IRS Issues Guidance on Gift Tax Consequences of Transfers in Trust

The IRS on Tuesday clarified for taxpayers that despite the provisions of IRC § 2511(c), the gift tax continues to apply to certain transfers to a wholly owned grantor trust (Notice 2010-19). Some taxpayers had interpreted section 2511(c) to exclude from gift tax all transfers in trust where the trust is wholly owned by the donor or the donor’s spouse. The notice says the IRS plans to issue further guidance on this topic.

Gift tax generally applies to both direct and indirect transfers (IRC § 2511(a)). Under section 2511(c), a transfer in trust is treated as a gift “unless the trust is treated as wholly owned by the donor or the donor’s spouse.” Section 2511(c) is effective for transfers after Dec. 31, 2009, and before Jan. 1, 2011.

According to the IRS, some taxpayers have interpreted section 2511(c) to mean that any transfer to a trust treated as wholly owned by the donor or the donor’s spouse is excluded from gift tax, even though the gift would otherwise be subject to gift tax. The IRS clarified in Notice 2010-19 that section 2511(c) broadens the scope of the gift tax to include transfers that might otherwise be considered an incomplete gift or would not have been treated as a transfer under the gift tax provisions in effect before 2010. It does not serve to exclude certain transfers in trust that would otherwise be subject to gift tax; the substantive gift tax provisions continue to apply in 2010.