[Federal Register Volume 60, Number 248 (Wednesday, December 27, 1995)]
[Rules and Regulations]
[Pages 66898-66926]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-30873]



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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 26, 301, and 602

[TD 8644]
RIN 1545-AJ11; 1545-AL75; 1545-AO89


Generation-Skipping Transfer Tax

AGENCY: Internal Revenue Service, Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains final generation-skipping transfer 
(GST) tax regulations under chapter 13 of the Internal Revenue Code 
(Code), as added by section 1431 of the Tax Reform Act of 1986. Changes 
to the applicable law were made by the Tax Reform Act of 1986, the 
Technical and Miscellaneous Revenue Act of 1988, and the Revenue 
Reconciliation Act of 1989. The regulations are necessary to provide 
guidance to taxpayers so that they may comply with chapter 13 of the 
Code.

EFFECTIVE DATE: December 27, 1995.
FOR FURTHER INFORMATION CONTACT: James F. Hogan, (202) 622-3090 (not a 
toll free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information requirements contained in these final 
regulations have been reviewed and approved by the Office of Management 
and Budget in accordance with the Paperwork Reduction Act (44 U.S.C. 
3507) under control numbers 1545-0985 (relating to Secs. 26.2601-1 and 
26.2662-2) and 1545-1358 (relating to Secs. 26.2632-1, 26.2642-1, 
26.2642-2, 26.2642-3, 26.2642-4 and 26.2652-2). All of these paperwork 
requirements will be consolidated under control number 1545-0985. 
Responses to this collection of information are required to ensure the 
proper collection of the generation-skipping transfer tax.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection unless the collection of information 
displays a valid control number.
    The estimated burden per respondent is 1 hour under control number 
1545-0985. The time estimates for the reporting and recordkeeping 
requirements under control number 1545-1358 are included in the 
estimates of burden applicable to Forms 706, 706NA, 706GS(T), 706GS(D), 
706GS(D-1), and 709.
    Comments concerning the accuracy of this burden estimate and 
suggestions for reducing this burden should be directed to the Internal 
Revenue Service, Attn: IRS Reports Clearance Officer T:FP, Washington, 
DC 20224, and to the Office of Management and Budget, Attn: Desk 
Officer for the Department of Treasury, Office of Information and 
Regulatory Affairs, Washington, DC 20503.
    Books or records relating to this collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    On March 15, 1988, the IRS published in the Federal Register a 
notice of proposed rulemaking (53 FR 8469) by cross reference to 
Temporary Regulations published on the same date in the Federal 
Register (53 FR 8441) under Secs. 2601 and 2662. Subsequently, on 
December 24, 1992, the IRS published a second notice of proposed 
rulemaking (57 FR 61353) amending the prior notice. Also, on December 
24, 1992, the IRS published a notice of proposed rulemaking in the 
Federal Register (57 FR 61356) containing proposed regulations under 
Secs. 2611, 2612, 2613, 2632, 2641, 2642, 2652, 2653, 2654, and 2663. 
The IRS received written and oral comments on the proposed regulations 
and, on April 21, 1993, a public hearing was held. These documents 
adopt final regulations with respect to these notices of proposed 
rulemaking.
    The following is a discussion of the more significant revisions 
that were made.

Section 2601--Transitional Rules

Transfers After September 25, 1985 and Before October 23, 1986
    Section 26.2601-1(a)(2)(i), relating to inter vivos transfers made 
after September 25, 1985, and before October 23, 1986, clarifies that 
chapter 13 applies to inter vivos transfers that are subject to chapter 
12 even though a gift tax is not actually paid because of, for example, 
the marital deduction or the unified credit.
    Section 26.2601-1(a)(2)(ii) (which treats inter vivos transfers 
made after September 25, 1985, and before October 23, 1986, as if made 
on October 23, 1986) clarifies that the value of the transferred 
property for purposes of chapter 13 is determined as of the actual 
transfer date rather than as of the deemed transfer date of October 23, 
1986.
    Section 26.2601-1(a)(4) adds an example illustrating that 
Sec. 26.2601-1(a)(2) does not apply to transfers made under a revocable 
trust that becomes irrevocable by reason of the grantor's death after 
September 25, 1985, but before October 23, 1986. Those transfers are 
not subject to chapter 13 because they are in the nature of 
testamentary transfers that occurred prior to October 23, 1986.
    Section 26.2601-1(b)(1)(ii)(C) clarifies that incidents of 
ownership in an insurance policy that are relinquished before September 
25, 1985, are not to be taken into account in determining whether a 
trust is irrevocable for purposes of Sec. 26.2601-1(b)(1), which 
exempts trusts that were irrevocable on September 25, 1985, from the 
provisions of chapter 13.
    Under Sec. 26.2601-1(b)(1)(iii)(A), a qualified terminable interest 
property (QTIP) trust that is grandfathered under Sec. 26.2601-1(b)(1) 
is treated as if the reverse QTIP election had been made under section 
2652(a)(3). Example 1 in Sec. 26.2601-1(b)(1)(iii)(B) has been revised 
to illustrate that the initial QTIP election under section 2523(f) need 
not be made before September 25, 1985, provided that the trust was 
irrevocable on that date. Further, Sec. 26.2601-1(b)(1)(v)(C) has been 
revised to provide that in the case of a trust with respect to which a 
reverse QTIP election is deemed to have been made, the failure to 
exercise the right of reimbursement under section 2207A will not be 
treated as a constructive addition to the trust. This conforms the 
treatment of trusts that are irrevocable on September 25, 1985, with 
the rule provided in Sec. 26.2652-1(a)(3) which applies to trusts 
created after September 25, 1985.

[[Page 66899]]

    In Sec. 26.2601-1(b)(2)(iv)(B), the phrase ``or to a generation-
skipping trust'' has been added to eliminate any implication that the 
provision is limited to situations involving direct skips. The 
provision applies to all generation-skipping transfers.
    Section 26.2601-1(b)(3)(iii) applies the transitional rules where 
the decedent was under a mental disability but had not been adjudged a 
mental incompetent. This section has been clarified to provide that any 
evidence submitted to establish the decedent's state of incompetency is 
not conclusive and is subject to examination. In addition, an example 
has been added to illustrate the transitional rules applicable in the 
case of mental incompetency.
Uniform Statutory Rule Against Perpetuities
    The notice of proposed rulemaking published on December 24, 1992, 
(57 FR 61353) contained a proposed modification to Sec. 26.2601-
1(b)(1)(v)(B)(2). Section 26.2601-1(b)(1)(v)(B)(2) provided that the 
exercise of a nongeneral power of appointment will not be treated as an 
addition to a grandfathered GST trust if the power is exercised in a 
manner that may not postpone or suspend the vesting, absolute 
ownership, or power of alienation of a interest in property for a 
period, measured from the date of creation of the trust, extending 
beyond any life in being at the date of creation of the trust plus a 
period of 21 years (perpetuities period).
    The proposed modification to Sec. 26.2601-1(b)(1)(v)(B)(2), which 
is finalized in this document, provides that the exercise of a 
nongeneral power of appointment that validly postpones or suspends the 
vesting, absolute ownership, or power of alienation of an interest in 
property for a term of years that will not exceed 90 years (measured 
from the date of creation of the trust) will not be considered an 
exercise that postpones vesting, etc., beyond the perpetuities period. 
The modification takes into account the fact that many states have 
adopted the Uniform Statutory Rule Against Perpetuities (USRAP) which 
allows either a 90 year perpetuities period or the common law 
perpetuities period. Under Sec. 26.2601-1(b)(1)(v)(B)(2), as modified, 
the nongeneral power may not be exercised in a manner that postpones 
vesting, etc., for the longer of 90 years or the common law period 
(lives in being plus 21 years).
    The discussion in the preamble published on December 24, 1992, 
indicates that USRAP has a ``wait and see'' aspect that is not 
appropriate for GST purposes because it will be necessary to determine 
the GST tax consequences of distributions and terminations at the time 
they occur. Thus, the preamble stated that, in order to comply with the 
regulation and avoid a constructive addition, it must be clear at the 
time the nongeneral power is exercised that the exercise may not 
postpone or suspend vesting, etc., beyond either lives in being plus 21 
years or 90 years (but not the longer of the two periods). A 
commentator has pointed out that the USRAP invalidates any attempt to 
exercise a power for the longer of the two periods. Under the USRAP, it 
will be clear at the time the nongeneral power is exercised that the 
exercise may not postpone or suspend vesting, etc., beyond one of the 
two periods (but not both). Under the USRAP, the common law period 
(lives in being plus 21 years) is imposed in the event that the power 
holder exercises the power in a manner that attempts to suspend or 
postpone vesting, etc., for the longer of the two periods. Although the 
preamble published on December 24, 1992, may have been misleading in 
referring to a ``wait and see'' aspect of USRAP, the modification to 
Sec. 26.2601-1(b)(1)(v)(B)(2) is not affected.

Section 2611 et. seq.--GST Substantive Rules

Definition of Generation-Skipping Transfers
    Section 26.2611-1 has been revised to clarify that, in determining 
whether an event is subject to the GST tax, reference must be made to 
the most recent transfer that was subject to Federal estate or gift 
tax. This is because the most recent transfer that was subject to 
estate or gift tax establishes the identity of the transferor, which in 
turn determines the identity of the skip persons and non-skip persons.
Definitions
    Section 26.2612-1(a)(2)(i) of the proposed regulations provides 
generally that, for purposes of determining whether a transfer 
constitutes a direct skip, the generation assignment of a person who 
would otherwise be a skip person is redetermined by disregarding the 
intervening generation, if certain individuals have died prior to the 
transfer (e.g., a predeceased child of the transferor). The section has 
been modified to provide that, if an individual who is a member of the 
intervening generation dies no later than 90 days after the transfer, 
the deceased individual is treated as having predeceased the 
transferor, if the governing instrument or applicable state law 
provides for such treatment.
    Section 26.2612-1(a)(2)(ii) has been added to provide that, if a 
transferor makes an addition to an existing trust after the death of an 
individual described in paragraph (a)(2)(i) of that section (i.e., an 
individual in the intervening generation), the additional property is 
treated as being held in a separate trust for purposes of chapter 13.
    Section 2612(a)(1) defines the term taxable termination to mean the 
termination of an interest in property held in trust unless, among 
other things, at no time after such termination may a distribution 
(including distributions on termination) be made from the trust to a 
skip person. Section 26.2612-1(b)(1)(iii), as proposed, has been 
revised to provide that, for purposes of applying this rule, potential 
distributions to skip persons are to be disregarded if the probability 
of occurrence is so remote as to be negligible. A similar rule has been 
applied to Sec. 26.2612-1(d)(2), regarding when a trust is considered a 
skip person. The probability that a distribution will occur is so 
remote as to be negligible only if it can be ascertained by actuarial 
standards that there is less than a 5 percent probability that the 
distribution will occur.
    Section 26.2612-1(c)(2) has been added to clarify that the look-
through rule in section 2651(e)(2) does not apply for purposes of 
determining whether a transfer from one trust to another trust is a 
taxable distribution. Thus, the transfer is treated as having been made 
to the recipient trust rather than to the beneficiaries of that trust. 
Accordingly, a transfer is a taxable distribution only if the recipient 
trust itself is a skip person.
    Section 26.2612-1(e)(3) has been added to provide that, in 
determining whether a trust is a skip person, trust interests 
disclaimed pursuant to a qualified disclaimer described in section 2518 
are not taken into account.
    Example 3 has been added to Sec. 26.2612-1(f) to illustrate that a 
transfer to a trust pursuant to which a beneficiary who is a skip 
person has a withdrawal power is not a direct skip unless the trust is 
a skip person.
    Example 9 has been added to Sec. 26.2612-1(f) to illustrate that a 
taxable termination may occur upon the distribution of the entire trust 
property (less amounts retained to pay a resulting GST tax and 
administration expenses).
    Example 14 contained in Sec. 26.2612-1(f) of the proposed 
regulations illustrates that an individual is not treated as having an 
interest in a trust 

[[Page 66900]]
for purposes of Chapter 13, if the individual's support obligation 
could be satisfied at the discretion of the trustee. This example has 
been renumbered as Example 15 and has been clarified to provide that an 
individual will have an interest in the trust if the trustee is 
required to make distributions for the beneficiary's support, in 
satisfaction of the individual's support obligation.
Allocation of GST Exemption
    Under Sec. 26.2632-1(b)(2)(ii)(A) of the proposed regulations, a 
late allocation of GST exemption is effective on the date the Form 709 
reporting the allocation is filed, and is deemed to precede in point of 
time any taxable event occurring on that date. This section has been 
revised to specify that the Form 709 is treated as filed on the date it 
is mailed to the appropriate IRS Service Center. Further, the late 
allocation may be made on a timely filed Form 709 reporting another 
transfer.
    Section 26.2632-1(b)(2)(ii)(B) has been added to clarify how the 
GST exemption allocated on a Federal gift tax return (Form 709) is to 
be apportioned in the event that the amount allocated on the return 
exceeds the value of the transfers reported on the return.
    Example 4 of Sec. 26.2632-1(b)(2)(iii) of the proposed regulations 
has been revised to better illustrate the effective date of a late 
allocation of GST exemption.
    Example 5 of Sec. 26.2632-1(b)(2)(iii) has been added to illustrate 
the automatic allocation of GST exemption to inter vivos direct skips 
in situations where split gift treatment is elected on an initial gift 
tax return filed after its due date.
    Section 26.2632-1(d)(1) has been revised to provide that a late 
allocation of GST exemption made by an executor with respect to an 
inter vivos transfer not included in the gross estate, is effective as 
of the date the allocation is filed. This rule does not apply to any 
automatic allocation under section 2632(b)(1). This revision conforms 
the regulation to section 2642(b)(3).
Estate Tax Inclusion Period
    As proposed, Sec. 26.2632-1(c)(2)(ii) provided that an estate tax 
inclusion period (ETIP) exists during the period in which the 
transferred property would have been includible in the transferor's 
gross estate had the transferor retained an interest held by the 
transferor's spouse, but only to the extent the spouse acquired the 
interest from the transferor in an inter vivos transfer that was not 
included in the transferor's taxable gifts or for which a deduction was 
allowed under section 2523. Commentators stated that there was no 
support in the statute for this spousal rule, and any such rule would 
require a legislative change. The final regulations eliminate this 
spousal rule and Example 5 of Sec. 26.2632-1(c)(5).
    Section 26.2632-1(c)(2)(ii)(A) has been added to provide that the 
ETIP rules do not apply when the possibility that the property will be 
included in the gross estate of the transferor (or the transferor's 
spouse) is so remote as to be negligible.
    Further, Sec. 26.2632-1(c)(2)(ii)(B) has been added to provide that 
transferred property will not be treated as being subject to inclusion 
in the transferor's spouse's gross estate, and thus, subject to an 
ETIP, where the only power possessed by the spouse is a right to 
withdraw no more than the greater of 5 percent or $5,000 of the trust's 
corpus and the withdrawal right terminates within 60 days of the 
transfer to the trust.
    Section 26.2632-1(c)(5) Example 3, of the proposed regulations 
illustrates that if a transferor's spouse elects gift-splitting 
treatment with respect to the transferor's gift that is subject to an 
ETIP, the spouse is treated as the transferor of one-half of the gift. 
The example has been expanded to illustrate that, since the spouse's 
deemed transfer is subject to an ETIP, if the spouse dies prior to the 
termination of the trust, the spouse's executor may allocate GST 
exemption to the trust. However, the allocation will not be effective 
until the ETIP terminates on the transferor's death.

Erroneous Allocations

    Under the proposed regulations, allocations in excess of the amount 
of the property transferred are void. This treatment has been expanded 
under the final regulations. Thus, any allocation to a trust that has 
no GST potential at the time of the allocation, with respect to the 
transferor for whom the allocation is made, is also void. This 
provision is intended to prevent the wasting of GST exemption because 
of an erroneous allocation with respect to a testamentary or inter 
vivos transfer. A trust will have no GST potential only if there is no 
possibility that a GST will be made from the trust with respect to the 
transferor.
Determination of Applicable Fraction
    Section 26.2642-1(b)(2) of the proposed regulations provided rules 
for determining the inclusion ratio with respect to a trust subject to 
an ETIP where GSTs are made from the trust during the ETIP. Comments 
were received that the rules were unclear regarding whether an 
ineffective allocation, i.e., an allocation made prior to any 
distributions or terminations, would apply in determining the amount of 
the transferor's unused GST exemption, or whether such an allocation 
could be modified prior to an ETIP termination. In response to the 
comments, Sec. 26.2632-1(c)(1) (providing rules for the allocation of 
exemption with respect to a trust subject to an ETIP) and Sec. 26.2642-
1(b)(2) clarify that an allocation made to a trust subject to an ETIP 
prior to any distribution or termination is not subject to modification 
or revocation. However, the allocation will not be effective, i.e., the 
allocation does not operate to fix the inclusion ratio of the trust, at 
the time it is made. Rather, the allocation becomes effective as of the 
date of a subsequent distribution or termination. Section 26.2632-
1(c)(5) Example 2, illustrates this point.
    Section 26.2642-2 of the proposed regulations provides valuation 
rules for determining the denominator of the applicable fraction under 
section 2642. Section 26.2642-2(a)(1) of the final regulations 
specifies that, in the case of a timely allocation of GST exemption 
with respect to an inter vivos transfer, the denominator of the 
applicable fraction is the fair market value of the transferred 
property, as finally determined for gift tax purposes.
    Section 26.2642-2(b)(1) of the proposed regulations provides 
special rules for determining the denominator of the applicable 
fraction in situations involving property subject to the special 
valuation rules contained in section 2032A. Under the proposed 
regulations, the special use value of the property could only be used 
in determining the applicable fraction if the property was transferred 
in a direct skip. Thus, a generation-skipping trust to which section 
2032A property was transferred in a transfer that was not a direct skip 
would not receive the benefit of the favorable valuation rules of 
section 2032A in determining the applicable fraction with respect to 
the trust.
    Comments stated that the proposed regulation was inconsistent with 
section 2642(b), which provides that the chapter 11 value must be used 
to determine the applicable fraction in the case of a testamentary 
transfer. Under the final regulations, the section 2032A value of 
property is to be used to determine the applicable fraction for a 
direct skip transfer and for a generation-skipping trust created in a 
transfer other than a direct skip.
    In the event that additional estate tax is imposed under section 
2032A(c) with respect to the property, then the 

[[Page 66901]]
applicable fraction is redetermined as of the transferor's date of 
death. Thus, the GST tax liability with respect to any direct skip, 
taxable termination, or taxable distribution occurring prior to the 
recapture event would be recomputed based on the redetermined 
applicable fraction, and an additional GST tax would be due. The 
taxation of any future GST transfers would also be based on the 
redetermined applicable fraction.
    Sections 26.2642-2(b) (2) and (3) of the proposed regulations 
contain special rules for determining the denominator of the applicable 
fraction in situations involving residuary and pecuniary payments. 
Generally, in the case of a residual GST after the payment of a 
pecuniary amount, the denominator of the applicable fraction will be 
the estate tax value of the total assets available to satisfy the 
pecuniary payment less the amount of the pecuniary payment, provided 
the pecuniary payment carries ``appropriate interest'' as defined in 
Sec. 26.2642-2(b)(4). Under Sec. 26.2642-2(b)(4)(ii), the payment need 
not carry appropriate interest if, inter alia, the payment is 
irrevocably ``set aside'' within 15 months of the transferor's death. 
The final regulations clarify that this exception to the appropriate 
interest requirement applies only if the entire payment is set aside. 
Further, the payment is treated as set aside if the amount is 
segregated and held in a separate account pending distribution. 
Finally, under the proposed regulation, the appropriate interest 
requirement can be satisfied if a pro rata share of estate income is 
allocated to the pecuniary bequest. The final regulations clarify that 
the payment of income may be allocated pursuant to the terms of the 
governing instrument or applicable local law.
    Section 26.2642-4(a)(3) of the proposed regulations addresses a 
situation where a lifetime allocation is made with respect to a trust 
when the trust was not subject to an ETIP, and the trust is 
subsequently included in the transferor's gross estate. The regulation 
has been revised to provide that, if additional GST exemption is 
allocated to the trust, the nontax portion of the trust is determined 
immediately after the date of the transferor's death. Also, if 
additional GST exemption is not allocated to the trust by the 
transferor's executor, the applicable fraction does not change, if the 
trust was not otherwise subject to an ETIP at the time the previous 
allocation of GST exemption was made. Further, where such property is 
included in the gross estate, the denominator of the applicable 
fraction is reduced to reflect any federal or state estate or 
inheritance tax paid by the trust.
Definition of Transferor
    Section 26.2652-1(a)(1) of the proposed regulations, defining 
transferor, has been revised to specify that a surviving spouse is 
treated as the transferor of a qualified domestic trust (QDOT) 
described in section 2056A that is included in the surviving spouse's 
gross estate for federal estate tax purposes, assuming the trust is not 
subject to a reverse QTIP election under section 2652(a)(3). The 
surviving spouse is also the transferor of any QDOT created by the 
surviving spouse under section 2056(d)(2)(B).
    Section 26.2652-1(a)(4), as proposed, provided that the creator of 
a special power of appointment will be treated as making a transfer 
subject to estate or gift tax (and thus be considered a transferor) if 
the holder of the power exercised the power in a manner that may 
postpone vesting, etc., of the property subject to the power beyond the 
permissible perpetuities period. This result is inconsistent with 
section 2041(a)(3), which treats the holder of the power as making a 
transfer under these circumstances. Accordingly, the regulation has 
been revised to provide that the holder of the power will be treated as 
making a taxable transfer, if the holder exercises the power in the 
manner prescribed.
    Section 26.2652-1(a)(5) has been added to specify that where a 
donor's spouse consents to have the donor's gift treated as made one-
half by the spouse, then for purposes of chapter 13, the spouse is 
treated as the transferor of one-half of the property transferred by 
the donor. Thus, if a donor transfers property to a trust and retains a 
qualified interest as defined in section 2702(b), with the remainder to 
a grandchild, a consenting spouse would be treated as the transferor of 
one-half the entire property. It was suggested that the spouse should 
only be treated as the transferor of that portion of the trust 
corresponding to one-half of the actuarial value of the interest 
passing to the grandchild, since under section 2513, only one half the 
gift to the grandchild may be treated as made by the consenting spouse. 
However, treating the consenting spouse as the transferor of one-half 
of the entire trust is consistent with the general treatment accorded 
other split-interest transfers. For example, if a transferor 
transferred property in trust retaining an interest that qualified 
under section 2702(b), with the remainder to the transferor's 
grandchild, the transferor would be considered the transferor of the 
entire trust for purposes of chapter 13, notwithstanding that, from a 
technical standpoint, only the actuarial value of the gift to the 
grandchild is subject to gift tax at the time of the transfer.
    Example 8 in Sec. 26.2652-1(a)(6) has been added illustrating that 
a surviving spouse will not be treated as making a contribution to a 
QTIP trust that is included in the spouse's gross estate and is subject 
to a reverse QTIP election, where the spouse directs in the will that 
the estate tax generated by the inclusion of the trust is to be paid 
from the spouse's probate estate.
Separate Shares Treated as Separate Trusts
    Section 26.2654-1 of the proposed regulations provides rules under 
which ``separate shares'' of a single trust that satisfy the 
requirements of the regulations will be recognized as separate trusts 
for GST purposes.
    Under the proposed regulations, a mandatory payment of a pecuniary 
amount is treated as a separate share of a trust (and thus, a separate 
trust for GST purposes) if certain conditions are satisfied. The 
section is clarified to specify that a mandatory payment is a payment 
that is nondiscretionary and noncontingent; i.e., the payment must be 
made in all events.
    A sentence was added to Example 3, now contained in Sec. 26.2654-
1(a)(5), to clarify that, where a decedent's probate estate pours over 
to a revocable trust, and then amounts are distributed pursuant to the 
terms of the trust, the distributions will be treated as separate 
shares for purposes of chapter 13.
    Example 4, now contained in Sec. 26.2654-1(a)(5), has been revised 
to specify that the bequest of a pecuniary amount payable in kind is 
not treated as a separate share of the trust, since, under the facts 
presented, neither the trust nor local law requires that the assets 
distributed in satisfaction of the bequest fairly reflect net 
appreciation and depreciation. This is the result regardless of whether 
the assets are distributed within 15 months of the transferor's death.
    Comments received suggested that the regulations should allow 
separate trust treatment whenever a single inter vivos trust was 
recognized as separate trusts under local law. For example, an inter 
vivos trust provides income to child for life, but when each grandchild 
reaches age 35, a separate trust is to be established for the child, 
the grandchild, and the grandchild's issue. Comments suggested that the 
Service should recognize each trust established when a grandchild 
reaches age 35 as a separate trust, and allow a late allocation of GST 

