- Written by Martin M. Shenkman
Form 709 for 2010 will be the most complex gift tax return you will complete during your career as a result of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (2010 Act). Gift tax returns are considered by some practitioners to be rather simple, when they are anything but.
You have to understand which gift transfers have to be reported. This is often not obvious.
The requirements to ensure “adequate disclosure” are onerous, and it is easy to overlook something that might be necessary. Some of the documents that should be disclosed are often prepared by the client’s attorney or held by the client’s financial planner and may not be readily available in the practitioner’s file.
Reporting generation skipping transfers (GST) is extraordinarily complex in “normal” years. Determining whether or not a particular transfer is subject to the GST tax can be daunting. Ascertaining whether or not the GST automatic allocation rules apply to automatically allocate GST exemption creates yet another layer of complexity.
The following checklist will focus on the changes and how they may affect this year’s Form 709:
Filing Due Date Complexity
April 18, 2011 is the actual due date for 2010 individual income tax returns and gift tax returns reporting 2010 gifts or GST. However, the 2010 Act granted a nine-month extension for certain items. So, September 19, 2011 is the extended deadline for the 2010 Act filing and payment leniency. This is confusing since the 2010 Act extension provision does not provide an extension for gift tax returns, although there is an extension for reporting transfers that have a GST tax impact. It appears that the allocation of GST exemption (or a decision not to allocate GST exemption or to expressly choose not to have the automatic GST exemption allocation rules apply) is extended. These decisions are generally reported on the same gift tax return, Form 709 that transfers subject to the gift tax are reported on.
It is possible that the gift tax return for 2010 could have two separate filing requirements; one for reporting gifts, which does not benefit from the special extension rules and one for reporting the GST implications of the same gifts, which is afforded the leniency of the extension. If so, then those filing these returns will have to determine how to address potentially different filings and different deadlines for the same gifts.
The safe answer is to file without regard to the extension period and only use that grace period if a change must be made to the original filing. An individual taxpayer who extends his or her income tax return can defer filing until October 17, which would extend the due date for the gift tax return. Given the complexity of these returns it is perhaps advisable to extend the due date for the filing of the decedent’s personal income tax return until October and thereby extend the filing of the gift tax return.
GST Automatic Allocation Opt-Out
GST transfers made in 2010 qualify for a zero percent GST tax rate so that there may be no advantage to also allocating GST exemption to those transfers. However, if the automatic allocation of GST exemption rules would apply, affirmatively opting out of that automatic allocation may be important to avoid wasting GST exemption. The opt out must be made on timely filed gift tax return. A client who might not otherwise have had to file a return might have to file merely to opt out.
The decision to opt out will not be obvious. If a client set up a trust in 2010 only for grandchildren (skip persons), the trust itself should be characterized as a skip person. The GST tax on a transfer to such a trust in 2010 was zero. If the trust will distribute out all trust assets to grandchildren a GST tax will never be assessed. For these types of trusts opting out of automatic GST allocation is probably advisable.
However, practitioners must understand the intent for the trust to determine the appropriate gift tax return reporting. If the intent for the trust is to continue in perpetuity beyond the grandchildren’s generation, GST tax may apply on distributions beyond the grandchildren’s generation and perhaps then GST exemption should be allowed to be automatically allocated. Without further analysis, including the possible impact of a disclaimer filed even in 2011, it may be impossible to ascertain the status of the trust. Extra precautions, coordination with the attorney who drafted the trust, and clear communication with the client are essential to make this determination.
Evaluating 2010 GST Trusts
While a trust might look like a typical “grandchild” trust, more in depth analysis is required to know how to file a 2010 gift tax return. For the special 2010 zero GST tax trust planning to succeed, only “skip persons” should have been beneficiaries of the trust. An important issue is confirming that the trust itself is in fact a skip person for GST purpose. This requires that all interests in the trust be held by skip persons (IRC 2613(a)). If no person holds an “interest” in the trust and at no time may a distribution be made to a non-skip person then the trust would qualify. This requires practitioners to carefully review the “interests” in the trusts involved to confirm that only skip people had interests.
Generally, disclaimers must be filed within nine months of creating an interest or the transferor’s death. The 2010 Act extended the time period for disclaimers for decedent’s dying prior to the December 17, 2010 enactment date for nine months. For decedent’s dying after enactment, the nine-month un-extended deadline will end between September 17-30, 2011, as there are no extensions for decedents dying December 17-31 2010. Clients may wish to disclaim gifts or bequests made in 2010 so that the family unit can take advantage of the zero GST tax rate that applied in 2010. Practitioners will have to confirm before filing a gift tax return whether any later disclaimers affected the transactions being reported.
For much of 2010 the 35% gift tax rate looked like a bargain in contrast to the 55%. Some taxpayers, especially wealthy elderly taxpayers, may have made substantial taxable gifts in 2010 to lock in what had thought would be a 20% lower rate. With the unexpected enactment of a 35% rate and $5 million gift exemption most of these taxpayers would have been better off not making those gifts, or at least delaying them until January 1, 2011.
Some advisors have endeavored to undue these gifts in light of the unfairness that the tax law uncertainty created. Some of these prior gifts might be renounced or other steps taken to “unwind” them. Some advisors have speculated that it might be feasible to make a rescission of the gift. Other practitioners have speculated that such gifts might be unwound based on a mistake of fact. Practitioners need to be alert to these transactions and how they are reported. Careful consideration should be given to fully disclosing the initial gifts and any positions taken as to how they were unwound or rescinded.
In the case, Breakiron v. Gudonis, 2010-2 USTC ¶ 60,597 (D. Mass. 2010), the parents created a qualified personal residence trust (“QPRT”). A remainder beneficiary was advised by his tax professional that he could disclaim the interests within nine months after the end of the parent’s retained interests. The disclaimer was valid under state law, but violated the time requirements under IRC Sec. 2518. The IRS assessed gift tax on the untimely disclaimer. To salvage the situation, the beneficiary went to district court and the court held that he could rescind the disclaimer voiding the taxable gift.
The unique 2010 GST tax rules provided another planning opportunity that practitioners need to be alert for. If a client created a trust that had a GST inclusion ratio greater than zero but less than one, this undesirable GST status could have been resolved by dividing the trust into two.
Assume, for example, that the inclusion ratio was .7. In 2010 it was possible because of the special 2010 Tax Act GST provisions to make distributions to skip persons when the GST tax rate was zero. The practitioner may have recommended that the above trust be divided in a “qualified severance.” The objective would have been to divide the trust into two parts. One part would be 30% of the whole, have a GST inclusion ratio of zero, and therefore be entirely GST exempt. The other part would be 70% of the whole with a GST inclusion ratio of 1 and be fully non-GST exempt.
If this severance were completed in 2010 the trustee could have (assuming the governing instrument so permitted) distributed the property out of the larger non-GST-exempt trust to skip persons when the GST tax rate applicable to the transfer was zero. The only trust left would be the fully GST-exempt trust. It will not be sufficient in 2010 to merely assume the clients are working with the same trusts that practitioners reported transfers to in prior years.
True or False? A charity may be a beneficiary of a special 2010 zero GST.
For the special 2010 zero GST tax trust planning to succeed, only “skip-persons” should have been beneficiaries of the trust.