Estate taxes can significantly impact a family’s wealth. A previous strategy many people used to avoid these estate taxes was to ‘skip’ a generation of their heirs to avoid a double estate tax liability. Double estate tax liability would apply when both transfers, one from parent to child and one from child to grandchild, were taxed. Although this strategy does have some benefits, the generation skipping transfer means it is not necessarily tax-free.
What is the Generation Skipping Transfer Tax?
The generation skipping transfer tax, commonly referred to simply as GST, was established to prevent the tax-free transfer of wealth from a grandparent to their grandchild or great-grandchild. Before the federal government implemented the GST tax, people could avoid the death tax that each generation is subject to by skipping one or two generations on at least a percentage of wealth. Therefore, families could avoid death taxes at least once or twice as family wealth was transferred throughout the generations.
While the original law was passed by Congress in 1976, there is an amended version of the law that was enacted in 1986. The new law imposes a tax upon each generation, regardless of whether that generation has enjoyed or used the property. Under the new tax law, individuals can now transfer approximately $11.2 million without being subject to the generation skipping transfer tax. Married couples can transfer approximately $22.4 million.
The maximum tax rate is 40 percent but when coupled with gift or estate taxes, all taxes could equal up to 64 percent. This means that only a small portion of property is received by the grandchild or great-grandchild.
The Different Types of Skips
Individuals known as ‘skips’ are people who are two or more generations younger than the original owner of an estate. Most commonly, grandchildren and great-grandchildren are known as skip individuals. There are exceptions, though. For example, if a grandchild’s parents pass away, the grandchild would move up to their level and would no longer be considered a skip person.
There are two types of skip individuals. The first are direct skips, who are individuals who receive gift assets directly from the person transferring the property. Direct skips have immediate rights of ownership.
Indirect skips are individuals who transfer money to an entity, such as a trust, that eventually might transfer the assets to the skip individual. At times, a bequest or gift will go to a trust and the skip individual may receive property from the trust, but it is not guaranteed. In these cases, the person transferring property can decide to allocate some of their exemption to the transfer. If a portion of the exemption is not transferred and the skip person eventually receives funds, those funds may be taxed.
Establishing Trusts to Avoid the Generation Skipping Transfer Tax
Trusts are valuable estate planning tools that can help individuals, and their loved ones, avoid many of the negative implications associated with the probate process. They can also be used to avoid the generation skipping transfer tax. These trusts are often known as legacy trusts or dynasty trusts. These trusts keep GST exempt trust assets beyond the transfer tax system until they are distributed from the trust.
When establishing a GST trust therefore, there is generally not a distribution date set. The distributions in GST trusts are typically discretionary instead. If they were not, the GST exemption would be lost when the trust was terminated.
GST trusts are generally grantor trusts, which means they were established while the grantor was still living. If the grantor of the trust passes away, it then becomes a complex trust and will have a federal tax ID number, along with a responsibility to report and pay taxes.
If the provisions of the trust allow discretionary distributions to exceed the distribution standard, approval from the independent trustee must be obtained. According to the Internal Revenue Code, Section 672 (c), an independent trustee can only be a qualified person or corporation who is independent, or unrelated, to the grantor and the beneficiaries.
Call Our Nevada Trust Administration Lawyer for Sound Legal Advice
The generation skipping transfer tax, and the trusts established to avoid them, are incredibly complex matters. At Boyer Law Group, our Nevada trust administration attorney can provide the sound legal advice you need to protect your loved ones and ensure they receive the inheritance you intended for them. Call us today at 702-255-2000 or contact us online to schedule a consultation with our experienced attorney and to get the legal help you need.