[[Page 66902]]
exemption specifically to that trust when severance occurs.
    This suggestion was rejected. Generally, the adoption of this 
approach would effectively allow the allocation of GST exemption to 
specific distributions from a GST trust, rather than to the entire 
trust. This result would be contrary to the clear language of the 
statute. See, e.g., sections 2642(a)(1)(A) and (a)(2).
Division of a Single Trust Into Separate Trusts
    Under Sec. 26.2654-1(c) of the proposed regulations, a testamentary 
trust could be severed into several parts, provided the severance was 
commenced prior to the filing of the estate tax return. Further, the 
new trusts created pursuant to the severance had to be identical to the 
old trusts. For example, a testamentary trust providing for income to 
spouse, remainder to be divided equally between child and grandchild 
could only be severed into two trusts both providing income to spouse 
with the remainder to be divided between child and grandchild. Finally, 
an inter vivos trust could not be severed unless it consisted of 
separate shares, or different transferors had contributed to the trust.
    The regulation has been clarified to specify that the division of a 
single trust that is included in the transferor's gross estate will be 
recognized if either: (1) The single trust consists of separate shares 
and is thus, treated as separate trusts; or (2) the single trust, 
although not consisting of separate shares, is severed into separate 
trusts pursuant to a direction in the governing instrument providing 
that the trust is to be divided into separate trusts on the 
transferor's death; or (3) the governing instrument does not require or 
direct severance but the trust is severed pursuant to the discretionary 
authority of the trustee granted under the governing instrument or 
local law.
    The final regulations provide that the trusts resulting from the 
severance of a single testamentary trust need not be identical. Thus, 
if the trust provides income to spouse, remainder to child and 
grandchild, the trust may be severed to create two trusts, one with 
income to spouse, remainder to child and a second with income to spouse 
remainder to grandchild. This result could be achieved through proper 
estate planning in any event. However, the regulations make it clear 
that the resulting trusts must provide for the same succession of 
interests as provided for under the original trusts. Thus, a trust 
providing for an income interest to a child, with remainder to a 
grandchild, could not be divided into one trust for the child (equal in 
value to the child's income interest) and another for the grandchild.
    The proposed regulations provided that the new trusts must be 
funded with a fractional share of each and every asset held by the 
original single trust. The provision has been revised to provide that 
the new trusts may also be funded on a nonpro rata basis, based on the 
fair market value of the assets selected on the date of severance. 
Thus, the executor or trustee may select the assets with which to fund 
each trust, and need not fractionalize each asset.
    An example has been added to illustrate that, if a revocable trust 
included in the transferor's gross estate is, under the terms of the 
trust, divided into multiple trusts on the transferor's death, then 
each trust established will be treated as a separate trust for GST 
purposes.
Due Date of Return
    New Sec. 26.2662-1(d)(2) has been added to provide that the due 
date of the return with respect to a taxable termination subject to an 
election under section 2624(c) (relating to alternate valuation in 
accordance with section 2032) is April 15th of the following year in 
which the taxable termination occurred or on or before the 15th day of 
the tenth month following the month in which the death that resulted in 
the taxable termination occurred, whichever is later.
Application of Chapter 13 to Nonresident Aliens
    Section 2663(2) requires that the Commissioner prescribe 
regulations, consistent with the provisions of chapters 11 and 12, 
providing for the application of the GST tax to a nonresident alien 
(NRA). In general, under Sec. 26.2663-2(b) as proposed, the GST tax 
applied to inter vivos and testamentary direct skip transfers by a NRA, 
to the extent that the transferred property was U.S. situs property 
such that the transfer was subject to a gift tax (in the case of inter 
vivos transfers) or an estate tax (in the case of testamentary 
transfers). Similarly, in the case of transfers in trust, chapter 13 
applied to taxable terminations and distributions to the extent the 
initial transfer to the trust (whether inter vivos or testamentary) 
consisted of U.S. situs property, such that the initial transfer was 
subject to the gift or estate tax. This was the case regardless of the 
situs of the property at the time of the actual distribution or 
termination and regardless of the residency or citizenship of the skip 
person receiving the beneficial interest or property.
    Under Sec. 26.2663-2(c) as proposed, if the property involved in a 
generation-skipping transfer was not situated in the U.S. at the time 
of the initial transfer, the generation-skipping transfer was still 
subject to the GST tax if: (1) At the time of the direct skip, taxable 
termination or distribution, the property passes to a skip person who 
is a U.S. resident or citizen; and (2) at the time of the initial 
transfer to the skip person or trust, a lineal descendant of the 
transferor, who is a lineal ancestor of the skip person, was a resident 
or citizen of the U.S. This rule applied regardless of the situs of the 
property at the time of the actual distribution or termination. Section 
26.2663-2(f) of the proposed regulations provided for the automatic 
allocation of a NRA's $1,000,000 GST exemption regardless of whether 
the transfer was a direct skip.
    Thus, the proposed regulations subjected non-U.S. situs property to 
the GST tax based on the status of the skip person/recipient of the 
property at the time the property was received, and the status of the 
generation that was skipped at the time of the initial transfer to the 
trust or skip person.
    Many comments were critical of this approach. In general, these 
comments emphasized that the estate and gift tax provisions subject 
transfers by NRAs to transfer tax based on the situs of the property, 
not the status of the recipient. Therefore, the proposed regulations 
conflict with section 2663, which provides that the regulations should 
be consistent with the principles of chapters 11 and 12 of the Internal 
Revenue Code (Code). Further, the commentators argued that treating a 
NRA who transfers non-U.S. situs property as a transferor for GST tax 
purposes would conflict with the definition of transferor under section 
2652, since the transfer would not be subject to estate or gift tax. 
Under section 2652, an individual is a transferor only to the extent 
the transfer is subject to U.S. gift tax or estate tax.
    The proposed regulations have been revised to address these 
concerns. Thus, the rules in the proposed regulations applying chapter 
13 to transfers of property that were not subject to estate or gift tax 
have been eliminated. Under the final regulations, the application of 
the GST tax will be limited to situations where an estate or gift tax 
is imposed on the property. Thus, the GST tax will apply to inter vivos 
and testamentary direct skip transfers by a NRA transferor to the 
extent a gift tax is imposed on the transfer (in the case of an inter 
vivos transfer) or the transferred property is 

[[Page 66903]]
included in the transferor's gross estate (in the case of a 
testamentary direct skip). In the case of taxable terminations and 
taxable distributions, chapter 13 will apply to the extent a gift tax 
was imposed on the initial transfer to the trust, or the property was 
included in the transferor's gross estate. Accordingly, under the final 
regulations (in the absence of a situation involving an ETIP), the 
application of Chapter 13 is generally dependent on the situs of the 
property at the time of the initial transfer. The regulations contain 
special rules for determining the applicable fraction and inclusion 
ratio where a trust is funded with both U.S. and foreign situs 
property.
    In general, the rules of Sec. 26.2632-1 apply with respect to the 
allocation of the exemption. However, the ETIP rule provided in 
Sec. 26.2632-1(c) applies only if the property transferred by the NRA 
is subsequently included in the transferor's gross estate. The final 
regulations provide transitional relief with respect to NRA's who made 
GST transfers and relied on the automatic allocation rules in the 
proposed regulations.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in EO 12866. Therefore, a 
regulatory assessment is not required. It has also been determined that 
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) 
and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to 
these regulations, and therefore, a Regulatory Flexibility Analysis is 
not required. Pursuant to section 7805(f) of the Internal Revenue Code, 
the notice of proposed rulemaking preceding these regulations was 
submitted to the Small Business Administration for comment on its 
impact on small business.
    Drafting Information. The principal author of these regulations is 
James F. Hogan, Office of the Chief Counsel, IRS. Other personnel from 
the IRS and Treasury Department participated in their development.

List of Subjects

26 CFR Part 26

    Estate taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

    Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income 
taxes, Penalties, Reporting and recordkeeping requirements.

26 CFR part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR parts 26, 301, and 602 are amended as follows:
    Paragraph 1. Part 26 is revised to read as follows:

PART 26--GENERATION-SKIPPING TRANSFER TAX REGULATIONS UNDER THE TAX 
REFORM ACT OF 1986

Sec.
26.2600-1  Table of contents.
26.2601-1  Effective dates.
26.2611-1  Generation-skipping transfer defined.
26.2612-1  Definitions.
26.2613-1  Skip person.
26.2632-1  Allocation of GST exemption.
26.2641-1  Applicable rate of tax.
26.2642-1  Inclusion ratio.
26.2642-2  Valuation.
26.2642-3  Special rule for charitable lead annuity trusts.
26.2642-4  Redetermination of applicable fraction.
26.2642-5  Finality of inclusion ratio.
26.2652-1  Transferor defined; other definitions.
26.2652-2  Special election for qualified terminable interest 
property.
26.2653-1  Taxation of multiple skips.
26.2654-1  Certain trusts treated as separate trusts.
26.2662-1  Generation-skipping transfer tax return requirements.
26.2663-1  Recapture tax under section 2032A.
26.2663-2  Application of chapter 13 to transfers by nonresidents 
not citizens of the United States.

    Authority: 26 U.S.C. 7805 and 26 U.S.C. 2663.

    Section 26.2632-1 also issued under 26 U.S.C. 2632 and 2663.
    Section 26.2642-4 also issued under 26 U.S.C. 2632 and 2663.
    Section 26.2662-1 also issued under 26 U.S.C. 2662.
    Section 26.2663-2 also issued under 26 U.S.C. 2632 and 2663.


Sec. 26.2600-1  Table of contents.

    This section lists the captions that appear in the regulations 
under sections 2601 through 2663.

Sec. 26.2601-1  Effective dates.

    (a) Transfers subject to the generation-skipping transfer tax.
    (1) In general.
    (2) Certain transfers treated as if made after October 22, 1986.
    (3) Certain trust events treated as if occurring after October 
22, 1986.
    (4) Example.
    (b) Exceptions.
    (1) Irrevocable trusts.
    (2) Transition rule for wills or revocable trusts executed 
before October 22, 1986.
    (3) Transition rule in the case of mental incompetency.
    (4) Exceptions to additions rule.
    (c) Additional effective dates.

Sec. 26.2611-1  Generation-skipping transfer defined.

Sec. 26.2612-1  Definitions.

    (a) Direct skip.
    (1) In general.
    (2) Special rule for certain lineal descendants.
    (b) Taxable termination.
    (1) In general.
    (2) Partial termination.
    (c) Taxable distribution.
    (1) In general.
    (2) Look-through rule not to apply.
    (d) Skip person.
    (e) Interest in trust.
    (1) In general.
    (2) Exceptions.
    (3) Disclaimers.
    (f) Examples.

Sec. 26.2613-1  Skip person.

Sec. 26.2632-1  Allocation of GST exemption.

    (a) General rule.
    (b) Lifetime allocations.
    (1) Automatic allocation to direct skips.
    (2) Allocation to other transfers.
    (c) Special rules during an estate tax inclusion period.
    (1) In general.
    (2) Estate tax inclusion period defined.
    (3) Termination of an ETIP.
    (4) Treatment of direct skips.
    (5) Examples.
    (d) Allocations after the transferor's death.
    (1) Allocation by executor.
    (2) Automatic allocation after death.

Sec. 26.2641-1  Applicable rate of tax.

Sec. 26.2642-1  Inclusion ratio.

    (a) In general.
    (b) Numerator of applicable fraction.
    (1) In general.
    (2) GSTs occurring during an ETIP.
    (c) Denominator of applicable fraction.
    (1) In general.
    (2) Zero denominator.
    (3) Nontaxable gifts.
    (d) Examples.

Sec. 26.2642-2  Valuation.

    (a) Lifetime transfers.
    (1) In general.
    (2) Special rule for late allocations during life.
    (b) Transfers at death.
    (1) In general.
    (2) Special rule for pecuniary payments.
    (3) Special rule for residual transfers after payment of a 
pecuniary payment.
    (4) Appropriate interest.
    (c) Examples.

Sec. 26.2642-3  Special rule for charitable lead annuity trusts.

    (a) In general.
    (b) Adjusted GST exemption defined.
    (c) Example.
    
[[Page 66904]]


Sec. 26.2642-4  Redetermination of applicable fraction.

    (a) In general.
    (1) Multiple transfers to a single trust.
    (2) Consolidation of separate trusts.
    (3) Property included in transferor's gross estate.
    (4) Imposition of recapture tax under section 2032A.
    (b) Examples.

Sec. 26.2642-5  Finality of inclusion ratio.

    (a) Direct skips.
    (b) Other GSTs.

Sec. 26.2652-1  Transferor defined; other definitions.

    (a) Transferor defined.
    (1) In general.
    (2) Transfers subject to Federal estate or gift tax.
    (3) Special rule for certain QTIP trusts.
    (4) Exercise of certain nongeneral powers of appointment.
    (5) Split-gift transfers.
    (6) Examples.
    (b) Trust defined.
    (1) In general.
    (2) Examples.
    (c) Trustee defined.
    (d) Executor defined.
    (e) Interest in trust.

Sec. 26.2652-2  Special election for qualified terminable interest 
property.

    (a) In general.
    (b) Time and manner of making election.
    (c) Transitional rule.
    (d) Examples.

Sec. 26.2653-1  Taxation of multiple skips.

    (a) General rule.
    (b) Examples.

Sec. 26.2654-1  Certain trusts treated as separate trusts.

    (a) Single trust treated as separate trusts.
    (1) Substantially separate and independent shares.
    (2) Multiple transferors with respect to a single trust.
    (3) Severance of a single trust.
    (4) Allocation of exemption.
    (5) Examples.
    (b) Division of a trust included in the gross estate.
    (1) In general.
    (2) Special rule.
    (3) Allocation of exemption.
    (4) Example.

Sec. 26.2662-1  Generation-skipping transfer tax return 
requirements.

    (a) In general.
    (b) Form of return.
    (1) Taxable distributions.
    (2) Taxable terminations.
    (3) Direct skip.
    (c) Person liable for tax and required to make return.
    (1) In general.
    (2) Special rule for direct skips occurring at death with 
respect to property held in trust arrangements.
    (3) Limitation on personal liability of trustee.
    (4) Exceptions.
    (d) Time and manner of filing return.
    (1) In general.
    (2) Exceptions for alternative valuation of taxable termination.
    (e) Place for filing returns.
    (f) Lien on property.

Sec. 26.2663-1  Recapture tax under section 2032A.

Sec. 26.2663-2  Application of chapter 13 to transfers by 
nonresidents not citizens of the United States.

    (a) In general.
    (b) Transfers subject to Chapter 13.
    (1) Direct skips.
    (2) Taxable distributions and taxable terminations.
    (c) Trusts funded in part with property subject to Chapter 13 
and in part with property not subject to Chapter 13.
    (1) In general.
    (2) Nontax portion of the trust.
    (3) Special rule with respect to estate tax inclusion period.
    (d) Examples.
    (e) Transitional rule for allocations for transfers made before 
December 27, 1995.


26.2601-1  Effective dates.

    (a) Transfers subject to the generation-skipping transfer tax--(1) 
In general. Except as otherwise provided in this section, the 
provisions of chapter 13 of the Internal Revenue Code of 1986 (Code) 
apply to any generation-skipping transfer (as defined in section 2611) 
made after October 22, 1986.
    (2) Certain transfers treated as if made after October 22, 1986. 
Solely for purposes of chapter 13, an inter vivos transfer is treated 
as if it were made on October 23, 1986, if it was--
    (i) Subject to chapter 12 (regardless of whether a tax was actually 
incurred or paid); and
    (ii) Made after September 25, 1985, but before October 23, 1986. 
For purposes of this paragraph, the value of the property transferred 
shall be the value of the property on the date the property was 
transferred.
    (3) Certain trust events treated as if occurring after October 22, 
1986. For purposes of chapter 13, if an inter vivos transfer is made to 
a trust after September 25, 1985, but before October 23, 1986, any 
subsequent distribution from the trust or termination of an interest in 
the trust that occurred before October 23, 1986, is treated as 
occurring immediately after the deemed transfer on October 23, 1986. If 
more than one distribution or termination occurs with respect to a 
trust, the events are treated as if they occurred on October 23, 1986, 
in the same order as they occurred. See paragraph (b)(1)(iv)(B) of this 
section for rules determining the portion of distributions and 
terminations subject to tax under chapter 13. This paragraph (a)(3) 
does not apply to transfers to trusts not subject to chapter 13 by 
reason of the transition rules in paragraphs (b) (2) and (3) of this 
section. The provisions of this paragraph (a)(3) do not apply in 
determining the value of the property under chapter 13.
    (4) Example. The following example illustrates the principle that 
paragraph (a)(2) of this section is not applicable to transfers under a 
revocable trust that became irrevocable by reason of the transferor's 
death after September 25, 1985, but before October 23, 1986:

    Example. T created a revocable trust on September 30, 1985, that 
became irrevocable when T died on October 10, 1986. Although the 
trust terminated in favor of a grandchild of T, the transfer to the 
grandchild is not treated as occurring on October 23, 1986, pursuant 
to paragraph (a)(2) of this section because it is not an inter vivos 
transfer subject to chapter 12. The transfer is not subject to 
chapter 13 because it is in the nature of a testamentary transfer 
that occurred prior to October 23, 1986.

    (b) Exceptions--(1) Irrevocable trusts--(i) In general. The 
provisions of chapter 13 do not apply to any generation-skipping 
transfer under a trust (as defined in section 2652(b)) that was 
irrevocable on September 25, 1985. The rule of the preceding sentence 
does not apply to a pro rata portion of any generation-skipping 
transfer under an irrevocable trust if additions are made to the trust 
after September 25, 1985. See paragraph (b)(1)(iv) of this section for 
rules for determining the portion of the trust that is subject to the 
provisions of chapter 13.
    (ii) Irrevocable trust defined--(A) In general. Unless otherwise 
provided in either paragraph (b)(1)(ii) (B) or (C) of this section, any 
trust (as defined in section 2652(b)) in existence on September 25, 
1985, is considered an irrevocable trust.
    (B) Property includible in the gross estate under section 2038. For 
purposes of this chapter a trust is not an irrevocable trust to the 
extent that, on September 25, 1985, the settlor held a power with 
respect to such trust that would have caused the value of the trust to 
be included in the settlor's gross estate for Federal estate tax 
purposes by reason of section 2038 (without regard to powers 
relinquished before September 25, 1985) if the settlor had died on 
September 25, 1985. A trust is considered subject to a power on 
September 25, 1985, even though the exercise of the power was subject 
to the precedent giving of notice, or even though the exercise could 
take effect only on the expiration of a stated period, whether or not 
on or before September 25, 1985, notice had been given or the power had 
been exercised. 

[[Page 66905]]
A trust is not considered subject to a power if the power is, by its 
terms, exercisable only on the occurrence of an event or contingency 
not subject to the settlor's control (other than the death of the 
settlor) and if the event or contingency had not in fact taken place on 
September 25, 1985.
    (C) Property includible in the gross estate under section 2042. A 
policy of insurance on an individual's life that is treated as a trust 
under section 2652(b) is not considered an irrevocable trust to the 
extent that, on September 25, 1985, the insured possessed any incident 
of ownership (as defined in Sec. 20.2042-1(c) of this chapter, and 
without regard to any incidents of ownership relinquished before 
September 25, 1985), that would have caused the value of the trust, 
(i.e., the insurance proceeds) to be included in the insured's gross 
estate for Federal estate tax purposes by reason of section 2042, if 
the insured had died on September 25, 1985.
    (D) Examples. The following examples illustrate the application of 
this paragraph (b)(1):

    Example 1. Section 2038 applicable. On September 25, 1985, T, 
the settlor of a trust that was created before September 25, 1985, 
held a testamentary power to add new beneficiaries to the trust. T 
held no other powers over any portion of the trust. The testamentary 
power held by T would have caused the trust to be included in T's 
gross estate under section 2038 if T had died on September 25, 1985. 
Therefore, the trust is not an irrevocable trust for purposes of 
this section.
    Example 2. Section 2038 not applicable when power held by a 
person other than settlor. On September 25, 1985, S, the spouse of 
the settlor of a trust in existence on that date, had an annual 
right to withdraw a portion of the principal of the trust. The trust 
was otherwise irrevocable on that date. Because the power was not 
held by the settlor of the trust, it is not a power described in 
section 2038. Thus, the trust is considered an irrevocable trust for 
purposes of this section.
    Example 3. Section 2038 not applicable. In 1984, T created a 
trust and retained the right to expand the class of remaindermen to 
include any of T's afterborn grandchildren. As of September 25, 
1985, all of T's grandchildren were named remaindermen of the trust. 
Since the exercise of T's power was dependent on there being 
afterborn grandchildren who were not members of the class of 
remaindermen, a contingency that did not exist on September 25, 
1985, the trust is not considered subject to the power on September 
25, 1985, and is an irrevocable trust for purposes of this section. 
The result is not changed even if grandchildren are born after 
September 25, 1985, whether or not T exercises the power to expand 
the class of remaindermen.
    Example 4. Section 2042 applicable. On September 25, 1985, T 
purchased an insurance policy on T's own life and designated child, 
C, and grandchild, GC, as the beneficiaries. T retained the power to 
obtain from the insurer a loan against the surrender value of the 
policy. T's insurance policy is a trust (as defined in section 
2652(b)) for chapter 13 purposes. The trust is not considered an 
irrevocable trust because, on September 25, 1985, T possessed an 
incident of ownership that would have caused the value of the policy 
to be included in T's gross estate under section 2042 if T had died 
on that date.
    Example 5. Trust partially irrevocable. In 1984, T created a 
trust naming T's grandchildren as the income and remainder 
beneficiaries. T retained the power to revoke the trust as to one-
half of the principal at any time prior to T's death. T retained no 
other powers over the trust principal. T did not die before 
September 25, 1985, and did not exercise or release the power before 
that date. The half of the trust not subject to T's power to revoke 
is an irrevocable trust for purposes of this section.

    (iii) Trust containing qualified terminable interest property--(A) 
In general. For purposes of chapter 13, a trust described in paragraph 
(b)(1)(ii) of this section that holds qualified terminable interest 
property by reason of an election under section 2056(b)(7) or section 
2523(f) (made either on, before or after September 25, 1985) is treated 
in the same manner as if the decedent spouse or the donor spouse (as 
the case may be) had made an election under section 2652(a)(3). Thus, 
transfers from such trusts are not subject to chapter 13, and the 
decedent spouse or the donor spouse (as the case may be) is treated as 
the transferor of such property. The rule of this paragraph (b)(1)(iii) 
does not apply to that portion of the trust that is subject to chapter 
13 by reason of an addition to the trust occurring after September 25, 
1985. See Sec. 26.2652-2(a) for rules where an election under section 
2652(a)(3) is made. See Sec. 26.2652-2(c) for rules where a portion of 
a trust is subject to an election under section 2652(a)(3).
    (B) Examples. The following examples illustrate the application of 
this paragraph (b)(1)(iii):

    Example 1. QTIP election made after September 25, 1985. On March 
28, 1985, T established a trust. The trust instrument provided that 
the trustee must distribute all income annually to T's spouse, S, 
during S's life. Upon S's death, the remainder is to be distributed 
to GC, the grandchild of T and S. On April 15, 1986, T elected under 
section 2523(f) to treat the property in the trust as qualified 
terminable interest property. On December 1, 1987, S died and soon 
thereafter the trust assets were distributed to GC. Because the 
trust was irrevocable on September 25, 1985, the transfer to GC is 
not subject to tax under chapter 13. T is treated as the transferor 
with respect to the transfer of the trust assets to GC in the same 
manner as if T had made an election under section 2652(a)(3) to 
reverse the effect of the section 2523(f) election for chapter 13 
purposes.
    Example 2. Section 2652(a)(3) election deemed to have been made. 
Assume the same facts as in Example 1, except the trust instrument 
provides that after S's death all income is to be paid annually to 
C, the child of T and S. Upon C's death, the remainder is to be 
distributed to GC. C died on October 1, 1992, and soon thereafter 
the trust assets are distributed to GC. Because the trust was 
irrevocable on September 25, 1985, the termination of C's interest 
is not subject to chapter 13.

