[Federal Register Volume 72, Number 148 (Thursday, August 2, 2007)]
[Proposed Rules]
[Pages 42340-42344]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-14850]



[[Page 42340]]

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 26

[REG-128843-05]
RIN 1545-BE70


Severance of a Trust for Generation-Skipping Transfer (GST) Tax 
Purposes II

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: These proposed regulations provide guidance regarding the 
generation-skipping transfer (GST) tax consequences of the severance of 
trusts in a manner that is effective under state law, but that does not 
meet the requirements of a qualified severance under section 2642(a)(3) 
of the Internal Revenue Code. These proposed regulations also provide 
guidance regarding the GST tax consequences of a qualified severance of 
a trust with an inclusion ratio between zero and one into more than two 
resulting trusts. These proposed regulations also provide special 
funding rules applicable to the non pro rata division of certain assets 
between or among resulting trusts. The regulations will affect trusts 
that are subject to the GST tax.

DATES: Written or electronic comments and requests for a public hearing 
must be received by October 31, 2007.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-128843-05), room 
5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-
128843-05), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC, or sent electronically, via the Federal 
eRulemaking Portal at http://www.regulations.gov (IRS REG-128843-05).

FOR FURTHER INFORMATION CONTACT: Mayer R. Samuels, (202) 622-3090 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    On August 24, 2004, proposed regulations under section 2642(a)(3) 
regarding qualified severances were published in the Federal Register 
(REG-145987-03, 2004-39 IRB 519, 69 FR 51967). Final regulations were 
published on August 2, 2007. The Treasury Department and the IRS 
determined that certain comments received in response to the proposed 
regulations under section 2642(a)(3) should be addressed in a separate 
notice of proposed rulemaking, instead of in the final regulations 
published on August 2, 2007. Accordingly, this notice of proposed 
rulemaking proposes additional changes to the regulations in response 
to those comments.
    Section 2642(a)(3) was added to the Internal Revenue Code (Code) by 
the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), 
Public Law 107-16 (115 Stat. 38 (2001)). Under section 2642(a)(3), if a 
trust is divided into two or more trusts in a ``qualified severance,'' 
the trusts resulting from the severance (resulting trusts), which may 
have different inclusion ratios, will be recognized as separate trusts 
for GST tax purposes. Once the resulting trusts are recognized as 
separate trusts, the transferor's lifetime GST tax exemption may be 
allocated separately to either trust. In addition, whether or not a GST 
taxable event occurs is determined separately for each resulting trust.
    One commentator with respect to the notice of proposed rulemaking 
under section 2642(a)(3) suggested that those regulations should 
expressly address the GST tax consequences of dividing a trust in a 
manner that does not satisfy the regulatory requirements of a qualified 
severance, but nonetheless is effective to create separate trusts under 
applicable state law. Specifically, the commentator requested that the 
regulations be amended to provide that the separate trusts created as 
the result of a trust's division that is effective under state law, but 
that does not qualify as a qualified severance, will be respected 
prospectively as separate trusts for GST tax purposes, but that the 
inclusion ratio of each of the resulting trusts will be the same as the 
inclusion ratio of the original trust immediately before its severance.
    As noted by a commentator, however, such a result would require an 
amendment to the existing regulations under section 2654. Generally, 
section 2654(b)(2) provides that ``substantially separate and 
independent shares'' of different beneficiaries in a trust will be 
treated as separate trusts for GST tax purposes. Section 26.2654-
1(a)(1)(i) provides that, for purposes of section 2654(b)(2), the term 
``substantially separate and independent shares'' generally has the 
same meaning as provided in Sec.  1.663(c)(3). However, these 
regulations further provide that a portion of a trust is not a separate 
share ``unless such share exists from and at all times after creation 
of the trust.''
    Section 26.2654-1(a)(5), Example 8, illustrates this rule. In 
Example 8, T creates a discretionary trust with discretionary power in 
the trustee to distribute income and principal among T's children and 
grandchildren. The trust agreement directs that, when T's youngest 
child reaches age 21, the trust be divided into separate shares, with 
one such share for each child of T; the income from a particular share 
is to be paid to T's child (for whom that share was created) for life, 
with the remainder from that share to be distributed to that child's 
own children. The example concludes that the separate shares that come 
into existence when the youngest child reaches age 21 are not 
recognized as separate trusts for GST tax purposes because the separate 
shares did not constitute separate and independent shares of a single 
trust at all times from the date of creation of the original trust, as 
required by Sec.  26.2654-1(a)(1). Thus, any allocation of GST tax 
exemption to the original trust, or to any of the separate shares after 
the division, will apply with respect to the entire trust. The example 
provides that the result would be the same if the original trust was 
divided into separate trusts rather than separate shares.
    Another commentator with respect to the notice of proposed 
rulemaking under section 2642(a)(3) requested that the regulations 
provide additional flexibility in severing a trust that has an 
inclusion ratio between zero and one. Generally, the final regulations 
apply section 2642(a)(3)(B)(ii) by requiring that the trust first be 
severed into two identical trusts, one of which would then have an 
inclusion ratio of zero and the other an inclusion ratio of one. The 
final regulations confirm that either or both of these trusts may then 
be further severed into a trust for the benefit of the skip person(s) 
and a trust for the benefit of the non-skip person(s). However, under 
this two-step procedure, one of the resulting trusts for the benefit of 
skip persons would have an inclusion ratio of one, and one of the 
trusts for the benefit of the non-skip persons would have an inclusion 
ratio of zero. The commentator requested that the regulations allow 
severances in a manner that would permit a more effective utilization 
of the exemption.
    The Treasury Department and the IRS believe that each of these 
suggestions merits further consideration in a new notice of proposed 
rulemaking. In addition, the new proposed regulations clarify the rules 
in the final regulations regarding the funding of resulting trusts.

