November 10, 2004

The Honorable Mark W. Everson
Commissioner
Internal Revenue Service
CC:PA:LPD:PR (REG–153841–02)
Room 5203
PO Box 7604
Ben Franklin Station
Washington, D.C.20044

Hand Delivered to Courier's Desk

Internal Revenue Service
1111 Constitution Avenue, NW
Washington, D.C.20044

Delivered Electronically to

RE: Comments on Proposed Regulations (REG-153841-02) Regarding Electing Out of GST Deemed Allocations Under Section 2632(c)(5)(A)(i), issued July 13, 2004

Dear Commissioner Everson:
Enclosed are the American Institute of Certified Public Accountants (AICPA) comments regarding proposed regulations on electing out of GST deemed allocations under section 2632(c). The proposed regulations provide guidance for making the election under section 2632(c)(5)(A)(i) to not have the deemed allocation of unused GST exemption under section 2632(c)(1) apply with regard to certain transfers to a GST trust, as defined in section 2632(c)(3)(B). The proposed regulations also provide guidance for making the election under section 2632(c)(5)(A)(ii) to treat a trust as a GST trust.
We recommend removing the language "(including an automatic allocation to a direct skip, but not an indirect skip)" from the final version of reg. section 26.2632-1(c)(1) regulations. This would eliminate any confusion about the deemed allocation of a GST exemption to direct and indirect skips. The section 2632(b)(1) deemed allocation rules apply only after the estate tax inclusion period (ETIP) terminates, under current reg. section 2632-1(c)(4) for direct skips, and prop. reg. section 26.2632-1(b)(2)(i) for indirect skips.
We also recommend expanding the last sentence of prop. reg. section 26.2632-1(b)(2)(i) to clarify its application. The final section 26.2632-1(b)(2)(i) regulations should read: "The transferor may prevent the automatic allocation of GST exemption with regard to an indirect skip (including indirect skips to which section 2642(f) may apply), as provided in paragraphs (b)(2)(ii) and (iii) of this section."
We also recommend that the final regulations contain one or two examples addressing the application of the deemed allocation rules for indirect skips to situations in which trusts subject to an ETIP terminate upon the expiration of an ETIP and distribute its assets to other trusts that may be GST trusts.
We welcome the opportunity to discuss our comments further with you or others at the IRS. Please contact me at (402) 280-2062; or Roby Sawyers, Chair of the AICPA Trust, Estate, and Gift Tax Technical Resource Panel, at (919) 515-4443; or Justin R. Ransome, Chair of the GST Deemed Allocation Regs Task Force, at (202) 533-4184; or Eileen Sherr, AICPA Technical Manager at (202) 434-9256.

Sincerely,

Thomas J. Purcell, III
Chair, AICPA Tax Executive Committee

cc: Mayer R. Samuels, Internal Revenue Service
Catherine V. Hughes, Treasury Department

AICPA COMMENTS ON

PROPOSED REGULATIONS (REG-153841-02)

REGARDING ELECTING OUT OF GST DEEMED ALLOCATIONS

I.Eliminate Confusing Language in Proposed Reg. Section 26.2632-1(c)(1)

Recommendation:

The AICPA recommends removing the language “(including an automatic allocation to a direct skip, but not an indirect skip)” from the final version of reg. section 26.2632-1(c)(1) regulations. This would eliminate any confusion about the deemed allocation of a GST exemption to direct and indirect skips. The section 2632(b)(1) deemed allocation rules apply only after the estate tax inclusion period (ETIP) terminates, under current reg. section 26.2632-1(c)(4) for direct skips, and prop. reg. section 26.2632-1(b)(2)(i) for indirect skips.

Discussion:

Section 2632(b)(1) regarding the deemed allocation of GST exemption to direct skips provides:

If any individual makes a direct skip during his lifetime, any unused portion of such individual’s GST exemption shall be allocated to the property transferred to the extent necessary to make the inclusion ratio for such property zero. If the amount of the direct skip exceeds such unused portion, the entire unused portion shall be allocated to the property transferred.

Section 2632(c)(1) regarding the deemed allocation of GST exemption to indirect skips provides:

If any individual makes an indirect skip during such individual's lifetime, any unused portion of such individual’s GST exemption shall be allocated to the property transferred to the extent necessary to make the inclusion ratio for such property zero. If the amount of the indirect skip exceeds such unused portion, the entire unused portion shall be allocated to the property transferred.

