IRS Letter Ruling Says GST Exemption Allocation to Trust is Invalid

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October 10, 2008

The IRS has ruled in a newly released letter ruling (PLR 2008-38-022) that an allocation of the generation skipping transfer exemption to a trust was invalid. Section 2631 grants every individual a GST exemption of $2 million (for 2008) to be allocated to transfers that may have GST tax potential. Section 2632 provides methods by which an individual's GST exemption may be allocated. Pursuant to Reg. Sec. 26.2632-1(b)(4)(i) (if an allocation is made during life) and Reg. Sec. 26.2632-1(d)(1) (if an allocation is made at death), the allocation of a GST exemption to a trust is void if the trust has no GST potential with respect to the transferor for whom the allocation is being made. The new ruling highlights a situation in which a GST exemption was allocated to a trust that had no GST tax potential (and therefore void) and was then reallocated to other trusts that may have GST tax potential.

In the letter ruling, the taxpayer died and the executor allocated the taxpayer's GST exemption to a trust that the taxpayer had created during his lifetime. Under the terms of the trust agreement, the taxpayer's daughter was to receive the income of the trust during her lifetime and the corpus of the trust when she reached certain ages with the balance of the trust being paid out to her at age 35. If the daughter died before the trust was paid out to her, the trust instrument granted her a testamentary general power of appointment to appoint the assets to whomever she wished after her death. Because the daughter (a nonskip person) had a testamentary general power of appointment, it was clear that the trust could not have a GST taxable event. Therefore, the IRS ruled that under Reg. Sec. 26.2632-1(d)(1), the allocation of the GST exemption to the trust by the executor was void.

Because the taxpayer had created a trust during his life and at his death that had GST tax potential, the IRS was asked the proper allocation of the taxpayer's GST exemption in light of the voided transfer. The IRS noted that Section 2632(e) provides that to the extent an individual's GST exemption has not been allocated within the time otherwise provided in Section 2632(a) (i.e., within the time required to file a taxpayer's estate tax return), such individual's remaining GST exemption is allocated in the following order until exhausted: (1) to direct skips and (2) to trust with respect to which the individual is a transferor and from which a taxable distribution or taxable termination may occur at or after such individual's death. In light of Section 2632(e), the IRS ruled that the taxpayer's GST exemption was to be allocated pro rata to the two trusts created by the taxpayer that could have GST tax potential.

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