[[Page 42341]]

Explanation of Provisions

    The proposed regulations amend the regulations under Sec.  26.2642-
6 to provide that trusts resulting from a severance that does not meet 
the requirements of a qualified severance nevertheless will be treated, 
after the severance, as separate trusts for GST tax purposes, provided 
that the resulting trusts are recognized as separate trusts under 
applicable state law. Because the severance is not a qualified 
severance, each such resulting trust will have the same inclusion ratio 
immediately after the severance as the original trust immediately 
before the severance. Nevertheless, GST tax exemption allocated after 
the severance may be separately allocated to one or more of the 
resulting trusts and the trusts will otherwise be treated as separate 
trusts for GST tax purposes. An example of a nonqualified severance is 
added to the regulations.
    The proposed regulations also revise Sec.  26.2654-1(a)(1)(i) and 
(a)(5), Example 8.
    In addition, pursuant to the authority granted in section 
2642(a)(3)(B)(iii), these proposed regulations provide for an 
additional type of qualified severance. Specifically, the proposed 
regulations provide that a trust with an inclusion ratio between zero 
and one may be severed in a qualified severance into more than two 
resulting trusts. One or more of the resulting trusts in the aggregate 
must receive that fractional share of the total value of the original 
trust as of the date of severance that is equal to the applicable 
fraction used to determine the inclusion ratio of the original trust 
immediately before the severance. The trust or trusts receiving such 
fractional share shall have an inclusion ratio of zero, and each of the 
other resulting trust or trusts shall have an inclusion ratio of one. 
Further, the trustee may designate the beneficiary of each separate 
resulting trust, provided that the designation results in each 
beneficiary having the same beneficial interest (within the meaning of 
Sec.  26.2642-6(d)(5)) after the severance as that beneficiary had in 
the original trust corpus. Guidance illustrating the application of 
this rule is included in Sec.  26.2642-6(d)(7)(ii) and Example 9 of 
Sec.  26.2642-6(j) of these proposed regulations.
    Finally, these proposed regulations clarify a provision of the 
final regulations issued contemporaneously with these proposed 
regulations. Specifically, Sec.  26.2642-6(d)(4) requires that each 
resulting trust be funded with a fraction or percentage of the entire 
trust and that, although particular assets may be divided among the 
resulting trusts on a non pro rata basis based on the fair market value 
of the assets on the date of severance, the sum of those fractions or 
percentages must be one or one hundred percent, respectively. Thus, if 
the resulting trusts are funded on a non pro rata basis, the sum of the 
values distributed to the resulting trusts must equal the fair market 
value of the trust being severed. These proposed regulations clarify 
that no discounts or other reductions from the value of an asset owned 
by the original trust, arising by reason of the division of the 
original trust's interest in the asset between or among the resulting 
trusts, are permitted in funding the resulting trusts. Instead, solely 
for funding purposes, each resulting trust's interest in the stock of a 
closely held corporation, partnership interest, or other single asset 
must be valued by multiplying the fair market value of the asset held 
in the original trust as of the date of severance by the fractional or 
percentage interest in that asset being distributed to that resulting 
trust. This clarification is proposed to be effective with respect to 
severances occurring on or after the date these proposed regulations 
are published in the Federal Register.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It also has 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) applies only to Sec.  26.2642-6(d)(7)(ii) of these 
regulations. It is hereby certified that this provision will not have a 
significant economic impact on a substantial number of small entities. 
Accordingly, a Regulatory Flexibility Analysis is not required. This 
provision directly affects individuals, not entities. Because the 
remaining sections of these regulations do not impose on small entities 
a collection of information requirement, the Regulatory Flexibility Act 
(5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the 
Code, this notice of proposed rulemaking will be submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on its impact on small business.