These provisions regarding the deemed allocation of GST exemption to direct skips and indirect skips are virtually identical.

Section 2642(f) regarding the allocation of GST exemption to a transfer that is subject to an estate tax inclusion period (ETIP) provides:

Except as provided in regulations:

(1)For purposes of determining the inclusion ratio, if:

(A)an individual makes an inter vivos transfer of property, and

(B)the value of such property would be includible in the gross estate of such individual under chapter 11 if such individual died immediately after making such transfer (other than by reason of section 2035),

any allocation of GST exemption to such property shall not be made before the close of the estate tax inclusion period (and the value of such property shall be determined under paragraph (2)). If such transfer is a direct skip, such skip shall be treated as occurring as of the close of the estate tax inclusion period. (Emphasis added.)

Section 2632(c)(4) regarding the deemed allocation of GST exemption to a transfer that is an indirect skip subject to an ETIP provides:

For purposes of this subsection, an indirect skip to which section 2642(f) applies shall be deemed to have been made only at the close of the estate tax inclusion period. The fair market value of such transfer shall be the fair market value of the trust property at the close of the estate tax inclusion period. (Emphasis added.)

The italicized provision in section 2642(f)(1) prevents the deemed allocation of GST exemption from applying to direct skips under section 2632(b)(1) until an ETIP has terminated. The italicized portion of section 2632(c)(4) prevents the deemed allocation of GST exemption from applying to indirect skips under section 2632(c)(1) until an ETIP has terminated. These substantially similar provisions prevent the deemed allocation of GST exemption rules from applying to direct or indirect skips until an ETIP terminates. However, the proposed regulations would result in different treatment.

Reg. section 26.2632-1(c)(1) currently provides:

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 section 26.2642-1(b)(2) for rules determining the inclusion ratio applicable in the case of GSTs during an ETIP. (Emphasis added.)

Reg. section 26.2632-1(c)(4) currently provides:

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.

As amended by the proposed regulations, the first sentence in reg. section 26.2632-1(c)(1) would be amended and an additional sentence would be inserted as follows:

An allocation of GST exemption (including an automatic allocation to a direct skip, but not an indirect skip) to property subject to an estate tax inclusion period (ETIP) cannot be revoked, but becomes effective no earlier than the date of any termination of the ETIP with respect to the trust. See paragraph (b)(2)(i) of this section regarding the automatic allocation of GST exemption to an indirect skip subject to an ETIP. (Emphasis added.)

With reference to an indirect skip subject to an ETIP, prop. reg. section 26.2632-1(b)(2)(i) provides:

In the case of an indirect skip to which section 2642(f) does apply, the indirect skip is deemed to be made at the close of the estate tax inclusion period and the GST exemption is deemed to be allocated at that time.

In both the current and the proposed versions of reg. section 26.2632-1(c)(1), the parenthetical language is confusing. The parentheticals indicate that an affirmative allocation of GST exemption can be made to a direct skip before the termination of an ETIP, but will not be effective until the ETIP terminates. Such an allocation, however, would not produce a result different from the result that would occur if no affirmative allocation was made and the deemed allocation rules under section 2632(b)(1) applied to the transfer at the end of the ETIP. The following example illustrates the ineffectiveness of an affirmative allocation of GST exemption to a transfer that is a direct skip and subject to an ETIP prior to the end of the ETIP.

EXAMPLE: Taxpayer creates a trust for the benefit of his grandchildren and transfers property worth $100,000 to the trust. Trust is irrevocable, however, Taxpayer is the trustee of the trust. The transfer to the trust is a direct skip but an ETIP exists.

Assume that Taxpayer does not wish the deemed allocation rules under section 2632(b)(1) to apply to the transfer. If he timely files a Form 709 reporting the transfer to the trust and pays the GSTT on the transfer, he has paid the tax prematurely because the transfer is still subject to an ETIP. In addition, the amount of the GSTT is not currently known at time of the transfer because section 2642(f) states that the direct skip has not yet occurred.

