IRS Rules on Effectiveness of Gift Splitting Elections with Respect to Gifts to GRATs
When a married couple elects to split gifts for a year in which one spouse funded a grantor retained annuity trust (GRAT), the impact of the gift splitting election may not be fully recognized. Under Internal Revenue Code Section 2513, married couples may elect to split gifts in a given year, allowing a married donor to use both spouses' annual exclusion and remaining applicable exclusion amounts. A gift splitting election automatically applies to all gifts made in the year of the election that are allowed to be split. If a spouse makes a gift in part to his spouse and in part to other beneficiaries, the gift splitting election with respect to the interest transferred to the non-spouse beneficiaries is effective only if the non-spouse beneficiaries' interest is ascertainable at the time of the gift and therefore severable from the interest transferred to the spouse. This limitation applies to gifts made to GRATs, and therefore if a donor and the donor's spouse wish to split gifts for a year in which the donor has funded a GRAT, is important to consider whether the spouse is a beneficiary of the remainder interest of the GRAT.
In June, the IRS issued Private Letter Ruling 201523003, which addresses whether gift splitting elections were effective with respect to certain gifts to GRATs. An individual (Husband) created and later transferred funds to a family trust. The terms of the family trust provided that an independent trustee could make distributions to Husband's spouse (Wife) as well as Husband's descendants. On the same date as the creation of the family trust, Husband also created and funded two GRATs. Both of the GRATs provided that at the end of their annuity terms, the remaining assets would be payable to the family trust. Husband and Wife each filed a gift tax return consenting to split the gifts to the family trust and the GRATs.
In a later year, Husband also created and funded two additional GRATs. At the end of the annuity terms, the remaining assets would also be payable to the family trust. Husband and Wife each filed a gift tax return and again consented to split the gifts to the GRATs.
The private letter ruling held that because Wife's interests in the family trust were "not susceptible of determination" and, therefore, "not severable from the gifts to the other beneficiaries," the gift splitting elections should not have been available with respect to the transfers to the GRATs. However, because the statute of limitations had expired on the transfers to the two GRATs created in the earlier year, the IRS could not deny the gift-splitting with respect to the gifts to those GRATs. The statute of limitations had not expired on the transfer to the two later GRATs and Husband was not precluded from filing a supplemental gift tax return to report the transfers as being solely made by him. The private letter ruling also held that if Husband filed a supplemental gift tax return reporting the later transfers to the GRATs as solely made by him, he could also allocate his available GST exemption to the transfers at the close of the estate tax inclusion period (ETIP) with respect to each of the GRATs.
It is common to structure a GRAT as a "zeroed-out" GRAT that does not result in a taxable gift. While gift splitting does not have a gift tax consequence for zeroed-out GRATs, if a gift splitting election is made in the year of the funding of the GRAT, the spouses will each be treated as transferors for the purpose of allocating GST exemption at the close of the ETIP.
Donors and advisors should be aware that a gift splitting election with respect to a gift to a GRAT may be ineffective if a donor's spouse is a beneficiary of the remainder interest in the GRAT and that interest is not severable from the third party interests. However, if a gift splitting election is incorrectly made with respect to a gift to a GRAT and the statute of limitations expires, the gift will continue to be treated as a split gift. In each case, any allocation of GST exemption to the transfer must be made by the person considered to be the donor of the gift for gift tax purposes.