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Part I: Federal income taxation. (TAX FACTS ON INVESTMENTS: Part 5).

Generation-skipping transfer tax

7575. What is the federal generation-skipping transfer tax?

The federal generation-skipping transfer (GST) tax is a tax on the right to transfer property to a skip person (a person two or more generations (see Q 7578) younger than the transferor). (4fw) The GST tax is repealed for one year in 2010. Technically, EGTRRA 2001 repeals the GST tax for transfers after 2009. However, EGTRRA 2001 sunsets (or expires) after 2010. (5fw)

Depending on the transfer, a generation-skipping transfer is reported on either a gift tax return or an estate tax return. The person required to file the return (Q 7581) and pay the tax (Q 7582) also depends on the type of transfer.

Generation-skipping transfers (Q1510) include direct skips, taxable terminations, and taxable distributions. Taxable terminations and taxable distributions apply to certain terminations of interests in trusts or distributions from trusts. A husband and wife can elect to have all generation-skipping transfers made by either spouse during the year treated as made one-half by each spouse (Q 7579).

Value is generally the value of the taxable amount at the time of the transfer (Q 7577).

A couple of exclusions are available from GST tax. A $13,000 (1fx) (2011 projected amount) annual exclusion is available for certain present interest gifts on a per donor/donee basis. An unlimited exclusion is available for qualified transfers for educational and medical purposes. See Q 7577.

A $1,000,000 (2fx) (in 2011) GST exemption is available to each transferor. Great flexibility is available to allocate or not allocate GST exemption to transfers. An inclusion ratio is derived from allocations of GST exemption to, in effect, determine the amount subject to GST tax. See Q 7577.

Tax is imposed on generation-skipping transfers. The tax rate (55% in 2011, see Appendix B) is a flat rate equal to the top estate tax rate. Tax is equal to the tax rate times the inclusion ratio times the GST (Q 7577).

7576. What is a generation-skipping transfer (GST) on which a generation-skipping transfer tax (GST tax) is imposed?

In general, it is a transfer to a person two or more generations younger than the transferor (called a "skip person"; see Q 7578 regarding generation assignments), and can take any one of three forms: (1) a taxable distribution, (2) a taxable termination, and (3) a direct skip. A trust is also a skip person if the trust can benefit only persons two or more generations younger than the transferor. (3fx) The GST tax is repealed for one year in 2010. (4fx)

Transferor

A "transferor," in the case of any property subject to the federal estate tax, is the decedent. In the case of any property subject to the federal gift tax, the transferor is the donor. (5fx) Thus, to the extent that a lapse of a general power of appointment (including a right of withdrawal) is subject to gift or estate tax, the powerholder becomes the transferor with respect to such lapsed amount. (6fx) Thus, a Crummey powerholder should not be treated as a transferor with respect to the lapse of a withdrawal power if the amount lapsing in any year is no greater than (1) $5,000, or (2) 5% of the assets out of which exercise of the power could be satisfied. (7fx)

If there is a generation-skipping transfer of any property and immediately after such transfer such property is held in trust, a different rule (the "multiple skip" rule) applies to subsequent transfers from such trust. In such case, the trust is treated as if the transferor (for purposes of subsequent transfers) were assigned to the first generation above the highest generation of any person having an "interest" (see below) in such trust immediately after such transfer. (8fx) If no person holds an interest immediately after the GST, then the transferor is assigned to the first generation above the highest generation of any person in existence at the time of the GST who may subsequently hold an interest in the trust. (9fx)

For the effect of making a "reverse QTIP election," see Q 7577.

Direct Skip

A direct skip is a transfer subject to federal gift or estate tax to a skip person. However, with respect to transfers before 1998, such a transfer was not a direct skip if the transfer was to a grandchild of the transferor or of the transferor's spouse or former spouse, and the grandchild's parent who was the lineal descendant of the transferor or his spouse or former spouse was dead at the time of the transfer. In other words, a person could be stepped-up in generations because a parent who had been in the line of descent predeceased such person. This rule could be reapplied to lineal descendants below that of a grandchild. Persons assigned to a generation under this rule were also assigned to such generation when such persons received transfers from the portion of a trust attributable to property to which the step-up in generation rule applied. (1fy) For purposes of this predeceased child rule, a living descendant who died no later than 90 days after a transferor was treated as predeceasing the transferor if treated as predeceased under the governing instrument or state law. (2fy) For a more expansive predeceased parent rule after 1997, see Q 7578.

In some circumstances, whether a step-up in generation was available could depend on whether a QTIP or a reverse QTIP marital election was made for GSTT purposes (see Q 7577). If the parent of a grandchild-distributee died after the transfer by a grandparent to a generation-skipping trust but before the distribution from the trust to the grandchild and a reverse QTIP election had been made, the distribution was a taxable termination and the "step-up in generation" rule was not available. However, if the reverse QTIP election had not been made, the distribution was eligible for the "step-up in generation" exception from treatment as a direct skip and was not subject to GSTT. (3fy)

Also, for purposes of the GST tax, the term "direct skip" did not include any transfer before January 1, 1990, from a transferor to a grandchild of the transferor to the extent that the aggregate transfers from such transferor to such grandchild did not exceed $2 million. This $2 million exemption was available with respect to a transfer in trust only if (1) during the life of such individual no portion of the trust corpus or income could be distributed to or for the benefit of any other person, (2) the trust would be included in such individual's estate if such individual were to die before the trust terminated, and (3) all of the income of the trust had to be distributed at least annually to the grandchild once he reached 21. Requirement (3) applied only to transfers after June 10, 1987. However, the Committee Report indicated that this requirement was not satisfied by a Crummey demand power. (4fy)

The $2 million per grandchild exemption applied to transfers to grandchildren only; the step-up in generation rule for a predeceased parent did not apply. A transfer which would have been a direct skip were it not for the $2 million exemption was likewise exempted from being treated as a taxable termination or taxable distribution. However, the rules which apply to the taxation of multiple skips will apply to subsequent transfers from such trust.

Taxable Termination

A taxable termination occurs when an "interest in property" (see below) held in trust (or some arrangement having substantially the same effect as a trust) for a skip person is terminated by an individual's death, lapse of time, release of a power, or otherwise, unless either (1) a nonskip person has an interest in the trust immediately after such termination, or (2) at no time after the termination may a distribution be made from the trust to a skip person, other than a distribution the probability of which occurring is so remote as to be negligible (i.e., less than a 5% actuarial probability). If upon the termination of an interest in a trust by reason of the death of a lineal descendant of the transferor, a portion of the trust is distributed to skip persons (or to trusts for such persons), such partial termination is treated as taxable. If a transfer subject to estate or gift tax occurs at the time of the termination, the transfer is not a taxable termination (but it may be a direct skip). (1fz)

Taxable Distribution

A taxable distribution is any distribution from a trust to a skip person (other than a taxable termination or a direct skip). (2fz)

Generation-Skipping Transfer Exceptions

However, the following are not considered generation-skipping transfers:

(1) Any transfer which, if made during life by an individual, would be a "qualified transfer" (see Q 7596); and

(2) Any transfer to the extent (a) the property transferred was subject to a prior GST tax, (b) the transferee in the prior transfer was in the same generation as the current transferee or a younger generation, and (c) the transfers do not have the effect of avoiding the GST tax. (3fz)

Interest in Property

A person has an "interest in property" held in trust if (at the time the determination is made) such person--

(1) has a present right to receive income or corpus from the trust (Ex: a life income interest);

(2) is a permissible current recipient of income or corpus from the trust (Ex: a beneficiary entitled to distribution of income or corpus, but only in the discretion of the trustee) and is not a charitable organization (specifically, one described in IRC Section 2055(a)); or

(3) is such a charitable organization and the trust is a charitable remainder annuity trust (see Q 7951), a charitable remainder unitrust (see Q 7952), or a pooled income fund (see Q 7953).

In determining whether a person has an interest in a trust, the fact that income or corpus may be used to satisfy a support obligation is disregarded if such use is discretionary or made pursuant to the Uniform Gifts to Minors Act (or similar state statute). In other words, a parent is not treated as having an interest in a trust merely because the parent acts as guardian for a child. However, a parent would be treated as having an interest in the trust if support obligations are mandatory. (1ga)

An interest may be disregarded if it is used primarily to postpone or avoid the generation-skipping tax. (2ga) The regulations provide that an interest is disregarded if a significant purpose for the creation of the interest is the postponement or avoidance of the generation-skipping tax. (3ga)

Effective Date and Transitional Rules

The rules explained here and in the succeeding questions apply generally to any generation-skipping transfer (GST) made after October 22, 1986. Also, any lifetime transfer after September 25, 1985, and on or before October 22, 1986, is treated as if made on October 23, 1986. These rules will not, however, apply to the following:

(1) Any GST under a trust that was irrevocable on September 25, 1985, but only to the extent that such transfer is not made out of corpus (or income attributable to such corpus) added to the trust after September 25, 1985;

(2) Any GST under a will or revocable trust executed before October 22, 1986, if the decedent died before January 1, 1987; and

(3) Any GST--

(a) under a trust to the extent such trust consists of property included in the gross estate of a decedent (other than property transferred by the decedent during his life after October 22, 1986), or reinvestments thereof, or

(b) which is a direct skip that occurs by reason of the death of any decedent;

but only if such decedent was, on October 22, 1986, under a mental disability to change the disposition of his property and did not regain his competence to dispose of such property before the date of his death. (4ga) It appears that Congress does not intend for the third grandfathering rule to apply with respect to property transferred after August 3, 1990 to an incompetent person, or to a trust of such a person. (5ga)

7577. How is the amount of tax on a GST determined? What is the GST exemption and how is it applied in determining the GST tax?

The amount of tax is the "taxable amount" (based on the kind of GST involved--see Q 7576) multiplied by the "applicable rate." (6ga) The applicable rate of tax applied to the taxable amount is itself a product. It is a product of the maximum federal estate tax rate in effect at the time of the GST (55% in 2011, see Appendix B) and the "inclusion ratio" with respect to the transfer. (1gb) The inclusion ratio, in turn, depends on allocations of the "GST exemption." (2gb) The GST tax is repealed for one year in 2010. (3gb)

Taxable Amount

In the case of a taxable distribution, the taxable amount is the value of the property received by the transferee reduced by any expense incurred by the transferee with respect to the GST tax imposed on the distribution. If any portion of the GST tax with respect to a taxable distribution is paid out of the trust, the taxable distribution is increased by such an amount. (4gb)

In the case of a taxable termination, the taxable amount is the value of all property with respect to which the taxable termination has occurred, reduced by the expenses, similar to those allowed as a deduction under IRC Section 2053 in determining the taxable estate for estate tax purposes (see Q 7572, the first heading), with respect to which the taxable termination has occurred. (5gb)

In the case of a direct skip, the taxable amount is the value of the property received by the transferee. (6e) Where a life estate was given to a skip person and a remainder interest was given to a non-skip person, the value of the entire property (and not just the actuarial value of the life estate) was subject to GST tax. (7gb)

GST Exemption

For purposes of determining the inclusion ratio, every individual is allowed a GST exemption of $1,000,000 (8gb) (in 2011, see Appendix B) which may be allocated irrevocably by him (or his executor) to any property with respect to which he is the transferor. In 2004 to 2009, the GST exemption is equal to the estate tax unified credit equivalent (applicable exclusion amount) rather than to $1 million as indexed (see Appendix B). [The $1,000,000 amount is adjusted for inflation, rounded down to the next lowest multiple of $10,000, after 1998 and before 2004 (and after 2010, if there is no Congressional legislation amending it). Any indexing increase in the GST exemption is available for all generation-skipping transfers occurring in the year of the increase and subsequent years in which the GST exemption is equal to $1 million as indexed up to the year of the decedent's death.] (9gb) The GST tax is repealed for one year in 2010. In general, an individual or the individual's executor may allocate the GST exemption at any time from the date of the transfer until the time for filing the individual's federal estate tax return (including extensions actually granted), regardless of whether a return is required (see Q 7574). (10gb)

The GST exemption is automatically allocated to lifetime direct skips unless otherwise elected on a timely filed federal gift tax return (see Q 7600). (1gc)

In addition, any unused GST exemption is automatically allocated to indirect skips to a GST trust, effective 2001 to 2009. (2gc) An indirect skip is a transfer (other than a direct skip) subject to gift tax to a GST trust. A transferor can elect to have the automatic allocation not apply to (1) an indirect skip, or (2) to any or all transfers made by the individual to a particular trust. The transferor can also elect to treat a trust as a GST trust with respect to any or all transfers made by the individual to the trust. Nevertheless, an allocation still cannot be made until the end of any estate tax inclusion period (see below).

A GST trust is a trust that could have a generation-skipping transfer with respect to the transferor unless:

1. The trust provides that more than 25% of the trust corpus must be distributed to, or may be withdrawn by, one or more individuals who are non-skip persons, either (a) before the individual's 46th birthday, (b) on or before a date prior to such birthday, or (c) an event that may reasonably be expected to occur before such birthday.

