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Abstract

One of the most significant aspects of the Tax Reform Act of 1986 for estate planners was the retroactive repeal of the original 1976 generation-skipping transfer (GST) tax and the enactment of an entirely new generation-skipping transfer tax. The new generation-skipping transfer tax, unlike the 1976 version, generally applies to transfers that constitute "direct skips," such as outright gifts to grandchildren. Like the earlier tax, the new tax also applies to "taxable terminations,” such as a termination of the life estate of the transferor's child resulting in the grandchild receiving possession of the transferred property in fee simple under the terms of the original transfer, and "taxable distributions," such as a discretionary distribution to a grandchild from a trust created for the benefit of the transferor's children and grandchildren. It is notable, however, that the taxable event (referred to in the statute as the "generation-skipping transfer") is the transfer of the property by the transferor in the case of a direct skip, while the taxable event in the case of a taxable termination or a taxable distribution will usually occur long after the initial transfer of property by the transferor. Although the scope of transfers potentially subject to tax under the 1986 generation-skipping transfer tax is broader than under the 1976 tax, the 1986 tax also includes a larger and more broadly applicable exemption. In lieu of the possible use under the earlier law of the transferor's remaining (at death) unused unified credit and a limited exemption for transfers to grandchildren, section 2631 provides each individual making generation-skipping transfers with a $1,000,000 GST exemption. The effect of the GST exemption on the computation of the generation-skipping transfer tax depends, however, on whether the exemption is allocated to a direct skip or to property with respect to which the individual is the transferor and which may be the subject of a taxable distribution or a taxable termination at a later date. Furthermore, section 2631 allows the individual or the executor of his estate to allocate the GST exemption to any property with respect to which the individual has made a generation-skipping transfer. Such allocations may be made expressly or by allowing the provisions of section 2632 to deem allocations with respect to certain transfers. Planning use of the GST exemption requires an understanding of both the manner in which the GST exemption operates with respect to different types of taxable transfers and the allocation choices that the transferor may make.

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