Comments and Requests for Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and eight 
(8) copies) or electronic comments that are submitted timely to the 
IRS. The IRS and Treasury Department request comments on the substance 
of the proposed regulations, as well as on the clarity of the proposed 
rules and how they may be made easier to understand. All comments will 
be available for public inspection and copying. A public hearing will 
be scheduled if requested in writing by any person that timely submits 
written comments. If a public hearing is scheduled, notice of the date, 
time, and place for the public hearing will be published in the Federal 
Register.

Drafting Information

    The principal author of these proposed regulations is Mayer R. 
Samuels, Office of the Associate Chief Counsel (Passthroughs and 
Special Industries), IRS. Other personnel from the IRS and the Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 26

    Estate taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 26 is proposed to be amended as follows:

PART 26--GENERATION-SKIPPING TRANSFER TAX REGULATIONS UNDER THE TAX 
REFORM ACT OF 1986

    Paragraph 1. The authority citation for part 26 continues to read 
in part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 2. In Sec.  26.2600-1, the table of contents is amended by 
adding the entry for Sec.  26.2642-6(h) to read as follows:


Sec.  26.2600-1  Table of contents.

* * * * *


Sec.  26.2642-6  Qualified severance.

* * * * *
    (h) Treatment of trusts resulting from a severance that is not a 
qualified severance.
* * * * *
    Par. 3. Section 26.2642-6 is amended as follows:
    1. Paragraphs (d)(4) and (d)(7) are revised.
    2. Paragraph (h) is added.
    3. Paragraph (j) Examples 6, 9, 12 and 13 are added.
    4. Paragraph (k)(1) is revised.
    The additions and revisions read as follows:


Sec.  26.2642-6  Qualified severance.

