniels

48. 48 MASTER EXAMPLE T creates irrevocable sprinkle trust for spouse, S, and children Upon death of T and S, trust divides into separate shares for T’s then living descendants, with each share held in trust until the descendant reaches age 40 Is this trust subject to Exception 2? –No, the trust property is not distributable to children upon death of T and S; it passes to age 40 trusts –If the trust provided for outright distributions to children, it should not be a GST trust Copyright 2010 by Daniel L. Daniels

49. 49 EXCEPTION 3 The trust agreement provides that if one or more individuals who are non-skip persons die on or before a date described in Exception 1 or 2 above, more than 25% of the corpus must be distributed to the estate of such individual or is subject to a general power of appointment exercisable by such individual Copyright 2010 by Daniel L. Daniels

50. 50 MASTER EXAMPLE T creates irrevocable sprinkle trust for spouse, S, and children Upon death of T and S, trust divides into separate shares for T’s then living descendants, with each share held in trust until the descendant reaches age 40 Is this trust subject to Exception 3? –No, because the children do not have general powers of appointment Copyright 2010 by Daniel L. Daniels

51. 51 EXCEPTION 4 The trust is a trust any portion of which would be included in the estate of a non-skip person (other than the transferor) if such person died immediately after the transfer Example: T creates an irrevocable trust for his child, C. Any trust principal remaining at C’s death is subject to C’s general power of appointment The trust is not a GST Trust Copyright 2010 by Daniel L. Daniels

52. 52 EXCEPTION 5 The trust is –A charitable lead annuity trust –A charitable remainder annuity trust or –A charitable remainder unitrust Copyright 2010 by Daniel L. Daniels

53. 53 EXCEPTION 6 The trust –is a charitable lead unitrust; and –is required to pay its remainder interest to a non-skip person if such person is alive at the expiration of the charitable lead interest Copyright 2010 by Daniel L. Daniels

54. 54 AUTOMATIC ALLOCATION PROCEDURE Transferor may opt out of automatic allocation Attach opt-out statement to gift tax return May be for current year or all future years Copyright 2010 by Daniel L. Daniels

55. 55 GST PLANNING OPPORTUNITIES Testamentary planning to capture exemption Dynasty Trust Health and Education Exclusion Trust (HEET) Copyright 2010 by Daniel L. Daniels

56. 56 COMMON PROBLEMS When should exemption be allocated? Dealing with the new Automatic Allocations Rules Handling Crummey powers Late Allocations Copyright 2010 by Daniel L. Daniels

57. Generation Skipping Transfer Tax: An Overview Presented by: Daniel L. Daniels Wiggin and Dana LLP www.wiggin.com Copyright 2010 by Daniel L. Daniels