    (iv) Additions to irrevocable trusts--(A) In general. If an 
addition is made after September 25, 1985, to an irrevocable trust 
which is excluded from chapter 13 by reason of paragraph (b)(1) of this 
section, a pro rata portion of subsequent distributions from (and 
terminations of interests in property held in) the trust is subject to 
the provisions of chapter 13. If an addition is made, the trust is 
thereafter deemed to consist of two portions, a portion not subject to 
chapter 13 (the non-chapter 13 portion) and a portion subject to 
chapter 13 (the chapter 13 portion), each with a separate inclusion 
ratio (as defined in section 2642(a)). The non-chapter 13 portion 
represents the value of the assets of the trust as it existed on 
September 25, 1985. The applicable fraction (as defined in section 
2642(a)(2)) for the non-chapter 13 portion is deemed to be 1 and the 
inclusion ratio for such portion is 0. The chapter 13 portion of the 
trust represents the value of all additions made to the trust after 
September 25, 1985. The inclusion ratio for the chapter 13 portion is 
determined under section 2642. This paragraph (b)(1)(iv)(A) requires 
separate portions of one trust only for purposes of determining 
inclusion ratios. For purposes of chapter 13, a constructive addition 
under paragraph (b)(1)(v) of this section is treated as an addition. 
See paragraph (b)(4) of this section for exceptions to the additions 
rule of this paragraph (b)(1)(iv). See Sec. 26.2654-1(a)(2) for rules 
treating additions to a trust by an individual other than the initial 
transferor as a separate trust for purposes of chapter 13.
    (B) Terminations of interests in and distributions from trusts. 
Where a termination or distribution described in section 2612 occurs 
with respect to a trust to which an addition has been made, the portion 
of such termination or distribution allocable to the chapter 13 portion 
is determined by reference to the allocation fraction, as defined in 
paragraph (b)(1)(iv)(C) of this section. In the case of a termination 
described in section 2612(a) with respect to a trust, the portion of 
such termination that is 

[[Page 66906]]
subject to chapter 13 is the product of the allocation fraction and the 
value of the trust (to the extent of the terminated interest therein). 
In the case of a distribution described in section 2612(b) from a 
trust, the portion of such distribution that is subject to chapter 13 
is the product of the allocation fraction and the value of the property 
distributed.
    (C) Allocation fraction--(1) In general. The allocation fraction 
allocates appreciation and accumulated income between the chapter 13 
and non-chapter 13 portions of a trust. The numerator of the allocation 
fraction is the amount of the addition (valued as of the date the 
addition is made), determined without regard to whether any part of the 
transfer is subject to tax under chapter 11 or chapter 12, but reduced 
by the amount of any Federal or state estate or gift tax imposed and 
subsequently paid by the recipient trust with respect to the addition. 
The denominator of the allocation fraction is the total value of the 
entire trust immediately after the addition. For purposes of this 
paragraph (b)(1)(iv)(C), the total value of the entire trust is the 
fair market value of the property held in trust (determined under the 
rules of section 2031), reduced by any amount attributable to or paid 
by the trust and attributable to the transfer to the trust that is 
similar to an amount that would be allowable as a deduction under 
section 2053 if the addition had occurred at the death of the 
transferor, and further reduced by the same amount that the numerator 
was reduced to reflect Federal or state estate or gift tax incurred by 
and subsequently paid by the recipient trust with respect to the 
addition. Where there is more than one addition to principal after 
September 25, 1985, the portion of the trust subject to chapter 13 
after each such addition is determined pursuant to a revised fraction. 
In each case, the numerator of the revised fraction is the sum of the 
value of the chapter 13 portion of the trust immediately before the 
latest addition, and the amount of the latest addition. The denominator 
of the revised fraction is the total value of the entire trust 
immediately after the addition. If the transfer to the trust is a 
generation-skipping transfer, the numerator and denominator are reduced 
by the amount of the generation-skipping transfer tax, if any, that is 
imposed by chapter 13 on the transfer and actually recovered from the 
trust. The allocation fraction is rounded off to five decimal places 
(.00001).
    (2) Examples. The following examples illustrate the application of 
paragraph (b)(1)(iv) of this section. In each of the examples, assume 
that the recipient trust does not pay any Federal or state transfer tax 
by reason of the addition.

    Example 1. Post September 25, 1985, addition to trust. (i) On 
August 16, 1980, T established an irrevocable trust. Under the trust 
instrument, the trustee is required to distribute the entire income 
annually to T's child, C, for life, then to T's grandchild, GC, for 
life. Upon GC's death, the remainder is to be paid to GC's issue. On 
October 1, 1986, when the total value of the entire trust is 
$400,000, T transfers $100,000 to the trust. The allocation fraction 
is computed as follows:
[GRAPHIC][TIFF OMITTED]TR27DE95.002

    (ii) Thus, immediately after the transfer, 20 percent of the 
value of future generation-skipping transfers under the trust will 
be subject to chapter 13.
    Example 2. Effect of expenses. Assume the same facts as in 
Example 1, except immediately prior to the transfer on October 1, 
1986, the fair market value of the individual assets in the trust 
totaled $400,000. Also, assume that the trust had accrued and unpaid 
debts, expenses, and taxes totaling $300,000. Assume further that 
the entire $300,000 represented amounts that would be deductible 
under section 2053 if the trust were includible in the transferor's 
gross estate. The numerator of the allocation fraction is $100,000 
and the denominator of the allocation fraction is $200,000 
(($400,000-$300,000)+$100,000). Thus, the allocation fraction is .5 
($100,000/$200,000) and 50 percent of the value of future 
generation-skipping transfers will be subject to chapter 13.
    Example 3. Multiple additions. (i) Assume the same facts as in 
Example 1, except on January 30, 1988, when the total value of the 
entire trust is $600,000, T transfers an additional $40,000 to the 
trust. Before the transfer, the value of the portion of the trust 
that was attributable to the prior addition was $120,000 
($600,000 x .2). The new allocation fraction is computed as follows:
[GRAPHIC][TIFF OMITTED]TR27DE95.003

    (ii) Thus, immediately after the transfer, 25 percent of the 
value of future generation-skipping transfers under the trust will 
be subject to chapter 13.
    Example 4. Allocation fraction at time of generation-skipping 
transfer. Assume the same facts as in Example 3, except on March 1, 
1989, when the value of the trust is $800,000, C dies. A generation-
skipping transfer occurs at C's death because of the termination of 
C's life estate. Therefore, $200,000 ($800,000 x .25) is subject to 
tax under chapter 13.

    (v) Constructive additions--(A) Powers of Appointment. Except as 
provided in paragraph (b)(1)(v)(B) of this section, where any portion 
of a trust remains in the trust after the post-September 25, 1985, 
release, exercise, or lapse of a power of appointment over that portion 
of the trust, and the release, exercise, or lapse is treated to any 
extent as a taxable transfer under chapter 11 or chapter 12, the value 
of the entire portion of the trust subject to the power that was 
released, exercised, or lapsed is treated as if that portion had been 
withdrawn and immediately retransferred to the trust at the time of the 
release, exercise, or lapse. The creator of the power will be 
considered the transferor of the addition except to the extent that the 
release, exercise, or lapse of the power is treated as a taxable 
transfer under chapter 11 or chapter 12. See Sec. 26.2652-1 for rules 
for determining the identity of the transferor of property for purposes 
of chapter 13.
    (B) Special rule for certain powers of appointment. The release, 
exercise, or lapse of a power of appointment (other than a general 
power of appointment as defined in section 2041(b)) is not treated as 
an addition to a trust if--
    (1) Such power of appointment was created in an irrevocable trust 
that is not subject to chapter 13 under paragraph (b)(1) of this 
section; and
    (2) In the case of an exercise, the power of appointment is not 
exercised in a manner that may postpone or 

[[Page 66907]]
suspend the vesting, absolute ownership or power of alienation of an 
interest in property for a period, measured from the date of creation 
of the trust, extending beyond any life in being at the date of 
creation of the trust plus a period of 21 years plus, if necessary, a 
reasonable period of gestation (the perpetuities period). For purposes 
of this paragraph (b)(1)(v)(B)(2), the exercise of a power of 
appointment that validly postpones or suspends the vesting, absolute 
ownership or power of alienation of an interest in property for a term 
of years that will not exceed 90 years (measured from the date of 
creation of the trust) will not be considered an exercise that 
postpones or suspends vesting, absolute ownership or the power of 
alienation beyond the perpetuities period. If a power is exercised by 
creating another power, it is deemed to be exercised to whatever extent 
the second power may be exercised.
    (C) Constructive addition if liability is not paid out of trust 
principal. Where a trust described in paragraph (b)(1) of this section 
is relieved of any liability properly payable out of the assets of such 
trust, the person or entity who actually satisfies the liability is 
considered to have made a constructive addition to the trust in an 
amount equal to the liability. The constructive addition occurs when 
the trust is relieved of liability (e.g., when the right of recovery is 
no longer enforceable). But see Sec. 26.2652-1(a)(3) for rules 
involving the application of section 2207A in the case of an election 
under section 2652(a)(3).
    (D) Examples. The following examples illustrate the application of 
this paragraph (b)(1)(v):

    Example 1. Lapse of a power of appointment. On June 19, 1980, T 
established an irrevocable trust with a corpus of $500,000. The 
trust instrument provides that the trustee shall distribute the 
entire income from the trust annually to T's spouse, S, during S's 
life. At S's death, the remainder is to be distributed to T and S's 
grandchild, GC. T also gave S a general power of appointment over 
one-half of the trust assets. On December 21, 1989, when the value 
of the trust corpus is $1,500,000, S died without having exercised 
the general power of appointment. The value of one-half of the trust 
corpus, $750,000 ($1,500,000  x  .5) is included in S's gross estate 
under section 2041(a) and is subject to tax under Chapter 11. 
Because the value of one-half of the trust corpus is subject to tax 
under Chapter 11 with respect to S's estate, S is treated as the 
transferor of that property for purposes of Chapter 13 (see section 
2652(a)(1)(A)). For purposes of the generation-skipping transfer 
tax, the lapse of S's power of appointment is treated as if $750,000 
($1,500,000  x  .5) had been distributed to S and then transferred 
back to the trust. Thus, S is considered to have added $750,000 
($1,500,000  x  .5) to the trust at the date of S's death. Because 
this constructive addition occurred after September 25, 1985, 50 
percent of the corpus of the trust became subject to Chapter 13 at 
S's death.
    Example 2. Multiple actual additions. On June 19, 1980, T 
established an irrevocable trust with a principal of $500,000. The 
trust instrument provides that the trustee shall distribute the 
entire income from the trust annually to T's spouse, S, during S's 
life. At S's death, the remainder is to be distributed to GC, the 
grandchild of T and S. On October 1, 1985, when the trust assets 
were valued at $800,000, T added $200,000 to the trust. After the 
transfer on October 1, 1985, the allocation fraction was .2 
($200,000/$1,000,000). On December 21, 1989, when the value of the 
trust principal is $1,000,000, T adds $1,000,000 to the trust. After 
this addition, the new allocation fraction is 0.6 ($1,200,000/
$2,000,000). The numerator of the fraction is the value of that 
portion of trust assets that were subject to chapter 13 immediately 
prior to the addition (by reason of the first addition), $200,000 
(.2 <divide> $1,000,000), plus the value of the second transfer, 
$1,000,000, which equals $1,200,000. The denominator of the 
fraction, $2,000,000, is the total value of the trust assets 
immediately after the second transfer. Thus, 60 percent of the 
principal of the trust becomes subject to chapter 13.
    Example 3. Entire portion of trust subject to lapsed power is 
treated as an addition. On September 25, 1985, B possessed a general 
power of appointment over the assets of an irrevocable trust that 
had been created by T in 1980. Under the terms of the trust, B's 
power lapsed on July 20, 1987. For Federal gift tax purposes, B is 
treated as making a gift of ninety-five percent (100%--5%) of the 
value of the principal (see section 2514). However, because the 
entire trust was subject to the power of appointment, 100 percent 
(that portion of the trust subject to the power) of the assets of 
the trust are treated as a constructive addition. Thus, the entire 
amount of all generation-skipping transfers occurring pursuant to 
the trust instrument after July 20, 1987, are subject to chapter 13.
    Example 4. Exercise of power of appointment in favor of another 
trust. On March 1, 1985, T established an irrevocable trust as 
defined in paragraph (b)(1)(ii) of this section. Under the terms of 
the trust instrument, the trustee is required to distribute the 
entire income annually to T's child, C, for life, then to T's 
grandchild, GC, for life. GC has the power to appoint any or all of 
the trust assets to Trust 2 which is an irrevocable trust (as 
defined in paragraph (b)(1)(ii) of this section) that was 
established on August 1, 1985. The terms of Trust 2's governing 
instrument provide that the trustee shall pay income to T's great 
grandchild, GGC, for life. Upon GGC's death the remainder is to be 
paid to GGC's issue. GGC was alive on March 1, 1985, when Trust 1 
was created. C died on April 1, 1986. On July 1, 1987, GC exercised 
the power of appointment. The exercise of GC's power does not 
subject future transfers from Trust 2 to tax under chapter 13 
because the exercise of the power in favor of Trust 2 does not 
suspend the vesting, absolute ownership, or power of alienation of 
an interest in property for a period, measured from the date of 
creation of Trust 1, extending beyond the life of GGC (a beneficiary 
under Trust 2 who was in being at the date of creation of Trust 1) 
plus a period of 21 years. The result would be the same if Trust 2 
had been created after the effective date of chapter 13.
    Example 5. Exercise of power of appointment in favor of another 
trust. Assume the same facts as in Example 3, except that GGC was 
born on March 28, 1986. The valid exercise of GC's power in favor of 
Trust 2 causes the principal of Trust 1 to be subject to chapter 13, 
because GGC was not born until after the creation of Trust 1. Thus, 
such exercise may suspend the vesting, absolute ownership, or power 
of alienation of an interest in the trust principal for a period, 
measured from the date of creation of Trust 1, extending beyond the 
life of GGC (a beneficiary under Trust 2 who was not a life in being 
at the date of creation of Trust 1).
    Example 6. Extension for the longer of two periods. Prior to the 
effective date of chapter 13, GP established an irrevocable trust 
under which the trust income was to be paid to GP's child, C, for 
life. C was given a testamentary power to appoint the remainder in 
further trust for the benefit of C's issue. In default of C's 
exercise of the power, the remainder was to pass to charity. C died 
on February 3, 1995, survived by a child who was alive when GP 
established the trust. C exercised the power in a manner that 
validly extends the trust in favor of C's issue until the latter of 
May 15, 2064 (80 years from the date the trust was created), or the 
death of C's child plus 21 years. C's exercise of the power is a 
constructive addition to the trust because the exercise may extend 
the trust for a period longer than the permissible periods of either 
the life of C's child (a life in being at the creation of the trust) 
plus 21 years or a term not more than 90 years measured from the 
creation of the trust. On the other hand, if C's exercise of the 
power could extend the trust based only on the life of C's child 
plus 21 years or only for a term of 80 years from the creation of 
the trust (but not the later of the two periods) then the exercise 
of the power would not have been a constructive addition to the 
trust.
    Example 7. Extension for the longer of two periods. The facts 
are the same as in Example 6 except local law provides that the 
effect of C's exercise is to extend the term of the trust until May 
15, 2064, whether or not C's child predeceases that date by more 
than 21 years. C's exercise is not a constructive addition to the 
trust because C exercised the power in a manner that cannot postpone 
or suspend vesting, absolute ownership, or power of alienation for a 
term of years that will exceed 90 years. The result would be the 
same if the effect of C's exercise is either to extend the term of 
the trust until 21 years after the death of C's child or to extend 
the term of the trust until the first to occur of May 15, 2064 or 21 
years after the death of C's child.

    (vi) Appreciation and income. Except to the extent that the 
provisions of paragraphs (b)(1)(iv) and (v) of this 

[[Page 66908]]
section allocate subsequent appreciation and accumulated income between 
the original trust and additions thereto, appreciation in the value of 
the trust and undistributed income added thereto are not considered an 
addition to the principal of a trust.
    (2) Transition rule for wills or revocable trusts executed before 
October 22, 1986--(i) In general. The provisions of chapter 13 do not 
apply to any generation-skipping transfer under a will or revocable 
trust executed before October 22, 1986, provided that--
    (A) The document in existence on October 21, 1986, is not amended 
at any time after October 21, 1986, in any respect which results in the 
creation of, or an increase in the amount of, a generation-skipping 
transfer;
    (B) In the case of a revocable trust, no addition is made to the 
revocable trust after October 21, 1986, that results in the creation 
of, or an increase in the amount of, a generation-skipping transfer; 
and
    (C) The decedent dies before January 1, 1987.
    (ii) Revocable trust defined. For purposes of this section, the 
term revocable trust means any trust (as defined in section 2652(b)) 
except to the extent that, on October 22, 1986, the trust--
    (A) Was an irrevocable trust described in paragraph (b)(1) of this 
section; or
    (B) Would have been an irrevocable trust described in paragraph 
(b)(1) of this section had it not been created or become irrevocable 
after September 25, 1985, and before October 22, 1986.
    (iii) Will or revocable trust containing qualified terminable 
interest property. The rules contained in paragraph (b)(1)(iii) of this 
section apply to any will or revocable trust within the scope of the 
transition rule of this paragraph (b)(2).
    (iv) Amendments to will or revocable trust. For purposes of this 
paragraph (b)(2), an amendment to a will or a revocable trust in 
existence on October 21, 1986, is not considered to result in the 
creation of, or an increase in the amount of, a generation-skipping 
transfer where the amendment is--
    (A) Basically administrative or clarifying in nature and only 
incidentally increases the amount transferred; or
    (B) Designed to ensure that an existing bequest or transfer 
qualifies for the applicable marital or charitable deduction for 
estate, gift, or generation-skipping transfer tax purposes and only 
incidentally increases the amount transferred to a skip person or to a 
generation-skipping trust.
    (v) Creation of, or increase in the amount of, a GST. In 
determining whether a particular amendment to a will or revocable trust 
creates, or increases the amount of, a generation-skipping transfer for 
purposes of this paragraph (b)(2), the effect of the instrument(s) in 
existence on October 21, 1986, is measured against the effect of the 
instrument(s) in existence on the date of death of the decedent or on 
the date of any prior generation-skipping transfer. If the effect of an 
amendment cannot be immediately determined, it is deemed to create, or 
increase the amount of, a generation-skipping transfer until a 
determination can be made.
    (vi) Additions to revocable trusts. Any addition made after October 
21, 1986, but before the death of the settlor, to a revocable trust 
subjects all subsequent generation-skipping transfers under the trust 
to the provisions of chapter 13. Any addition made to a revocable trust 
after the death of the settlor (if the settlor dies before January 1, 
1987) is treated as an addition to an irrevocable trust. See paragraph 
(b)(1)(v) of this section for rules involving constructive additions to 
trusts. See paragraph (b)(1)(v)(B) of this section for rules providing 
that certain transfers to trusts are not treated as additions for 
purposes of this section.
    (vii) Examples. The following examples illustrate the application 
of paragraph (b)(2)(iv) of this section:
    (A) Facts applicable to Examples 1 through 5. In each of Examples 1 
through 5 assume that T executed a will prior to October 22, 1986, and 
that T dies on December 31, 1986.

    Example 1. Administrative change. On November 1, 1986, T 
executes a codicil to T's will removing one of the co-executors 
named in the will. Although the codicil may have the effect of 
lowering administrative costs and thus increasing the amount 
transferred, it is considered administrative in nature and thus does 
not cause generation-skipping transfers under the will to be subject 
to chapter 13.
    Example 2. Effect of amendment not immediately determinable. On 
November 1, 1986, T executes a codicil to T's will revoking a 
bequest of $100,000 to C, a non-skip person (as defined under 
section 2613(b)) and causing that amount to be added to a residuary 
trust held for a skip person. The amendment is deemed to increase 
the amount of a generation-skipping transfer and prevents any 
transfers under the will from qualifying under paragraph (b)(2)(i) 
of this section. If, however, C dies before T and under local law 
the property would have been added to the residue in any event 
because the bequest would have lapsed, the codicil is not considered 
an amendment that increases the amount of a generation-skipping 
transfer.
    Example 3. Refund of tax paid because of amendment. T's will 
provided that an amount equal to the maximum allowable marital 
deduction would pass to T's spouse with the residue of the estate 
passing to a trust established for the benefit of skip persons. On 
October 23, 1986, the will is amended to provide that the marital 
share passing to T's spouse shall be the lesser of the maximum 
allowable marital deduction or the minimum amount that will result 
in no estate tax liability for T's estate. The amendment may 
increase the amount of a generation-skipping transfer. Therefore, 
any generation-skipping transfers under the will are subject to tax 
under chapter 13. If it becomes apparent that the amendment does not 
increase the amount of a generation-skipping transfer, a claim for 
refund may be filed with respect to any generation-skipping transfer 
tax that was paid within the period set forth in section 6511. For 
example, it would become apparent that the amendment did not result 
in an increase in the residue if it is subsequently determined that 
the maximum marital deduction and the minimum amount that will 
result in no estate tax liability are equal in amount.
    Example 4. An amendment that increases a generation-skipping 
transfer causes complete loss of exempt status. T's will provided 
for the creation of two trusts for the benefit of skip persons. On 
November 1, 1986, T executed a codicil to the will specifically 
increasing the amount of a generation-skipping transfer under the 
will. All transfers made pursuant to the will or either of the 
trusts created thereunder are precluded from qualifying under the 
transition rule of paragraph (b)(2)(i) of this section and are 
subject to tax under chapter 13.
    Example 5. Corrective action effective. Assume that T in Example 
4 later executes a second codicil deleting the increase to the 
generation-skipping transfer. Because the provision increasing a 
generation-skipping transfer does not become effective, it is not 
considered an amendment to a will in existence on October 22, 1986.

    (B) Facts applicable to Examples 6 through 9. T created a trust on 
September 30, 1985, in which T retained the power to revoke the 
transfer at any time prior to T's death. The trust provided that, upon 
the death of T, the income was to be paid to T's spouse, W, for life 
and then to A, B, and C, the children of T's sibling, S, in equal 
shares for life, with one-third of the principal to be distributed per 
stirpes to each child's surviving issue upon the death of the child. 
The trustee has the power to make discretionary distributions of trust 
principal to T's sibling, S.

    Example 6. Amendment that affects only a person who is not a 
skip person. A became disabled, and T modified the trust on December 
1, 1986, to increase A's share of the income. Since the amendment 
does not result in the creation of, or increase in the amount of, a 
generation-skipping transfer, 

[[Page 66909]]
transfers pursuant to the trust are not subject to chapter 13.
    Example 7. Amendment increasing skip person's share. Assume that 
A, B, and C are the grandchildren of S rather than the children (and 
thus are skip persons as defined in section 2613). T's amendment of 
the trust increasing A's share of the income subjects the trust to 
the provisions of chapter 13 because the amendment increases the 
amount of the generation-skipping transfers to be made to A.
    Example 8. Amendment that adds a skip person. Assume that T 
amends the trust to add T's grandchild, D, as an income beneficiary. 
The trust will be subject to the provisions of chapter 13 because 
the amendment creates a generation-skipping transfer.
    Example 9. Refund of tax paid during interim period when effect 
of amendment is not determinable. Assume that T amends the trust to 
provide that the issue of S are to take a one-fourth share of the 
principal per stirpes upon S's death. Because the distribution to be 
made upon S's death may involve skip persons, the amendment is 
considered an amendment that creates or increases the amount of a 
generation-skipping transfer until a determination can be made. 
Accordingly, any distributions from (or terminations of interests 
in) such trust are subject to chapter 13 until it is determined that 
no skip person has been added to the trust. At that time, a claim 
for refund may be filed within the period set forth in section 6511 
with respect to any generation-skipping transfer tax that was paid.