* * * * *

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    (d) * * *
    (4) The single trust (original trust) is severed on a fractional 
basis, such that each new trust (resulting trust) is funded with a 
fraction or percentage of the original trust, and the sum of those 
fractions or percentages is one or one hundred percent, respectively. 
For this purpose, the fraction or percentage may be determined by means 
of a formula (for example, that fraction of the trust the numerator of 
which is equal to the transferor's unused GST tax exemption, and the 
denominator of which is the fair market value of the original trust's 
assets on the date of severance). The severance of a trust based on a 
pecuniary amount does not satisfy this requirement. For example, the 
severance of a trust is not a qualified severance if the trust is 
divided into two trusts, with one trust to be funded with $1,500,000 
and the other trust to be funded with the balance of the original 
trust's assets. With respect to the particular assets to be distributed 
to each resulting trust, each resulting trust may be funded with the 
appropriate fraction or percentage (pro rata portion) of each asset 
held by the original trust. Alternatively, the assets may be divided 
among the resulting trusts on a non-pro rata basis, based on the fair 
market value of the assets on the date of severance. However, if a 
resulting trust is funded on a non-pro rata basis, each asset received 
by a resulting trust must be valued, solely for funding purposes, by 
multiplying the fair market value of the asset held in the original 
trust as of the date of severance by the fraction or percentage of that 
asset received by that resulting trust. Thus, the assets must be valued 
without taking into account any discount or premium arising from the 
severance, for example, any valuation discounts that might arise 
because the resulting trust receives less than the entire interest held 
by the original trust. See paragraph (j), Example 6 of this section.
* * * * *
    (7) In the case of a qualified severance occurring after GST tax 
exemption has been allocated to the trust (whether by an affirmative 
allocation, a deemed allocation, or an automatic allocation pursuant to 
the rules contained in section 2632), if the trust has an inclusion 
ratio as defined in Sec.  26.2642-1 that is greater than zero and less 
than one, then either paragraph (d)(7)(i) or (ii) of this section must 
be satisfied.
    (i) The trust is severed initially into only two resulting trusts. 
One resulting trust must receive that fractional share of the total 
value of the original trust as of the date of severance that is equal 
to the applicable fraction, as defined in Sec.  26.2642-1(b) and (c), 
used to determine the inclusion ratio of the original trust immediately 
before the severance. The other resulting trust must receive that 
fractional share of the total value of the original trust as of the 
date of severance that is equal to the excess of one over the 
fractional share described in the preceding sentence. The trust 
receiving the fractional share equal to the applicable fraction shall 
have an inclusion ratio of zero, and the other trust shall have an 
inclusion ratio of one. If the applicable fraction with respect to the 
original trust is .50, then, with respect to the two equal trusts 
resulting from the severance, the Trustee may designate which of the 
resulting trusts will have an inclusion ratio of zero and which will 
have an inclusion ratio of one. Each separate trust resulting from the 
severance then may be further divided in accordance with the rules of 
this section. See paragraph (j), Example 7 of this section.
    (ii) The trust is severed initially into more than two resulting 
trusts. One or more of the resulting trusts in the aggregate must 
receive that fractional share of the total value of the original trust 
as of the date of severance that is equal to the applicable fraction 
used to determine the inclusion ratio of the original trust immediately 
before the severance. The trust or trusts receiving such fractional 
share shall have an inclusion ratio of zero, and each of the other 
resulting trust or trusts shall have an inclusion ratio of one. (If, 
however, two or more of the resulting trusts each receives the 
fractional share of the total value of the original trust equal to the 
applicable fraction, the trustee may designate which of those resulting 
trusts will have an inclusion ratio of zero and which will have an 
inclusion ratio of one.) The resulting trust or trusts with an 
inclusion ratio of one must receive in the aggregate that fractional 
share of the total value of the original trust as of the date of 
severance that is equal to the excess of one over the fractional share 
described in the second sentence of this paragraph. See paragraph (j), 
Example 9 of this section.
* * * * *
    (h) Treatment of trusts resulting from a severance that is not a 
qualified severance. Trusts resulting from a severance (other than a 
severance under Sec.  26.2654-1) that does not meet the requirements of 
a qualified severance under paragraph (b) of this section will be 
treated, after the date of severance, as separate trusts for purposes 
of the generation-skipping transfer (GST) tax, provided that the trusts 
resulting from such severance are recognized as separate trusts under 
applicable state law. The post-severance treatment of the resulting 
trusts as separate trusts for GST tax purposes generally permits the 
allocation of GST tax exemption, the making of various elections 
permitted for GST tax purposes, and the occurrence of a taxable 
distribution or termination with regard to a particular resulting 
trust, with no GST tax impact on any other trust resulting from that 
severance. Each trust resulting from a severance described in this 
paragraph, however, will have the same inclusion ratio immediately 
after the severance as that of the original trust immediately before 
the severance. (See Sec.  26.2654-1 for the inclusion ratio of each 
trust resulting from a severance described in that section.)
* * * * *
    (j) * * *

