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Oct 1992

The courts and IRS assist planners who have million dollar GST problems. (generation-skipping transfer tax) (Personal Financial Planning)

by Marshall, Anthony P.

    Abstract- Generation skipping transfer tax (GST) is required for all estate transfers involving skip persons. The classification skip persons would refer to grandchildren and kin who are not linear descendants of the grandparents of the transferor or to persons younger than the transferor by more than 37 and 1/2 years. Husbands and wives must be made aware that GST exemption is nontransferable, making thorough planning a necessity for maximizing the two million dollar tax exemption provided to them. The division of property shares as either wholly exempt or non-exempt serves as a good means of maximizing GST exemption. Several cases are cited that illustrate the leniency of courts in allowing modifications in wills that facilitate the separation of trusts as exempt and non-exemptor, as well as wills that do not provide for individual trusts.

Although everyone has a $1 million GST exemption, it is not transferable between spouses. Therefore, careful planning is required for a husband and wife to make full use of their $2 million worth of exemptions. For GST purposes, the transferor is the donor if the property is subject to estate tax. Sec. 2652(a)(3) allows the estate of the first spouse to die to elect to be the transferor of QTIP property even though such property is subject to estate tax in the surviving spouse's estate.

To maximize a person's exemption, property should be separated into wholly exempt and non-exempt shares for several reasons.

* Property that is partially exempt cannot be segregated later, and every distribution from a partially exempt trust, whether or to a skip person, would be deemed partially exempt and partially non-exempt;

* Complete segregation allows the pursuit of separate investment strategies appropriate for present and future generations; and

* Estate taxes attributable to both shares can be allocated wholly to the non-exempt share.

Although the GST is over 5 years old, many wills are offered for probate that neither provide for separate GST trusts nor authorize the executor or trustee to divide trusts into exempt (inclusion ratio of zero) and non-exempt trusts. Fortunately, the courts have been liberal in sanctioning reformations.

The first reported case |Matter of Will of Ghoate, 141 Misc. 2d 489,533 N.Y.S.2d 272(1988) involved a classic situation: the residuary estate was devised to one QTIP trust. Upon the surviving spouse's death, the trust was to be divided into two equal trusts, one for the decedent's son and the other for grandchildren. The court permitted the residuary estate to be divided into three trusts: Trust A, equal to one-half of the residuary estate, would continue in trust for the son after the widow's death; Trust B, equal to $1 million, would continue in trust for the grandchildren; and Trust C, equal to one-half of the residuary estate minus $1 million, would also continue in trust for the grandchildren; and Trust C, equal to one-half of the residuary estate minus $1 million, would also continue in trust for the grandchildren. The reformation further provided that after the widow's death, estate taxes attributable to Trust B would be paid from Trust C. Thus, the court sanctioned a change to effectively use the $1 million GST exemption.

In the Estate of Alfred L. Kaskel, 146 Misc. 2d 278,549 N.Y.S.2d 587(1989), the court was asked to reform not the decedent's will but the will of the decedent's husband who died in 1968, many years before the enactment of the first generation-skipping transfer tax. Under his will, the residuary estate was divided into two trusts: the marital trust and the residuary trust.

Mrs. Kaskel had a general power of appointment over the marital trust, which would be added to the residuary trust in default of exercise. She was also the income beneficiary of the residuary trust that continued after her death in separate trusts for each of three children, with the remainder to grandchildren. Mrs. Kaskel died in 1988 without exercising her power of appointment. Nevertheless, because of this power, the assets in the marital trust were not grandfathered from the GST, unlike the assets in the residuary trust that were. The court permitted the marital trust to be divided into two trusts, a $1 million trust to which Mrs. Haskel's exemption could be allocated, and another of the balance. The estate taxes attributable to the $1 million trust would be paid from the second trust and both trusts would then be subdivided into three separate trusts for each child so that each would have two exempt trusts and one non-exempt trust.

Reform Into Three Trusts

The will in Estate of Nossiter, 146 Misc. 2d 899,552 N.Y.S.2d 834(1990), directed that upon the surviving spouse's death, the QTIP trust be distributed equally among the son and four grandchildren. The court permitted the QTIP to be reformed into three trusts: the first (the son's trust) equal to 20% of the assets, the second equal to 80% less the remaining GST exemption (in this case $975,000), and the third (the exempt trust) equal to $975,000. Income from all three trusts would be paid to the widow. The son would be the remainderman of the first trust and the grandchildren of the second and third trusts. Upon the widow's death, estate taxes would be allocated, 20% to the first trust and 80% to the second trust. The decedent's exemption could shelter the exempt trust, and the widow's exemption could shelter the second trust at her death.

In Estate of David Stettner (NYI-J, July 9, 1991, p. 22), the will created a single residuary trust of approximately $2.2 million to last until 21 years after the death of the last of the decedent's grandchildren living at his death. The decedent's son was to receive 80% of the income and his issue the rest. $120,000 of the decedent's GST exemption was allocated to pre-residuary direct to be allocated to the residuary trust. A court permitted the residuary trust to be reformed into three trusts: the first equal to 20% of the residuary estate (approximately $440,000), with income payable to the son's issue, the second equal to the remaining GST exemption alter allocations to the pre-residuary direct skips and the first residuary trust, with income payable to the son, and the last equal to the balance of the residuary estate (approximately $1,320,000), also with income payable to the son. Thus, only the third trust would be subject to GST.

IRS Is Also Accommodating

The IRS, in PLR 9028005, also approved a reformation to make effective use of the GST exemption. Upon the decedent's death, the surviving spouse became the sole beneficiary of the decedent's revocable trust. She was entitled to all the income and had lifetime and testamentary general powers of appointment over the trust principal. She disclaimed her powers over one-half of the trust property, and a court proceeding was commenced to divide the single trust into three trusts. Trust A would equal the half of the trust over which the widow retained her powers of appointment, Trust B the amount of the decedent's unused GST exemption, and Trust C the balance of the trust property. The ruling allowed the division to permit Trust B to qualify as QTIP property, thereby enabling a Sec. 2652(a)(3) election to be made to treat the decedent as the transferor of that trust so that his GST exemption could be allocated to it.

As drastic as some of these reformations seem, none of them substantively change the testator's dispositive scheme. In each case, both the beneficiaries and the nature of their interests remain the same. Does it matter if grandchildren receive 20% of the income from one trust or all the income from a trust one-fifth the size (Stettner)? Or if the surviving spouse receives all the income from one QTIP trust, or all the income from three QTIP trusts equal to the one QTIP (Choate, Nossiter)? Allocating estate taxes solely against the reformed non- exempt trust or trusts does not substantively change the scheme. The tax burden is still on the same remaindermen (50% on the son and 50% on the grandchildren in Choate; 20% on the son and 80% on the four grandchildren in Nossiter). The key to a successful reformation is rearranging the estate to isolate a portion of the QTIP for the Sec. 2652(aX3) election and to separate potential direct skip interests from other interests in trust--all without changing the nature or amount of any of the beneficial interests.

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