Final GST exemption allocation regulations may provide relief: PwC

In brief

What happened?

On May 6, Treasury released final regulations under Section 2642(g)(1), which detail the circumstances and procedures under which extensions of time will be granted to make allocations and certain elections under Section 2632 related to the generation skipping tax (GST) exemption.

Why is it important?

Treasury originally published proposed regulations (REG-147775-06) under Section 2642(g) on April 17, 2008. According to the proposed regulations, relief would not be granted to taxpayers to decrease or revoke a timely allocation of GST exemption, nor would relief be granted to revoke an election under Section 2632(b)(3) (an election not to have the deemed allocation rules apply to certain lifetime direct skips) and Section 2632(c)(5) (an election to have the automatic allocation rules not apply to an indirect skip trust or an election to treat any trust as a GST trust where automatic allocation rules apply). Thus, as drafted, the proposed regulations would have limited GST relief by preventing taxpayers from correcting inadvertent or unintentional elections related to GST.

In a departure from the proposed regulations, the final regulations clarify that such elections are not irrevocable; therefore, relief may be available in appropriate circumstances to revoke or correct elections under Section 2632(b)(3) and Section 2632(c)(5) assuming the standards for relief are met. However, the final regulations also indicate that relief will not be available for manual (i.e., affirmative) allocations of GST under Section 2632(a) or Section 2642(b) except under very limited circumstances. Guidance also is provided regarding the substantiation needed to accompany relief requests.

Actions to consider

The final regulations offer taxpayers an opportunity to remedy errors and oversights related to GST allocations and elections. Despite this favorable guidance, taxpayers should make every reasonable effort to file gift and estate tax returns with correct elections and allocations of GST, without needing to rely on costly relief requests that are not guaranteed and could be denied on other grounds.

In detail

The GST tax is imposed at a flat 40% rate on the taxable transfer of assets to a “skip person” in excess of the transferor’s GST exemption amount. A skip person includes an individual who is two or more generations below the transferor (such as a transfer from a grandparent to a grandchild), an unrelated person who is 37 ½ years younger than the transferor, and certain trusts. For 2024, the GST exemption amount is $13.61 million per person ($27.22 million for married couples). Transfers in certain types of trusts – referred to as “indirect skips” — also may be subject to GST tax in the future if the trust benefits a skip person.

A transferor’s available GST exemption is automatically allocated to a direct skip transfer unless an election out under Section 2632(b)(3) is made and GST tax on the amount of the transfer is paid with the return. For indirect-skip transfers and transfers to certain trusts, a transferor has two election options (1) they can choose to elect out of the automatic allocation rules under Section 2632(c)(5)(A)(i), such that no amount of GST exemption is allocated to the transfer made to the trust; or (2) the transferor can elect to treat any trust as a GST trust under Section 2632(c)(5)(A)(ii), so that the transferor's unused GST exemption may be allocated automatically to those transfers. These elections must be made on a timely-filed gift or estate tax return.

The final regulations provide guidance to taxpayers seeking to correct or revoke a previous GST election made on a timely-filed return, including the circumstances under which such relief will be granted, and the required documentation needed to support such requests.

Relief for timely allocation and elections

The final regulations supplement Section 2642(g)(1), which authorizes Treasury to prescribe the circumstances and procedures under which taxpayers will be granted an extension of time to allocate GST exemption or make an election under Section 2632(b)(3) or Section 2632(c)(5). The proposed regulations indicated that such elections were irrevocable; however, according to the preamble to the final regulations, Congress believed that relief should be granted in appropriate circumstances, such as when the taxpayer intended to allocate GST exemption and their failure to do so was inadvertent. Therefore, the final regulations provide that relief may be granted to taxpayers seeking to revoke such elections if certain requirements are met.

For taxpayers seeking to decrease or revoke an affirmative allocation of GST under Section 2632(a) or Section 2642(b), the final regulations state that relief may only be granted in three limited circumstances (1) the amount of GST previously allocated exceeded the amount necessary to obtain an inclusion ratio of zero; (2) an allocation of GST was made to a trust that had no GST potential with respect to the transferor at the time of the allocation; and (3) the taxpayer previously made a late allocation of GST prior to December 31, 2000 solely to mitigate the tax consequences of originally failing to allocate GST on a timely-filed gift tax return, and the taxpayer otherwise was not eligible for relief prior to the enactment of Section 2642(g)(1).

Observation: A request for relief would not be required for the first two situations and could be corrected on a filed Form 709; however, the third situation would require relief under Section 2642(g)(1).

Taxpayers seeking to qualify for relief under Section 2642(g)(1) must apply through the IRS private letter ruling program.

Nonexclusive list of factors needed for relief

To qualify for relief, taxpayers not only must satisfy the documentation requirements set forth in the final regulations, but they also must establish to the satisfaction of the IRS that they acted reasonably and in good faith. The final regulations provide a nonexclusive list of factors that will be considered to establish whether the transferor acted reasonably and in good faith. These factors include intent (including evidence of intent contained in the trust instrument), intervening events, lack of awareness, consistency, and reliance on the advice of a qualified tax professional.

The preamble indicates that no single factor can be determinative “given the inherent complexity of the GST exemption rules.” Further, whether the taxpayer acted reasonably and in good faith does not depend on the timing of the taxpayer’s request for relief relative to the IRS’s discovery of the error. In other words, a taxpayer will not satisfy the good faith and reasonableness standard only because they request relief before the IRS notices the mistake; similarly, discovery by the IRS will not automatically represent the absence of good faith on the part of the taxpayer.

Observation: Although GST elections now potentially can be revoked, taxpayers still will need to meet the standards for relief, which means putting together a compelling package that the intent was not reflected properly on the timely filed return and the revocation is not related to hindsight or a change in circumstances.

Overview of the affidavit requirements

When requesting relief, in addition to providing evidence supporting the list of factors noted above, the final regulations maintained the requirement in the proposed regulations that the request include detailed affidavits. The affidavits must describe the events that led to the transferor’s failure to timely allocate GST exemption or failure to timely make an election under Section 2632(b)(3) or Section 2632(c)(5), along with the events that led to the discovery of such failure. The final regulations reduce the amount of information required to be included in such affidavits from the requirements in the proposed regulations.

The affidavit must include copies of any writings (including notes and emails) and other contemporaneous documents that would be relevant to determine the transferor’s original GST intent. If the transferor relied on a tax professional, the affidavit also must include details regarding the scope of the tax engagement, the responsibilities that the transferor believed the tax advisor assumed, and the extent to which the transferor relied on the tax professional.

The transferor requesting relief also must submit affidavits from certain individuals who have knowledge or information about the events that led to the failure to allocate GST exemption or the failure to make a proper election under Section 2632(b)(3) or Section 2632(c)(5), including the discovery of such error. These individuals include:

Each agent or legal representative of the transferor who participated in the consideration of the allocation of GST exemptions or elections;
The relevant federal estate or gift tax return preparer;
Each individual (including an employee of the transferor) who provided information or advice regarding the decision concerning the allocation of GST exemption or elections;
Each tax professional who advised or was consulted by the transferor.

In cases where the IRS believes additional information is required or would be helpful in determining whether to grant the transferor’s relief request, the final regulations enable the IRS to request additional affidavits and copies of writings from individuals other than those described above.

Observation: For taxpayers who have used GST exemption on trusts unintentionally or have a non-exempt or mixed inclusion ratio trust where GST was intended to be allocated, the final regulations offer another potential solution to remedy the mistake. However, the relief request could be costly and there is no guarantee that relief would be granted so all factors should be considered.