The Generation-Skipping Tax
by: Prof. Beckett G. Cantley
Atlanta’s John Marshal Law School
Note: Currently, the Applicable Exclusion allows for $5 million in assets to be transferred during life per person without paying transfer taxes. For married couples, it is not necessary for one spouse to use all of his or her $5 million during life to get the full benefit of the Applicable Exclusion. Instead, the surviving spouse can make use of the deceased spouse's remaining Applicable Exclusion even after the deceased spouse has passed. These rules are scheduled to expire on January 1, 2013, if Congress does not act to extend them. if Congress does not act, on January 1, 2013, the Estate and GST Taxes revert to the form they existed in back in 2001. It is anticipated that Congress will act sometime during 2012 to extend these benefits or otherwise create new benefits that are more generous than the 2001 version. The below article is written from the perspective of the Estate and GST Taxes as they would exist on January 1, 2013, if Congress does not act.
Most people are aware that the government has imposed a Federal Estate Tax (“Estate Tax”) and a Federal Gift Tax (“Gift Tax”) liability on transfers of property. However, few people are aware that there is a second level of transfer tax imposed by Uncle Sam on transfers made by an individual during life or at death: the Generation-Skipping Transfer Tax (“GST Tax”). A lifetime gift-giving program to one’s children which makes use of an individual’s $13,000 annual exclusion from Gift Tax is generally a good estate planning tool. Likewise, a basic, tax-oriented Last Will and Testament (“Will”) is generally a good estate planning tool when cash or other assets are being transferred only to a decedent’s wife and/or children. However, if an individual transfers cash or other assets directly to his or her grandchildren, either in life or at death (while either of the grandchild’s parents are living), then this transfer is a generation-skipping transfer. Likewise, if an individual (the “Grantor”) places cash or other assets into a trust for the benefit of his or her children for life with the remainder upon their deaths to pass to their children, then when the Grantor’s children die, the transfer from the Grantor’s children to the Grantor’s grandchildren is a generation-skipping transfer. In addition, if the Grantor places cash or other assets into a trust for the benefit of his or her descendants, and at some future date the Grantor’s grandchildren receive a distribution of income or principal from the trust, then the transfer is also a generation-skipping transfer.
In each of the above generation-skipping transfers, the GST Tax imposes a transfer tax. In the case of the cash or other assets remaining in trust, this transfer tax is imposed essentially as if the children had owned the cash or other assets outright and in fee simple at their deaths and had directly transferred it to their children. This, however, may not be the end of the taxing of the transferred cash or other assets. After the deaths of the grandchildren, if the property remains in trust for the benefit of the great-grandchildren, then upon their deaths, the property is subject to another application of the GST Tax. This is because each transfer to a lower generation is an additional generation-skipping transfer, unless certain exemptions apply. The GST Tax is in addition to any then applicable Estate Taxes that may be due at each generation.
Every individual has a $1,000,000 exemption from the application of the GST Tax in 2011. This exemption works much like the Applicable Exclusion from Estate Tax liability. As such, if their documents are properly drafted, an individual and his or her spouse may pass up to $2,000,000 (as indexed) from the application of the GST Tax through their Wills or by way of an inter-vivos trust. In addition, if a trust is set up which contains $1,000,000 or less, and an individual applies his or her GST Tax Exemption to the trust in a manner which completely exempts the property in the trust from GST Tax, then that trust will be permitted to skip generations. This means that the income and/or principal of a properly drafted trust can be used for the benefit of an individual’s children for life, then the children’s children, then the children’s grandchildren, etc... The number of generations that can be benefitted is limited only by a complicated state law known as the rule against perpetuities (which is beyond the parameters of this discussion).
Thus, although the GST Tax adds another complication to an individual’s estate plan, the $1,000,000 GST Tax Exemption is likely to shelter many people’s estates from its application. In addition, individuals who have larger estates may undertake proper planning to benefit their children, grandchildren and potentially their great-grandchildren.