Generation-Skipping Transfer Tax

Federal RegisterDec 27, 1995

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 26, 301, and 602

[TD 8644]

RIN 1545-AJ11; 1545-AL75; 1545-AO89

Generation-Skipping Transfer Tax

AGENCY: Internal Revenue Service, Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains final generation-skipping transfer

(GST) tax regulations under chapter 13 of the Internal Revenue Code

(Code), as added by section 1431 of the Tax Reform Act of 1986. Changes

to the applicable law were made by the Tax Reform Act of 1986, the

Technical and Miscellaneous Revenue Act of 1988, and the Revenue

Reconciliation Act of 1989. The regulations are necessary to provide

guidance to taxpayers so that they may comply with chapter 13 of the

Code.

EFFECTIVE DATE: December 27, 1995.

FOR FURTHER INFORMATION CONTACT: James F. Hogan, (202) 622-3090 (not a

toll free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information requirements contained in these final

regulations have been reviewed and approved by the Office of Management

and Budget in accordance with the Paperwork Reduction Act (44 U.S.C.

3507) under control numbers 1545-0985 (relating to Secs. 26.2601-1 and

26.2662-2) and 1545-1358 (relating to Secs. 26.2632-1, 26.2642-1,

26.2642-2, 26.2642-3, 26.2642-4 and 26.2652-2). All of these paperwork

requirements will be consolidated under control number 1545-0985.

Responses to this collection of information are required to ensure the

proper collection of the generation-skipping transfer tax.

An agency may not conduct or sponsor, and a person is not required

to respond to, a collection unless the collection of information

displays a valid control number.

The estimated burden per respondent is 1 hour under control number

1545-0985. The time estimates for the reporting and recordkeeping

requirements under control number 1545-1358 are included in the

estimates of burden applicable to Forms 706, 706NA, 706GS(T), 706GS(D),

706GS(D-1), and 709.

Comments concerning the accuracy of this burden estimate and

suggestions for reducing this burden should be directed to the Internal

Revenue Service, Attn: IRS Reports Clearance Officer T:FP, Washington,

DC 20224, and to the Office of Management and Budget, Attn: Desk

Officer for the Department of Treasury, Office of Information and

Regulatory Affairs, Washington, DC 20503.

Books or records relating to this collection of information must be

retained as long as their contents may become material in the

administration of any internal revenue law. Generally, tax returns and

tax return information are confidential, as required by 26 U.S.C. 6103.

Background

On March 15, 1988, the IRS published in the Federal Register a

notice of proposed rulemaking (53 FR 8469) by cross reference to

Temporary Regulations published on the same date in the Federal

December 24, 1992, the IRS published a second notice of proposed

rulemaking (57 FR 61353) amending the prior notice. Also, on December

24, 1992, the IRS published a notice of proposed rulemaking in the

Federal Register (57 FR 61356) containing proposed regulations under

Secs. 2611, 2612, 2613, 2632, 2641, 2642, 2652, 2653, 2654, and 2663.

The IRS received written and oral comments on the proposed regulations

and, on April 21, 1993, a public hearing was held. These documents

adopt final regulations with respect to these notices of proposed

rulemaking.

The following is a discussion of the more significant revisions

that were made.

Section 2601--Transitional Rules

Transfers After September 25, 1985 and Before October 23, 1986

Section 26.2601-1(a)(2)(i), relating to inter vivos transfers made

after September 25, 1985, and before October 23, 1986, clarifies that

chapter 13 applies to inter vivos transfers that are subject to chapter

12 even though a gift tax is not actually paid because of, for example,

the marital deduction or the unified credit.

Section 26.2601-1(a)(2)(ii) (which treats inter vivos transfers

made after September 25, 1985, and before October 23, 1986, as if made

on October 23, 1986) clarifies that the value of the transferred

property for purposes of chapter 13 is determined as of the actual

transfer date rather than as of the deemed transfer date of October 23,

1986.

Section 26.2601-1(a)(4) adds an example illustrating that

Sec. 26.2601-1(a)(2) does not apply to transfers made under a revocable

trust that becomes irrevocable by reason of the grantor's death after

September 25, 1985, but before October 23, 1986. Those transfers are

not subject to chapter 13 because they are in the nature of

testamentary transfers that occurred prior to October 23, 1986.

Section 26.2601-1(b)(1)(ii)(C) clarifies that incidents of

ownership in an insurance policy that are relinquished before September

25, 1985, are not to be taken into account in determining whether a

trust is irrevocable for purposes of Sec. 26.2601-1(b)(1), which

exempts trusts that were irrevocable on September 25, 1985, from the

provisions of chapter 13.

Under Sec. 26.2601-1(b)(1)(iii)(A), a qualified terminable interest

property (QTIP) trust that is grandfathered under Sec. 26.2601-1(b)(1)

is treated as if the reverse QTIP election had been made under section

2652(a)(3). Example 1 in Sec. 26.2601-1(b)(1)(iii)(B) has been revised

to illustrate that the initial QTIP election under section 2523(f) need

not be made before September 25, 1985, provided that the trust was

irrevocable on that date. Further, Sec. 26.2601-1(b)(1)(v)(C) has been

revised to provide that in the case of a trust with respect to which a

reverse QTIP election is deemed to have been made, the failure to

exercise the right of reimbursement under section 2207A will not be

treated as a constructive addition to the trust. This conforms the

treatment of trusts that are irrevocable on September 25, 1985, with

the rule provided in Sec. 26.2652-1(a)(3) which applies to trusts

created after September 25, 1985.

[[Page 66899]]

In Sec. 26.2601-1(b)(2)(iv)(B), the phrase ``or to a generation-

skipping trust'' has been added to eliminate any implication that the

provision is limited to situations involving direct skips. The

provision applies to all generation-skipping transfers.

Section 26.2601-1(b)(3)(iii) applies the transitional rules where

the decedent was under a mental disability but had not been adjudged a

mental incompetent. This section has been clarified to provide that any

evidence submitted to establish the decedent's state of incompetency is

not conclusive and is subject to examination. In addition, an example

has been added to illustrate the transitional rules applicable in the

case of mental incompetency.

Uniform Statutory Rule Against Perpetuities

The notice of proposed rulemaking published on December 24, 1992,

(57 FR 61353) contained a proposed modification to Sec. 26.2601-

1(b)(1)(v)(B)(2). Section 26.2601-1(b)(1)(v)(B)(2) provided that the

exercise of a nongeneral power of appointment will not be treated as an

addition to a grandfathered GST trust if the power is exercised in a

manner that may not postpone or suspend the vesting, absolute

ownership, or power of alienation of a interest in property for a

period, measured from the date of creation of the trust, extending

beyond any life in being at the date of creation of the trust plus a

period of 21 years (perpetuities period).

The proposed modification to Sec. 26.2601-1(b)(1)(v)(B)(2), which

is finalized in this document, provides that the exercise of a

nongeneral power of appointment that validly postpones or suspends the

vesting, absolute ownership, or power of alienation of an interest in

property for a term of years that will not exceed 90 years (measured

from the date of creation of the trust) will not be considered an

exercise that postpones vesting, etc., beyond the perpetuities period.

The modification takes into account the fact that many states have

adopted the Uniform Statutory Rule Against Perpetuities (USRAP) which

allows either a 90 year perpetuities period or the common law

perpetuities period. Under Sec. 26.2601-1(b)(1)(v)(B)(2), as modified,

the nongeneral power may not be exercised in a manner that postpones

vesting, etc., for the longer of 90 years or the common law period

(lives in being plus 21 years).

The discussion in the preamble published on December 24, 1992,

indicates that USRAP has a ``wait and see'' aspect that is not

appropriate for GST purposes because it will be necessary to determine

the GST tax consequences of distributions and terminations at the time

they occur. Thus, the preamble stated that, in order to comply with the

regulation and avoid a constructive addition, it must be clear at the

time the nongeneral power is exercised that the exercise may not

postpone or suspend vesting, etc., beyond either lives in being plus 21

years or 90 years (but not the longer of the two periods). A

commentator has pointed out that the USRAP invalidates any attempt to

exercise a power for the longer of the two periods. Under the USRAP, it

will be clear at the time the nongeneral power is exercised that the

exercise may not postpone or suspend vesting, etc., beyond one of the

two periods (but not both). Under the USRAP, the common law period

(lives in being plus 21 years) is imposed in the event that the power

holder exercises the power in a manner that attempts to suspend or

postpone vesting, etc., for the longer of the two periods. Although the

preamble published on December 24, 1992, may have been misleading in

referring to a ``wait and see'' aspect of USRAP, the modification to

Sec. 26.2601-1(b)(1)(v)(B)(2) is not affected.

Section 2611 et. seq.--GST Substantive Rules

Definition of Generation-Skipping Transfers

Section 26.2611-1 has been revised to clarify that, in determining

whether an event is subject to the GST tax, reference must be made to

the most recent transfer that was subject to Federal estate or gift

tax. This is because the most recent transfer that was subject to

estate or gift tax establishes the identity of the transferor, which in

turn determines the identity of the skip persons and non-skip persons.

Definitions

Section 26.2612-1(a)(2)(i) of the proposed regulations provides

generally that, for purposes of determining whether a transfer

constitutes a direct skip, the generation assignment of a person who

would otherwise be a skip person is redetermined by disregarding the

intervening generation, if certain individuals have died prior to the

transfer (e.g., a predeceased child of the transferor). The section has

been modified to provide that, if an individual who is a member of the

intervening generation dies no later than 90 days after the transfer,

the deceased individual is treated as having predeceased the

transferor, if the governing instrument or applicable state law

provides for such treatment.

Section 26.2612-1(a)(2)(ii) has been added to provide that, if a

transferor makes an addition to an existing trust after the death of an

individual described in paragraph (a)(2)(i) of that section (i.e., an

individual in the intervening generation), the additional property is

treated as being held in a separate trust for purposes of chapter 13.

Section 2612(a)(1) defines the term taxable termination to mean the

termination of an interest in property held in trust unless, among

other things, at no time after such termination may a distribution

(including distributions on termination) be made from the trust to a

skip person. Section 26.2612-1(b)(1)(iii), as proposed, has been

revised to provide that, for purposes of applying this rule, potential

distributions to skip persons are to be disregarded if the probability

of occurrence is so remote as to be negligible. A similar rule has been

applied to Sec. 26.2612-1(d)(2), regarding when a trust is considered a

skip person. The probability that a distribution will occur is so

remote as to be negligible only if it can be ascertained by actuarial

standards that there is less than a 5 percent probability that the

distribution will occur.

Section 26.2612-1(c)(2) has been added to clarify that the look-

through rule in section 2651(e)(2) does not apply for purposes of

determining whether a transfer from one trust to another trust is a

taxable distribution. Thus, the transfer is treated as having been made

to the recipient trust rather than to the beneficiaries of that trust.

Accordingly, a transfer is a taxable distribution only if the recipient

trust itself is a skip person.

Section 26.2612-1(e)(3) has been added to provide that, in

determining whether a trust is a skip person, trust interests

disclaimed pursuant to a qualified disclaimer described in section 2518

are not taken into account.

Example 3 has been added to Sec. 26.2612-1(f) to illustrate that a

transfer to a trust pursuant to which a beneficiary who is a skip

person has a withdrawal power is not a direct skip unless the trust is

a skip person.

Example 9 has been added to Sec. 26.2612-1(f) to illustrate that a

taxable termination may occur upon the distribution of the entire trust

property (less amounts retained to pay a resulting GST tax and

administration expenses).

Example 14 contained in Sec. 26.2612-1(f) of the proposed

regulations illustrates that an individual is not treated as having an

interest in a trust

[[Page 66900]]

for purposes of Chapter 13, if the individual's support obligation

could be satisfied at the discretion of the trustee. This example has

been renumbered as Example 15 and has been clarified to provide that an

individual will have an interest in the trust if the trustee is

required to make distributions for the beneficiary's support, in

satisfaction of the individual's support obligation.

Allocation of GST Exemption

Under Sec. 26.2632-1(b)(2)(ii)(A) of the proposed regulations, a

late allocation of GST exemption is effective on the date the Form 709

reporting the allocation is filed, and is deemed to precede in point of

time any taxable event occurring on that date. This section has been

revised to specify that the Form 709 is treated as filed on the date it

is mailed to the appropriate IRS Service Center. Further, the late

allocation may be made on a timely filed Form 709 reporting another

transfer.

Section 26.2632-1(b)(2)(ii)(B) has been added to clarify how the

GST exemption allocated on a Federal gift tax return (Form 709) is to

be apportioned in the event that the amount allocated on the return

exceeds the value of the transfers reported on the return.

Example 4 of Sec. 26.2632-1(b)(2)(iii) of the proposed regulations

has been revised to better illustrate the effective date of a late

allocation of GST exemption.

Example 5 of Sec. 26.2632-1(b)(2)(iii) has been added to illustrate

the automatic allocation of GST exemption to inter vivos direct skips

in situations where split gift treatment is elected on an initial gift

tax return filed after its due date.

Section 26.2632-1(d)(1) has been revised to provide that a late

allocation of GST exemption made by an executor with respect to an

inter vivos transfer not included in the gross estate, is effective as

of the date the allocation is filed. This rule does not apply to any

automatic allocation under section 2632(b)(1). This revision conforms

the regulation to section 2642(b)(3).

Estate Tax Inclusion Period

As proposed, Sec. 26.2632-1(c)(2)(ii) provided that an estate tax

inclusion period (ETIP) exists during the period in which the

transferred property would have been includible in the transferor's

gross estate had the transferor retained an interest held by the

transferor's spouse, but only to the extent the spouse acquired the

interest from the transferor in an inter vivos transfer that was not

included in the transferor's taxable gifts or for which a deduction was

allowed under section 2523. Commentators stated that there was no

support in the statute for this spousal rule, and any such rule would

require a legislative change. The final regulations eliminate this

spousal rule and Example 5 of Sec. 26.2632-1(c)(5).

Section 26.2632-1(c)(2)(ii)(A) has been added to provide that the

ETIP rules do not apply when the possibility that the property will be

included in the gross estate of the transferor (or the transferor's

spouse) is so remote as to be negligible.

Further, Sec. 26.2632-1(c)(2)(ii)(B) has been added to provide that

transferred property will not be treated as being subject to inclusion

in the transferor's spouse's gross estate, and thus, subject to an

ETIP, where the only power possessed by the spouse is a right to

withdraw no more than the greater of 5 percent or $5,000 of the trust's

corpus and the withdrawal right terminates within 60 days of the

transfer to the trust.

Section 26.2632-1(c)(5) Example 3, of the proposed regulations

illustrates that if a transferor's spouse elects gift-splitting

treatment with respect to the transferor's gift that is subject to an

ETIP, the spouse is treated as the transferor of one-half of the gift.

The example has been expanded to illustrate that, since the spouse's

deemed transfer is subject to an ETIP, if the spouse dies prior to the

termination of the trust, the spouse's executor may allocate GST

exemption to the trust. However, the allocation will not be effective

until the ETIP terminates on the transferor's death.

Erroneous Allocations

Under the proposed regulations, allocations in excess of the amount

of the property transferred are void. This treatment has been expanded

under the final regulations. Thus, any allocation to a trust that has

no GST potential at the time of the allocation, with respect to the

transferor for whom the allocation is made, is also void. This

provision is intended to prevent the wasting of GST exemption because

of an erroneous allocation with respect to a testamentary or inter

vivos transfer. A trust will have no GST potential only if there is no

possibility that a GST will be made from the trust with respect to the

transferor.

Determination of Applicable Fraction

Section 26.2642-1(b)(2) of the proposed regulations provided rules

for determining the inclusion ratio with respect to a trust subject to

an ETIP where GSTs are made from the trust during the ETIP. Comments

were received that the rules were unclear regarding whether an

ineffective allocation, i.e., an allocation made prior to any

distributions or terminations, would apply in determining the amount of

the transferor's unused GST exemption, or whether such an allocation

could be modified prior to an ETIP termination. In response to the

comments, Sec. 26.2632-1(c)(1) (providing rules for the allocation of

exemption with respect to a trust subject to an ETIP) and Sec. 26.2642-

1(b)(2) clarify that an allocation made to a trust subject to an ETIP

prior to any distribution or termination is not subject to modification

or revocation. However, the allocation will not be effective, i.e., the

allocation does not operate to fix the inclusion ratio of the trust, at

the time it is made. Rather, the allocation becomes effective as of the

date of a subsequent distribution or termination. Section 26.2632-

1(c)(5) Example 2, illustrates this point.

