REVENUE RULE 92-26

1992-1 C.B. 314, 1992-14 I.R.B. 8.

Internal Revenue Service
Revenue Ruling

GENERATION ASSIGNMENT OF GRANDCHILD WITH PREDECEASED PARENT

Published: April 6, 1992

SECTION 2612. TAXABLE TERMINATION; TAXABLE DISTRIBUTION; DIRECT SKIP

(See Also Sections 2611, 2631, 2651, 2652.)

Generation assignment of grandchild with predeceased parent. The generation assignment of a grandchild of a terminating trust subject to elections under sections 2056(b)(7) and 2652(a)(3)(A) of the Code is not raised one generation level even though the grandchild's parent died before the trust terminated.

ISSUE

If the parent of a grandchild-distributee dies after the transfer by a grandparent to a generation-skipping trust but before the distribution from the trust to the grandchild, is the distribution a direct skip and is the generation assignment of the grandchild raised one generation level under section 2612(c)(2) of the Internal Revenue Code, thereby treating the grandchild as a grandparent's child?

FACTS

D died in 1987 survived by S (D's spouse), C (the child of D and S), and G (C's child and the grandchild of D and S). D's will provided for D's residuary estate to be divided into three parts: (1) a $600,000 pecuniary amount to be distributed to C, (2) a $1,000,000 pecuniary amount to be distributed to a trust that was to pay income to S during S's life and that was to terminate upon S's death with the remainder to be distributed to G, and (3) the balance of the residuary estate to be distributed to a trust that was to pay income to S during S's life and that was to terminate upon the death of S with the remainder to be distributed to C if C survived S or to G if C predeceased S.

On a timely filed United States Estate (and Generation-Skipping Transfer) Tax Return, D's executor made elections under section 2056(b)(7) of the Code to treat the $1,000,000 trust and the residuary trust as qualified terminable interest property to qualify the trusts for the estate tax marital deduction. D's executor also elected under section 2652(a)(3)(A) to treat the $1,000,000 trust for generation-skipping transfer tax purposes as if the section 2056(b)(7) election had not been made for that trust. D's executor allocated to the $1,000,000 trust the portion of D's exemption allowed under section 2631 (described in that section as a "GST exemption") that remained unused at D's death. The unused portion of D's GST exemption so allocated to the $1,000,000 trust was $800,000. C died in 1990, and S died in 1991. Consequently, the corpus of each of the two trusts was distributed to G upon S's death.

LAW

Section 2056(b)(7) of the Code allows an estate tax marital deduction with respect to qualified terminable interest property that passes to a surviving spouse. The term "qualified terminable interest property" is defined in section 2056(b)(7)(B) to mean property (1) that passes from the decedent, (2) in which the surviving spouse has a qualifying income interest for life, and (3) with respect to which an election is made by the executor on the estate tax return.

Sections 2044(a) and 2044(b) of the Code provide that, if an estate tax marital deduction was previously allowed under section 2056(b)(7) for the transfer of property in which the surviving spouse had a qualifying income interest for life, the value of the property is includible in the gross estate of the surviving spouse when he or she dies. Section 2044(c) provides that property includible in the gross estate of a decedent under section 2044(a) is treated as property passing from that decedent for purposes of the estate tax and the generation-skipping transfer tax.

Section 2601 of the Code imposes a tax on every generation-skipping transfer. Section 2611(a) provides that the term "generation-skipping transfer" means a taxable termination, a taxable distribution, or a direct skip.

Section 2612(a) of the Code provides that the term "taxable termination" means the termination (by death, lapse of time, release of power, or otherwise) of an interest in property held in trust unless (1) immediately after the termination, a non-skip person has an interest in the property, or (2) at no time after the termination may a distribution (including distributions on termination) be made from the trust to a skip person.

Section 2613(a)(1) of the Code provides that a "skip person is a natural person assigned to a generation that is two or more generations below the generation level of the transferor. Section 2613(a)(2) provides that a trust may also be a skip person (A) if all interests in the trust are held by skip persons or (B) if there is no person holding an interest in the trust and at no time after the transfer to the trust may a distribution (including distributions on termination) be made from the trust to a non-skip person. The term "non-skip person" is defined in section 2613(b) to mean any person who is not a skip person. Generation levels in relation to the transferor are determined under section 2651. Section 2652(c)(1) provides, with exceptions not relevant for present purposes, that a person has "an interest in property held in trust" if the person (1) has a current right to receive income or corpus, or (2) is a permissible current recipient of income or corpus.

