Thursday April 18, 2024

3.5.8 Lead Trust Generation-Skipping Transfer Taxation

Lead Trust Generation-Skipping Transfer Taxation

Annuity Lead Trust for Grandchildren:   Generation-skipping transfer taxes (GSTTs) are particularly significant for charitable lead trusts.

Applicable Fraction for an Annuity Lead Trust:   With an annuity lead trust, the applicable fraction is not calculated until the termination of the trust.

Unitrust Lead Trust for Grandchildren -- Applicable Fraction :   In contrast to a lead annuity trust, a lead unitrust is permitted to calculate the applicable fraction as of the date of death of the testator.

Zero Inclusion Ratio:   Because the value of the trust at the date of death may be determined, in estates in which the value of the taxable transfer is equal to or less than the exemption amount, it is quite common to use a testamentary charitable lead unitrust.

Multiple-Layer Lead Trusts for Children and Grandchildren:   A strategy to minimize total taxation is to create a multi-layer lead trust.

Annuity Lead Trust for Grandchildren

Generation-skipping transfer taxes (GSTTs) are particularly significant for charitable lead trusts. Since the goal of many grandparents is to allow grandchildren to grow to greater levels of maturity before receiving a significant inheritance, the opportunity to leverage an inheritance through a lead trust for grandchildren is quite attractive. It is possible to pass two to seven times the exemption amount to grandchildren with a testamentary lead trust and still have zero GSTTs.

Applicable Fraction for an Annuity Lead Trust

With an annuity lead trust, the applicable fraction is not calculated until the termination of the trust. The applicable fraction then equals the exemption with growth for the trust term calculated at the applicable federal rate as of trust inception, divided by the value of the trust at termination. Sec. 2642(e)(2). This method subjects the trust to considerable uncertainty. While it is possible to know the value of the exemption with projected growth, the actual trust corpus will not be known with certainty until the date of distribution. While it has been suggested that it could be possible to transfer to family the amount equal to the adjusted exemption and transfer the balance to charity at that time, there is no specific statute or ruling that approves of this concept.

The applicable fraction formula is (the allocated GSTT exemption times (1+AFR)^ selected term)/(trust corpus). This formula results in a zero inclusion if the exemption adjusted upward by the AFR growth rate for the selected number of years results in a number that exceeds the trust corpus. However, if the trust corpus grows significantly, payment of a very substantial generation-skipping transfer tax could be required. Since this is a taxable termination, the tax would be payable by the trustee at the rate applicable at the time of termination.

Unitrust Lead Trust for Grandchildren -- Applicable Fraction

In contrast to a lead annuity trust, a lead unitrust is permitted to calculate the applicable fraction as of the testator's date of death. This enables the trust to use a formula or other allocation method to zero the GSTT. With a unitrust lead trust, the applicable fraction equals the allocated exemption divided by the fair market value of the property minus the charitable deduction. If the allocated exemption is equal to the present value of the taxable gift, the applicable fraction equals one/one. Since the inclusion ratio equals one minus one, or zero, the lead unitrust is exempt from generation-skipping transfer tax.

Zero Inclusion Ratio

Because the value of the trust at the date of death may be determined, in estates in which the value of the taxable transfer is equal to or less than the exemption amount, it is quite common to use a testamentary charitable lead unitrust. The testamentary CLUT may be created and the funding or the payout adjusted so that the available exemption is fully utilized in a trust with a zero inclusion ratio and an exemption from generation-skipping transfer tax.

Multiple-Layer Lead Trusts for Children and Grandchildren

A strategy to minimize total taxation is to create a multi-layer lead trust. The first two layers could be charitable lead annuity trusts, with distributions to children. Thus, these layers would not be subject to generation-skipping transfer tax. However, layers three and four could be trusts for a longer duration with remainders to grandchildren or great-grandchildren. Through formula clauses or careful planning for trust funding levels, the charitable lead unitrusts for grandchildren would be designed to be exempt from generation-skipping transfer tax. It is even possible that the lead unitrust remainders could be distributed to a dynasty trust in a state without a rule against perpetuities.