2. The trust provides that more than 25% of the trust corpus must be distributed to, or may be withdrawn by, one or more individuals who are non-skip persons and who are living on the date of death of an individual identified in the trust (by name or class) who is more than 10 years older than such individuals.

3. The trust provides that, if one or more individuals who are non-skip persons die before a date or event described in (1) or (2), more than 25% of the trust corpus must either (a) be distributed to the estate(s) of one or more of such individuals, or (b) be subject to a general power of appointment exercisable by one or more of such individuals.

4. Any portion of the trust would be included in the gross estate of a non-skip person (other than the transferor) if such person died immediately after the transfer.

5. The trust is a charitable lead annuity trust (CLAT), charitable remainder annuity trust (CRAT), charitable remainder unitrust (CRUT), or a charitable lead unitrust (CLUT) with a non-skip remainder person.

For purposes of these GST trust rules, the value of transferred property is not treated as includable in the gross estate of a non-skip person nor subject to a power of withdrawal if the withdrawal right does not exceed the amount of the gift tax annual exclusion with respect to the transfer. It is also assumed that a power of appointment held by a non-skip person will not be exercised.

Regulations generally permit elections to allocate or not allocate GST exemption to individual transfers or to all current or future transfers to a trust, or any combination of these. An election with regard to all transfers to a trust can later be revoked with respect to future transfers to the trust. The regulations also permit elections with regard to individual transfers to a trust even where an election is in place with regard to all transfers to a trust. (1gd)

Planning Point: It probably makes sense for grantors to make elections to allocate or not allocate GST exemption with respect to all transfers to a particular trust. GST exemption can be allocated to trusts benefiting skip persons; while allocations are not made to trusts benefiting non-skip persons. If need be, the election could be changed later, for future transfers.

A retroactive allocation of the GST exemption can be made when certain non-skip beneficiaries of a trust predecease the transferor, effective 2001 to 2009. The non-skip beneficiary must (1) have an interest or a future interest (for this purpose, a future interest means the trust may permit income or corpus to be paid to such person on a date or dates in the future) in the trust to which any transfer has been made, (2) be a lineal descendant of a grandparent of the transferor or of a grandparent of the transferor's spouse or former spouse, (3) be assigned to a generation lower than that of the transferor, and (4) predecease the transferor. In such a case, an allocation of the transferor's unused GST exemption (determined immediately before the non-skip person's death) can be made to any previous transfer or transfers to the trust (value of transfer is its gift tax value at the time of the transfer) on a chronological order. The allocation is made by the transferor on the gift tax return for the year of the non-skip person's death. The allocation is treated as effective immediately before the non-skip person's death. (2gd)

Example. Grandparent creates a trust for the primary benefit of Child, with Grandchild as contingent remainder beneficiary. Grandparent doesn't expect Grandchild will receive anything, or that the trust will be generation-skipping; so he doesn't allocate GST exemption to the trust. (Or, perhaps, allocation of the GST exemption was simply overlooked.) Child dies unexpectedly before Grandparent. There is a GST taxable termination at Child's death. Grandparent can make a retroactive allocation of GST exemption to the trust to reduce or eliminate the GST tax on the taxable termination.

With regard to lifetime transfers other than a direct skip, an allocation is made on the federal gift tax return. An allocation can use a formula (e.g., the amount necessary to produce an inclusion ratio of zero). An allocation on a timely filed gift tax return is generally effective as of the date of the transfer. An allocation on an untimely filed gift tax return is generally effective as of the date the return is filed and is deemed to precede any taxable event occurring on such date. (For certain retroactive allocations, see above.) An allocation of the GST exemption is irrevocable after the due date. However, an allocation of GST exemption to a trust (other than a charitable lead annuity trust, see below) is void to the extent the amount allocated exceeds the amount needed to produce an inclusion ratio of zero (see below). (3gd)

An executor can make an allocation of the transferor's unused GST exemption on the transferor's federal estate tax return. An allocation with respect to property included in the transferor's estate is effective as of the date of death. A late allocation of the GST with respect to a lifetime transfer can be made by the executor on the estate tax return and is effective as of the date the allocation is filed.

A decedent's unused GST exemption is automatically and irrevocably allocated on the due date for the federal estate tax return to the extent not otherwise allocated by the executor. The automatic allocation is made to nonexempt property: first to direct skips occurring at death, and then to trusts with potential taxable distributions or taxable terminations. (1ge)

Inclusion Ratio

In general, the inclusion ratio with respect to any property transferred in a GST is the excess of one minus (a) the "applicable fraction" for the trust from which the transfer is made, or (b) in the case of a direct skip, the applicable fraction determined for the skip. (2ge)

The "applicable fraction" is a fraction (a) the numerator of which is the amount of the GST exemption allocated to the trust (or to the property transferred, if a direct skip), and (b) the denominator of which is the value of the property transferred reduced by (i) the sum of any federal estate or state death tax actually recovered from the trust attributable to such property, (ii) any federal gift tax or estate tax charitable deduction allowed with respect to such property, and (iii) with respect to a direct skip, the portion that is a nontaxable gift (see below). The fraction should be rounded to the nearest one-thousandth, with five rounded up (i.e., .2345 is rounded to .235). If the denominator of the applicable fraction is zero, the inclusion ratio is zero. (3ge)

Example. In the year 2009, G transfers irrevocably in trust for his grandchildren $10 million and allocates all his $3,500,000 GST exemption to the transfer. The applicable fraction is 3,500,000/10,000,000, or .350. The inclusion ratio is 1 minus .350, or .650. The maximum estate tax rate, 45%, is applied against the inclusion ratio, .650. The resulting percentage, 29.25%, is applied against the value of the property transferred, $10,000,000, to produce a GST tax of $2,925,000. The tax is paid by G, the transferor, because this is a direct skip (other than a direct skip from a trust) (see Q 7576).

Example. Same facts as in preceding example, except that for federal gift tax purposes G's wife consented to a split gift of the $10 million (see Q 7579). Thus, for GST tax purposes as well, the gift is considered split between the spouses. If they both elect to have their respective GST exemptions allocated to the transfer, the applicable fraction for each is 3,500,000/5,000,000, or .700. The inclusion ratio is 1 minus .700, or .300. The maximum estate tax rate, 45%, is applied against the inclusion ratio, .300. The resulting percentage, 13.5%, is applied against the value of the property transferred, $5,000,000, to produce a GST tax of $675,000 for each, or a total GST tax of $1,350,000 on the $10 million transfer. The tax is paid 1/2 each by G and G's wife, the transferors, because each gift is a direct skip (other than a direct skip from a trust) (see Q 7576).

Example. In 2009, G transfers $100,000 to a trust and allocates $100,000 GST exemption to the trust. The trust has an inclusion ratio of zero, and taxable distributions and taxable terminations can be made free of GST tax.

Example. In 2009, G transfers $100,000 to a trust and allocates no GST exemption to the trust. If all the trust beneficiaries are grandchildren of G, G has made a direct skip fully subject to GST tax. The GST tax is $45,000 ($100,000 transfer X 45% GST tax rate in 2009) and is payable by G. If the trust beneficiaries are children and grandchildren of G, the trust has an inclusion ratio of one, and GST transfers are fully subject to tax at the GST tax rate at the time of any later transfer.

If there is more than one transfer in trust the applicable fraction must be recomputed at the time of each transfer. Thus, if property is transferred to a preexisting trust, the "recomputed applicable fraction" is determined as follows: The numerator of such fraction is the sum of

(1) the amount of the GST exemption allocated to the property involved in such transfer and

(2) the nontax portion of the trust immediately before the transfer. (The nontax portion of the trust is the value of the trust immediately before the transfer multiplied by the applicable fraction in effect before such transfer.) The denominator of such fraction is the value of the trust immediately after the transfer reduced by (i) the sum of any federal estate or state death tax actually recovered from the trust attributable to such property, (ii) any federal gift tax or estate tax charitable deduction allowed with respect to such property, and (iii) with respect to a direct skip, the portion that is a nontaxable gift (see below). (1gf)

Example. In the year 1995, G transfers irrevocably in trust for his children and grandchildren $4 million and allocates all his $1 million GST exemption to the transfer. The applicable fraction is 1,000,000/4,000,000, or .250. The inclusion ratio is 1 minus .250, or .750.

In 2001, the trust makes a taxable distribution to the grandchildren of $100,000. The maximum estate tax rate, 55% in 2001, is applied against the inclusion ratio, .750. The resulting percentage, 41.25%, is multiplied by the $100,000 transfer, resulting in a GST tax of $41,250. GST taxes in this example are paid by the grandchildren, the transferees, because the transfers are taxable distributions (see Q 7582).

In 2009, the trust makes a taxable distribution to the grandchildren of $100,000. The maximum estate tax rate, 45% in 2009, is applied against the inclusion ratio, .750. The resulting percentage, 33.75%, is multiplied by the $100,000 transfer, resulting in a GST tax of $33,750.

Later in 2009, when the trust property has grown to $6 million, G transfers an additional $3 million to the trust. An additional $2,500,000 of GST exemption is available to G in 2009 ($3,500,000 GST exemption in 2009 minus $1,000,000 exemption already used). The numerator of the recomputed fraction is the value of the nontax portion of the trust immediately before the transfer, or $1.5 million (value of the trust, $6 million, multiplied by the applicable fraction of .250), plus $2,500,000 additional exemption, or $4,000,000. The denominator of the recomputed fraction is $9 million (the sum of the transferred property, $3 million, and the value of all the property in the trust immediately before the transfer, $6 million). The applicable fraction is 4,000,000/9,000,000, or .444. The inclusion ratio is 1 minus .444, or .556.

Later in 2009, the trust makes a taxable distribution to the grandchildren of $100,000. The maximum estate tax rate, 45% in 2009, is applied against the inclusion ratio, .556. The resulting percentage, 25.02%, is multiplied by the $100,000 transfer, resulting in a GST tax of $25,020.

Planning Point: Trusts are usually created with an inclusion ratio of either one (GST transfers, if any, with respect to trust are fully taxable) or zero (fully exempt from GST tax). A trust has an inclusion ratio of zero if GST exemption is allocated to any transfer to the trust that is not a nontaxable gift (an allocation of GST exemption is not needed for a direct skip nontaxable gift (see below); it has an inclusion ratio of zero). For information on severing a trust to create separate trusts with inclusion ratios of zero and one, see "Separate Trusts," below.

Valuation

"Value" of the property is its value at the time of the transfer. In the case of a direct skip of property that is included in the transferor's gross estate, the value of the property is its estate tax value. In the case of a taxable termination with respect to a trust occurring at the same time as and as a result of the death of an individual, an election may be made to value at the alternate valuation date (see Q 7602). In any case, the value of the property may be reduced by any consideration given by the transferee. (1gg)

For purposes of determining the GST inclusion ratio, certain other valuation rules may apply in some instances. For purposes of determining the denominator of the applicable fraction (see above), the value of property transferred during life is its fair market value as of the effective date of the GST exemption allocation (see above). However, with respect to late allocations of the GST exemption to a trust, the transferor may elect (solely for purpose of determining the fair market value of trust assets) to treat the allocation as made on the first day of the month in which the allocation is made. This election is not effective with respect to a life insurance policy, or a trust holding a life insurance policy, if the insured individual has died. For purposes of determining the denominator of the applicable fraction, the value of property included in the decedent's gross estate is its value for estate tax purposes. However, special use valuation (see Q 7601) is not available unless the recapture agreement under IRC Section 2032A specifically refers to the GST tax. There are special rules in the regulations concerning the allocation of post-death appreciation or depreciation with respect to pecuniary payments and residuary payments made after a pecuniary payment. (2gg)

Charitable Lead Annuity Trusts

With respect to property transferred after October 13, 1987, the GST tax exemption inclusion ratio for any charitable lead annuity trust (see Q 7958) is to be determined by dividing the amount of exemption allocated to the trust by the value of the property in the trust following the charitable term. For this purpose, the exemption allocated to the trust is increased by interest determined at the interest rate used in determining the amount of the estate or gift tax charitable deduction with respect to such a trust over the charitable term. With respect to a late allocation of the GST exemption (see above), interest accrues only from the date of the late allocation. The amount of GST exemption allocated to the trust is not reduced even though it is determined at a later time that a lesser amount of GST exemption would have produced a zero inclusion ratio. (3gg)

Estate Tax Inclusion Period (ETIP)

With respect to inter vivos transfers subject at some point in time to the GST tax, the allocation of any portion of the GST tax exemption to such a transfer is postponed until the earlier of (a) the expiration of the period (not to extend beyond the transferor's death) during which the property being transferred would be included in the transferor's estate (other than by reason of the gifts within three years of death rule of IRC Section 2035) if he died, or (b) the GST. For purposes of determining the inclusion ratio with respect to such exemption, the value of such property is: (a) its estate tax value if it is included in the transferor's estate (other than by reason of the three year rule of IRC Section 2035), or (b) its value determined at the end of the ETIP. However, if the allocation of the exemption under the second valuation method is not made on a timely filed gift tax return for the year in which the ETIP ends, determination of value is postponed until such allocation is filed. (4gg)

Example. Grantor sets up an irrevocable trust: income retained for 10 years, then life estate for children, followed by remainder to grandchildren. The valuation of property for purpose of the inclusion rule is delayed until the earlier of the expiration of the 10-year period or the transferor's death. If the grantor were to die during such time the property would be included in the grantor's estate under IRC Section 2036(a) (see Q 7565). However, if the grantor survived the 10-year period and failed to make an allocation of the exemption on a timely filed gift tax return, the determination of value is postponed until the earlier of the time an allocation is filed or death.