    Example 6. Funding of severed trusts on a non-pro rata basis. 
T's will establishes an irrevocable trust, Trust, for the benefit of 
T's descendants. As a result of the allocation of GST tax exemption, 
the applicable fraction with respect to Trust is .60 and Trust's 
inclusion ratio is .40 [1-.60]. Pursuant to authority granted under 
applicable state law, on August 1, 2008, the trustee executes a 
document severing Trust into two trusts, Trust 1 and Trust 2, each 
of which is identical to Trust. The instrument of severance provides 
that the severance is intended to qualify as a qualified severance 
within the meaning of section 2642(a)(3) and designates August 3, 
2008, as the date of severance (within the meaning of paragraph 
(d)(3) of this section). The instrument further provides that Trust 
1 and Trust 2 are to be funded on a non-pro rata basis with Trust 1 
funded with assets having a fair market value on the date of 
severance equal to 40% of the value of Trust's assets on that date 
and Trust 2 funded with assets having a fair market value equal to 
60% of the value of Trust's assets on that date. The fair market 
value of the assets used to fund each trust is to be determined in 
compliance with the requirements of paragraph (d)(4) of this 
section. On August 3, 2008, the fair market value of the Trust 
assets totals $4,000,000, consisting of 52% of the outstanding 
common stock in Company, a closely-held corporation, valued at 
$3,000,000 and $1,000,000 in cash and marketable securities. Trustee 
proposes to divide the Company stock equally between Trust 1 and 
Trust 2, and thus transfer 26% of the Company stock to Trust 1 and 
26% of the stock to Trust 2. In addition, the appropriate amount of 
cash and marketable securities will be distributed to each trust. In 
accordance with paragraph (d)(4) of this section, for funding 
purposes, the interest in the Company stock distributed to each 
trust is valued as a pro rata portion of the value of the 52% 
interest in Company held by Trust before severance, without taking 
into account, for example, any valuation discount that might 
otherwise apply in valuing the noncontrolling interest

[[Page 42343]]

