Generation-Skipping Transfer Tax
One useful way to preserve wealth for future generations is to skip the transfer taxes that would ordinarily be due at the death of each generation of heirs. This is done by establishing generation skipping transfer trust (GST trust), which preserves an individuals federal generation skip exemption (currently $2,000,000). Generation-skipping tax is a particularly nasty tax because generation-skipping transfers that exceed the exemption amount are subject to a flat tax of 50% of the value transferred, in addition to any estate tax and gift tax otherwise imposed. It is important to understand that a GST trust does not skip a generation of heirs, rather it skips the transfer taxes that would ordinarily be due. Beneficiaries of the trust (usually children and future generations) may benefit from a GST trust by receiving distributions, but not have trust assets included in their estate for estate tax purposes.
Reducing the Impact of the Generation-Skipping Transfer Tax
Consider making full use of the annual gift tax exclusion of $12,000 to any number of donees; e.g., children, grandchildren, in-laws, etc.
Encourage children or grandchildren (or trusts for their benefit) to purchase and own large life insurance policies on the parent or grandparent. At death, the insurance proceeds would not generally be subject to federal estate tax or the generation-skipping transfer tax.
Married couples should consider a generation-skipping trust plan. The first spouse to die could allocate the allowable portion of his or her GST exemption to a credit-shelter trust (usually equivalent to the applicable exclusion amount). A GST trust allows each generation to receive benefits from the trust without having the trust assets included in the beneficiaries estates for federal estate tax purposes. The remaining assets could pass to a marital trust.
Potential Generation-Skipping Transfer Tax Problem
Each person who transfers assets during lifetime or at death has an exemption ($1,000,000 in 2011) from the generation-skipping transfer tax (GST). For example, you can transfer $1,000,000 to your grandchildren and not pay the tax even though a generation of heirs (your children) is skipped.
Initially, assets in the credit-shelter trust usually qualify for $1,000,000 of the decedent spouse’s GST exemption. However, once the surviving spouse passes on and trust assets are distributed to children or other beneficiaries, the GST exemption is lost because children or other beneficiaries either receive their inheritance outright or through a general power of appointment trust.
Solution
One solution to this potential problem is to create generation skipping trusts. A generation skipping trust preserves your GST exemption without having trust assets included in the estates of your children or other beneficiaries for estate tax purposes. It allows each generation of beneficiaries to receive income or principal from the GST trusts for health, support and education while excluding the value of the trusts in the beneficiaries’ estate for estate tax purposes.