Generation-Skipping Transfer Tax Chapter 18 Tools & Techniques of Estate Planning Copyright 2011,...

Generation-Skipping Transfer Tax

Chapter 18Tools & Techniques of

Estate Planning

Copyright 2011, The National Underwriter Company 1

What is GSTT?

• Generation Skipping Transfer Tax applies to transfers of property during life or at death to persons determined to be two or more generations below the transferor known as “skip persons,” generally including:– Family members: Grandchildren, great-grandchildren, grand

nieces or nephews (and spouses of such family members)– Non-family members: Persons 37.5 years younger than

transferor



Estate Planning


Tax Implications

• Each person has a GST tax exemption • The GST exemption is:

– $2,000,000 (2006 - 2008)– $3,500,000 (2009)– $5,000,000 (2010 2012)– $1,120,000 (plus indexing for inflation after 2003)



Estate Planning


• The GST tax is calculated by multiplying the GST tax rate by the amount of the GST transfer and the inclusion ratio (based on allocation of GST exemption)

• The GST tax rate is equal to the highest estate tax rate for the year the transfer is complete:

– 46% (2006)– 45% (2007-2009)– 0% (2010)– 35% (2011-2012)– 55% (2013)

Tax Implications (cont’d)



Estate Planning


• The annual exclusion amount of $13,000 (in 2009 and 2011) applies to present interest gifts to skip parties

• Both the medical and tuition exemptions are available for transfers made on behalf of skip parties

Tax Implications (cont’d)



Estate Planning


• Client stands to inherit a substantial estate from a parent and already has a substantial estate of his own

• Parents wish to minimize transfer taxes in a child’s estate but still give the child the use and benefit of the property

• Parents wish to protect property from a spendthrift child or from being subject to loss through a child’s divorce or bankruptcy

• Client wishes to make a direct transfer to a grandchild or other skip person for their support or enjoyment

When Is The Use Of A Generation Skipping Trust Appropriate?



Estate Planning


• Trigger: Any gift, establishment of a trust, or transfer of property at death, that will or may benefit a skip person

What Are The Requirements For A GST?



Estate Planning


• A GST trust may be established during life or by a will provision at death

• There are two trusts established by the will or trust instrument:– GST exempt trust

• GST exemption is allocated to these assets, so they pass tax-free

– GST nonexempt trust

How Is It Done?



Estate Planning


• Related persons are assigned to a generation in reference to the ancestral chain

• Spouses of the transferor or a decedent are always assigned to the same generation as the transferor or descendant

Generation Assignment



Estate Planning


• Unrelated persons are assigned as follows:– < 12.5 years younger the same generation as the transferor– 12.5 years < unrelated person < 37.5 years first younger

generation– 37.5 years < unrelated person < 62.5 years second younger

generation (skip person)– Generation assignments continue in 25 year increments

• Predeceased parent rule: If an individual’s parent who is a lineal descendent of the transferor is deceased at the time of a transfer from which the individual’s interest is derived, the individual and all succeeding generations move up one generation– Applies to collateral relatives (e.g., nephews and nieces) if transferor

had no living descendants at the time of the transfer

Generation Assignment



Estate Planning


• If transferee is an entity (estate, trust, partnership, corporation), individuals who own beneficial interests in the entity are assigned generations

Generation Assignment (cont’d)



Estate Planning


• Skip person = person assigned two or more generations below the transferor

• A trust may be a skip person if all the beneficiaries holding interests are skip persons

Skip Persons



Estate Planning


• Taxable distribution• Taxable termination• Direct skip

Types of GSTs



Estate Planning


• Any distribution of income or corpus from a trust to a skip person that is not otherwise subject to gift or estate tax

• Transferee is obligated to file Form 706GS(D) and pay the tax– Note: If the trust pays the tax for the transferee, the

payment will be treated as an additional taxable distribution

Taxable Distribution



Estate Planning


• Taxable amount is what the distributee received, reduced by:

– Any expenses incurred by distributee in connection with the determination, collection, or refund of GST tax, and

– Any consideration he paid for the distribution

Taxable Distribution (cont’d)



Estate Planning


• Taxable distributions are “tax inclusive” meaning the amount subject to tax includes:– The property, and– The GST tax itself

• Example:A trustee makes a taxable distribution of $10,000 of trust income to a grandchild in 2009 (assuming a tax inclusion ratio of one), the tax would be $4,500 if paid by the grandchild. Grandchild will net $5,500.