Section 26.2642-2 of the proposed regulations provides valuation

rules for determining the denominator of the applicable fraction under

section 2642. Section 26.2642-2(a)(1) of the final regulations

specifies that, in the case of a timely allocation of GST exemption

with respect to an inter vivos transfer, the denominator of the

applicable fraction is the fair market value of the transferred

property, as finally determined for gift tax purposes.

Section 26.2642-2(b)(1) of the proposed regulations provides

special rules for determining the denominator of the applicable

fraction in situations involving property subject to the special

valuation rules contained in section 2032A. Under the proposed

regulations, the special use value of the property could only be used

in determining the applicable fraction if the property was transferred

in a direct skip. Thus, a generation-skipping trust to which section

2032A property was transferred in a transfer that was not a direct skip

would not receive the benefit of the favorable valuation rules of

section 2032A in determining the applicable fraction with respect to

the trust.

Comments stated that the proposed regulation was inconsistent with

section 2642(b), which provides that the chapter 11 value must be used

to determine the applicable fraction in the case of a testamentary

transfer. Under the final regulations, the section 2032A value of

property is to be used to determine the applicable fraction for a

direct skip transfer and for a generation-skipping trust created in a

transfer other than a direct skip.

In the event that additional estate tax is imposed under section

2032A(c) with respect to the property, then the

[[Page 66901]]

applicable fraction is redetermined as of the transferor's date of

death. Thus, the GST tax liability with respect to any direct skip,

taxable termination, or taxable distribution occurring prior to the

recapture event would be recomputed based on the redetermined

applicable fraction, and an additional GST tax would be due. The

taxation of any future GST transfers would also be based on the

redetermined applicable fraction.

Sections 26.2642-2(b) (2) and (3) of the proposed regulations

contain special rules for determining the denominator of the applicable

fraction in situations involving residuary and pecuniary payments.

Generally, in the case of a residual GST after the payment of a

pecuniary amount, the denominator of the applicable fraction will be

the estate tax value of the total assets available to satisfy the

pecuniary payment less the amount of the pecuniary payment, provided

the pecuniary payment carries ``appropriate interest'' as defined in

Sec. 26.2642-2(b)(4). Under Sec. 26.2642-2(b)(4)(ii), the payment need

not carry appropriate interest if, inter alia, the payment is

irrevocably ``set aside'' within 15 months of the transferor's death.

The final regulations clarify that this exception to the appropriate

interest requirement applies only if the entire payment is set aside.

Further, the payment is treated as set aside if the amount is

segregated and held in a separate account pending distribution.

Finally, under the proposed regulation, the appropriate interest

requirement can be satisfied if a pro rata share of estate income is

allocated to the pecuniary bequest. The final regulations clarify that

the payment of income may be allocated pursuant to the terms of the

governing instrument or applicable local law.

Section 26.2642-4(a)(3) of the proposed regulations addresses a

situation where a lifetime allocation is made with respect to a trust

when the trust was not subject to an ETIP, and the trust is

subsequently included in the transferor's gross estate. The regulation

has been revised to provide that, if additional GST exemption is

allocated to the trust, the nontax portion of the trust is determined

immediately after the date of the transferor's death. Also, if

additional GST exemption is not allocated to the trust by the

transferor's executor, the applicable fraction does not change, if the

trust was not otherwise subject to an ETIP at the time the previous

allocation of GST exemption was made. Further, where such property is

included in the gross estate, the denominator of the applicable

fraction is reduced to reflect any federal or state estate or

inheritance tax paid by the trust.

Definition of Transferor

Section 26.2652-1(a)(1) of the proposed regulations, defining

transferor, has been revised to specify that a surviving spouse is

treated as the transferor of a qualified domestic trust (QDOT)

described in section 2056A that is included in the surviving spouse's

gross estate for federal estate tax purposes, assuming the trust is not

subject to a reverse QTIP election under section 2652(a)(3). The

surviving spouse is also the transferor of any QDOT created by the

surviving spouse under section 2056(d)(2)(B).

Section 26.2652-1(a)(4), as proposed, provided that the creator of

a special power of appointment will be treated as making a transfer

subject to estate or gift tax (and thus be considered a transferor) if

the holder of the power exercised the power in a manner that may

postpone vesting, etc., of the property subject to the power beyond the

permissible perpetuities period. This result is inconsistent with

section 2041(a)(3), which treats the holder of the power as making a

transfer under these circumstances. Accordingly, the regulation has

been revised to provide that the holder of the power will be treated as

making a taxable transfer, if the holder exercises the power in the

manner prescribed.

Section 26.2652-1(a)(5) has been added to specify that where a

donor's spouse consents to have the donor's gift treated as made one-

half by the spouse, then for purposes of chapter 13, the spouse is

treated as the transferor of one-half of the property transferred by

the donor. Thus, if a donor transfers property to a trust and retains a

qualified interest as defined in section 2702(b), with the remainder to

a grandchild, a consenting spouse would be treated as the transferor of

one-half the entire property. It was suggested that the spouse should

only be treated as the transferor of that portion of the trust

corresponding to one-half of the actuarial value of the interest

passing to the grandchild, since under section 2513, only one half the

gift to the grandchild may be treated as made by the consenting spouse.

However, treating the consenting spouse as the transferor of one-half

of the entire trust is consistent with the general treatment accorded

other split-interest transfers. For example, if a transferor

transferred property in trust retaining an interest that qualified

under section 2702(b), with the remainder to the transferor's

grandchild, the transferor would be considered the transferor of the

entire trust for purposes of chapter 13, notwithstanding that, from a

technical standpoint, only the actuarial value of the gift to the

grandchild is subject to gift tax at the time of the transfer.

Example 8 in Sec. 26.2652-1(a)(6) has been added illustrating that

a surviving spouse will not be treated as making a contribution to a

QTIP trust that is included in the spouse's gross estate and is subject

to a reverse QTIP election, where the spouse directs in the will that

the estate tax generated by the inclusion of the trust is to be paid

from the spouse's probate estate.

Separate Shares Treated as Separate Trusts

Section 26.2654-1 of the proposed regulations provides rules under

which ``separate shares'' of a single trust that satisfy the

requirements of the regulations will be recognized as separate trusts

for GST purposes.

Under the proposed regulations, a mandatory payment of a pecuniary

amount is treated as a separate share of a trust (and thus, a separate

trust for GST purposes) if certain conditions are satisfied. The

section is clarified to specify that a mandatory payment is a payment

that is nondiscretionary and noncontingent; i.e., the payment must be

made in all events.

A sentence was added to Example 3, now contained in Sec. 26.2654-

1(a)(5), to clarify that, where a decedent's probate estate pours over

to a revocable trust, and then amounts are distributed pursuant to the

terms of the trust, the distributions will be treated as separate

shares for purposes of chapter 13.

Example 4, now contained in Sec. 26.2654-1(a)(5), has been revised

to specify that the bequest of a pecuniary amount payable in kind is

not treated as a separate share of the trust, since, under the facts

presented, neither the trust nor local law requires that the assets

distributed in satisfaction of the bequest fairly reflect net

appreciation and depreciation. This is the result regardless of whether

the assets are distributed within 15 months of the transferor's death.

Comments received suggested that the regulations should allow

separate trust treatment whenever a single inter vivos trust was

recognized as separate trusts under local law. For example, an inter

vivos trust provides income to child for life, but when each grandchild

reaches age 35, a separate trust is to be established for the child,

the grandchild, and the grandchild's issue. Comments suggested that the

Service should recognize each trust established when a grandchild

reaches age 35 as a separate trust, and allow a late allocation of GST

[[Page 66902]]

exemption specifically to that trust when severance occurs.

This suggestion was rejected. Generally, the adoption of this

approach would effectively allow the allocation of GST exemption to

specific distributions from a GST trust, rather than to the entire

trust. This result would be contrary to the clear language of the

statute. See, e.g., sections 2642(a)(1)(A) and (a)(2).

Division of a Single Trust Into Separate Trusts

Under Sec. 26.2654-1(c) of the proposed regulations, a testamentary

trust could be severed into several parts, provided the severance was

commenced prior to the filing of the estate tax return. Further, the

new trusts created pursuant to the severance had to be identical to the

old trusts. For example, a testamentary trust providing for income to

spouse, remainder to be divided equally between child and grandchild

could only be severed into two trusts both providing income to spouse

with the remainder to be divided between child and grandchild. Finally,

an inter vivos trust could not be severed unless it consisted of

separate shares, or different transferors had contributed to the trust.

The regulation has been clarified to specify that the division of a

single trust that is included in the transferor's gross estate will be

recognized if either: (1) The single trust consists of separate shares

and is thus, treated as separate trusts; or (2) the single trust,

although not consisting of separate shares, is severed into separate

trusts pursuant to a direction in the governing instrument providing

that the trust is to be divided into separate trusts on the

transferor's death; or (3) the governing instrument does not require or

direct severance but the trust is severed pursuant to the discretionary

authority of the trustee granted under the governing instrument or

local law.

The final regulations provide that the trusts resulting from the

severance of a single testamentary trust need not be identical. Thus,

if the trust provides income to spouse, remainder to child and

grandchild, the trust may be severed to create two trusts, one with

income to spouse, remainder to child and a second with income to spouse

remainder to grandchild. This result could be achieved through proper

estate planning in any event. However, the regulations make it clear

that the resulting trusts must provide for the same succession of

interests as provided for under the original trusts. Thus, a trust

providing for an income interest to a child, with remainder to a

grandchild, could not be divided into one trust for the child (equal in

value to the child's income interest) and another for the grandchild.

The proposed regulations provided that the new trusts must be

funded with a fractional share of each and every asset held by the

original single trust. The provision has been revised to provide that

the new trusts may also be funded on a nonpro rata basis, based on the

fair market value of the assets selected on the date of severance.

Thus, the executor or trustee may select the assets with which to fund

each trust, and need not fractionalize each asset.

An example has been added to illustrate that, if a revocable trust

included in the transferor's gross estate is, under the terms of the

trust, divided into multiple trusts on the transferor's death, then

each trust established will be treated as a separate trust for GST

purposes.

Due Date of Return

New Sec. 26.2662-1(d)(2) has been added to provide that the due

date of the return with respect to a taxable termination subject to an

election under section 2624(c) (relating to alternate valuation in

accordance with section 2032) is April 15th of the following year in

which the taxable termination occurred or on or before the 15th day of

the tenth month following the month in which the death that resulted in

the taxable termination occurred, whichever is later.

Application of Chapter 13 to Nonresident Aliens

Section 2663(2) requires that the Commissioner prescribe

regulations, consistent with the provisions of chapters 11 and 12,

providing for the application of the GST tax to a nonresident alien

(NRA). In general, under Sec. 26.2663-2(b) as proposed, the GST tax

applied to inter vivos and testamentary direct skip transfers by a NRA,

to the extent that the transferred property was U.S. situs property

such that the transfer was subject to a gift tax (in the case of inter

vivos transfers) or an estate tax (in the case of testamentary

transfers). Similarly, in the case of transfers in trust, chapter 13

applied to taxable terminations and distributions to the extent the

initial transfer to the trust (whether inter vivos or testamentary)

consisted of U.S. situs property, such that the initial transfer was

subject to the gift or estate tax. This was the case regardless of the

situs of the property at the time of the actual distribution or

termination and regardless of the residency or citizenship of the skip

person receiving the beneficial interest or property.

Under Sec. 26.2663-2(c) as proposed, if the property involved in a

generation-skipping transfer was not situated in the U.S. at the time

of the initial transfer, the generation-skipping transfer was still

subject to the GST tax if: (1) At the time of the direct skip, taxable

termination or distribution, the property passes to a skip person who

is a U.S. resident or citizen; and (2) at the time of the initial

transfer to the skip person or trust, a lineal descendant of the

transferor, who is a lineal ancestor of the skip person, was a resident

or citizen of the U.S. This rule applied regardless of the situs of the

property at the time of the actual distribution or termination. Section

26.2663-2(f) of the proposed regulations provided for the automatic

allocation of a NRA's $1,000,000 GST exemption regardless of whether

the transfer was a direct skip.

Thus, the proposed regulations subjected non-U.S. situs property to

the GST tax based on the status of the skip person/recipient of the

property at the time the property was received, and the status of the

generation that was skipped at the time of the initial transfer to the

trust or skip person.

Many comments were critical of this approach. In general, these

comments emphasized that the estate and gift tax provisions subject

transfers by NRAs to transfer tax based on the situs of the property,

not the status of the recipient. Therefore, the proposed regulations

conflict with section 2663, which provides that the regulations should

be consistent with the principles of chapters 11 and 12 of the Internal

Revenue Code (Code). Further, the commentators argued that treating a

NRA who transfers non-U.S. situs property as a transferor for GST tax

purposes would conflict with the definition of transferor under section

2652, since the transfer would not be subject to estate or gift tax.

Under section 2652, an individual is a transferor only to the extent

the transfer is subject to U.S. gift tax or estate tax.

The proposed regulations have been revised to address these

concerns. Thus, the rules in the proposed regulations applying chapter

13 to transfers of property that were not subject to estate or gift tax

have been eliminated. Under the final regulations, the application of

the GST tax will be limited to situations where an estate or gift tax

is imposed on the property. Thus, the GST tax will apply to inter vivos

and testamentary direct skip transfers by a NRA transferor to the

extent a gift tax is imposed on the transfer (in the case of an inter

vivos transfer) or the transferred property is

[[Page 66903]]

included in the transferor's gross estate (in the case of a

testamentary direct skip). In the case of taxable terminations and

taxable distributions, chapter 13 will apply to the extent a gift tax

was imposed on the initial transfer to the trust, or the property was

included in the transferor's gross estate. Accordingly, under the final

regulations (in the absence of a situation involving an ETIP), the

application of Chapter 13 is generally dependent on the situs of the

property at the time of the initial transfer. The regulations contain

special rules for determining the applicable fraction and inclusion

ratio where a trust is funded with both U.S. and foreign situs

property.

In general, the rules of Sec. 26.2632-1 apply with respect to the

allocation of the exemption. However, the ETIP rule provided in

Sec. 26.2632-1(c) applies only if the property transferred by the NRA

is subsequently included in the transferor's gross estate. The final

regulations provide transitional relief with respect to NRA's who made

GST transfers and relied on the automatic allocation rules in the

proposed regulations.

Special Analyses

It has been determined that this Treasury decision is not a

significant regulatory action as defined in EO 12866. Therefore, a

regulatory assessment is not required. It has also been determined that

section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)

and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to

these regulations, and therefore, a Regulatory Flexibility Analysis is

not required. Pursuant to section 7805(f) of the Internal Revenue Code,

the notice of proposed rulemaking preceding these regulations was

submitted to the Small Business Administration for comment on its

impact on small business.

Drafting Information. The principal author of these regulations is

James F. Hogan, Office of the Chief Counsel, IRS. Other personnel from

the IRS and Treasury Department participated in their development.

List of Subjects

26 CFR Part 26

Estate taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income

taxes, Penalties, Reporting and recordkeeping requirements.

26 CFR part 602

Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 26, 301, and 602 are amended as follows:

Paragraph 1. Part 26 is revised to read as follows:

PART 26--GENERATION-SKIPPING TRANSFER TAX REGULATIONS UNDER THE TAX

REFORM ACT OF 1986

Sec.

26.2600-1 Table of contents.

26.2601-1 Effective dates.

26.2611-1 Generation-skipping transfer defined.

26.2612-1 Definitions.

26.2613-1 Skip person.

26.2632-1 Allocation of GST exemption.

26.2641-1 Applicable rate of tax.

26.2642-1 Inclusion ratio.

26.2642-2 Valuation.

26.2642-3 Special rule for charitable lead annuity trusts.

26.2642-4 Redetermination of applicable fraction.

26.2642-5 Finality of inclusion ratio.

26.2652-1 Transferor defined; other definitions.

26.2652-2 Special election for qualified terminable interest

property.

26.2653-1 Taxation of multiple skips.

26.2654-1 Certain trusts treated as separate trusts.

26.2662-1 Generation-skipping transfer tax return requirements.

26.2663-1 Recapture tax under section 2032A.

26.2663-2 Application of chapter 13 to transfers by nonresidents

not citizens of the United States.

Authority: 26 U.S.C. 7805 and 26 U.S.C. 2663.

Section 26.2632-1 also issued under 26 U.S.C. 2632 and 2663.

