There is a bit of a cat-and-mouse aspect to the estate planning game. Tax policy legislators impose a tax, and then astute estate planners determine how to legally minimize a person’s tax liability within the law. Then, once legislators see an unintentional loophole being used too often, they close that loophole. In response, the estate planners find other ways to avoid high tax liability. And on and on the cycle goes.
One example of that process playing out is the generation-skipping tax, also called the generation-skipping transfer tax. In order to avoid estate taxes back in the day, some people would transfer their wealth directly to their grandchildren. However, tax legislators ultimately tried to capture some lost tax revenue from that technique by creating the generation-skipping tax. In this blog, we will discuss that tax, and we will begin by touching upon the fundamental debate surrounding the estate tax in the U.S.
The Estate Tax Saga
Proponents of an estate tax believe that taxation of the wealthiest people’s assets at death avoids severe income inequality. Specifically, the thought is that families with significant wealth who consistently pass down the wealth to future generations keep those assets away from the economy where it can be put to better economic use. In fact, Winston Churchill once stated that estate taxes for the wealthy are “a certain corrective against the development of a race of idle rich.”
By contrast, those against the estate tax believe that it punishes people who work hard, become successful, and want to pass on the fruits of their labor to their children. They also believe that it serves as a strong disincentive toward entrepreneurship.
All that being said, effective tax and estate planning can help individuals avoid estate taxes. As noted, one strategy that was used to avoid estate taxes was to pass wealth down to grandchildren instead of children. If a person could “skip” a generation, then they could, in many circumstances, avoid the estate tax.
But, as with other strategies, the laws were changed to put a tax on such “generation skipping” strategies.
What is the Generation-Skipping Tax?
The generation-skipping tax (GST) is an additional tax on assets passed down to a grandchild at death, or given as a gift during the donor’s lifetime. In short, the tax is incurred when grandparents directly give money or property to their grandchildren, and “skip” giving the assets to their children.
Notably, the GST does not only apply to grandchildren. It applies to gifts or transfers made to other family members and unrelated people who are at least 37 and one-half years younger than the person transferring the assets. The beneficiaries of such an asset transfer are called “skip persons.”
The idea is that the transfer skips a generation so the assets are not taxed twice – once when it goes from the donors to their children, and a second time when the assets go from the children to the children’s children.
Thus, since 1976, the generation-skipping tax has been used to compensate for the estate taxes that might otherwise have been avoided by doing the skip.
Does a Skip Person Have to be a Person?
No. The GST applies to trusts as well. The beneficiaries of a trust are considered the “skip persons” for GST purposes, but the trust is also a “skip person” in most circumstances.
What is the Generation-Skipping Tax Exemption?
Generally speaking, an exemption is the money or property that can be transferred from a grandparent to a grandchild without incurring the GST. In 2011, the exemption was $5 million, which meant that the GST did not apply to transfers of $5 million or less. But, any transfers or gifts over $5 million would be taxed at 35 percent. That exemption went up gradually over subsequent years.
In 2018, however, the new tax law doubled the exemption amount to $11.18 million. Therefore, a grandparent can directly transfer $11.18 million to a grandchild without having to pay any tax on that money. Also, married couples can double those exemption amounts.
Finally, the federal tax law provides for an “annual GST exclusion,” similar to gift taxes. That exclusion allows someone to give away up to $15,000 to a “skip person” per year without incurring any GST. That number is doubled for transfers by married couples.
Reporting GST Gifts
All direct GST gifts that go over the $15,000 annual exclusion are to be reported on IRS form 709, which is the U.S. Gift (and Generation-Skipping Transfer) Tax Return. Because each person has a lifetime exemption (which, as noted is currently $11.18 million), the gifts to “skip persons” are subtracted from that lifetime exemption each year that you make a gift over the $15,000 threshold. Remember, making generation-skipping gifts during your lifetime will reduce the exemption that you would use to protect your estate at the time of your passing.
Learn More About Estate Planning with Regard to the GST From Doane & Doane
If you have concerns about the generation-skipping tax, you should discuss your estate plan with a qualified estate planning attorney. We, therefore, welcome you to call us at Doane & Doane.
The attorneys at Doane & Doane have, for over 16 years, worked with purpose to be one of South Florida’s most prominent Estate Planning law firms. We are proud to offer our clients the resources of a large law firm with the personal attention of a smaller boutique firm. We understand the delicate and emotional nature of making an estate plan, and we take the care and time to understand your needs. Please give us a call at 561-656-0200, and schedule a free consultation with one of our estate planning lawyers. You will be glad you did.
The seasoned attorneys at Doane & Doane assist individuals, families, and businesses with unique estate planning needs all the time. We have handled matters such as business succession, tax planning, high net worth, and charitable giving planning in our West Palm Beach office.
Whatever your goals in connection with the generation-skipping tax, we can help you achieve them. We know that estate planning is a very personal process, and there is no universal formula that applies to everyone.
At Doane & Doane, we have handled a number of generation-skipping transactions. We know when it is most appropriate, and we can guide you accordingly. Again, call Doane & Doane today for more information at 561-656-0200.