    (3) Transition rule in the case of mental incompetency--(i) In 
general. If an individual was under a mental disability to change the 
disposition of his or her property continuously from October 22, 1986, 
until the date of his or her death, the provisions of chapter 13 do not 
apply to any generation-skipping transfer-(A) Under a trust (as defined 
in section 2652(b)) to the extent such trust consists of property, or 
the proceeds of property, the value of which was included in the gross 
estate of the individual (other than property transferred by or on 
behalf of the individual during the individual's life after October 22, 
1986); or
    (B) Which is a direct skip (other than a direct skip from a trust) 
that occurs by reason of the death of the individual.
    (ii) Mental disability defined. For purposes of this paragraph 
(b)(2), the term mental disability means mental incompetence to execute 
an instrument governing the disposition of the individual's property, 
whether or not there was an adjudication of incompetence and regardless 
of whether there has been an appointment of a guardian, fiduciary, or 
other person charged with either the care of the individual or the care 
of the individual's property.
    (iii) Decedent who has not been adjudged mentally incompetent. If 
there has not been a court adjudication that the decedent was mentally 
incompetent on or before October 22, 1986, the executor must file, with 
Form 706, either--
    (A) A certification from a qualified physician stating that the 
decedent was--
    (1) mentally incompetent at all times on and after October 22, 
1986; and
    (2) did not regain competence to modify or revoke the terms of the 
trust or will prior to his or her death; or
    (B) Sufficient other evidence demonstrating that the decedent was 
mentally incompetent at all times on and after October 22, 1986, as 
well as a statement explaining why no certification is available from a 
physician; and
    (C) Any judgment or decree relating to the decedent's incompetency 
that was made after October 22, 1986. Such items will be considered 
relevant, but not determinative, in establishing the decedent's state 
of competency.
    (iv) Decedent who has been adjudged mentally incompetent. If the 
decedent has been adjudged mentally incompetent on or before October 
22, 1986, a copy of the judgment or decree, and any modification 
thereof, must be filed with the Form 706.
    (v) Rule applies even if another person has power to change trust 
terms. In the case of a transfer from a trust, this paragraph (b)(3) 
applies even though a person charged with the care of the decedent or 
the decedent's property has the power to revoke or modify the terms of 
the trust, provided that the power is not exercised after October 22, 
1986, in a manner that creates, or increases the amount of, a 
generation-skipping transfer. See paragraph (b)(2)(iv) of this section 
for rules concerning amendments that create or increase the amount of a 
generation-skipping transfer.
    (vi) Example. The following example illustrates the application of 
paragraph (b)(3)(v) of this section:

    Example. T was mentally incompetent on October 22, 1986, and 
remained so until death in 1993. Prior to becoming incompetent, T 
created a revocable generation-skipping trust that was includible in 
T's gross estate. Prior to October 22, 1986, the appropriate court 
issued an order under which P, who was thereby charged with the care 
of T's property, had the power to modify or revoke the revocable 
trust. Although P exercised the power after October 22, 1986, and 
while T was incompetent, the power was not exercised in a manner 
that created, or increased the amount of, a generation-skipping 
transfer. Thus, the existence and exercise of P's power did not 
cause the trust to lose its exempt status under paragraph (b)(3) of 
this section. The result would be the same if the court order was 
issued after October 22, 1986.

    (4) Exceptions to additions rule--(i) In general. Any addition to a 
trust made pursuant to an instrument or arrangement covered by the 
transition rules in paragraph (b) (2) or (3) of this section is not 
treated as an addition for purposes of this section. Moreover, any 
property transferred inter vivos to a trust is not treated as an 
addition if the same property would have been added to the trust 
pursuant to an instrument covered by the transition rules in paragraph 
(b) (2) or (3) of this section.
    (ii) Examples. The following examples illustrate the application of 
paragraph (b)(4)(i) of this section:

    Example 1. Addition pursuant to terms of exempt instrument. On 
December 31, 1980, T created an irrevocable trust having a principal 
of $100,000. Under the terms of the trust, the principal was to be 
held for the benefit of T's grandchild, GC. Pursuant to the terms of 
T's will, a document entitled to relief under the transition rule of 
paragraph (b)(2) of this section, the residue of the estate was paid 
to the trust. Because the addition to the trust was paid pursuant to 
the terms of an instrument (T's will) that is not subject to the 
provisions of chapter 13 because of paragraph (b)(2) of this 
section, the payment to the trust is not considered an addition to 
the principal of the trust. Thus, distributions to or for the 
benefit of GC, are not subject to the provisions of chapter 13.
    Example 2. Property transferred inter vivos that would have been 
transferred to the same trust by the transferor's will. T is the 
grantor of a trust that was irrevocable on September 25, 1985. T's 
will, which was executed before October 22, 1986, and not amended 
thereafter, provides that, upon T's death, the entire estate will 
pour over into T's trust. On October 1, 1985, T transfers $100,000 
to the trust. While T's will otherwise qualifies for relief under 
the transition rule in paragraph (b)(2) of this section, the 
transition rule is not applicable unless T dies prior to January 1, 
1987. Thus, if T dies after December 31, 1986, the transfer is 
treated as an addition to the trust for purposes of any distribution 
made from the trust after the transfer to the trust on October 1, 
1985. If T dies before January 1, 1987, the entire trust (as well as 
any distributions from or terminations of interests in the trust 
prior to T's death) is exempt, under paragraph (b)(2) of this 
section, from chapter 13 because the $100,000 would have been added 
to the trust under a will that would have qualified under paragraph 
(b)(2) of this section. In either case, for any generation-skipping 
transfers made after the transfer to the trust on October 1, 1985, 
but before T's death, the $100,000 is treated as an addition to the 
trust and a proportionate amount of the trust is subject to chapter 
13.
    Example 3. Pour over to a revocable trust. T and S are the 
settlors of separate revocable trusts with equal values. Both trusts 
were established for the benefit of skip persons (as 

[[Page 66910]]
defined in section 2613). S dies on December 1, 1985, and under the 
provisions of S's trust, the principal pours over into T's trust. If 
T dies before January 1, 1987, the entire trust is excluded under 
paragraph (b)(2) of this section from the operation of chapter 13. 
If T dies after December 31, 1986, the entire trust is subject to 
the generation-skipping transfer tax provisions because T's trust is 
not a trust described in paragraph (b)(1) or (2) of this section. In 
the latter case, the fact that S died before January 1, 1987, is 
irrelevant because the principal of S's trust was added to a trust 
that never qualified under the transition rules of paragraph (b)(1) 
or (2) of this section.
    Example 4. Pour over to exempt trust. Assume the same facts as 
in Example 3, except upon the death of S on December 1, 1985, S's 
trust continues as an irrevocable trust and that the principal of 
T's trust is to be paid over upon T's death to S's trust. Again, if 
T dies before January 1, 1987, S's entire trust falls within the 
provisions of paragraph (b)(2) of this section. However, if T dies 
after December 31, 1986, the pour-over is considered an addition to 
the trust. Therefore, S's trust is not a trust excluded under 
paragraph (b)(2) of this section because an addition is made to the 
trust.
    Example 5. Lapse of a general power of appointment. S, the 
spouse of the settlor of an irrevocable trust that was created in 
1980, had, on September 25, 1985, a general power of appointment 
over the trust assets. The trust provides that should S fail to 
exercise the power of appointment the property is to remain in the 
trust. On October 21, 1986, S executed a will under which S failed 
to exercise the power of appointment. If S dies before January 1, 
1987, without having exercised the power in a manner which results 
in the creation of, or increase in the amount of, a generation-
skipping transfer (or amended the will in a manner that results in 
the creation of, or increase in the amount of, a generation-skipping 
transfer), transfers pursuant to the trust or the will are not 
subject to chapter 13 because the trust is an irrevocable trust and 
the will qualifies under paragraph (b)(2) of this section.
    Example 6. Lapse of general power of appointment held by 
intestate decedent. Assume the same facts as in Example 5, except on 
October 22, 1986, S did not have a will and that S dies after that 
date. Upon S's death, or upon the prior exercise or release of the 
power, the value of the entire trust is treated as having been 
distributed to S, and S is treated as having made an addition to the 
trust in the amount of the entire principal. Any distribution or 
termination pursuant to the trust occurring after S's death is 
subject to chapter 13. It is immaterial whether S's death occurs 
before January 1, 1987, since paragraph (b)(2) of this section is 
only applicable where a will or revocable trust was executed before 
October 22, 1986.

    (c) Additional effective dates. Except as otherwise provided, the 
regulations under Secs. 26.2611-1, 26.2612-1, 26.2613-1, 26.2632-1, 
26.2641-1, 26.2642-1, 26.2642-2, 26.2642-3, 26.2642-4, 26.2642-5, 
26.2652-1, 26.2652-2, 26.2653-1, 26.2654-1, 26.2663-1, and 26.2663-2 
are effective with respect to generation-skipping transfers as defined 
in Sec. 26.2611-1 made on or after [December 27, 1995]. However, 
taxpayers may, at their option, rely on these regulations in the case 
of generation-skipping transfers made, and trusts that became 
irrevocable, after December 23, 1992, and before December 27, 1995.


Sec. 26.2611-1  Generation-skipping transfer defined.

    A generation-skipping transfer (GST) is an event that is either a 
direct skip, a taxable distribution, or a taxable termination. See 
Sec. 26.2612-1 for the definition of these terms. The determination as 
to whether an event is a GST is made by reference to the most recent 
transfer subject to the estate or gift tax. See Sec. 26.2652-1(a)(2) 
for determining whether a transfer is subject to Federal estate or gift 
tax.


Sec. 26.2612-1   Definitions.

    (a) Direct skip--(1) In general. A direct skip is a transfer to a 
skip person that is subject to Federal estate or gift tax. If property 
is transferred to a trust, the transfer is a direct skip only if the 
trust is a skip person. Only one direct skip occurs when a single 
transfer of property skips two or more generations. See paragraph (d) 
of this section for the definition of skip person. See Sec. 26.2652-
1(b) for the definition of trust. See Sec. 26.2632-1(c)(4) for the time 
that a direct skip occurs if the transferred property is subject to an 
estate tax inclusion period.
    (2) Special rule for certain lineal descendants--(i) In general. 
Solely for the purpose of determining whether a transfer to or for the 
benefit of a lineal descendant of the transferor, the transferor's 
spouse, or a former spouse of the transferor is a direct skip, the 
generation assignment of the descendant is determined by disregarding 
the generation of a predeceased individual who was both an ancestor of 
the descendant and a lineal descendant of the transferor, the 
transferor's spouse, or a former spouse of the transferor (a 
predeceased child). If a transfer to a trust would be a direct skip but 
for this paragraph, any generation assignment determined under this 
paragraph continues to apply in determining whether any subsequent 
distribution from (or termination of an interest in) the portion of the 
trust attributable to that transfer is a GST. A living descendant who 
dies no later than 90 days after the subject transfer is treated as 
having predeceased the transferor to the extent that either the 
governing instrument or applicable local law provides that such 
individual shall be treated as predeceasing the transferor. Except as 
provided in this paragraph (a)(2), a living descendant is not treated 
as a predeceased child solely by reason of applicable local law; e.g., 
an individual is not treated as a predeceased child solely because 
state law treats an individual executing a disclaimer as having 
predeceased the transferor of the disclaimed property. See 
Sec. 26.2652-1(a)(1) for the definition of transferor. See paragraph 
(e) of this section for the definition of interest in trust.
    (ii) Special rule. If a transferor makes an addition to an existing 
trust after the death of an individual described in paragraph (a)(2)(i) 
of this section (so that the transferor would be assigned to a lower 
generation by reason of that death), the additional property is treated 
as being held in a separate trust for purposes of chapter 13 and the 
provisions of Sec. 26.2654-1(a)(2) apply as if the portions of the 
single trust had separate transferors. Subsequent additions are treated 
as additions to the appropriate portion of the single trust.
    (b) Taxable termination--(1) In general. Except as otherwise 
provided in this paragraph (b), a taxable termination is a termination 
(occurring for any reason) of an interest in trust unless--
    (i) A transfer subject to Federal estate or gift tax occurs with 
respect to the property held in the trust at the time of the 
termination (i.e., a new transferor is determined with respect to the 
property);
    (ii) Immediately after the termination, a person who is not a skip 
person has an interest in the trust; or
    (iii) At no time after the termination may a distribution, other 
than a distribution the probability of which occurring is so remote as 
to be negligible (including a distribution at the termination of the 
trust) be made from the trust to a skip person. For this purpose, the 
probability that a distribution will occur is so remote as to be 
negligible only if it can be ascertained by actuarial standards that 
there is less than a 5 percent probability that the distribution will 
occur.
    (2) Partial termination. If a distribution of a portion of trust 
property is made to a skip person by reason of a termination occurring 
on the death of a lineal descendant of the transferor, the termination 
is a taxable termination with respect to the distributed property.
    (3) Simultaneous terminations. A simultaneous termination of two or 


[[Page 66911]]
more interests creates only one taxable termination.
    (c) Taxable distribution--(1) In general. A taxable distribution is 
a distribution of income or principal from a trust to a skip person 
unless the distribution is a taxable termination or a direct skip. If 
any portion of GST tax (including penalties and interest thereon) 
imposed on a distributee is paid from the distributing trust, the 
payment is an additional taxable distribution to the distributee. For 
purposes of chapter 13, the additional distribution is treated as 
having been made on the last day of the calendar year in which the 
original taxable distribution is made. If Federal estate or gift tax is 
imposed on any individual with respect to an interest in property held 
by a trust, the interest in property is treated as having been 
distributed to the individual to the extent that the value of the 
interest is subject to Federal estate or gift tax. See Sec. 26.2652-
1(a)(6) Example 5, regarding the treatment of the lapse of a power of 
appointment as a transfer to a trust.
    (2) Look-through rule not to apply. Solely for purposes of 
determining whether any transfer from a trust to another trust is a 
taxable distribution, the rules of section 2651(e)(2) do not apply. If 
the transferring trust and the recipient trust have the same 
transferor, see Sec. 26.2642-4(a) (1) and (2) for rules for recomputing 
the applicable fraction of the recipient trust.
    (d) Skip person. A skip person is--
    (1) An individual assigned to a generation more than one generation 
below that of the transferor (determined under the rules of section 
2651); or
    (2) A trust if--
    (i) All interests in the trust are held by skip persons; or
    (ii) No person holds an interest in the trust and no distributions, 
other than a distribution the probability of which occurring is so 
remote as to be negligible (including distributions at the termination 
of the trust), may be made after the transfer to a person other than a 
skip person. For this purpose, the probability that a distribution will 
occur is so remote as to be negligible only if it can be ascertained by 
actuarial standards that there is less than a 5 percent probability 
that the distribution will occur.
    (e) Interest in trust--(1) In general. An interest in trust is an 
interest in property held in trust as defined in section 2652(c) and 
these regulations. An interest in trust exists if a person--
    (i) Has a present right to receive trust principal or income;
    (ii) Is a permissible current recipient of trust principal or 
income and is not described in section 2055(a); or
    (iii) Is described in section 2055(a) and the trust is a charitable 
remainder annuity trust or unitrust (as defined in section 664(d)) or a 
pooled income fund (as defined in section 642(c)(5)).
    (2) Exceptions--(i) Support obligations. In general, an individual 
has a present right to receive trust income or principal if trust 
income or principal may be used to satisfy the individual's support 
obligations. However, an individual does not have an interest in a 
trust merely because a support obligation of that individual may be 
satisfied by a distribution that is either within the discretion of a 
fiduciary or pursuant to provisions of local law substantially 
equivalent to the Uniform Gifts (Transfers) to Minors Act.
    (ii) Certain interests disregarded. An interest which is used 
primarily to postpone or avoid the GST tax is disregarded for purposes 
of chapter 13. An interest is considered as used primarily to postpone 
or avoid the GST tax if a significant purpose for the creation of the 
interest is to postpone or avoid the tax.
    (3) Disclaimers. An interest does not exist to the extent it is 
disclaimed pursuant to a disclaimer that constitutes a qualified 
disclaimer under section 2518.
    (f) Examples. The following examples illustrate the provisions of 
this section. Unless stated otherwise, paragraph (a)(2) of this 
section, which assigns descendants to a higher generation when there is 
a predeceased ancestor, does not apply.

    Example 1. Direct skip. T gratuitously conveys Blackacre to T's 
grandchild. Because the transfer is a transfer to a skip person of 
property subject to Federal gift tax, it is a direct skip.
    Example 2. Direct skip of more than one generation. T 
gratuitously conveys Blackacre to T's great-grandchild. The transfer 
is a direct skip. Only one GST tax is imposed on the direct skip 
although two generations are skipped by the transfer.
    Example 3. Withdrawal power in trust. T transfers $50,000 to a 
new trust providing that trust income is to be paid to T's child, C, 
for life and, on C's death, the trust principal is to be paid to T's 
descendants. Under the terms of the trust, T grants four 
grandchildren the right to withdraw $10,000 from the trust for a 60 
day period following the transfer. Since C, who is not a skip 
person, has an interest in the trust, the trust is not a skip 
person. T's transfer to the trust is not a direct skip.
    Example 4. Taxable termination. T establishes an irrevocable 
trust under which the income is to be paid to T's child, C, for 
life. On the death of C, the trust principal is to be paid to T's 
grandchild, GC. Since C has an interest in the trust, the trust is 
not a skip person and the transfer to the trust is not a direct 
skip. If C dies survived by GC, a taxable termination occurs at C's 
death because C's interest in the trust terminates and thereafter 
the trust property is held by a skip person who occupies a lower 
generation than C.
    Example 5. Direct skip of property held in trust. T establishes 
a testamentary trust under which the income is to be paid to T's 
surviving spouse, S, for life and the remainder is to be paid to a 
grandchild of T and S. T's executor elects to treat the trust as 
qualified terminable interest property under section 2056(b)(7). The 
transfer to the trust is not a direct skip because S, a person who 
is not a skip person, holds a present right to receive income from 
the trust. Upon S's death, the trust property is included in S's 
gross estate under section 2044 and passes directly to a skip 
person. The GST occurring at that time is a direct skip because it 
is a transfer subject to chapter 11. The fact that the interest 
created by T is terminated at S's death is immaterial because S 
becomes the transferor at the time of the transfer subject to 
chapter 11.
    Example 6. Predeceased ancestor exception. T establishes an 
irrevocable trust providing that trust income is to be paid to T's 
grandchild, GC, for 5 years. At the end of the 5-year period, the 
trust is to terminate and the principal is to be distributed to GC. 
T's child, C, a parent of GC, is deceased at the time T establishes 
the trust. Therefore, GC is treated as a child of T rather than as a 
grandchild. As a result, GC is not a skip person, and the initial 
transfer to the trust is not a direct skip. Similarly, distributions 
to GC during the term of the trust and at the termination of the 
trust will not be GSTs.
    Example 7. Predeceased ancestor exception not applicable. The 
facts are the same as in Example 6, except the trust income is to be 
paid to T's spouse, S, during the first two years of the trust. 
Since S has an interest in the trust, the trust is not a skip person 
and the transfer by T is not a direct skip. Since the transfer is 
not a direct skip, the predeceased ancestor rule does not apply and 
GC is not treated as the child of T. A taxable termination occurs at 
the expiration of S's interest.
    Example 8. Taxable termination. T establishes an irrevocable 
trust for the benefit of T's child, C, T's grandchild, GC, and T's 
great-grandchild, GGC. Under the terms of the trust, income and 
principal may be distributed to any or all of the living 
beneficiaries at the discretion of the trustee. Upon the death of 
the second beneficiary to die, the trust principal is to be paid to 
the survivor. C dies first. A taxable termination occurs at that 
time because, immediately after C's interest terminates, all 
interests in the trust are held by skip persons (GC and GGC).
    Example 9. Taxable termination resulting from distribution. The 
facts are the same as in Example 8, except twenty years after C's 
death the trustee exercises its discretionary power and distributes 
the entire principal to GGC. The distribution results in a taxable 
termination because GC's interest in the trust terminates as a 
result of the distribution of 

[[Page 66912]]
the entire trust property to GGC, a skip person. The result would be 
the same if the trustee retained sufficient funds to pay the GST tax 
due by reason of the taxable termination, as well as any expenses of 
winding up the trust.
    Example 10. Simultaneous termination of interests of more than 
one beneficiary. T establishes an irrevocable trust for the benefit 
of T's child, C, T's grandchild, GC, and T's great-grandchild, GGC. 
Under the terms of the trust, income and principal may be 
distributed to any or all of the living beneficiaries at the 
discretion of the trustee. Upon the death of C, the trust property 
is to be distributed to GGC if then living. If C is survived by both 
GC and GGC, both C's and GC's interests in the trust will terminate 
on C's death. However, because both interests will terminate at the 
same time and as a result of one event, only one taxable termination 
occurs.
    Example 11. Partial taxable termination. T creates an 
irrevocable trust providing that trust income is to be paid to T's 
children, A and B, in such proportions as the trustee determines for 
their joint lives. On the death of the first child to die, one-half 
of the trust principal is to be paid to T's then living 
grandchildren. The balance of the trust principal is to be paid to 
T's grandchildren on the death of the survivor of A and B. If A 
predeceases B, the distribution occurring on the termination of A's 
interest in the trust is a taxable termination and not a taxable 
distribution. It is a taxable termination because the distribution 
is a distribution of a portion of the trust that occurs as a result 
of the death of A, a lineal descendant of T. It is immaterial that a 
portion of the trust continues and that B, a person other than a 
skip person, thereafter holds an interest in the trust.
    Example 12. Taxable distribution. T establishes an irrevocable 
trust under which the trust income is payable to T's child, C, for 
life. When T's grandchild, GC, attains 35 years of age, GC is to 
receive one-half of the principal. The remaining one-half of the 
principal is to be distributed to GC on C's death. Assume that C 
survives until GC attains age 35. When the trustee distributes one-
half of the principal to GC on GC's 35th birthday, the distribution 
is a taxable distribution because it is a distribution to a skip 
person and is neither a taxable termination nor a direct skip.
    Example 13. Exercise of withdrawal right as taxable 
distribution. The facts are the same as in Example 12, except GC 
holds a continuing right to withdraw trust principal and after one 
year GC withdraws $10,000. The withdrawal by GC is not a taxable 
termination because the withdrawal does not terminate C's interest 
in the trust. The withdrawal by GC is a taxable distribution to GC.
    Example 14. Interest in trust. T establishes an irrevocable 
trust under which the income is to be paid to T's child, C, for 
life. On the death of C, the trust principal is to be paid to T's 
grandchild, GC. Because C has a present right to receive income from 
the trust, C has an interest in the trust. Because GC cannot 
currently receive distributions from the trust, GC does not have an 
interest in the trust.
    Example 15. Support obligation. T establishes an irrevocable 
trust for the benefit of T's grandchild, GC. The trustee has 
discretion to distribute property for GC's support without regard to 
the duty or ability of GC's parent, C, to support GC. Because GC is 
a permissible current recipient of trust property, GC has an 
interest in the trust. C does not have an interest in the trust 
because the potential use of the trust property to satisfy C's 
support obligation is within the discretion of a fiduciary. C would 
be treated as having an interest in the trust if the trustee was 
required to distribute trust property for GC's support.


Sec. 26.2613-1  Skip person.

    For the definition of skip person see Sec. 26.2612-1(d).


Sec. 26.2632-1  Allocation of GST exemption.