Assume, alternatively, that Taxpayer wishes to affirmatively allocate GST exemption to the transfer under section 2632(a) which provides that a taxpayer may allocate GST exemption to any property with respect to which he or she is the transferor. While section 2632 does not prohibit such an allocation to a direct skip subject to an ETIP, the allocation does not change the GSTT consequences that would otherwise apply under the deemed allocation rules under section 2632(b)(1) and section 2642(f) to the direct skip at the termination of the ETIP.

If, at the time the direct skip is deemed to have occurred (i.e., at the termination of the ETIP), the value of the transfer for GSTT purposes is in excess of the amount of GST exemption affirmatively allocated to the transfer on the date of transfer (i.e., Taxpayer under-allocated GST exemption to the transfer), the deemed allocation rules under section 2036(b) will apply and allocate additional GST exemption to the transfer (assuming he or she has GST exemption available) unless he pays the tax with regard to value of the transfer in excess of the affirmative allocation at the time the direct skip is deemed to have occurred.

If, at the time the direct skip is deemed to have occurred (i.e., at the termination of the ETIP), the value of the transfer for GSTT purposes is less than the amount of GST exemption affirmatively allocated to the transfer on the date of transfer (i.e., Taxpayer over allocated GST exemption to the transfer), reg. section 26.2632-1(b)(4)(i) (prior to redesignation by the proposed regulations), would void that part of the affirmative allocation in excess of the value of the direct skip on the date it is deemed to have occurred.

In the meantime, if Taxpayer otherwise has made transfers to which GST exemption has been allocated (either automatically or affirmatively), the original affirmative allocation by Taxpayer to the transfer is void to the extent that he has already used his maximum GST exemption prior to the deemed occurrence of the direct skip. In effect, he has revoked his previous allocation to the direct skip that did not occur in time prior to his maximization of the use of his GST exemption.

In all the above instances, the effect of the allocations and/or elections prior to the deemed occurrence of the direct skip did not change the GSTT consequences of the direct skip at the time it is deemed to have occurred. In effect, the GSTT consequences of the deemed occurrence of the direct skip are the same as if the deemed allocation rules under section 2036(b)(1) had operated exclusive of Taxpayer’s previous allocations.

We suggest that the italicized parenthetical in reg. section 26.2632-1(c)(1) and the amended italicized parenthetical in reg. section 26.2632-1(c)(1) be removed in the final regulations. This would remove the misconception to the unsuspecting taxpayer that he or she could circumvent the deemed allocation rules for direct (or indirect) skips as they apply to transfers subject to an ETIP prior to the time the direct (or indirect) skip is deemed to have occurred. Reg. section 2632-1(c)(4) makes it clear that the deemed allocation rules under section 2632(b)(1) do not apply to direct skips until the termination of the ETIP. Reg. section 26.2632-1(b)(2)(i) makes it clear that the deemed allocation rules under section 2632(b)(1) do not apply to indirect skips until the termination of the ETIP.

II.Clarify that Elections for Indirect Skips Subject to an ETIP May Be Made at the Original Date of Transfer

Recommendation:

The AICPA recommends expanding the last sentence of reg. section 26.2632-1(b)(2)(i) to clarify its application. The final regulations should read: “The transferor may prevent the automatic allocation of GST exemption with regard to an indirect skip (including indirect skips to which section 2642(f) may apply), as provided in paragraphs (b)(2)(ii) and (iii) of this section.” In addition, the AICPA recommends that the final regulations include in reg. section 26.2632-1(b)(3)(i) the following sentence after the third sentence in reg. section 26.2632-1(b)(3)(i): This election may be made without regard to whether, as to the electing transferor, the trust is subject to section 2642(f).

Discussion:

The last sentence of reg. section 26.2632-1(b)(2)(i) provides that:

The transferor may prevent the automatic allocation of GST exemption with regard to an indirect skip, as provided in paragraphs (b)(2)(ii) and (iii) of this section.