distributed to each resulting trust. Accordingly, for funding 
purposes, each 26% interest in Company stock distributed to Trust 1 
and Trust 2 is valued at $1,500,000 (.5 x $3,000,000). Therefore, 
Trust 1, which is to be funded with $1,600,000 (.40 x $4,000,000), 
receives $100,000 in cash and marketable securities valued as of 
August 3, 2008, in addition to the Company stock, and Trust 2, which 
is to be funded with $2,400,000 (.60 x $4,000,000), receives 
$900,000 in cash and marketable securities in addition to the 
Company stock. Therefore, the severance is a qualified severance, 
provided that all other requirements of section 2642(a)(3) and this 
section are satisfied.
* * * * *
    Example 9. Regulatory qualified severance. In 2004, T 
establishes an inter vivos irrevocable trust (Trust) providing that 
Trust income is to be paid annually in equal shares to T's children, 
A and B, for 10 years. If either (or both) dies prior to the 
expiration of the 10-year term, the deceased child's share of trust 
income is to be paid to the child's then living descendants, per 
stirpes, for the balance of the trust term. At the expiration of the 
10-year trust term, the corpus is to be distributed equally to A and 
B; if A and B (or either or them) is not then living, then such 
decedent's share is to be distributed instead to such decedent's 
then living descendants, per stirpes. T allocates GST tax exemption 
to Trust such that Trust's applicable fraction is .25 and its 
inclusion ratio is .75. In 2006, pursuant to applicable state law, 
the trustee severs the trust into three trusts: Trust 1, Trust 2, 
and Trust 3. The instrument severing Trust provides that Trust 1 is 
to receive 50% of Trust's assets, Trust 2 is to receive 25% of 
Trust's assets, and Trust 3 is to receive 25% of Trust's assets. All 
three resulting trusts are identical to Trust, except that each has 
different beneficiaries: A and A's issue are designated as the 
beneficiaries of Trust 1, and B and B's issue are designated as the 
beneficiaries of Trust 2 and Trust 3. The severance constitutes a 
qualified severance, provided that all other requirements of section 
2642(a)(3) and this section are satisfied. Trust 1 will have an 
inclusion ratio of 1. Because both Trust 2 and Trust 3 have each 
received the fractional share of Trust's assets equal to Trust's 
applicable fraction of .25, trustee designates that Trust 2 will 
have an inclusion ratio of one and that Trust 3 will have an 
inclusion ratio of zero.
* * * * *
    Example 12. Mandatory severance that does not qualify as a 
qualified severance. In 1996, T creates an irrevocable inter vivos 
trust (Trust) that provides the trustee with the discretionary power 
to distribute income or corpus from time to time to one or more of 
T's children and grandchildren. Trust provides that, when T's 
youngest child reaches age 30, Trust is to be divided equally into 
separate trusts (resulting trusts), with one resulting trust for 
each child of T who is then living, and one resulting trust for each 
child of T who is then deceased and who has then living descendants. 
The income from a child's resulting trust will be paid to that child 
during the child's life, with the remainder passing to such child's 
descendants (grandchildren and younger generation descendants of T). 
On a timely filed Form 709, ``United States Gift (and Generation-
Skipping Transfer) Tax Return,'' reporting the transfer, T allocates 
all of T's remaining GST tax exemption to Trust. As a result of the 
allocation, the applicable fraction with respect to Trust is .20, so 
Trust's inclusion ratio is .80 [1 -.20]. T's youngest child reaches 
age 30 in 2008. (No additional gifts are made through 2008 and 
Trust's inclusion ratio does not change.) In accordance with Trust's 
terms, Trust is divided in 2008 into three separate trusts (Trust 1, 
Trust 2, and Trust 3), one trust for each of T's three children, 
each of whom is then living. Trust 1, Trust 2, and Trust 3 are each 
recognized as a separate trust under applicable state law. With the 
consent of all interested parties, each resulting trust is funded 
with assets different from the assets distributed to the other two 
resulting trusts in a manner that does not meet the requirements of 
paragraph (d)(3) of this section. As a result, the severance does 
not satisfy the requirements of a qualified severance under this 
section. Under paragraph (h) of this section, however, Trust 1, 
Trust 2, and Trust 3 are each recognized as a separate trust for GST 
tax purposes prospectively from the date of severance, because the 
severance was effective to create three separate trusts under 
applicable state law. Therefore, after the severance, if T becomes 
entitled to any additional GST tax exemption pursuant to subsequent 
changes in applicable Federal tax law, T may allocate that 
additional GST tax exemption to any one or more of these three 
resulting trusts. Because the severance is not a qualified 
severance, however, the inclusion ratio of each of the three new 
trusts immediately after the severance will be .80, the same as 
Trust's inclusion ratio immediately before the severance.
    Example 13. Other severance that does not qualify as a qualified 
severance. In 2004, T establishes an irrevocable inter vivos trust 
(Trust) providing that Trust income is to be paid to T's children, A 
and B, in equal shares for their joint lives. Upon the death of the 
first to die of A and B, all Trust income will be paid to the 
survivor of A and B. At the death of the survivor, the corpus is to 
be distributed in equal shares to T's grandchildren, W and X (with 
any then-deceased grandchild's share being paid in accordance with 
that grandchild's testamentary general power of appointment). W is 
A's child and X is B's child. T elects under section 2632(c)(5) not 
to have the automatic allocation rules contained in section 2632(c) 
apply with respect to T's transfers to Trust, and T does not 
otherwise allocate GST tax exemption to Trust. In 2006, the trustee 
of Trust, as permitted by applicable state law, divides Trust into 
two separate trusts, Trust 1 and Trust 2. Trust 1 provides that 
trust income is to be paid to A for life and, on A's death, the 
remainder is to be distributed to W (or pursuant to W's testamentary 
general power of appointment). Trust 2 provides that trust income is 
to be paid to B for life and, on B's death, the remainder is to be 
distributed to X (or pursuant to X's testamentary general power of 
appointment). Because Trust 1 and Trust 2 do not provide A and B 
with the contingent survivor income interests that were provided to 
A and B under the terms of Trust, Trust 1 and Trust 2 do not provide 
for the same succession of interests in the aggregate as provided by 
Trust. Therefore, the severance does not satisfy the requirements of 
this section and is not a qualified severance. However, under 
paragraph (h) of this section, provided that Trust 1 and Trust 2 are 
recognized as separate trusts under applicable state law, Trust 1 
and Trust 2 will be recognized as separate trusts for GST tax 
purposes, prospectively from the date of the severance. Trust 1 and 
Trust 2 each have the same inclusion ratio immediately after the 
severance as Trust's inclusion ratio immediately before the 
severance.

    (k) * * *
    (1) In general. Except as otherwise provided, this section applies 
to severances occurring on or after August 2, 2007. Paragraph 
(d)(7)(ii), paragraph (h), and Examples 9, 12, and 13 of paragraph (j) 
of this section apply to severances occurring on or after [DATE THIS 
DOCUMENT IS PUBLISHED IN THE Federal Register AS FINAL REGULATIONS]. 
Paragraph (d)(4) and Example 6 of paragraph (j) apply to severances 
occurring on or after August 2, 2007.
    Par. 4. Section 26.2654-1 is amended as follows:
    1. Paragraph (a)(1)(i) is revised.
    2. A new paragraph (a)(1)(iii) is added.
    3. In paragraph (a)(5), Example 8 is revised.
    The additions and revisions read as follows:


Sec.  26.2654-1  Certain trusts treated as separate trusts.

