United States Estate (and Generation-Skipping Transfer) Tax Return

Dividing Direct Skips Between Schedules R and R-1

Report all generation-skipping transfers on Schedule R unless the rules below specifically provide that they are to be reported on Schedule R-1.

Under section 2603(a)(2), the GST tax on direct skips from a trust (as defined for GST tax purposes above) is to be paid by the trustee and not by the estate. Schedule R-1 serves as a notification from the executor to the trustee that a GST tax is due.

For a direct skip to be reportable on Schedule R-1, the trust must be includible in the decedent's gross estate.

If the decedent was the surviving spouse life beneficiary of a marital deduction power of appointment (or QTIP) trust created by the decedent's spouse, then transfers caused by reason of the decedent's death from that trust to skip persons are direct skips required to be reported on Schedule R-1.

If a direct skip is made from a trust under these rules, it is reportable on Schedule R-1 even if it is also made to a trust rather than to an individual.

Similarly, if property in a trust (as defined for GST tax purposes on page 19) is included in the decedent's gross estate under section 2035, 2036, 2037, 2038, 2039, 2041, or 2042 and such property is, by reason of the decedent's death, transferred to skip persons, the transfers are direct skips required to be reported on Schedule R-1.

Special rule for trusts other than explicit trusts. An explicit trust is a trust as defined in Regulations section 301.7701-4(a) as an arrangement created by a will or by an inter vivos declaration whereby trustees take title to property for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules applied in chancery or probate courts. Direct skips from explicit trusts are required to be reported on Schedule R-1 regardless of their size unless the executor is also a trustee (see below).

Direct skips from trusts that are trusts for GST tax purposes but are not explicit trusts are to be shown on Schedule R-1 only if the total of all tentative maximum direct skips from the entity is $250,000 or more. If this total is less than $250,000, the skips should be shown on Schedule R. For purposes of the $250,000 limit, tentative maximum direct skips is the amount you would enter on line 5 of Schedule R-1 if you were to file that schedule.

A liquidating trust (such as a bankruptcy trust) under Regulations section 301.7701-4(d) is not treated as an explicit trust for the purposes of this special rule.

If the proceeds of a life insurance policy are includible in the gross estate and are payable to a beneficiary who is a skip person, the transfer is a direct skip from a trust that is not an explicit trust. It should be reported on Schedule R-1 if the total of all the tentative maximum direct skips from the company is $250,000 or more. Otherwise, it should be reported on Schedule R.

Similarly, if an annuity is includible on Schedule I and its survivor benefits are payable to a beneficiary who is a skip person, then the estate tax value of the annuity should be reported as a direct skip on Schedule R-1 if the total tentative maximum direct skips from the entity paying the annuity is $250,000 or more.

Executor as trustee. If any of the executors of the decedent's estate are trustees of the trust, then all direct skips with respect to that trust must be shown on Schedule R and not on Schedule R-1 even if they would otherwise have been required to be shown on Schedule R-1. This rule applies even if the trust has other trustees who are not executors of the decedent's estate.

How To Complete Schedules R and R-1

Valuation. Enter on Schedules R and R-1 the estate tax value of the property interests subject to the direct skips. If you elected alternate valuation (section 2032) and/or special use valuation (section 2032A), you must use the alternate and/or special use values on Schedules R and R-1.

How To Complete Schedule R

Part 1 - GST exemption reconciliation. Part 1, line 6 of both Parts 2 and 3, and line 4 of Schedule R-1 are used to allocate the decedent's GST exemption. This allocation is made by filing Form 706. Once made, the allocation is irrevocable. You are not required to allocate all of the decedent's GST exemption. However, the portion of the exemption that you do not allocate will be allocated by the IRS under the deemed allocation at death rules of section 2632(e).

The amount of the GST exemption is indexed to inflation for transfers made after 1998. For generation-skipping transfers made through 1998, the amount of the exemption is $1 million. The amount of each Inflation adjustment can only be allocated to transfers made (or appreciation that occurred) during or after the year of the increase.

For example, the exemption for 1999 was $1,010,000. This $10,000 increase over the 1998 exemption can only be allocated to transfers made during or after 1999. For generation-skipping transfers made in 2000, the exemption was $1,030,000, and for 2001, the exemption is $1,060,000. The IRS will announce future exemption amounts in an annual revenue procedure.

