The U.S. generation-skipping transfer tax (“GSTT”) imposes a tax on both outright gifts and transfers in trust to or for the benefit of unrelated persons who are more than 37.5 years younger than the donor or to related persons more than one generation younger than the donor, such as grandchildren.Wikipedia
Consider Tom, who has one son, Sam, and one grandson (Sam’s son), George. Tom wants the wealth he has accumulated over his lifetime to benefit his family for as long as possible, but he is concerned about the potential estate and gift tax consequences of passing his assets to future generations. If Tom gifts his assets during his lifetime and/or leaves them upon his death to Sam, then Tom (or his estate) may owe gift taxes and/or estate taxes on the transfer(s). Years later, Sam may be in the same position that Tom is in now, and if Sam then gifts or leaves the remaining assets (along with any additional wealth that Sam accumulates during his lifetime) to George, then a second taxable transfer may occur. Tom will have to pay the tax on the transfer to Sam, and Sam will have to pay the tax on the transfer to George.
However, Tom has a bright idea—if he leaves the bulk of his estate to George (perhaps even in a trust that makes income distributions to Sam during his lifetime), then he will have successfully passed his wealth to his grandson’s generation with only one potentially taxable transfer. In this scenario, Tom’s transfer would “skip” Sam’s generation. Such a transfer is known as a “generation-skipping” transfer.
What is the Generation-Skipping Transfer Tax?
Prior to 1976, wealthy individuals were able to minimize the taxes on the transfer of their wealth by making generation-skipping transfers such as the one described above. Since 1976, however, the generation-skipping transfer tax (“GSTT”) has been imposed on such transfers. The GSTT is applied in addition to any gift or estate tax that may be applied to a transfer. The current GSTT tax rate is 40% on any amount transferred over the generation-skipping transfer tax exemption amount (discussed below).
What is a Generation-Skipping Transfer?
Technically speaking, a generation-skipping transfer is any transfer involving a “skip person.” With respect to persons who are related, a “skip person” is any person who is more than one generation below the transferor, such as the transferor’s grandchildren or more-distant descendants. In the familial context, it is possible for a skip person to “step-up” a generation and become a non-skip person if the skip person’s parent predeceases the transferor. Going back to the example at the start of this blog post, if Sam were to predecease Tom and George, then George would no longer be considered a skip person with respect to a transfer from Tom because George would “step-up” into his father’s (Sam’s) generation. With respect to unrelated persons, a “skip person” is any person who is at least 37 ½ years younger than the transferor. A trust may also be treated as a “skip person” if all of the beneficiaries of the trust are skip persons.
Generation-skipping transfers generally occur in one of two ways. A direct transfer (or “direct skip”) occurs when a transferor transfers property directly to a skip person (e.g., Tom transfers his property to George or to a trust of which George is the only beneficiary). An indirect transfer (or “indirect skip”) occurs when a non-skip person is also involved, which is often the case with respect to transfers to a trust. For example, if Tom transfers assets to a trust which distributes income to Sam (a non-skip person) for Sam’s lifetime, and upon Sam’s death the trust’s principal is distributed to George (a skip person), then the property in the trust may be subject to the GSTT upon Sam’s death and the transfer to George. The event triggering the transfer to the skip person (Sam’s death, in this case) is known as a “taxable termination.”
What is the GST Tax Exemption?
Fortunately, just as the applicable credit against the estate and gift tax (the “Unified Credit”) shields most transferors from actually paying estate and gift taxes, there is also a GSTT exemption that allows most generation-skipping transfers to occur without any GSTT actually being paid. In 2020, the GSTT exemption amount is $11.58 million ($23.16 for married couples), which is the same amount as the Unified Credit; however, the GSTT exemption is not directly tied to the Unified Credit (i.e., it is not “unified” in the way that the credits for lifetime gifts and transfers from an estate are). Therefore, if a transferor makes a taxable gift of $1 million to a non-skip person, the transferor’s available Unified Credit amount will be reduced, but the transferor’s GSTT exemption will be unaffected.
How can I take advantage of the GSTT exemption?
Only a small percentage of people have current concerns about the GSTT due to the historically high GSTT exemption amount. However, just as there is risk (particularly after an election) that the Unified Credit may be reduced, there is also risk that the GSTT exemption may be reduced. There are several advanced estate planning techniques that may allow you to effectively and efficiently allocate your GSTT exemption between transfers made during your life and at your death. GSTT planning is essential if the value of your estate is over or near the current GSTT exemption amount, but it may also be helpful to discuss effective use of the current GSTT exemption amount with an estate planning attorney even if the value of your current estate is much lower, as the current GSTT exemption amount may offer greater flexibility and more planning options.
If you have any questions about the Generation-Skipping Transfer Tax, the use of its exemption, or any other aspects of estate planning, we invite you to contact an attorney at Thomas, Fisher & Edwards, P.A. at (864) 232-0041.
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