the proceeds of the distribution, or the taxes were paid by the trustee out of trust monies which are paid over directly to the Government. In the case of a taxable termination, the tax base equaled (1) the value of the trust property in which an interest has terminated and/or (2) the value of the property which was the subject of a power (where a power had terminated).

Neither the deemed transferor nor his or her estate was liable for the tax imposed under these provisions. Generally, the tax was paid out of the proceeds of the trust property. In the case of a taxable distribution, however, the distributee of the property was personally liable for the tax to the extent of the fair market value of the property which he or she received (determined as of the date of the distribution). In the case of a taxable termination, the trustee was personally liable for the tax. However, the trustee was permitted to file a request with the Internal Revenue Service for information concerning the transfer tax rate bracket of the deemed transferor. Where the transfer was to a grandchild of the grantor of the trust, the trustee could have also requested information concerning the extent to which the $250,000 exclusion of the deemed transferor had not been fully utilized. The trustee was not liable for tax to the extent that any shortfall in the payment of the tax ultimately determined to be due resulted from the trustee's reliance on the information supplied by the Internal Revenue Service, in response to either of these requests.

Credit for State taxes

Because the generation-skipping transfer tax was calculated by reference to the transfer tax history of the deemed transferor, the generation-skipping trust was entitled to any unused portion of the deemed transferor's credit for state death taxes.

No specific credit was provided with respect to the payment of state generation-skipping transfer taxes.

Coordination with other provisions

Estate tax

To the extent consistent with the specific provisions concerning generation-skipping transfers, the rules of the Code relating to the gift tax applied in cases where the deemed transferor was alive at the time of the generation-skipping transfer, and the rules relating to the estate tax applied where the generation-skipping transfer occurred at or after the death of the deemed transferor.

To the extent that transfers were subject to the generation-skipping transfer tax as a result of the death of the deemed transferor, prior law permitted utilization of the unused estate tax deductions and credits of the deemed transferor. Thus, the generation-skipping transfer tax was calculated after taking into account such items as the unified credit, the State death tax credit, the previously taxed property credit, and remaining deductions for charitable bequests and administration expenses actually paid by the trust.

The alternate valuation date was available where a taxable termination occurred as a result of the death of the deemed transferor. In this case, the election to use the alternate valuation date was made by the trustee of the generation-skipping trust (who was also

the person liable for the tax under these circumstances); it was not required that the executor of the deemed transferor's estate also elect that provision.

Income tax

Where certain rights to income were subject to the tax on generation-skipping transfers, the income tax treatment of so-called "income in respect of a decedent" could have applied to this income. Thus, the recipient of this income was entitled to a deduction (in computing income tax on this income) for the generationskipping transfer tax in the same way as that recipient is allowed a deduction for the estate tax imposed on these items (sec. 691(c)). Also, where a generation-skipping transfer which was subject to tax occurred as a result of the death of the deemed transferor, section 303 treatment, which permits certain tax-free redemptions of stock to pay estate tax, was available. The trust and the actual estate of the deemed transferor were treated separately for purposes of the section 303 qualification requirements.

Reasons for Change

The Congress believed, as it stated when the generation-skipping transfer tax originally was enacted in 1976, that the purpose of the three transfer taxes (gift, estate, and generation-skipping) was not only to raise revenue, but also to do so in a manner that has as nearly as possible a uniform effect. This policy is best served when transfer tax consequences do not vary widely depending on whether property is transferred outright to immediately succeeding generations or is transferred in ways that skip generations. The Congress determined that the present generation-skipping transfer tax was unduly complicated. Therefore, the Congress determined that this tax should be replaced with a simplified tax, determined at a flat rate. The Act accomplishes Congress' goal of simplified administration while ensuring that transfers having a similar substantial effect will be subject to tax in a similar manner.

Overview

Explanation of Provisions

The Act amends the existing generation-skipping transfer tax, which attempted to determine the additional gift or estate tax that would have been paid if property had been transferred directly from one generation to another, to impose a simplified tax determined at a flat rate. The generation-skipping transfer tax is expanded to include direct generation-skipping transfers (e.g., a direct transfer from a grandparent to a grandchild) as well as transfers (subject to tax under the prior tax) in which benefits are "shared" by beneficiaries in more than one younger generation.

Transfers of up to $1 million per grantor are exempt from tax. Additional exemptions are provided for certain transfers that are not subject to gift tax and for direct transfers to grandchildren of the transferor before 1990 if the aggregate amount of such transfers does not exceed $2 million per grandchild.

Imposition of tax

As under prior law, a generation-skipping transfer is defined as a transfer to a beneficiary at least two generations younger than the transferor. Thus, only transfers to grandchildren or younger generations are subject to tax. Generation-skipping transfers are subject to tax whether in trust, pursuant to an arrangement similar to a trust, or outright.

In general, the Act retains the prior-law rules on generation assignment, except that lineal descendants of the grandparents of the transferor's spouse also are assigned to generations on a basis like that for such descendants of the transferor.

Taxable events

A generation-skipping transfer tax is imposed on the occurrence of any one of three events-a taxable distribution, a taxable termination, or a direct skip.

The first two events generally involve transfers that were taxable under prior law. A taxable distribution occurs upon distribution of property to a generation-skipping beneficiary (e.g., a grandchild). A taxable termination occurs upon the expiration of an interest in a trust if, after that termination, all interests in the trust are held by generation-skipping beneficiaries. Persons holding interests in property are defined to include only those persons having a current right to property (or income therefrom) or persons who are current permissible recipients of the property (or income therefrom). For example, a person having an income interest for life or a holder of a general power of appointment is treated as having an interest in property.