Section 26.2642-4 also issued under 26 U.S.C. 2632 and 2663.

Section 26.2662-1 also issued under 26 U.S.C. 2662.

Section 26.2663-2 also issued under 26 U.S.C. 2632 and 2663.

Sec. 26.2600-1 Table of contents.

This section lists the captions that appear in the regulations

under sections 2601 through 2663.

Sec. 26.2601-1 Effective dates.

(a) Transfers subject to the generation-skipping transfer tax.

(1) In general.

(2) Certain transfers treated as if made after October 22, 1986.

(3) Certain trust events treated as if occurring after October

22, 1986.

(4) Example.

(b) Exceptions.

(1) Irrevocable trusts.

(2) Transition rule for wills or revocable trusts executed

before October 22, 1986.

(3) Transition rule in the case of mental incompetency.

(4) Exceptions to additions rule.

Sec. 26.2611-1 Generation-skipping transfer defined.

Sec. 26.2612-1 Definitions.

(a) Direct skip.

(1) In general.

(2) Special rule for certain lineal descendants.

(b) Taxable termination.

(1) In general.

(2) Partial termination.

(1) In general.

(2) Look-through rule not to apply.

(d) Skip person.

(e) Interest in trust.

(1) In general.

(2) Exceptions.

(3) Disclaimers.

(f) Examples.

Sec. 26.2613-1 Skip person.

Sec. 26.2632-1 Allocation of GST exemption.

(a) General rule.

(b) Lifetime allocations.

(1) Automatic allocation to direct skips.

(2) Allocation to other transfers.

(1) In general.

(2) Estate tax inclusion period defined.

(3) Termination of an ETIP.

(4) Treatment of direct skips.

(5) Examples.

(d) Allocations after the transferor's death.

(1) Allocation by executor.

(2) Automatic allocation after death.

Sec. 26.2641-1 Applicable rate of tax.

Sec. 26.2642-1 Inclusion ratio.

(a) In general.

(b) Numerator of applicable fraction.

(1) In general.

(2) GSTs occurring during an ETIP.

(1) In general.

(2) Zero denominator.

(3) Nontaxable gifts.

(d) Examples.

Sec. 26.2642-2 Valuation.

(a) Lifetime transfers.

(1) In general.

(2) Special rule for late allocations during life.

(b) Transfers at death.

(1) In general.

(2) Special rule for pecuniary payments.

(3) Special rule for residual transfers after payment of a

pecuniary payment.

(4) Appropriate interest.

Sec. 26.2642-3 Special rule for charitable lead annuity trusts.

(a) In general.

(b) Adjusted GST exemption defined.

[[Page 66904]]

Sec. 26.2642-4 Redetermination of applicable fraction.

(a) In general.

(1) Multiple transfers to a single trust.

(2) Consolidation of separate trusts.

(3) Property included in transferor's gross estate.

(4) Imposition of recapture tax under section 2032A.

(b) Examples.

Sec. 26.2642-5 Finality of inclusion ratio.

(a) Direct skips.

(b) Other GSTs.

Sec. 26.2652-1 Transferor defined; other definitions.

(a) Transferor defined.

(1) In general.

(2) Transfers subject to Federal estate or gift tax.

(3) Special rule for certain QTIP trusts.

(4) Exercise of certain nongeneral powers of appointment.

(5) Split-gift transfers.

(6) Examples.

(b) Trust defined.

(1) In general.

(2) Examples.

(d) Executor defined.

(e) Interest in trust.

Sec. 26.2652-2 Special election for qualified terminable interest

property.

(a) In general.

(b) Time and manner of making election.

(d) Examples.

Sec. 26.2653-1 Taxation of multiple skips.

(a) General rule.

(b) Examples.

Sec. 26.2654-1 Certain trusts treated as separate trusts.

(a) Single trust treated as separate trusts.

(1) Substantially separate and independent shares.

(2) Multiple transferors with respect to a single trust.

(3) Severance of a single trust.

(4) Allocation of exemption.

(5) Examples.

(b) Division of a trust included in the gross estate.

(1) In general.

(2) Special rule.

(3) Allocation of exemption.

(4) Example.

Sec. 26.2662-1 Generation-skipping transfer tax return

requirements.

(a) In general.

(b) Form of return.

(1) Taxable distributions.

(2) Taxable terminations.

(3) Direct skip.

(1) In general.

(2) Special rule for direct skips occurring at death with

respect to property held in trust arrangements.

(3) Limitation on personal liability of trustee.

(4) Exceptions.

(d) Time and manner of filing return.

(1) In general.

(2) Exceptions for alternative valuation of taxable termination.

(e) Place for filing returns.

(f) Lien on property.

Sec. 26.2663-1 Recapture tax under section 2032A.

Sec. 26.2663-2 Application of chapter 13 to transfers by

nonresidents not citizens of the United States.

(a) In general.

(b) Transfers subject to Chapter 13.

(1) Direct skips.

(2) Taxable distributions and taxable terminations.

and in part with property not subject to Chapter 13.

(1) In general.

(2) Nontax portion of the trust.

(3) Special rule with respect to estate tax inclusion period.

(d) Examples.

(e) Transitional rule for allocations for transfers made before

December 27, 1995.

26.2601-1 Effective dates.

(a) Transfers subject to the generation-skipping transfer tax--(1)

In general. Except as otherwise provided in this section, the

provisions of chapter 13 of the Internal Revenue Code of 1986 (Code)

apply to any generation-skipping transfer (as defined in section 2611)

made after October 22, 1986.

(2) Certain transfers treated as if made after October 22, 1986.

Solely for purposes of chapter 13, an inter vivos transfer is treated

as if it were made on October 23, 1986, if it was--

(i) Subject to chapter 12 (regardless of whether a tax was actually

incurred or paid); and

(ii) Made after September 25, 1985, but before October 23, 1986.

For purposes of this paragraph, the value of the property transferred

shall be the value of the property on the date the property was

transferred.

(3) Certain trust events treated as if occurring after October 22,

1986. For purposes of chapter 13, if an inter vivos transfer is made to

a trust after September 25, 1985, but before October 23, 1986, any

subsequent distribution from the trust or termination of an interest in

the trust that occurred before October 23, 1986, is treated as

occurring immediately after the deemed transfer on October 23, 1986. If

more than one distribution or termination occurs with respect to a

trust, the events are treated as if they occurred on October 23, 1986,

in the same order as they occurred. See paragraph (b)(1)(iv)(B) of this

section for rules determining the portion of distributions and

terminations subject to tax under chapter 13. This paragraph (a)(3)

does not apply to transfers to trusts not subject to chapter 13 by

reason of the transition rules in paragraphs (b) (2) and (3) of this

section. The provisions of this paragraph (a)(3) do not apply in

determining the value of the property under chapter 13.

(4) Example. The following example illustrates the principle that

paragraph (a)(2) of this section is not applicable to transfers under a

revocable trust that became irrevocable by reason of the transferor's

death after September 25, 1985, but before October 23, 1986:

Example. T created a revocable trust on September 30, 1985, that

became irrevocable when T died on October 10, 1986. Although the

trust terminated in favor of a grandchild of T, the transfer to the

grandchild is not treated as occurring on October 23, 1986, pursuant

to paragraph (a)(2) of this section because it is not an inter vivos

transfer subject to chapter 12. The transfer is not subject to

chapter 13 because it is in the nature of a testamentary transfer

that occurred prior to October 23, 1986.

(b) Exceptions--(1) Irrevocable trusts--(i) In general. The

provisions of chapter 13 do not apply to any generation-skipping

transfer under a trust (as defined in section 2652(b)) that was

irrevocable on September 25, 1985. The rule of the preceding sentence

does not apply to a pro rata portion of any generation-skipping

transfer under an irrevocable trust if additions are made to the trust

after September 25, 1985. See paragraph (b)(1)(iv) of this section for

rules for determining the portion of the trust that is subject to the

provisions of chapter 13.

(ii) Irrevocable trust defined--(A) In general. Unless otherwise

provided in either paragraph (b)(1)(ii) (B) or (C) of this section, any

trust (as defined in section 2652(b)) in existence on September 25,

1985, is considered an irrevocable trust.

(B) Property includible in the gross estate under section 2038. For

purposes of this chapter a trust is not an irrevocable trust to the

extent that, on September 25, 1985, the settlor held a power with

respect to such trust that would have caused the value of the trust to

be included in the settlor's gross estate for Federal estate tax

purposes by reason of section 2038 (without regard to powers

relinquished before September 25, 1985) if the settlor had died on

September 25, 1985. A trust is considered subject to a power on

September 25, 1985, even though the exercise of the power was subject

to the precedent giving of notice, or even though the exercise could

take effect only on the expiration of a stated period, whether or not

on or before September 25, 1985, notice had been given or the power had

been exercised.

[[Page 66905]]

A trust is not considered subject to a power if the power is, by its

terms, exercisable only on the occurrence of an event or contingency

not subject to the settlor's control (other than the death of the

settlor) and if the event or contingency had not in fact taken place on

September 25, 1985.

policy of insurance on an individual's life that is treated as a trust

under section 2652(b) is not considered an irrevocable trust to the

extent that, on September 25, 1985, the insured possessed any incident

of ownership (as defined in Sec. 20.2042-1(c) of this chapter, and

without regard to any incidents of ownership relinquished before

September 25, 1985), that would have caused the value of the trust,

(i.e., the insurance proceeds) to be included in the insured's gross

estate for Federal estate tax purposes by reason of section 2042, if

the insured had died on September 25, 1985.

(D) Examples. The following examples illustrate the application of

this paragraph (b)(1):

Example 1. Section 2038 applicable. On September 25, 1985, T,

the settlor of a trust that was created before September 25, 1985,

held a testamentary power to add new beneficiaries to the trust. T

held no other powers over any portion of the trust. The testamentary

power held by T would have caused the trust to be included in T's

gross estate under section 2038 if T had died on September 25, 1985.

Therefore, the trust is not an irrevocable trust for purposes of

this section.

Example 2. Section 2038 not applicable when power held by a

person other than settlor. On September 25, 1985, S, the spouse of

the settlor of a trust in existence on that date, had an annual

right to withdraw a portion of the principal of the trust. The trust

was otherwise irrevocable on that date. Because the power was not

held by the settlor of the trust, it is not a power described in

section 2038. Thus, the trust is considered an irrevocable trust for

purposes of this section.

Example 3. Section 2038 not applicable. In 1984, T created a

trust and retained the right to expand the class of remaindermen to

include any of T's afterborn grandchildren. As of September 25,

1985, all of T's grandchildren were named remaindermen of the trust.

Since the exercise of T's power was dependent on there being

afterborn grandchildren who were not members of the class of

remaindermen, a contingency that did not exist on September 25,

1985, the trust is not considered subject to the power on September

25, 1985, and is an irrevocable trust for purposes of this section.

The result is not changed even if grandchildren are born after

September 25, 1985, whether or not T exercises the power to expand

the class of remaindermen.

Example 4. Section 2042 applicable. On September 25, 1985, T

purchased an insurance policy on T's own life and designated child,

C, and grandchild, GC, as the beneficiaries. T retained the power to

obtain from the insurer a loan against the surrender value of the

policy. T's insurance policy is a trust (as defined in section

2652(b)) for chapter 13 purposes. The trust is not considered an

irrevocable trust because, on September 25, 1985, T possessed an

incident of ownership that would have caused the value of the policy

to be included in T's gross estate under section 2042 if T had died

on that date.

Example 5. Trust partially irrevocable. In 1984, T created a

trust naming T's grandchildren as the income and remainder

beneficiaries. T retained the power to revoke the trust as to one-

half of the principal at any time prior to T's death. T retained no

other powers over the trust principal. T did not die before

September 25, 1985, and did not exercise or release the power before

that date. The half of the trust not subject to T's power to revoke

is an irrevocable trust for purposes of this section.

(iii) Trust containing qualified terminable interest property--(A)

In general. For purposes of chapter 13, a trust described in paragraph

(b)(1)(ii) of this section that holds qualified terminable interest

property by reason of an election under section 2056(b)(7) or section

2523(f) (made either on, before or after September 25, 1985) is treated

in the same manner as if the decedent spouse or the donor spouse (as

the case may be) had made an election under section 2652(a)(3). Thus,

transfers from such trusts are not subject to chapter 13, and the

decedent spouse or the donor spouse (as the case may be) is treated as

the transferor of such property. The rule of this paragraph (b)(1)(iii)

does not apply to that portion of the trust that is subject to chapter

13 by reason of an addition to the trust occurring after September 25,

1985. See Sec. 26.2652-2(a) for rules where an election under section

2652(a)(3) is made. See Sec. 26.2652-2(c) for rules where a portion of

a trust is subject to an election under section 2652(a)(3).

(B) Examples. The following examples illustrate the application of

this paragraph (b)(1)(iii):

Example 1. QTIP election made after September 25, 1985. On March

28, 1985, T established a trust. The trust instrument provided that

the trustee must distribute all income annually to T's spouse, S,

during S's life. Upon S's death, the remainder is to be distributed

to GC, the grandchild of T and S. On April 15, 1986, T elected under

section 2523(f) to treat the property in the trust as qualified

terminable interest property. On December 1, 1987, S died and soon

thereafter the trust assets were distributed to GC. Because the

trust was irrevocable on September 25, 1985, the transfer to GC is

not subject to tax under chapter 13. T is treated as the transferor

with respect to the transfer of the trust assets to GC in the same

manner as if T had made an election under section 2652(a)(3) to

reverse the effect of the section 2523(f) election for chapter 13

purposes.

Example 2. Section 2652(a)(3) election deemed to have been made.

Assume the same facts as in Example 1, except the trust instrument

provides that after S's death all income is to be paid annually to

C, the child of T and S. Upon C's death, the remainder is to be

distributed to GC. C died on October 1, 1992, and soon thereafter

the trust assets are distributed to GC. Because the trust was

irrevocable on September 25, 1985, the termination of C's interest

is not subject to chapter 13.

(iv) Additions to irrevocable trusts--(A) In general. If an

addition is made after September 25, 1985, to an irrevocable trust

which is excluded from chapter 13 by reason of paragraph (b)(1) of this

section, a pro rata portion of subsequent distributions from (and

terminations of interests in property held in) the trust is subject to

the provisions of chapter 13. If an addition is made, the trust is

thereafter deemed to consist of two portions, a portion not subject to

chapter 13 (the non-chapter 13 portion) and a portion subject to

chapter 13 (the chapter 13 portion), each with a separate inclusion

ratio (as defined in section 2642(a)). The non-chapter 13 portion

represents the value of the assets of the trust as it existed on

September 25, 1985. The applicable fraction (as defined in section

2642(a)(2)) for the non-chapter 13 portion is deemed to be 1 and the

inclusion ratio for such portion is 0. The chapter 13 portion of the

trust represents the value of all additions made to the trust after

September 25, 1985. The inclusion ratio for the chapter 13 portion is

determined under section 2642. This paragraph (b)(1)(iv)(A) requires

separate portions of one trust only for purposes of determining

inclusion ratios. For purposes of chapter 13, a constructive addition

under paragraph (b)(1)(v) of this section is treated as an addition.

See paragraph (b)(4) of this section for exceptions to the additions

rule of this paragraph (b)(1)(iv). See Sec. 26.2654-1(a)(2) for rules

treating additions to a trust by an individual other than the initial

transferor as a separate trust for purposes of chapter 13.

(B) Terminations of interests in and distributions from trusts.

Where a termination or distribution described in section 2612 occurs

with respect to a trust to which an addition has been made, the portion

of such termination or distribution allocable to the chapter 13 portion

is determined by reference to the allocation fraction, as defined in

paragraph (b)(1)(iv)(C) of this section. In the case of a termination

described in section 2612(a) with respect to a trust, the portion of

such termination that is

[[Page 66906]]

subject to chapter 13 is the product of the allocation fraction and the

value of the trust (to the extent of the terminated interest therein).

In the case of a distribution described in section 2612(b) from a

trust, the portion of such distribution that is subject to chapter 13

is the product of the allocation fraction and the value of the property

distributed.

allocates appreciation and accumulated income between the chapter 13

and non-chapter 13 portions of a trust. The numerator of the allocation

fraction is the amount of the addition (valued as of the date the

addition is made), determined without regard to whether any part of the

transfer is subject to tax under chapter 11 or chapter 12, but reduced

by the amount of any Federal or state estate or gift tax imposed and

subsequently paid by the recipient trust with respect to the addition.

