Christopher Stoneman Estate Planning Articles

XI - Federal Transfer Tax - Part 1

     The three prongs of the federal* transfer-tax trident are the gift tax, the estate tax and the generation-skipping transfer tax (hereafter “GSTT”).  We will consider each of these in turn in this and succeeding articles.  But let us preface that discussion with an introductory overview of the entire transfer-tax landscape.
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As noted, there are three transfer taxes, excise taxes imposed on various types of transfers:  the gift tax,  the estate tax and the most recently imposed of the trio,  the GSTT, which, in its present incarnation,** was added to the Internal Revenue Code in 1986.

     A.  The gift tax.  The gift tax, contained in Sections 2501 through 2524 of the Code, applies to transfers made by individuals during their lifetimes.***  It was formerly imposed at lower rates than the estate tax, which generally had the effect of favoring living transfers to those made at death - a factor which often figured in estate-planning strategies.  This is no longer the case; the two taxes have been coordinated in the sense that both are now subject to the same progressive rate table.  The more one gives away during one’s lifetime, the higher the bracket at which the unitary tax schedule becomes applicable to whatever assets one still owns at one’s death.
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*       Two of these, an estate tax and a generation-skipping tax, are imposed by Vermont. Some of the other states have a gift tax, and one or two levy a generation-skipping transfer tax.
**     The GSTT had a false start in 1976 .  This was repealed and replaced by the present tax in 1986.
***   The gift tax does not apply to corporations or to trusts and estates.  It is possible, however, that a transfer by a corporation may under certain circumstances be treated as a gift by its shareholders.

While the gift tax is comprehensive in nature, there are a number of extraordinary provisions which we will touch on later in greater detail: the annual per donee exclusion adjusted for inflation (Section 2503(b));  certain gifts to minors (Section 2503(c)(3)); the rule with respect to certain gifts made by a spouse to a third party (Section 2513); certain gifts which are subject to the GSTT (Section 2515); and certain property settlements which accompany a divorce (Section 2516).

The comprehensive gift-tax rule, as spelt out in Section 2511, entitled Transfers in General,  states in principal part as follows:

[T]he tax imposed by section 2501 shall apply 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**; but in the case of a nonresident not a citizen of the United States,*** shall apply to a transfer only if the property is situated within the United States.

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*        For example, the making of an interest-free loan.  Certain transfers nominally made by closely-held corporations may for gift-tax purposes be treated as gifts by the corporation’s shareholders.
**      E.g., a painting (tangible) or shares of stock (intangible).  See Article III.   
***    A United States citizen domiciled, say, in Switzerland remains subject to the gift tax regardless of his or her nonresidence, and no matter where the subject matter of the gift is situated.
****   The gross estate of a nonresident not a citizen of the United States is limited to “that part of his [Section 2031] gross estate which at the time of his death is situated within the United States.” (Section 2511).

B.  The estate tax.  The estate tax is contained in Sections 2001 through 2210.  It is a great deal lengthier than the gift tax and spells out in  considerable detail the various situations which will trigger inclusion in what is termed the “gross estate” (Section 2031(a)), which is the starting point for computation of an estate’s estate-tax liability:

[T]he value at the time of [a decedent’s] death of all property, real or personal, tangible or intangible, wherever situated.*

From the gross estate there are deducted the various items of deduction - debts,expenses, certain gifts to charity and gifts to the decedent’s surviving spouse (known as the “marital** deduction”) - in order to arrive at the “taxable estate.”  As noted, the level at which the combined gift- and estate-tax rate schedule is applied to the taxable estate will depend upon the extent, if any, to which the decedent has made taxable gifts during his or her lifetime.  A “tentative tax” is then determined and various credits are applied against the tentative tax to arrive at the final estate-tax liability.  The tax is payable by the “executor,” defined by the Code to include, if no executor or administrator has been appointed, “any person in actual or constructive possession of any property of the decedent.”***

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*      The gross estate of a nonresident not a citizen of the United States is limited to “that part of his [Section 2031] gross estate which at the time of his death is situated within the United States.”
(Section 2511).
**    Not a “martial” deduction, as some unhappy spouses have been heard to state it.
***  Section 7701(a)(47).

