Back
Back
Back
Back
Back
Back
Back
Back
Back
Back
Back
Back
Back
Back
Back
Back
Back

What the Heck is Generation Skipping Transfer Tax Anyway?

Written by: William V.A. Zorn

Co-written by: Doria Aronson

(Published in the New Hampshire Bar News, March 2011)

Eventually every estate planning attorney encounters clients who desire to either bypass their children and pass their wealth directly to their grandchildren, great grandchildren, etc., or set up their estate plan to first provide for their children, and second for their grandchildren or subsequent generations upon their children’s deaths. There are numerous reasons for such estate plans, including minimizing the Federal Estate Tax (“FET”) exposure on the estates of the client’s descendents, asset protection for beneficiaries and perpetuating family values. These are the cases when an estate planner needs to understand the generation skipping transfer (“GST”) tax, the GST tax exemption and be able to develop an estate plan that maximizes a client’s ability to pass wealth to “skip” persons, while minimizing the GST tax.

One of the major advantages of general skipping transfers is to avoid unnecessary estate taxes imposed on a client’s descendents.  Under The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “2010 Tax Relief Act”) the estate tax exclusion amount (“exemption”) is $5,000,000.  For example, if an unmarried person passes away with a gross estate of $5,000,000 and leaves the entire amount to a child, there is no estate tax.  However, when that child subsequently passes away, then that child’s inherited wealth plus his own assets (e.g. $1,000,000.) are subject to estate tax.  Under this example, the child’s estate tax is ($1,000,000. multiplied by 35%) $350,000.  This estate tax could have been avoided if the parent had left the child’s inheritance in trust for his or her lifetime with the remaining trust estate passing to grandchildren.

There are three different types of taxable transfers (direct skips, taxable terminations and taxable distributions) that trigger the GST tax.  If a GST tax is imposed, the assets are taxed at the then highest FET rate (currently 35%).  For lifetime transfers that are exempt from gift tax by virtue of the annual exclusion they are also exempt from the GST tax.  IRC § 2642(c)(1).

The first and simplest taxable transfer is a direct skip.  This results from a transfer directly to a skip person. A “skip person” is a person who is more than one generation removed from the transferor.  IRC § § 2612(c), 2612.  If the transferee is unrelated to the transferor, then the transfer is considered a GST if the transferee is more than 37 ½ years younger than the transferor.  IRC § 2651(d). When a transferor transfers assets to a grandchild, great grandchild, etc…, this is a GST, because the transferor “skips” his or her child and transfers the assets directly to the next generation.  For example, a grandparent gives grandchild $5,000,000.  There is an exception to these rules where one generation has passed away and the next generation “steps up” for the purpose of calculating the number of generations (e.g. if a child has predeceased his parents, then his children are viewed as only one generation below his parents).  IRC § 2651(e)(1).

The other two types of taxable transfers are taxable terminations and taxable distributions.

A taxable termination is a termination of an interest in property held in trust unless 1) immediately thereafter a non-skip person has an interest in the property; or 2) no distributions may be made at any time thereafter to a skip person.  IRC § 2612(a)(1).  For example, a parent’s trust pays income to the son for life and at the son’s death the principal is to be distributed to grandchild.  At the son’s death a taxable termination has occurred.  There is not a taxable termination if income is paid to the son for life, then income and/or principal is paid to the daughter for life, since each beneficiary is only one generation removed from the transferor.

A taxable distribution is a distribution from a trust to a skip person that is not a direct skip or a taxable termination.  IRC § 2612(b).  For example, a parent’s trust makes discretionary distributions to grandchild prior to the trust’s final termination.  When such distribution is made a taxable distribution has occurred.

In a well drafted estate plan, a parent can allocate his GST tax exemption to his trust that will bypass estate tax when a child dies while providing a benefit to grandchildren at the child’s death.  The trust can benefit a child for that child’s life, with certain limitations, but avoid inclusion in that child’s gross estate at that child’s death.  In this situation, a parent would want to allocate his GST tax exemption to this Trust to avoid GST tax.  All subsequent appreciation on this GST is also exempt.  It is important to note that the GST tax exemption is automatically allocated to direct skips first, so the client must opt out of this automatic allocation if the client chooses to allocate their GST exemption to a transfer in trust.  Opting out of this automatic allocation is done on the client’s gift tax return (Form 709) or estate tax return (Form 706).

The Tax Relief Act of 2010 increased the GST tax exemption to $5,000,000 for 2011 and 2012.  (It should be noted that unused GST tax exemption is not portable.)  Therefore, wealthier clients should consider GSTs during 2011 and 2012 to take full advantage of the increased GST tax exemption amount.  This can be accomplished through direct gifts to skip persons, or through the creation of irrevocable trusts in to which contributions can be made and the GST tax exemption can be allocated. Future taxable terminations and taxable distributions can then avoid GST tax.

Integrity and trust

At McLane Middleton we establish and maintain long-standing relationships with our clients to help us better achieve their unique goals over time. This approach to building trust requires that our esteemed lawyers and professionals use their broad, in-depth knowledge and work together with integrity to ascertain sound resolutions to legal matters for their clients.

Strength in numbers

McLane Middleton is made up of more than 105 attorneys who represent a broad range of clients throughout the region, delivering customized solutions. As a firm we are recognized as having the highest legal ability rating. The firm is rated Preeminent by Martindale Hubbell and is recognized as one of the nation's leading law firms in Chambers USA. Our attorneys are distinguished leaders in their respective practice areas.

Meet Our People

Commitment and collaboration

McLane Middleton's versatile group of attorneys and paralegals become trusted authorities on each case through collaboration. We work with our clients to learn their individual needs first and foremost and, together, we develop comprehensive solutions to their specific legal matters. This approach helps us exceed our clients' expectations efficiently and effectively, client by client, case by case.

Practice Areas

A history of excellence

McLane Middleton was established in 1919 in New Hampshire, and has five offices across two states. However, deep historical roots don't allow you to become innate. Our firm is organized, technological, and knowledgeable. Our history means we are recognized. But our reputation is built on the highest quality of service and experience in very specific areas of law.

The Firm

Intelligence paired with action

Our team continuously seeks opportunities to enhance their professional development and put key learnings to action. The pursuit of further insight guides us to volunteer service opportunities, speaking engagements, and teaching roles. Our lawyers are sought after thought leaders across their industries, and recipients of leadership awards throughout the region.