The denominator of the allocation fraction is the total value of the

entire trust immediately after the addition. For purposes of this

paragraph (b)(1)(iv)(C), the total value of the entire trust is the

fair market value of the property held in trust (determined under the

rules of section 2031), reduced by any amount attributable to or paid

by the trust and attributable to the transfer to the trust that is

similar to an amount that would be allowable as a deduction under

section 2053 if the addition had occurred at the death of the

transferor, and further reduced by the same amount that the numerator

was reduced to reflect Federal or state estate or gift tax incurred by

and subsequently paid by the recipient trust with respect to the

addition. Where there is more than one addition to principal after

September 25, 1985, the portion of the trust subject to chapter 13

after each such addition is determined pursuant to a revised fraction.

In each case, the numerator of the revised fraction is the sum of the

value of the chapter 13 portion of the trust immediately before the

latest addition, and the amount of the latest addition. The denominator

of the revised fraction is the total value of the entire trust

immediately after the addition. If the transfer to the trust is a

generation-skipping transfer, the numerator and denominator are reduced

by the amount of the generation-skipping transfer tax, if any, that is

imposed by chapter 13 on the transfer and actually recovered from the

trust. The allocation fraction is rounded off to five decimal places

(.00001).

(2) Examples. The following examples illustrate the application of

paragraph (b)(1)(iv) of this section. In each of the examples, assume

that the recipient trust does not pay any Federal or state transfer tax

by reason of the addition.

Example 1. Post September 25, 1985, addition to trust. (i) On

August 16, 1980, T established an irrevocable trust. Under the trust

instrument, the trustee is required to distribute the entire income

annually to T's child, C, for life, then to T's grandchild, GC, for

life. Upon GC's death, the remainder is to be paid to GC's issue. On

October 1, 1986, when the total value of the entire trust is

$400,000, T transfers $100,000 to the trust. The allocation fraction

is computed as follows:

[GRAPHIC][TIFF OMITTED]TR27DE95.002

(ii) Thus, immediately after the transfer, 20 percent of the

value of future generation-skipping transfers under the trust will

be subject to chapter 13.

Example 2. Effect of expenses. Assume the same facts as in

Example 1, except immediately prior to the transfer on October 1,

1986, the fair market value of the individual assets in the trust

totaled $400,000. Also, assume that the trust had accrued and unpaid

debts, expenses, and taxes totaling $300,000. Assume further that

the entire $300,000 represented amounts that would be deductible

under section 2053 if the trust were includible in the transferor's

gross estate. The numerator of the allocation fraction is $100,000

and the denominator of the allocation fraction is $200,000

(($400,000-$300,000)+$100,000). Thus, the allocation fraction is .5

($100,000/$200,000) and 50 percent of the value of future

generation-skipping transfers will be subject to chapter 13.

Example 3. Multiple additions. (i) Assume the same facts as in

Example 1, except on January 30, 1988, when the total value of the

entire trust is $600,000, T transfers an additional $40,000 to the

trust. Before the transfer, the value of the portion of the trust

that was attributable to the prior addition was $120,000

($600,000 x .2). The new allocation fraction is computed as follows:

[GRAPHIC][TIFF OMITTED]TR27DE95.003

(ii) Thus, immediately after the transfer, 25 percent of the

value of future generation-skipping transfers under the trust will

be subject to chapter 13.

Example 4. Allocation fraction at time of generation-skipping

transfer. Assume the same facts as in Example 3, except on March 1,

1989, when the value of the trust is $800,000, C dies. A generation-

skipping transfer occurs at C's death because of the termination of

C's life estate. Therefore, $200,000 ($800,000 x .25) is subject to

tax under chapter 13.

(v) Constructive additions--(A) Powers of Appointment. Except as

provided in paragraph (b)(1)(v)(B) of this section, where any portion

of a trust remains in the trust after the post-September 25, 1985,

release, exercise, or lapse of a power of appointment over that portion

of the trust, and the release, exercise, or lapse is treated to any

extent as a taxable transfer under chapter 11 or chapter 12, the value

of the entire portion of the trust subject to the power that was

released, exercised, or lapsed is treated as if that portion had been

withdrawn and immediately retransferred to the trust at the time of the

release, exercise, or lapse. The creator of the power will be

considered the transferor of the addition except to the extent that the

release, exercise, or lapse of the power is treated as a taxable

transfer under chapter 11 or chapter 12. See Sec. 26.2652-1 for rules

for determining the identity of the transferor of property for purposes

of chapter 13.

(B) Special rule for certain powers of appointment. The release,

exercise, or lapse of a power of appointment (other than a general

power of appointment as defined in section 2041(b)) is not treated as

an addition to a trust if--

(1) Such power of appointment was created in an irrevocable trust

that is not subject to chapter 13 under paragraph (b)(1) of this

section; and

(2) In the case of an exercise, the power of appointment is not

exercised in a manner that may postpone or

[[Page 66907]]

suspend the vesting, absolute ownership or power of alienation of an

interest in property for a period, measured from the date of creation

of the trust, extending beyond any life in being at the date of

creation of the trust plus a period of 21 years plus, if necessary, a

reasonable period of gestation (the perpetuities period). For purposes

of this paragraph (b)(1)(v)(B)(2), the exercise of a power of

appointment that validly postpones or suspends the vesting, absolute

ownership or power of alienation of an interest in property for a term

of years that will not exceed 90 years (measured from the date of

creation of the trust) will not be considered an exercise that

postpones or suspends vesting, absolute ownership or the power of

alienation beyond the perpetuities period. If a power is exercised by

creating another power, it is deemed to be exercised to whatever extent

the second power may be exercised.

principal. Where a trust described in paragraph (b)(1) of this section

is relieved of any liability properly payable out of the assets of such

trust, the person or entity who actually satisfies the liability is

considered to have made a constructive addition to the trust in an

amount equal to the liability. The constructive addition occurs when

the trust is relieved of liability (e.g., when the right of recovery is

no longer enforceable). But see Sec. 26.2652-1(a)(3) for rules

involving the application of section 2207A in the case of an election

under section 2652(a)(3).

(D) Examples. The following examples illustrate the application of

this paragraph (b)(1)(v):

Example 1. Lapse of a power of appointment. On June 19, 1980, T

established an irrevocable trust with a corpus of $500,000. The

trust instrument provides that the trustee shall distribute the

entire income from the trust annually to T's spouse, S, during S's

life. At S's death, the remainder is to be distributed to T and S's

grandchild, GC. T also gave S a general power of appointment over

one-half of the trust assets. On December 21, 1989, when the value

of the trust corpus is $1,500,000, S died without having exercised

the general power of appointment. The value of one-half of the trust

corpus, $750,000 ($1,500,000 x .5) is included in S's gross estate

under section 2041(a) and is subject to tax under Chapter 11.

Because the value of one-half of the trust corpus is subject to tax

under Chapter 11 with respect to S's estate, S is treated as the

transferor of that property for purposes of Chapter 13 (see section

2652(a)(1)(A)). For purposes of the generation-skipping transfer

tax, the lapse of S's power of appointment is treated as if $750,000

($1,500,000 x .5) had been distributed to S and then transferred

back to the trust. Thus, S is considered to have added $750,000

($1,500,000 x .5) to the trust at the date of S's death. Because

this constructive addition occurred after September 25, 1985, 50

percent of the corpus of the trust became subject to Chapter 13 at

S's death.

Example 2. Multiple actual additions. On June 19, 1980, T

established an irrevocable trust with a principal of $500,000. The

trust instrument provides that the trustee shall distribute the

entire income from the trust annually to T's spouse, S, during S's

life. At S's death, the remainder is to be distributed to GC, the

grandchild of T and S. On October 1, 1985, when the trust assets

were valued at $800,000, T added $200,000 to the trust. After the

transfer on October 1, 1985, the allocation fraction was .2

($200,000/$1,000,000). On December 21, 1989, when the value of the

trust principal is $1,000,000, T adds $1,000,000 to the trust. After

this addition, the new allocation fraction is 0.6 ($1,200,000/

$2,000,000). The numerator of the fraction is the value of that

portion of trust assets that were subject to chapter 13 immediately

prior to the addition (by reason of the first addition), $200,000

(.2 $1,000,000), plus the value of the second transfer,

$1,000,000, which equals $1,200,000. The denominator of the

fraction, $2,000,000, is the total value of the trust assets

immediately after the second transfer. Thus, 60 percent of the

principal of the trust becomes subject to chapter 13.

Example 3. Entire portion of trust subject to lapsed power is

treated as an addition. On September 25, 1985, B possessed a general

power of appointment over the assets of an irrevocable trust that

had been created by T in 1980. Under the terms of the trust, B's

power lapsed on July 20, 1987. For Federal gift tax purposes, B is

treated as making a gift of ninety-five percent (100%--5%) of the

value of the principal (see section 2514). However, because the

entire trust was subject to the power of appointment, 100 percent

(that portion of the trust subject to the power) of the assets of

the trust are treated as a constructive addition. Thus, the entire

amount of all generation-skipping transfers occurring pursuant to

the trust instrument after July 20, 1987, are subject to chapter 13.

Example 4. Exercise of power of appointment in favor of another

trust. On March 1, 1985, T established an irrevocable trust as

defined in paragraph (b)(1)(ii) of this section. Under the terms of

the trust instrument, the trustee is required to distribute the

entire income annually to T's child, C, for life, then to T's

grandchild, GC, for life. GC has the power to appoint any or all of

the trust assets to Trust 2 which is an irrevocable trust (as

defined in paragraph (b)(1)(ii) of this section) that was

established on August 1, 1985. The terms of Trust 2's governing

instrument provide that the trustee shall pay income to T's great

grandchild, GGC, for life. Upon GGC's death the remainder is to be

paid to GGC's issue. GGC was alive on March 1, 1985, when Trust 1

was created. C died on April 1, 1986. On July 1, 1987, GC exercised

the power of appointment. The exercise of GC's power does not

subject future transfers from Trust 2 to tax under chapter 13

because the exercise of the power in favor of Trust 2 does not

suspend the vesting, absolute ownership, or power of alienation of

an interest in property for a period, measured from the date of

creation of Trust 1, extending beyond the life of GGC (a beneficiary

under Trust 2 who was in being at the date of creation of Trust 1)

plus a period of 21 years. The result would be the same if Trust 2

had been created after the effective date of chapter 13.

Example 5. Exercise of power of appointment in favor of another

trust. Assume the same facts as in Example 3, except that GGC was

born on March 28, 1986. The valid exercise of GC's power in favor of

Trust 2 causes the principal of Trust 1 to be subject to chapter 13,

because GGC was not born until after the creation of Trust 1. Thus,

such exercise may suspend the vesting, absolute ownership, or power

of alienation of an interest in the trust principal for a period,

measured from the date of creation of Trust 1, extending beyond the

life of GGC (a beneficiary under Trust 2 who was not a life in being

at the date of creation of Trust 1).

Example 6. Extension for the longer of two periods. Prior to the

effective date of chapter 13, GP established an irrevocable trust

under which the trust income was to be paid to GP's child, C, for

life. C was given a testamentary power to appoint the remainder in

further trust for the benefit of C's issue. In default of C's

exercise of the power, the remainder was to pass to charity. C died

on February 3, 1995, survived by a child who was alive when GP

established the trust. C exercised the power in a manner that

validly extends the trust in favor of C's issue until the latter of

May 15, 2064 (80 years from the date the trust was created), or the

death of C's child plus 21 years. C's exercise of the power is a

constructive addition to the trust because the exercise may extend

the trust for a period longer than the permissible periods of either

the life of C's child (a life in being at the creation of the trust)

plus 21 years or a term not more than 90 years measured from the

creation of the trust. On the other hand, if C's exercise of the

power could extend the trust based only on the life of C's child

plus 21 years or only for a term of 80 years from the creation of

the trust (but not the later of the two periods) then the exercise

of the power would not have been a constructive addition to the

trust.

Example 7. Extension for the longer of two periods. The facts

are the same as in Example 6 except local law provides that the

effect of C's exercise is to extend the term of the trust until May

15, 2064, whether or not C's child predeceases that date by more

than 21 years. C's exercise is not a constructive addition to the

trust because C exercised the power in a manner that cannot postpone

or suspend vesting, absolute ownership, or power of alienation for a

term of years that will exceed 90 years. The result would be the

same if the effect of C's exercise is either to extend the term of

the trust until 21 years after the death of C's child or to extend

the term of the trust until the first to occur of May 15, 2064 or 21

years after the death of C's child.

(vi) Appreciation and income. Except to the extent that the

provisions of paragraphs (b)(1)(iv) and (v) of this

[[Page 66908]]

section allocate subsequent appreciation and accumulated income between

the original trust and additions thereto, appreciation in the value of

the trust and undistributed income added thereto are not considered an

addition to the principal of a trust.

(2) Transition rule for wills or revocable trusts executed before

October 22, 1986--(i) In general. The provisions of chapter 13 do not

apply to any generation-skipping transfer under a will or revocable

trust executed before October 22, 1986, provided that--

(A) The document in existence on October 21, 1986, is not amended

at any time after October 21, 1986, in any respect which results in the

creation of, or an increase in the amount of, a generation-skipping

transfer;

(B) In the case of a revocable trust, no addition is made to the

revocable trust after October 21, 1986, that results in the creation

of, or an increase in the amount of, a generation-skipping transfer;

and

(ii) Revocable trust defined. For purposes of this section, the

term revocable trust means any trust (as defined in section 2652(b))

except to the extent that, on October 22, 1986, the trust--

(A) Was an irrevocable trust described in paragraph (b)(1) of this

section; or

(B) Would have been an irrevocable trust described in paragraph

(b)(1) of this section had it not been created or become irrevocable

after September 25, 1985, and before October 22, 1986.

(iii) Will or revocable trust containing qualified terminable

interest property. The rules contained in paragraph (b)(1)(iii) of this

section apply to any will or revocable trust within the scope of the

transition rule of this paragraph (b)(2).

(iv) Amendments to will or revocable trust. For purposes of this

paragraph (b)(2), an amendment to a will or a revocable trust in

existence on October 21, 1986, is not considered to result in the

creation of, or an increase in the amount of, a generation-skipping

transfer where the amendment is--

(A) Basically administrative or clarifying in nature and only

incidentally increases the amount transferred; or

(B) Designed to ensure that an existing bequest or transfer

qualifies for the applicable marital or charitable deduction for

estate, gift, or generation-skipping transfer tax purposes and only

incidentally increases the amount transferred to a skip person or to a

generation-skipping trust.

(v) Creation of, or increase in the amount of, a GST. In

determining whether a particular amendment to a will or revocable trust

creates, or increases the amount of, a generation-skipping transfer for

purposes of this paragraph (b)(2), the effect of the instrument(s) in

existence on October 21, 1986, is measured against the effect of the

instrument(s) in existence on the date of death of the decedent or on

the date of any prior generation-skipping transfer. If the effect of an

amendment cannot be immediately determined, it is deemed to create, or

increase the amount of, a generation-skipping transfer until a

determination can be made.

(vi) Additions to revocable trusts. Any addition made after October

21, 1986, but before the death of the settlor, to a revocable trust

subjects all subsequent generation-skipping transfers under the trust

to the provisions of chapter 13. Any addition made to a revocable trust

after the death of the settlor (if the settlor dies before January 1,

1987) is treated as an addition to an irrevocable trust. See paragraph

(b)(1)(v) of this section for rules involving constructive additions to

trusts. See paragraph (b)(1)(v)(B) of this section for rules providing

that certain transfers to trusts are not treated as additions for

purposes of this section.

(vii) Examples. The following examples illustrate the application

of paragraph (b)(2)(iv) of this section:

(A) Facts applicable to Examples 1 through 5. In each of Examples 1

through 5 assume that T executed a will prior to October 22, 1986, and

that T dies on December 31, 1986.

Example 1. Administrative change. On November 1, 1986, T

executes a codicil to T's will removing one of the co-executors

named in the will. Although the codicil may have the effect of

lowering administrative costs and thus increasing the amount

transferred, it is considered administrative in nature and thus does

not cause generation-skipping transfers under the will to be subject

to chapter 13.

Example 2. Effect of amendment not immediately determinable. On

November 1, 1986, T executes a codicil to T's will revoking a

bequest of $100,000 to C, a non-skip person (as defined under

section 2613(b)) and causing that amount to be added to a residuary

trust held for a skip person. The amendment is deemed to increase

the amount of a generation-skipping transfer and prevents any

transfers under the will from qualifying under paragraph (b)(2)(i)

of this section. If, however, C dies before T and under local law

the property would have been added to the residue in any event

because the bequest would have lapsed, the codicil is not considered

an amendment that increases the amount of a generation-skipping

transfer.