    (a) Single trust treated as separate trusts--(1) Substantially 
separate and independent shares--(i) In general. If a single trust 
consists solely of substantially separate and independent shares for 
different beneficiaries, the share attributable to each beneficiary (or 
group of beneficiaries) is treated as a separate trust for purposes of 
chapter 13. The phrase ``substantially separate and independent 
shares'' generally has the same meaning as provided in Sec.  1.663(c)-3 
of this chapter. However, except as provided in paragraph (a)(1)(iii) 
of this section, a portion of a trust is not a separate share unless 
such share exists from and at all times after the creation of the 
trust. For purposes of this paragraph (a)(1), a trust is treated as 
created at the date of death of the grantor if the trust is includible 
in its entirety in the grantor's gross estate for Federal estate tax 
purposes. Further, treatment of a single trust as separate trusts under 
this paragraph (a)(1) does

[[Page 42344]]

not permit treatment of those portions as separate trusts for purposes 
of filing returns and payment of tax or for purposes of computing any 
other tax imposed under the Internal Revenue Code. Also, additions to, 
and distributions from, such trusts are allocated pro rata among the 
separate trusts, unless the governing instrument expressly provides 
otherwise. See Sec.  26.2642-6 and paragraph (b) of this section 
regarding the treatment, for purposes of chapter 13, of separate trusts 
resulting from the actual severance of a single trust.
* * * * *
    (iii) Mandatory severances. For purposes of this section, if the 
governing instrument of a trust requires the division or severance of a 
single trust into separate trusts upon the future occurrence of a 
particular event not within the discretion of the trustee or any other 
person, and if the trusts resulting from such a division or severance 
are recognized as separate trusts under applicable state law, then each 
resulting trust is treated as a separate trust for purposes of chapter 
13. For this purpose, the rules of paragraph (b)(1)(ii)(C) of this 
section apply with respect to the severance and funding of the trusts. 
Similarly, if the governing instrument requires the division of a 
single trust into separate shares under the circumstances described in 
this paragraph, each such resulting share is treated as a separate 
trust for purposes of chapter 13. The post-severance treatment of the 
resulting trusts or shares as separate trusts for GST tax purposes 
generally permits the allocation of GST tax exemption, the making of 
various elections permitted for GST tax purposes, and the occurrence of 
a taxable distribution or termination with regard to a particular 
resulting trust or share, with no GST tax impact on any other trust or 
share resulting from that severance. The treatment of a single trust as 
separate trusts under this paragraph (a)(1), however, does not permit 
treatment of those portions as separate trusts for purposes of filing 
returns and payment of tax or for purposes of computing any other tax 
imposed under the Internal Revenue Code. Also, additions to, and 
distributions from, such trusts are allocated pro rata among the 
separate trusts, unless the governing instrument expressly provides 
otherwise. Each separate share and each trust resulting from a 
mandatory division or severance described in this paragraph will have 
the same inclusion ratio immediately after the severance as that of the 
original trust immediately before the division or severance.
* * * * *
    (5) * * *

    Example 8. Subsequent mandatory division into separate trusts. T 
creates an irrevocable trust that provides the trustee with the 
discretionary power to distribute income or corpus to T's children 
and grandchildren. The trust provides that, when T's youngest child 
reaches age 21, the trust will be divided into separate shares, one 
share for each child of T. The income from a respective child's 
share will be paid to the child during the child's life, with the 
remainder passing on the child's death to such child's children 
(grandchildren of T). The separate shares that come into existence 
when the youngest child reaches age 21 will be recognized as of that 
date as separate trusts for purposes of Chapter 13. Any allocation 
of GST tax exemption to the trust after T's youngest child reaches 
age 21 may be made to any one or more of the separate shares. The 
result would be the same if the trust instrument provided that the 
trust was to be divided into separate trusts when T's youngest child 
reached age 21, provided that the severance and funding of the 
separate trusts meets the requirements of this section.
* * * * *

Linda E. Stiff,
Acting Deputy Commissioner for Services and Enforcement.
 [FR Doc. E7-14850 Filed 8-1-07; 8:45 am]
BILLING CODE 4830-01-P