    (a) General rule. Except as otherwise provided in this section, an 
individual or the individual's executor may allocate the individual's 
$1 million GST exemption at any time from the date of the transfer 
through the date for filing the individual's Federal estate tax return 
(including any extensions for filing that have been actually granted). 
If no estate tax return is required to be filed, the GST exemption may 
be allocated at any time through the date a Federal estate tax return 
would be due if a return were required to be filed (including any 
extensions actually granted). If property is held in trust, the 
allocation of GST exemption is made to the entire trust rather than to 
specific trust assets. If a transfer is a direct skip to a trust, the 
allocation of GST exemption to the transferred property is also treated 
as an allocation of GST exemption to the trust for purposes of future 
GSTs with respect to the trust by the same transferor.
    (b) Lifetime allocations--(1) Automatic allocation to direct 
skips--(i) In general. If a direct skip occurs during the transferor's 
lifetime, the transferor's GST exemption not previously allocated 
(unused GST exemption) is automatically allocated to the transferred 
property (but not in excess of the fair market value of the property on 
the date of the transfer). The transferor may prevent the automatic 
allocation of GST exemption by describing on a timely-filed United 
States Gift (and Generation-Skipping Transfer) Tax Return (Form 709) 
the transfer and the extent to which the automatic allocation is not to 
apply. In addition, a timely-filed Form 709 accompanied by payment of 
the GST tax (as shown on the return with respect to the direct skip) is 
sufficient to prevent an automatic allocation of GST exemption with 
respect to the transferred property. See paragraph (c)(4) of this 
section for special rules in the case of direct skips treated as 
occurring at the termination of an estate tax inclusion period.
    (ii) Time for filing Form 709. A Form 709 is timely filed if it is 
filed on or before the date required for reporting the transfer if it 
were a taxable gift (i.e., the date prescribed by section 6075(b), 
including any extensions to file actually granted (the due date)). 
Except as provided in paragraph (b)(1)(iii) of this section, the 
automatic allocation of GST exemption (or the election to prevent the 
allocation, if made) is irrevocable after the due date. An automatic 
allocation of GST exemption is effective as of the date of the transfer 
to which it relates. Except as provided above, a Form 709 need not be 
filed to report an automatic allocation.
    (iii) Transitional rule. An election to prevent an automatic 
allocation of GST exemption filed on or before January 26, 1996, 
becomes irrevocable on July 24, 1996.
    (2) Allocation to other transfers--(i) In general. An allocation of 
GST exemption to property transferred during the transferor's lifetime, 
other than in a direct skip, is made on Form 709. The allocation must 
clearly identify the trust to which the allocation is being made, the 
amount of GST exemption allocated to it, and if the allocation is late 
or if an inclusion ratio greater than zero is claimed, the value of the 
trust assets at the effective date of the allocation. See paragraph 
(b)(2)(ii) of this section. The allocation should also state the 
inclusion ratio of the trust after the allocation. Except as otherwise 
provided in this paragraph, an allocation of GST exemption may be made 
by a formula; e.g., the allocation may be expressed in terms of the 
amount necessary to produce an inclusion ratio of zero. However, 
formula allocations made with respect to charitable lead annuity trusts 
are not valid except to the extent they are dependent on values as 
finally determined for Federal estate or gift tax purposes. With 
respect to a timely allocation, an allocation of GST exemption becomes 
irrevocable after the due date of the return. Except as provided in 
Sec. 26.2642-3 (relating to charitable lead annuity trusts), an 
allocation of GST exemption to a trust is void to the extent the amount 
allocated exceeds the amount necessary to obtain an inclusion ratio of 
zero with respect to the trust. See Sec. 26.2642-1 for the definition 
of inclusion ratio. An allocation is also void if the allocation is 
made with respect to a trust that has no GST potential with respect to 
the transferor making the allocation, at the time of the allocation. 
For this purpose, a trust has GST potential even if the 

[[Page 66913]]
possibility of a GST is so remote as to be negligible.
     (ii) Effective date of allocation--(A) In general. (1) Except as 
otherwise provided, an allocation of GST exemption is effective as of 
the date of any transfer as to which the Form 709 on which it is made 
is a timely filed return (a timely allocation). If more than one timely 
allocation is made, the earlier allocation is modified only if the 
later allocation clearly identifies the transfer and the nature and 
extent of the modification. Except as provided in paragraph (d)(1) of 
this section, an allocation to a trust made on a Form 709 filed after 
the due date for reporting a transfer to the trust (a late allocation) 
is effective on the date the Form 709 is filed and is deemed to precede 
in point of time any taxable event occurring on such date. For purposes 
of this paragraph (b)(2)(ii), the Form 709 is deemed filed on the date 
it is postmarked to the Internal Revenue Service Center. See 
Sec. 26.2642-2 regarding the effect of a late allocation in determining 
the inclusion ratio, etc. See paragraph (c)(1) of this section 
regarding allocation of GST exemption to property subject to an estate 
tax inclusion period. If it is unclear whether an allocation of GST 
exemption on a Form 709 is a late or a timely allocation to a trust, 
the allocation is effective in the following order--
    (i) To any transfer to the trust disclosed on the return as to 
which the return is a timely return;
    (ii) As a late allocation; and
    (iii) To any transfer to the trust not disclosed on the return as 
to which the return would be a timely return.
    (2) A late allocation to a trust may be made on a Form 709 that is 
timely filed with respect to another transfer. A late allocation is 
irrevocable when made.
    (B) Amount of allocation. If other transfers exist with respect to 
which GST exemption could be allocated under paragraphs 
(b)(2)(ii)(A)(1) (ii) and (iii), any GST exemption allocated under 
paragraph (b)(2)(ii)(A)(1)(i) of this section is allocated in an amount 
equal to the value of the transferred property as reported on the Form 
709. Thus, if the GST exemption allocated on the Form 709 exceeds the 
value of the transfers reported on that return that have generation-
skipping potential, the initial allocation under paragraph 
(b)(2)(ii)(A)(1)(i) of this section is in the amount of the value of 
those transfers as reported on that return. Any remaining amount of GST 
exemption allocated on that return is then allocated pursuant to 
paragraphs (b)(2)(ii)(A)(1) (ii) and (iii) of this section, 
notwithstanding any subsequent upward adjustment in value of the 
transfers reported on the return.
    (iii) Examples. The following examples illustrate the provisions of 
this paragraph (b):

     Example 1. Modification of allocation of GST exemption. T 
transfers $100,000 to an irrevocable generation-skipping trust on 
December 1, 1996. The transfer to the trust is not a direct skip. 
The date prescribed for filing the gift tax return reporting the 
taxable gift is April 15, 1997. On February 10, 1997, T files a Form 
709 allocating $50,000 of GST exemption to the trust. On April 10 of 
the same year, T files an amended Form 709 allocating $100,000 of 
GST exemption to the trust in a manner that clearly indicates the 
intention to modify and supersede the prior allocation with respect 
to the 1996 transfer. The allocation made on the April 10 return 
supersedes the prior allocation because it is made on a timely-filed 
Form 709 that clearly identifies the trust and the nature and extent 
of the modification of GST exemption allocation. The allocation of 
$100,000 of GST exemption to the trust is effective as of December 
1, 1996. The result would be the same if the amended Form 709 
decreased the amount of the GST exemption allocated to the trust.
    Example 2. Modification of allocation of GST exemption. The 
facts are the same as in Example 1, except on July 10, 1997, T files 
a Form 709 attempting to reduce the earlier allocation. The return 
is not a timely-filed return. The $100,000 GST exemption allocated 
to the trust, as amended on April 10, 1997, remains in effect 
because an allocation, once made, is irrevocable and may not be 
modified after the last date on which a timely-filed Form 709 can be 
filed.
    Example 3. Effective date of late allocation of GST exemption. T 
transfers $100,000 to an irrevocable generation-skipping trust on 
December 1, 1996. The transfer to the trust is not a direct skip. 
The date prescribed for filing the gift tax return reporting the 
taxable gift is April 15, 1997. On December 1, 1997, T files a Form 
709 and allocates $50,000 to the trust. The allocation is effective 
as of December 1, 1997.
    Example 4. Effective date of late allocation of GST exemption. T 
transfers $100,000 to a generation-skipping trust on December 1, 
1996, in a transfer that is not a direct skip. T does not make an 
allocation of GST exemption on a timely-filed Form 709. On July 1, 
1997, the trustee makes a taxable distribution from the trust to T's 
grandchild in the amount of $30,000. Immediately prior to the 
distribution, the value of the trust assets was $150,000. On the 
same date, T allocates GST exemption to the trust in the amount of 
$50,000. The allocation of GST exemption on the date of the transfer 
is treated as preceding in point of time the taxable distribution. 
At the time of the GST, the trust has an inclusion ratio of .6667 (1 
- (50,000/150,000)).
    Example 5. Automatic allocation to split-gift direct skip. On 
May 15, 1996, T transfers $50,000 to a trust in a direct skip. T 
does not file a timely gift tax return electing out of the automatic 
allocation. On April 30, 1998, T and T's spouse, S, file an initial 
gift tax return for 1996 on which they consent, pursuant to section 
2513, to have the gift treated as if one-half had been made by each. 
As a result of the election under section 2513, which is retroactive 
to the date of T's transfer, T and S are each treated as the 
transferor of one-half of the property transferred in the direct 
skip. Thus, $25,000 of T's unused GST exemption and $25,000 of S's 
unused GST exemption is automatically allocated to the trust. Both 
allocations are effective on and after the date that T made the 
transfer.

    (c) Special rules during an estate tax inclusion period--(1) In 
general. An allocation of GST exemption (including an automatic 
allocation) to property subject to an estate tax inclusion period 
(ETIP) that is made prior to termination of the ETIP cannot be revoked, 
but becomes effective no earlier than the date of any termination of 
the ETIP with respect to the trust. Where an allocation has not been 
made prior to the termination of the ETIP, an allocation is effective 
at the termination of the ETIP during the transferor's lifetime if made 
by the due date for filing a Form 709 that would apply to a taxable 
gift occurring at the time the ETIP terminates (timely ETIP return). An 
allocation is effective in the case of the termination of the ETIP on 
the death of the transferor as provided in paragraph (d) of this 
section. If any part of a trust is subject to an ETIP, the entire trust 
is subject to the ETIP. See Sec. 26.2642-1(b)(2) for rules determining 
the inclusion ratio applicable in the case of GSTs during an ETIP.
    (2) Estate tax inclusion period defined--(i) In general. An ETIP is 
the period during which, should death occur, the value of transferred 
property would be includible (other than by reason of section 2035) in 
the gross estate of--
    (A) The transferor; or
    (B) The spouse of the transferor.
    (ii) Exceptions--(A) For purposes of paragraph (c)(2) of this 
section, the value of transferred property is not considered as being 
subject to inclusion in the gross estate of the transferor or the 
spouse of the transferor if the possibility that the property will be 
included is so remote as to be negligible. A possibility is so remote 
as to be negligible if it can be ascertained by actuarial standards 
that there is less than a 5 percent probability that the property will 
be included in the gross estate.
    (B) For purposes of paragraph (c)(2) of this section, the value of 
transferred property is not considered as being subject to inclusion in 
the gross estate of the spouse of the transferor, if the spouse 
possesses with respect to any transfer to the trust, a right to 
withdraw 

[[Page 66914]]
no more than the greater of $5,000 or 5 percent of the trust corpus, 
and such withdrawal right terminates no later than 60 days after the 
transfer to the trust.
    (C) The rules of this paragraph (c)(2) do not apply to qualified 
terminable interest property with respect to which the special election 
under Sec. 26.2652-2 has been made.
    (3) Termination of an ETIP. An ETIP terminates on the first to 
occur of--
    (i) The death of the transferor;
    (ii) The time at which no portion of the property is includible in 
the transferor's gross estate (other than by reason of section 2035) 
or, in the case of an individual who is a transferor solely by reason 
of an election under section 2513, the time at which no portion would 
be includible in the gross estate of the individual's spouse (other 
than by reason of section 2035);
    (iii) The time of a GST, but only with respect to the property 
involved in the GST; or
    (iv) In the case of an ETIP arising by reason of an interest or 
power held by the transferor's spouse under subsection (c)(2)(i)(B) of 
this section, at the first to occur of--
    (A) The death of the spouse; or
    (B) The time at which no portion of the property would be 
includible in the spouse's gross estate (other than by reason of 
section 2035).
    (4) Treatment of direct skips. If property transferred to a skip 
person is subject to an ETIP, the direct skip is treated as occurring 
on the termination of the ETIP.
    (5) Examples. The following examples illustrate the rules of this 
section as they apply to the termination of an ETIP during the lifetime 
of the transferor. In each example assume that T transfers $100,000 to 
an irrevocable trust:

    Example 1. Allocation of GST exemption during ETIP. The trust 
instrument provides that trust income is to be paid to T for 9 years 
or until T's prior death. The trust principal is to be paid to T's 
grandchild on the termination of T's income interest. If T dies 
within the 9-year period, the value of the trust principal is 
includible in T's gross estate under section 2036(a). Thus, the 
trust is subject to an ETIP. T files a timely Form 709 reporting the 
transfer and allocating $100,000 of GST exemption to the trust. The 
allocation of GST exemption to the trust is not effective until the 
termination of the ETIP.
    Example 2. Effect of prior allocation on termination of ETIP. 
The facts are the same as in Example 1, except the trustee has the 
power to invade trust principal on behalf of T's grandchild, GC, 
during the term of T's income interest. In year 4, when the value of 
the trust is $200,000, the trustee distributes $15,000 to GC. The 
distribution is a taxable distribution. The ETIP with respect to the 
property distributed to GC terminates at the time of the taxable 
distribution. See paragraph (c)(3)(iii) of this section. Solely for 
purposes of determining the trust's inclusion ratio with respect to 
the taxable distribution, the prior $100,000 allocation of GST 
exemption (as well as any additional allocation made on a timely 
ETIP return) is effective immediately prior to the taxable 
distribution. See Sec. 26.2642-1(b)(2). The trust's inclusion ratio 
with respect to the taxable distribution is therefore .50 
(1-(100,000/200,000)).
    Example 3. Split-gift transfers subject to ETIP. The trust 
instrument provides that trust income is to be paid to T for 9 years 
or until T's prior death. The trust principal is to be paid to T's 
grandchild on the termination of T's income interest. T files a 
timely Form 709 reporting the transfer. T's spouse, S, consents to 
have the gift treated as made one-half by S under section 2513. 
Because S is treated as transferring one-half of the property to T's 
grandchild, S becomes the transferor of one-half of the trust for 
purposes of chapter 13. Because the value of the trust would be 
includible in T's gross estate if T died immediately after the 
transfer, S's transfer is subject to an ETIP. If S should die prior 
to the termination of the trust, S's executor may allocate S's GST 
exemption to the trust, but only to the portion of the trust for 
which S is treated as the transferor. However, the allocation does 
not become effective until the earlier of the expiration of T's 
income interest or T's death.
    Example 4. Transfer of retained interest as ETIP termination. 
The trust instrument provides that trust income is to be paid to T 
for 9 years or until T's prior death. The trust principal is to be 
paid to T's grandchild on the termination of T's income interest. 
Four years after the initial transfer, T transfers the income 
interest to T's sibling. The ETIP with respect to the trust 
terminates on T's transfer of the income interest because, after the 
transfer, the trust property would not be includible in T's gross 
estate (other than by reason of section 2035) if T died at that 
time.

    (d) Allocations after the transferor's death--(1) Allocation by 
executor. Except as otherwise provided in this paragraph (d), an 
allocation of a decedent's unused GST exemption by the executor of the 
decedent's estate is made on the appropriate United States Estate (and 
Generation-Skipping Transfer) Tax Return (Form 706 or Form 706NA) filed 
on or before the date prescribed for filing the return by section 
6075(a) (including any extensions actually granted (the due date)). An 
allocation of GST exemption with respect to property included in the 
gross estate of a decedent is effective as of the date of death. A 
timely allocation of GST exemption by an executor with respect to a 
lifetime transfer of property that is not included in the transferor's 
gross estate is made on a Form 709. A late allocation of GST exemption 
by an executor, other than an allocation that is deemed to be made 
under section 2632(b)(1), with respect to a lifetime transfer of 
property is made on Form 706 or Form 706NA and is effective as of the 
date the allocation is filed. An allocation of GST exemption to a trust 
(whether or not funded at the time the Form 706 or Form 706NA is filed) 
is effective if the notice of allocation clearly identifies the trust 
and the amount of the decedent's GST exemption allocated to the trust. 
An executor may allocate the decedent's GST exemption by use of a 
formula. For purposes of this section, an allocation is void if the 
allocation is made for a trust that has no GST potential with respect 
to the transferor for whom the allocation is being made, as of the date 
of the transferor's death. For this purpose, a trust has GST potential 
even if the possibility of a GST is so remote as to be negligible.
    (2) Automatic allocation after death. A decedent's unused GST 
exemption is automatically allocated on the due date for filing Form 
706 or Form 706NA to the extent not otherwise allocated by the 
decedent's executor on or before that date. The automatic allocation 
occurs whether or not a return is actually required to be filed. Unused 
GST exemption is allocated pro rata (subject to the rules of 
Sec. 26.2642-2(b)), on the basis of the value of the property as 
finally determined for purposes of chapter 11 (chapter 11 value), first 
to direct skips treated as occurring at the transferor's death. The 
balance, if any, of unused GST exemption is allocated pro rata (subject 
to the rules of Sec. 26.2642-2(b)) on the basis of the chapter 11 value 
of the nonexempt portion of the trust property (or in the case of 
trusts that are not included in the gross estate, on the basis of the 
date of death value of the trust) to trusts with respect to which a 
taxable termination may occur or from which a taxable distribution may 
be made. The automatic allocation of GST exemption is irrevocable, and 
an allocation made by the executor after the automatic allocation is 
made is ineffective. No automatic allocation of GST exemption is made 
to a trust that will have a new transferor with respect to the entire 
trust prior to the occurrence of any GST with respect to the trust. In 
addition, no automatic allocation of GST exemption is made to a trust 
if, during the nine month period ending immediately after the death of 
the transferor--
    (i) No GST has occurred with respect to the trust; and
    (ii) At the end of such period no future GST can occur with respect 
to the trust.

[[Page 66915]]



Sec. 26.2641-1  Applicable rate of tax.

    The rate of tax applicable to any GST (applicable rate) is 
determined by multiplying the maximum Federal estate tax rate in effect 
at the time of the GST by the inclusion ratio (as defined in 
Sec. 26.2642-1). For this purpose, the maximum Federal estate tax rate 
is the maximum rate set forth under section 2001(c) (without regard to 
section 2001(c)(2)).


Sec. 26.2642-1  Inclusion ratio.

    (a) In general. Except as otherwise provided in this section, the 
inclusion ratio is determined by subtracting the applicable fraction 
(rounded to the nearest one-thousandth (.001)) from 1. In rounding the 
applicable fraction to the nearest one-thousandth, any amount that is 
midway between one one-thousandth and another one-thousandth is rounded 
up to the higher of those two amounts.
    (b) Numerator of applicable fraction--(1) In general. Except as 
otherwise provided in this paragraph (b), and in Secs. 26.2642-3 
(providing a special rule for charitable lead annuity trusts) and 
26.2642-4 (providing rules for the redetermination of the applicable 
fraction), the numerator of the applicable fraction is the amount of 
GST exemption allocated to the trust (or to the transferred property in 
the case of a direct skip not in trust).
    (2) GSTs occurring during an ETIP--(i) In general. For purposes of 
determining the inclusion ratio with respect to a taxable termination 
or a taxable distribution that occurs during an ETIP, the numerator of 
the applicable fraction is the sum of--
    (A) The GST exemption previously allocated to the trust (including 
any allocation made to the trust prior to any taxable termination or 
distribution) reduced (but not below zero) by the nontax amount of any 
prior GSTs with respect to the trust; and
    (B) Any GST exemption allocated to the trust on a timely ETIP 
return filed after the termination of the ETIP. See Sec. 26.2632-
1(c)(5) Example 2.
    (ii) Nontax amount of a prior GST. (1) The nontax amount of a prior 
GST with respect to the trust is the amount of the GST multiplied by 
the applicable fraction attributable to the trust at the time of the 
prior GST.
    (2) For rules regarding the allocation of GST exemption to property 
during an ETIP, see Sec. 26.2632-1(c).
    (c) Denominator of applicable fraction--(1) In general. Except as 
otherwise provided in this paragraph (c) and in Secs. 26.2642-3 and 
26.2642-4, the denominator of the applicable fraction is the value of 
the property transferred to the trust (or transferred in a direct skip 
not in trust) (as determined under Sec. 26.2642-2) reduced by the sum 
of--
    (i) Any Federal estate tax and any State death tax incurred by 
reason of the transfer that is chargeable to the trust and is actually 
recovered from the trust;
    (ii) The amount of any charitable deduction allowed under section 
2055, 2106, or 2522 with respect to the transfer; and
    (iii) In the case of a direct skip, the value of the portion of the 
transfer that is a nontaxable gift. See paragraph (c)(3) of this 
section for the definition of nontaxable gift.
    (2) Zero denominator. If the denominator of the applicable fraction 
is zero, the inclusion ratio is zero.
    (3) Nontaxable gifts. Generally, for purposes of chapter 13, a 
transfer is a nontaxable gift to the extent the transfer is excluded 
from taxable gifts by reason of section 2503(b) (after application of 
section 2513) or section 2503(e). However, a transfer to a trust for 
the benefit of an individual is not a nontaxable gift for purposes of 
this section unless--
    (i) Trust principal or income may, during the individual's 
lifetime, be distributed only to or for the benefit of the individual; 
and
    (ii) The assets of the trust will be includible in the gross estate 
of the individual if the individual dies before the trust terminates.
    (d) Examples. The following examples illustrate the provisions of 
this section. See Sec. 26.2652-2(d) Examples 2 and 3 for illustrations 
of the computation of the inclusion ratio where the special (reverse 
QTIP) election may be applicable.

    Example 1. Computation of the inclusion ratio. T transfers 
$100,000 to a newly-created irrevocable trust providing that income 
is to be accumulated for 10 years. At the end of 10 years, the 
accumulated income is to be distributed to T's child, C, and the 
trust principal is to be paid to T's grandchild. T allocates $40,000 
of T's GST exemption to the trust on a timely-filed gift tax return. 
The applicable fraction with respect to the trust is .40 ($40,000 
(the amount of GST exemption allocated to the trust) over $100,000 
(the value of the property transferred to the trust)). The inclusion 
ratio is .60 (1 - .40). If the maximum Federal estate tax rate is 55 
percent at the time of a GST, the rate of tax applicable to the 
transfer (applicable rate) will be .333 (55 percent (the maximum 
estate tax rate)  x  .60 (the inclusion ratio)).
    Example 2. Gift entirely nontaxable. On December 1, 1996, T 
transfers $10,000 to an irrevocable trust for the benefit of T's 
grandchild, GC. GC possesses a right to withdraw any contributions 
to the trust such that the entire transfer qualifies for the annual 
exclusion under section 2503(b). Under the terms of the trust, the 
income is to be paid to GC for 10 years or until GC's prior death. 
Upon the expiration of GC's income interest, the trust principal is 
payable to GC or GC's estate. The transfer to the trust is a direct 
skip. T made no prior gifts to or for the benefit of GC during 1996. 
The entire $10,000 transfer is a nontaxable transfer. For purposes 
of computing the tax on the direct skip, the denominator of the 
applicable fraction is zero, and thus, the inclusion ratio is zero.
    Example 3. Gift nontaxable in part. T transfers $12,000 to an 
irrevocable trust for the benefit of T's grandchild, GC. Under the 
terms of the trust, the income is to be paid to GC for 10 years or 
until GC's prior death. Upon the expiration of GC's income interest, 
the trust principal is payable to GC or GC's estate. Further, GC has 
the right to withdraw $10,000 of any contribution to the trust such 
that $10,000 of the transfer qualifies for the annual exclusion 
under section 2503(b). The amount of the nontaxable transfer is 
$10,000. Solely for purposes of computing the tax on the direct 
skip, T's transfer is divided into two portions. One portion is 
equal to the amount of the nontaxable transfer ($10,000) and has a 
zero inclusion ratio; the other portion is $2,000 ($12,000 - 
$10,000). With respect to the $2,000 portion, the denominator of the 
applicable fraction is $2,000. Assuming that T has sufficient GST 
exemption available, the numerator of the applicable fraction is 
$2,000 (unless T elects to have the automatic allocation provisions 
not apply). Thus, assuming T does not elect to have the automatic 
allocation not apply, the applicable fraction is one ($2,000/$2,000 
= 1) and the inclusion ratio is zero (1 - 1 = 0).
    Example 4. Gift nontaxable in part. Assume the same facts as in 
Example 3, except T files a timely Form 709 electing that the 
automatic allocation of GST exemption not apply to the $12,000 
transferred in the direct skip. T's transfer is divided into two 
portions, a $10,000 portion with a zero inclusion ratio and a $2,000 
portion with an applicable fraction of zero (0/$2,000 = 0) and an 
inclusion ratio of one (1 - 0 = 1).


Sec. 26.2642-2  Valuation.

