PSVS Blog

PSVS posts about once a month, but frequently more often. If you would like to be notified when new blogs are posted, please subscribe to our newsletter.

If you have questions about this post, please leave a comment or contact us.

Leave a comment

Avoid Getting Hit With The Generation-Skipping Tax

(posted: November 21st, 2016)

There's no question that recent tax law changes have made estate planning easier.

But you're not out of the woods quite yet.

Strategy:
Implement plans to minimize the risk of getting hit with the generation-skipping transfer (GST) tax. This little-known but potentially expensive tax can apply to transfers that "skip" a generation or two or three. If you don't address the GST tax, your heirs could face a major tax hit years from now.

Here's the whole story:
The federal estate tax law has gone down a long and winding road since the turn of the century. First, the monumental Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) changed the landscape. EGTRRA gradually increased estate tax exemption amounts and decreased tax rates until a one-year repeal in 2010. Following EGTRRA, the estate tax was reinstated and temporary legislation allowed a $5 million exemption per individual (with future indexing), while the estate tax rate was lowered to 35%.

Under the American Taxpayer Relief Act of 2012 (ATRA):

  • the federal estate tax exemption is now permanently set at $5 million, subject to inflation indexing (it's $5.45 million for decedents dying in 2016)
  • the estate tax rate has been bumped up to 40%
  • the federal estate and gift tax systems were reunified and,
  • the provision allowing exemptions between spouses to be "portable" is now permanent, meaning an unused exemption amount can be used by a surviving spouse or his or her estate.

As with the estate tax exemptions, the GST tax exemption is also set at $5 million (indexed to $5.45 million in 2016). However, unlike the estate tax exemption, GST tax exemptions aren't portable between spouses. That might lead to complications.

How the GST tax works

The GST tax applies to both "direct" and "indirect" transfers to descendants such as your grandchildren, your great-grandchildren and so on. In other words, these transfers bypass your immediate offspring, your children.

  1. Direct transfers:
    This refers to gifts or other transfers that go right into the hands of a grandchild or to a trust with a single grandchild named as the sole beneficiary. The transfer may be either a lifetime gift or a testamentary transfer by will.
  1. Indirect transfers:
    An indirect transfer includes those made to a trust where grandchildren are named as the contingent beneficiaries or the primary beneficiaries of the trust with your child or children. As with direct transfers, indirect transfers can be made during your lifetime or by a bequest upon your death.

GST tax problems can easily be avoided for most direct transfers. However, if you're not careful, the GST tax could blind-side unsuspecting heirs when indirect transfers occur years from now.

Example:
In 2016, you transfer $3 million to a trust and name your sole child as the primary beneficiary. After your child dies, the remaining assets will be split evenly among the child's three children, the contingent beneficiaries. Under the $5.45 million unified estate and gift tax exemption, the entire transfer is sheltered from gift tax. And there's no GST tax to worry about, at least not now.

However, suppose when your child dies years from now, the assets in the trust have grown to $15 million?

No one knows for sure what the indexed GST tax exemption amount will be by then, or whether the law will have changed again, but your grandchildren might owe millions in GST taxes. Worst of all, this tax catastrophe could have been easily avoided.

All you have to do is allocate part of your GST tax exemption to cover the transfer to the trust. That way, there will be zero GST tax when your grandchildren inherit the $15 million in assets.

Tip: The allocation is made on Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return.

PSVS can help! Contact us with your questions or concerns.

Feedback

Leave a comment

close form

Blog Feedback Form

first name: last:

Email Address and Last Name are required for security ONLY they do NOT appear with your post.

Allow 10 minutes between posts.

All post are subject to moderation.

email:

feedback (2000 chars):

Subscribe me to PSVS's E-Newletter

For Individuals

For Business

General Services

Real Estate

Audits

Advisory Services

Financial Services

Risk Management