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IRS issues favorable new regulations regarding GST taxes
Posted in Tax and Finance

The Internal Revenue Service (IRS) recently issued final guidance for qualified severances of trusts for generation-skipping transfer (GST) tax purposes. By using the procedures outlined in the new regulation, taxpayers have another tool to more effectively and flexibly use their GST exemption.

Used properly, a taxpayer may now split a trust that is partially subject to GST tax. Under this approach, two trusts can be created — one holding property to which the GST exemption was originally allocated, and the other holding property not originally allocated any GST exemption. Through this approach, the new GST-exempt trust can minimize current distributions to older generation beneficiaries (e.g., children) and maximize distributions to younger generation beneficiaries (e.g., grandchildren). The new trust subject to GST tax can then be managed to maximize distributions to non-skip persons and minimize distributions to skip persons. An approach such as this offers significant tax benefits to taxpayers, while still allowing them to meet their overall family financial needs. Using the regulation another way, the GST exemption can be allocated all to a trust for one beneficiary, and none to trusts for other beneficiaries.

The new regulation applies to severances occurring on or after August 2, 2007. If a qualified severance occurred after December 31, 2000, and before August 2, 2007, taxpayers may rely on any reasonable interpretation of the new regulation as long as reasonable notice concerning the qualified severance and identification of the trusts involved has been given to the IRS.

To qualify under the new regulation, the qualified severance must meet several requirements. These requirements include: (i) the severance must be made pursuant to the terms of the trust severed or applicable local law; (ii) the severance must be effective under local law; (iii) the funding of the trusts resulting from the severance must occur within a reasonable time from the date of severance, but no later than 90 days; (iv) the original trust must be severed on a fractional basis, with each resulting trust funded with part of that fraction and with the total of all trust fractions allocated equaling one; and (v) the interests of the beneficiaries of the resulting trust must be the same, in the aggregate, as the beneficiaries’ interests in the original trust.

The regulation goes on to list other requirements a severance must be meet in order to fall under the regulation’s provisions. For example, in funding the resulting trusts with an allocation based on fair market value, no discount or other deduction from the value of an asset owned by the original trust is permitted. Thus, a taxpayer would be well advised to seek the assistance of counsel before undertaking any trust severance for GST purposes.

An example provided by the new regulation may be just as important as providing guidance on qualified severances. That example implicitly recognized that a general power of appointment, the existence of which is based on the GST-exempt status of a trust, can itself be used to avoid GST tax. This should come as good news to those still in doubt on this issue.

The new regulation provides a unique tax planning opportunity to those looking to minimize the GST tax. Properly following the regulation’s requirements can result in significant tax planning opportunities for taxpayers. Significantly, the final regulation also reinstates the familiar prior Internal Revenue Code section 2654 approach to dividing trusts for GST purposes that are created under your estate plan at your death. The prior proposed regulation would have eliminated this method.

  • Partner

    John is a partner in the firm's Estate Planning Department. He focuses his practice on estates, trusts, family business and disability planning, and the administration of estates and trusts. John also has an active health law ...

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