    (a) Lifetime transfers--(1) In general. For purposes of determining 
the denominator of the applicable fraction, the value of property 
transferred during life is its fair market value on the effective date 
of the allocation of GST exemption. In the case of a timely allocation 
under Sec. 26.2632-1(b)(2)(ii), the denominator of the applicable 
fraction is the fair market value of the property as finally determined 
for purposes of chapter 12.
    (2) Special rule for late allocations during life. If a transferor 
makes a late allocation of GST exemption to a trust, the value of the 
property transferred to the trust is the fair market value of the trust 
assets determined on the effective date of the allocation of GST 
exemption. Except as otherwise provided in this paragraph (a)(2), if a 
transferor makes a 

[[Page 66916]]
late allocation of GST exemption to a trust, the transferor may, solely 
for purposes of determining the fair market value of the trust assets, 
elect to treat the allocation as having been made on the first day of 
the month during which the late allocation is made (valuation date). An 
election under this paragraph (a)(2) is not effective with respect to a 
life insurance policy or a trust holding a life insurance policy, if 
the insured individual has died. An allocation subject to the election 
contained in this paragraph (a)(2) is not effective until it is 
actually filed with the Internal Revenue Service. The election is made 
by stating on the Form 709 on which the allocation is made--
    (i) That the election is being made;
    (ii) The applicable valuation date; and
    (iii) The fair market value of the trust assets on the valuation 
date.
    (b) Transfers at death--(1) In general. Except as provided in 
paragraphs (b) (2) and (3) of this section, in determining the 
denominator of the applicable fraction, the value of property included 
in the decedent's gross estate is its value for purposes of chapter 11. 
In the case of qualified real property with respect to which the 
election under section 2032A is made, the value of the property is the 
value determined under section 2032A provided the recapture agreement 
described in section 2032A(d)(2) filed with the Internal Revenue 
Service specifically provides for the signatories' consent to the 
imposition of, and personal liability for, additional GST tax in the 
event an additional estate tax is imposed under section 2032A(c). See 
Sec. 26.2642-4(a)(4). If the recapture agreement does not contain these 
provisions, the value of qualified real property as to which the 
election under section 2032A is made is the fair market value of the 
property determined without regard to the provisions of section 2032A.
    (2) Special rule for pecuniary payments--(i) In general. If a 
pecuniary payment is satisfied with cash, the denominator of the 
applicable fraction is the pecuniary amount. If property other than 
cash is used to satisfy a pecuniary payment, the denominator of the 
applicable fraction is the pecuniary amount only if payment must be 
made with property on the basis of the value of the property on--
    (A) The date of distribution; or
    (B) A date other than the date of distribution, but only if the 
pecuniary payment must be satisfied on a basis that fairly reflects net 
appreciation and depreciation (occurring between the valuation date and 
the date of distribution) in all of the assets from which the 
distribution could have been made.
    (ii) Other pecuniary amounts payable in kind. The denominator of 
the applicable fraction with respect to any property used to satisfy 
any other pecuniary payment payable in kind is the date of distribution 
value of the property.
    (3) Special rule for residual transfers after payment of a 
pecuniary payment--(i) In general. Except as otherwise provided in this 
paragraph (b)(3), the denominator of the applicable fraction with 
respect to a residual transfer of property after the satisfaction of a 
pecuniary payment is the estate tax value of the assets available to 
satisfy the pecuniary payment reduced, if the pecuniary payment carries 
appropriate interest (as defined in paragraph (b)(4) of this section), 
by the pecuniary amount. The denominator of the applicable fraction 
with respect to a residual transfer of property after the satisfaction 
of a pecuniary payment that does not carry appropriate interest is the 
estate tax value of the assets available to satisfy the pecuniary 
payment reduced by the present value of the pecuniary payment. For 
purposes of this paragraph (b)(3)(i), the present value of the 
pecuniary payment is determined by using--
    (A) The interest rate applicable under section 7520 at the death of 
the transferor; and
    (B) The period between the date of the transferor's death and the 
date the pecuniary amount is paid.
    (ii) Special rule for residual transfers after pecuniary payments 
payable in kind. The denominator of the applicable fraction with 
respect to any residual transfer after satisfaction of a pecuniary 
payment payable in kind is the date of distribution value of the 
property distributed in satisfaction of the residual transfer, unless 
the pecuniary payment must be satisfied on the basis of the value of 
the property on--
    (A) The date of distribution; or
    (B) A date other than the date of distribution, but only if the 
pecuniary payment must be satisfied on a basis that fairly reflects net 
appreciation and depreciation (occurring between the date of death and 
the date of distribution) in all of the assets from which the 
distribution could have been made.
    (4) Appropriate interest--(i) In general. For purposes of this 
section and Sec. 26.2654-1 (relating to certain trusts treated as 
separate trusts), appropriate interest means that interest must be 
payable from the date of death of the transferor (or from the date 
specified under applicable State law requiring the payment of interest) 
to the date of payment at a rate--
    (A) At least equal to--
    (1) The statutory rate of interest, if any, applicable to pecuniary 
bequests under the law of the State whose law governs the 
administration of the estate or trust; or
    (2) If no such rate is indicated under applicable State law, 80 
percent of the rate that is applicable under section 7520 at the death 
of the transferor; and
    (B) Not in excess of the greater of--
    (1) The statutory rate of interest, if any, applicable to pecuniary 
bequests under the law of the State whose law governs the 
administration of the trust; or
    (2) 120 percent of the rate that is applicable under section 7520 
at the death of the transferor.
    (ii) Pecuniary payments deemed to carry appropriate interest. For 
purposes of this paragraph (b)(4), if a pecuniary payment does not 
carry appropriate interest, the pecuniary payment is considered to 
carry appropriate interest to the extent--
    (A) The entire payment is made or property is irrevocably set aside 
to satisfy the entire pecuniary payment within 15 months of the 
transferor's death; or
    (B) The governing instrument or applicable local law specifically 
requires the executor or trustee to allocate to the pecuniary payment a 
pro rata share of the income earned by the fund from which the 
pecuniary payment is to be made between the date of death of the 
transferor and the date of payment. For purposes of paragraph 
(b)(4)(ii)(A) of this section, property is irrevocably set aside if it 
is segregated and held in a separate account pending distribution.
    (c) Examples. The following examples illustrate the provisions of 
this section:

    Example 1. T transfers $100,000 to a newly-created irrevocable 
trust on December 15, 1996. The trust provides that income is to be 
paid to T's child for 10 years. At the end of the 10-year period, 
the trust principal is to be paid to T's grandchild. T does not 
allocate any GST exemption to the trust on the gift tax return 
reporting the transfer. On November 15, 1997, T files a Form 709 
allocating $50,000 of GST exemption to the trust. Because the 
allocation was made on a late filed return, the value of the 
property transferred to the trust is determined on the date the 
allocation is filed (unless an election is made pursuant to 
paragraph (a)(2) of this section to value the trust property as of 
the first day of the month in which the allocation document is filed 
with the Internal Revenue Service). On November 15, 1997, the value 
of the trust property is $150,000. Effective as of November 15, 
1997, the applicable fraction with respect to the trust is .333 
($50,000 (the 

[[Page 66917]]
amount of GST exemption allocated to the trust) over $150,000 (the 
value of the trust principal on the effective date of the GST 
exemption allocation)), and the inclusion ratio is .667 (1.0-.333).
    Example 2. The facts are the same as in Example 1, except the 
value of the trust property is $80,000 on November 15, 1997. The 
applicable fraction is .625 ($50,000 over $80,000) and the inclusion 
ratio is .375 (1.0-.625).
    Example 3. T transfers $100,000 to a newly-created irrevocable 
trust on December 15, 1996. The trust provides that income is to be 
paid to T's child for 10 years. At the end of the 10-year period, 
the trust principal is to be paid to T's grandchild. T does not 
allocate any GST exemption to the trust on the gift tax return 
reporting the transfer. On November 15, 1997, T files a Form 709 
allocating $50,000 of GST exemption to the trust. T elects to value 
the trust principal on the first day of the month in which the 
allocation is made pursuant to the election provided in paragraph 
(a)(2) of this section. Because the late allocation is made in 
November, the value of the trust is determined as of November 1, 
1997.


Sec. 26.2642-3  Special rule for charitable lead annuity trusts.

    (a) In general. In determining the applicable fraction with respect 
to a charitable lead annuity trust--
    (1) The numerator is the adjusted generation-skipping transfer tax 
exemption (adjusted GST exemption); and
    (2) The denominator is the value of all property in the trust 
immediately after the termination of the charitable lead annuity.
    (b) Adjusted GST exemption defined. The adjusted GST exemption is 
the amount of GST exemption allocated to the trust increased by an 
amount equal to the interest that would accrue if an amount equal to 
the allocated GST exemption were invested at the rate used to determine 
the amount of the estate or gift tax charitable deduction, compounded 
annually, for the actual period of the charitable lead annuity. If a 
late allocation is made to a charitable lead annuity trust, the 
adjusted GST exemption is the amount of GST exemption allocated to the 
trust increased by the interest that would accrue if invested at such 
rate for the period beginning on the date of the late allocation and 
extending for the balance of the actual period of the charitable lead 
annuity. The amount of GST exemption allocated to a charitable lead 
annuity trust is not reduced even though it is ultimately determined 
that the allocation of a lesser amount of GST exemption would have 
resulted in an inclusion ratio of zero. For purposes of chapter 13, a 
charitable lead annuity trust is any trust providing an interest in the 
form of a guaranteed annuity described in Sec. 25.2522(c)-3(c)(2)(vi) 
of this chapter for which the transferor is allowed a charitable 
deduction for Federal estate or gift tax purposes.
    (c) Example. The following example illustrates the provisions of 
this section:

    Example. T creates a charitable lead annuity trust for a 10-year 
term with the remainder payable to T's grandchild. T timely 
allocates an amount of GST exemption to the trust which T expects 
will ultimately result in a zero inclusion ratio. However, at the 
end of the charitable lead interest, because the property has not 
appreciated to the extent T anticipated, the numerator of the 
applicable fraction is greater than the denominator. The inclusion 
ratio for the trust is zero. No portion of the GST exemption 
allocated to the trust is restored to T or to T's estate.


Sec. 26.2642-4  Redetermination of applicable fraction.

    (a) In general. The applicable fraction for a trust is redetermined 
whenever additional exemption is allocated to the trust or when certain 
changes occur with respect to the principal of the trust. Except as 
otherwise provided in this paragraph (a), the numerator of the 
redetermined applicable fraction is the sum of the amount of GST 
exemption currently being allocated to the trust (if any) plus the 
value of the nontax portion of the trust, and the denominator of the 
redetermined applicable fraction is the value of the trust principal 
immediately after the event occurs. The nontax portion of a trust is 
determined by multiplying the value of the trust assets, determined 
immediately prior to the event, by the then applicable fraction.
    (1) Multiple transfers to a single trust. If property is added to 
an existing trust, the denominator of the redetermined applicable 
fraction is the value of the trust immediately after the addition 
reduced as provided in Sec. 26.2642-1(c).
    (2) Consolidation of separate trusts. If separate trusts created by 
one transferor are consolidated, a single applicable fraction for the 
consolidated trust is determined. The numerator of the redetermined 
applicable fraction is the sum of the nontax portions of each trust 
immediately prior to the consolidation.
    (3) Property included in transferor's gross estate. If the value of 
property held in a trust created by the transferor, with respect to 
which an allocation was made at a time that the trust was not subject 
to an ETIP, is included in the transferor's gross estate, the 
applicable fraction is redetermined if additional GST exemption is 
allocated to the property. The numerator of the redetermined applicable 
fraction is an amount equal to the nontax portion of the property 
immediately after the death of the transferor increased by the amount 
of GST exemption allocated by the executor of the transferor's estate 
to the trust. If additional GST exemption is not allocated to the 
trust, the applicable fraction immediately before death is not changed, 
if the trust was not subject to an ETIP at the time GST exemption was 
allocated to the trust. The denominator of the applicable fraction is 
reduced to reflect any federal or state, estate or inheritance taxes 
paid from the trust.
    (4) Imposition of recapture tax under section 2032A--(i) If an 
additional estate tax is imposed under section 2032A and if the section 
2032A election was effective (under Sec. 26.2642-2(b)) for purposes of 
the GST tax, the applicable fraction with respect to the property is 
redetermined as of the date of death of the transferor. In making the 
redetermination, any available GST exemption not allocated at the death 
of the transferor (or at a prior recapture event) is automatically 
allocated to the property. The denominator of the applicable fraction 
is the fair market value of the property at the date of the 
transferor's death reduced as provided in Sec. 26.2642-1(c) and further 
reduced by the amount of the additional GST tax actually recovered from 
the trust.
    (ii) The GST tax imposed with respect to any taxable termination, 
taxable distribution, or direct skip occurring prior to the recapture 
event is recomputed based on the applicable fraction as redetermined. 
Any additional GST tax as recomputed is due and payable on the date 
that is six months after the event that causes the imposition of the 
additional estate tax under section 2032A. The additional GST tax is 
remitted with Form 706-A and is reported by attaching a statement to 
Form 706-A showing the computation of the additional GST tax.
    (iii) The applicable fraction, as redetermined under this section, 
is also used in determining any GST tax imposed with respect to GSTs 
occurring after the date of the recapture event.
    (b) Examples. The following examples illustrate the principles of 
this section:

    Example 1. Allocation of additional exemption. T transfers 
$200,000 to an irrevocable trust under which the income is payable 
to T's child, C, for life. Upon the termination of the trust, the 
remainder is payable to T's grandchild, GC. At a time when no ETIP 
exists with respect to the trust property, T makes a timely 
allocation of $100,000 of GST exemption, resulting in an inclusion 
ratio of .50. Subsequently, when the entire trust property is valued 
at $500,000, T allocates an additional $100,000 of T's unused GST 
exemption to the trust. The inclusion ratio of the trust is 
recomputed at that time. The numerator of the applicable fraction is 
$350,000 ($250,000 (the nontax 

[[Page 66918]]
portion as of the date of the allocation) plus $100,000 (the GST 
exemption currently being allocated)). The denominator is $500,000 
(the date of allocation fair market value of the trust). The 
inclusion ratio is .30 (1 - .70).
    Example 2. Multiple transfers to a trust, allocation both timely 
and late. On December 10, 1993, T transfers $10,000 to an 
irrevocable trust that does not satisfy the requirements of section 
2642(c)(2). T makes identical transfers to the trust on December 10, 
1994, 1995, 1996, and on January 15, 1997. Immediately after the 
transfer on January 15, 1997, the value of the trust principal is 
$40,000. On January 14, 1998, when the value of the trust principal 
is $50,000, T allocates $30,000 of GST exemption to the trust. T 
discloses the 1997 transfer on the Form 709 filed on January 14, 
1998. Thus, T's allocation is a timely allocation with respect to 
the transfer in 1997, $10,000 of the allocation is effective as of 
the date of that transfer, and, on and after January 15, 1997, the 
inclusion ratio of the trust is .75 (1 - ($10,000/$40,000)). The 
balance of the allocation is a late allocation with respect to prior 
transfers to the trust and is effective as of January 14, 1998. In 
redetermining the inclusion ratio as of that date, the numerator of 
the redetermined applicable fraction is $32,500 ($12,500 (.25  x  
$50,000), the nontax portion of the trust on January 14, 1998) plus 
$20,000 (the amount of GST exemption allocated late to the trust). 
The denominator of the new applicable fraction is $50,000 (the value 
of the trust principal at the time of the late allocation).
    Example 3. Excess allocation. (i) T creates an irrevocable trust 
for the benefit of T's child and grandchild in 1996 transferring 
$50,000 to the trust on the date of creation. T allocates no GST 
exemption to the trust on the Form 709 reporting the transfer. On 
July 1, 1997 (when the value of the trust property is $60,000), T 
transfers an additional $40,000 to the trust.
    (ii) On April 15, 1998, when the value of the trust is $150,000, 
T files a Form 709 reporting the 1997 transfer and allocating 
$150,000 of GST exemption to the trust. The allocation is a timely 
allocation of $40,000 with respect to the 1997 transfer and is 
effective as of that date. Thus, the applicable fraction for the 
trust as of July 1, 1997 is .40 ($40,000/$100,000 ($40,000 + 
$60,000)).
    (iii) The allocation is also a late allocation of $90,000, the 
amount necessary to attain a zero inclusion ratio on April 15, 1998, 
computed as follows: $60,000 (the nontax portion immediately prior 
to the allocation (.40  x  $150,000)) plus $90,000 (the additional 
allocation necessary to produce a zero inclusion ratio based on a 
denominator of $150,000)/$150,000 equals one and, thus, an inclusion 
ratio of zero. The balance of the allocation, $20,000 ($150,000 less 
the timely allocation of $40,000 less the late allocation of 
$90,000) is void.
    Example 4. Undisclosed transfer. (i) The facts are the same as 
in Example 3, except that on February 1, 1998 (when the value of the 
trust is $150,000), T transfers an additional $50,000 to the trust 
and the value of the entire trust corpus on April 15, 1998 is 
$220,000. The Form 709 filed on April 15, 1998 does not disclose the 
1998 transfer. Under the rule in Sec. 26.2632-1(b)(2)(ii), the 
allocation is effective first as a timely allocation to the 1997 
transfer; second, as a late allocation to the trust as of April 15, 
1998; and, finally as a timely allocation to the February 1, 1998 
transfer. As of April 15, 1998, $55,000, a pro rata portion of the 
trust assets, is considered to be the property transferred to the 
trust on February 1, 1998 (($50,000/$200,000)  x  $220,000). The 
balance of the trust, $165,000, represents prior transfers to the 
trust.
    (ii) As in Example 3, the allocation is a timely allocation as 
to the 1997 transfer (and the applicable fraction as of July 1, 1997 
is .40) and a late allocation as of 1998. The amount of the late 
allocation is $99,000, computed as follows: (.40  x  $165,000 plus 
$99,000)/$165,000 = one.
    (iii) The balance of the allocation, $11,000 ($150,000 less the 
timely allocation of $40,000 less the late allocation of $99,000) is 
a timely allocation as of February 1, 1998. The applicable fraction 
with respect to the trust, as of February 1, 1998, is .355, computed 
as follows: $60,000 (the nontax portion of the trust immediately 
prior to the February 1, 1998 transfer (.40  x  $150,000)) plus 
$11,000 (the amount of the timely allocation to the 1998 transfer)/
$200,000 (the value of the trust on February 1, 1998, after the 
transfer on that date) = $71,000/$200,000 = .355.
    (iv) The applicable fraction with respect to the trust, as of 
April 15, 1998, is .805 computed as follows: $78,100 (the nontax 
portion immediately prior to the allocation (.355  x  $220,000)) 
plus $99,000 (the amount of the late allocation)/ $220,000 = 
$177,100/$220,000 = .805.
    Example 5. Redetermination of inclusion ratio on ETIP 
termination. (i) T transfers $100,000 to an irrevocable trust. The 
trust instrument provides that trust income is to be paid to T for 9 
years or until T's prior death. The trust principal is to be paid to 
T's grandchild, GC, on the termination of T's income interest. The 
trustee has the power to invade trust principal for the benefit of 
GC during the term of T's income interest. The trust is subject to 
an ETIP while T holds the retained income interest. T files a timely 
Form 709 reporting the transfer and allocates $100,000 of GST 
exemption to the trust. In year 4, when the value of the trust is 
$200,000, the trustee distributes $15,000 to GC. The distribution is 
a taxable distribution. Because of the existence of the ETIP, the 
inclusion ratio with respect to the taxable distribution is 
determined immediately prior to the occurrence of the GST. Thus, the 
inclusion ratio applicable to the year 4 GST is .50 (1 - ($100,000/
$200,000 = .50).
    (ii) In year 5, when the value of the trust is again $200,000, 
the trustee distributes another $15,000 to GC. Because the trust is 
still subject to the ETIP in year 5, the inclusion ratio with 
respect to the year 5 GST is again computed immediately prior to the 
GST. In computing the new inclusion ratio, the numerator of the 
applicable fraction is reduced by the nontax portion of prior GSTs 
occurring during the ETIP. Thus, the numerator of the applicable 
fraction with respect to the GST in year 5 is $92,500 ($100,000 - 
(.50  x  $15,000)) and the inclusion ratio applicable with respect 
to the GST in year 5 is .537 (1 - ($92,500/$200,000) = .463). Any 
additional GST exemption allocated on a timely ETIP return with 
respect to the GST in year 5 is effective immediately prior to the 
transfer.


Sec. 26.2642-5  Finality of inclusion ratio.

    (a) Direct skips. The inclusion ratio applicable to a direct skip 
becomes final when no additional GST tax (including additional GST tax 
payable as a result of a cessation, etc. of qualified use under section 
2032A(c)) may be assessed with respect to the direct skip.
    (b) Other GSTs. With respect to taxable distributions and taxable 
terminations, the inclusion ratio for a trust becomes final, on the 
later of--
    (1) The expiration of the period for assessment with respect to the 
first GST tax return filed using that inclusion ratio; (unless the 
trust is subject to an election under section 2032A in which case the 
applicable date under this subsection is the expiration of the period 
of assessment of any additional GST tax due as a result of a cessation, 
etc. of qualified use under section 2032A); or
    (2) The expiration of the period for assessment of Federal estate 
tax with respect to the estate of the transferor. For purposes of this 
paragraph (b)(2), if an estate tax return is not required to be filed, 
the period for assessment is determined as if a return were required to 
be filed and as if the return were timely filed within the period 
prescribed by section 6075(a).


Sec. 26.2652-1  Transferor defined; other definitions.

    (a) Transferor defined--(1) In general. Except as otherwise 
provided in paragraph (a)(3) of this section, the individual with 
respect to whom property was most recently subject to Federal estate or 
gift tax is the transferor of that property for purposes of chapter 13. 
An individual is treated as transferring any property with respect to 
which the individual is the transferor. Thus, an individual may be a 
transferor even though there is no transfer of property under local law 
at the time the Federal estate or gift tax applies. For purposes of 
this paragraph, a surviving spouse is the transferor of a qualified 
domestic trust created by the deceased spouse that is included in the 
surviving spouse's gross estate, provided the trust is not subject to 
the election described in Sec. 26.2652-2 (reverse QTIP election). A 
surviving spouse is also the transferor of a qualified domestic trust 
created by the surviving spouse pursuant to section 2056(d)(2)(B).
    (2) Transfers subject to Federal estate or gift tax. For purposes 
of this section, 

[[Page 66919]]
a transfer is subject to Federal gift tax if a gift tax is imposed 
under section 2501(a). A transfer is subject to Federal estate tax if 
the value of the property is includible in the decedent's gross estate 
as determined under section 2031 or section 2103.
    (3) Special rule for certain QTIP trusts. Solely for purposes of 
chapter 13, if a transferor of qualified terminable interest property 
(QTIP) elects under Sec. 26.2652-2(a) to treat the property as if the 
QTIP election had not been made (reverse QTIP election), the identity 
of the transferor of the property is determined without regard to the 
application of sections 2044, 2207A, and 2519.
    (4) Exercise of certain nongeneral powers of appointment. The 
exercise of a power of appointment that is not a general power of 
appointment (as defined in section 2041(b)) is treated as a transfer 
subject to Federal estate or gift tax by the holder of the power if the 
power is exercised in a manner that may postpone or suspend the 
vesting, absolute ownership, or power of alienation of an interest in 
property for a period, measured from the date of creation of the trust, 
extending beyond any specified life in being at the date of creation of 
the trust plus a period of 21 years plus, if necessary, a reasonable 
period of gestation (perpetuities period). For purposes of this 
paragraph (a)(4), the exercise of a power of appointment that validly 
postpones or suspends the vesting, absolute ownership, or power of 
alienation of an interest in property for a term of years that will not 
exceed 90 years (measured from the date of creation of the trust) is 
not an exercise that may extend beyond the perpetuities period.
    (5) Split-gift transfers. In the case of a transfer with respect to 
which the donor's spouse makes an election under section 2513 to treat 
the gift as made one-half by the spouse, the electing spouse is treated 
as the transferor of one-half of the entire value of the property 
transferred by the donor, regardless of the interest the electing 
spouse is actually deemed to have transferred under section 2513. The 
donor is treated as the transferor of one-half of the value of the 
entire property. See Sec. 26.2632-1(c)(5) Example 3, regarding 
allocation of GST exemption with respect to split-gift transfers 
subject to an ETIP.
    (6) Examples. The following examples illustrate the principles of 
this paragraph (a):

    Example 1. Identity of transferor. T transfers $100,000 to a 
trust for the sole benefit of T's grandchild. The transfer is a 
completed gift under Sec. 25.2511-2 of this chapter. Thus, for 
purposes of chapter 13, T is the transferor of the $100,000. It is 
immaterial that a portion of the transfer is excluded from the total 
amount of T's taxable gift by reason of section 2503(b).
    Example 2. Gift splitting and identity of transferor. The facts 
are the same as in Example 1, except T's spouse, S, consents under 
section 2513 to split the gift with T. For purposes of chapter 13, S 
and T are each treated as a transferor of $50,000 to the trust.
    Example 3. Change of transferor on subsequent transfer tax 
event. T transfers $100,000 to a trust providing that all the net 
trust income is to be paid to T's spouse, S, for S's lifetime. T 
elects under section 2523(f) to treat the transfer as a transfer of 
qualified terminable interest property, and T does not make the 
reverse QTIP election under section 2652(a)(3). On S's death, the 
trust property is included in S's gross estate under section 2044. 
Thus, S becomes the transferor at the time of S's death.
    Example 4. Effect of transfer of an interest in trust on 
identity of the transferor. T transfers $100,000 to a trust 
providing that all of the net income is to be paid to T's child, C, 
for C's lifetime. At C's death, the trust property is to be paid to 
T's grandchild. C transfers the income interest to X, an unrelated 
party, in a transfer that is a completed transfer for Federal gift 
tax purposes. Because C's transfer is a transfer of a term interest 
in the trust that does not affect the rights of other parties with 
respect to the trust property, T remains the transferor with respect 
to the trust.
    Example 5. Effect of lapse of withdrawal right on identity of 
transferor. T transfers $10,000 to a new trust providing that the 
trust income is to be paid to T's child, C, for C's life and, on the 
death of C, the trust principal is to be paid to T's grandchild, GC. 
The trustee has discretion to distribute principal for GC's benefit 
during C's lifetime. C has a right to withdraw $10,000 from the 
trust for a 60-day period following the transfer. Thereafter, the 
power lapses. C does not exercise the withdrawal right. The transfer 
by T is a completed transfer within the meaning of Sec. 25.2511-2 of 
this chapter and, thus, T is treated as having transferred the 
entire $10,000 to the trust. On the lapse of the withdrawal right, C 
becomes a transferor to the extent C is treated as having made a 
completed transfer for purposes of chapter 12. Therefore, except to 
the extent that the amount with respect to which the power of 
withdrawal lapses exceeds the greater of $5,000 or 5% of the value 
of the trust property, T remains the transferor of the trust 
property for purposes of chapter 13.
    Example 6. Effect of reverse QTIP election on identity of the 
transferor. T establishes a testamentary trust having a principal of 
$500,000. Under the terms of the trust, all trust income is payable 
to T's surviving spouse, S, during S's lifetime. T's executor makes 
an election to treat the trust property as qualified terminable 
interest property and also makes the reverse QTIP election. For 
purposes of chapter 13, T is the transferor with respect to the 
trust. On S's death, the then full fair market value of the trust is 
includible in S's gross estate under section 2044. However, because 
of the reverse QTIP election, S does not become the transferor with 
respect to the trust; T continues to be the transferor.
    Example 7. Effect of reverse QTIP election on constructive 
additions. The facts are the same as in Example 6, except the 
inclusion of the QTIP trust in S's gross estate increased the 
Federal estate tax liability of S's estate by $200,000. The estate 
does not exercise the right of recovery from the trust granted under 
section 2207A. Under local law, the beneficiaries of S's residuary 
estate (which bears all estate taxes under the will) could compel 
the executor to exercise the right of recovery but do not do so. 
Solely for purposes of chapter 13, the beneficiaries of the 
residuary estate are not treated as having made an addition to the 
trust by reason of their failure to exercise their right of 
recovery. Because of the reverse QTIP election, for GST purposes, 
the trust property is not treated as includible in S's gross estate 
and, under those circumstances, no right of recovery exists.
    Example 8. Effect of reverse QTIP election on constructive 
additions. S, the surviving spouse of T, dies testate. At the time 
of S's death, S was the beneficiary of a trust with respect to which 
T's executor made a QTIP election under section 2056(b)(7). Thus, 
the trust is includible in S's gross estate under section 2044. T's 
executor also made the reverse QTIP election with respect to the 
trust. S's will provides that all death taxes payable with respect 
to the trust are payable from S's residuary estate. Since the 
transferor of the property is determined without regard to section 
2044 and section 2207A, S is not treated as making a constructive 
addition to the trust by reason of the tax apportionment clause in 
S's will.
    Example 9. Exercise of a nongeneral power of appointment. On May 
15, 1990, T established an irrevocable trust under which the trust 
income is to be paid to T's child, C, for life. C is given a 
testamentary power to appoint the remainder in further trust for the 
benefit of C's issue. In default of C's exercise of the power, the 
remainder is to pass to charity. C dies on February 3, 1997, 
survived by two children and a sibling, S (who was born prior to May 
15, 1990). C exercises the power in a manner that validly extends 
the trust in favor of C's issue until the later of May 15, 2070 (80 
years from the date the trust was created), or the death of S. C's 
exercise of the power is considered a transfer by C that is subject 
to the estate or gift tax because it may extend the term of the 
trust beyond the perpetuities period.
    Example 10. Exercise of a nongeneral power of appointment. The 
facts are the same as in Example 9, except local law provides that 
the effect of C's exercise is to extend the term of the trust until 
May 15, 2070, whether or not S survives that date. C is not treated 
as having made a transfer to the trust as a result of the exercise 
of the power because the exercise of the power does not extend the 
term of the trust beyond a period of 90 years measured from the 
creation of the trust. The result would be the same if the effect of 
C's exercise is either to extend the term of the trust until the 
death of S or to extend the term of the trust until the first to 
occur of May 15, 2070, or the death of S.