An enumeration of the inclusionary  provisions of the estate-tax law will give an idea of the scope of the tax:

All property “to the extent of the interest therein of the decedent at the time of his death”- Section 2033;

Gifts made by decedent within three years of his death - Section 2039;

Transfers by decedent during his lifetime where he has retained the right topossession or enjoyment of the transferred  property during his lifetime - Section 2036;

Certain transfers made by the decedent where possession or enjoyment of the transferred property can only be had by surviving the decedent and the decedent has retained a more than five percent reversionary interest in the transferred property - Section 2037;

Transfers where enjoyment of the transferred property was subject at the time of the decedent’s death to his power to amend or evoke the transfer, whether alone or in conjunction with any other person, or such a power was relinquished within three years of the decedent’s death - Section 2038;

Certain annuities - Section 2039;

Property held by the decedent jointly with another person with right of survivorship - Section 2040;

Property over which the decedent has a general power of appointment*  at the time of his death - Section 2041; and

Proceeds of policies of insurance on the life of the decedent which are payable to the executor of his estate - Section 2042.

As the foregoing enumeration illustrates, inclusion in a decedent’s gross estate (as well as ownership for gift-tax purposes) does not always require actual ownership at the time of death (or at the making of the gift) but may be based upon other criteria.  Section 2036, for example, is based upon the transfer of title to one’s property with the retention of the right to enjoyment;** Section 2039 requires a transfer of ownership within three years of death.  The exercise of a general power of appointment over property which the donor may not own is treated as a transfer for estate-tax purposes.

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*       See Article XI at page 5.
**     A typical example would be when the owner of paintings gives them to a child on condition that they remain in the donor’s home for her to continue to enjoy for the rest of her life

     C.  The GSTT.  As indicated, the junior member of the three transfer-tax segments of the Internal Revenue Code is the generation-skipping transfer tax.  It is generally agreed that what the GSTT lacks in age it most assuredly makes up for in complexity.  Some history may be helpful.

The broad legislative purpose of the GSTT is to plug a gap - a perceived, indeed a very real, gap - in the federal transfer-tax scheme.  With careful planning. Congress recognized, it was possible to pass wealth down the line in dynastic fashion from generation to generation completely free of transfer tax.  In states which had no Rule Against Perpetuities* this could be accomplished for indefinite periods of time.  Thus, as one of the leading treatises on estate planning has summarized the pre-GSTT situation,

[A] settlor could create a trust to last for a child’s lifetime, remainder to more remote descendants, without causing estate or gift taxation to the child.  In such a trust it was possible to grant the child interests including (1) the right to all income, (2) principal in the trustee’s discretion, or subject to a [limited] power of withdrawal in the child ...,  (3) a nongeneral power of appointment, and (4) if properly done, even full powers as trustee, all without causing any change in the tax minimization or avoidance possibility of the trust.**

In states such as Vermont, which retains a benign version of the Rule***, such freedom from federal transfer tax may be accomplished for periods of as much as 90 or 100 years.

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*      A long-standing common law rule requiring (to state the Rule simply) that property “vest” in someone within the period beginning with the transfer and ending not later than the death of one or more “measuring” lives (i.e., people living at the time of the transfer) plus 21 years.
**     1 Casner and Pennell, Estate Planning, Section 1.4.
***    The so-called “wait and see” version:  if at the time of the event (i.e., the execution of the deed or the creation of the trust agreement) the common law measure has not been violated, there is no current violation.  See, e.g., Burgess v. Howe, 134 Vt 370 (1976), and 27 V.S.A. Section 501.

It was to eliminate this loophole that the GSTT was added to the transfer-tax armory.  In a later article we will describe more fully the way the GSTT achieves its dread purpose.  The two basic requirements for its application are (i) the making of a “generation-skipping transfer” (Section 2611(a)), (ii) to a “skip person” (Section 2613).  A generation-skipping transfer is defined as one of the following: a “direct skip” (Section 2612(c)) to a skip person; a “taxable termination” (Section 2612 (a); or a “taxable distribution” to a skip person (Section 2612 (b)).  A ‘skip person,” the nextessential element, is defined in part as a natural person who is assigned to a generation which is two or more generations below the transferor (Section 2613).  The GSTT has a substantial exemption from the tax  - presently $2,000,000 - which makes it inapplicable to the great majority of taxpayers.  When the exemption is exceeded, the tax is imposed at the highest estate tax rate (without any progressive “run-up”).

       D.   Prospective repeal of estate tax and GSTT.  As things presently stand - and not necessarily as they will eventually happen - the estate tax and the GSTT (but not the gift tax) are due to go out of existence in 2010.*  Again, as things presently stand, the estate-tax law and the GSTT, in the form in which they were in existence prior to their  repeal, will go back into effect on January 1, 2011.**  All of this is subject, of course, to the possibility of further change between now and 2010.  A possibility which may ripen into probability if as presently anticipated the forthcoming Presidential election results in a change of party affiliation. 

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*     Economic Growth and Tax Relief Reconciliation Act of 2001.
**   I.e., shorn of amendments made during the period 2001-2010.

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