Except as provided in regulations, for purpose of the GST tax exemption allocation rules, any reference to an individual or a transferor is generally treated as including the spouse of such individual or transferor. (1gh) Thus, an ETIP includes the period during which, if death occurred, the property being transferred would be included in the estate (other than by reason of the gifts within three years of death rule of IRC Section 2035) of the transferor or the spouse of the transferor. The property is not considered as includable in the estate of the transferor or the spouse of the transferor if the possibility of inclusion is so remote as to be negligible (i.e., less than a 5% actuarial probability). The property is not considered as includable in the estate of the spouse of the transferor by reason of a withdrawal power limited to the greater of $5,000 or 5% of the trust corpus if the withdrawal power terminates no later than 60 days after the transfer to trust. Apparently, the ETIP rules do not apply if a reverse QTIP election (see below) is made. The ETIP terminates on the earlier of (1) the death of the transferor; (2) the time at which no portion would be includable in the transferor's estate (other than by reason of IRC Section 2035) or, in the case of the spouse who consents to a split-gift, the time at which no portion would be includable in the other spouse's estate; (3) the time of the GST (but only with respect to property involved in the GST); or (4) in the case of an ETIP arising because of an interest or power held by the transferor's spouse, at the earlier of (a) the death of the spouse, or (b) the time at which no portion would be includable in the spouse's estate (other than by reason of IRC Section 2035). (2gh)

Example. Grantor sets up an irrevocable trust: income retained for the shorter of nine years or life, remainder to grandchild. Grantor and spouse elect to split the gift. If spouse dies during trust term, spouse's executor can allocate GST exemption to spouse's deemed one-half of the trust. However, the allocation is not effective until the earlier of the expiration of grantor's income interest or grantor's death.

The regulations provide that the election out of automatic allocation of GST exemption for either a direct skip or an indirect skip can be made at any time up until the due date for filing the gift tax return for the year the ETIP ends. If the transfer subject to an ETIP occurred in an earlier year, the election must specify the particular transfer. An affirmative allocation of GST exemption cannot be revoked after the due date for filing the gift tax return for the year the affirmative election is made (or after the allocation is made in the case of a late allocation), even where actual allocation is not effective until the end of an ETIP. (3gh)

Separate Trusts

In general, portions of a trust are not to be treated as separate trusts. However, portions attributable to different transferors, substantially separate and independent shares of different beneficiaries of a trust, and trusts treated as separate trusts under state law are to be treated as separate trusts for GST tax purposes. (1gi) However, treatment of a single trust as separate shares for purposes of the GST tax does not permit treatment as separate trusts for purposes of filing or payment of tax, or for purposes of any other tax. Additions to, or distributions from, such a trust are allocated pro-rata among all shares unless expressly provided otherwise. In general, a separate share is not treated as such unless it exists at all times from and after creation of the trust.

Trusts created from a qualified severance are treated as separate trusts for GST tax purposes, effective for 2001 to 2009. A qualified severance means the division of a single trust into two or more trusts under the trust document or state law if (1) the single trust is divided on a fractional basis, and (2) in the aggregate, the terms of the new trusts provide for the same succession of interests of beneficiaries as are provided in the original trust. In the case of a trust with a GST inclusion ratio of greater than zero and less than one (i.e., the trust is partially protected from the GST by allocations of the GST exemption), a severance is a qualified severance only if the single trust is divided into two trusts, one of which receives a fractional amount equal to the GST applicable fraction multiplied by the single trust's assets. The trust receiving the fractional amount receives an inclusion ratio of zero (i.e., it is not subject to GST tax), and the other trust receives an inclusion ratio of one (i.e., it is fully subject to GST tax). (2gi)

Otherwise, severance of a trust included in the taxable estate (or created in the transferor's will) into single shares will be recognized for GST purposes if (1) the trusts are severed pursuant to the governing instrument or state law, (2) such severance occurs (or a reformation proceeding is begun and is indicated on the estate tax return) prior to the date for filing the estate tax return (including extensions actually granted), and (3) the trusts are funded using (a) fractional interests or (b) pecuniary amounts for which appropriate adjustments are made. (3gi)

Regulations provide that a qualified severance must be done on a fractional or percentage basis; a severance based on a specific pecuniary amount is not permitted. The terms of the new trusts must provide in the aggregate for the same succession of beneficiaries. With respect to trusts from which discretionary distributions may be made on a non pro rata basis, this requirement can be satisfied even if each permissible beneficiary might be a beneficiary of only one of the separate trusts, but only if no beneficial interest is shifted to a lower generation and the time for vesting of any beneficial interest is not extended. (4gi)

The regulations provide that the separate trusts must be funded with property from the severed trust with either a pro rata portion of each asset or on a non pro rata basis. If funded on a non pro rata basis, the separate trusts must be funded by applying the appropriate severance fraction or percentage to the fair market value of all the property on the date of severance. The date of severance is either the date selected by the trustee or a court-imposed date of funding. The funding of the separate trusts must commence immediately, and occur within a reasonable period of time (not more than 90 days) after the date of severance.

A qualified severance is deemed to occur before a taxable termination or a taxable distribution that occurs by reason of the qualified severance. For example, a trust provides for trust income to be paid annually to grantor's child (C) and grandchild (GC) for 10 years, remainder to C and GC or their descendants. If either dies during the trust term, income is payable to that person's then-living descendants. The inclusion ratio for the trust is .50. The trust is severed into one trust for C and C's descendants and one for GC and GC's descendants. The trustee designates the trust for C as having an inclusion ratio of one, and the trust for GC as having an inclusion ratio of zero. The severance causes either a taxable termination of C's interest in, or a taxable distribution to, GC's trust (which is a skip person). However, the severance is deemed to occur before the GST and GC's trust has an inclusion ratio of zero; therefore, there is no GST tax due. (1gj)

A trust that is partly grandfathered from GST tax can be severed into a grandfathered and a nongrandfathered trust under these rules.

Regulations provide that, for purpose of funding the separate trusts, assets must be valued without taking into consideration any discount or premium arising from the severance. (2gj) For example, if the severance creates a minority interest when the separate trust receives less than the interest owned by the original trust, such a minority discount is disregarded for funding purposes.

Regulations provide that, with respect to a qualified severance of a trust with an inclusion ratio greater than zero and less than one, one or more resulting trusts must be funded with an amount equal to the GST applicable fraction (used to determine the GST inclusion ratio for the original trust immediately before the severance) times the value of the original trust on the date of severance. Each such resulting trust receives an inclusion ratio of zero. All other resulting trusts receive an inclusion ratio of one. If two or more trusts receive an amount equal to the applicable fraction of the original trust, the trustee can select which of the resulting trusts has an inclusion ratio of zero, and which has the inclusion ratio of one. For example, if the original trust has an applicable percentage of .50 and the trust is severed into two trusts, the trustee can select which of the two resulting trusts has an inclusion ratio of zero, and which has an inclusion ratio of one. (3gj)

Regulations provide that, where a trust is severed and the severance is not qualified, the resulting trusts each receive an inclusion ratio equal to the inclusion ratio of the original trust. (4gj)

Regulations provide that, for purposes of the requirements that a separate share is not treated as such unless it exists at all times from and after creation of the trust, a trust is treated as created on the date of death of the grantor if the trust is fully includable in the gross estate of the grantor for estate tax purposes. Also, if the trust document requires the mandatory severance of a trust upon the occurrence of an event (not within the discretion of any person), the resulting trusts will be treated as separate trusts for GST tax purposes. The resulting trusts each receive an inclusion ratio equal to the inclusion ratio of the original trust. (5gj)

Planning Point: The advantage of having portions or shares of a trust treated as separate trusts is that the transferor can decide whether or not to allocate a portion of his GST tax exemption to each separate trust and the trustee can make distributions from the separate trusts in a way which minimizes GST tax.

Nontaxable Gifts

In the case of any direct skip which is a nontaxable gift, the inclusion ratio is zero. For this purpose, a nontaxable gift means any transfer of property to the extent the transfer is not treated as a taxable gift by reason of the gift tax annual exclusion (taking into account the split gift provision for married couples--see Q 7596) or the "qualified transfer" exclusion (see Q 7596). In other words, there is no GST tax imposed on direct skip gifts that come within the gift tax annual exclusion or that are "qualified transfers." However, with respect to transfers after March 31, 1988, a nontaxable gift which is a direct skip to a trust for the benefit of an individual has an inclusion ratio of zero only if (1) during the life of such individual no portion of the trust corpus or income may be distributed to or for the benefit of any other person, and (2) the trust would be included in such individual's estate if the trust did not terminate before such individual died. (1gk)

Reverse QTIP Election

A qualified terminable interest property (QTIP) election can be made to qualify property for the estate tax (see Q 7572) and gift tax (see Q 7597) marital deductions. A reverse QTIP election may be made for such property under the GST tax. The effect of making the reverse QTIP election is to have the decedent or the donor treated as the transferor (see Q 7576) for GST tax purposes. However, if a reverse QTIP election is made for property in a trust, the election must be made for all of the property in the trust. However, the Committee Report states that if the executor indicates on the federal estate tax return that separate trusts will be created, such trusts will be treated as separate trusts. In other words, separate trusts can be created so that the QTIP and reverse QTIP election can be made for different amounts, and thus minimize all transfer taxes. (2gk) See "Separate Trusts," above regarding the creation of separate shares from a single trust.

Example. In 2009, decedent (who has made $500,000 of taxable gifts protected by the unified credit) with a $7,000,000 estate leaves $3,000,000 in a credit shelter trust and $4,000,000 to his surviving spouse in a QTIP trust, reducing his estate tax to zero. (Assume each trust would be subject to GST tax to the extent that the $3,500,000 exemption is not allocated to such trust.) The executor allocates $3,000,000 of the decedent's $3,500,000 GST tax exemption to the credit shelter trust and makes a reverse QTIP election as to $500,000 of the QTIP property so that the decedent's full $3,500,000 exemption can be used. The surviving spouse's $3,500,000 exemption amount may then be used to protect the remaining $3,500,000 of property, and the entire $7,000,000 has escaped GST tax (assuming separate QTIP trusts of $3,500,000 and $500,000 are created).

Basis Adjustment

Where the basis of property subject to the GST tax is increased (or decreased) to fair market value because property transferred in a taxable termination occurs at the same time and as a result of the death of an individual, any increase (or decrease) in basis is limited by multiplying such increase (or decrease) by the inclusion ratio used in allocating the GST exemption. (3gk)

7578. How are individuals assigned to generations for purposes of the GST tax?

An individual (and his spouse or former spouse) who is a lineal descendant of a grandparent of the transferor (or the transferor's spouse) is assigned to that generation which results from comparing the number of generations between the grandparent and such individual with the number of generations between the grandparent and the transferor (or the transferor's spouse). A relationship by legal adoption is treated as a relationship by blood, and a relationship by the half-blood is treated as a relationship of the whole blood. (1gl)

A person who could be assigned to more than one generation is assigned to the youngest generation. However, regulations provide that adopted individuals will be treated as one generation younger than the adoptive parent where: (1) a transfer is made to the adopted individual from the adoptive parent, the spouse or former spouse of the adoptive parent, or a lineal descendant of a grandparent of the adoptive parent; (2) the adopted individual is a descendant of the adoptive parent (or the spouse or former spouse of the adoptive parent); (3) the adopted individual is under age 18 at the time of adoption; and (4) the adoption is not primarily for the purpose of avoiding GST tax. (2gl)

However, with respect to terminations, distributions, and transfers occurring after 1997, where an individual's parent is dead at the time of a transfer subject to gift or estate tax upon which the individual's interest is established or derived, such individual will be treated as being one generation below the lower of (1) the transferor's generation or (2) the generation of the youngest living ancestor of the individual who is also a descendant of the parents of the transferor or the transferor's spouse. This predeceased parent rule applies to collateral relatives (e.g., nieces and nephews) only if there are no living lineal descendants of the transferor at the time of the transfer. (3gl) For a narrower predeceased parent rule that applied to direct skips before 1998, see Q 7576.

