In prior articles, we’ve focused on the federal gift and estate taxes and the advisability of engaging in careful estate planning to minimize the need to pay these hefty transfer taxes, which are imposed at a 40 percent rate to the extent an individual’s cumulative taxable wealth transfers exceed the $5.25 million exemption. There is another burdensome transfer tax to be concerned about at the federal level — the generation-skipping transfer (GST) tax, which is imposed at the same rate as the other transfer taxes, in addition to those taxes. The GST tax applies to transfers of wealth, either directly or via trust, to a “skip person” (i.e., a beneficiary in a generation more than one generation below that of the transferor, such as a grandchild, or more remote descendant). The simplest example of a transfer subject to GST tax is when a grandparent leaves a bequest to his or her grandchild, which bypasses or “skips” a living child. Fortunately, just as is the case with the federal gift and estate taxes, there is a $5.25 million exemption available for the GST tax. Thus, only GST taxable transfers above that amount (on a cumulative basis for each taxpayer/donor) would be taxed at the 40 percent rate.
The GST tax was created in 1986 to limit the amount wealthy families could “tax shelter” from the federal gift and estate taxes at future generational levels through the use of long-term trusts. Before the GST tax existed, it was possible for parents to avoid the imposition of future estate and gift taxes on the wealth they left behind, upon the death of subsequent generations of their family, by funding long-term trusts with their entire asset base (or by less egregiously simply skipping the tax at the child’s generation through direct gifts to grandchildren). Had the children instead received those funds outright and later passed them onto their own children (i.e., the grandchildren) at death, a federal estate tax would have been imposed on the portion of their asset base attributable to their inheritance from their parents — so, the same assets would have been subject to an estate tax in the children’s estate as well as the grandparents’ estates — a double tax. By skipping the tax at the children’s generation, and potentially subsequent generations as well, more family wealth could be preserved.
