GST Exemption Allocation for 2019, Better Late than Timely

“You may already know that the depressed market presents a great opportunity to make late allocations of GST exemption to prior years’ gifts.  Don’t forget that another opportunity exists for 2019 gifts whose value has declined since the date of the gift.  By purposefully failing to make a timely allocation (or timely opting out of automatic allocation with respect to a “GST trust”) and then making a late manual allocation of GST exemption, the taxpayer can get a zero inclusion ratio using less exemption.”

Beth Shapiro Kaufman and Megan E. Wernke provide members with commentary that reviews a great planning opportunity for making late allocation of the GST exemption for 2019 gifts. As they point out in their commentary, this technique provides a new twist on an old adage by demonstrating that sometimes it’s better to be late than timely. 

Beth Shapiro Kaufman is a Member in Caplin & Drysdale's Washington, D.C., office, where she leads the Private Client practice group.  Ms. Kaufman counsels clients, lawyers and other professionals on complex issues regarding estate, gift, and generation-skipping transfer taxes.  She frequently represents clients with respect to private letter rulings, as well as estate and gift tax controversies.  Ms. Kaufman is an adjunct professor at the University of Miami School of Law where she teaches a course on Generation-Skipping Transfer Tax.  She is a Fellow of the American College of Trust and Estate Counsel and a frequent speaker at national conferences. Ms. Kaufman is a graduate of Pomona College and Harvard Law School, where she was Notes Editor of the Harvard Law Review.

Megan E. Wernke is a Member in Caplin & Drysdale’s Private Client practice group. Ms. Wernke advises wealthy individuals and the fiduciaries of large estates and trusts on a wide range of sophisticated tax and estate planning matters. Her practice includes developing tax-efficient estate plans, addressing clients’ business succession and creditor protection goals, and helping clients come into compliance with U.S. tax requirements.  With her significant experience in tax controversies and litigation, Ms. Wernke advises clients with respect to substantial gift tax, estate tax, generation-skipping tax, and fiduciary income tax issues at all stages of controversy.  Ms. Wernke is a graduate of Princeton University and Harvard Law School, where she was Executive Editor of the Harvard Law Review and an Ames Moot Court Semifinalist. 

Here is their commentary:

Executive Summary:

You may already know that the depressed market presents a great opportunity to make late allocations of GST exemption to prior years’ gifts.  Don’t forget that another opportunity exists for 2019 gifts whose value has declined since the date of the gift.  By purposefully failing to make a timely allocation (or timely opting out of automatic allocation with respect to a “GST trust”) and then making a late manual allocation of GST exemption, the taxpayer can get a zero inclusion ratio using less exemption.

The issue is best illustrated with an example.  On September 18, 2019, when the stock price was approximately $90 per share, Samantha created a dynastic generation-skipping trust and funded the trust with 10,000 shares of United Airlines common stock.  The trust is a “GST trust.”  The value of those shares has now dropped to approximately $23 per share (as of this writing).  In light of Notice 2020-20, Samantha’s 2019 gift tax return will not be due until July 15, 2020.  Absent any GST elections by Samantha on the 2019 gift tax return, $900,000 of GST exemption will be automatically allocated to that transfer.  However, if Samantha files an opt-out election with her timely 2019 gift tax return, she can then file another return after July 15, 2020 making a late allocation of GST exemption using the then-current value of the stock.  If the stock price remains at today’s level, she can preserve an extra $670,000 of GST exemption for later use.  This newsletter examines the steps necessary to do that.

Comment:

Gifts to GST Trusts

In the above example, Samantha’s dynastic trust is a “GST trust” within the meaning of Internal Revenue Code (“Code”) section 2632(c)(2)(B).  As such, GST exemption will be automatically allocated to the trust under Code section 2632(c)(1) in order to give the trust an inclusion ratio of zero.  The automatic allocation relates back to the date of the gift and uses the date of gift value of the property transferred.  Treas. Reg. §26.2632-1(b)(2)(1). 

However, under Code section 2632(c)(5), Samantha can opt out of automatic allocation by making an election on her timely-filed 2019 gift tax return.  As long as there have been no distributions from the trust to skip persons in the intervening months, Samantha should consider making this opt-out election.  A series of Q&As published on the IRS website in April[i] make it clear that the deadline for making this opt out election is also postponed until July 15, 2020:

Q.  Is there a postponement of time to make an allocation of GST exemption or elect in or out of automatic allocation of GST exemption?

 A.  Any GST election or allocation made with respect to a 2019 transfer on Form 709 due on or after April 1, 2020, and before July 15, 2020, is timely (and, therefore, effective on the date of the transfer) if made on a Form 709 filed on or before July 15, 2020.