Regulations make clear that if the generation-skipping property is subject to gift tax or estate tax on more than one occasion, the time for determining application of the predeceased parent rule is on the first of such occasions. In the case of a qualified terminable interest property (QTIP) marital deduction election, the time for determining application of the predeceased parent rule can essentially wait until the surviving spouse dies or makes a gift of the QTIP property. However, where a reverse QTIP election is made, application of the predeceased parent rule is made at the time of the first spouse's death. Also, at times property may be transferred to a trust before the predeceased parent rule is applicable. Later, the predeceased parent rule applies to additional property transferred to the trust. The additional property is treated as being held in a separate trust for GST tax purposes. Each portion has, in effect, a separate transferor. (4gl)

An individual who cannot be assigned to a generation under the foregoing rules is assigned to a generation on the basis of his date of birth. An individual born not more than 12 1/2 years after the date of birth of the transferor is assigned to the transferor's generation. An individual born more than 12 1/2 years but not more than 37 1/2 years after the date of birth of the transferor is assigned to the first generation younger than the transferor. There are similar rules for a new generation every 25 years. (1gm)

7579. Can married couples make a split gift for purposes of the GST tax?

Yes. If a split gift is made for gift tax purposes (see Q 7596), such gift will be so treated for purposes of the GST tax. (2gm) Split gifts allow spouses to, in effect, utilize each other's annual exclusions and exemptions (see Q 7577). One memorandum permitted a taxpayer to elect after his spouse's death to split gifts with his spouse and thus take advantage of his spouse's GST tax exemption where the gifts were made by the taxpayer shortly before the spouse's death. (3gm)

7580. What credits are allowed against the GST tax?

For decedents dying before 2005 or after 2010, if a GST (other than a direct skip) occurs at the same time as and as a result of the death of an individual, a credit against the GST tax imposed is allowed in an amount equal to the GST tax actually paid to any state in respect to any property included in the GST, but the amount cannot exceed 5% of the GST tax. (4gm) The credit is eliminated for 2005 to 2010. (5gm)

7581. What are the return requirements with respect to the GST tax?

The person required to file the return is the person liable for paying the tax (see Q 7582). In the case of a direct skip (other than from a trust), the return must be filed on or before the due date for the gift or estate tax return with respect to the transfer. In all other cases, the return must be filed on or before the 15th day of the 4th month after the close of the taxable year of the person required to make the return. (6gm)

7582. Who is liable for paying the GST tax?

In the case of a taxable distribution, the tax is paid by the transferee. In the case of a taxable termination or a direct skip from a trust, the tax is paid by the trustee. In the case of a direct skip (other than a direct skip from a trust), the tax is paid by the transferor. Unless the governing instrument of transfer otherwise directs, the GST tax is charged to the property constituting the transfer. (7gm)

Gift tax

7583. What is the federal gift tax?

The federal gift tax is an excise tax on the right to transfer property during life. (8gm) The gift tax is a cumulative tax and the tax rates are progressive. Gifts made in prior years are taken into account in computing the tax on gifts made in the current year, with the result that later gifts are usually taxed in a higher bracket than earlier gifts (a drop in tax rates could obviate this result). Moreover, the tax is a unified tax; the same tax that is imposed on taxable gifts is imposed on taxable estates. However, the estate tax is repealed for one year in 2010 (see Q 7564), while the gift tax is not.

A gift tax return, if required, must generally be filed by April 15 of the following year. A six month extension for filing is available. Tax is generally due by April 15, but certain extensions for payment may be available. See Q 7600.

The Federal Gift Tax Worksheet, below, shows the steps for calculating the gift tax. Calculation starts with determining what a gift for gift tax purposes is (see Q 7584). In general, gifts include gratuitous transfers of all kinds. A husband and wife can elect to have all gifts made by either spouse during the year treated as made one-half by each spouse (Q 7595). A qualified disclaimer is not treated as a gift (Q 7586).

Gifts are generally valued at fair market value on the date of the gift (Q 7601). Special rules apply for a wide variety of investments and to net gifts (Q 7591), and Chapter 14 special valuation rules apply to transfers to family members of certain interests in corporations, partnerships, or trusts (Q 7617).

A couple of exclusions are available from gifts. A $13,000 (in 2010) annual exclusion is available for present interest gifts on a per donor/donee basis. An unlimited exclusion is available for qualified transfers for educational and medical purposes. See Q 7596.

A couple of deductions are also available. Unlimited marital (Q 7597) and charitable (Q 7598) deductions are available for certain transfers to the donor's spouse and to charities.

Taxable gifts equals gifts made during the year reduced by all exclusions and deductions.

Tax is imposed on taxable gifts. Tax rates (Appendix B) are generally progressive and tax is based on cumulative taxable transfers during lifetime. To implement this, tax is calculated on total taxable gifts, the sum of the taxable gifts made during the year (current taxable gifts) and prior taxable gifts, and the gift tax that would have been payable on prior taxable gifts (using the current tax rates) is then subtracted out.

Planning Point: A gift made after August 5, 1997, cannot be revalued, if the gift was adequately disclosed on a gift tax return and the gift tax statute of limitations (generally, three years) has passed. (1gn) Consider filing gift tax returns even for annual exclusion gifts.

The tentative tax is then reduced by the unified credit (Q 7599) to produce gift tax payable.
Federal Gift Tax Worksheet

Current Year                                   Q 7584

Current Gifts
--Annual Exclusions                Q 7596
--Qualified Transfers Exclusion    Q 7596
--Marital Deduction                Q 7597
--Charitable Deduction             Q 7598
--Total Reductions

1. IRC Sec. 6501(c)(9).

Current Taxable Gifts
+ Prior Taxable Gifts
Total Taxable Gifts
Tax on Total Taxable Gifts                  Appendix B
- Tax on Prior Taxable Gifts                Appendix B
Tentative Tax                               Appendix B
- Unified Credit                               Q 7599
Federal Gift Tax


7584. What kinds of transfers are subject to the federal gift tax?

The gift tax applies to a transfer by way of gift whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible. For example, a taxable transfer may be effected by the creation of a trust; the forgiving of a debt (see Q 7588); the assignment of a judgment; the transfer of cash, certificates of deposit, federal, state, municipal, or corporate bonds, or stocks. (1go)

All transactions whereby property or property rights or interests are gratuitously passed or conferred upon another, regardless of the means or device employed, constitute gifts subject to tax. (2go) Donative intent on the part of the transferor is not an essential element in the application of the gift tax to the transfer. The application of the tax is based on the objective facts of the transfer and the circumstances under which it is made, rather than on the subjective motives of the donor. (3go) Generally, if property is transferred gratuitously or for an inadequate consideration, a gift (of the full value of the property transferred or the portion in excess of the consideration given) will be considered a gift. (4go)

Shareholders of nonparticipating preferred stock in profitable family held corporations have been held to have made gifts to the common stockholders (typically descendants of the preferred shareholder) by waiving payment of dividends or simply by failing to exercise conversion rights or other options available to a preferred stockholder to preserve his position. (5go) The Tax Court has held that the failure to convert noncumulative preferred stock to cumulative preferred stock did not give rise to a gift, but that thereafter a gift was made each time a dividend would have accumulated. However, the failure to exercise a put option at par plus accumulated dividends plus interest was not treated as a gift of foregone interest. (6go)

A transaction involving the nonexercise by a son of an option under a cross-purchase buy-sell agreement followed by the sale of the same stock by the father to a third party when the fair market value of the stock was substantially higher than the option price was treated as a gift from the son to the father. (7go) Also, a father indirectly made a gift to his son to the extent that the fair market value of stock exceeded its redemption price when the father failed to exercise his right under a buy-sell agreement to have a corporation redeem all of the available shares held by his brother-in-law's estate and the stock passed to the son. (8go)

With respect to a trust, the grantor/income beneficiary may be treated as making additional gifts of remainder interests in each year that the grantor fails to exercise his right to make nonproductive or underproductive property normally productive. (1gp) A mother made gifts to her children to the extent that the children were paid excessive trustee fees from the marital deduction trust of which the mother was a beneficiary. (2gp) However, a grantor of a trust does not make a gift to trust beneficiaries by paying the income tax on trust income taxable to the grantor under the grantor trust rules (see Q 7558). (3gp) Where a trust was modified to add adopted persons as beneficiaries, the beneficiaries with trust interests prior to the modification were treated as making gifts to the newly added beneficiaries. (4gp)

Letter Ruling 9113009 (withdrawn without comment by TAM 9409018) had ruled that a parent who guaranteed loans to his children made a gift to his children because, without the guarantees, the children could not have obtained the loans or, at the very least, would have paid a higher interest rate.

The gift tax is imposed only on completed gifts (see Q 7585).

Where spouses enter into joint and mutual wills, the surviving spouse may be treated as making a gift of a remainder interest at the other spouse's death. (5gp)

The transfer of a qualifying income interest for life in qualified terminable interest property for which a marital deduction was allowed (see Q 7572, Q 7597) will be treated as a transfer of such property for gift tax purposes. (6gp) If a QTIP trust is severed into Trust A and Trust B and the spouse renounces her interest in Trust A, such renunciation will not cause the spouse to be treated as transferring Trust B under IRC Section 2519. (7gp)

The spouse is entitled to collect from the donee the gift tax on the transfer of a QTIP interest. The amount treated as a transfer for gift tax purposes is reduced by the amount of the gift tax the spouse is entitled to recover from the donee. Thus, the transfer is treated as a net gift (see Q 7591). The failure of a spouse to exercise the right to recover gift tax from the donee is treated as a transfer of the unrecovered amount to the donee when the right to recover is no longer enforceable. If a written waiver of the right of recovery is executed before the right becomes unenforceable, the transfer of the unrecovered gift tax is treated as made on the later of (1) the date of the waiver, or (2) the date the tax is paid by the transferor. Any delay in exercise of the right of recovery is treated as an interest-free loan (see Q 7587) for gift tax purposes. (8gp)

Where a surviving spouse acquires a remainder interest in QTIP marital deduction property in connection with a transfer of property or cash to the holder of the remainder interest, the surviving spouse makes a gift to the remainder person under both IRC Section 2519 (disposition of QTIP interest) and IRC Sections 2511 and 2512 (transfers and valuation of gifts). The amount of the gift is equal to the greater of (1) the value of the remainder interest, or (2) the value of the property or cash transferred to the holder of the remainder interest. (1gq) On the other hand, children would be treated as making a gift if the children transfer their remainder interest in a QTIP marital deduction trust to the surviving spouse. (2gq)

Any subsequent transfer by the donor spouse of an interest in such property is not treated as a transfer for gift tax purposes, unless the transfer occurs after the donee spouse is treated as having transferred such property under IRC Section 2519 or after such property is includable in the donee spouse's estate under IRC Section 2044 (see Q 7565). (3gq) Also, if property for which a QTIP marital deduction was taken is includable in the estate of the spouse who was given the QTIP interest and the estate of such spouse fails to recover from the person receiving the property any estate tax attributable to the QTIP interest being included in such spouse's estate, such failure is treated as a transfer for gift tax purposes unless (1) such spouse's will waives the right to recovery, or (2) the beneficiaries cannot compel recovery of the taxes (e.g., where the executor is given discretion to waive the right of recovery in such spouse's will). (4gq)

The gift tax is not applicable to a transfer for a full and adequate consideration in money or money's worth, or to ordinary business transactions (i.e., transactions which are bona fide, at arm's length, and free from any donative intent). A consideration not reducible to a value in money or money's worth, as love and affection, promise of marriage, etc., is wholly disregarded, and the entire value of the property transferred constitutes the amount of the gift. Similarly, a relinquishment or promised relinquishment of dower or curtesy, or of a statutory estate created in lieu of dower or curtesy, or of other marital rights in the spouse's property or estate, is not considered to any extent a consideration "in money or money's worth." (5gq)

Transfers of property or interest in property made under the terms of a written agreement between spouses in settlement of their marital or property rights are deemed to be for an adequate and full consideration in money or money's worth and, therefore, exempt from the gift tax (whether or not such agreement is approved by a divorce decree), if the spouses obtain a final decree of divorce from each other within the three-year period beginning on the date one year before the agreement is entered into. (6gq)

For recapture rules applicable where distributions are not timely made in connection with the transfer of an interest in a corporation or partnership which is subject to the Chapter 14 valuation rules, see Q 7618. For deemed transfers upon the lapse of certain voting or liquidation rights in a corporation or partnership, see Q 7621.

A gift may be made of foregone interest with respect to interest-free and bargain rate loans (see Q 7587).

A United States citizen or resident who receives a covered gift from certain expatriates may owe gift tax on the transfer. (7gq)

7585. When does a complete gift take place for purposes of the federal gift tax?

The gift is complete when the donor has so parted with dominion and control over the property or interest in property he is giving as to leave in him no power to change its disposition whether for his own benefit or for the benefit of another. (1gr) In general, a transfer of an interest in a revocable trust is incomplete until the interest becomes irrevocable. However, if the interest becomes irrevocable at the grantor's death, it will generally be subject to estate tax (see Q 7565) rather than to gift tax.

