Because Congress intends that transfer taxes only apply to wealthy families, the law provides a lifetime exemption threshold from all such taxes and an annual exclusion for lifetime gifts. The GSTT exemption and applicable exclusion are determined every year and are indexed for inflation.
Legislation has been introduced this year proposing to lower the GSTT exemption and cap the duration of trusts that are exempt from GSTT to 50 years — presumably assessing GSTT at the end of the period at the same rate as the estate tax.
The tax is either paid by the trustee, the executor or the skip person who receives the transfer, depending on the circumstances. However, a proper application of the gift tax, estate tax and GSTT lifetime exemption relieves most trusts and estates from paying any transfer taxes at all. Your estate planning professional will also have you include a provision in your estate plan that:. Besides the exemptions, there is another exception for a taxable transfer to a grandchild whose parents are deceased.
This applies if the parent died before the taxable transfer or was deceased at the time the irrevocable trust is executed. To benefit from these exemptions and exclusions, you must file a gift tax return for any lifetime taxable transfers you make to allocate the gift, estate and GSTT lifetime exemption in that year.
It will never pay any transfer taxes even when it terminates although any proceeds that your grandchildren receive outright could be taxed if they then make taxable transfers to someone else.
This tax-exempt status applies for as long as the trust lasts, unless it violates state law limiting the duration of trusts or a prohibition of a restraint on the alienation of real property.
So, you could draft the aforementioned college education trust so that rather than terminating when the youngest beneficiary reaches age 25, it could instead divide into eight separate share trusts for the benefit of each grandchild and their descendants for as long as state law allows which is years to forever, depending on the state and avoid transfer taxes the entire time.
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The above article is intended to provide generalized financial information designed to educate a broad segment of the public; it does not give personalized tax, investment, legal, or other business and professional advice. Skip To Main Content. What is the generation-skipping transfer tax?
When does the generation-skipping tax come into play? A person has a beneficial interest in a trust in two circumstances: a He or she has a present right to income or principal, or b he or she is a permissible income or principal recipient for example, there are no current mandatory income or principal beneficiaries, and the trustee has the right to sprinkle income or principal to a group that includes the person in question. A direct skip is a transfer directly to a skip person.
A grandparent writing a check to a grandchild is the most obvious form of direct skip, but direct skips also happen at death.
An outright bequest to a skip person counts. Transfers in trust are more complicated. They can occur in two ways: by a taxable distribution from a trust to a skip person, or a taxable termination. The latter occurs when an interest in a trust terminates, unless a only non—skip persons receive the trust assets, and b no skip persons have a right to receive the assets after the termination.
The inclusion ratio is the key to the GSTT on transfers in trust. First, establish a ratio based on the amount of the GSTT exemption allocated to the trust assets. The numerator is the amount of the GSTT exemption allocated to the trust, and the denominator, generally, is the value of the property transferred to the trust. The resulting ratio is then subtracted from 1 to establish the inclusion ratio. An inclusion ratio of 0 means no part of the interest in trust is subject to the GSTT; a ratio of 1 means the entire interest is subject to the GSTT; and a ratio in between means that percentage of the interest is subject to the GSTT.
The GSTT exemption is best leveraged to prevent subsequent additional estate taxes. To do this, taxpayers must opt out of automatic allocation to direct skips so their exemption is preserved for taxable distributions or taxable terminations, which are known as indirect skips.
Opting out is a two-step process. First, taxpayers must address their direct skips. If they make only direct skips in a year, they can preserve their exemption by reporting the direct skips and allocating none of their GSTT exemption to them on Form , Schedule C. Second, they must address their indirect skips. Since those transfers are not yet subject to the GSTT, all that the donors are doing is creating a paper trail.
But if they make both direct and indirect skips in a year, then they report the direct skips on Part 2 of Schedule A, report the indirect skips on Part 3 of Schedule A, and then allocate their exemption only to the indirect skips on Schedule C.
Ultimately, the GSTT is payable when a taxable distribution or taxable termination occurs. Taxable terminations have a less complicated reporting system. Allocation of the GSTT exemption should be made on a timely filed gift or estate tax return. When allocations are made timely, they are based on the value of the transfer as of the date of transfer.
The transfer to the skip person occurs upon the death of a non-skip person — typically the child of the transferor. As an example of a taxable termination, a transferor establishes an income-producing trust for his son. A taxable distribution refers to any distribution of income or property from a trust to a skip person that is not otherwise subject to estate or gift tax.
If a grandmother established a trust that made payments to her grandson, those payments would be subject to GSTT taxes, which the recipient is responsible for paying. Individuals should not make decisions that carry potential tax consequences alone.
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