The IRS has granted an extension to opt out of the automatic GST tax allocation for a series of grantor retained annuity trusts (GRATs). This decision, outlined in Private Letter Ruling 202633002, comes after the taxpayer’s estate requested relief due to incomplete filing of gift tax returns. The taxpayer, over many years, established multiple GRATs with varying terms, including 2-, 3-, and 4-year GRATs in Year 1, and additional 2-year GRATs in Years 6, 7, and 9.
Background on GRATs and GST Tax
A GRAT is a type of trust that allows a grantor to transfer assets to beneficiaries while retaining an annuity interest. The GST tax, or generation-skipping transfer tax, applies to transfers made to beneficiaries who are more than one generation below the grantor, such as grandchildren. The remainders of these GRATs were distributed to irrevocable trusts, all classified as GST trusts under the Internal Revenue Code, with potential distributions to skip persons.
The Issue: Incomplete Gift Tax Returns
The taxpayer failed to file gift tax returns that opted out of the automatic GST tax allocation for some years, despite having filed returns for others. This oversight was discovered upon the taxpayer’s death, prompting the estate to request an extension to make the necessary elections. The taxpayer’s advisors, including drafting lawyers, a family office, and an accounting firm, did not fully advise on the need to file these returns or opt out of the automatic GST tax allocation.
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Under GST regulations, the GST tax exemption is automatically allocated to all indirect skips. For transfers subject to the estate tax inclusion period (ETIP), the taxpayer can opt out of this automatic allocation by filing a gift tax return for the year the ETIP closes. The mistake was only identified after the taxpayer’s death, leading the estate to seek relief.
The ruling also raises questions about the ETIP periods for different GRATs. Regs. Section 26.2632-1(c)(2)(ii)(A).
IRS Relief and Good Faith Considerations
The IRS granted relief under Treas. Regs. Section 26.2642-7, which allows for an extension of time to allocate GST tax exemption if the taxpayer or estate acted reasonably and in good faith. Here, the IRS granted the taxpayer’s request for relief, finding that the estate had provided sufficient evidence that the taxpayer had acted in good faith and reasonably relied on their advisors.
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ETIP Periods and GRATs: A Closer Look
The PLR clarified that the 3- and 4-year GRATs from Year 1 were subject to ETIP, with the period ending when the GRATs terminated. The 2-year GRAT from Year 1, however, terminated before the deemed GST tax allocation rule under Section 2632(c) took effect, making ETIP inapplicable. The ruling didn’t mention when the ETIP ended because the automatic allocation rule wouldn’t apply.
For the 2-year GRATs created in Years 6 and 7, the IRS determined that the possibility of the grantor’s death during the term was negligible—less than 5%—under Treas. Regs. Section 26.2632-1(c)(2)(ii)(A). This made them exempt from ETIP. In contrast, the 2-year GRAT from Year 9 was subject to ETIP, likely due to the grantor’s advanced age increasing the probability of death during the term. The varying ETIP treatments across GRATs show the complexity of GST tax rules and the need for precise estate planning, particularly in assessing the likelihood of the grantor’s death during the GRAT term.
About the Authors
David A. Handler, a partner in the Trusts and Estates Practice Group of Kirkland & Ellis LLP, is recognized as a leading expert in estate planning. The October 2011 edition of Leading Lawyers Magazine lists him as one of the “Top Ten Trust, Will & Estate” lawyers in Illinois and a “Top 100 Consumer” lawyer in the state. He serves on the Tax Management Estates, Gifts and Trusts Advisory Board and is an Editorial Advisory Board Member of Trusts & Estates Magazine, where he writes the monthly “Tax Update” column. His expertise includes trust and estate planning, administration, and charitable giving, with a focus on high-net-worth individuals and closely-held businesses.