If a donor delivers a properly endorsed stock certificate to the donee or the donee's agent, the gift is completed for gift tax purposes on the date of delivery. If the donor delivers the certificate to his bank or broker as his agent, or to the issuing corporation or its transfer agent, for transfer into the name of the donee, the gift is completed on the date the stock is transferred on the books of the corporation. (2gr)

A transfer of a nonstatutory stock option which was not traded on an established market would be treated as a gift to a family member on the later of (1) the transfer or (2) the time when the donee's right to exercise the option is no longer conditioned on the performance of services by the transferor. (3gr)

The gratuitous transfer by the maker of a legally binding promissory note is a completed gift (the transfer of a legally unenforceable promissory note is an incomplete gift); if the note is unpaid at the donor's death, the gift is not treated as an adjusted taxable gift in computing the tentative estate tax (see Q 7564), and no deduction is allowable from the gross estate for the promisee's claim with respect to the note (see Q 7572). (4gr)

In the case of a gift by check, when is the gift complete, when the check is delivered, or when the check is cashed? In the litigation to date, the courts initially appeared to make a distinction between gifts to charitable donees and gifts to noncharitable donees. In the former case it has been held that at least where there is timely presentment and payment, payment of the check by the bank relates back to the date of delivery for purposes of determining completeness of the gift. (5gr) In the latter case, the courts have shown less of a willingness to apply the "relation back" doctrine. In Est. of Dillingham v. Comm., (6gr) the noncharitable donees did not cash the checks until 35 days after their delivery, the donor's death having intervened. The court said that this delay cast doubt as to whether the checks were unconditionally delivered. Since the estate failed to prove unconditional delivery, the court declined to extend the relation back doctrine to the case before it. It then turned to local law to determine whether the decedent had parted with dominion and control upon delivery of the checks. It determined that under applicable local law (Oklahoma), the donor did not part with dominion and control until the checks were cashed. However, in Est. of Gagliardi v. Comm. , (7gr) checks written by a brokerage firm and charged against the decedent's account prior to decedent's death were treated as completed gifts to the noncharitable donees even though some checks were cashed after decedent's death. Also, in Est. of Metzger v. Comm., (1gs) the relation-back doctrine was applied to gifts made by check to noncharitable beneficiaries where the taxpayer was able to establish: (1) the donor's intent to make gifts, (2) unconditional delivery of the checks, (3) presentment of the check during the year for which a gift tax annual exclusion was sought and within a reasonable time after issuance, and (4) that there were sufficient funds to pay the checks at all relevant times. In W. H. Braum Family Partnership v. Comm., (2gs) the relation-back doctrine was not applied where the taxpayer could not establish either (2) or (4). In response to Metzger, the Service has issued a revenue ruling providing that a gift by check to a noncharitable beneficiary will be considered complete on the earlier of (1) when the donor has so parted with dominion and control under state law such that the donor can no longer change its disposition, or (2) when the donee deposits the check, cashes the check against available funds, or presents the check for payment if the following conditions are met: (a) the check must be paid by the drawee bank when first presented for payment to the drawee bank; (b) the donor must be alive when the check is paid by the drawee bank; (c) the donor must have intended a gift; (d) delivery of the check by the donor must have been unconditional; (e) the check must be deposited, cashed or presented in the calendar year for which the completed gift tax treatment is sought; and (f) the check must be deposited, cashed, or presented within a reasonable time of issuance. (3gs)

7586. If a person refuses to accept an interest in property (a disclaimer), is he considered to have made a gift of the interest for federal gift tax purposes?

Not if he makes a qualified disclaimer. A "qualified disclaimer" means an irrevocable and unqualified refusal to accept an interest in property created in the person disclaiming by a taxable transfer made after 1976. With respect to inter vivos transfers, for the purpose of determining when a timely disclaimer is made (see condition (3) below), a taxable transfer occurs when there is a completed gift for federal gift tax purposes regardless of whether a gift tax is imposed on the completed gift. Thus, gifts qualifying for the gift tax annual exclusion are regarded as taxable transfers for this purpose. (4gs) Furthermore, a disclaimer of a remainder interest in a trust created prior to the enactment of the federal gift tax was subject to the gift tax where the disclaimer was not timely and the disclaimer occurred after enactment of the gift tax. (5gs) In order to effectively disclaim property for transfer tax purposes, a disclaimer of property received from a decedent at death should generally be made within nine months of death rather than within nine months of the probate of the decedent's will. (6gs)

In general, the disclaimer must satisfy these conditions: (1) the disclaimer must be irrevocable and unqualified; (2) the disclaimer must be in writing; (3) the writing must be delivered to the transferor of the interest, his legal representative, the holder of the legal title to the property, or the person in possession of the property, not later than nine months after the later of (a) the day on which the transfer creating the interest is made, or (b) the day on which the disclaimant reaches age 21; (4) the disclaimant must not have accepted the interest disclaimed or any of its benefits; and (5) the interest disclaimed must pass either to the spouse of the decedent or to a person other than the disclaimant without any direction on the part of the person making the disclaimer. (1gt) A person cannot disclaim a remainder interest in property while retaining a life estate or income interest in the same property. (2gt)

If a person makes a qualified disclaimer, for purposes of the federal estate, gift, and generation-skipping transfer tax provisions, the disclaimed interest in property is treated as if it had never been transferred to the person making the qualified disclaimer. Instead it is considered as passing directly from the transferor of the property to the person entitled to receive the property as a result of the disclaimer. Accordingly, a person making a qualified disclaimer is not treated as making a gift. Similarly, the value of a decedent's gross estate for purposes of the federal estate tax does not include the value of property with respect to which the decedent or his executor has made a qualified disclaimer. (3gt)

In the case of a joint tenancy with rights of survivorship or a tenancy by the entirety, the interest which the donee receives upon creation of the joint interest can be disclaimed within nine months of the creation of the interest and the survivorship interest received upon the death of the first joint tenant to die (deemed to be a one-half interest in the property) can be disclaimed within nine months of the death of the first joint tenant to die, without regard to (1) whether either joint tenant can sever unilaterally under local law, (2) the portion of the property attributable to consideration furnished by the disclaimant, or (3) the portion of the property includable in the decedent's gross estate under IRC Section 2040. However, in the case of a creation of a joint tenancy between spouses or tenancy by the entirety created after July 13, 1988 where the donee spouse is not a U.S. citizen, a surviving spouse can make a disclaimer within nine months of the death of the first spouse to die of any portion of the joint interest that is includable in the decedent's estate under IRC Section 2040. Also, in the case of a transfer to a joint bank, brokerage, or other investment account (e.g., mutual fund account) where the transferor can unilaterally withdraw amounts contributed by the transferor, the surviving joint tenant may disclaim amounts contributed by the first joint tenant to die within nine months of the death of the first joint tenant to die. (4gt)

For purposes of a qualified disclaimer, the mere act of making a surviving spouse's statutory election is not to be treated as an acceptance of an interest in the disclaimed property or any of its benefits. However, the disclaimer of a portion of the property subject to the statutory election must be made within nine months of the decedent spouse's death, rather than within nine months of the surviving spouse's statutory election. (5gt)

A power with respect to property is treated as an interest in such property. (6gt) The exercise of a power of appointment to any extent by the donee of the power is an acceptance of its benefits. (7gt)

A beneficiary who is under 21 years of age has until nine months after his 21st birthday in which to make a qualified disclaimer of his interest in property. Any actions taken with regard to an interest in property by a beneficiary or a custodian prior to the beneficiary's 21st birthday will not be an acceptance by the beneficiary of the interest. (1gu) This rule holds true even as to custodianship gifts in states which provide that custodianship ends when the donee reaches an age below 21. (2gu)

7587. Are gifts made of foregone interest with respect to interest-free and bargain rate loans?

An interest-free or low-interest loan within a family or in any other circumstances where the foregone interest is in the nature of a gift results in a gift subject to the federal gift tax. IRC Section 7872 applies in the case of term loans made after June 6, 1984 and demand loans outstanding after that date.

In general, IRC Section 7872 recharacterizes a below-market loan (an interest-free or low-interest loan) as an arm's length transaction in which the lender (1) made a loan to the borrower in exchange for a note requiring the payment of interest at a statutory rate, and (2) made a gift, distributed a dividend, made a contribution to capital, paid compensation, or made another payment to the borrower which, in turn, is used by the borrower to pay the interest. The difference between the statutory rate of interest and the rate (if any) actually charged by the lender, the "foregone interest," is thus either a gift to the borrower or income to him, depending on the circumstances. The income tax aspects of below-market loans are discussed in Q 7511. The gift tax aspects of such loans are discussed here.

First, some definitions: The term "gift loan" means any below-market loan where the foregoing of interest is in the nature of a gift. The term "demand loan" means any loan which is payable in full at any time on the demand of the lender. The term "term loan" means any loan which is not a demand loan. The term "applicable federal rate" means: in the case of a demand loan or a term loan of up to three years, the federal short-term rate; in the case of a term loan over three years but not over nine years, the federal mid-term rate; in the case of a term loan over nine years, the federal long-term rate. In the case of a term loan, the applicable rate is compounded semiannually. These rates are reset monthly. (3gu) The "present value" of any payment is determined (a) as of the date of the loan, and (b) by using a discount rate equal to the applicable federal rate. (4gu) The term "below-market loan" means any loan if (a) in the case of a demand loan, interest is payable on the loan at a rate less than the applicable federal rate, or (b) in the case of a term loan, the amount loaned exceeds the present value of all payments due under the loan. The term "foregone interest" means, with respect to any period during which the loan is outstanding, the excess of (a) the amount of interest that would have been payable on the loan for the period if the interest accrued on the loan at the applicable federal rate and were payable annually on the last day of the appropriate calendar year, over (b) any interest payable on the loan properly allocable to the period.

In the case of a demand gift loan, the foregone interest is treated as transferred from the lender to the borrower and retransferred by the borrower to the lender as interest on the last day of each calendar year the loan is outstanding. In the case of a term gift loan, the lender is treated as having transferred on the date the loan was made, and the borrower is treated as having received on such date, cash in an amount equal to the excess of (a) the amount loaned over (b) the present value of all payments which are required to be made under the terms of the loan. The provisions do not apply in the case of a gift loan between individuals (a husband and wife are treated as one person) that at no time exceeds $10,000 in the aggregate amount outstanding on all loans, whether below-market or not. The $10,000 de minimis exception does not apply, however, to loans attributable to acquisition of income-producing assets.

IRC Section 7872 does not apply to life insurance policy loans. (1gv) Neither does IRC Section 7872 apply to loans to a charitable organization if at no time during the taxable year the aggregate outstanding amount of loans by the lender to that organization does not exceed $250,000. (2gv)

The Tax Court has held that IRC Section 483 and safe harbor interest rates contained therein do not apply for gift tax purposes. Consequently, the value of a promissory note given in exchange for real property was discounted to reflect time value of money concepts under IRC Section 7282 (without benefit of IRC Section 483). (3gv)

Prior to enactment of IRC Section 7872, the Supreme Court held that, in the case of an interest-free demand loan made within a family, a gift subject to federal gift tax is made of the value of the use of the money lent. (4gv) The court did not decide how to value such a gift, but implicit in the decision was the assumption that low-interest or interest-free loans within a family context have, since the first federal gift tax statute was enacted in 1924, resulted in gifts. Rev. Proc. 85-46 (5gv) provided guidance in valuing and reporting gift demand loans not covered by IRC Section 7872.

7588. If an individual transfers property or an interest in property to children or grandchildren or to an irrevocable trust for same, and takes back noninterest-bearing term notes covering the value of the property transferred, which notes the transferor intends to forgive as they come due, what are the gift implications?

If the transferor's receipt of the noninterest-bearing notes is characterized as a "term gift loan," the lender/transferor will be treated as having transferred on the date of the receipt, and the borrower/transferee will be treated as having received on such date, cash in an amount equal to the excess of (a) the amount loaned over (b) the present value of all payments required to be made under the terms of the loan (see Q 7584). (6gv) If the receipt of the notes is not so characterized, then the discussion in the following paragraph, relating to transactions occurring before June 7, 1984, is pertinent.

The IRS takes the position that such a transfer is a gift of the entire value of the property or interest given at the time of the transfer and is not a sale. If the transfer is of a remainder interest in property, it is a future interest gift that does not qualify for the gift tax annual exclusion (see Q 7596). The Service distinguishes between an intent to forgive the notes and donative intent (see Q 7584) with respect to transfer of the property: "A finding of an intent to forgive the note relates to whether the transaction was in reality a bona fide sale or a disguised gift." (1gw) The Tax Court, however, makes a distinction based on the nature of the notes given, holding that if the notes are secured by valid vendor's liens, the transaction is to be treated as a sale; a gift occurs on each date a note is due and forgiven, the value of the gift being the amount due on the note. (2gw)

7589. Are gratuitous transfers by individuals of federal, state, and municipal obligations subject to federal transfer taxation?

