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IRS issues Notice clarifying 2010 gift tax rule on transfers to grantor trusts
Posted in Tax and Finance

Most of us have, at one time or another, had someone impart upon us the following pearl of wisdom – “if it sounds too good to be true…it probably is.” The IRS recently released a notice which confirms just that with respect to one interpretation of the meaning of section 2511(c) of the Internal Revenue Code of 1986, as amended (Code), which became effective on January 1, 2010 and ceases to apply at the end of the year.

Under the terms of section 2511(a) of the Code, all completed transfers, in trust or otherwise, direct or indirect, are subject to gift tax. Typically, a gift must be “complete,” which means that the transferor has relinquished dominion and control of the transferred property. Prior to January 1, 2010, a transferor could make an “incomplete gift” to a trust by retaining the power to change the disposition of the transferred property. An “incomplete gift” to a trust was not a transfer which was subject to immediate gift tax. This technique was sometimes used to shift income tax recognition without removing the transferred property from the donor’s estate for estate tax purposes.

Congress changed this with the enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), which added section 2511(c) to the Code, but delayed its effectiveness until January 1, 2010. Section 2511(c) now provides that a transfer in trust is treated as a transfer of property by gift, unless the trust is treated as wholly owned by the transferor or the transferor’s spouse under the grantor trust rules. The first part of this provision effectively makes most “incomplete gifts” to trusts subject to gift tax. However, the latter part of the provision has led to confusion among taxpayers and practitioners alike.

Near the end of 2009 (when it became apparent that Congress would not act to prevent the repeal of the federal estate tax), some taxpayers and practitioners began to suggest that section 2511(c) should be interpreted to exclude from gift tax all transfers to grantor trusts in 2010. If this interpretation were correct, a taxpayer could transfer a majority of his or her property to a grantor trust in 2010 without incurring gift tax liability or using up lifetime gift tax exemption. Of course, this interpretation sounded “too good to be true.”

Informed of this possible interpretation of section 2511(c), the IRS released Notice 2010-19 (Notice) as an initial response to the interpretation. First, the Notice reaffirms the clear language of section 2511(c) which provides that any transfer of property to a trust which is not treated as wholly owned by the transferor or the transferor’s spouse under the grantor trust rules is treated as a transfer by gift of the entire interest in the property. Then, the IRS goes on to address what it considers to be the inaccurate interpretation of the latter part of section 2511(c).

The Notice provides that EGTRRA did not amend the substantive law related to the gift tax which was in effect prior to its enactment. Therefore, the substantive gift tax provisions continue to apply to transfers made during 2010, and section 2511(c) is merely an addition to those rules. As a result, the scope of the gift tax is only broadened during 2010 to include transfers to trusts which would have been “incomplete gifts” (and not subject to gift tax) prior to January 1, 2010. 

The gift tax provisions which existed prior to January 1, 2010 must still be used to determine whether or not the gift tax applies to a 2010 transfer to a trust which is treated as wholly owned by the transferor or the transferor’s spouse under the grantor trust rules.

While the IRS intends to issue regulations to confirm the conclusions contained in the Notice, the issues addressed in the Notice could be moot before any such regulations are published. Section 2511(c) is scheduled to disappear on January 1, 2011 along with the other EGTRRA provisions which were enacted by Congress as part of the repeal of the federal estate tax. Congress could also act to remove these provisions and reinstate the estate tax prior to the end of 2010. 

The uncertainty in the estate and gift tax law creates unique estate planning opportunities, albeit with some risk. We would be happy to review your estate plan with you in light of the current estate and gift tax laws and to help you determine what changes are necessary and what planning opportunities may be advantageous for you. 

  • 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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