The following example shows the application of this rule.

Example. In 1997, G made a direct skip of $1 million and applied her full $1 million of GST exemption to the transfer. G made a $10,000 taxable direct skip in 1998 and no GST transfers in 1999. In 2000, G made a direct skip of $40,000. G cannot apply any exemption to the 1998 transfer, but she can apply $30,000 to the 2000 transfer ($10,000 inflation adjustment from 1999 and another $20,000 adjustment in 2000). In 2001, G made a $20,000 direct skip. She can apply $20,000 of the $30,000 inflation adjustment for 2001 to her 2001 transfer, but nothing to the transfer made in 2000. At the end of 2001, G would have $10,000 of exemption that she can apply to future transfers.

Special QTIP election. In the case of property for which a marital deduction is allowed to the decedent's estate under section 2056(b)(7) (QTIP election), section 2652(a)(3) allows you to treat such property for purposes of the GST tax as if the election to be treated as qualified terminable interest property had not been made.

The 2652(a)(3) election must include the value of all property in the trust for which a QTIP election was allowed under section 2056(b)(7).

If a section 2652(a)(3) election is made, then the decedent will for GST tax purposes be treated as the transferor of all the property in the trust for which a marital deduction was allowed to the decedent's estate under section 2056(b)(7). In this case, the executor of the decedent's estate may allocate part or all of the decedent's GST exemption to the property.

You make the election simply by listing qualifying property on line 9 of Part 1.

Line 2. These allocations will have been made either on Forms 709 filed by the decedent or on Notices of Allocation made by the decedent for inter vivos transfers that were not direct skips but to which the decedent allocated the GST exemption. These allocations by the decedent are irrevocable.

Also include on this line allocations deemed to have been made by the decedent under the rules of section 2632. Unless the decedent elected out of the deemed allocation rules, allocations are deemed to have been made in the following order:

1. To intervivos direct skips, and
2. Beginning with transfers made after December 31, 2000, to lifetime transfers to certain trusts, by the decedent, that constituted indirect skips that were subject to the gift tax.

For more information, see section 2632

Line 3. Make an entry on this line if you are filing Form(s) 709 for the decedent and wish to allocate any exemption.

Lines 4, 5, and 6. These lines represent your allocation of the GST exemption to direct skips made by reason of the decedent's death. Complete Parts 2 and 3 and Schedule R-1 before completing these lines.

Line 9. Line 9 is used to allocate the remaining unused GST exemption (from line 8) and to help you compute the trust's inclusion ratio. Line 9 is a Notice of Allocation for allocating the GST exemption to trusts as to which the decedent is the transferor and from which a generation-skipping transfer could occur after the decedent's death.

If line 9 is not completed, the deemed allocation at death rules will apply to allocate the decedent's remaining unused GST exemption, first to property that is the subject of a direct skip occurring at the decedent's death, and then to trusts as to which the decedent is the transferor. If you wish to avoid the application of the deemed allocation rules, you should enter on line 9 every trust (except certain trusts entered on Schedule R-1, as described below) to which you wish to allocate any part of the decedent's GST exemption. Unless you enter a trust on line 9, the unused GST exemption will be allocated to it under the deemed allocation rules.

If a trust is entered on Schedule R-1, the amount you entered on line 4 of Schedule R-1 serves as a Notice of Allocation and you need not enter the trust on line 9 unless you wish to allocate more than the Schedule R-1, line 4 amount to the trust. However, you must enter the trust on line 9 if you wish to allocate any of the unused GST exemption amount to it. Such an additional allocation would not ordinarily be appropriate in the case of a trust entered on Schedule R-1 when the trust property passes outright (rather than to another trust) at the decedent's death. However, where section 2032A property is involved it may be appropriate to allocate additional exemption amounts to the property. See the instructions for line 10.

Note: To avoid application of the deemed allocation rules, Form 706 and Schedule R should be filed to allocate the exemption to trusts that may later have taxable terminations or distributions under section 2612 even if the form is not required to be filed to report estate or GST tax.

Line 9, column C. Enter the GST exemption included on lines 2 through 6 of Part 1 of Schedule R, and discussed above, that was allocated to the trust.