Yes. It is provided by statute that gratuitous transfers of obligations that are exempt from federal income tax are not exempt from federal estate tax, gift tax, or generation-skipping transfer tax, as the case may be, at least as to estates of decedents dying, gifts made, and transfers made on or after June 19, 1984. In the case of any provision of law enacted after July 18, 1984, such provision is not treated as exempting the transfer of property from such transfer taxes unless it refers to the appropriate IRC provisions. (3gw) Also, the removal of transfer tax exemption applies in the case of any transfer of property (or interest in property) if at any time there was filed an estate or gift tax return showing such transfer as subject to federal estate or gift tax. (4gw) Congress also added that no inference was to be drawn that transfers of such obligations occurring before such time were exempt from transfer taxation.

In U.S. v. Wells Fargo, (5gw) the United States Supreme Court determined that "tax-exempt" bonds have always been subject to transfer taxes unless specifically provided otherwise by statute (even before enactment of TRA '84, Sec. 641). This determination was based on the longstanding principle that tax exemption cannot be inferred. The differing language concerning project notes issued pursuant to Housing Acts, providing at one time for exemption from all taxation and at another for exemption from all taxation except surtax, estate, inheritance, and gift taxes, could be explained by the need to address a surtax in 1937, and not by a Congressional intent to exempt the project notes from estate taxation, the court concluded. The project notes were not exempt from transfer taxes, the court ruled, and included the notes in the decedent's estate.

7590. What are the federal gift tax implications of taking title to investment property in joint names?

There may be a gift for federal gift tax purposes either at the time title is taken in joint names or at a later time when one of the joint owners reduces some or all of the property to his own possession. Consider the following examples:

"If A creates a joint bank account for himself and B (or a similar type of ownership by which A can regain the entire fund without B's consent), there is a gift to B when B draws upon the account for his own benefit, to the extent of the amount drawn without any obligation to account for a part of the proceeds to A. Similarly, if A purchases a United States savings bond, registered as payable to 'A or B,' there is a gift to B when B surrenders the bond for cash without any obligation to account for a part of the proceeds to A." (6gw) Likewise, "where A, with his separate funds, creates a joint brokerage account for himself and B, and the securities purchased on behalf of the account are registered in the name of a nominee of the firm, A has not made a gift to B, for federal gift tax purposes, unless and until B draws upon the account for his own benefit without any obligation to account to A. If B makes a withdrawal under such circumstances, the value of the gift by A would be the sum of money or the value of the property actually withdrawn from the account by B." (1gx)

"If A with his own funds purchases property and has the title conveyed to himself and B as joint owners, with rights of survivorship (other than a joint ownership described in [the foregoing paragraph]) but which rights may be defeated by either party severing his interest, there is a gift to B in the amount of half the value of the property." (2gx)

Where A purchases and registers U.S. Treasury notes in the names of A or B or survivor, in a jurisdiction in which this registration creates a joint tenancy, there is a completed gift of the survivorship rights in the notes and an undivided one-half interest in the interest payments and redemption rights pertaining to the notes; in a jurisdiction in which a joint tenancy is not created by such registration, there is a gift of the survivorship rights in the interest payments and in the notes at maturity. (3gx) Computation of the value of the gifts in both situations is set forth in Rev. Rul. 78-215.

In the above examples, if A and B are husband and wife, any gift will be offset by the marital deduction to the extent available (see Q 7597). (4gx)

7591. What are the federal gift tax results if the donee agrees to pay the gift tax?

If a gift is made subject to the express or implied condition that the donee pay the gift tax, the donor may deduct the amount of tax from the gift in determining the value of the gift. In such a transaction, the donor receives consideration for the transfer in the amount of the gift tax paid by the donee; thus, to the extent of the tax paid, the donee does not receive a gift. (5gx) Similarly, if the donor makes a gift in trust subject to an agreement that the trustee pay the gift tax, the value of the property transferred is reduced for gift tax purposes by the amount of the tax. (6gx)

The computation of the tax requires the use of an algebraic formula, since the amount of the tax is dependent on the value of the gift which in turn is dependent on the amount of the tax. The formula is

Tentative Tax/1 plus Rate of Tax = True Tax.

Examples illustrating the use of this formula, with the algebraic method, to determine the tax in a net gift situation are contained in IRS Publication 904 (Rev. May 1985). Three of the examples show the effect of a state gift tax upon the computation.

Although the donee pays the tax, it is the donor's unified credit that is used in computing the gift tax, not the donee's. (1gy)

7592. How is a gift of property under the Uniform Gifts to Minors Act or under the Uniform Transfers to Minors Act treated for federal gift tax purposes?

Any transfer of property to a minor under either Uniform Act constitutes a complete gift for federal gift tax purposes to the extent of the full fair market value of the property transferred. Generally, such a gift qualifies for the gift tax annual exclusion (see Q 7596). (2gy) The allowance of the exclusion is not affected by the amendment of a state's Uniform Act lowering the age of majority and thus requiring that property be distributed to the donee at age 18. (3gy) These rulings base the allowance of the exclusion on the assumption that gifts under the Uniform Act come within the purview of IRC Section 2503(c). Gifts to minors under IRC Section 2503(c) must pass to the donee on his attaining age 21. If a state statute varies from the Uniform Act by providing that under certain conditions custodianship may be extended past the donee's age 21, gifts made under those conditions would not qualify for the exclusion. For tables of state laws concerning the Uniform Acts, see Appendix D.

7593. When is a gift made with respect to an education savings account?

Contributions to an education savings account are treated as completed gifts to the beneficiary of a present interest in property which can qualify for the gift tax and generation-skipping transfer (GST) tax annual exclusion. If contributions for a year exceed the gift tax annual exclusion, the donor can elect to prorate the gifts over a five year period beginning with such year. A contribution to an education savings account does not qualify for the gift tax or GST tax exclusion for qualified transfers for educational purposes. (4gy) Distributions from an education savings account are not treated as taxable gifts. Also, if the designated beneficiary of the education savings account is changed, or if funds in education savings account are rolled over to a new beneficiary, such a transfer is subject to the gift tax or GST tax only if the new beneficiary is a generation below the old beneficiary. Transfers within the same generation do not trigger a gift tax liability. (5gy)

See Q 7567 for the estate tax treatment and Q 7516 for the income tax treatment of education savings accounts.

7594. When is a gift made with respect to a qualified tuition program?

For gift tax and generation-skipping transfer (GST) tax purposes, a contribution to a qualified tuition program on behalf of a designated beneficiary is not treated as a qualified transfer for purposes of the gift tax and GST tax exclusion for educational expenses, but is treated as a completed gift of a present interest to the beneficiary which qualifies for the annual exclusion (see Q 7596). If a donor makes contributions to a qualified tuition program in excess of the gift tax annual exclusion, the donor may elect to take the donation into account ratably over a five-year period. (1gz) Distributions from a qualified tuition program are not treated as taxable gifts. Also, if the designated beneficiary of a qualified tuition program is changed, or if funds in a qualified tuition program are rolled over to the account of a new beneficiary, such a transfer is subject to the gift tax or generation-skipping transfer tax only if the new beneficiary is a generation below the old beneficiary. (2gz)

See Q 7568 for the estate tax treatment and Q 7517 for the income tax treatment of qualified tuition programs.

7595. When is the "split-gift" provision available?

When a husband or wife makes a gift to a third person, it may be treated as having been made one-half by each if the other spouse consents to the gift. (3gz)

Planning Point: The split-gift provision enables a spouse who owns most of the property to take advantage of the other spouse's annual exclusions (see Q 7596) and unified credit (see Q 7599). Thus, a spouse, with the other spouse's consent, can give up to $26,000 (2 x $13,000 annual exclusion in 2011, see Appendix B) (4gz) a year to each donee free of gift tax, and, in addition, will have both their unified credits to apply against gift tax imposed on gifts in excess of the annual exclusion. Moreover, by splitting the gifts between husband and wife, they will fall in lower gift tax brackets.

Where spouses elect to use the "split-gift" provision, the consent applies to all gifts made by either spouse to third persons during the calendar year. (5gz) A technical advice memorandum permitted a taxpayer to elect after his spouse's death to split gifts with his spouse where the gifts were made by the taxpayer shortly before the spouse's death. (6gz)

Exclusions and Deductions

7596. What gift tax exclusions are available to a donor?

The Annual Exclusion

The gift tax annual exclusion is an exclusion of $10,000 as indexed ($13,000 (7gz) in 2011, see Appendix B) per calendar year per donee applied to gifts of a present interest in property. The $10,000 amount is adjusted for inflation, rounded down to the next lowest multiple of $1,000, after 1998. (8gz) The exclusion is not cumulative; that is, an exclusion unused in one year cannot be carried over and used in a future year. A gift of a present interest is one in which the donee has the right to immediate possession, use, and enjoyment of the property.

The exclusion does not apply to gifts of a future interest in property, i.e., the right to use and enjoy the property only in the future. For example, if G transfers income producing property in trust, the terms of which provide that the income from the trust property will be paid to A for his lifetime and upon A's death the trust property will be paid to B free of trust, A's life income interest would be a present interest gift and B's remainder interest would be a future interest gift. G would be allowed to exclude from the value of gifts reported on his gift tax return the value of A's life income interest up to $13,000 (1ha) (in 2011, assuming G made no other present interest gifts to A during the calendar year), but he would not be able to exclude any of the value of B's remainder interest. If the trustee were given discretion to withhold payments of income to A and add such amounts to the trust corpus, A's income interest would not be a present interest, and G would not be allowed to claim any exclusion.

A gift of property to a trust which directs the trustee to distribute the trust income annually to the beneficiary is a present interest gift of an income interest qualifying for the annual exclusion. However, a gift of property to a trust which directs the trustee to distribute from the trust annually a certain dollar amount to the beneficiary is a gift of a future interest not qualifying for the exclusion. (2ha)

A gift of property in trust will qualify for the gift tax annual exclusion if the trust terms (1) provide that the trust beneficiary (or beneficiaries) be given timely written notice (notice given within 10 days after the transfer has been held timely) that the beneficiary has a reasonable period (45 days has been held reasonable) within which to demand immediate withdrawal (usually the trust specifies that the withdrawal right is limited to the amount of the exclusion), and (2) give the trustee the power to convert property in the trust to cash to the extent necessary to meet withdrawal demands. Such trusts are popularly known as Crummey trusts, after the name of a leading case that upheld them. (3ha)

The IRS has ruled with respect to Crummey trusts that the annual exclusion could not be applied to trust contributions on behalf of trust beneficiaries who had withdrawal rights as to the contributions (except to the extent they exercised their withdrawal rights) but who had either no other interest in the trust (a naked power) or only remote contingent interests in the remainder. (4ha) However, the Tax Court has rejected the IRS's argument that a power holder must hold rights other than the withdrawal right to obtain the annual exclusion. The withdrawal right (assuming there is no agreement to not exercise the right) is sufficient to obtain the annual exclusion. (5ha) (Language in Cristofani appears to support use of naked powers although case did not involve naked powers). In an Action On Decision, the Service stated that, applying the substance over form doctrine, the annual exclusions should not be allowed where the withdrawal rights are not in substance what they purport to be in form. If the facts and circumstances show an understanding that the power is not meant to be exercised or that exercise would result in undesirable consequences, then creation of the withdrawal right is not a bona fide gift of a present interest and an annual exclusion should not be allowed. (6ha) In TAM 9628004, annual exclusions were not allowed where transfers to trust were made so late in the first year that Crummey withdrawal powerholders had no opportunity to exercise their rights, most powerholders had either no other interest in the trust or discretionary income or remote contingent remainder interests, and withdrawal powers were never exercised in any year. However, annual exclusions were allowed where the IRS was unable to prove that there was an understanding between the donor and the beneficiaries that the withdrawal rights should not be exercised. (1hb) InTAM 9731004, annual exclusions were denied where eight trusts were created for eight primary beneficiaries, but Crummey withdrawal powers were given to 16 or 17 persons who never exercised their powers and most powerholders held either a remote contingent interest or no interest other than the withdrawal power in the trusts in which the powerholder was not the primary beneficiary.

The annual exclusion was not allowed where the beneficiaries waived their right to receive notice of contributions to trust with respect to which their withdrawal rights could be exercised. Furthermore, the annual exclusion was not allowed because the grantor set up a trust which provided that notice was to be given to the trustee as to whether a beneficiary could exercise a withdrawal power with respect to a transfer to trust and the grantor never notified the trustee that the withdrawal powers could be exercised with respect to any of the transfers to trust. (2hb)

Substance over form analysis may be applied to deny annual exclusions where indirect transfers are used in an attempt to obtain inappropriate annual exclusions for gifts to intermediate recipients. (3hb) For example, suppose A transfers $13,000 (4hb) to each of B, C, and D in 2011. By arrangement, B, C, and D each immediately transfer $13,000 (5hb) to E. The annual exclusion for A's indirect transfers to E is limited to $13,000 (6hb) and A has made taxable gifts of $26,000 (7hb) to E.