Taxable Distribution (cont’d)



Estate Planning


• A taxable termination occurs by death, lapse of time, release of a power, or otherwise and results in skip persons holding all the interests in the trust

• The trustee is responsible for filing Form 706GS(T) and paying the tax

• Taxable amount is the value of all property involved less:– Deduction for any expenses, debts, and taxes (other than

GST tax) generated by the property, and– Any consideration paid by the transferee

Taxable Termination



Estate Planning


• Taxable terminations are also “tax inclusive”– Property subject to transfer includes generation skipping tax

• Example:Grantor placed $1 million into an irrevocable trust for the benefit of her daughter for life, with remainder to her grandson. At the daughter’s death in 2011, a taxable termination occurs. Assuming no exemptions were claimed and the trust has an inclusion ration of one, the tax is:

35% x ($1,000,000 x 1) = $350,000

The $350,000 must be paid out of the property passing to the grandson, so the grandson nets $650,000

Taxable Termination (cont’d)



Estate Planning


• Transfer subject to an estate or gift tax made to a skip person– Gift from individual to his granddaughter– Gift from individual to a trust where all beneficiaries are skip persons

• The transferor (donor or decedent) is responsible for the payment of GST tax

• Taxable amount equals the amount received by transferee, reduced by consideration paid by transferee

Direct Skips



Estate Planning


• Tax on a direct skip is “tax exclusive” meaning tax paid by the transferor or the estate does not include the amount of GST tax

• Example:A grandfather makes a lifetime gift of $1 million to his grand-daughter in 2011. Assuming an inclusion ration of 1 and no exemptions are available, the grandfather must pay GST tax of:

35% x ($1,000,000 x 1) = $350,000

The tax is paid not out of the gift, but out of additional assets of the grandfather. Granddaughter’s net gift received is the full $1,000,000.

Direct Skips (cont’d)



Estate Planning


Year20062007200820092010201120122013

Exemption

$2,000,000$2,000,000$2,000,000$3,500,000$5,000,000$5,000,000$5,000,000$1,120,000

Rate

46%45%45%45%0%

35%35%55%

Exemptions and Tax Rates



Estate Planning


• Gifts subject to GST tax which are split by the spouses will be treated as having been made half by each spouse, and each spouse can use some or all of their exemption to avoid the GST tax

• Gifts of direct payment for donee’s educational or medical expenses are exempt

Exemptions and Exclusions



Estate Planning


• Transfers that pass under annual exclusion (special trust rules)

• Transfers already subjected to GST tax in which the transferee was in the same or lower generation as the present transferee

• Unless governing document directs otherwise, GST tax is charged to the property constituting the transfer

Exemptions and Exclusions (cont’d)



Estate Planning


Step 1 List Value of property transferred $_____Step 2 List Exemption allocated to transfer $_____Step 3 List State & fed tax paid on transfer $_____ Step 4 List Gift or estate tax charitable

deductions allowed on transfer $_____Step 5 Add Steps 3 & 4 $_____Step 6 Subtract Step 5 from Step 1 $_____Step 7 Divide Step 2 by Step 6

This is the “applicable fraction” _____Step 8 Subtract Step 7 from (1)

This is the “inclusion ratio” _____Step 9 Multiply Step 8 by GST tax rate

This is the “applicable rate” _____Step 10 Multiply Step 1 by Step 9 $_____

Calculating GST Tax: A Simplified Worksheet



Estate Planning


• Transferor conveyed property worth $500,000 to a GST trust in 2009 and allocated $300,000 of exemption to it. In 2011, when the property was worth $700,000, transferor transferred additional $100,000 in cash to trust and allocated $100,000 of exemption. Calculate the inclusion ratio:

1 - $100,000 + (.600 x $700,000) $100,000 + $700,000

1 - $520,000 = .350 $800,000

Note: The .600 represents the non-tax portion of the trust before the second transfer $300,000 / $500,000

Inclusion Ratio Example

=



Estate Planning


Type of Who’s Responsible

GST Transfer for Payment

Taxable Distribution Transferee

Taxable Termination Trustee

Direct Skip Transferor

Liability For Payment of GST Tax



Estate Planning


There are special provisions for the following as they relate to GST transfers:

– QTIP property– Taxation of multiple skips– Basis adjustments– Disclaimers– Administration– Return Requirements

