The GSTT is in addition to the normal estate or gift tax and is applied to the transfer of property to a person two or more generations younger than the transferor (e.g., from grandparent to grandchild). (1) The maximum estate tax rate, 45 percent in 2009, is used in calculating the GSTT. (2) However, there is an exemption which allows aggregate transfers of $3,500,000, during lifetime or at death, to be exempt from the GST tax ($7,000,000 total for both husband and wife). (3)
To illustrate, assume that Grandparents have an estate totaling $10,000,000. Assume also that their Children have substantial estates in their own right and the Grandparents desire to fully use their GSTT exemptions.
UPON THE FIRST GRANDPARENT'S DEATH. In order to take maximum advantage of the GSTT exemption in 2009, $3,500,000 must be passed to the Grandchildren. This $3,500,000 could be placed in a family or nonmarital trust (the "B" trust) that would provide income to the surviving Grandparent. (4)
UPON THE SECOND GRANDPARENT'S DEATH. Again, in order to take maximum advantage of the GSTT exemption, an additional $3,500,000 must now be passed to the Grandchildren. After payment of $1,350,000 in federal estate taxes on a taxable estate of $6,500,000, $3,500,000 is passed to the Grandchildren. In order to avoid any GST taxes, the remaining $1,650,000 is passed to the Children. (5) The $3,500,000 originally placed in the "B" trust is also distributed to the Grandchildren. Of the original $10,000,000 estate, estate taxes totaling $1,350,000 have been paid at the second death. Full use of the Grandparent's GSTT exemptions has the potential of producing estate tax savings of $3,150,000 at the Children's generation. (6)
Application of the GSTT can be quite complicated and its impact is substantial in larger estates. Careful analysis by qualified counsel is essential if unexpected tax consequences are to be avoided. (7)
INFORMATION REQUIRED FOR ANALYSIS & PROPOSAL
1. Size of grandparent's estate.
2. Nature of prior gifts, if any, made by grandparents.
3. Numbers and ages of children and grandchildren.
4. Size of children's estates and ability of children to support themselves without inherited assets.
See also information required for exemption trust wills on page 30.
CROSS REFERENCES TO TAX FACTS ON INSURANCE & EMPLOYEE BENEFITS (2010)
Q 750. Life insurance proceeds and annuities are subject to GST tax.
Q 751. Gifts to life insurance trust and the GST tax.
Q 752. Leveraging the exemption with a life insurance trust.
Q 916. Discussion of "qualified transfers."
Q 950. Overview of the generation-skipping transfer tax.
Q 951. What is a generation-skipping transfer (GST).
Q 952. Determination of the GST tax and exemption.
Q 953. How individuals are assigned to generations.
Q 954. Split gifts can be made for purposes of the GST tax.
Q 955. Credits allowed against the GST tax.
Q 956. Return requirements for the GST tax.
Q 957. Who is liable for paying the GST tax.
(1) Because grandchildren are two or more generations below the grandparent (transferor), they are known as skip persons, whereas children are known as nonskip persons (the transferor's spouse is also a nonskip person, since she is of the same generation as the transferor). When the transfer is directly from one generation to a person two or more generations younger than the transferor it is referred to as a "direct skip" (e.g., in his will grandfather leaves property to grandchild). In the case of a direct skip, the GSTT is payable at the time of the transfer, not upon the death of the person in the skipped generation (e.g., the GSTT is payable upon the grandfather's death, not when the child dies). Any transfer is generally not subject to the GSTT if the person in the intervening generation (the child) is not alive at the time of the transfer to the skip person (the grandchild).
(2) The amount of tax is calculated by multiplying the "taxable amount" by the "applicable rate." In fact, the applicable rate is itself a product of the maximum federal estate tax rate times the "inclusion ratio." The inclusion ratio, in turn, depends on allocations of the "GST exemption." For example, assume G transfers irrevocably in trust for his grandchildren $5,500,000 in 2009 and allocates all his $3,500,000 GST exemption to the transfer. The applicable fraction is 3,500,000 / 5,500,000, or .636. The inclusion ratio is 1 minus .636, or .364. The maximum estate tax rate, 45 percent, is applied against the inclusion ratio of .364. The resulting percentage, 16.38 percent, is applied against the value of the property transferred, $5,500,000, to produce a GSTT of $900,900.
(3) In 2009, the generation-skipping exemption was $3,500,000 (this is the same as the federal estate tax unified credit equivalent). As with the federal estate tax, unless Congress changes the tax law the generation-skipping transfer tax has been terminated for decedents dying in 2010 but is scheduled to return in 2011. The exemption is scheduled to revert back to $1,120,000 in 2011 (subject to indexing for inflation). This exemption can be elected on the gift tax return of the transferor, or on the estate tax return if claimed on a bequest. There is no GSTT imposed on direct skip gifts that come within the gift tax annual exclusion (see chart on page 55) or that are "qualified transfers." In general, qualified transfers are payments for the education or medical care of a skip person. Special rules apply to transfers in trusts such as the irrevocable life insurance trust (see footnote 7 below).
(4) Since it also applies to taxable distributions and terminations, it is not possible to use a trust to avoid application of the GSTT. A taxable distribution may occur with a distribution from a trust to the grandchild of the grantor. A taxable termination occurs upon the death of the child where a trust provides for a life income to the child with remainder to the grandchild. But, in this example, allocation of the full $3,500,000 GSTT exemption eliminates the GSTT because the inclusion ratio is zero (1 - (3,500,000 / 3,500,000) = 0). For further discussion, see footnote 2 above.
(5) Upon the second death the entire estate could be passed to the Grandchildren, but that would require payment of a GSTT in addition to the federal estate tax.
(6) This assumes that the Child's estate, often referred to as the "intervening generation's estate," would be subject to a maximum federal estate tax rate of 45 percent in 2009 (.45 x $7,000,000 = $3,150,000).
(7) Although a life insurance trust can be very effective in leveraging the GSTT exemption, application of the GSTT can be complicated. The GSTT generally applies to an irrevocable life insurance trust whenever grandchildren are trust beneficiaries. It is essential to maintain a zero inclusion ratio (see footnotes 2 and 4 above). To shelter such a trust from the GSTT, the exemption must be allocated by filing a timely gift tax return after each gift to the trust.