In other words, the rule that an election is timely if made on or before the due date of the return reporting the gift to which GST exemption is allocated still holds for 2019 gifts, but that due date is not April 15, 2020, it is July 15, 2020.  In fact, the due date could be later if Samantha either uses a Form 4768 to get a 6-month extension (typically to October 15, 2020) for her income tax return (which automatically extends the due date of the gift tax return as well) or if she files a Form 8892 to get a 6-month extension only for her gift tax return.  It is also possible that the IRS could announce a further extension of the due date applicable to all taxpayers.  The due date of the 2019 gift tax return is a key date in implementing this late-allocation strategy, so be careful with extensions, automatic or requested!

Assume that the IRS does not move the due date again and Samantha does not apply for either 6-month extension so that her gift tax return will be due on July 15, 2020.  Prior to filing the gift tax return on or shortly before July 15, 2020, Samantha should check the price of United Airlines stock on July 1, 2020.  If the stock price is still materially below the price on the date of the gift, then Samantha should:

• File a timely return by July 15, 2020 to elect out of automatic allocation of GST exemption to her September 2019 gift to the trust.  That will avoid the automatic allocation of GST exemption to the gift based on the date-of-gift value.
• Sometime after July 15, Samantha should file another Form 709 for 2019 for the sole purpose of making a late allocation of GST exemption to her 2019 gift.  Watching the stock market for the right time to allocate is key.  The late allocation will be effective as of the date she files the return, but a special rule in the regulations allows Samantha to elect to use the value as of the first day of the month for purposes of this allocation.  The following language can be used to make that election:

The taxpayer hereby elects pursuant to Treasury Regulation section 26.2642-2(a)(2) to treat the allocation of GST exemption as having been made on the first day of the month during which this allocation is made.  For purposes of this election, the applicable valuation date for this allocation is July 1, 2020.  

• Assuming a stock price on July 1, 2020 of $23 per share, Samantha’s late allocation anytime between July 16 and July 31 will get the trust a zero inclusion ratio by allocating only $230,000 of GST exemption to the trust (or potentially less, if she finds a date with a lower share value), rather than the $900,000 of GST exemption that would be required for a timely allocation. 
• If Samantha reaches the end of July and believes that the stock price will drop even further, she could wait until a later month to make her late allocation.  In all events, however, she should make the allocation of GST exemption before any distributions are made from the trust to a skip person. 
• If Samantha’s death would cause a taxable termination or a taxable distribution, it is important to make the late allocation before she dies, so use caution in deciding to take advantage of a late allocation if Samantha is in poor health.  If Samantha’s death would not cause a generation-skipping event to occur, a late allocation would still be advantageous.  Her executor could make the late election on either her estate tax return or a gift tax return, and it will be effective when made.  Treas. Reg. §26.2632-1(d)(1). 

Direct Skips

The above technique will not work if the trust to which the gift is made is itself a “skip person” within the meaning of Code section 2613(a)(2) – that is, a trust in which all of the interests are held by skip persons or in which no person holds an interest but no distributions may be made to a non-skip person.  In that case, the transfer to the trust is a direct skip on which GST tax is due immediately if GST exemption is not allocated.  Although one can elect out of automatic allocation to a direct skip under Code section 2632(b)(3), doing so would result in an immediate GST tax based on the date of gift value of the assets transferred.  This is not likely to be attractive tax planning for most clients.

Trusts That Are Not GST Trusts

The above example involving Samantha’s trust discusses the steps for making a late allocation to a GST trust, but the same timing considerations apply to a trust that is not a GST trust.  In this case, the taxpayer should still review the value of the asset on July 1, and if it is materially lower than the value on the date of the gift, she should timely file a gift tax return, but make no GST exemption allocation to the trust.  She can then, keeping in mind the due date and death risks discussed above, review the asset’s value each month to find the best time to file another gift tax return on which she will make a late allocation of GST exemption to the trust.  Caution, though: it is sometimes hard to determine whether a trust is a GST trust or not.  If in doubt, just make a protective election out of automatic allocation on the timely return (as if the trust is a GST trust) in order to preserve the ability to make a late allocation later.

Unfortunately there is no analogous way in which to use the lower stock price for gift tax purposes, but at least Samantha can preserve some of her GST exemption for later use by harnessing the benefit of the lower stock price for GST purposes through a late allocation. 

This technique proves that sometimes it is better to be late than timely.  Just don’t forget to allocate GST exemption at some point because “better late than never” is also true!