An outright gift of a bond, note (though bearing no interest until maturity), or other obligation which is to be discharged by payments in the future is a gift of a present interest. (8hb) Normally, a direct gift of shares of corporate stock is a present interest gift. However, if the gift is made subject to a stock transfer restriction agreement under which the donee is prohibited for a period of time from selling or pledging the stock, it has been held that the gift is one of a future interest which does not qualify for the gift tax annual exclusion. (9hb)

It has been held that the gift of a portion of the donor's interest in real property, if under the terms of the transfer the donee receives the present unrestricted right to the immediate use, possession, and enjoyment of an ascertainable interest in the property, qualifies for the gift tax annual exclusion. (10hb)

If a donor transfers a specified portion of real property subject to an "adjustment clause" (i.e., under terms that provide that if the IRS subsequently determines that the value of the specified portion exceeds the amount of the annual exclusion, the portion of property given will be reduced accordingly, or the donee will compensate the donor for the excess), the adjustment clause will be disregarded for federal tax purposes. (11hb)

A gift of property to a minor, whether in trust or otherwise, is not considered a gift of a future interest in property if the terms of the transfer satisfy all the following conditions:

(1) Both the property itself and its income may be expended by or for the benefit of the donee before he attains the age of 21 years;

(2) Any portion of the property and its income not disposed of under (1) will pass to the donee when he attains the age of 21 years; and

(3) Any portion of the property and its income not disposed of under (1) will be payable either to the estate of the donee or as he may appoint under a general power of appointment if he dies before attaining the age of 21 years. (1hc)

A gift to a minor under the Uniform Gifts to Minors Act or under the Uniform Transfers to Minors Act generally is a gift of a present interest and qualifies for the annual exclusion. (2hc) Most states in recent years have adopted the later Uniform Transfers to Minors Act, which allows for any kind of property, real or personal, tangible or intangible, to be transferred under the Act. Other states have amended their Uniform Gifts to Minors Act to provide for gifts of various kinds of property ranging from real estate to partnership interests and other tangible and intangible interests in property. Originally, the Uniform Act provided for gifts of only money or securities. The allowance of the exclusion is not affected by the amendment of a state's Uniform Act lowering the age of majority and thus requiring that property be distributed to the donee at age 18. (3hc) The revenue rulings cited in this paragraph base the allowance of the exclusion on the assumption that gifts under the Uniform Act come within the purview of IRC Section 2503(c). Gifts to minors under IRC Section 2503(c) must pass to the donee on his attaining age 21. If a state statute varies from the Uniform Act by providing that under certain conditions custodianship may be extended past the donee's age 21, gifts made under those conditions would not qualify for the exclusion. For a state-by-state summary of the types of property which can be given under, and the adult age for purposes of, the Uniform Act, see Appendix D.

A gift of property to a corporation generally represents a gift of a future interest in the property to the individual shareholders to the extent of their proportionate interests in the corporation. (4hc) Also a gift for the benefit of a corporation is a gift of a future interest in the property to its shareholders and does not qualify for the annual exclusion. (5hc) However, gifts made to individual partnership capital accounts have been treated as gifts of a present interest which qualify for the annual exclusion where the partners were free to make immediate withdrawals of the gifts from their capital accounts. (6hc) However, annual exclusions were denied for gifts of limited partnership interests where (1) the general partner could retain income for any reason whatsoever, (2) limited partnership interests could not be transferred or assigned without the permission of a supermajority of other partners, and (3) limited partnership interests generally could not withdraw from the partnership or receive a return of capital contributions for many years into the future. (7hc) Similarly, annual exclusions were denied for gifts of business interests where the beneficiaries were not free to withdraw from the business entity, could not sell their interests, and could not control whether any income would be distributed (and no immediate income was expected). (1hd)

A donor's gratuitous payment of the monthly amount due on the mortgage on a house owned in joint tenancy by others has been held a present interest gift to the joint tenants in proportion to their ownership interests. (2hd)

By means of the "split gift" provision (see Q 7595), a married couple can effectively use each other's annual exclusions. Thus, if, in 2011, A makes a $26,000 (3hd) gift of securities to his child, C, and A's wife, B, joins in making the gift (by signifying her consent on the gift tax return), the gift would be considered as having been made one-half by each, the exclusion is effectively doubled, and no gift tax would have to be paid (assuming neither A nor B made any other gifts to C during the calendar year). (4hd) However, say A and B join in making the same gift to F, child of A's brother D and wife E, while at the same time D and E make similar gifts to C and F, the scheme does not effectively again double the exclusion. (5hd)

If the spouse of the donor is not a United States citizen, the annual exclusion for a transfer from the donor spouse to the non-citizen spouse is increased from $10,000 (as indexed) to $100,000 as indexed ($---,--- in 2011, see Appendix B) (provided the transfer would otherwise qualify for the marital deduction if the donee spouse were a United States citizen).The $100,000 amount is adjusted for inflation, as is the $10,000 amount (see above). (6hd) However, the marital deduction is not available for a transfer to a spouse who is not a United States citizen (see Q 7597).

Exclusion for "Qualified Transfers"

A "qualified transfer" is not considered a gift for gift tax purposes. A "qualified transfer" means any amount paid on behalf of an individual--

(A) as tuition to an educational organization (7hd) for the education or training of such individual, or

(B) to any person who provides medical care (8hd) with respect to such individual as payment for such medical care. (9hd) A technical advice memorandum treated tuition payments for future years as qualified transfers where the payments were nonrefundable. (10hd)

7597. What is the gift tax marital deduction?

It is a deduction for the entire value of gifts made between spouses. (11hd) The deduction does not apply, however, to a gift of a "nondeductible terminable interest" in property. (12hd) A "terminable interest" in property is an interest which will terminate or fail on the lapse of time or on the occurrence or failure to occur of some contingency. Life estates, terms for years, annuities, patents, and copyrights are therefore terminable interests. However, a bond, note, or similar contractual obligation, the discharge of which would not have the effect of an annuity or term for years, is not a terminable interest. (1he)

In general, if a donor transfers a terminable interest in property to the donee spouse, the marital deduction is disallowed with respect to the transfer if the donor spouse also (1) transferred an interest in the same property to another donee, or (2) retained an interest in the same property in himself, or (3) retained a power to appoint an interest in the same property, and (4) gave the other donee, himself, or the possible appointee the right to possess or enjoy any part of the property after the termination or failure of the interest transferred to the donee spouse. (2he) However, a terminable interest in property qualifies for the marital deduction if the donee spouse is given (1) a right to the income from the property for life and a general power of appointment over the principal; or (2) a "qualifying income interest for life" in property transferred by the donor spouse as to which the donor must make an election (on or before the date, including extensions, for filing a gift tax return with respect to the year in which the transfer was made--see Q 7600) to have the marital deduction apply. The donee spouse has a "qualifying income interest for life" if (1) the donee spouse is entitled to all the income from the property, payable annually or at more frequent intervals, and (2) no person has a power to appoint any part of the property to any person other than the donee spouse during the donee spouse's lifetime. (3he) Also, the interest of a donee spouse in a joint and survivor annuity in which only the donor and donee spouses have a right to receive payments during such spouses' joint lifetimes is treated as a "qualifying income interest for life" unless the donor spouse irrevocably elects otherwise within the time allowed for filing a gift tax return. (4he) In the two exceptions to the nondeductible terminable interest rule explained above, income producing property is contemplated. If a gift of nonincome producing property in a form to comply with either of the two exceptions is proposed, Treasury Regulation Section 25.2523(e)-1(f) should be read carefully. A marital deduction has been disallowed for a transfer to an irrevocable trust where state law provided that the interest given the spouse would be revoked upon divorce and the grantor had not provided in the trust instrument that the trust would not be revoked upon divorce. (5he)

If the spouse of the donor is not a United States citizen, the marital deduction is not available for a transfer to such a spouse. However, in such a case, the annual exclusion (see Q 7596) for the transfer from the donor spouse to the non-citizen spouse is increased from $10,000 (as indexed) to $100,000 as indexed ($133,000 in 2009, see Appendix B) (provided the transfer would otherwise qualify for the marital deduction if the donee spouse were a United States citizen). The $100,000 amount is adjusted for inflation, as is the $10,000 amount (see Q 7596). (6he)

7598. Is a gift tax deduction allowed for gifts to charity?

Yes. In general, a deduction is allowed for the entire value of gifts to qualified charitable organizations. (7he)

Where a donor makes a gift of an interest in property (other than a remainder interest in a personal residence or farm or an undivided portion of the donor's entire interest in property or certain gifts of property interests exclusively for conservation purposes) to a qualified charity, and an interest in the same property is retained by the donor or is given to a donee not a charity, no charitable deduction is allowed for the interest given the charity unless--

(1) in the case of a remainder interest, such interest is in a trust which is a charitable remainder annuity trust (see Q 7951) or a charitable remainder unitrust (see Q 7952) or a pooled income fund (see Q 7953), or

(2) in the case of any other interest (such as an interest in the income from a short term trust), such interest is in the form of a guaranteed annuity or is a fixed percentage distributed yearly of the fair market value of the property (to be determined yearly). (1hf)

A charitable contribution deduction is allowable for a gift to charity of a legal remainder interest in the donor's personal residence even though the interest conveyed to charity is in the form of a tenancy in common with an individual. (2hf)

If an individual creates a qualified charitable remainder trust in which his spouse is the only non-charitable beneficiary other than certain ESOP remainder beneficiaries, the grantor will receive a charitable contributions deduction for the value of the remainder interest. (3hf)

7599. What is the gift tax unified credit?

It is a dollar amount ($345,800 in 2011) that is credited against the gift tax computed as shown in Q 7583 (see Appendix B for amounts in other years). (4hf) It protects $1,000,000 of taxable gifts from gift tax (the gift tax unified credit applicable exclusion amount). (For application of the unified credit to the federal estate tax, see Q 7573.)

The amount of unified credit allowed against the tax on gifts made in any calendar year cannot exceed the dollar amount of credit applicable to the period in which the gifts were made, reduced by the sum of the amounts of unified credit allowed the donor against gifts made in all prior calendar periods, and reduced further by the rule explained in the next paragraph (but in no event can the allowable credit exceed the amount of the tax).

The unified credit was enacted by the Tax Reform Act of 1976. Under prior law, separate exemptions were provided for estate and gift taxes. The gift tax specific exemption was $30,000 for each donor (or $60,000 if the donor's spouse joined in making the gift). The exemption was not applied automatically, as in the case of the unified credit, but had to be elected by the donor, and once used was gone. The law provides that as to gifts made after September 8, 1976, and before January 1, 1977, if the donor elected to apply any of his lifetime exemption to such gifts, his unified credit is reduced by an amount equal to 20% of the amount allowed as a specific exemption. (5hf) (The unified credit is not reduced by any amount allowed as a specific exemption for gifts made prior to September 9, 1976.)

By means of the "split gift" provision (see Q 7595), a married couple can effectively use each other's unified credit.

7600. What are the requirements for filing the gift tax return and paying the tax?

A donor need not file a gift tax return if the only gifts he makes during the calendar year are covered by the annual exclusion (Q 7596) or the marital deduction (Q 7597), or are gifts to charity of the donor's entire interest in the property transferred where the donor does not (and has not) transferred any interest in the property to a noncharitable beneficiary. (Amounts paid on behalf of an individual as tuition to an educational organization or to a person providing medical care for him are not considered gifts for gift tax purposes. (1hg)) (2hg) However, in the case of a split gift (where the donor's spouse joins in making a gift to a third party), a gift tax return must be filed even though the amount of the gift comes within the spouses' annual exclusions.

The return (Form 709) is due on or before April 15 following close of the calendar year for which the return is made; however, if the donor is given an extension of time for filing his income tax return, the same extension applies to filing the gift tax return. Where a gift is made during the calendar year in which the donor dies, the time for filing the gift tax return is not later than the time (including extensions) for filing the estate tax return. (3hg) However, should the time for filing the estate tax return fall later than the 15th day of April following the close of the calendar year, the time for filing the gift tax return is on or before the 15th day of April following the close of the calendar year, unless an extension (not extending beyond the time for filing the estate tax return) was granted for filing the gift tax return. If no estate tax return is required to be filed, the time for filing the gift tax return is on or before the 15th day of April following the close of the calendar year, unless an extension was given for filing the gift tax return. (4hg)

The penalty for failure to file timely a federal tax return is 5% of the tax for each month the return is past due, up to a maximum of 25%. The penalty can be avoided only if "it is shown that such failure is due to reasonable cause and not due to willful neglect." (5hg) The regulations say that "reasonable cause" means that the taxpayer filing a late return must show that he "exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time." (6hg) In U.S. v. Boyle, (7hg) the Supreme Court held that a taxpayer's reliance on an agent who says he will file the appropriate tax return does not avoid the penalty tax for failure to make a timely filing. However, the court was careful to distinguish the case where the taxpayer relies on his tax advisor to determine whether a return should be filed at all. In Est. of Buring v. Comm., (8hg) the estate avoided the penalty tax because the court found that the decedent had relied upon her accountant's advice in failing to file gift tax returns for substantial advances of cash the decedent made to her son, even though the accountant apparently had not actually advised her that it was not necessary to file gift tax returns.

