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GST Tax Traps to Avoid When Preparing Clients' 2010 Federal Gift Tax Returns
Many clients made large gifts last year to take advantage of perceived opportunities offered by the sunset of EGTRRA. Proper reporting of those gifts can be tricky. The Tax Relief Act of 2010 created a number of potential traps that may have adverse consequences. Advisors should exercise special care in completing federal gift tax returns (Form 709) for 2011 gifts.
The Tax Relief Act of 2010 gave each taxpayer $1 million of gift tax exemption, and $5 million of generation skipping transfer (GST) tax exemption for use in 2010 (each reduced by any prior allocation of exemption). In deference to taxpayers who relied on the repeal of the GST tax, a 0% rate applies to GST taxable transfers in 2010.
Allocation of GST Exemption: Considerations
One primary consideration for 2010 gift tax returns is whether to allocate GST exemption to 2010 transfers. While at first glance it may seem that electing out of allocating GST exemption to all 2010 gifts and "paying" the 0% rate is the best choice to preserve exemption for later use, allocating GST exemption specifically to certain gifts may be a better choice as explained below.
GST Reporting Considerations Based on Gift Types:
- Direct Skips in Trust
GST exemption is automatically allocated to direct skips, including direct skips to GST trusts. Consider the following in deciding whether to "opt-out" of the automatic allocation to such trusts:
- Short Duration Trust—Consider Electing Out
A gift to a trust that is expected to make distributions only to "non-skip" beneficiaries has minimal risk of taxable distributions or terminations later. Paying the GST tax at the 0% rate will avoid GST tax on the distributions to the most senior generation due to the application of the "move-down" rule, but distributions or terminations that result in payment to more remote generations will still trigger GST tax.
- Dynasty Trust—Allocate GST Exemption
A trust that is expected to last for multiple generations should be allocated GST exemption, as it will ensure that future distributions will not be taxable distributions or taxable terminations which trigger GST tax. In addition, assets transferred to this type of trust may appreciate significantly, making corrective late allocations in future years an expensive use of remaining GST exemption.
- Indirect Skips in Trust
GST exemption is automatically allocated to indirect skips, which are transfers subject to gift tax currently and which may be subject to GST tax later. Similar considerations apply to these gifts as to direct skips, and an election out may be appropriate if the non-skip beneficiaries are likely to consume most or all of the trust assets.
- Established Trusts
Trusts which have been in place for many years may present exceptions to the guidelines above. The administration of a trust in the future may be made significantly more difficult if the gifts to that trust in one year must be accounted for or considered differently over time. Facilitating easier administration in the future may be more valuable to the client than preserving GST exemption for later use.
Electing Out of Automatic Allocation
Donors may elect out of automatic allocation on Schedule A of Form 709. The preparer must attach a statement detailing the scope of the election. Special care is required here. The attachment should explain whether the allocation applies (1) only for 2010; or (2) for 2010 and future years. If the attachment is not clear, or does not specify, the election out of automatic allocation will apply to the current year and future years unless corrected on a later gift tax return.
Remember the Filing Deadlines
Gift tax returns are due at the same time as the donor's income tax return, subject to extension. In most cases this will be April 18, unless an extension is obtained by extending the income tax return deadline, or specifically extending the gift tax return deadline (Form 8892). Remember that extending the filing deadline does not extend the deadline to pay any gift or GST tax due.
Preparers should keep in mind § 301 of the 2010 Tax Relief Act, which extended the deadline for reporting certain transfers made between January 1, 2010, and December 17, 2010, including GST taxable transfers. The interaction between the September 17 deadline resulting from § 301 of the 2010 Tax Relief Act and the October 18 deadline applicable to extended returns is unclear, and the return preparer would be well advised to complete and file the return sooner.
Correction Methods Preserved
The 2010 Tax Relief Act (see summary) preserved a number of additional GST tax strategies and tools, including late allocations of GST exemption and qualified severance of trusts. If the donor chooses not to allocate exemption to certain transfers in trust, perhaps thinking that later taxable distributions are a remote possibility, the donor may later file a gift tax return and allocate GST exemption (based on the then-current asset values) to that transfer. This could allow a donor to adjust their planning for changes in family circumstances, etc.
We Can Help
If you would like to discuss any of the information contained in this newsletter, please contact a member of our Estate Planning Group.
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