Do not overlook the income tax deductions for the GST tax.

The Tax Reform Act of 1986 (TRA) revised the method of taxing generation-skipping transfers (GSTs), which Sec. 2611(a) defines as - taxable distributions, - taxable terminations, and - direct skips.

By now every estate planner should be familiar with the provisions of that law. However, few are aware that payment of the GST tax can give rise to valuable income tax deductions - because transfers subject to the GST tax include any distribution from a trust to a "skip" person (other than a taxable termination or a direct skip) (Sec. 2612(b)). This would include not only distributions from principal but also from income. (A skip person is defined in the following Tax Clinic item, "Lapsing Crummey Powers and the GST Tax.")

Tax advisers are aware that Sec. 691(c) has long entitled a distributee who receives income in respect of a decedent (IRD) to an income tax deduction for any Federal estate tax attributable to such income. Sec. 691(c)(3) was amended in 1986 to provide a comparable income tax deduction for the portion of the GST tax imposed on a taxable termination or a direct skip, occurring as a result of the transferor's death, attributable to IRD.

Further, Sec. 164(a)(5), also enacted as part of the TRA, permits an income tax deduction for the GST tax imposed on an income distribution to a skip person - unless the distribution is subject to the "throwback" rules of Sec. 666. However, unlike the Sec. 691(c)(3) deduction, which is allowed only for the Federal GST tax on IRD, the Sec. 164(a)(5) income tax deduction is allowed for both Federal and state GST tax imposed on the distribution. (See Ann. 91-43 for computational guidance.)

Finally, it should be noted that neither income tax deduction (under Sec. 164(a)(5) or 691(c)(3) is subject to the 2% of adjusted gross income floor, since they are not, by definition, "miscellaneous itemized deductions" under Sec. 67 (Sec. 67(b)(2) and (8)).