[[Page 66920]]

    Example 11. Split-gift transfers. T transfers $100,000 to an 
inter vivos trust that provides T with an annuity payable for ten 
years or until T's prior death. The annuity satisfies the definition 
of a qualified interest under section 2702(b). When the trust 
terminates, the corpus is to be paid to T's grandchild, GC. T's 
spouse, S, consents under section 2513 to have the gift treated as 
made one-half by S. Under section 2513, only the actuarial value of 
the gift to GC is eligible to be treated as made one-half by S. 
However, because S is treated as the donor of one-half of the gift 
to GC, S becomes the transferor of one-half of the entire trust 
($50,000) for purposes of Chapter 13.

    (b) Trust defined--(1) In general. A trust includes any arrangement 
(other than an estate) that has substantially the same effect as a 
trust. Thus, for example, arrangements involving life estates and 
remainders, estates for years, and insurance and annuity contracts are 
trusts. Generally, a transfer as to which the identity of the 
transferee is contingent upon the occurrence of an event is a transfer 
in trust; however, a transfer of property included in the transferor's 
gross estate, as to which the identity of the transferee is contingent 
upon an event that must occur within 6 months of the transferor's 
death, is not considered a transfer in trust solely by reason of the 
existence of the contingency.
    (2) Examples. The following examples illustrate the provisions of 
this paragraph (b):

    Example 1. Uniform gifts to minors transfers. T transfers cash 
to an account in the name of T's child, C, as custodian for C's 
child, GC (who is a minor), under a state statute substantially 
similar to the Uniform Gifts to Minors Act. For purposes of chapter 
13, the transfer to the custodial account is treated as a transfer 
to a trust.
    Example 2. Contingent transfers. T bequeaths $200,000 to T's 
child, C, provided that if C does not survive T by more than 6 
months, the bequest is payable to T's grandchild, GC. C dies 4 
months after T. The bequest is not a transfer in trust because the 
contingency that determines the recipient of the bequest must occur 
within 6 months of T's death. The bequest to GC is a direct skip.
    Example 3. Contingent transfers. The facts are the same as in 
Example 2, except C must survive T by 18 months to take the bequest. 
The bequest is a transfer in trust for purposes of chapter 13, and 
the death of C is a taxable termination.

    (c) Trustee defined. The trustee of a trust is the person 
designated as trustee under local law or, if no such person is so 
designated, the person in actual or constructive possession of property 
held in trust.
    (d) Executor defined. For purposes of chapter 13, the executor is 
the executor or administrator of the decedent's estate. However, if no 
executor or administrator is appointed, qualified or acting within the 
United States, the executor is the fiduciary who is primarily 
responsible for payment of the decedent's debts and expenses. If there 
is no such executor, administrator or fiduciary, the executor is the 
person in actual or constructive possession of the largest portion of 
the value of the decedent's gross estate.
    (e) Interest in trust. See Sec. 26.2612-1(e) for the definition of 
interest in trust.


Sec. 26.2652-2  Special election for qualified terminable interest 
property.

    (a) In general. If an election is made to treat property as 
qualified terminable interest property (QTIP) under section 2523(f) or 
section 2056(b)(7), the person making the election may, for purposes of 
chapter 13, elect to treat the property as if the QTIP election had not 
been made (reverse QTIP election). An election under this section is 
irrevocable. An election under this section is not effective unless it 
is made with respect to all of the property in the trust to which the 
QTIP election applies. See, however, Sec. 26.2654-1(b)(1). Property 
that qualifies for a deduction under section 2056(b)(5) is not eligible 
for the election under this section.
    (b) Time and manner of making election. An election under this 
section is made on the return on which the QTIP election is made. If a 
protective QTIP election is made, no election under this section is 
effective unless a protective reverse QTIP election is also made.
    (c) Transitional rule. If a reverse QTIP election is made with 
respect to a trust prior to December 27, 1995, and GST exemption has 
been allocated to that trust, the transferor (or the transferor's 
executor) may elect to treat the trust as two separate trusts, one of 
which has a zero inclusion ratio by reason of the transferor's GST 
exemption previously allocated to the trust. The separate trust with 
the zero inclusion ratio consists of that fractional share of the value 
of the entire trust equal to the value of the nontax portion of the 
trust under Sec. 26.2642-4(a). The reverse QTIP election is treated as 
applying only to the trust with the zero inclusion ratio. An election 
under this paragraph (c) is made by attaching a statement to a copy of 
the return on which the reverse QTIP election was made under section 
2652(a)(3). The statement must indicate that an election is being made 
to treat the trust as two separate trusts and must identify the values 
of the two separate trusts. The statement is to be filed in the same 
place in which the original return was filed and must be filed before 
June 24, 1996. A trust subject to the election described in this 
paragraph is treated as a trust that was created by two transferors. 
See Sec. 26.2654-1(a)(2) for special rules involving trusts with 
multiple transferors.
    (d) Examples. The following examples illustrate the provisions of 
this section:

    Example 1. Special (reverse QTIP) election under section 
2652(a)(3). T transfers $1,000,000 to a trust providing that all 
trust income is to be paid to T's spouse, S, for S's lifetime. On 
S's death, the trust principal is payable to GC, a grandchild of S 
and T. T elects to treat all of the transfer as a transfer of QTIP 
and also makes the reverse QTIP election for all of the property. 
Because of the reverse QTIP election, T continues to be treated as 
the transferor of the property after S's death for purposes of 
chapter 13. A taxable termination rather than a direct skip occurs 
on S's death.
    Example 2. Election under transition rule. In 1994, T died 
leaving $4 million in trust for the benefit of T's surviving spouse, 
S. On January 16, 1995, T's executor filed T's Form 706 on which the 
executor elects to treat the entire trust as qualified terminable 
interest property. The executor also makes a reverse QTIP election. 
The reverse QTIP election is effective with respect to the entire 
trust even though T's executor could allocate only $1 million of GST 
exemption to the trust. T's executor may elect to treat the trust as 
two separate trusts, one having a value of 25% of the value of the 
single trust and an inclusion ratio of zero, but only if the 
election is made prior to June 24, 1996. If the executor makes the 
transitional election, the other separate trust, having a value of 
75% of the value of the single trust and an inclusion ratio of one, 
is not treated as subject to the reverse QTIP election.
    Example 3. Denominator of the applicable fraction of QTIP trust. 
T bequeaths $1,500,000 to a trust in which T's surviving spouse, S, 
receives an income interest for life. Upon the death of S, the 
property is to remain in trust for the benefit of C, the child of T 
and S. Upon C's death, the trust is to terminate and the trust 
property paid to the descendants of C. The bequest qualifies for the 
estate tax marital deduction under section 2056(b)(7) as QTIP. The 
executor does not make the reverse QTIP election under section 
2652(a)(3). As a result, S becomes the transferor of the trust at 
S's death when the value of the property in the QTIP trust is 
included in S's gross estate under section 2044. For purposes of 
computing the applicable fraction with respect to the QTIP trust 
upon S's death, the denominator of the fraction is reduced by any 
Federal estate tax (whether imposed under section 2001, 2101 or 
2056A(b)) and State death tax attributable to the trust property 
that is actually recovered from the trust.


Sec. 26.2653-1  Taxation of multiple skips.

    (a) General rule. If property is held in trust immediately after a 
GST, solely for purposes of determining whether future events involve a 
skip person, the transferor is thereafter deemed to occupy the 
generation immediately 

[[Page 66921]]
above the highest generation of any person holding an interest in the 
trust immediately after the transfer. If no person holds an interest in 
the trust immediately after the GST, the transferor is treated as 
occupying the generation above the highest generation of any person in 
existence at the time of the GST who then occupies the highest 
generation level of any person who may subsequently hold an interest in 
the trust. See Sec. 26.2612-1(e) for rules determining when a person 
has an interest in property held in trust.
    (b) Examples. The following examples illustrate the provisions of 
this section:

    Example 1. T transfers property to an irrevocable trust for the 
benefit of T's grandchild, GC, and great-grandchild, GGC. During 
GC's life, the trust income may be distributed to GC and GGC in the 
trustee's absolute discretion. At GC's death, the trust property 
passes to GGC. Both GC and GGC have an interest in the trust for 
purposes of chapter 13. The transfer by T to the trust is a direct 
skip, and the property is held in trust immediately after the 
transfer. After the direct skip, the transferor is treated as being 
one generation above GC, the highest generation individual having an 
interest in the trust. Therefore, GC is no longer a skip person and 
distributions to GC are not taxable distributions. However, because 
GGC occupies a generation that is two generations below the deemed 
generation of T, GGC is a skip person and distributions of trust 
income to GGC are taxable distributions.
    Example 2. T transfers property to an irrevocable trust 
providing that the income is to be paid to T's child, C, for life. 
At C's death, the trust income is to be accumulated for 10 years and 
added to principal. At the end of the 10-year accumulation period, 
the trust income is to be paid to T's grandchild, GC, for life. Upon 
GC's death, the trust property is to be paid to T's great-
grandchild, GGC, or to GGC's estate. A GST occurs at C's death. 
Immediately after C's death and during the 10-year accumulation 
period, no person has an interest in the trust within the meaning of 
section 2652(c) and Sec. 26.2612-1(e) because no one can receive 
current distributions of income or principal. Immediately after C's 
death, T is treated as occupying the generation above the generation 
of GC (the trust beneficiary in existence at the time of the GST who 
then occupies the highest generation level of any person who may 
subsequently hold an interest in the trust). Thus, subsequent income 
distributions to GC are not taxable distributions.


Sec. 26.2654-1  Certain trusts treated as separate trusts.

    (a) Single trust treated as separate trusts--(1) Substantially 
separate and independent shares--(i) In general. If a single trust 
consists solely of substantially separate and independent shares for 
different beneficiaries, the share attributable to each beneficiary (or 
group of beneficiaries) is treated as a separate trust for purposes of 
chapter 13. The phrase ``substantially separate and independent 
shares'' generally has the same meaning as provided in Sec. 1.663(c)-3 
of this chapter. However, a portion of a trust is not a separate share 
unless such share exists from and at all times after the creation of 
the trust. For purposes of this paragraph (a)(1), a trust is treated as 
created at the date of death of the grantor if the trust is includible 
in its entirety in the grantor's gross estate for Federal estate tax 
purposes. Further, treatment of a single trust as separate trusts under 
this paragraph (a)(1) does not permit treatment of those portions as 
separate trusts for purposes of filing returns and payment of tax or 
for purposes of computing any other tax imposed under the Internal 
Revenue Code. Also, additions to, and distributions from, such trusts 
are allocated pro rata among the separate trusts, unless the governing 
instrument expressly provides otherwise.
    (ii) Certain pecuniary amounts. For purposes of this section, if a 
person holds the current right to receive a mandatory (i.e., 
nondiscretionary and noncontingent) payment of a pecuniary amount at 
the death of the transferor from an inter vivos trust that is 
includible in the transferor's gross estate, or a testamentary trust, 
the pecuniary amount is a separate and independent share if--
    (A) The trustee is required to pay appropriate interest (as defined 
in Sec. 26.2642-2(b)(4)(i) and (ii)) to the person; or
    (B) If the pecuniary amount is payable in kind on the basis of 
value other than the date of distribution value of the assets, the 
trustee is required to allocate assets to the pecuniary payment in a 
manner that fairly reflects net appreciation or depreciation in the 
value of the assets in the fund available to pay the pecuniary amount 
measured from the date of death to the date of payment.
    (2) Multiple transferors with respect to single trust--(i) In 
general. If there is more than one transferor with respect to a trust, 
the portions of the trust attributable to the different transferors are 
treated as separate trusts for purposes of chapter 13. Treatment of a 
single trust as separate trusts under this paragraph (a)(2) does not 
permit treatment of those portions as separate trusts for purposes of 
filing returns and payment of tax or for purposes of computing any 
other tax imposed under the Internal Revenue Code. Also, additions to, 
and distributions from, such trusts are allocated pro rata among the 
separate trusts unless otherwise expressly provided in the governing 
instrument.
    (ii) Addition by a transferor. If an individual makes an addition 
to a trust of which the individual is not the sole transferor, the 
portion of the single trust attributable to each separate trust is 
determined by multiplying the fair market value of the single trust 
immediately after the contribution by a fraction. The numerator of the 
fraction is the value of the separate trust immediately after the 
contribution. The denominator of the fraction is the fair market value 
of all the property in the single trust immediately after the transfer.
    (3) Severance of a single trust. A single trust treated as separate 
trusts under paragraphs (a)(1) or (2) of this section may be divided at 
any time into separate trusts to reflect that treatment. For this 
purpose, the rules of paragraph (b)(1)(ii)(C) of this section apply 
with respect to the severance and funding of the severed trusts.
    (4) Allocation of exemption--(i) In general. With respect to a 
separate share treated as a separate trust under paragraph (a)(1) or 
(2) of this section, an individual's GST exemption is allocated to the 
separate trust. See Sec. 26.2632-1 for rules concerning the allocation 
of GST exemption.
    (ii) Automatic allocation to direct skips. If the transfer is a 
direct skip to a trust that occurs during the transferor's lifetime and 
is treated as a transfer to separate trusts under paragraphs (a)(1) or 
(a)(2) of this section, the transferor's GST exemption not previously 
allocated is automatically allocated on a pro rata basis among the 
separate trusts. The transferor may prevent an automatic allocation of 
GST exemption to a separate share of a single trust by describing on a 
timely-filed United States Gift (and Generation-Skipping Transfer) Tax 
Return (Form 709) the transfer and the extent to which the automatic 
allocation is not to apply to a particular share. See Sec. 26.2632-1(b) 
for rules for avoiding the automatic allocation of GST exemption.
    (5) Examples. The following examples illustrate the principles of 
this section (a):

    Example 1. Separate shares as separate trusts. T transfers 
$100,000 to a trust under which income is to be paid in equal shares 
for 10 years to T's child, C, and T's grandchild, GC (or their 
respective estates). The trust does not permit distributions of 
principal during the term of the trust. At the end of the 10-year 
term, the trust principal is to be distributed to C and GC in equal 
shares. The shares of C and GC in the trust are separate and 
independent and, therefore, are treated as separate trusts. The 
result 

[[Page 66922]]
would not be the same if the trust permitted distributions of principal 
unless the distributions could only be made from a one-half separate 
share of the initial trust principal and the distributee's future 
rights with respect to the trust are correspondingly reduced. T may 
allocate part of T's GST exemption under section 2632(a) to the 
share held for the benefit of GC.
    Example 2. Separate share rule inapplicable. The facts are the 
same as in Example 1, except the trustee holds the discretionary 
power to distribute the income in any proportion between C and GC 
during the last year of the trust. The shares of C and GC in the 
trust are not separate and independent shares throughout the entire 
term of the trust and, therefore, are not treated as separate trusts 
for purposes of chapter 13.
    Example 3. Pecuniary payment as separate share. T creates a 
lifetime revocable trust providing that on T's death $500,000 is 
payable to T's spouse, S, with the balance of the principal to be 
held for the benefit of T's grandchildren. The value of the trust is 
includible in T's gross estate upon T's death. Under the terms of 
the trust, the payment to S is required to be made in cash, and 
under local law S is entitled to receive interest on the payment at 
an annual rate of 6 percent, commencing immediately upon T's death. 
For purposes of chapter 13, the trust is treated as created at T's 
death, and the $500,000 payable to S from the trust is treated as a 
separate share. The result would be the same if the payment to S 
could be satisfied using noncash assets at their value on the date 
of distribution. Further, the result would be the same if the 
decedent's probate estate poured over to the revocable trust on the 
decedent's death and was then distributed in accordance with the 
terms of the trust.
    Example 4. Pecuniary payment not treated as separate share. The 
facts are the same as in Example 3, except the bequest to S is to be 
paid in noncash assets valued at their values as finally determined 
for Federal estate tax purposes. Neither the trust instrument nor 
local law requires that the assets distributed in satisfaction of 
the bequest fairly reflect net appreciation or depreciation in all 
the assets from which the bequest may be funded. S's $500,000 
bequest is not treated as a separate share and the trust is treated 
as a single trust for purposes of chapter 13.
    Example 5. Multiple transferors to single trust. A transfers 
$100,000 to an irrevocable generation-skipping trust; B 
simultaneously transfers $50,000 to the same trust. As of the time 
of the transfers, the single trust is treated as two trusts for 
purposes of chapter 13. Because A contributed \2/3\ of the value of 
the initial corpus, \2/3\ of the single trust principal is treated 
as a separate trust created by A. Similarly, because B contributed 
\1/3\ of the value of the initial corpus, \1/3\ of the single trust 
is treated as a separate trust created by B. A or B may allocate 
their GST exemption under section 2632(a) to the respective separate 
trusts.
    Example 6. Additional contributions. A transfers $100,000 to an 
irrevocable generation-skipping trust; B simultaneously transfers 
$50,000 to the same trust. When the value of the single trust has 
increased to $180,000, A contributes an additional $60,000 to the 
trust. At the time of the additional contribution, the portion of 
the single trust attributable to each grantor's separate trust must 
be redetermined. The portion of the single trust attributable to A's 
separate trust immediately after the contribution is \3/4\ ((2/3  x  
$180,000) + $60,000)/$240,000). The portion attributable to B's 
separate trust after A's addition is \1/4\.
    Example 7. Distributions from a separate share. The facts are 
the same as in Example 6, except that, after A's second 
contribution, $50,000 is distributed to a beneficiary of the trust. 
Absent a provision in the trust instrument that charges the 
distribution against the contribution of either A or B, \3/4\ of the 
distribution is treated as made from the separate trust of which A 
is the transferor and 1/4 from the separate trust of which B is the 
transferor.
    Example 8. Separate share rule inapplicable. T creates an 
irrevocable trust that provides the trustee with the discretionary 
power to distribute income or corpus to T's children and 
grandchildren. The trust provides that, when T's youngest child 
reaches age 21, the trust will be divided into separate shares, one 
share for each child of T. The income from a respective child's 
share will be paid to the child during the child's life with the 
remainder passing to such child's children (grandchildren of T). The 
separate shares that come into existence when the youngest child 
reaches age 21 will not be recognized as separate trusts for 
purposes of Chapter 13 because the shares did not exist from and at 
all times after the creation of the trust. Any allocation of GST 
exemption to the trust either before or after T's youngest child 
reaches age 21 will apply with respect to the entire trust. Thus, 
the inclusion ratio will be the same with respect to any 
distribution from the trust or the separate shares. The result would 
be the same if, the trust instrument provided that the trust was to 
be divided into separate trusts when T's youngest child reached age 
21.

    (b) Division of a trust included in the gross estate--(1) In 
general. The severance of a trust that is included in the transferor's 
gross estate (or created under the transferor's will) into two or more 
trusts is recognized for purposes of chapter 13 if--
    (i) The trust is severed pursuant to a direction in the governing 
instrument providing that the trust is to be divided upon the death of 
the transferor; or
     (ii) The governing instrument does not require or otherwise direct 
severance but the trust is severed pursuant to discretionary authority 
granted either under the governing instrument or under local law; and
    (A) The terms of each of the new trusts provide for the same 
succession of interests and beneficiaries as are provided in the 
original trust;
    (B) The severance occurs (or a reformation proceeding, if required, 
is commenced) prior to the date prescribed for filing the Federal 
estate tax return (including extensions actually granted) for the 
estate of the transferor; and
    (C) Either--
    (1) The new trusts are severed on a fractional basis. If severed on 
a fractional basis, the separate trusts need not be funded with a pro 
rata portion of each asset held by the undivided trust. The trusts may 
be funded on a nonpro rata basis provided funding is based on either 
the fair market value of the assets on the date of funding or in a 
manner that fairly reflects the net appreciation or depreciation in the 
value of the assets measured from the date of death to the date of 
funding; or
    (2) If the severance is required (by the terms of the governing 
instrument) to be made on the basis of a pecuniary amount, the 
pecuniary payment is satisfied in a manner that would meet the 
requirements of paragraph (a)(1)(ii) of this section if it were paid to 
an individual.
    (2) Special rule. If a court order severing the trust has not been 
issued at the time the Federal estate tax return is filed, the executor 
must indicate on a statement attached to the return that a proceeding 
has been commenced to sever the trust and describe the manner in which 
the trust is proposed to be severed. A copy of the petition or other 
instrument used to commence the proceeding must also be attached to the 
return. If the governing instrument of a trust or local law authorizes 
the severance of the trust, a severance pursuant to that authorization 
is treated as meeting the requirement of paragraph (b)(1)(ii)(B) of 
this section if the executor indicates on the Federal estate tax return 
that separate trusts will be created (or funded) and clearly sets forth 
the manner in which the trust is to be severed and the separate trusts 
funded.
    (3) Allocation of exemption. An individual's GST exemption under 
Sec. 2632 may be allocated to the separate trusts created pursuant to 
this section at the discretion of the executor or trustee.
    (4) Examples. The following examples illustrate the provisions of 
this section (b):

    Example 1. Severance of single trust. T's will establishes a 
testamentary trust providing that income is to be paid to T's spouse 
for life. At the spouse's death, one-half of the corpus is to be 
paid to T's child, C, or C's estate (if C fails to survive the 
spouse) and one-half of the corpus is to be paid to T's grandchild, 
GC, or GC's estate (if GC fails to survive the spouse). If the 
requirements of paragraph (b) of this section are otherwise 
satisfied, T's executor may divide the testamentary trust equally 
into two separate trusts, one trust providing an income interest to 
spouse for life with 

[[Page 66923]]
remainder to C, and the other trust with an income interest to spouse 
for life with remainder to GC. Furthermore, if the requirements of 
paragraph (b) of this section are satisfied, the executor or trustee 
may further divide the trust for the benefit of GC. GST exemption 
may be allocated to any of the divided trusts.
    Example 2. Severance of revocable trust. T creates an inter 
vivos revocable trust providing that, at T's death and after payment 
of all taxes and administration expenses, the remaining corpus will 
be divided into two trusts. One trust, for the benefit of T's 
spouse, is to be funded with the smallest amount that, if qualifying 
for the marital deduction, will reduce the estate tax to zero. The 
other trust, for the benefit of T's descendants, is to be funded 
with the balance of the revocable trust corpus. The trust corpus is 
includible in T's gross estate. Each trust is recognized as a 
separate trust for purposes of chapter 13.