This sentence should be expanded to make it clear that the sentence applies to indirect skips to which section 2642(f) applies (i.e., an ETIP). Section 2632(c)(5)(B) (as amended by the Economic Growth and Tax Relief Reconciliation Act of 2001) indicates that the elections that may be made under section 2632(c)(5)(A)(i)(I) with regard to indirect skips may be made either (1) at the time the transfer is made; (2) at the time the transfer is deemed to have been made; or (3) at some later date prescribed by the Secretary of Treasury. Under section 2632(c)(5)(A)(i)(II) and (B), elections may be made at any time. Specifically, with regard to when elections under section 2632(c)(5)(A) may be made, section 2632(c)(5)(B) states:

(i) Elections with respect to indirect skips. An election under subparagraph (A)(i)(I) shall be deemed to be timely if filed on a timely filed gift tax return for the calendar year in which the transfer was made or deemed to have been made pursuant to paragraph (4) or on such later date or dates as may be prescribed by the Secretary.

(ii) Other elections. An election under clause (i)(II) or (ii) of subparagraph (A) may be made on a timely filed gift tax return for the calendar year for which the election is to become effective.

Nothing in this language prevents an election under section 2632(c)(5)(A) for an indirect skip subject to an ETIP from being made and given effect at the time the transfer is made to a trust. Although section 2632(c)(5)(B)(i) specifically states that an election under section 2632(c)(5)(A)(i)(I) may be made when the ETIP terminates, this provision is expansive and does not prohibit the election from being made at the time of the original transfer to the trust. In addition, section 2632(c)(5(B)(ii) does not limit the elections under section 2632(c)(5)(A)(i)(II) and (ii) in any way. Presumably Congress intended to allow such elections with regard to transfers that are indirect skips subject to an ETIP at the time of the original transfer to the trust.

Accordingly, we suggest amending the last sentence of reg. section 26.2632-1(b)(2)(i) to read as follows:

The transferor may prevent the automatic allocation of GST exemption with regard to an indirect skip (including indirect skips to which section 2642(f) may apply), as provided in paragraphs (b)(2)(ii) and (iii) of this section.

Because they do not refer to section 2642(f), paragraphs (b)(2)(ii) and (iii) of the proposed regulations need not be changed. Presumably elections with regard to indirect skips subject to an ETIP may be made pursuant to these paragraphs.

Additionally, reg. section 26.2632-1(b)(3)(i) should make it clear that an election to treat a trust as a GST trust under section 2632(c)(5)(A)(ii) may be made by a transferor at the time a transfer is made to a trust even though the trust (or property transferred to such trust) is subject to an ETIP as to the transferor. Accordingly, we suggest amending reg. section 26.2632-1(b)(3)(i) by adding the following sentence after the first sentence in reg. section 26.2632-1(b)(3)(i):

This election may be made without regard to whether, as to the electing transferor, the trust is subject to section 2642(f).

As a practical matter, a taxpayer’s inability to make one of the above elections for an indirect skip transfer subject to an ETIP at the time of the original transfer to the trust may create unintended GSTT consequences. Taxpayers may easily forget that an ETIP period has terminated and that they need to take action to address the GST allocation issues. This is especially true where the ETIP terminates due to the death of the transferor, leaving the executor to take action and direct the consequences of a deemed indirect skip. Allowing transferors to make the above elections at the time of the original transfer will ensure that the intended GSTT consequences of the transferor are satisfied.

III.Clarify the Deemed Allocation Rules to Indirect Skips Subject to an ETIP upon Termination of the ETIP and Distribution of Trust Assets to Other Trusts

Recommendation:

The AICPA recommends that the final regulations contain one or two examples addressing the application of the deemed allocation rules for indirect skips to situations in which trusts subject to an ETIP terminate upon the expiration of an ETIP and distribute the assets to other trusts that may be GST trusts.

Discussion:

The above recommendation is best explained by considering the following fact pattern:

Taxpayer creates an irrevocable trust, Trust Z, in which the taxpayer has a qualified annuity interest (as defined in section 2072(b)) for the shorter of the taxpayer’s life or 10 years. Upon the termination of the annuity interest, Trust Z is to be separated into two trusts, Trust A and Trust B. Trust A is for the exclusive benefit of Taxpayer’s children and grandchildren. Trust B is for the exclusive benefit of Taxpayer’s children. Trust A is to receive from Trust Z so much of the Trust Z’s assets as is equal to Taxpayer’s remaining GST exemption, if any. Trust B is to receive from Trust Z the balance of Trust Z’s assets, if any, after funding Trust A.