Line 9, column D. Allocate the amount on line 8 of Part l of Schedule R in line 9, column D. This amount may be allocated to transfers into trusts that are not otherwise reported on Form 706. For example, the line 8 amount may be allocated to an inter vivos trust established by the decedent during his or her lifetime and not included in the gross estate. This allocation is made by identifying the trust on line 9 and making an allocation to it using column D. If the trust is not included in the gross estate, value the trust as of the date of death. You should inform the trustee of each trust listed on line 9 of the total GST exemption you allocated to the trust. The trustee will need this information to compute the GST tax on future distributions and terminations.

Line 9, column E - trust's inclusion ratio. The trustee must know the trust's inclusion ratio to figure the trust's GST tax for future distributions and terminations. You are not required to inform the trustee of the inclusion ratio and may not have enough information to compute it. Therefore, you are not required to make an entry in column E. However, column E and the worksheet below are provided to assist you in computing the inclusion ratio for the trustee if you wish to do so.

You should inform the trustee of the amount of the GST exemption you allocated to the trust. Line 9, columns C and D may be used to compute this amount for each trust.

This worksheet will compute an accurate inclusion ratio only if the decedent was the only settlor of the trust. You should use a separate worksheet for each trust (or separate share of a trust that is treated as a separate trust).

WORKSHEET (inclusion ratio for trust):

Line 10 - Special use allocation. For skip persons who receive an interest in section 2032A special use property, you may allocate more GST exemption than the direct skip amount to reduce the additional GST tax that would be due when the interest is later disposed of or qualified use ceases. See Schedule A-1 of this Form 706 for more details about this additional GST tax.

Enter on line 10 the total additional GST exemption you are allocating to all skip persons who received any interest in section 2032A property. Attach a special use allocation schedule listing each such skip person and the amount of the GST exemption allocated to that person.

If you do not allocate the GST exemption, it will be automatically allocated under the deemed allocation at death rules. To the extent any amount is not so allocated it will be automatically allocated (under regulations to be published) to the earliest disposition or cessation that is subject to the GST tax. Under certain circumstances, post-death events may cause the decedent to be treated as a transferor for purposes of Chapter 13.

Line 10 may be used to set aside an exemption amount for such an event. You must attach a schedule listing each such event and the amount of exemption allocated to that event.

Parts 2 and 3. Use Part 2 to compute the GST tax on transfers in which the property interests transferred are to bear the GST tax on the transfers. Use Part 3 to report the GST tax on transfers in which the property interests transferred do not bear the GST tax on the transfers.

Section 2603(b) requires that unless the governing instrument provides otherwise, the GST tax is to be charged to the property constituting the transfer. Therefore, you will usually enter all of the direct skips on Part 2.

You may enter a transfer on Part 3 only if the will or trust instrument directs, by specific reference, that the GST tax is not to be paid from the transferred property interests.

Part 2 - Line 3. Enter zero on this line unless the will or trust instrument specifies that the GST taxes will be paid by property other than that constituting the transfer (as described above). Enter on line 3 the total of the GST taxes shown on Part 3 and Schedule(s) R-1 that are payable out of the property interests shown on Part 2, line 1.

Part 2 - Line 6. Do not enter more than the amount on line 5. Additional allocations may be made using Part 1.

Part 3 - Line 3. See the instructions to Part 2, line 3, above. Enter only the total of the GST taxes shown on Schedule(s) R-1 that are payable out of the property interests shown on Part 3, line 1.

Part 3 - Line 6. See the instructions to Part 2, line 6, above.

How To Complete Schedule R-1

Filing due date. Enter the due date of Schedule R, Form 706. You must send the copies of Schedule R-1 to the fiduciary by this date.

Line 4. Do not enter more than the amount on line 3. If you wish to allocate an additional GST exemption, you must use Schedule R, Part 1. Making an entry on line 4 constitutes a Notice of Allocation of the decedent's GST exemption to the trust.

Line 6. If the property interests entered on line 1 will not bear the GST tax, multiply line 6 by 55% (.55).

Signature. The executor(s) must sign Schedule R-1 in the same manner as Form 706. See Signature and Verification on page 2.

Filing Schedule R-1. Attach to Form 706 one copy of each Schedule R-1 that you prepare. Send two copies of each Schedule R-1 to the fiduciary.

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