Section 2612(b) of the Code provides that a "taxable distribution" is any distribution from a trust to a skip person (other than a taxable termination or a direct skip).

Section 2612(c)(1) of the Code provides that a "direct skip" is a transfer of property to a skip person that is subject to the tax imposed by chapter 11 (the estate tax) or chapter 12 (the gift tax).

A direct gift or bequest from a transferor to the transferor's grandchild is ordinarily a direct skip because the grandchild is two generations below the transferor. However, section 2612(c)(2) of the Code provides a special rule for the purpose of determining whether a transfer to a grandchild is a direct skip. Under this rule, if an individual is a grandchild of the transferor (or the transferor's spouse or former spouse) and as of the time of the transfer, the parent of that individual who is a lineal descendant of the transferor (or the transferor's spouse or former spouse) is dead, then that individual is treated as a child of the transferor. When the rule in section 2612(c)(2) applies, a gift or bequest from a transferor to a grandchild of the transferor (a transfer that would ordinarily be a direct skip) is not a direct skip because the grandchild is treated as being only one generation below the transferor. See H.R. Rep. No. 795, 100th Cong., 2d Sess. 350-51 (1988).

Section 2652(a)(1) of the Code states, as a general rule, that the term "transferor" means the decedent (in the case of property subject to the estate tax) or the donor (in the case of property subject to the gift tax). In applying this rule, the identity of the transferor and, thus, the character of the transfer, is determined by reference to the most recent transfer of the property that was subject to the estate or gift tax. Thus, in the case of the bequest of a life income interest in a trust to a child of the decedent, with a remainder interest to a grandchild, the trust property is subject to estate tax in the estate of the decedent, and, as a result, the decedent is the transferor of the trust property. However, if the income interest is for the benefit of the decedent's surviving spouse and the decedent's executor makes an election under section 2056(b)(7) to treat the trust as qualified terminable interest property, the trust property will be subject to estate tax under section 2044 at the death of the surviving spouse, and the surviving spouse then becomes the transferor of the trust property for purposes of the generation-skipping transfer tax. Section 2652(a)(3)(A) provides an exception to this general rule.

Section 2652(a)(3)(A) of the Code provides that, if a decedent's estate is allowed an estate tax marital deduction under section 2056(b)(7) for property in trust, the decedent's executor may elect to treat, for generation-skipping transfer tax purposes, all of the property in that trust as if the section 2056(b)(7) election had not been made. Making the election causes the application of section 2044 to be disregarded for generation-skipping transfer tax purposes. Therefore, if the election is made, the predeceasing spouse (instead of the surviving spouse) will continue to be treated as the transferor of the trust for generation-skipping transfer tax purposes after the death of the surviving spouse. As a result of this treatment, the executor of the predeceasing spouse may allocate to that trust any unused portion of the $1,000,000 GST exemption allowed to that spouse under section 2631.

ANALYSIS

D'S BEQUEST TO C. D's bequest of $600,000 to C was a transfer subject to estate tax in D's estate. Therefore, under section 2652(a)(1)(A) of the Code, D is the transferor of the $600,000 for generation-skipping transfer tax purposes. Under the generation-assignment rules of section 2651(b)(1), C is a nonskip person because C is only one generation below D. Consequently, the $600,000 bequest is not subject to the generation-skipping transfer tax.

D'S BEQUESTS FOR THE BENEFIT OF S. D's bequests creating the two trusts were subject to estate tax in D's estate. As a result, at D's death, D was the transferor of those trusts under section 2652(a)(1)(A) of the Code. The initial transfers to the trusts were not direct skips because the trusts were not skip persons. The trusts were not skip persons because immediately after D's death S, who was a non-skip person, held an interest in the trust. In addition, because S is a non-skip person, the distributions from the trusts to S are not subject to the generation-skipping transfer tax.

BEQUESTS FOR THE BENEFIT OF G. By reason of the election by D's executor under section 2056(b)(7) of the Code, the property in both trusts was includible in S's gross estate under section 2044 at S's death. The general rule of section 2652(a)(1)(A) of the Code, which provides that the identity of the transferor and the character of the transfer are determined by reference to the most recent imposition of the estate tax, applies to the residuary trust property. Therefore, S is the transferor of the property in the residuary trust for generation-skipping transfer tax purposes. The special rule of section 2652(a)(3)(A), which, if elected, causes the application of section 2044 to be disregarded, applies to the $1,000,000 trust and treats D, rather than S, as the transferor of that trust for generation-skipping transfer tax purposes. Thus, for purposes of the generation-skipping transfer tax, S is regarded as the transferor of the property in the residuary trust from the time of S's death, and D continues to be the transferor of the property in the $1,000,000 trust after S's death.

