End of an Estate Tax Inclusion Period (ETIP): The Ultimate Guide to Form 709

Navigating somewhat confusing guidance to elect out of automatic allocation

This is a continuation of the series on preparing Form 709. For the first article in this series and a series index, click here.

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Table of Contents

1. Intro

2. ETIP Examples

   1. GRAT

   2. QPRT

   3. Incomplete Gift Trusts

3. ETIP Reporting In General

4. Gift Portion

5. GST Portion

6. ETIP-Only Filing

7. Late Returns

8. Conclusion

Intro

To a certain extent, this article works backwards by punting the calculation and reporting standards for a transfer that is subject to an estate tax inclusion period (ETIP).  But, this is for good reason.  There is somewhat of a mismatch between the GST tax Regulations, and the instructions for Form 709.  Nonetheless, getting this right can be important for trusts that are subject to an ETIP. 

To start, what is an ETIP?  According to IRC Section 2642(f), it is a period during which an “inter vivos transfer of property” would be included in the gross estate of the transferor or their spouse if either were to die.  This is significant for GST tax planning and reporting purposes, because no allocation of GST exemption can be made until the close of an ETIP.  Then, under Treas. Reg. 26.2631-1(b)(2)(i), automatic allocation of GST exemption occurs at the close of the ETIP period.  The value of the transfer is also determined as of the close of the ETIP according to IRC Section 2632(c)(4). 

(Note that in this article I will use terms such as “transferor,” “donor,” “grantor,” and “taxpayer” interchangeably as the context requires. But, these terms will almost always apply to the same individual who is making a transfer subject to an ETIP.)

These allocation rules can create interesting and unanticipated outcomes which, at best, create uncertainty for the allocation of GST exemption and, at worst, mean that any time-value discounts for a retained interest apply only for gift tax purposes and not GST tax purposes.  Let’s look at some common ETIP outcomes.

ETIP Examples

GRAT

With a GRAT, the grantor (and sometimes the grantor’s spouse) retains an annual (or more frequent) right to a distribution of a set annuity amount from a trust – often for a fixed term.  Then, at the end of the term, the balance of the trust goes to other remainder beneficiaries in trust or outright.  As long as the annuity distribution is structured in a way that satisfies IRC Section 2702, the transfer to remainder beneficiaries may be reduced by the present value of the annuity interest retained by the grantor.  Depending on the annuity amount (with annual increases), term and interest rates, the present value of the remainder can be reduced to (or close to) zero.  The outcome is a transfer substantially free of gift tax or use of applicable credit against gift tax. 

The issue, however, is that this transfer creates an ETIP.  If the grantor dies before the end of the annuity term, the remaining GRAT property is included in the grantor’s gross estate under IRC Section 2036(a)(1) at the lesser of date-of-death fair market value, or the annual annuity divided by the 7520 rate for the month of the grantor’s death. 

If the GRAT remainder goes to non-skip persons or to the grantor’s estate, there is no GST potential and thus no need for allocation of GST exemption. (In the case of non-skip persons, we often cannot predict with 100% certainty that they will indeed be the remainder beneficiaries for GST tax purposes.)  But, if the remainder could go to descendants per stirpes, or to a trust with GST potential (due to living or unborn skip persons as beneficiaries), this would be an indirect skip resulting in allocation of GST exemption. 

At the grantor’s death, there is a different set of allocation rules we will cover in a separate series of articles.  But, if the term of the GRAT ends during the grantor’s life, there would be automatic allocation of GST exemption at that time based on the value of the GRAT at that time. 

Long story short, this means we cannot use the reduced or zeroed-out gift tax value for GST tax purposes.  We lose that leverage, while also creating an unpredictable amount of GST exemption to be allocated if indeed we do allocate GST exemption.  Due to this uncertainty, the intent is often to not allocate GST exemption to the remainder - leaving the remainder GST-nonexempt with an inclusion ratio of 1.

QPRT

A QPRT is similar to a GRAT, but for two key differences.  One, the present value of the grantor’s use right of the home is used in lieu of the present value of an annuity to reduce the gift tax.  Two, this discount is sometimes smaller (because there is no depletion of the trust’s ownership of the residence as a result of no in-kind distribution of interests in the residence), leading to a much higher remainder value to which GST exemption might be allocated at the end of the QPRT term.  

Incomplete Gift Trusts

This is a bit of a misnomer, as incomplete gift trusts do not create a completed gift transfer and thus cannot be subject to allocation of GST exemption to begin with unless or until a distribution is made to a skip person or the grantor dies.  But, there are a couple of issues to keep in mind. 

Under Treas. Reg. 301.6501-1(f)(5), the gift tax reporting statute of limitations can run for a completed gift transfer that is adequately disclosed but is later determined to be an incomplete gift.  The opposite, however, does not hold true – adequate disclosure of an incomplete gift transfer that is later determined to be complete does not start this statute unless or until the donor reports the gift as complete. 

What does this have to do with an ETIP?  In the former case, there is no way to allocate GST exemption unless or until the gift is complete.  But, in the latter case, GST exemption might get automatically and retroactively allocated to the transfer as of the time of the initial gift.  This creates the opposite problem – the lack of an ETIP when one was originally intended.  We will talk about reporting for these types of trusts in another article, but this is another area in which sensitivity to the timing of GST exemption allocation becomes important. 

ETIP Reporting In General