The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA 2001) added IRC Section 2511(c) to provide for certain transfers in trust in 2010. Some had hoped that the provision would exclude from the gift tax all transfers to a wholly-owned grantor trust in 2010. However, in a recent notice, the IRS states that the EGTRRA 2001 provision for certain transfers in trust in 2010 expands, rather than restricts, the gift tax. Therefore, a transfer made in 2010 to a trust that is not treated as wholly owned by the donor or the donor's spouse under the grantor trust rules is considered a gift of the entire transfer under IRC Section 2511(c).
IRC Section 2511(c) provides specifically for 2010 that, "Notwithstanding any other provision of this section and except as provided in regulations, a transfer in trust shall be treated as a transfer of property by gift, unless the trust is treated as wholly owned by the donor or the donor's spouse under subpart E of part I of subchapter J of chapter 1." Subpart E of part I of subchapter J of chapter 1 is IRC Sections 671 to 679, the grantor trust rules. Under the grantor trust rules, the grantor is taxed on part or all of the trust income for income tax purposes where the grantor is treated as a substantial owner of the trust because of certain interests held by the grantor or the grantor's spouse.
Some commentators have speculated on what IRC Section 2511(c) meant for transfers in trust for 2010. In the notice, the IRS observed that some may have inaccurately concluded that IRC Section 2511(c) would exclude from gift tax a transfer to a trust that is treated as wholly owned by the donor or the donor's spouse under the grantor trust rules, even though such transfers would otherwise have been subject to gift tax. The IRS stated that EGTRRA 2001 did not amend any of the substantive gift tax provisions. Rather, IRC Section 2511(c) expands the transfers subject to gift tax to certain transfers that might have been considered incomplete and, thus, not subject to gift tax. Therefore, a transfer made in 2010 to a trust that is not treated as wholly owned by the donor or the donor's spouse under the grantor trust rules is considered a gift of the entire transfer under IRC Section 2511(c). The IRS intends to issue regulations confirming this conclusion.
The estate tax was repealed for one year in 2010, but the gift tax was not. It is thought that the gift tax was not repealed because, in some ways, the gift tax acts as a backstop for the income tax. If it were not for the gift tax, groups of individuals, especially related individuals, could freely transfer property back and forth between themselves so that income taxes were reduced. For example, property producing taxable income might be temporarily transferred to an individual in a low income tax bracket. The kiddie tax might reduce the income tax savings where the property is transferred to a child under age 19 (24 if a full-time student).
Without IRC Section 2511(c), if there was an incomplete gift to a trust, there would be no transfer for gift tax purposes. Furthermore, in 2010 there would be no estate tax to catch the incomplete gift at death. Without IRC Section 2511(c), if there were an incomplete gift, there would be no gift tax, and if the transfer is to a trust that is not treated as wholly owned by the donor or the donor's spouse under the grantor trust rules there could be income tax shifting to the trust or other beneficiaries. IRC Section 2511(c) seems to be consistent with retention of the gift tax in 2010 and the gift tax acting as a backstop to the income tax by providing that a transfer to a trust in 2010 that might otherwise be considered incomplete is treated as a transfer to the trust for gift tax purposes if the trust income would be taxable to anyone other than the grantor.
Presumably, the IRS merely intends to provide that certain gifts in trust in 2010 that would otherwise have been considered incomplete are treated as complete so as to prevent shifting of income to persons other than the grantor. The use of the phrase "is considered to be a transfer by gift of the entire interest in the property" [emphasis added] may have been unfortunate. Presumably, the regulations will provide that rules for transfers to trust under IRC Section 2702, valuation tables measuring various interests in trust under IRC Section 7520, and split-interest transfers to certain charitable trusts are not affected by IRC Section 2511(c); merely that certain additional transfers in trust in 2010 will be considered complete.
Notice 2010-19, 2010-7 IRB 404
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