Understanding the Generation-Skipping Transfer Tax (GSTT)
Navigating the intricacies of estate planning, you may come across the concept of the generation-skipping transfer tax (GSTT), an important tax that affects the distribution of wealth across multiple generations. This tax impacts how large sums of money and assets are passed down, often to grandchildren or individuals who are at least one generation removed from the donor. Here’s a breakdown of the GST and how it functions in estate planning.
What is the Generation-Skipping Transfer Tax?
The principle of the generation-skipping tax is relatively straightforward. Typically, taxes are levied when wealth transfers upon death, with estate taxes affecting trusts established for the benefit of immediate offspring and subsequent generations. However, prior to legislative changes, once a trust beneficiary died, the assets within the trust bypassed estate taxation, as the beneficiary did not “own” the assets as per estate tax requirements.
To prevent affluent families from circumventing estate taxes through such trusts, Congress enacted the Generation-Skipping Transfer Tax (GSTT) in 1986. The GSTT ensures assets considered “not owned” for estate tax purposes are “deemed owned” for GST purposes and imposes a transfer tax, specifically the GST tax, when assets shift from children to future generations.
This tax rate aligns with the highest estate tax rate. Each individual is granted a “GST exemption”—an amount that can be transferred without invoking the GST, currently at $13,610,000, the same amount as the unified credit. It should be noted that the GST exemption and the unified credit serve different purposes; the former prevents GST tax on transfers to further generations, whereas the latter shields against estate tax when assets pass to immediate heirs.
Key Questions to Demystify the GST
When unpacking the GST, several questions arise to better understand its application.
Identification of the Transferor
The transferor could be:
- The individual making a gift
- The last individual by whose estate the assets are subject to estate tax
Generational Level Assignments and “Skip Persons”
After pinpointing the transferor, it’s crucial to determine each person’s generational level relative to the transferor. Individuals one generation level below the transferor may include adult children receiving assets, whereas “skip persons”—those two or more generations below—often reference grandchildren.
For instance, a father places assets in a trust for his son, which are later passed on to the grandchildren. If the son has the discretion to direct assets at his death and chooses not to, the grandchildren become one generation level below him, thus reassigning the generation-skipping event.
There are rules guiding generational-level assignments, especially when the relations are non-linear or when significant age gaps exist between the transferor and recipients. Intricacies lie in scenarios where relatives are of disparate ages, spouses, or from different familial branches.
Confirmation of a Generation-Skipping Transfer
Generation-skipping transfers can be classified into three types:
- Taxable terminations
- Taxable distributions
- Direct skips
A taxable termination generally occurs when a trust designated for a non-skip person, like a child, concludes, and the assets proceed to a skip person, potentially a grandchild. A taxable distribution involves discretionary trust distributions made to skip persons, such as grandchildren, while the non-skip person, typically the child, is still living. Lastly, a direct skip directly transfers assets to a skip person, typically during the donor’s lifetime.
Exceptions to the GST
Payments made directly to a doctor for the benefit of a skip person, or to pay for health insurance for a skip person, is not subject to the GST. Similarly, any payments made directly to a school for the tuition of a skip person is not subject to the GST.
An annual exclusion gift outright to a skip person is not subject to the GST. An annual exclusion gift to a trust for a skip person is not subject to the GST only if: (a) the trust is solely for the benefit of that skip person; and (b) when that skip person dies the trust will be subject to estate tax.
By imposing the GST rules, Congress allows one free generational transfer, but not more.
Conclusion
Learning how the generation-skipping transfer tax operates is key in structuring your estate plans efficiently and ensuring wealth distribution aligns with your wishes and legal parameters. It’s a tax designed to not only facilitate order in the passage of wealth across generations but also to maintain fairness in tax burdens across familial lines.
For estate planners, understanding the GST requires thoughtful consideration of not just who inherits the wealth, but also how and when they receive it to minimize the tax impact. As tax laws evolve, staying informed and seeking professional guidance is the most effective strategy to protect and preserve wealth for generations to come.