Example 3. Refund of tax paid because of amendment. T's will

provided that an amount equal to the maximum allowable marital

deduction would pass to T's spouse with the residue of the estate

passing to a trust established for the benefit of skip persons. On

October 23, 1986, the will is amended to provide that the marital

share passing to T's spouse shall be the lesser of the maximum

allowable marital deduction or the minimum amount that will result

in no estate tax liability for T's estate. The amendment may

increase the amount of a generation-skipping transfer. Therefore,

any generation-skipping transfers under the will are subject to tax

under chapter 13. If it becomes apparent that the amendment does not

increase the amount of a generation-skipping transfer, a claim for

refund may be filed with respect to any generation-skipping transfer

tax that was paid within the period set forth in section 6511. For

example, it would become apparent that the amendment did not result

in an increase in the residue if it is subsequently determined that

the maximum marital deduction and the minimum amount that will

result in no estate tax liability are equal in amount.

Example 4. An amendment that increases a generation-skipping

transfer causes complete loss of exempt status. T's will provided

for the creation of two trusts for the benefit of skip persons. On

November 1, 1986, T executed a codicil to the will specifically

increasing the amount of a generation-skipping transfer under the

will. All transfers made pursuant to the will or either of the

trusts created thereunder are precluded from qualifying under the

transition rule of paragraph (b)(2)(i) of this section and are

subject to tax under chapter 13.

Example 5. Corrective action effective. Assume that T in Example

4 later executes a second codicil deleting the increase to the

generation-skipping transfer. Because the provision increasing a

generation-skipping transfer does not become effective, it is not

considered an amendment to a will in existence on October 22, 1986.

(B) Facts applicable to Examples 6 through 9. T created a trust on

September 30, 1985, in which T retained the power to revoke the

transfer at any time prior to T's death. The trust provided that, upon

the death of T, the income was to be paid to T's spouse, W, for life

and then to A, B, and C, the children of T's sibling, S, in equal

shares for life, with one-third of the principal to be distributed per

stirpes to each child's surviving issue upon the death of the child.

The trustee has the power to make discretionary distributions of trust

principal to T's sibling, S.

Example 6. Amendment that affects only a person who is not a

skip person. A became disabled, and T modified the trust on December

1, 1986, to increase A's share of the income. Since the amendment

does not result in the creation of, or increase in the amount of, a

generation-skipping transfer,

[[Page 66909]]

transfers pursuant to the trust are not subject to chapter 13.

Example 7. Amendment increasing skip person's share. Assume that

A, B, and C are the grandchildren of S rather than the children (and

thus are skip persons as defined in section 2613). T's amendment of

the trust increasing A's share of the income subjects the trust to

the provisions of chapter 13 because the amendment increases the

amount of the generation-skipping transfers to be made to A.

Example 8. Amendment that adds a skip person. Assume that T

amends the trust to add T's grandchild, D, as an income beneficiary.

The trust will be subject to the provisions of chapter 13 because

the amendment creates a generation-skipping transfer.

Example 9. Refund of tax paid during interim period when effect

of amendment is not determinable. Assume that T amends the trust to

provide that the issue of S are to take a one-fourth share of the

principal per stirpes upon S's death. Because the distribution to be

made upon S's death may involve skip persons, the amendment is

considered an amendment that creates or increases the amount of a

generation-skipping transfer until a determination can be made.

Accordingly, any distributions from (or terminations of interests

in) such trust are subject to chapter 13 until it is determined that

no skip person has been added to the trust. At that time, a claim

for refund may be filed within the period set forth in section 6511

with respect to any generation-skipping transfer tax that was paid.

(3) Transition rule in the case of mental incompetency--(i) In

general. If an individual was under a mental disability to change the

disposition of his or her property continuously from October 22, 1986,

until the date of his or her death, the provisions of chapter 13 do not

apply to any generation-skipping transfer-(A) Under a trust (as defined

in section 2652(b)) to the extent such trust consists of property, or

the proceeds of property, the value of which was included in the gross

estate of the individual (other than property transferred by or on

behalf of the individual during the individual's life after October 22,

1986); or

(B) Which is a direct skip (other than a direct skip from a trust)

that occurs by reason of the death of the individual.

(ii) Mental disability defined. For purposes of this paragraph

(b)(2), the term mental disability means mental incompetence to execute

an instrument governing the disposition of the individual's property,

whether or not there was an adjudication of incompetence and regardless

of whether there has been an appointment of a guardian, fiduciary, or

other person charged with either the care of the individual or the care

of the individual's property.

(iii) Decedent who has not been adjudged mentally incompetent. If

there has not been a court adjudication that the decedent was mentally

incompetent on or before October 22, 1986, the executor must file, with

Form 706, either--

(A) A certification from a qualified physician stating that the

decedent was--

(1) mentally incompetent at all times on and after October 22,

1986; and

(2) did not regain competence to modify or revoke the terms of the

trust or will prior to his or her death; or

(B) Sufficient other evidence demonstrating that the decedent was

mentally incompetent at all times on and after October 22, 1986, as

well as a statement explaining why no certification is available from a

physician; and

that was made after October 22, 1986. Such items will be considered

relevant, but not determinative, in establishing the decedent's state

of competency.

(iv) Decedent who has been adjudged mentally incompetent. If the

decedent has been adjudged mentally incompetent on or before October

22, 1986, a copy of the judgment or decree, and any modification

thereof, must be filed with the Form 706.

(v) Rule applies even if another person has power to change trust

terms. In the case of a transfer from a trust, this paragraph (b)(3)

applies even though a person charged with the care of the decedent or

the decedent's property has the power to revoke or modify the terms of

the trust, provided that the power is not exercised after October 22,

1986, in a manner that creates, or increases the amount of, a

generation-skipping transfer. See paragraph (b)(2)(iv) of this section

for rules concerning amendments that create or increase the amount of a

generation-skipping transfer.

(vi) Example. The following example illustrates the application of

paragraph (b)(3)(v) of this section:

Example. T was mentally incompetent on October 22, 1986, and

remained so until death in 1993. Prior to becoming incompetent, T

created a revocable generation-skipping trust that was includible in

T's gross estate. Prior to October 22, 1986, the appropriate court

issued an order under which P, who was thereby charged with the care

of T's property, had the power to modify or revoke the revocable

trust. Although P exercised the power after October 22, 1986, and

while T was incompetent, the power was not exercised in a manner

that created, or increased the amount of, a generation-skipping

transfer. Thus, the existence and exercise of P's power did not

cause the trust to lose its exempt status under paragraph (b)(3) of

this section. The result would be the same if the court order was

issued after October 22, 1986.

(4) Exceptions to additions rule--(i) In general. Any addition to a

trust made pursuant to an instrument or arrangement covered by the

transition rules in paragraph (b) (2) or (3) of this section is not

treated as an addition for purposes of this section. Moreover, any

property transferred inter vivos to a trust is not treated as an

addition if the same property would have been added to the trust

pursuant to an instrument covered by the transition rules in paragraph

(b) (2) or (3) of this section.

(ii) Examples. The following examples illustrate the application of

paragraph (b)(4)(i) of this section:

Example 1. Addition pursuant to terms of exempt instrument. On

December 31, 1980, T created an irrevocable trust having a principal

of $100,000. Under the terms of the trust, the principal was to be

held for the benefit of T's grandchild, GC. Pursuant to the terms of

T's will, a document entitled to relief under the transition rule of

paragraph (b)(2) of this section, the residue of the estate was paid

to the trust. Because the addition to the trust was paid pursuant to

the terms of an instrument (T's will) that is not subject to the

provisions of chapter 13 because of paragraph (b)(2) of this

section, the payment to the trust is not considered an addition to

the principal of the trust. Thus, distributions to or for the

benefit of GC, are not subject to the provisions of chapter 13.

Example 2. Property transferred inter vivos that would have been

transferred to the same trust by the transferor's will. T is the

grantor of a trust that was irrevocable on September 25, 1985. T's

will, which was executed before October 22, 1986, and not amended

thereafter, provides that, upon T's death, the entire estate will

pour over into T's trust. On October 1, 1985, T transfers $100,000

to the trust. While T's will otherwise qualifies for relief under

the transition rule in paragraph (b)(2) of this section, the

transition rule is not applicable unless T dies prior to January 1,

1987. Thus, if T dies after December 31, 1986, the transfer is

treated as an addition to the trust for purposes of any distribution

made from the trust after the transfer to the trust on October 1,

1985. If T dies before January 1, 1987, the entire trust (as well as

any distributions from or terminations of interests in the trust

prior to T's death) is exempt, under paragraph (b)(2) of this

section, from chapter 13 because the $100,000 would have been added

to the trust under a will that would have qualified under paragraph

(b)(2) of this section. In either case, for any generation-skipping

transfers made after the transfer to the trust on October 1, 1985,

but before T's death, the $100,000 is treated as an addition to the

trust and a proportionate amount of the trust is subject to chapter

13.

Example 3. Pour over to a revocable trust. T and S are the

settlors of separate revocable trusts with equal values. Both trusts

were established for the benefit of skip persons (as

[[Page 66910]]

defined in section 2613). S dies on December 1, 1985, and under the

provisions of S's trust, the principal pours over into T's trust. If

T dies before January 1, 1987, the entire trust is excluded under

paragraph (b)(2) of this section from the operation of chapter 13.

If T dies after December 31, 1986, the entire trust is subject to

the generation-skipping transfer tax provisions because T's trust is

not a trust described in paragraph (b)(1) or (2) of this section. In

the latter case, the fact that S died before January 1, 1987, is

irrelevant because the principal of S's trust was added to a trust

that never qualified under the transition rules of paragraph (b)(1)

or (2) of this section.

Example 4. Pour over to exempt trust. Assume the same facts as

in Example 3, except upon the death of S on December 1, 1985, S's

trust continues as an irrevocable trust and that the principal of

T's trust is to be paid over upon T's death to S's trust. Again, if

T dies before January 1, 1987, S's entire trust falls within the

provisions of paragraph (b)(2) of this section. However, if T dies

after December 31, 1986, the pour-over is considered an addition to

the trust. Therefore, S's trust is not a trust excluded under

paragraph (b)(2) of this section because an addition is made to the

trust.

Example 5. Lapse of a general power of appointment. S, the

spouse of the settlor of an irrevocable trust that was created in

1980, had, on September 25, 1985, a general power of appointment

over the trust assets. The trust provides that should S fail to

exercise the power of appointment the property is to remain in the

trust. On October 21, 1986, S executed a will under which S failed

to exercise the power of appointment. If S dies before January 1,

1987, without having exercised the power in a manner which results

in the creation of, or increase in the amount of, a generation-

skipping transfer (or amended the will in a manner that results in

the creation of, or increase in the amount of, a generation-skipping

transfer), transfers pursuant to the trust or the will are not

subject to chapter 13 because the trust is an irrevocable trust and

the will qualifies under paragraph (b)(2) of this section.

Example 6. Lapse of general power of appointment held by

intestate decedent. Assume the same facts as in Example 5, except on

October 22, 1986, S did not have a will and that S dies after that

date. Upon S's death, or upon the prior exercise or release of the

power, the value of the entire trust is treated as having been

distributed to S, and S is treated as having made an addition to the

trust in the amount of the entire principal. Any distribution or

termination pursuant to the trust occurring after S's death is

subject to chapter 13. It is immaterial whether S's death occurs

before January 1, 1987, since paragraph (b)(2) of this section is

only applicable where a will or revocable trust was executed before

October 22, 1986.

regulations under Secs. 26.2611-1, 26.2612-1, 26.2613-1, 26.2632-1,

26.2641-1, 26.2642-1, 26.2642-2, 26.2642-3, 26.2642-4, 26.2642-5,

26.2652-1, 26.2652-2, 26.2653-1, 26.2654-1, 26.2663-1, and 26.2663-2

are effective with respect to generation-skipping transfers as defined

in Sec. 26.2611-1 made on or after [December 27, 1995]. However,

taxpayers may, at their option, rely on these regulations in the case

of generation-skipping transfers made, and trusts that became

irrevocable, after December 23, 1992, and before December 27, 1995.

Sec. 26.2611-1 Generation-skipping transfer defined.

A generation-skipping transfer (GST) is an event that is either a

direct skip, a taxable distribution, or a taxable termination. See

Sec. 26.2612-1 for the definition of these terms. The determination as

to whether an event is a GST is made by reference to the most recent

transfer subject to the estate or gift tax. See Sec. 26.2652-1(a)(2)

for determining whether a transfer is subject to Federal estate or gift

tax.

Sec. 26.2612-1 Definitions.

(a) Direct skip--(1) In general. A direct skip is a transfer to a

skip person that is subject to Federal estate or gift tax. If property

is transferred to a trust, the transfer is a direct skip only if the

trust is a skip person. Only one direct skip occurs when a single

transfer of property skips two or more generations. See paragraph (d)

of this section for the definition of skip person. See Sec. 26.2652-

1(b) for the definition of trust. See Sec. 26.2632-1(c)(4) for the time

that a direct skip occurs if the transferred property is subject to an

estate tax inclusion period.

(2) Special rule for certain lineal descendants--(i) In general.

Solely for the purpose of determining whether a transfer to or for the

benefit of a lineal descendant of the transferor, the transferor's

spouse, or a former spouse of the transferor is a direct skip, the

generation assignment of the descendant is determined by disregarding

the generation of a predeceased individual who was both an ancestor of

the descendant and a lineal descendant of the transferor, the

transferor's spouse, or a former spouse of the transferor (a

predeceased child). If a transfer to a trust would be a direct skip but

for this paragraph, any generation assignment determined under this

paragraph continues to apply in determining whether any subsequent

distribution from (or termination of an interest in) the portion of the

trust attributable to that transfer is a GST. A living descendant who

dies no later than 90 days after the subject transfer is treated as

having predeceased the transferor to the extent that either the

governing instrument or applicable local law provides that such

individual shall be treated as predeceasing the transferor. Except as

provided in this paragraph (a)(2), a living descendant is not treated

as a predeceased child solely by reason of applicable local law; e.g.,

an individual is not treated as a predeceased child solely because

state law treats an individual executing a disclaimer as having

predeceased the transferor of the disclaimed property. See

Sec. 26.2652-1(a)(1) for the definition of transferor. See paragraph

(e) of this section for the definition of interest in trust.

(ii) Special rule. If a transferor makes an addition to an existing

trust after the death of an individual described in paragraph (a)(2)(i)

of this section (so that the transferor would be assigned to a lower

generation by reason of that death), the additional property is treated

as being held in a separate trust for purposes of chapter 13 and the

provisions of Sec. 26.2654-1(a)(2) apply as if the portions of the

single trust had separate transferors. Subsequent additions are treated

as additions to the appropriate portion of the single trust.

(b) Taxable termination--(1) In general. Except as otherwise

provided in this paragraph (b), a taxable termination is a termination

(occurring for any reason) of an interest in trust unless--

(i) A transfer subject to Federal estate or gift tax occurs with

respect to the property held in the trust at the time of the

termination (i.e., a new transferor is determined with respect to the

property);

(ii) Immediately after the termination, a person who is not a skip

person has an interest in the trust; or

(iii) At no time after the termination may a distribution, other

than a distribution the probability of which occurring is so remote as

to be negligible (including a distribution at the termination of the

trust) be made from the trust to a skip person. For this purpose, the

probability that a distribution will occur is so remote as to be

negligible only if it can be ascertained by actuarial standards that

there is less than a 5 percent probability that the distribution will

occur.

(2) Partial termination. If a distribution of a portion of trust

property is made to a skip person by reason of a termination occurring

on the death of a lineal descendant of the transferor, the termination

is a taxable termination with respect to the distributed property.

(3) Simultaneous terminations. A simultaneous termination of two or

[[Page 66911]]

more interests creates only one taxable termination.

a distribution of income or principal from a trust to a skip person

unless the distribution is a taxable termination or a direct skip. If

any portion of GST tax (including penalties and interest thereon)

imposed on a distributee is paid from the distributing trust, the

payment is an additional taxable distribution to the distributee. For

purposes of chapter 13, the additional distribution is treated as

having been made on the last day of the calendar year in which the

original taxable distribution is made. If Federal estate or gift tax is

imposed on any individual with respect to an interest in property held

by a trust, the interest in property is treated as having been

distributed to the individual to the extent that the value of the

interest is subject to Federal estate or gift tax. See Sec. 26.2652-

1(a)(6) Example 5, regarding the treatment of the lapse of a power of

appointment as a transfer to a trust.

