The Tax Cuts and Jobs Act nearly doubled the gift and GST tax exemptions to approximately $11.2 million per person. This creates opportunities to allocate unused GST exemption to existing irrevocable trusts. Practitioners should analyze trusts to determine the inclusion ratio and whether unused GST exemption can be allocated. The rules around automatic GST allocation to trusts are complex, and hinge on factors like beneficiary ages and withdrawal rights. Filing gift tax returns can stop inadvertent GST allocation or allow late allocation of increased exemption to partially exempt trusts.

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Opportunities Created by the Tax Cuts and Jobs Act
for Partially GST-Exempt Trusts
By Melissa L. Dougherty
The wide-ranging changes to U.S. tax law contained in the Tax Cuts and Jobs Act of 2017 (P.L.
115-97, the act) have created opportunities for clients whose net worth is expected to remain
below the federal estate and gift tax exemption amounts. In particular, practitioners may wish
to analyze the federal generation-skipping transfer tax (GST) treatment of existing irrevocable
trusts in order to confirm each trust’s inclusion ratio and, if appropriate, take affirmative steps
to allocate GST exemption to partially exempt trusts.
The act as signed into law on Dec. 22, 2017, significantly increased the federal gift tax lifetime
exemption and federal generation-skipping transfer tax exemption amounts from $5.49 million
in 2017 to approximately $11.2 million in 2018, although the precise amount is still not finalized.
These amounts are indexed for inflation and absent legislative action, will sunset on Dec. 31,
2025, and revert back to pre-act levels (indexed for inflation in 2026). The federal gift tax
exemption is currently unified with the federal estate tax exemption. With the advent of
portability, a married couple in 2018 can effectively give away, during life or at death, amounts
exceeding approximately $22 million before incurring federal estate or gift tax. Because no
similar portability election is available for unused GST exemption, many practitioners are
taking a “use it or lose it” approach to this newfound, increased GST exemption.
One important first step is to determine the amount of GST exemption that a client has
already used, either by affirmative or automatic allocation. The rules governing automatic
allocation of GST exemption to trusts are complex. I.R.C. § 2632(c) provides that GST
exemption will be automatically allocated to transfers made after December 31, 2000 to a “GST
trust” without the need for any affirmative action by the taxpayer. A “GST trust” is broadly
defined as any trust that could have a generation-skipping transfer unless one of the exceptions
contained in I.R.C. § 2632(c)(3)(B) applies at the time of the transfer. This appears to include
one common iteration of the irrevocable life insurance trust (ILIT), where Spouse 1 creates an
irrevocable inter vivos trust for the benefit of Spouse 2, and after Spouse 2’s death the property
is held in further trust for children and for a child’s own children in the event that a child dies
before the termination of child’s trust. I.R.C. § 2632(c) was originally enacted to aid taxpayers
who transferred property to irrevocable trusts that were intended to be generation-skipping
but, for one reason or another, inadvertently did not allocate the needed GST exemption to
the transfer. However, in practice this wide-sweeping definition of what constitutes a “GST
trust,” and therefore a trust to which GST exemption will be automatically allocated, has
ensnared many trusts that were not intended to be GST exempt. As a result, unless one of the
exceptions applied to each transfer made to the trust, some amount of GST exemption was
automatically (albeit inadvertently and in some situations, unknowingly) allocated to the
trust.