Private Letter Rulings

PLR 199903045 Lead Unitrust - GSTT:   Grantor A proposes creating a 6%/15-year lead unitrust with remainder to a family trust. The lead trust will make payments to a charity in which the grantor is a member, but he or she will have no power to allocate the gifted amounts. The family trust would pay to both children and grandchildren. Thus, a lead unitrust payout method was chosen in order to allocate generation-skipping transfer taxes (GSTT) exemption and have a zero inclusion ratio. Grantor sought rulings that (i) there would be a completed gift, (ii) there would be no estate inclusion and (iii) the lead unitrust would not be a grantor trust.

PLR 199922007 Unitrust Lead Trust With Income Tax Deduction:   Taxpayer created a lead unitrust paying 5% for a 10-year term, with remainder to grandchildren. Taxpayer also created a second charitable trust that qualified as a private foundation. The Service determined that the first trust could potentially be a grantor trust because of a retained Sec. 675(4) power. Second, the first trust was a qualified unitrust that qualified for both a gift tax deduction under Sec. 2522 and an income tax deduction under Sec. 170(f)(2)(B. Since the Sec. 675(4) power does not require inclusion under Sec. 2033, Sec. 2036(a) or Sec. 2036(a)(1) of the Code, the trust would not be includable in taxpayer's estate.

PLR 199936038 Living Charitable Lead Unitrust for Grandchildren:   Grantor and spouse plan to fund a charitable lead unitrust making annual payments to qualified charities for a term of 12 years, with remainder to grandchildren. They requested a ruling that the lead trust would not be subject to the Sec. 2702 gift tax rules, and that the present value of the unitrust payouts would qualify under Sec. 2522 for a charitable gift deduction.

PLR 200030014 Lead Trust for Grandchildren May Pay to Family Foundation:   Donor A desires to create a 25-year 7% lead unitrust with remainder to his grandchildren. Donor's spouse B and children C and D will be directors of a family private foundation that is to be created and receive funding from the lead trust. Neither the donor nor the donor's spouse will be a trustee of the lead trust. A also will not be an officer or director of the private foundation. In addition, B, C and D will be permitted to receive expense reimbursements but will not receive salaries from the private foundation.

PLR 9840036 Testamentary Lead Trust Drafting Provisions:   The testator and spouse desire to establish a lead trust upon the demise of the survivor. The Service rules that the present value of the unitrust interest in a testamentary charitable lead trust will qualify for an estate tax charitable deduction upon the survivor's death. The term of the charitable lead unitrust is to be set at the surviving spouse's death by calculating the amount necessary to produce an initial value for the remainder interest equal to the surviving spouse's available generation-skipping transfer tax exemption. The Service observes that the formula for determining the term of the charitable lead unitrust will be fixed and ascertainable as of the surviving spouse's death. With respect to generation-skipping transfer tax, the charitable lead unitrust will have an exclusion ratio of zero if the appropriate amount of the surviving spouse's exemption is allocated to the trust. Finally, the ordering rules for the payment of the unitrust amount will be disregarded for federal income tax purposes.

Related Topics on Lead Trust Generation-Skipping Transfer Taxation

1.4.4  Lead Annuity Trust GSTT:    Generation-skipping transfer tax (GSTT) is particularly significant for charitable lead trusts. Since the goal of many grandparents is to allow grandchildren to fully mature before receiving a significant inheritance, the opportunity to leverage an inheritance through a lead trust for grandchildren is quite attractive. It is possible to pass two to seven times the exemption amount to grandchildren with a testamentary lead trust and still have zero GSTT.

1.4.5  Lead Unitrust GSTT:    In contrast to a lead annuity trust, a lead unitrust is permitted to calculate the applicable fraction as of the testator's date of death. This enables the trust to use a formula or other allocation method that zeros out the GSTT. With a lead unitrust, the applicable fraction equals the allocated exemption divided by the fair market value of the property minus the charitable deduction. If the allocated exemption is equal to the present value of the taxable gift, the applicable fraction equals 1-1. Since the inclusion ratio equals one minus one or zero, the lead unitrust is exempt from GSTT.

3.6.6  Generation-Skipping Transfer Taxes - Lead Trust for Children and Grandchildren:    A very powerful combination is a family limited partnership with layered lead trusts. Two or three layers may be annuity lead trusts for children and the remaining layer or layers may be lead unitrusts for grandchildren.

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