A direct skip occurs upon an outright transfer for the benefit of a person at least two generations below the transferor or a transfer of property to a trust for one or more such beneficiaries. As described in the Overview, an example of a direct skip is a gift from a grandparent to his or her grandchild.

Effect of disclaimers

A disclaimer that results in property passing to a person at least two generations below that of the original transferor results in imposition of the generation-skipping transfer tax. For example, if a child of a decedent makes a qualified disclaimer, and, under local law, the disclaimed property passes to the grandchildren of the decedent, a generation-skipping transfer tax is imposed on the transfer (in addition to any estate tax to which the transfer is subject). The disclaimed property, rather than the decedent's estate generally, is primarily liable for payment of the generation-skipping transfer tax.

Tax on income distributions

Unlike prior law, the Act provides that generation-skipping distributions from a trust are subject to tax whether the distributions carry out trust income or trust corpus. However, an income tax deduction is allowed to the recipient for the generation-skipping transfer tax imposed on the distribution.

Tax on trusts providing for generation-skipping transfers to more than one younger generation

A single trust may provide for transfers to more than one generation of generation-skipping beneficiaries. For example, a trust may provide for income payments to the grantor's child for life, then for such payments to the grantor's grandchild, and finally for distribution of the trust property to the grantor's great-grandchild. Were such property left outright to each such generation, the property would be subject to gift or estate tax a total of three times. Under the Act, the property likewise is subject to transfer tax a total of three times-gift or estate tax on the original transfer and generation-skipping transfer tax on the transfers to the grandchild and the great-grandchild.

Exemptions from tax

$1 million exemption

The Act provides an exemption of up to $1 million for each person making generation-skipping transfers. In the case of transfers by a married individual, the individual and his or her spouse may elect to treat the transfer as made one half by each spouse. In addition, an individual may allocate all or a portion of his or her specific exemption to property with respect to which a generationskipping transfer will occur upon its disposition by (or on the death of) the transferor's spouse as a result of an election to treat that property as qualified terminable interest property (QTIP property). (See secs. 2056(b)(7) and 2523(f)). Once a transfer, or portion of a transfer, is designated as exempt, all subsequent appreciation in value of the exempt property also is exempt from generation-skipping transfer tax.

The operation of the specific exemption may be illustrated by the following example. Assume a grantor transfers $1 million in trust for the benefit of his or her children and grandchildren. If the grantor allocates $1 million of exemption to the trust, no part of the trust will ever be subject to generation-skipping transfer taxeven if the value of the trust property appreciates in subsequent years to $10 million or more. On the other hand, if the grantor allocates only $500,000 of exemption to the trust, one-half of all distributions to grandchildren will be subject to tax and one-half of the trust property will be subject to tax on termination of the children's interest. If, after creation of the trust, the grantor allocates an additional $250,000 of exemption to the trust, the exempt_portion of trust will be redetermined, based upon the values of the trust property at that time. This new inclusion ratio applies to future distributions and terminations, but generally does not change the tax treatment of any past events.

Exemption for nontaxable gifts

The generation-skipping transfer tax does not apply to any inter vivos transfer which is exempt from gift tax pursuant to either the $10,000 annual exclusion or the special exclusion for certain tuition and medical expense payments.

Special exemption for certain direct skips to grandchildren A special exemption from the generation-skipping transfer tax is provided for certain direct skips (either in trust or otherwise) to grandchildren of the grantor prior to 1990. For each grantor, this special exemption is limited to $2 million per grandchild. As is true with taxable generation-skipping transfers and taxable gifts, married individuals may elect to treat these exempt transfers as made one-half by each spouse.

Special exemption for certain other transfers to grandchildren The Act also provides a special rule on generation assignment for grandchildren of the grantor when a grandchild's parent who is a lineal descendant of the grantor is deceased. In such a case, the grandchild and all succeeding lineal descendants of the grandchild are "moved up" a generation. Thus, transfers to such grandchild are not taxed as generation-skipping transfers.

Computation of tax

Rate of tax

The rate of tax on generation-skipping transfers is equal to the maximum gift and estate tax rate. Thus, the tax rate is 55 percent until 1988, when it is scheduled to decline to 50 percent.

Tax base and payment of tax

The tax base and method of paying the generation-skipping transfer tax generally parallels the method applicable to the most closely analogous transfer subject to gift or estate tax. Generationskipping transfers, therefore, are taxed as follows:

Taxable distributions.-The amount subject to tax is the amount received by the transferee (i.e., the tax is imposed on a "tax-inclusive" basis). The transferee pays the tax on a taxable distribution. (If a trustee pays any amount of the tax, the trustee is treated as making an additional taxable distribution of that amount.)

Taxable terminations.-The amount subject to tax is the value of the property in which the interest terminates (i.e., the tax is imposed on a "tax-inclusive" basis). The trustee pays the tax on a taxable termination.

Direct skips.-The amount subject to tax is the value (net of tax) of the property received by the transferee (i.e., the tax is imposed "tax-exclusive" basis). The person making the transfer pays the tax on a direct skip.

Credit for State taxes

A credit not exceeding five percent of the amended Federal generation skipping transfer tax is allowed for generation-skipping transfer tax imposed by a State with respect to taxable transfers occurring by reason of death.

Coordination with other provisions

The Act also includes several provisions coordinating the generation-skipping transfer tax with the gift and estate taxes. The Code provisions governing administration of the gift and estate taxes also apply to the amended generation-skipping transfer tax. Estate