The gift tax is payable by the donor on the date the gift tax return is due to be filed (April 15). An extension of time given to file the return does not act as an extension of time to pay the tax. (1hh) If the donor does not pay the tax when it is due, the donee is liable for the tax to the extent of the value of the gift. (2hh) If an extension of time for payment of the tax is granted, interest compounded daily is charged at an annual rate adjusted quarterly so as to be three percentage points over the short term federal rate. (3hh) The underpayment rate for the last quarter of 2010 is 4%. (4hh)

Valuation

7601. How is investment property valued for federal transfer tax purposes?

"Fair market value" is the measure, defined as "the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts." In the case of the estate tax, fair market value is determined as of the date of the decedent's death, except that if the executor elects the alternate valuation method, fair market value is determined in accordance with the rules explained at Q 7602. In the case of the gift tax, fair market value is determined as of the date of the gift. Property is not to be valued at the value at which it is assessed for local tax purposes unless that value represents the fair market value as of the applicable valuation date. All relevant facts and elements of value as of the applicable valuation date are to be considered in every case. (5hh)

In the case of any taxable gift which is a direct skip within the meaning of the generation-skipping transfer tax (GST tax) (see Q 7576 et seq.), the amount of such gift is increased by the amount of the GST tax imposed on the transfer. (6hh) See Q 7577 for special GST tax valuation rules.

Special rules apply to the valuation of particular kinds of investment property, such as stocks and bonds (Q 7603), notes (Q 7605), mutual fund shares (Q 7609), certain kinds of business interests (Q 7611). See Q 7613 on the valuation of real estate. The principle of blockage discounting, applied in the valuation of a sizeable block of shares of corporate stock (see Q 7603), can also be applied in valuing art work. (7hh) Special rules also apply where, under certain conditions spelled out in IRC Section 2032A, an executor may elect to value, for federal estate tax purposes, real property (called "qualified real property") devoted to farming or other trade or business (called "qualified use") by the decedent or a member of the decedent's family on the date of the decedent's death, on the basis of its actual use rather than by taking into account the "highest and best" use to which the property could be put. See also Q 7937.

Assets in a restricted management account (RMA) are valued at fair market value, without regard to any RMA restrictions. (8hh)

Property includable in a surviving spouse's estate as qualified terminable interest property (see Q 7572) under IRC Section 2044 (see Q 7565) is not aggregated with other property includable in the estate for estate tax valuation purposes. (1hi) However, property included in the gross estate because of a general power of appointment under IRC Section 2041 (see Q 7565) should be aggregated with property owned outright by the powerholder for estate tax valuation purposes. (2hi)

With respect to gift and estate tax returns, 20% of an underpayment attributable to a substantial gift or estate tax valuation understatement is added to tax. There is a substantial gift or estate tax valuation understatement if (1) the value claimed was 65% or less of the correct amount, and (2) the underpayment exceeds $5,000. If the value claimed was 40% or less of the correct amount (and the underpayment exceeds $5,000), 40% of an underpayment attributable to such a gross gift or estate tax valuation understatement is added to tax. (3hi) The 20% or 40% penalty is not imposed with respect to any portion of the underpayment for which it is shown that there was reasonable cause and the taxpayer acted in good faith. (4hi)

A gift which is disclosed on a gift tax return in a manner adequate to apprise the Service of the nature of the item may not be revalued after the statute of limitations (generally, three years after the return is filed) has expired. (5hi)

See Q 7617 for Chapter 14 special valuation rules.

7602. How does the executor's election of the alternate valuation method affect the valuation of property for federal estate tax purposes?

The law permits the executor to elect an alternate valuation method if the election will decrease the value of the gross estate and the sum of the amount of the federal estate tax and generation-skipping transfer tax payable by reason of the decedent's death with respect to the property includable in the decedent's gross estate. (6hi) If the alternate valuation method is elected, the property will be valued under the following rules:

Any property distributed, sold, exchanged or otherwise disposed of within six months after decedent's death is valued as of the date of such distribution, sale, exchange, or other disposition. The phrase "distributed, sold, exchanged, or otherwise disposed of" comprehends all possible ways by which property ceases to form a part of the gross estate. For example, money on hand at the date of the decedent's death which is thereafter used in the payment of funeral expenses, or which is thereafter invested, falls within the term "otherwise disposed of." The term also includes the surrender of a stock certificate for corporate assets in complete or partial liquidation of a corporation pursuant to IRC Section 331. The term does not, however, extend to transactions which are mere changes in form. Thus, it does not include a transfer of assets to a corporation controlled by the transferor in exchange for its stock in a transaction with respect to which no gain or loss would be recognized for income tax purposes under IRC Section 351. Nor does it include an exchange of stock or securities in a corporation for stock or securities in the same corporation or another corporation in a transaction, such as a merger, recapitalization, reorganization, or other transaction described in IRC Section 368(a) or IRC Section 355, with respect to which no gain or loss is recognizable for income tax purposes under IRC Section 354 or IRC Section 355. (1hj)

In Est. of Smith v. Comm., (2hj) the decedent's stock in X corporation was exchanged for stock and warrants in Y corporation pursuant to a plan of merger. The court held that the warrants were received in exchange for the estate's stock in X and were to be valued as of the date of the merger. The Commissioner conceded, surprisingly, that the transaction should not be treated as an "exchange" with respect to the receipt of stock in Y, and that even though the value of the Y stock had declined substantially between the decedent's date of death and the alternate valuation date, the stock should be valued as of the alternate valuation date .The court's decision, however, was limited to the controverted issue as to the proper valuation date of the warrants. Apparently, the IRS soon changed its mind. In Rev. Rul. 77-221, (3hj) on substantially similar facts, the Service concluded that the exchange of X stock for Y stock and warrants constitutes an "exchange" and held that the X stock given in exchange was to be valued as of the date of the exchange.

If the property is listed stock and is sold in an arm's length transaction, the stock is valued at the actual selling price. (4hj) An exercise of stock rights is a "disposition" thereof; their value is equal to the excess, if any, of the fair market value of the stock acquired by such rights at the time the rights are exercised over the subscription price. (5hj)

Any property not distributed, sold, exchanged, or otherwise disposed of within six months after decedent's death is valued as of the date six months after death. When shares of stock in the estate are sold at a discount between the date of death and the alternate valuation date, such sales and the number of shares sold cannot be taken into account in determining whether the shares remaining in the estate at the alternate valuation date are eligible for "blockage" valuation (see Q 7603). (6hj)

Any property interest whose value is affected by mere lapse of time is valued as of the date of decedent's death. But an adjustment is made for any change in value during the six-month period (or during the period between death and distribution, sale, or exchange) which is not due to mere lapse of time. (7hj) The phrase "affected by mere lapse of time" has no reference to obligations for the payment of money, whether or not interest bearing, the value of which changes with the passage of time. (8hj)

Proposed regulations would provide that the election to value property includable in the gross estate on the alternate valuation date applies only to the extent that the change in value is a result of market conditions. (9hj)

If the alternate valuation method is elected, it must be applied to all the property included in the gross estate, and cannot be applied to only a portion of the property. (1hk)

The election to value property using the alternate valuation method must be made no later than one year after the due date (including extensions) for filing the estate tax return. The election is irrevocable, unless it is revoked no later than the due date (including extensions) for filing the estate tax return. If use of the alternate valuation method would not result in a decrease in both the value of the gross estate and the amount of estate tax and generation-skipping transfer tax on a filed return, a protective election can be made to use the alternate valuation method if it is later determined that such a decrease would occur. A request for an extension of time to make the election or protective election may be made if the estate tax return was filed no later than one year after the due date (including extensions) for filing the estate tax return but an election or protective election was not made on the return. (2hk)

Property earned or accrued (whether received or not) after the date of the decedent's death and during the alternate valuation period with respect to property included in the gross estate is excluded in valuing the gross estate under the alternate valuation method, and is referred to as "excluded property." (3hk)

Thus, as to interest-bearing obligations included in the gross estate ("included property"), interest accrued after the date of death and before the subsequent valuation date constitutes "excluded property." However, any part payment of principal made between the date of death and the subsequent valuation date, or any advance payment of interest for a period after the subsequent valuation date made during the alternate valuation period which has the effect of reducing the value of the principal obligation as of the subsequent valuation date, will be included in the gross estate, and valued as of the date of such payment. (4hk)

The same principles applicable to interest-bearing obligations also apply to leased realty or personalty which is included in the gross estate and with respect to which an obligation to pay rent has been reserved. Both the realty or personalty itself and the rents accrued to the date of death constitute "included property," and each is to be separately valued as of the applicable valuation date. Any rent accrued after the date of death and before the subsequent valuation date is "excluded property." Similarly, the principle applicable with respect to interest paid in advance is equally applicable with respect to advance payments of rent. (5hk)

Assets sold continue as included property, "even though they change in form." (6hk) Where royalty and working interests in oil and gas property were included property, the proceeds from the sale of oil and gas extracted from this property between the date of the decedent's death and the alternate valuation date were held to be included property (merely the translation of the decedent's interest in the in-place reserves the decedent owned at the time of her death into cash). As for the portion of proceeds to be included in the gross estate, the appropriate value was held to be the in-place value of the oil and gas on the date of its severance. (1hl)

In the case of noninterest-bearing obligations sold at a discount, such as savings bonds, the principal obligation and the discount amortized to the date of death are property interests existing at the date of death and constitute "included property." The obligation itself is to be valued at the subsequent valuation date without regard to any further increase in value due to amortized discount. The additional discount amortized after death and during the alternate valuation period is the equivalent of interest accruing during that period and is, therefore, not to be included in the gross estate under the alternate valuation method. (2hl)

Shares of stock in a corporation and dividends declared to stockholders of record on or before the date of the decedent's death and not collected at the date of death constitute "included property" of the estate. On the other hand, ordinary dividends out of earnings and profits (whether in cash, shares of the corporation, or other property) declared to stockholders of record after the date of the decedent's death are "excluded property" and are not to be valued under the alternate valuation method. If, however, dividends are declared to stockholders of record after the date of the decedent's death with the effect that the shares of stock at the subsequent valuation date do not reasonably represent the same "included property" of the gross estate as existed at the date of the decedent's death, the dividends are "included property," except to the extent that they are out of earnings of the corporation after the date of the decedent's death. For example, if a corporation makes a distribution in partial liquidation to stockholders of record during the alternate valuation period which is not accompanied by a surrender of a stock certificate for cancellation, the amount of the distribution received on stock included in the gross estate is itself "included property," except to the extent that the distribution was out of earnings and profits since the date of the decedent's death. Similarly, if a corporation, in which the decedent owned a substantial interest and which possessed at the date of the decedent's death accumulated earnings and profits equal to its paid-in capital, distributed all of its accumulated earnings and profits as a cash dividend to shareholders of record during the alternate valuation period, the amount of the dividends received on stock includable in the gross estate will be included in the gross estate under the alternate valuation method. Likewise, a stock dividend distributed under such circumstances is "included property." (3hl) "Included property" also includes the following: (a) nontaxable stock rights and proceeds from the sale of such rights occurring after decedent's death but before the alternate valuation date, where the rights are issued subsequent to the decedent's death in respect of stock owned by the decedent at death; (b) a nontaxable stock dividend received subsequent to decedent's death but before the alternate valuation date; (c) payments on the principal of mortgages received between the date of death and the alternate valuation date. (4hl) But where an estate owned mutual fund shares, and between the date of the decedent's death and the alternate valuation date capital gains dividends attributable solely to gains on stocks held by the companies at decedent's death were declared and paid, it was held that the dividends were not "included property." (5hl)

In the determination of the value of a decedent's gross estate, dividends declared before death, on stock includable in the gross estate, payable to stockholders of record after the date of the decedent's death, must be considered in making an adjustment in the ex-dividend quotation of the stock at the date of the decedent's death. Such dividends may not be included in the gross estate under the alternate method of valuing the gross estate either as a separate asset or as an adjustment of the ex-dividend quoted value of the stock as of the alternate valuation date or as of some intermediate date.

Under the alternate method of valuing the gross estate, stock includable in the gross estate and selling ex-dividend is to be valued at its ex-dividend quoted selling price as of the alternate valuation date or at any intermediate valuation date, increased by the amount of dividends declared on the stock during the alternate valuation period payable to stockholders of record subsequent to the alternate valuation date or such intermediate date. No part of the value so determined is deemed to be excluded property in determining the value of the gross estate. (1hm)
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Publication:Tax Facts on Investments
Date:Jan 1, 2011
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