[Code of Federal Regulations]
[Title 26, Volume 14]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR26.2642-1]

[Page 717-718]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 26_GENERATION-SKIPPING TRANSFER TAX REGULATIONS UNDER THE TAX REFORM ACT OF 1986--Table of Contents
 
Sec.  26.2642-1  Inclusion ratio.

    (a) In general. Except as otherwise provided in this section, the 
inclusion ratio is determined by subtracting the applicable fraction 
(rounded to the nearest one-thousandth (.001)) from 1. In rounding the 
applicable fraction to the nearest one-thousandth, any amount that is 
midway between one one-thousandth and another one-thousandth is rounded 
up to the higher of those two amounts.
    (b) Numerator of applicable fraction--(1) In general. Except as 
otherwise provided in this paragraph (b), and in Sec. Sec.  26.2642-3 
(providing a special rule for charitable lead annuity trusts) and 
26.2642-4 (providing rules for the redetermination of the applicable 
fraction), the numerator of the applicable fraction is the amount of GST 
exemption allocated to the trust (or to the transferred property in the 
case of a direct skip not in trust).
    (2) GSTs occurring during an ETIP--(i) In general. For purposes of 
determining the inclusion ratio with respect to a taxable termination or 
a taxable distribution that occurs during an ETIP, the numerator of the 
applicable fraction is the sum of--
    (A) The GST exemption previously allocated to the trust (including 
any allocation made to the trust prior to any taxable termination or 
distribution) reduced (but not below zero) by the nontax amount of any 
prior GSTs with respect to the trust; and
    (B) Any GST exemption allocated to the trust on a timely ETIP return 
filed after the termination of the ETIP. See Sec.  26.2632-1(c)(5) 
Example 2.
    (ii) Nontax amount of a prior GST. (1) The nontax amount of a prior 
GST with respect to the trust is the amount of the GST multiplied by the 
applicable fraction attributable to the trust at the time of the prior 
GST.
    (2) For rules regarding the allocation of GST exemption to property 
during an ETIP, see Sec.  26.2632-1(c).
    (c) Denominator of applicable fraction--(1) In general. Except as 
otherwise provided in this paragraph (c) and in Sec. Sec.  26.2642-3 and 
26.2642-4, the denominator of the applicable fraction is the value of 
the property transferred to the trust (or transferred in a direct skip 
not in trust) (as determined under Sec.  26.2642-2) reduced by the sum 
of--
    (i) Any Federal estate tax and any State death tax incurred by 
reason of the transfer that is chargeable to the trust and is actually 
recovered from the trust;
    (ii) The amount of any charitable deduction allowed under section 
2055, 2106, or 2522 with respect to the transfer; and
    (iii) In the case of a direct skip, the value of the portion of the 
transfer that is a nontaxable gift. See paragraph (c)(3) of this section 
for the definition of nontaxable gift.
    (2) Zero denominator. If the denominator of the applicable fraction 
is zero, the inclusion ratio is zero.
    (3) Nontaxable gifts. Generally, for purposes of chapter 13, a 
transfer is a nontaxable gift to the extent the transfer is excluded 
from taxable gifts by reason of section 2503(b) (after application of 
section 2513) or section 2503(e). However, a transfer to a trust for the 
benefit of an individual is not a nontaxable gift for purposes of this 
section unless--
    (i) Trust principal or income may, during the individual's lifetime, 
be distributed only to or for the benefit of the individual; and
    (ii) The assets of the trust will be includible in the gross estate 
of the individual if the individual dies before the trust terminates.
    (d) Examples. The following examples illustrate the provisions of 
this section. See Sec.  26.2652-2(d) Examples 2 and 3 for illustrations 
of the computation of the inclusion ratio where the special (reverse 
QTIP) election may be applicable.

    Example 1. Computation of the inclusion ratio. T transfers $100,000 
to a newly-created irrevocable trust providing that income is to

[[Page 718]]

be accumulated for 10 years. At the end of 10 years, the accumulated 
income is to be distributed to T's child, C, and the trust principal is 
to be paid to T's grandchild. T allocates $40,000 of T's GST exemption 
to the trust on a timely-filed gift tax return. The applicable fraction 
with respect to the trust is .40 ($40,000 (the amount of GST exemption 
allocated to the trust) over $100,000 (the value of the property 
transferred to the trust)). The inclusion ratio is .60 (1 - .40). If the 
maximum Federal estate tax rate is 55 percent at the time of a GST, the 
rate of tax applicable to the transfer (applicable rate) will be .333 
(55 percent (the maximum estate tax rate) x .60 (the inclusion ratio)).
    Example 2. Gift entirely nontaxable. On December 1, 1996, T 
transfers $10,000 to an irrevocable trust for the benefit of T's 
grandchild, GC. GC possesses a right to withdraw any contributions to 
the trust such that the entire transfer qualifies for the annual 
exclusion under section 2503(b). Under the terms of the trust, the 
income is to be paid to GC for 10 years or until GC's prior death. Upon 
the expiration of GC's income interest, the trust principal is payable 
to GC or GC's estate. The transfer to the trust is a direct skip. T made 
no prior gifts to or for the benefit of GC during 1996. The entire 
$10,000 transfer is a nontaxable transfer. For purposes of computing the 
tax on the direct skip, the denominator of the applicable fraction is 
zero, and thus, the inclusion ratio is zero.
    Example 3. Gift nontaxable in part. T transfers $12,000 to an 
irrevocable trust for the benefit of T's grandchild, GC. Under the terms 
of the trust, the income is to be paid to GC for 10 years or until GC's 
prior death. Upon the expiration of GC's income interest, the trust 
principal is payable to GC or GC's estate. Further, GC has the right to 
withdraw $10,000 of any contribution to the trust such that $10,000 of 
the transfer qualifies for the annual exclusion under section 2503(b). 
The amount of the nontaxable transfer is $10,000. Solely for purposes of 
computing the tax on the direct skip, T's transfer is divided into two 
portions. One portion is equal to the amount of the nontaxable transfer 
($10,000) and has a zero inclusion ratio; the other portion is $2,000 
($12,000 - $10,000). With respect to the $2,000 portion, the denominator 
of the applicable fraction is $2,000. Assuming that T has sufficient GST 
exemption available, the numerator of the applicable fraction is $2,000 
(unless T elects to have the automatic allocation provisions not apply). 
Thus, assuming T does not elect to have the automatic allocation not 
apply, the applicable fraction is one ($2,000/$2,000 = 1) and the 
inclusion ratio is zero (1 - 1 = 0).
    Example 4. Gift nontaxable in part. Assume the same facts as in 
Example 3, except T files a timely Form 709 electing that the automatic 
allocation of GST exemption not apply to the $12,000 transferred in the 
direct skip. T's transfer is divided into two portions, a $10,000 
portion with a zero inclusion ratio and a $2,000 portion with an 
applicable fraction of zero (0/$2,000 = 0) and an inclusion ratio of one 
(1 - 0 = 1).