(2) Look-through rule not to apply. Solely for purposes of

determining whether any transfer from a trust to another trust is a

taxable distribution, the rules of section 2651(e)(2) do not apply. If

the transferring trust and the recipient trust have the same

transferor, see Sec. 26.2642-4(a) (1) and (2) for rules for recomputing

the applicable fraction of the recipient trust.

(d) Skip person. A skip person is--

(1) An individual assigned to a generation more than one generation

below that of the transferor (determined under the rules of section

2651); or

(2) A trust if--

(i) All interests in the trust are held by skip persons; or

(ii) No person holds an interest in the trust and no distributions,

other than a distribution the probability of which occurring is so

remote as to be negligible (including distributions at the termination

of the trust), may be made after the transfer to a person other than a

skip person. For this purpose, the probability that a distribution will

occur is so remote as to be negligible only if it can be ascertained by

actuarial standards that there is less than a 5 percent probability

that the distribution will occur.

(e) Interest in trust--(1) In general. An interest in trust is an

interest in property held in trust as defined in section 2652(c) and

these regulations. An interest in trust exists if a person--

(i) Has a present right to receive trust principal or income;

(ii) Is a permissible current recipient of trust principal or

income and is not described in section 2055(a); or

(iii) Is described in section 2055(a) and the trust is a charitable

remainder annuity trust or unitrust (as defined in section 664(d)) or a

pooled income fund (as defined in section 642(c)(5)).

(2) Exceptions--(i) Support obligations. In general, an individual

has a present right to receive trust income or principal if trust

income or principal may be used to satisfy the individual's support

obligations. However, an individual does not have an interest in a

trust merely because a support obligation of that individual may be

satisfied by a distribution that is either within the discretion of a

fiduciary or pursuant to provisions of local law substantially

equivalent to the Uniform Gifts (Transfers) to Minors Act.

(ii) Certain interests disregarded. An interest which is used

primarily to postpone or avoid the GST tax is disregarded for purposes

of chapter 13. An interest is considered as used primarily to postpone

or avoid the GST tax if a significant purpose for the creation of the

interest is to postpone or avoid the tax.

(3) Disclaimers. An interest does not exist to the extent it is

disclaimed pursuant to a disclaimer that constitutes a qualified

disclaimer under section 2518.

(f) Examples. The following examples illustrate the provisions of

this section. Unless stated otherwise, paragraph (a)(2) of this

section, which assigns descendants to a higher generation when there is

a predeceased ancestor, does not apply.

Example 1. Direct skip. T gratuitously conveys Blackacre to T's

grandchild. Because the transfer is a transfer to a skip person of

property subject to Federal gift tax, it is a direct skip.

Example 2. Direct skip of more than one generation. T

gratuitously conveys Blackacre to T's great-grandchild. The transfer

is a direct skip. Only one GST tax is imposed on the direct skip

although two generations are skipped by the transfer.

Example 3. Withdrawal power in trust. T transfers $50,000 to a

new trust providing that trust income is to be paid to T's child, C,

for life and, on C's death, the trust principal is to be paid to T's

descendants. Under the terms of the trust, T grants four

grandchildren the right to withdraw $10,000 from the trust for a 60

day period following the transfer. Since C, who is not a skip

person, has an interest in the trust, the trust is not a skip

person. T's transfer to the trust is not a direct skip.

Example 4. Taxable termination. T establishes an irrevocable

trust under which the income is to be paid to T's child, C, for

life. On the death of C, the trust principal is to be paid to T's

grandchild, GC. Since C has an interest in the trust, the trust is

not a skip person and the transfer to the trust is not a direct

skip. If C dies survived by GC, a taxable termination occurs at C's

death because C's interest in the trust terminates and thereafter

the trust property is held by a skip person who occupies a lower

generation than C.

Example 5. Direct skip of property held in trust. T establishes

a testamentary trust under which the income is to be paid to T's

surviving spouse, S, for life and the remainder is to be paid to a

grandchild of T and S. T's executor elects to treat the trust as

qualified terminable interest property under section 2056(b)(7). The

transfer to the trust is not a direct skip because S, a person who

is not a skip person, holds a present right to receive income from

the trust. Upon S's death, the trust property is included in S's

gross estate under section 2044 and passes directly to a skip

person. The GST occurring at that time is a direct skip because it

is a transfer subject to chapter 11. The fact that the interest

created by T is terminated at S's death is immaterial because S

becomes the transferor at the time of the transfer subject to

chapter 11.

Example 6. Predeceased ancestor exception. T establishes an

irrevocable trust providing that trust income is to be paid to T's

grandchild, GC, for 5 years. At the end of the 5-year period, the

trust is to terminate and the principal is to be distributed to GC.

T's child, C, a parent of GC, is deceased at the time T establishes

the trust. Therefore, GC is treated as a child of T rather than as a

grandchild. As a result, GC is not a skip person, and the initial

transfer to the trust is not a direct skip. Similarly, distributions

to GC during the term of the trust and at the termination of the

trust will not be GSTs.

Example 7. Predeceased ancestor exception not applicable. The

facts are the same as in Example 6, except the trust income is to be

paid to T's spouse, S, during the first two years of the trust.

Since S has an interest in the trust, the trust is not a skip person

and the transfer by T is not a direct skip. Since the transfer is

not a direct skip, the predeceased ancestor rule does not apply and

GC is not treated as the child of T. A taxable termination occurs at

the expiration of S's interest.

Example 8. Taxable termination. T establishes an irrevocable

trust for the benefit of T's child, C, T's grandchild, GC, and T's

great-grandchild, GGC. Under the terms of the trust, income and

principal may be distributed to any or all of the living

beneficiaries at the discretion of the trustee. Upon the death of

the second beneficiary to die, the trust principal is to be paid to

the survivor. C dies first. A taxable termination occurs at that

time because, immediately after C's interest terminates, all

interests in the trust are held by skip persons (GC and GGC).

Example 9. Taxable termination resulting from distribution. The

facts are the same as in Example 8, except twenty years after C's

death the trustee exercises its discretionary power and distributes

the entire principal to GGC. The distribution results in a taxable

termination because GC's interest in the trust terminates as a

result of the distribution of

[[Page 66912]]

the entire trust property to GGC, a skip person. The result would be

the same if the trustee retained sufficient funds to pay the GST tax

due by reason of the taxable termination, as well as any expenses of

winding up the trust.

Example 10. Simultaneous termination of interests of more than

one beneficiary. T establishes an irrevocable trust for the benefit

of T's child, C, T's grandchild, GC, and T's great-grandchild, GGC.

Under the terms of the trust, income and principal may be

distributed to any or all of the living beneficiaries at the

discretion of the trustee. Upon the death of C, the trust property

is to be distributed to GGC if then living. If C is survived by both

GC and GGC, both C's and GC's interests in the trust will terminate

on C's death. However, because both interests will terminate at the

same time and as a result of one event, only one taxable termination

occurs.

Example 11. Partial taxable termination. T creates an

irrevocable trust providing that trust income is to be paid to T's

children, A and B, in such proportions as the trustee determines for

their joint lives. On the death of the first child to die, one-half

of the trust principal is to be paid to T's then living

grandchildren. The balance of the trust principal is to be paid to

T's grandchildren on the death of the survivor of A and B. If A

predeceases B, the distribution occurring on the termination of A's

interest in the trust is a taxable termination and not a taxable

distribution. It is a taxable termination because the distribution

is a distribution of a portion of the trust that occurs as a result

of the death of A, a lineal descendant of T. It is immaterial that a

portion of the trust continues and that B, a person other than a

skip person, thereafter holds an interest in the trust.

Example 12. Taxable distribution. T establishes an irrevocable

trust under which the trust income is payable to T's child, C, for

life. When T's grandchild, GC, attains 35 years of age, GC is to

receive one-half of the principal. The remaining one-half of the

principal is to be distributed to GC on C's death. Assume that C

survives until GC attains age 35. When the trustee distributes one-

half of the principal to GC on GC's 35th birthday, the distribution

is a taxable distribution because it is a distribution to a skip

person and is neither a taxable termination nor a direct skip.

Example 13. Exercise of withdrawal right as taxable

distribution. The facts are the same as in Example 12, except GC

holds a continuing right to withdraw trust principal and after one

year GC withdraws $10,000. The withdrawal by GC is not a taxable

termination because the withdrawal does not terminate C's interest

in the trust. The withdrawal by GC is a taxable distribution to GC.

Example 14. Interest in trust. T establishes an irrevocable

trust under which the income is to be paid to T's child, C, for

life. On the death of C, the trust principal is to be paid to T's

grandchild, GC. Because C has a present right to receive income from

the trust, C has an interest in the trust. Because GC cannot

currently receive distributions from the trust, GC does not have an

interest in the trust.

Example 15. Support obligation. T establishes an irrevocable

trust for the benefit of T's grandchild, GC. The trustee has

discretion to distribute property for GC's support without regard to

the duty or ability of GC's parent, C, to support GC. Because GC is

a permissible current recipient of trust property, GC has an

interest in the trust. C does not have an interest in the trust

because the potential use of the trust property to satisfy C's

support obligation is within the discretion of a fiduciary. C would

be treated as having an interest in the trust if the trustee was

required to distribute trust property for GC's support.

Sec. 26.2613-1 Skip person.

For the definition of skip person see Sec. 26.2612-1(d).

Sec. 26.2632-1 Allocation of GST exemption.

(a) General rule. Except as otherwise provided in this section, an

individual or the individual's executor may allocate the individual's

$1 million GST exemption at any time from the date of the transfer

through the date for filing the individual's Federal estate tax return

(including any extensions for filing that have been actually granted).

If no estate tax return is required to be filed, the GST exemption may

be allocated at any time through the date a Federal estate tax return

would be due if a return were required to be filed (including any

extensions actually granted). If property is held in trust, the

allocation of GST exemption is made to the entire trust rather than to

specific trust assets. If a transfer is a direct skip to a trust, the

allocation of GST exemption to the transferred property is also treated

as an allocation of GST exemption to the trust for purposes of future

GSTs with respect to the trust by the same transferor.

(b) Lifetime allocations--(1) Automatic allocation to direct

skips--(i) In general. If a direct skip occurs during the transferor's

lifetime, the transferor's GST exemption not previously allocated

(unused GST exemption) is automatically allocated to the transferred

property (but not in excess of the fair market value of the property on

the date of the transfer). The transferor may prevent the automatic

allocation of GST exemption by describing on a timely-filed United

States Gift (and Generation-Skipping Transfer) Tax Return (Form 709)

the transfer and the extent to which the automatic allocation is not to

apply. In addition, a timely-filed Form 709 accompanied by payment of

the GST tax (as shown on the return with respect to the direct skip) is

sufficient to prevent an automatic allocation of GST exemption with

respect to the transferred property. See paragraph (c)(4) of this

section for special rules in the case of direct skips treated as

occurring at the termination of an estate tax inclusion period.

(ii) Time for filing Form 709. A Form 709 is timely filed if it is

filed on or before the date required for reporting the transfer if it

were a taxable gift (i.e., the date prescribed by section 6075(b),

including any extensions to file actually granted (the due date)).

Except as provided in paragraph (b)(1)(iii) of this section, the

automatic allocation of GST exemption (or the election to prevent the

allocation, if made) is irrevocable after the due date. An automatic

allocation of GST exemption is effective as of the date of the transfer

to which it relates. Except as provided above, a Form 709 need not be

filed to report an automatic allocation.

(iii) Transitional rule. An election to prevent an automatic

allocation of GST exemption filed on or before January 26, 1996,

becomes irrevocable on July 24, 1996.

(2) Allocation to other transfers--(i) In general. An allocation of

GST exemption to property transferred during the transferor's lifetime,

other than in a direct skip, is made on Form 709. The allocation must

clearly identify the trust to which the allocation is being made, the

amount of GST exemption allocated to it, and if the allocation is late

or if an inclusion ratio greater than zero is claimed, the value of the

trust assets at the effective date of the allocation. See paragraph

(b)(2)(ii) of this section. The allocation should also state the

inclusion ratio of the trust after the allocation. Except as otherwise

provided in this paragraph, an allocation of GST exemption may be made

by a formula; e.g., the allocation may be expressed in terms of the

amount necessary to produce an inclusion ratio of zero. However,

formula allocations made with respect to charitable lead annuity trusts

are not valid except to the extent they are dependent on values as

finally determined for Federal estate or gift tax purposes. With

respect to a timely allocation, an allocation of GST exemption becomes

irrevocable after the due date of the return. Except as provided in

Sec. 26.2642-3 (relating to charitable lead annuity trusts), an

allocation of GST exemption to a trust is void to the extent the amount

allocated exceeds the amount necessary to obtain an inclusion ratio of

zero with respect to the trust. See Sec. 26.2642-1 for the definition

of inclusion ratio. An allocation is also void if the allocation is

made with respect to a trust that has no GST potential with respect to

the transferor making the allocation, at the time of the allocation.

For this purpose, a trust has GST potential even if the

[[Page 66913]]

possibility of a GST is so remote as to be negligible.

(ii) Effective date of allocation--(A) In general. (1) Except as

otherwise provided, an allocation of GST exemption is effective as of

the date of any transfer as to which the Form 709 on which it is made

is a timely filed return (a timely allocation). If more than one timely

allocation is made, the earlier allocation is modified only if the

later allocation clearly identifies the transfer and the nature and

extent of the modification. Except as provided in paragraph (d)(1) of

this section, an allocation to a trust made on a Form 709 filed after

the due date for reporting a transfer to the trust (a late allocation)

is effective on the date the Form 709 is filed and is deemed to precede

in point of time any taxable event occurring on such date. For purposes

of this paragraph (b)(2)(ii), the Form 709 is deemed filed on the date

it is postmarked to the Internal Revenue Service Center. See

Sec. 26.2642-2 regarding the effect of a late allocation in determining

the inclusion ratio, etc. See paragraph (c)(1) of this section

regarding allocation of GST exemption to property subject to an estate

tax inclusion period. If it is unclear whether an allocation of GST

exemption on a Form 709 is a late or a timely allocation to a trust,

the allocation is effective in the following order--

(i) To any transfer to the trust disclosed on the return as to

which the return is a timely return;

(ii) As a late allocation; and

(iii) To any transfer to the trust not disclosed on the return as

to which the return would be a timely return.

(2) A late allocation to a trust may be made on a Form 709 that is

timely filed with respect to another transfer. A late allocation is

irrevocable when made.

(B) Amount of allocation. If other transfers exist with respect to

which GST exemption could be allocated under paragraphs

(b)(2)(ii)(A)(1) (ii) and (iii), any GST exemption allocated under

paragraph (b)(2)(ii)(A)(1)(i) of this section is allocated in an amount

equal to the value of the transferred property as reported on the Form

709. Thus, if the GST exemption allocated on the Form 709 exceeds the

value of the transfers reported on that return that have generation-

skipping potential, the initial allocation under paragraph

(b)(2)(ii)(A)(1)(i) of this section is in the amount of the value of

those transfers as reported on that return. Any remaining amount of GST

exemption allocated on that return is then allocated pursuant to

paragraphs (b)(2)(ii)(A)(1) (ii) and (iii) of this section,

notwithstanding any subsequent upward adjustment in value of the

transfers reported on the return.

(iii) Examples. The following examples illustrate the provisions of

this paragraph (b):

Example 1. Modification of allocation of GST exemption. T

transfers $100,000 to an irrevocable generation-skipping trust on

December 1, 1996. The transfer to the trust is not a direct skip.

The date prescribed for filing the gift tax return reporting the

taxable gift is April 15, 1997. On February 10, 1997, T files a Form

709 allocating $50,000 of GST exemption to the trust. On April 10 of

the same year, T files an amended Form 709 allocating $100,000 of

GST exemption to the trust in a manner that clearly indicates the

intention to modify and supersede the prior allocation with respect

to the 1996 transfer. The allocation made on the April 10 return

supersedes the prior allocation because it is made on a timely-filed

Form 709 that clearly identifies the trust and the nature and extent

of the modification of GST exemption allocation. The allocation of

$100,000 of GST exemption to the trust is effective as of December

1, 1996. The result would be the same if the amended Form 709

decreased the amount of the GST exemption allocated to the trust.

