Back to the future tax: what to know about generation-skipping transfer tax.
Almost a parallel tax, the easily overlooked GST tax comes into play when assets are transferred during life or at death to "skip persons," typically grandchildren or trusts created for the benefit of grandchildren or future generations. GST tax rules can be complex and far-reaching, providing a powerful tool for estate planning or unpleasant surprises when ignored.
What Is the GST Tax?
Enacted in 1976, then repealed and replaced with a new version in 1986, the generation-skipping transfer tax prevents estate tax savings that could be obtained in the past by transferring assets directly to grandchildren or future generations and skipping the generation directly below the transferor, the child's generation.
Example: Sally has a $9 million estate and, at her death, leaves her entire estate to her daughter Jane. Assuming a $5 million lifetime exemption is in effect in the year of Sally's death, the excess $4 million over the exemption amount is subject to estate tax. When Jane dies several years later, having fully utilized her exemption for lifetime gifting, the S4 million taxable estate she leaves to her daughter Kim (Sally's grandchild) at her death is also subject to estate tax--thereby subjecting the $4 million to estate tax twice, once at each generation below Sally.
Assuming there were no GST tax laws in place, Sally could instead bypass estate tax at Jane's generation by leaving the $4 million taxable portion of her estate directly to her granddaughter Kim, paying the estate tax at only one transfer.
The GST tax laws prevent the estate tax savings in the example above by imposing a generation-skipping transfer tax, in addition to the regular estate tax, when Sally leaves her taxable estate directly to her granddaughter Kim. (An exception may apply when a child pre-deceases the parent, which is discussed later in this article.)
GST Tax Rate, Exemptions and Exclusion
The GST tax is imposed at a flat rate equal to the highest estate tax rate: 40 percent. There is a lifetime GST tax exemption available to each taxpayer equal to the regular estate tax exemption amount, or $5.43 million in 2015. Certain transfers also qualify for an annual exclusion, which is $14,000 per recipient.
If a direct skip is made in trust, the annual exclusion only will apply for GST tax purposes if the trust is for a single beneficiary and the trust property will be included in that beneficiary's gross estate. In addition, transfers made directly to providers to pay tuition or medical expenses of a person are exempt from gift tax under IRC Sec. 2503(e) and also are exempt from GST tax.
Finally, remember to keep an eye out for some older trusts that may escape the GST tax altogether. Specifically, trusts that were irrevocable on Sept. 25, 1985, are grandfathered trusts to the extent that there are no additions or modifications to the trust after that date--and thus are not subject to GST tax.
Definition of 'Skip Person' and Other Players
Determining when GST tax is an issue requires an understanding of key GST terms:
* Transferor: A person who has disposed of property, outright or in trust, in a transfer that is subject to either federal gift or estate tax.
* Skip person: A person who is assigned at least two generations below that of the transferor.
** Generations normally are assigned among family members along family lines, e.g. grandparents and their siblings and spouses belong to one generation. Spouses are in the same generation as their family member spouse.
** Individuals who are not part of the family of the transferor or transferor's spouse are considered to be in the generation of the transferor if they are not more than 12.5 years older or younger than the transferor; they are considered to be in the generation of the transferor's children if they are more than 12.5 years younger, but not more than 37.5 years younger than the transferor; they are assigned to successive lower generations in 25-year increments.
** Trusts for the benefit of skip persons are treated as skip persons when all beneficiaries eligible or entitled to receive trust income or principal are skip persons, or no person is currently eligible or entitled to receive trust income or principal, and at no time may distributions be made to beneficiaries who are not skip persons. For these purposes, a distribution that has less than a 5 percent chance of being made, determined by actuarial standards, is ignored.
* Predeceased child rule: To determine whether a direct skip occurred, a grandchild or more remote descendant of a transferor (or the transferor's spouse or former spouse) is moved up one generation if the parent of that individual, who was also a descendant of the transferor (or their spouse or former spouse), was deceased at the time of transfer.
* Non-skip person: Any person or trust that is not a skip person,
** A trust in which a non-skip person has an interest is also a non-skip person, unless the probability of distributions to the non-skip person is less than 5 percent.
** For this purpose, only present interests in property are considered to be "interests." Thus, persons holding interests in property include only those persons who have a current right to receive income or principal from the trust, and persons who are permissible recipients of income or principal under a spray provision.
Trusts Can Be Tricky
Trusts can be skip or non-skip persons with respect to GST tax considerations. This characterization will help determine if transfers in trust are direct skips (transfers by gift or at death of an interest in property to skip persons) or indirect skips (gifts to trusts that may later be subject to GST tax).
Further, as a result of the Economic Growth and Tax Relief Reconciliation Act of 2001, beginning in 2001, lifetime indirect skips to GST trusts receive an automatic allocation of the transferor's GST tax exemption unless an election is made to elect out of the automatic allocation.
GST' trusts are defined by IRC Sec. 2632(c)(3) and include any trust in which there is a significant likelihood that a GST tax ultimately will be owed as a result of a "taxable termination" or "taxable distribution," defined by IRC secs. 2612(a)-(b) and must be considered when working with trusts in this context.
Only by reading the trust document and reviewing previous gift tax or estate tax returns can the practitioner begin to determine how the beneficiaries, gifts and distribution provisions fit into the GST tax rules.
Frequently additional inquiries will need to be made, and it's generally prudent for the practitioner to confirm their understanding of the GST tax implications and potential allocation of GST tax exemption, or election out of automatic exemption allocation, with the client's estate attorney.
Late Exemption Allocations, Relief Available
The change in rules made by the 2001 Act has created a situation where certain pre-2001 trusts may have inadvertently become partially subject to potential GST tax.
Specifically, GST trusts that received lifetime gifts before 2001 did not benefit from automatic GST tax exemption allocations and would have required exemption allocation on a Form 709 gift tax return, whereas gifts to those same trusts after 2000 would have received automatic exemption allocations absent an election out (notwithstanding the special rules for grandfathered trusts, discussed above).
Practitioners should review these trusts carefully and consider applying for relief and retroactive allocation, or electing out of allocation (provided by Prop. Reg. Sec. 26.2642-7 and Rev. Proc. 2004-46) or making allocations of GST tax exemptions at asset values.
Tax Return Reporting
Lifetime GST taxable gifts, allocations of GST tax exemption or elections out of automatic GST tax exemption allocation are reported on a Form 709 gift tax return. GST transfers and exemption allocations made at death, or direct skips from trusts included in a taxable estate, are reported on a Form 706 estate tax return, as well as a reconciliation of the decedent's lifetime GST tax and exemption use. Trustees report taxable terminations on Form 706-GS(T), and taxable distributions on Form 706-GS(D-1).
Client interests are best served when the planning team communicates openly to ensure that the GST tax reporting conforms with the client's overall estate plan and intentions for future asset transfers.
Julie Malekhedayat, CPA is a partner at Abbott, Stringham & Lynch Certified Public Accountants & Business Advisors and is chair of the CalCPA Estate Planning Committee. You can reach her at firstname.lastname@example.org.
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|Title Annotation:||estate planning|
|Date:||Mar 1, 2015|
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