26.2662-1  Generation-skipping transfer tax return requirements.

    (a) In general. Chapter 13 imposes a tax on generation-skipping 
transfers (as defined in section 2611). The requirements relating to 
the return of tax depend on the type of generation-skipping transfer 
involved. This section contains rules for filing the required tax 
return. Paragraph (c)(2) of this section provides special rules 
concerning the return requirements for generation-skipping transfers 
pursuant to certain trust arrangements (as defined in paragraph 
(c)(2)(ii) of this section), such as life insurance policies and 
annuities.
    (b) Form of return--(1) Taxable distributions. Form 706GS(D) must 
be filed in accordance with its instructions for any taxable 
distribution (as defined in section 2612(b)). The trust involved in a 
transfer described in the preceding sentence must file Form 706GS(D-1) 
in accordance with its instructions. A copy of Form 706GS(D-1) shall be 
sent to each distributee.
    (2) Taxable terminations. Form 706GS(T) must be filed in accordance 
with its instructions for any taxable termination (as defined in 
section 2612(a)).
    (3) Direct skip--(i) Inter vivos direct skips. Form 709 must be 
filed in accordance with its instructions for any direct skip (as 
defined in section 2612(c)) that is subject to chapter 12 and occurs 
during the life of the transferor.
    (ii) Direct skips occurring at death--(A) In general. Form 706 or 
Form 706NA must be filed in accordance with its instructions for any 
direct skips (as defined in section 2612(c)) that are subject to 
chapter 11 and occur at the death of the decedent.
    (B) Direct skips payable from a trust. Schedule R-1 of Form 706 
must be filed in accordance with its instructions for any direct skip 
from a trust if such direct skip is subject to chapter 11. See 
paragraph (c)(2) of this section for special rules relating to the 
person liable for tax and required to make the return under certain 
circumstances.
    (c) Person liable for tax and required to make return--(1) In 
general. Except as otherwise provided in this section, the following 
person is liable for the tax imposed by section 2601 and must make the 
required tax return--
    (i) The transferee in a taxable distribution (as defined in section 
2612(b));
    (ii) The trustee in the case of a taxable termination (as defined 
in section 2612(a));
    (iii) The transferor (as defined in section 2652(a)(1)(B)) in the 
case of an inter vivos direct skip (as defined in section 2612(c));
    (iv) The trustee in the case of a direct skip from a trust or with 
respect to property that continues to be held in trust; or
    (v) The executor in the case of a direct skip (other than a direct 
skip described in paragraph (c)(1)(iv) of this section) if the transfer 
is subject to chapter 11. See paragraph (c)(2) of this section for 
special rules relating to direct skips to or from certain trust 
arrangements (as defined in paragraph (c)(2)(ii) of this section).
    (2) Special rule for direct skips occurring at death with respect 
to property held in trust arrangements--(i) In general. In the case of 
certain property held in a trust arrangement (as defined in paragraph 
(c)(2)(ii) of this section) at the date of death of the transferor, the 
person who is required to make the return and who is liable for the tax 
imposed by chapter 13 is determined under paragraphs (c)(2)(iii) and 
(iv) of this section.
    (ii) Trust arrangement defined. For purposes of this section, the 
term trust arrangement includes any arrangement (other than an estate) 
which, although not an explicit trust, has the same effect as an 
explicit trust. For purposes of this section, the term ``explicit 
trust'' means a trust described in Sec. 301.7701-4(a).
    (iii) Executor's liability in the case of transfers with respect to 
decedents dying on or after June 24, 1996 if the transfer is less than 
$250,000. In the case of a direct skip occurring at death, the executor 
of the decedent's estate is liable for the tax imposed on that direct 
skip by chapter 13 and is required to file Form 706 or Form 706NA (and 
not Schedule R-1 of Form 706) if, at the date of the decedent's death--
    (A) The property involved in the direct skip is held in a trust 
arrangement; and
    (B) The total value of the property involved in direct skips with 
respect to the trustee of that trust arrangement is less than $250,000.
    (iv) Executor's liability in the case of transfers with respect to 
decedents dying prior to June 24, 1996 if the transfer is less than 
$100,000. In the case of a direct skip occurring at death with respect 
to a decedent dying prior to June 24, 1996, the rule in paragraph 
(c)(2)(iii) of this section that imposes liability upon the executor 
applies only if the property involved in the direct skip with respect 
to the trustee of the trust arrangement, in the aggregate, is less than 
$100,000.
    (v) Executor's right of recovery. In cases where the rules of 
paragraphs (c)(2)(iii) and (iv) of this section impose liability for 
the generation-skipping transfer tax on the executor, the executor is 
entitled to recover from the trustee (if the property continues to be 
held in trust) or from the recipient of the property (in the case of a 
transfer from a trust), the generation-skipping transfer tax 
attributable to the transfer.
    (vi) Examples. The following examples illustrate the application of 
this paragraph (c)(2) with respect to decedents dying on or after June 
24, 1996:

    Example 1. Insurance proceeds less than $250,000. On August 1, 
1997, T, the insured under an insurance policy, died. The proceeds 
($200,000) were includible in T's gross estate for Federal estate 
tax purposes. T's grandchild GC, was named the sole beneficiary of 
the policy. The insurance policy is treated as a trust under section 
2652(b)(1), and the payment of the proceeds to GC is a transfer from 
a trust for purposes of chapter 13. Therefore, the payment of the 
proceeds to GC is a direct skip. Since the proceeds from the policy 
($200,000) are less than $250,000, the executor is liable for the 
tax imposed by chapter 13 and is required to file Form 706.
    Example 2. Aggregate insurance proceeds of $250,000 or more. 
Assume the same facts as in Example 1, except T is the insured under 
two insurance policies issued by the same insurance company. The 
proceeds ($150,000) from each policy are includible in T's gross 
estate for Federal estate tax purposes. T's grandchild, GC1, was 
named the sole beneficiary of Policy 1, and T's other grandchild, 
GC2, was named the sole beneficiary of Policy 2. GC1 and GC2 are 
skip persons (as defined in section 2613). Therefore, the payments 
of the proceeds are direct skips. Since the total value of the 
policies ($300,000) exceeds $250,000, the insurance company is 
liable for the tax imposed by chapter 13 and is required to file 
Schedule R-1 of Form 706.
    Example 3. Insurance proceeds of $250,000 or more held by 
insurance company. On August 1, 1997, T, the insured under an 
insurance policy, dies. The policy provides that the insurance 
company shall make 

[[Page 66924]]
monthly payments of $750 to GC, T's grandchild, for life with the 
remainder payable to T's great grandchild, GGC. The face value of 
the policy is $300,000. Since the proceeds continue to be held by 
the insurance company (the trustee), the proceeds are treated as if 
they were transferred to a trust for purposes of chapter 13. The 
trust is a skip person (as defined in section 2613(a)(2)) and the 
transfer is a direct skip. Since the total value of the policy 
($300,000) exceeds $250,000, the insurance company is liable for the 
tax imposed by chapter 13 and is required to file Schedule R-1 of 
Form 706.
    Example 4. Insurance proceeds less than $250,000 held by 
insurance company. Assume the same facts as in Example 3, except the 
policy provides that the insurance company shall make monthly 
payments of $500 to GC and that the face value of the policy is 
$200,000. The transfer is a transfer to a trust for purposes of 
chapter 13. However, since the total value of the policy ($200,000) 
is less than $250,000, the executor is liable for the tax imposed by 
chapter 13 and is required to file Form 706.
    Example 5. On August 1, 1997, A, the insured under a life 
insurance policy, dies. The insurance proceeds on A's life that are 
payable under policies issued by Company X are in the aggregate 
amount of $200,000 and are includible in A's gross estate. Because 
the proceeds are includible in A's gross estate, the generation-
skipping transfer that occurs upon A's death, if any, will be a 
direct skip rather than a taxable distribution or a taxable 
termination. Accordingly, because the aggregate amount of insurance 
proceeds with respect to Company X is less than $250,000, Company X 
may pay the proceeds without regard to whether the beneficiary is a 
skip person in relation to the decedent-transferor.

    (3) Limitation on personal liability of trustee. Except as provided 
in paragraph (c)(3)(iii) of this section, a trustee is not personally 
liable for any increases in the tax imposed by section 2601 which is 
attributable to the fact that--
    (i) A transfer is made to the trust during the life of the 
transferor for which a gift tax return is not filed; or
    (ii) The inclusion ratio with respect to the trust, determined by 
reference to the transferor's gift tax return, is erroneous, the actual 
inclusion ratio being greater than the reported inclusion ratio.
    (iii) This paragraph (c)(3) does not apply if the trustee has or is 
deemed to have knowledge of facts sufficient to reasonably conclude 
that a gift tax return was required to be filed or that the inclusion 
ratio is erroneous. A trustee is deemed to have knowledge of such facts 
if the trustee's agent, employee, partner, or co-trustee has knowledge 
of such facts.
    (4) Exceptions--(i) Legal or mental incapacity. If a distributee is 
legally or mentally incapable of making a return, the return may be 
made for the distributee by the distributee's guardian or, if no 
guardian has been appointed, by a person charged with the care of the 
distributee's person or property.
    (ii) Returns made by fiduciaries. See section 6012(b) for a 
fiduciary's responsibilities regarding the returns of decedents, 
returns of persons under a disability, returns of estates and trusts, 
and returns made by joint fiduciaries.
    (d) Time and manner of filing return--(1) In general. Forms 706, 
706NA, 706GS(D), 706GS(D-1), 706GS(T), 709, and Schedule R-1 of Form 
706 must be filed with the Internal Revenue Service office with which 
an estate or gift tax return of the transferor must be filed. The 
return shall be filed--
    (i) Direct skip. In the case of a direct skip, on or before the 
date on which an estate or gift tax return is required to be filed with 
respect to the transfer (see section 6075(b)(3)); and
    (ii) Other transfers. In all other cases, on or before the 15th day 
of the 4th month after the close of the calendar year in which such 
transfer occurs. See paragraph (d)(2) of this section for an exception 
to this rule when an election is made under section 2624(c) to value 
property included in certain taxable terminations in accordance with 
section 2032.
    (2) Exception for alternative valuation of taxable termination. In 
the case of a taxable termination with respect to which an election is 
made under section 2624(c) to value property in accordance with section 
2032, a Form 706GS(T) must be filed on or before the 15th day of the 
4th month after the close of the calendar year in which the taxable 
termination occurred, or on or before the 10th month following the 
month in which the death that resulted in the taxable termination 
occurred, whichever is later.
    (e) Place for filing returns. See section 6091 for the place for 
filing any return, declaration, statement, or other document, or copies 
thereof, required by chapter 13.
    (f) Lien on property. The liens imposed under sections 6324, 6324A, 
and 6324B are applicable with respect to the tax imposed under chapter 
13. Thus, a lien under section 6324 is imposed in the amount of the tax 
imposed by section 2601 on all property transferred in a generation-
skipping transfer until the tax is fully paid or becomes uncollectible 
by reason of lapse of time. The lien attaches at the time of the 
generation-skipping transfer and is in addition to the lien for taxes 
under section 6321.


Sec. 26.2663-1  Recapture tax under section 2032A.

    See Sec. 26.2642-4(a)(4) for rules relating to the recomputation of 
the applicable fraction and the imposition of additional GST tax, if 
additional estate tax is imposed under section 2032A.


Sec. 26.2663-2  Application of chapter 13 to transfers by nonresidents 
not citizens of the United States.

    (a) In general. This section provides rules for applying chapter 13 
of the Internal Revenue Code to transfers by a transferor who is a 
nonresident not a citizen of the United States (NRA transferor). For 
purposes of this section, an individual is a resident or citizen of the 
United States if that individual is a resident or citizen of the United 
States under the rules of chapter 11 or 12 of the Internal Revenue 
Code, as the case may be. Every NRA transferor is allowed a GST 
exemption of $1,000,000. See Sec. 26.2632-1 regarding the allocation of 
the exemption.
    (b) Transfers subject to chapter 13--(1) Direct skips. A transfer 
by a NRA transferor is a direct skip subject to chapter 13 only to the 
extent that the transfer is subject to the Federal estate or gift tax 
within the meaning of Sec. 26.2652-1(a)(2). See Sec. 26.2612-1(a) for 
the definition of direct skip.
    (2) Taxable distributions and taxable terminations. Chapter 13 
applies to a taxable distribution or a taxable termination to the 
extent that the initial transfer of property to the trust by a NRA 
transferor, whether during life or at death, was subject to the Federal 
estate or gift tax within the meaning of Sec. 26.2652-1(a)(2). See 
Sec. 26.2612-1(b) for the definition of a taxable termination and 
Sec. 26.2612-1(c) for the definition of a taxable distribution.
    (c) Trusts funded in part with property subject to chapter 13 and 
in part with property not subject to chapter 13--(1) In general. If a 
single trust created by a NRA transferor is in part subject to chapter 
13 under the rules of paragraph (b) of this section and in part not 
subject to chapter 13, the applicable fraction with respect to the 
trust is determined as of the date of the transfer, except as provided 
in paragraph (c)(3) of this section.
    (i) Numerator of applicable fraction. The numerator of the 
applicable fraction is the sum of the amount of GST exemption allocated 
to the trust (if any) plus the value of the nontax portion of the 
trust.
    (ii) Denominator of applicable fraction. The denominator of the 
applicable fraction is the value of the property transferred to the 
trust reduced as provided in Sec. 26.2642-1(c).
    (2) Nontax portion of the trust. The nontax portion of a trust is a 
fraction, the numerator of which is the value of property not subject 
to chapter 13 

[[Page 66925]]
determined as of the date of the initial completed transfer to the 
trust, and the denominator of which is the value of the entire trust. 
For example, T, a NRA transferor, transfers property that has a value 
of $1,000 to a generation-skipping trust. Of the property transferred 
to the trust, property having a value of $200 is subject to chapter 13 
and property having a value of $800 is not subject to chapter 13. The 
nontax portion is .8 ($800 (the value of the property not subject to 
chapter 13) over $1,000 (the total value of the property transferred to 
the trust).
    (3) Special rule with respect to the estate tax inclusion period. 
For purposes of this section, the provisions of Sec. 26.2632-1(c), 
providing rules applicable in the case of an estate tax inclusion 
period (ETIP), apply only if the property transferred by the NRA 
transferor is subsequently included in the transferor's gross estate. 
If the property is not subsequently included in the gross estate, then 
the nontax portion of the trust and the applicable fraction are 
determined as of the date of the initial transfer. If the property is 
subsequently included in the gross estate, then the nontax portion and 
the applicable fraction are determined as of the date of death.
    (d) Examples. The following examples illustrate the provisions of 
this section. In each example T, a NRA, is the transferor; C is T's 
child; and GC is C's child and a grandchild of T:

    Example 1. Direct transfer to skip person. T transfers property 
to GC in a transfer that is subject to Federal gift tax under 
chapter 12 within the meaning of Sec. 26.2652-1(a)(2). At the time 
of the transfer, C and GC are NRAs. T's transfer is subject to 
chapter 13 because the transfer is subject to gift tax under chapter 
12.
    Example 2. Transfers of both U.S. and foreign situs property. 
(i) T's will established a testamentary trust for the benefit of C 
and GC. The trust was funded with stock in a publicly traded U.S. 
corporation having a value on the date of T's death of $100,000, and 
property not situated in the United States (and therefore not 
subject to estate tax) having a value on the date of T's death of 
$400,000.
    (ii) On a timely filed estate tax return (Form 706NA), the 
executor of T's estate allocates $50,000 of GST exemption under 
section 2632(a) to the trust. The numerator of the applicable 
fraction is $450,000, the sum of $50,000 (the amount of exemption 
allocated to the trust) plus $400,000 (the value of the nontax 
portion of the trust (4/5 x $500,000)). The denominator is $500,000. 
Hence, the applicable fraction with respect to the trust is .9 
($450,000/$500,000), and the inclusion ratio is .1 (1 - 9/10).
    Example 3. Inter vivos transfer of U.S. and foreign situs 
property to a trust and a timely allocation of GST exemption. T 
establishes a trust providing that trust income is payable to T's 
child for life and the remainder is to be paid to T's grandchild. T 
transfers property to the trust that has a value of $100,000 and is 
subject to chapter 13. T also transfers property to the trust that 
has a value of $300,000 but is not subject to chapter 13. T 
allocates $100,000 of exemption to the trust on a timely filed 
United States Gift (and Generation-Skipping Transfer) Tax return 
(Form 709). The applicable fraction with respect to the trust is 1, 
determined as follows: $300,000 (the value of the nontax portion of 
the trust) plus $100,000 (the exemption allocated to the trust)/ 
$400,000 (the total value of the property transferred to the trust).
    Example 4. Inter vivos transfer of U.S. and foreign situs 
property to a trust and a late allocation of GST exemption. (i) In 
1996, T transfers $500,000 of property to an inter vivos trust the 
terms of which provide that income is payable to C, for life, with 
the remainder to GC. The property transferred to the trust consists 
of property subject to chapter 13 that has a value of $400,000 on 
the date of the transfer and property not subject to chapter 13 that 
has a value of $100,000. T does not allocate GST exemption to the 
trust. On the transfer date, the nontax portion of the trust is .2 
($100,000/$500,000) and the applicable fraction is also .2 
determined as follows: $100,000 (the value of the nontax portion of 
the trust)/$500,000 (the value of the property transferred to the 
trust).
    (ii) In 1999, when the value of the trust is $800,000, T 
allocates $100,000 of GST exemption to the trust. The applicable 
fraction of the trust must be recomputed. The numerator of the 
applicable fraction is $260,000 ($100,000 (the amount of GST 
exemption allocated to the trust)) plus $160,000 (the value of the 
nontax portion of the trust as of the date of allocation (.2 x 
$800,000)). The denominator of the applicable fraction is $800,000. 
Accordingly, the applicable fraction with respect to the trust after 
the allocation is .325 ($260,000/$800,000) and the inclusion ratio 
is .675 (1 - .325).
    Example 5. Taxable termination. The facts are the same as in 
Example 4 except that, in 2006, when the value of the property is 
$1,200,000, C dies and the trust corpus is distributed to GC. The 
termination is a taxable termination. If no further GST exemption 
has been allocated to the trust, the applicable fraction remains 
.325 and the inclusion ratio remains .675.
    Example 6. Estate Tax Inclusion Period. (i) T transferred 
property to an inter vivos trust the terms of which provided T with 
an annuity payable for 10 years or until T's prior death. The 
annuity satisfies the definition of a qualified interest under 
section 2702(b). The trust also provided that, at the end of the 
trust term, the remainder will pass to GC or GC's estate. The 
property transferred to the trust consisted of property subject to 
chapter 13 that has a value of $100,000 and property not subject to 
chapter 13 that has a value of $400,000. T allocated $100,000 of GST 
exemption to the trust. If T dies within the 10 year period, the 
value of the trust principal will be subject to inclusion in T's 
gross estate to the extent provided in sections 2103 and 2104(b). 
Accordingly, the ETIP rule under paragraph (c)(3) of this section 
applies.
    (ii) In year 6 of the trust term, T died. At T's death, the 
trust corpus had a value of $800,000, and $500,000 was includible in 
T's gross estate as provided in sections 2103 and 2104(b). Thus, 
$500,000 of the trust corpus is subject to chapter 13 and $300,000 
is not subject to chapter 13. The $100,000 GST exemption allocation 
is effective as of T's date of death. Also, the nontax portion of 
the trust and the applicable fraction are determined as of T's date 
of death. In this case, the nontax portion of the trust is .375, 
determined as follows: $300,000 (the value of the trust not subject 
to chapter 13)/$800,000 (the value of the trust). The numerator of 
the applicable fraction is $400,000, determined as follows: $100,000 
(GST exemption previously allocated to the trust) plus $300,000 (the 
value of the nontax portion of the trust). The denominator of the 
applicable fraction is $800,000. Thus, the applicable fraction with 
respect to the trust is .50, unless additional exemption is 
allocated to the trust by T's executor or the automatic allocation 
rules of Sec. 26.2632-1(d)(2) apply.
    Example 7. The facts are the same as in Example 6 except that T 
survives the termination date of T's retained annuity and the trust 
corpus is distributed to GC. Since the trust was not included in T's 
gross estate, the ETIP rules do not apply. Accordingly, the nontax 
portion of the trust and the applicable fraction are determined as 
of the date of the transfer to the trust. The nontax portion of the 
trust is .80 ($400,000/$500,000). The numerator of the applicable 
fraction is $500,000 determined as follows: $100,000 (GST exemption 
allocated to the trust) plus $400,000 (the value of the nontax 
portion of the trust). Accordingly, the applicable fraction is 1, 
and the inclusion ratio is zero.

     (e) Transitional rule for allocations for transfers made before 
December 27, 1995. If an NRA made a GST (inter vivos or testamentary) 
after December 23, 1992, and before December 27, 1995 that is subject 
to chapter 13 (within the meaning of Sec. 26.2663-2), the NRA will be 
treated as having made a timely allocation of GST exemption to the 
transfer in a calendar year in the order prescribed in section 2632(c). 
Thus, an NRA's unused GST exemption will initially be treated as 
allocated to any direct skips made during the calendar year and then to 
any trusts with respect to which the NRA made transfers during the same 
calendar year and from which a taxable distribution or a taxable 
termination may occur. Allocations within the above categories are made 
in the order in which the transfers occur. Allocations among 
simultaneous transfers within the same category are made pursuant to 
the principles of section 2632(c)(2). This transitional allocation rule 
will not apply if the NRA transferor, or the executor of the NRA's 
estate, as the case may be, elected to have an automatic allocation of 
GST exemption not apply by describing on a timely-filed Form 709 for 
the year of the 

[[Page 66926]]
transfer, or a timely filed Form 706NA, the details of the transfer and 
the extent to which the allocation was not to apply.

PART 301--PROCEDURE AND ADMINISTRATION

    Par. 2. The authority citation for part 301 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805.* * *

    Par. 3. Section 301.9100-7T is amended as follows:
    a. Paragraph (a)(1) is amended in the table by removing both 
entries for ``1431(a)''.
    b. Paragraph (a)(4)(i) is amended in the table by removing the 
entry for ``1431(a)''.
    c. Paragraph (a)(4)(iii) is revised to read as follows:

Sec. 301.9100-7T   Time and manner of making certain elections under 
the Tax Reform Act of 1986.

    (a) * * *
    (4) * * *
    (iii) Freely revocable election. The election described in this 
section under Act section 311(d)(2) is freely revocable.
* * * * *

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

    Par. 4. The authority citation for part 602 continues to read as 
follows:
    Authority: 26 U.S.C. 7805.
    Par. 5. In Sec. 602.101, paragraph (c) is amended by adding entries 
in numerical order in the table to read as follows:


Sec. 602.101 OMB Control numbers.

* * * * *
    (c) * * *

------------------------------------------------------------------------
 CFR part or section where identified and                               
                 described                     Current OMB control No.  
------------------------------------------------------------------------
                                                                        
              *        *        *        *        *                     
26.2601-1.................................  1545-0985                   
                                                                        
                  *        *        *        *        *                 
26.2632-..................................  1545-0985                   
                                                                        
                   *        *        *        *      *                  
26.2642-1.................................  1545-0985                   
26.2642-2.................................  1545-0985                   
26.2642-3.................................  1545-0985                   
26.2642-4.................................  1545-0985                   
                                                                        
                  *        *        *        *        *                 
26.2652-2.................................  1545-0985                   
                                                                        
                  *        *        *        *        *                 
26.2662-2.................................  1545-0985                   
                                                                        
                  *        *        *        *        *                 
------------------------------------------------------------------------


    Approved: December 14, 1995
Michael P. Dolan,
Deputy Commissioner of Internal Revenue.
Leslie Samuels,
Assistant Secretary of the Treasury
 [FR Doc. 95-30873 Filed 12-26-95; 8:45 am]
BILLING CODE 4830-01-U