How to fix an incorrect GST exemption allocation

Editors: Mindy Tyson Weber, CPA, and Trina Pinneau, J.D., LL.M.

In a series of recent private letter rulings, the IRS addressed the circumstances under which taxpayers or their personal representatives may obtain relief to file late elections in or out of the allocation of the generation-skipping transfer (GST) tax exemption in regard to transfers to GST trusts. A GST trust is defined under Sec. 2632(c)(3)(B) as a trust that could have a GST with respect to the transferor unless certain provisions within the trust instrument disqualify it as a GST trust. In all the letter rulings reviewed in this item, the IRS granted relief to make late elections pursuant to Sec. 2642(g) and Regs. Sec. 301.9100-3. The ability to obtain relief ensures that an individual’s GST exemption can be allocated correctly to certain transfers in trust. If relief is not granted, incorrect allocations are generally irrevocable.

The method for allocating the GST exemption to a GST trust can differ depending on the date the trust was created. If a trust was created on or before Dec. 31, 2000, an individual would need to directly allocate the GST exemption on a timely filed Form 709, United States Gift Tax (and Generation-Skipping Transfer Tax) Return. However, a GST trust created after Dec. 31, 2000, falls under the automatic allocation rules of Sec. 2632, unless the individual affirmatively elects out of the automatic allocation. To make the election, the individual must timely file a Form 709 for the calendar year in which the transfer(s) occurred and attach a written election statement to the form (Sec. 2632(c)(5)). In general, the statement must identify the trust and specifically provide that the individual is electing out of the automatic allocation of GST exemption with respect to the described transfer(s) (Regs. Sec. 26.2632-1(b)(2)(iii)(B)).

Letter Rulings 201635005 and 201638020 involve requests for an extension of time to make a late election out of the automatic allocation rules under Sec. 2632(c)(5). In Letter Ruling 201635005, the taxpayer retained a tax professional to prepare a Form 709 to report a transfer to an irrevocable trust created after Dec. 31, 2000. The tax professional timely filed the form and elected out of the automatic allocation of GST exemption for this initial transfer. In preparing the following year’s Form 709 to report two additional transfers to the trust, the tax professional inadvertently failed to elect out of the automatic allocation of GST exemption for these subsequent transfers.

Similarly, in Letter Ruling 201638020, a taxpayer after Dec. 31, 2000, created and funded a trust for the benefit of his son and daughter. The taxpayer engaged a firm to prepare a Form 709 to report the transfer to the trust. Although the form was timely filed, the tax professionals neglected to make the election out of the automatic allocation of GST exemption.

Both letter rulings discuss the circumstances and procedures under which an extension of time will be granted to make a late election out of the automatic allocation of GST exemption. Sec. 2642(g)(1)(B) provides that the secretary of the Treasury shall take into account all relevant circumstances, including evidence of intent contained in the trust instrument and any other factors the secretary deems relevant, when determining whether to grant relief. The standards used to determine whether to grant an extension of time to make the election are contained in Regs. Sec. 301.9100-3. Specifically, the taxpayer must provide satisfactory evidence to show he or she acted reasonably and in good faith and that granting relief will not prejudice the government’s interests.

Regs. Sec. 301.9100-3(b) provides a list of circumstances under which the taxpayer will be deemed to have acted reasonably and in good faith. As to the letter rulings, both taxpayers were deemed to have acted reasonably and in good faith because they reasonably relied on a qualified tax professional and the tax professional failed to make or advise the taxpayer to make the election (Regs. Sec. 301.9100-3(b)(1)(v)). Therefore, both taxpayers were granted extensions of time to elect out of the automatic allocation rules with respect to the transfers to the trusts. The taxpayers were each directed to file a supplemental Form 709 for the year in which the transfer(s) occurred.

In contrast, Letter Rulings 201639003 and 201636022 address requests for an extension of time to allocate GST exemption to trust transfers. In Letter Ruling 201639003, the taxpayer created an irrevocable trust and retained a firm to prepare Form 709 to report the transfer. However, in this instance, the trust was created and funded prior to Dec. 31, 2000, and the tax professionals neglected to directly allocate the taxpayer’s GST exemption to the trust on Form 709.

The IRS granted the taxpayer’s request for an extension of time to allocate the GST exemption to the transfer to the trust, based on Sec. 2642(g) and Regs. Sec. 301.9100-3. The taxpayer met the reasonableness and good-faith requirements by reasonably relying on a qualified tax professional under Regs. Sec. 301.9100-3(b)(1)(v).

In Letter Ruling 201636022, the taxpayer had died, and the authorized representatives of the taxpayer’s estate requested an extension of time to sever a marital trust into two subtrusts, a GST-exempt trust and a GST-nonexempt trust. The taxpayer’s surviving spouse was given a special power of appointment over the assets of the exempt trust. To the extent the spouse did not exercise her power of appointment, the exempt trust’s assets were to be added to a third trust, a GST trust.

The surviving spouse engaged an attorney to prepare the Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. A qualified terminable interest property (QTIP) election (Sec. 2056(b)(7)) was made on Schedule M with respect to all of the marital trust property. However, the return did not indicate that the marital trust comprised two subtrusts—the exempt trust and the nonexempt trust. No reverse QTIP election (Sec. 2652(a)(3)) was made with respect to the exempt trust, so none of the decedent’s GST exemption was allocated to the exempt trust on Form 706.

A reverse QTIP election allows the estate to treat all of the property in the marital trust as if the QTIP election had not been made. Thus, the decedent remains the transferor of the marital trust, and the decedent’s GST exemption may be allocated to the trust, which in this case is the exempt trust. The reverse QTIP election must be made on the same return on which the QTIP election is made (Regs. Sec. 26.2652-2(b)).

The trustees’ request for an extension of time to sever the marital trust into the exempt trust and nonexempt trust was granted under Sec. 2642(g) and Regs. Sec. 301.9100-3. The trustees were directed to file a supplemental Form 706 on which they could sever the marital trust, make the reverse QTIP election, and allocate the decedent’s GST exemption to the exempt trust. As in the other letter rulings, the trustees’ reasonable reliance on a qualified tax professional under Regs. Sec. 301.9100-3(b)(1)(v) met the requirements of acting reasonably and in good faith.

Although all of the reviewed letter rulings allowed relief based on the taxpayer’s reasonable reliance on a qualified tax professional, Regs. Sec. 301.9100-3(b)(1) describes additional circumstances in which the taxpayer is deemed to have acted reasonably and in good faith. These circumstances include:

• The taxpayer experienced intervening events reasonably beyond the taxpayer’s control;
• The taxpayer was not aware of the necessity for the election (having exercised reasonable diligence and considering his or her experience and the complexity of the return or issue);
• The taxpayer reasonably relied on written advice from the IRS; and
• The taxpayer requested relief before the IRS discovered the failure.

In addition, Regs. Sec. 301.9100-3(e) contains the specific procedural requirements for requesting relief. Practitioners will want to review the entire section, including the examples in subsection (f), when allocation errors of GST exemption are discovered. Requesting relief through a late election will ensure that an individual’s GST exemption has been allocated correctly to property transferred to a GST trust.

EditorNotes

Mindy Tyson Weber is a senior director, Washington National Tax for RSM US LLP. Trina Pinneau is a manager, Washington National Tax for RSM US LLP.

For additional information about this item, contact the author at Barbara.Larson@rsmus.com.

Unless otherwise noted, contributors are members of or associated with RSM US LLP.