Understanding the Generation Skipping Transfer Tax
Authors: Jim Beaudoin and Mike Thiriot
What is a Generation Skipping Transfer (GST)?
The federal government assesses a tax on the right to transfer property. Transfers during life are subject to gift tax, and transfers at death are subject to estate tax. A transfer to your children may be subject to estate or gift tax and then, when your children die, any wealth that remains is subject to another layer of tax when that wealth is transferred to their children (your grandchildren). Can multiple layers of tax be avoided by transferring assets directly to your grandchildren (skipping a generation)? The answer: it’s complicated.
The Generation Skipping Transfer Tax
In order to recoup the tax revenue lost when a transfer of property skips a generation, the government imposes a generation skipping transfer (GST) tax. This way, if you leave property directly to your grandchildren, the same amount of tax would be paid as if you had left the property to your children who in turn left it to their children. But with smart planning, it is possible to minimize the amount of GST tax paid.
Who is a Skip Person?
A skip person is a lineal descendant two or more generations below the transferor. If you give a gift to your grandchild, your grandchild is considered a skip person. A skip person can also be a non-lineal descendant (not related to you) who is more than 37 ½ years younger than you. A trust can also be considered a skip person if the only beneficiaries are skip persons. A trust for the benefit of your children and your grandchildren would not be considered a skip person. But if the only beneficiaries are your grandchildren, then the trust would be considered a skip person. A transfer of property to that trust would be a GST event and subject to GST tax. The trust would also be subject to GST tax if upon your children’s death the trust assets are not taxed in their estates.
Exemptions
You may already be aware of lifetime exemptions from gift and estate tax. This means the property you transfer to the next generation is only taxed if the value of the property is more than your lifetime exemption. In 2020, that exemption is $11.58 million, but it is scheduled to drop by 50% after 2025. There is also an exemption for the generation skipping transfer. Currently, the amount of GST exemption is the same as the lifetime exemption. But unlike the lifetime exemption, the GST exemption can be allocated, to a trust for example. By doing so, it is possible to transfer property in trust for the benefit of your grandchildren and/or future generations without having to pay GST tax. With proper planning, the trust can be exempted from GST tax for all future generations.
The Importance of Planning
Allocating GST exemption is complicated. In some situations, the allocation is automatically made by law. In other situations, there is no automatic allocation and a gift, or an estate tax return is required to make the allocation. Careful planning is needed to avoid an unnecessary allocation (wasting the exemption) or failing to make a needed GST exemption allocation to avoid tax. GST exemption planning should accompany every gift made by using a trust.
Meet with your Tax Advisor
The generation skipping transfer tax is something that is often overlooked. It can lead to problems that fester and don’t become apparent for many years. By careful planning, it’s possible to protect your assets from this tax and preserve more of your hard-earned wealth for your heirs. Reach out to our tax advisors to get your planning started.