Example 2. Modification of allocation of GST exemption. The

facts are the same as in Example 1, except on July 10, 1997, T files

a Form 709 attempting to reduce the earlier allocation. The return

is not a timely-filed return. The $100,000 GST exemption allocated

to the trust, as amended on April 10, 1997, remains in effect

because an allocation, once made, is irrevocable and may not be

modified after the last date on which a timely-filed Form 709 can be

filed.

Example 3. Effective date of late allocation of GST exemption. T

transfers $100,000 to an irrevocable generation-skipping trust on

December 1, 1996. The transfer to the trust is not a direct skip.

The date prescribed for filing the gift tax return reporting the

taxable gift is April 15, 1997. On December 1, 1997, T files a Form

709 and allocates $50,000 to the trust. The allocation is effective

as of December 1, 1997.

Example 4. Effective date of late allocation of GST exemption. T

transfers $100,000 to a generation-skipping trust on December 1,

1996, in a transfer that is not a direct skip. T does not make an

allocation of GST exemption on a timely-filed Form 709. On July 1,

1997, the trustee makes a taxable distribution from the trust to T's

grandchild in the amount of $30,000. Immediately prior to the

distribution, the value of the trust assets was $150,000. On the

same date, T allocates GST exemption to the trust in the amount of

$50,000. The allocation of GST exemption on the date of the transfer

is treated as preceding in point of time the taxable distribution.

At the time of the GST, the trust has an inclusion ratio of .6667 (1

- (50,000/150,000)).

Example 5. Automatic allocation to split-gift direct skip. On

May 15, 1996, T transfers $50,000 to a trust in a direct skip. T

does not file a timely gift tax return electing out of the automatic

allocation. On April 30, 1998, T and T's spouse, S, file an initial

gift tax return for 1996 on which they consent, pursuant to section

2513, to have the gift treated as if one-half had been made by each.

As a result of the election under section 2513, which is retroactive

to the date of T's transfer, T and S are each treated as the

transferor of one-half of the property transferred in the direct

skip. Thus, $25,000 of T's unused GST exemption and $25,000 of S's

unused GST exemption is automatically allocated to the trust. Both

allocations are effective on and after the date that T made the

transfer.

general. An allocation of GST exemption (including an automatic

allocation) to property subject to an estate tax inclusion period

(ETIP) that is made prior to termination of the ETIP cannot be revoked,

but becomes effective no earlier than the date of any termination of

the ETIP with respect to the trust. Where an allocation has not been

made prior to the termination of the ETIP, an allocation is effective

at the termination of the ETIP during the transferor's lifetime if made

by the due date for filing a Form 709 that would apply to a taxable

gift occurring at the time the ETIP terminates (timely ETIP return). An

allocation is effective in the case of the termination of the ETIP on

the death of the transferor as provided in paragraph (d) of this

section. If any part of a trust is subject to an ETIP, the entire trust

is subject to the ETIP. See Sec. 26.2642-1(b)(2) for rules determining

the inclusion ratio applicable in the case of GSTs during an ETIP.

(2) Estate tax inclusion period defined--(i) In general. An ETIP is

the period during which, should death occur, the value of transferred

property would be includible (other than by reason of section 2035) in

the gross estate of--

(A) The transferor; or

(B) The spouse of the transferor.

(ii) Exceptions--(A) For purposes of paragraph (c)(2) of this

section, the value of transferred property is not considered as being

subject to inclusion in the gross estate of the transferor or the

spouse of the transferor if the possibility that the property will be

included is so remote as to be negligible. A possibility is so remote

as to be negligible if it can be ascertained by actuarial standards

that there is less than a 5 percent probability that the property will

be included in the gross estate.

(B) For purposes of paragraph (c)(2) of this section, the value of

transferred property is not considered as being subject to inclusion in

the gross estate of the spouse of the transferor, if the spouse

possesses with respect to any transfer to the trust, a right to

withdraw

[[Page 66914]]

no more than the greater of $5,000 or 5 percent of the trust corpus,

and such withdrawal right terminates no later than 60 days after the

transfer to the trust.

terminable interest property with respect to which the special election

under Sec. 26.2652-2 has been made.

(3) Termination of an ETIP. An ETIP terminates on the first to

occur of--

(i) The death of the transferor;

(ii) The time at which no portion of the property is includible in

the transferor's gross estate (other than by reason of section 2035)

or, in the case of an individual who is a transferor solely by reason

of an election under section 2513, the time at which no portion would

be includible in the gross estate of the individual's spouse (other

than by reason of section 2035);

(iii) The time of a GST, but only with respect to the property

involved in the GST; or

(iv) In the case of an ETIP arising by reason of an interest or

power held by the transferor's spouse under subsection (c)(2)(i)(B) of

this section, at the first to occur of--

(A) The death of the spouse; or

(B) The time at which no portion of the property would be

includible in the spouse's gross estate (other than by reason of

section 2035).

(4) Treatment of direct skips. If property transferred to a skip

person is subject to an ETIP, the direct skip is treated as occurring

on the termination of the ETIP.

(5) Examples. The following examples illustrate the rules of this

section as they apply to the termination of an ETIP during the lifetime

of the transferor. In each example assume that T transfers $100,000 to

an irrevocable trust:

Example 1. Allocation of GST exemption during ETIP. The trust

instrument provides that trust income is to be paid to T for 9 years

or until T's prior death. The trust principal is to be paid to T's

grandchild on the termination of T's income interest. If T dies

within the 9-year period, the value of the trust principal is

includible in T's gross estate under section 2036(a). Thus, the

trust is subject to an ETIP. T files a timely Form 709 reporting the

transfer and allocating $100,000 of GST exemption to the trust. The

allocation of GST exemption to the trust is not effective until the

termination of the ETIP.

Example 2. Effect of prior allocation on termination of ETIP.

The facts are the same as in Example 1, except the trustee has the

power to invade trust principal on behalf of T's grandchild, GC,

during the term of T's income interest. In year 4, when the value of

the trust is $200,000, the trustee distributes $15,000 to GC. The

distribution is a taxable distribution. The ETIP with respect to the

property distributed to GC terminates at the time of the taxable

distribution. See paragraph (c)(3)(iii) of this section. Solely for

purposes of determining the trust's inclusion ratio with respect to

the taxable distribution, the prior $100,000 allocation of GST

exemption (as well as any additional allocation made on a timely

ETIP return) is effective immediately prior to the taxable

distribution. See Sec. 26.2642-1(b)(2). The trust's inclusion ratio

with respect to the taxable distribution is therefore .50

(1-(100,000/200,000)).

Example 3. Split-gift transfers subject to ETIP. The trust

instrument provides that trust income is to be paid to T for 9 years

or until T's prior death. The trust principal is to be paid to T's

grandchild on the termination of T's income interest. T files a

timely Form 709 reporting the transfer. T's spouse, S, consents to

have the gift treated as made one-half by S under section 2513.

Because S is treated as transferring one-half of the property to T's

grandchild, S becomes the transferor of one-half of the trust for

purposes of chapter 13. Because the value of the trust would be

includible in T's gross estate if T died immediately after the

transfer, S's transfer is subject to an ETIP. If S should die prior

to the termination of the trust, S's executor may allocate S's GST

exemption to the trust, but only to the portion of the trust for

which S is treated as the transferor. However, the allocation does

not become effective until the earlier of the expiration of T's

income interest or T's death.

Example 4. Transfer of retained interest as ETIP termination.

The trust instrument provides that trust income is to be paid to T

for 9 years or until T's prior death. The trust principal is to be

paid to T's grandchild on the termination of T's income interest.

Four years after the initial transfer, T transfers the income

interest to T's sibling. The ETIP with respect to the trust

terminates on T's transfer of the income interest because, after the

transfer, the trust property would not be includible in T's gross

estate (other than by reason of section 2035) if T died at that

time.

(d) Allocations after the transferor's death--(1) Allocation by

executor. Except as otherwise provided in this paragraph (d), an

allocation of a decedent's unused GST exemption by the executor of the

decedent's estate is made on the appropriate United States Estate (and

Generation-Skipping Transfer) Tax Return (Form 706 or Form 706NA) filed

on or before the date prescribed for filing the return by section

6075(a) (including any extensions actually granted (the due date)). An

allocation of GST exemption with respect to property included in the

gross estate of a decedent is effective as of the date of death. A

timely allocation of GST exemption by an executor with respect to a

lifetime transfer of property that is not included in the transferor's

gross estate is made on a Form 709. A late allocation of GST exemption

by an executor, other than an allocation that is deemed to be made

under section 2632(b)(1), with respect to a lifetime transfer of

property is made on Form 706 or Form 706NA and is effective as of the

date the allocation is filed. An allocation of GST exemption to a trust

(whether or not funded at the time the Form 706 or Form 706NA is filed)

is effective if the notice of allocation clearly identifies the trust

and the amount of the decedent's GST exemption allocated to the trust.

An executor may allocate the decedent's GST exemption by use of a

formula. For purposes of this section, an allocation is void if the

allocation is made for a trust that has no GST potential with respect

to the transferor for whom the allocation is being made, as of the date

of the transferor's death. For this purpose, a trust has GST potential

even if the possibility of a GST is so remote as to be negligible.

(2) Automatic allocation after death. A decedent's unused GST

exemption is automatically allocated on the due date for filing Form

706 or Form 706NA to the extent not otherwise allocated by the

decedent's executor on or before that date. The automatic allocation

occurs whether or not a return is actually required to be filed. Unused

GST exemption is allocated pro rata (subject to the rules of

Sec. 26.2642-2(b)), on the basis of the value of the property as

finally determined for purposes of chapter 11 (chapter 11 value), first

to direct skips treated as occurring at the transferor's death. The

balance, if any, of unused GST exemption is allocated pro rata (subject

to the rules of Sec. 26.2642-2(b)) on the basis of the chapter 11 value

of the nonexempt portion of the trust property (or in the case of

trusts that are not included in the gross estate, on the basis of the

date of death value of the trust) to trusts with respect to which a

taxable termination may occur or from which a taxable distribution may

be made. The automatic allocation of GST exemption is irrevocable, and

an allocation made by the executor after the automatic allocation is

made is ineffective. No automatic allocation of GST exemption is made

to a trust that will have a new transferor with respect to the entire

trust prior to the occurrence of any GST with respect to the trust. In

addition, no automatic allocation of GST exemption is made to a trust

if, during the nine month period ending immediately after the death of

the transferor--

(i) No GST has occurred with respect to the trust; and

(ii) At the end of such period no future GST can occur with respect

to the trust.

[[Page 66915]]

Sec. 26.2641-1 Applicable rate of tax.

The rate of tax applicable to any GST (applicable rate) is

determined by multiplying the maximum Federal estate tax rate in effect

at the time of the GST by the inclusion ratio (as defined in

Sec. 26.2642-1). For this purpose, the maximum Federal estate tax rate

is the maximum rate set forth under section 2001(c) (without regard to

section 2001(c)(2)).

Sec. 26.2642-1 Inclusion ratio.

(a) In general. Except as otherwise provided in this section, the

inclusion ratio is determined by subtracting the applicable fraction

(rounded to the nearest one-thousandth (.001)) from 1. In rounding the

applicable fraction to the nearest one-thousandth, any amount that is

midway between one one-thousandth and another one-thousandth is rounded

up to the higher of those two amounts.

(b) Numerator of applicable fraction--(1) In general. Except as

otherwise provided in this paragraph (b), and in Secs. 26.2642-3

(providing a special rule for charitable lead annuity trusts) and

26.2642-4 (providing rules for the redetermination of the applicable

fraction), the numerator of the applicable fraction is the amount of

GST exemption allocated to the trust (or to the transferred property in

the case of a direct skip not in trust).

(2) GSTs occurring during an ETIP--(i) In general. For purposes of

determining the inclusion ratio with respect to a taxable termination

or a taxable distribution that occurs during an ETIP, the numerator of

the applicable fraction is the sum of--

(A) The GST exemption previously allocated to the trust (including

any allocation made to the trust prior to any taxable termination or

distribution) reduced (but not below zero) by the nontax amount of any

prior GSTs with respect to the trust; and

(B) Any GST exemption allocated to the trust on a timely ETIP

return filed after the termination of the ETIP. See Sec. 26.2632-

1(c)(5) Example 2.

(ii) Nontax amount of a prior GST. (1) The nontax amount of a prior

GST with respect to the trust is the amount of the GST multiplied by

the applicable fraction attributable to the trust at the time of the

prior GST.

(2) For rules regarding the allocation of GST exemption to property

during an ETIP, see Sec. 26.2632-1(c).

otherwise provided in this paragraph (c) and in Secs. 26.2642-3 and

26.2642-4, the denominator of the applicable fraction is the value of

the property transferred to the trust (or transferred in a direct skip

not in trust) (as determined under Sec. 26.2642-2) reduced by the sum

of--

(i) Any Federal estate tax and any State death tax incurred by

reason of the transfer that is chargeable to the trust and is actually

recovered from the trust;

(ii) The amount of any charitable deduction allowed under section

2055, 2106, or 2522 with respect to the transfer; and

(iii) In the case of a direct skip, the value of the portion of the

transfer that is a nontaxable gift. See paragraph (c)(3) of this

section for the definition of nontaxable gift.

(2) Zero denominator. If the denominator of the applicable fraction

is zero, the inclusion ratio is zero.

(3) Nontaxable gifts. Generally, for purposes of chapter 13, a

transfer is a nontaxable gift to the extent the transfer is excluded

from taxable gifts by reason of section 2503(b) (after application of

section 2513) or section 2503(e). However, a transfer to a trust for

the benefit of an individual is not a nontaxable gift for purposes of

this section unless--

(i) Trust principal or income may, during the individual's

lifetime, be distributed only to or for the benefit of the individual;

and

(ii) The assets of the trust will be includible in the gross estate

of the individual if the individual dies before the trust terminates.

(d) Examples. The following examples illustrate the provisions of

this section. See Sec. 26.2652-2(d) Examples 2 and 3 for illustrations

of the computation of the inclusion ratio where the special (reverse

QTIP) election may be applicable.

Example 1. Computation of the inclusion ratio. T transfers

$100,000 to a newly-created irrevocable trust providing that income

is to be accumulated for 10 years. At the end of 10 years, the

accumulated income is to be distributed to T's child, C, and the

trust principal is to be paid to T's grandchild. T allocates $40,000

of T's GST exemption to the trust on a timely-filed gift tax return.

The applicable fraction with respect to the trust is .40 ($40,000

(the amount of GST exemption allocated to the trust) over $100,000

(the value of the property transferred to the trust)). The inclusion

ratio is .60 (1 - .40). If the maximum Federal estate tax rate is 55

percent at the time of a GST, the rate of tax applicable to the

transfer (applicable rate) will be .333 (55 percent (the maximum

estate tax rate) x .60 (the inclusion ratio)).

Example 2. Gift entirely nontaxable. On December 1, 1996, T

transfers $10,000 to an irrevocable trust for the benefit of T's

grandchild, GC. GC possesses a right to withdraw any contributions

to the trust such that the entire transfer qualifies for the annual

exclusion under section 2503(b). Under the terms of the trust, the

income is to be paid to GC for 10 years or until GC's prior death.

Upon the expiration of GC's income interest, the trust principal is

payable to GC or GC's estate. The transfer to the trust is a direct

skip. T made no prior gifts to or for the benefit of GC during 1996.

The entire $10,000 transfer is a nontaxable transfer. For purposes

of computing the tax on the direct skip, the denominator of the

applicable fraction is zero, and thus, the inclusion ratio is zero.

Example 3. Gift nontaxable in part. T transfers $12,000 to an

irrevocable trust for the benefit of T's grandchild, GC. Under the

terms of the trust, the income is to be paid to GC for 10 years or

until GC's prior death. Upon the expiration of GC's income interest,

the trust principal is payable to GC or GC's estate. Further, GC has

the right to withdraw $10,000 of any contribution to the trust such

that $10,000 of the transfer qualifies for the annual exclusion

under section 2503(b). The amount of the nontaxable transfer is

$10,000. Solely for purposes of computing the tax on the direct

skip, T's transfer is divided into two portions. One portion is

equal to the amount of the nontaxable transfer ($10,000) and has a

zero inclusion ratio; the other portion is $2,000 ($12,000 -

$10,000). With respect to the $2,000 portion, the denominator of the

applicable fraction is $2,000. Assuming that T has sufficient GST

exemption available, the numerator of the applicable fraction is

$2,000 (unless T elects to have the automatic allocation provisions

not apply). Thus, assuming T does not elect to have the automatic

allocation not apply, the applicable fraction is one ($2,000/$2,000

= 1) and the inclusion ratio is zero (1 - 1 = 0).