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The exceptions are nuanced and focus upon several factors including the ages of the trust’s
beneficiaries at the time of the transfer, the trust’s total value in a given year, and the value of
accumulated hanging Crummey withdrawal powers possessed by beneficiaries. Thus, the
required analysis is highly fact-intensive, so the determination of whether one of the
exceptions applies to a transfer (and therefore, whether GST exemption was automatically
allocated) may, and often does, change from year to year.
One exception in particular can be troublesome for trusts in which beneficiaries possess
hanging Crummey powers. A trust will not be considered to be a GST Trust, and therefore
GST exemption will not be automatically allocated, if any portion of the trust property would
be included in a non-skip person’s gross estate (other than the transferor) if the non-skip person
(other than the transferor) were to die immediately after the transfer. This would seem to
include any trust that provides children (non-skip persons) with Crummey withdrawal powers
over property contributed to a trust created by a parent, and the Crummey powers are designed
to not lapse fully (i.e., will “hang”) at the end of each year. If a Crummey power holder dies
before her withdrawal right fully lapses, the value of her withdrawal right is includible in her
gross estate for federal estate tax purposes. Realizing that the death of any Crummey power
holder could potentially prevent the allocation of GST exemption with unintended results, the
Internal Revenue Code limits the application of this exception to situations where the total
value of property subject to a Crummey power (hanging and current) exceeds the federal gift
tax annual exclusion amount for that particular year. Unfortunately, many ILITs with
hanging Crummey powers will still run afoul of this exception, although not necessarily in
every year, resulting in a trust that is not fully exempt or non-exempt for GST purposes.
For example, presume that Grantor creates an irrevocable trust for the benefit of Spouse and
Child, and the trust agreement provides that upon any contribution made to the trust, Child
has the right to withdraw an amount equal to the lesser of (i) the amount of the contribution
or (ii) the federal gift tax annual exclusion amount available for Child, and on December 31 of
that year Child’s withdrawal power will lapse up to an amount equal to the greater of $5,000 or
5% of the trust’s value. In 2016 (the year the trust was created), Grantor contributed $14,000 to
the trust and did not file a gift tax return reporting the transfer or electing GST allocation
treatment. Child’s withdrawal right was $14,000, and on December 31, 2016, Child’s withdrawal
right lapsed by $5,000, so that $9,000 of the withdrawal right hangs. This particular exception
would not be triggered because Child’s total withdrawal right did not exceed the federal gift
tax annual exclusion amount ($14,000 in 2016), the trust would be a GST trust and GST
exemption would be automatically allocated to the transfer. Assume that in 2017, Grantor
contributed another $14,000 to the trust. Child’s total withdrawal right as of the date of transfer
was $23,000 ($9,000 hanging withdrawal right plus $14,000 current withdrawal right). Because
the value of Child’s total withdrawal right exceeded the federal gift tax annual exclusion
($14,000 in 2017), the exception was triggered and the trust will not be considered to be a GST
trust at the time of the 2017 transfer; therefore, GST exemption would not be automatically
allocated to the transfer.
Many similar trusts that hold life insurance policies with moderate premiums that build cash
value may experience a bell curve of GST exemption allocation if the grantor contributes cash
to the trust annually to pay premiums. The beneficiaries’ hanging Crummey powers can
accumulate slowly for the first several years after the trust’s creation (resulting in the
automatic allocation of GST exemption), until the aggregate value of the hanging powers hits

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a tipping point that exceeds the federal gift tax annual exclusion amount (stopping the
automatic allocation of GST exemption). Then, the hanging Crummey amounts eventually
lapse as the insurance policy’s cash value grows in value to the point that 5% of the trust’s value
is greater than $5,000 (resulting again in the automatic allocation of GST exemption to future
transfers).
Of course, one way to avoid the need for this complex analysis is to timely file a federal gift
tax return for the year in which a contribution is first made to the trust and make an
affirmative election to opt-in or opt-out of the GST exemption automatic allocation rules for
that trust. Other options must be explored for already existing trusts.
The Act creates a potential “spring cleaning” opportunity for clients who have created
irrevocable trusts. Such clients may wish to file a 2018 federal gift tax return with two goals.
First, a return can be filed to stop any inadvertent hemorrhaging of GST exemption by making
an election to opt-out of the I.R.C. § 2632(c) automatic allocation rules. Second, it may be
appropriate for some clients to use a portion of their newly doubled GST exemption to make
a late allocation to any trusts that were intended to be fully exempt from GST tax but are
suspected to be only partially exempt. With careful navigation of the automatic allocation rules
and proactive (albeit late) allocation of GST exemption, many trusts can soon look sparkling
new.
Reprinted with permission from the February 12, 2018 edition of The Legal Intelligencer
Wealth Management Trusts & Estates Special Section© 2018 ALM Media Properties, LLC.
All rights reserved.
Further duplication without permission is prohibited. ALMReprints.com – 877-257-3382 -
reprints@alm.com.
If you have any questions about any of the above information, or wish to discuss a particular
matter, please feel free to speak with Ms. Dougherty or any other member of our Estates &
Trusts Practice by calling us at 412-297-4900 or visiting
https://www.cohenlaw.com/practices/estates-trusts/. To receive future news alerts, please send
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