Understanding Tax on Generation-Skipping Transfers
A generation-skipping transfer tax (GST) applies to transfers that skip a generation of heirs. Its primary design is to prevent wealthier individuals from avoiding estate and gift taxes by transferring large amounts of assets to their grandchildren, bypassing their children. The GST tax applies on top of all other applicable estate or gift tax, and its calculation is a percentage of the transfer’s value. The tax ensures that transferred wealth has tax consequences from generation to generation.
Even though GST can have tax consequences, there are still several benefits when implementing a generation-skipping transfer:
- Estate Tax Savings – This type of transfer may allow a person to reduce or eliminate the estate tax liability.
- Asset Protection – The transferor may be able to protect those assets from creditors or other potential claims.
- Wealth Continuation – Skipping a generation may ensure that the property remains in the family for multiple generations.
- Property Control – When transferring property to a trust, the transferor may retain some control over the property, even after the transfer.
It’s important to understand that the specific benefits of implementing a GST tax plan will depend on the individual’s specific circumstances. Consult an estate planning attorney to determine the best plan for generational wealth transfer.
What is a “Skip Person”
Skipping the immediate child’s generation and naming grandchildren as beneficiaries allows inheritable assets to skip one generation of the estate tax. The person in the generation being bypassed is the “skip person.” In 1986, the IRS Internal Revenue Code (IRC) began applying a flat tax on generation-skipping transfers. A grandfather clause permits older irrevocable trusts from being affected by the GST tax.
The GST can also apply to direct transfers to these beneficiaries and any gifts made to them through a trust. Therefore, under certain circumstances, some trusts can also be a “skip person.” There are exceptions for those descendants who are grandchildren of parents who have predeceased them. In this instance, the children effectively “move up,” taking their parents’ place, so the GST tax no longer applies to them as the gift doesn’t skip a generation.
It’s important to note that the IRC provides GST tax exclusions, as it does with gift taxes. In 2023, the GST lifetime exemption excludes the first $12.92 million, whereas the gift tax exclusion annually allows $17,000 tax-free per person. Married couples may double the amount because the tax-free status applies to each person gifting.
How does the IRS Assess the tax, and who pays the GST?
GST calculations are currently a flat rate of 40% which is equal to the estate and gift tax rate on transfers above the lifetime GST tax exemption amount. According to the IRS, the 2023 federal estate, gift, and GST basic exclusion amounts are $12,920,000 per person. This lifetime GST tax exemption amount will grow annually through 2025 based on inflation rates. Without Congressional action, the exemption amount in 2026 will revert to a $5,000,000 baseline, indexed for inflation.
Some states collect generation-skipping transfer taxes. Typically this occurs in states that already impose estate taxes. These states may continue mimicking federal GST regulations and revert to a $5 million baseline in 2026, although some states may act independently.
If the assets and money are in a direct GST, the trust grantor, who opens and funds the trust, will set up provisions to pay the tax. If assets are in an indirect GST, the skip beneficiary (usually a grandchild) is responsible for paying the tax; however, they may pay out of inheritance proceeds.
Using a Lifetime Exemption from GST
The lifetime exemption offers some advantages as it can apply to any combination of transfers during your life or those made at the time of death. Two potential strategies might be:
- During your lifetime, you can gift up to $12.92 million into a trust that eventually distributes assets to your grandchildren. This strategy will shelter projected appreciation for future generations.
- At your death, your testamentary trust may leave up to $12.92 million in lifetime trusts for your children. Upon their death, the trust’s $12.92 million (plus appreciation) passes to your grandchildren without incurring a GST or estate tax.
Although you don’t need much money to implement a GST tax plan, most people will never encounter the GST because of the high dollar threshold.
Why an Estate Planning Attorney is Recommended
While you aren’t legally required to hire a lawyer to handle your GST tax situation, you should consult with one. GST tax can be complex, and there are many rules and regulations. An estate planning attorney understands the tax implications of your planned transfers and ensures that your estate plan’s structure will comprehensively minimize your tax liability. Additionally, an estate planning lawyer can navigate any legal issues that arise and provide valuable advice on the best course of responsive action. Hiring an estate planning attorney to assist with the GST tax process is a sound strategy if you have a significant estate and are considering transferring assets to future generations.
We hope you found this article helpful. If you have questions or would like to discuss your legal needs please contact us at (270) 483-3001. We look forward to the opportunity to work with you.