Example 4. Gift nontaxable in part. Assume the same facts as in

Example 3, except T files a timely Form 709 electing that the

automatic allocation of GST exemption not apply to the $12,000

transferred in the direct skip. T's transfer is divided into two

portions, a $10,000 portion with a zero inclusion ratio and a $2,000

portion with an applicable fraction of zero (0/$2,000 = 0) and an

inclusion ratio of one (1 - 0 = 1).

Sec. 26.2642-2 Valuation.

(a) Lifetime transfers--(1) In general. For purposes of determining

the denominator of the applicable fraction, the value of property

transferred during life is its fair market value on the effective date

of the allocation of GST exemption. In the case of a timely allocation

under Sec. 26.2632-1(b)(2)(ii), the denominator of the applicable

fraction is the fair market value of the property as finally determined

for purposes of chapter 12.

(2) Special rule for late allocations during life. If a transferor

makes a late allocation of GST exemption to a trust, the value of the

property transferred to the trust is the fair market value of the trust

assets determined on the effective date of the allocation of GST

exemption. Except as otherwise provided in this paragraph (a)(2), if a

transferor makes a

[[Page 66916]]

late allocation of GST exemption to a trust, the transferor may, solely

for purposes of determining the fair market value of the trust assets,

elect to treat the allocation as having been made on the first day of

the month during which the late allocation is made (valuation date). An

election under this paragraph (a)(2) is not effective with respect to a

life insurance policy or a trust holding a life insurance policy, if

the insured individual has died. An allocation subject to the election

contained in this paragraph (a)(2) is not effective until it is

actually filed with the Internal Revenue Service. The election is made

by stating on the Form 709 on which the allocation is made--

(i) That the election is being made;

(ii) The applicable valuation date; and

(iii) The fair market value of the trust assets on the valuation

date.

(b) Transfers at death--(1) In general. Except as provided in

paragraphs (b) (2) and (3) of this section, in determining the

denominator of the applicable fraction, the value of property included

in the decedent's gross estate is its value for purposes of chapter 11.

In the case of qualified real property with respect to which the

election under section 2032A is made, the value of the property is the

value determined under section 2032A provided the recapture agreement

described in section 2032A(d)(2) filed with the Internal Revenue

Service specifically provides for the signatories' consent to the

imposition of, and personal liability for, additional GST tax in the

event an additional estate tax is imposed under section 2032A(c). See

Sec. 26.2642-4(a)(4). If the recapture agreement does not contain these

provisions, the value of qualified real property as to which the

election under section 2032A is made is the fair market value of the

property determined without regard to the provisions of section 2032A.

(2) Special rule for pecuniary payments--(i) In general. If a

pecuniary payment is satisfied with cash, the denominator of the

applicable fraction is the pecuniary amount. If property other than

cash is used to satisfy a pecuniary payment, the denominator of the

applicable fraction is the pecuniary amount only if payment must be

made with property on the basis of the value of the property on--

(A) The date of distribution; or

(B) A date other than the date of distribution, but only if the

pecuniary payment must be satisfied on a basis that fairly reflects net

appreciation and depreciation (occurring between the valuation date and

the date of distribution) in all of the assets from which the

distribution could have been made.

(ii) Other pecuniary amounts payable in kind. The denominator of

the applicable fraction with respect to any property used to satisfy

any other pecuniary payment payable in kind is the date of distribution

value of the property.

(3) Special rule for residual transfers after payment of a

pecuniary payment--(i) In general. Except as otherwise provided in this

paragraph (b)(3), the denominator of the applicable fraction with

respect to a residual transfer of property after the satisfaction of a

pecuniary payment is the estate tax value of the assets available to

satisfy the pecuniary payment reduced, if the pecuniary payment carries

appropriate interest (as defined in paragraph (b)(4) of this section),

by the pecuniary amount. The denominator of the applicable fraction

with respect to a residual transfer of property after the satisfaction

of a pecuniary payment that does not carry appropriate interest is the

estate tax value of the assets available to satisfy the pecuniary

payment reduced by the present value of the pecuniary payment. For

purposes of this paragraph (b)(3)(i), the present value of the

pecuniary payment is determined by using--

(A) The interest rate applicable under section 7520 at the death of

the transferor; and

(B) The period between the date of the transferor's death and the

date the pecuniary amount is paid.

(ii) Special rule for residual transfers after pecuniary payments

payable in kind. The denominator of the applicable fraction with

respect to any residual transfer after satisfaction of a pecuniary

payment payable in kind is the date of distribution value of the

property distributed in satisfaction of the residual transfer, unless

the pecuniary payment must be satisfied on the basis of the value of

the property on--

(A) The date of distribution; or

(B) A date other than the date of distribution, but only if the

pecuniary payment must be satisfied on a basis that fairly reflects net

appreciation and depreciation (occurring between the date of death and

the date of distribution) in all of the assets from which the

distribution could have been made.

(4) Appropriate interest--(i) In general. For purposes of this

section and Sec. 26.2654-1 (relating to certain trusts treated as

separate trusts), appropriate interest means that interest must be

payable from the date of death of the transferor (or from the date

specified under applicable State law requiring the payment of interest)

to the date of payment at a rate--

(A) At least equal to--

(1) The statutory rate of interest, if any, applicable to pecuniary

bequests under the law of the State whose law governs the

administration of the estate or trust; or

(2) If no such rate is indicated under applicable State law, 80

percent of the rate that is applicable under section 7520 at the death

of the transferor; and

(B) Not in excess of the greater of--

(1) The statutory rate of interest, if any, applicable to pecuniary

bequests under the law of the State whose law governs the

administration of the trust; or

(2) 120 percent of the rate that is applicable under section 7520

at the death of the transferor.

(ii) Pecuniary payments deemed to carry appropriate interest. For

purposes of this paragraph (b)(4), if a pecuniary payment does not

carry appropriate interest, the pecuniary payment is considered to

carry appropriate interest to the extent--

(A) The entire payment is made or property is irrevocably set aside

to satisfy the entire pecuniary payment within 15 months of the

transferor's death; or

(B) The governing instrument or applicable local law specifically

requires the executor or trustee to allocate to the pecuniary payment a

pro rata share of the income earned by the fund from which the

pecuniary payment is to be made between the date of death of the

transferor and the date of payment. For purposes of paragraph

(b)(4)(ii)(A) of this section, property is irrevocably set aside if it

is segregated and held in a separate account pending distribution.

this section:

Example 1. T transfers $100,000 to a newly-created irrevocable

trust on December 15, 1996. The trust provides that income is to be

paid to T's child for 10 years. At the end of the 10-year period,

the trust principal is to be paid to T's grandchild. T does not

allocate any GST exemption to the trust on the gift tax return

reporting the transfer. On November 15, 1997, T files a Form 709

allocating $50,000 of GST exemption to the trust. Because the

allocation was made on a late filed return, the value of the

property transferred to the trust is determined on the date the

allocation is filed (unless an election is made pursuant to

paragraph (a)(2) of this section to value the trust property as of

the first day of the month in which the allocation document is filed

with the Internal Revenue Service). On November 15, 1997, the value

of the trust property is $150,000. Effective as of November 15,

1997, the applicable fraction with respect to the trust is .333

($50,000 (the

[[Page 66917]]

amount of GST exemption allocated to the trust) over $150,000 (the

value of the trust principal on the effective date of the GST

exemption allocation)), and the inclusion ratio is .667 (1.0-.333).

Example 2. The facts are the same as in Example 1, except the

value of the trust property is $80,000 on November 15, 1997. The

applicable fraction is .625 ($50,000 over $80,000) and the inclusion

ratio is .375 (1.0-.625).

Example 3. T transfers $100,000 to a newly-created irrevocable

trust on December 15, 1996. The trust provides that income is to be

paid to T's child for 10 years. At the end of the 10-year period,

the trust principal is to be paid to T's grandchild. T does not

allocate any GST exemption to the trust on the gift tax return

reporting the transfer. On November 15, 1997, T files a Form 709

allocating $50,000 of GST exemption to the trust. T elects to value

the trust principal on the first day of the month in which the

allocation is made pursuant to the election provided in paragraph

(a)(2) of this section. Because the late allocation is made in

November, the value of the trust is determined as of November 1,

1997.

Sec. 26.2642-3 Special rule for charitable lead annuity trusts.

(a) In general. In determining the applicable fraction with respect

to a charitable lead annuity trust--

(1) The numerator is the adjusted generation-skipping transfer tax

exemption (adjusted GST exemption); and

(2) The denominator is the value of all property in the trust

immediately after the termination of the charitable lead annuity.

(b) Adjusted GST exemption defined. The adjusted GST exemption is

the amount of GST exemption allocated to the trust increased by an

amount equal to the interest that would accrue if an amount equal to

the allocated GST exemption were invested at the rate used to determine

the amount of the estate or gift tax charitable deduction, compounded

annually, for the actual period of the charitable lead annuity. If a

late allocation is made to a charitable lead annuity trust, the

adjusted GST exemption is the amount of GST exemption allocated to the

trust increased by the interest that would accrue if invested at such

rate for the period beginning on the date of the late allocation and

extending for the balance of the actual period of the charitable lead

annuity. The amount of GST exemption allocated to a charitable lead

annuity trust is not reduced even though it is ultimately determined

that the allocation of a lesser amount of GST exemption would have

resulted in an inclusion ratio of zero. For purposes of chapter 13, a

charitable lead annuity trust is any trust providing an interest in the

form of a guaranteed annuity described in Sec. 25.2522(c)-3(c)(2)(vi)

of this chapter for which the transferor is allowed a charitable

deduction for Federal estate or gift tax purposes.

this section:

Example. T creates a charitable lead annuity trust for a 10-year

term with the remainder payable to T's grandchild. T timely

allocates an amount of GST exemption to the trust which T expects

will ultimately result in a zero inclusion ratio. However, at the

end of the charitable lead interest, because the property has not

appreciated to the extent T anticipated, the numerator of the

applicable fraction is greater than the denominator. The inclusion

ratio for the trust is zero. No portion of the GST exemption

allocated to the trust is restored to T or to T's estate.

Sec. 26.2642-4 Redetermination of applicable fraction.

(a) In general. The applicable fraction for a trust is redetermined

whenever additional exemption is allocated to the trust or when certain

changes occur with respect to the principal of the trust. Except as

otherwise provided in this paragraph (a), the numerator of the

redetermined applicable fraction is the sum of the amount of GST

exemption currently being allocated to the trust (if any) plus the

value of the nontax portion of the trust, and the denominator of the

redetermined applicable fraction is the value of the trust principal

immediately after the event occurs. The nontax portion of a trust is

determined by multiplying the value of the trust assets, determined

immediately prior to the event, by the then applicable fraction.

(1) Multiple transfers to a single trust. If property is added to

an existing trust, the denominator of the redetermined applicable

fraction is the value of the trust immediately after the addition

reduced as provided in Sec. 26.2642-1(c).

(2) Consolidation of separate trusts. If separate trusts created by

one transferor are consolidated, a single applicable fraction for the

consolidated trust is determined. The numerator of the redetermined

applicable fraction is the sum of the nontax portions of each trust

immediately prior to the consolidation.

(3) Property included in transferor's gross estate. If the value of

property held in a trust created by the transferor, with respect to

which an allocation was made at a time that the trust was not subject

to an ETIP, is included in the transferor's gross estate, the

applicable fraction is redetermined if additional GST exemption is

allocated to the property. The numerator of the redetermined applicable

fraction is an amount equal to the nontax portion of the property

immediately after the death of the transferor increased by the amount

of GST exemption allocated by the executor of the transferor's estate

to the trust. If additional GST exemption is not allocated to the

trust, the applicable fraction immediately before death is not changed,

if the trust was not subject to an ETIP at the time GST exemption was

allocated to the trust. The denominator of the applicable fraction is

reduced to reflect any federal or state, estate or inheritance taxes

paid from the trust.

(4) Imposition of recapture tax under section 2032A--(i) If an

additional estate tax is imposed under section 2032A and if the section

2032A election was effective (under Sec. 26.2642-2(b)) for purposes of

the GST tax, the applicable fraction with respect to the property is

redetermined as of the date of death of the transferor. In making the

redetermination, any available GST exemption not allocated at the death

of the transferor (or at a prior recapture event) is automatically

allocated to the property. The denominator of the applicable fraction

is the fair market value of the property at the date of the

transferor's death reduced as provided in Sec. 26.2642-1(c) and further

reduced by the amount of the additional GST tax actually recovered from

the trust.

(ii) The GST tax imposed with respect to any taxable termination,

taxable distribution, or direct skip occurring prior to the recapture

event is recomputed based on the applicable fraction as redetermined.

Any additional GST tax as recomputed is due and payable on the date

that is six months after the event that causes the imposition of the

additional estate tax under section 2032A. The additional GST tax is

remitted with Form 706-A and is reported by attaching a statement to

Form 706-A showing the computation of the additional GST tax.

(iii) The applicable fraction, as redetermined under this section,

is also used in determining any GST tax imposed with respect to GSTs

occurring after the date of the recapture event.

(b) Examples. The following examples illustrate the principles of

this section:

Example 1. Allocation of additional exemption. T transfers

$200,000 to an irrevocable trust under which the income is payable

to T's child, C, for life. Upon the termination of the trust, the

remainder is payable to T's grandchild, GC. At a time when no ETIP

exists with respect to the trust property, T makes a timely

allocation of $100,000 of GST exemption, resulting in an inclusion

ratio of .50. Subsequently, when the entire trust property is valued

at $500,000, T allocates an additional $100,000 of T's unused GST

exemption to the trust. The inclusion ratio of the trust is

recomputed at that time. The numerator of the applicable fraction is

$350,000 ($250,000 (the nontax

[[Page 66918]]

portion as of the date of the allocation) plus $100,000 (the GST

exemption currently being allocated)). The denominator is $500,000

(the date of allocation fair market value of the trust). The

inclusion ratio is .30 (1 - .70).

Example 2. Multiple transfers to a trust, allocation both timely

and late. On December 10, 1993, T transfers $10,000 to an

irrevocable trust that does not satisfy the requirements of section

2642(c)(2). T makes identical transfers to the trust on December 10,

1994, 1995, 1996, and on January 15, 1997. Immediately after the

transfer on January 15, 1997, the value of the trust principal is

$40,000. On January 14, 1998, when the value of the trust principal

is $50,000, T allocates $30,000 of GST exemption to the trust. T

discloses the 1997 transfer on the Form 709 filed on January 14,

1998. Thus, T's allocation is a timely allocation with respect to

the transfer in 1997, $10,000 of the allocation is effective as of

the date of that transfer, and, on and after January 15, 1997, the

inclusion ratio of the trust is .75 (1 - ($10,000/$40,000)). The

balance of the allocation is a late allocation with respect to prior

transfers to the trust and is effective as of January 14, 1998. In

redetermining the inclusion ratio as of that date, the numerator of

the redetermined applicable fraction is $32,500 ($12,500 (.25 x

$50,000), the nontax portion of the trust on January 14, 1998) plus

$20,000 (the amount of GST exemption allocated late to the trust).

The denominator of the new applicable fraction is $50,000 (the value

of the trust principal at the time of the late allocation).

Example 3. Excess allocation. (i) T creates an irrevocable trust

for the benefit of T's child and grandchild in 1996 transferring

$50,000 to the trust on the date of creation. T allocates no GST

exemption to the trust on the Form 709 reporting the transfer. On

July 1, 1997 (when the value of the trust property is $60,000), T

transfers an additional $40,000 to the trust.

(ii) On April 15, 1998, when the value of the trust is $150,000,

T files a Form 709 reporting the 1997 transfer and allocating

$150,000 of GST exemption to the trust. The allocation is a timely

allocation of $40,000 with respect to the 1997 transfer and is

effective as of that date. Thus, the applicable fraction for the

trust as of July 1, 1997 is .40 ($40,000/$100,000 ($40,000 +

$60,000)).

(iii) The allocation is also a late allocation of $90,000, the

amount necessary to attain a zero inclusion ratio on April 15, 1998,

computed as follows: $60,000 (the nontax portion immediately prior

to the allocation (.40 x $150,000)) plus $90,000 (the additional

allocation necessary to produce a zero inclusion ratio base

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