Generation-skipping transfer tax
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|Taxation in the
United States of America
The U.S. generation-skipping transfer tax imposes a tax on both outright gifts and transfers in trust to or for the benefit of unrelated persons who are more than 37.5 years younger than the donor or to related persons more than one generation younger than the donor, such as grandchildren. The generation-skipping tax will be imposed only if the transfer avoids incurring a gift or estate tax at each generation level.
For example, property is placed in a trust for the donor's child and grandchildren. The income may be distributed among the child and grandchildren in accordance with their needs and the principal of the trust will be distributed outright to the grandchildren following the child's death. If the trust property is not subject to estate tax at the child's death, a generation-skipping tax will be imposed when the child dies.
The first version of the tax (1976)
The first version of the generation-skipping tax was introduced in 1976. That version attempted to impose a generation-skipping tax exactly equal to the estate or gift tax that was avoided. In the above example, the Executor of the child's Will would have had to determine the estate tax, if any, the child's estate owed without regard to the existence of the trust. Then the Trustee of trust would have to use the child's Federal Estate Tax Return as the basis for recomputing the child's estate tax liability as if the trust property had been part of the child's estate.
The version of the tax starting in 1986
The most recent version of the generation-skipping tax, applicable to estate or gift transfers through December 31, 2009, did not attempt to impose a tax equal to the estate or gift tax that was avoided. Instead, the generation-skipping tax was imposed at a flat rate equal to the highest marginal estate and gift bracket applicable at the time of the gift, bequest, transfer or termination. In 2009, that rate was 45%.
In 2009, each taxpayer enjoyed a $3,500,000 exemption from the generation-skipping tax. That meant that only aggregate gifts and bequests to grandchildren or younger beneficiaries in excess of $3,500,000 (potentially $7,000,000 for a married couple acting in concert) would be subject to the generation-skipping transfer tax.
In 2010, like the Federal Estate Tax, the generation-skipping transfer tax was repealed. In some ways, it could be viewed that the exemption is essentially unlimited in 2010 for transfers that would otherwise be subject to the tax. However, the law that created the increases and ultimate repeal of the GST Tax Exemption expired on December 31, 2010. In 2016, the exemption is 5.45 million dollars.
For generation-skipping trusts created in the years of 2011 and 2012 and for outright gifts to skip-persons, taxpayers are entitled to a $5 million GST tax exemption.
Advantages of using exemptions from the tax
Many individuals who might otherwise leave their entire estates outright to their children allocate their generation-skipping exemption to transfers to generation-skipping trusts for the benefit of their children and grandchildren. Such trusts will be funded with cash or property worth up to the available generation-skipping transfer tax exemption. If the term of such a trust is not limited, the trusts are often referred to as dynasty trusts.
Using the generation-skipping tax exemption in this manner offers two important advantages:
- The trust will escape all transfer taxes when the children die and will pass tax-free to the grandchildren.
- The trust may be protected from the claims of creditors and, to some degree, from claims of ex-spouses. Had the trust property been left to the children outright, the property would be subject to such claims.
In some states, property acquired by gift or inheritance from a third party is not subject to division in divorce proceedings and would not be subject to claims by an ex-spouse.
The child may serve as trustee of the trust and hence control trust investment policy. If so, it would be necessary to limit the child's discretionary powers over distributions of income and principal by an "ascertainable standard" in order to avoid subjecting the trust to federal estate taxation at the child's death. Appointing the child as sole trustee may subject the trust to claims of the child's creditors.
- See IRS Form 709 Instructions
- The Tax Reform Act of 1976, Pub. L. No. 94-455, § 2006, 90 Stat. 1520, 1879−90.
- Tax Rm Act of 1986, Pub. L. No. 99-514, §§ 1431−33, 100 Stat. 2085, 2717−32.
- The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, Pub. L. No. 111-312 § 101 (codified as amended in scattered sections of 26 U.S.C.) (extending the sunset provision in Pub. L. No. 107-16 from Dec. 31, 2010 to Dec. 31, 2012).