Trusts can have multiple generation skipsIRC Section 303IRC Section 6166

Special Provisions



Estate Planning


• GST tax may be imposed in addition to any estate or gift tax due because of the transfer

• In some cases the total cost of making a property transfer can exceed the value of the gift

• Trust distributions will be subjected to the tax regardless of whether they are made from income or corpus

Planning For GST Tax



Estate Planning


• Once assets are protected by the exemption, future appreciation is also exempt from GST

• GST may be allocated by the donor or his executor among any property that is transferred

• Election is irrevocable

• GST exemption will be automatically allocated to direct skips during life, unless the donor elects otherwise

Allocation of GST Exemption



Estate Planning


• If total value of the QTIP trust may exceed available GST exemption: Will or trust should provide for division of single QTIP trust into two trusts, exempt and non-exempt, to take advantage of the reverse election

• “All or nothing election” that must apply to all qualifying property in the trust (exempt trust)

• QTIP election qualifies the transfer property for the marital deduction in the transferor’s estate, while the reverse QTIP treats the property as part of the transferor’s estate for GST purposes

Reverse QTIP Election



Estate Planning


• Grantor retained income, annuity, and unitrusts where the remainder interests pass to skip persons

• Transfer may be complete for gift tax purposes, but includable in the transferor’s taxable estate, so that allocation of the GST exemption will be postponed during this “estate tax inclusion period” (ETIP)

GRIT’s, GRAT’s & GRUT’s



Estate Planning


• GST rules postpone allocation of exemption during the ETIP period until:– There is an actual GST transfer,– Transferor dies, or– Property would no longer be included in the transferor’s

taxable estate

GRIT’s, GRAT’s & GRUT’s (cont’d)



Estate Planning


• Dynasty Trust to avoid estate and generation skipping taxation on transfers to succeeding generations of skip persons (subject to any applicable rule against perpetuities)

• Advantage of a Dynasty Trust:$2,000,000 placed into a trust todayGrowing at annual rate of 4%Over a period of 75 yearsWill increase to over $37,000,000

• Combined with the leverage of a survivorship life insurance policy this tool is even more powerful

Multi-Generational Planning



Estate Planning


• Inclusion ratio for nontaxable gifts is zero

• Gifts that are not taxable by reason of the gift tax annual exclusion are also exempt from GST including gifts under IRC Sections

– 2503(b) – 2503(c)– 2503(e)

Exclusion For Nontaxable Gifts



Estate Planning


• Inclusion ratio for nontaxable gifts to trust are not zero unless:

– No portion of the trust could be distributed to a person other than a single beneficiary, and

– If that beneficiary dies before the trust terminates, trust assets will be included in beneficiary’s estate

Exclusion For Nontaxable Gifts (cont’d)



Estate Planning


• Compare GST tax cost on direct skip vs. Estate and gift tax cost on transfers to children, who then transfer to grandchildren (Assume a 2009 45% transfer rate)– Gift tax is exclusive of the gift, so a 45% gift tax rate = a tax

inclusive rate of 31.034% [45% / (1 + 45%)]

– Estate tax is included in the tax base, so the estate tax inclusive rate is 45%

– GST tax on taxable distributions and taxable terminations is imposed on the transferee and is tax inclusive at a rate of 45%

To Skip Or Not To Skip?



Estate Planning


• Compare GST tax cost on direct skip vs. estate and gift tax cost on transfers to children, who then transfer to grandchildren (Assume a 2009 45% transfer rate)– GST on direct skips is tax exclusive, resulting in a tax inclusive

rate of 31.034%• Note: GST on lifetime gifts also considered a taxable gift, so gift

tax will be paid on the GST tax. Similarly, a direct skip at death will result in GST tax being paid from assets subject to estate tax. Note: If a lifetime direct skip transfer is made, both gift and GST tax paid will reduce the donor’s taxable estate

To Skip Or Not To Skip? (cont’d)



Estate Planning


• Generally, GST tax applies to transfers made after October 22,1986

• Irrevocable trusts grandfathered for GST purposes on September 25, 1985, may become “tainted” by actual or constructive additions– Constructive addition consists of exercise, release, or lapse

of a general power of appointment over a portion of the grandfathered trust

Other Planning Considerations



Estate Planning


• Gift splitting by husbands and wives may not be necessary

• Transfers from wealthier spouse to less wealthy spouse may not be necessary so that both may utilize their full exemptions

Issues In Community Property States

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