For those of us navigating the treacherous seas of estate planning, we have to deal with the monstrous GSTT aka Generation Skipping Transfer Tax at some point or the other. Swimming through all the complications, we can many a time whittle it all down to a simple set of circumstances to watch for when your clients would be subject to GSTT. But before we can do that, we need to know the following:
What is GSTT?: If some or all of your estate bypasses your children and goes directly to a grandchild, there is another tax on your estate called the generation skipping transfer tax.
Although it wouldn’t serve to pay this tax intentionally, in some circumstances, this could be unintentional. If the inheritance is in a trust, the heir dies after the client but before receiving the full amount, and under the terms of the trust, the grandchildren receive the remaining inheritance, the inheritance could be subject to the GSTT.
Why This GSTT?: In the past, generation skipping trusts were common. These trusts distributed only income to the children and the trust principal would later be distributed to the grandchildren and generations beyond. The trusts grew tax free and appreciated in value, avoiding heavy taxation much to Uncle Sam’s chagrin! So wanting their share of the proverbial pie, the government passed the Tax Reform Act in 1986.
Generations-Who Are Part of It? Grandchildren, great grand-children and future generations fall under the GSTT. This tax also applies if you leave assets to a non-relative who is more than 37 and 1/2 years younger than you.
How much is the GSTT?: This is a very expensive tax. It is equal to the highest federal estate tax rate in effect at the time. In 2013, the top rate is 55%. And the GST is in addition to the federal estate tax.
How Estate Planning Would Help?: For simplicity’s sake, if $10 million out of a $15 million estate was left directly to the grandchildren in 2013 with no estate planning, $5.5 million (10% of $10 million) would be paid in estate tax. Another $2,475,000 (55% of the remaining $4.5 million) would be paid in GST taxes. Thus the grand-children would receive only $2,025,000 of their $10 million inheritance!
GSTT Exemptions: For 2013, the GST exemption is $1,400,000. So in 2013, the spouses together can leave up to $2,800,000 to grandchildren & future generations, without having to pay GSTT. However careful planning is required if this exemption is not to be wasted.
Bibliography: Form 709 & Instructions; Journal of Accountancy Quick Guide to GSTT; irs.gov; Various articles on Elder Law.