(A) THE $1,000,000 TRUST.

The termination of S's income interest in the $1,000,000 trust at S's death was a termination of an interest in property held in trust within the meaning of section 2612(a)(1) of the Code. That termination of S's interest "as a taxable termination under section 2612(a)(1) because neither of the two exceptions in sections 2612(a)(1)(A) and (B) apply, i.e., a skip person (and only a skip person) had an interest in the trust property after S's interest terminated. Because the distribution is the result of a taxable termination it is not a taxable distribution even though it is a distribution to a skip person. See section 2612(b).

The distribution to G from the $1,000,000 trust after the death of S was not a direct skip from D because the distribution was not subject to an estate or gift tax on D at the time of the distribution. Although the distribution from the $1,000,000 trust to G was subject to S's estate tax at the time of the distribution, the distribution was not a direct skip from S because S is not considered the transferor of that trust due to the section 2652(a)(3) election that was made by D's executor.

Section 2612(c)(2) of the Code, which raises a grandchild one generation level if the grandchild's parent died before the transfer, applies only in the case of a transfer that would otherwise be a direct skip. In the present case, the distribution to G from the $1,000,000 trust was a taxable termination and not a direct skip. Therefore, section 2612(c)(2) does not apply to treat G as the child of D (the transferor of the trust property).

(B) THE RESIDUARY TRUST.

As indicated above, the application of section 2044(c) of the Code to the residuary trust at S's death causes S to he treated by section 2652(a)(1)(A) as the transferor of the property distributed to in from that trust. In addition, the rules of section 2612 apply to determine whether the generation-skipping transfer tax is imposed on the distribution to G from the residuary trust.

The distribution to G from the residuary trust was not a taxable distribution described in section 2612(b) of the Code because that section provides that a distribution to a skip person is a taxable distribution only if it is not a taxable termination or a direct skip. Although the statute does not specifically provide that a direct skip takes precedence over a taxable termination, the general statutory framework indicates that a direct skip takes precedence over taxable terminations as well as taxable distributions.

The legislative history of these provisions explains that the generation- skipping transfer tax on a taxable termination or a taxable distribution is computed on a "tax inclusive" basis, while the tax on a direct skip is computed on a "tax exclusive" basis. The effective rate of tax for the tax exclusive application of the generation-skipping transfer tax is lower than the effective rate for the tax inclusive application. The tax inclusive application of the generation-skipping transfer tax was not intended to apply in situations where a transferor's gift tax or estate tax is imposed at the same time as that transferor's generation-skipping transfer tax. Thus, a distribution to a skip person that is subject to the transferor's gift tax or estate tax at the time of the distribution, is governed by the direct skip provisions of section 2612(c) in the absence of the election under section 2652(a)(3).

S was treated for generation-skipping transfer tax purposes as making the transfer to G from the residuary trust at S's death, and the transfer was subject to S's estate tax at that time. If G's parent C had not died before S, the transfer would have been a direct skip to a grandchild of S. However, G's parent died before S, and section 2612(c)(2), which applies for purposes of determining whether a transfer is a direct skip, treats G as the child of S. Thus, solely for purposes of section 2612(c), G is not a skip person in relation to S. Therefore, the distribution from the residuary trust to G is not a direct skip and the generation-skipping transfer tax is not imposed on the distribution to G from the residuary trust.

HOLDING

If the parent of a grandchild-distributee dies after the transfer by a grandparent to a generation-skipping trust that is subject to an election under section 2652(a)(3) of the Code but before the distribution from the trust to the grandchild, the distribution is a taxable termination and not a direct skip and the generation assignment of the grandchild is not raised one generation level under section 2612(c)(2). If the election under section 2652(a)(3) is not made, the distribution to the grandchild would ordinarily be a direct skip; however, because under these facts, the generation assignment of the grandchild is raised one generation level under section 2612(c)(2), thereby treating the grandchild as the surviving grandparent's child, the distribution is not a direct skip.

DRAFTING INFORMATION

The principal author of this revenue ruling is John B. Franklin of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling, contact Mr. Franklin on (202) 535-9508 (not a toll-free call).

Rev. Rul. 92-26, 1992-1 C.B. 314, 1992-14 I.R.B. 8.