- Asset Protection Planning
- Business Succession Planning
- Charitable Giving
- Disability and Special Needs
- Elder Law
- Executor and Trustee Responsibilities
- Financial Powers of Attorney
- Inheritance Planning
- Lifetime Gifts
- Medical Directives
- Planning for Minors
- Retirement Accounts
Protect against the Generation-Skipping Transfer Tax
When you die, if some or all of your estate bypasses your children and goes directly to a grandchild, your estate could have to pay a tax called the generation-skipping transfer (GST) tax. This is a very expensive tax. It is equal to the highest federal estate tax rate in effect at the time, and it is in addition to the federal estate tax.
Skipping a generation and incurring this tax can happen in three ways. It can happen intentionally, for example, if you skip the living parent (your child) and leave an inheritance directly to your grandchildren. It can also happen unintentionally. For example, if the inheritance is in a trust for your child, your child dies after you but before receiving the full amount in the trust, and your grandchildren will receive their parent's remaining inheritance under the terms of the trust, it could then be subject to the GST tax. This tax also applies if you leave assets to a nonrelative who is more than 37½ years younger than you.
Why do we even have this tax? In the past, generation-skipping trusts were common, especially among the wealthy. For example, a grandfather would set up a trust that distributed only income (no principal) to his children. The trust principal would be distributed later to his grandchildren and future generations. This allowed the trust assets to grow estate tax-free and appreciate in value. It also avoided the heavy taxation that would have occurred if each generation had been taxed on the full inheritance. The Rockefellers are one family who used this concept to great advantage, building (and retaining) considerable wealth for several generations.
Eventually, of course, Uncle Sam decided he wanted his share of taxes, just as if each generation had received its inheritance and paid taxes on it. Thus, if you leave substantial assets to your grandchildren and future generations—bypassing your children's generation—these assets may be subject to the GST tax.
The good news is that everyone has an exemption from this tax. In 2020, the GST tax exemption is $11.58 million. So you and your spouse could potentially leave up to $23.16 million to your grandchildren and future generations without having to pay the generation-skipping transfer tax. Just like the federal estate tax exemption, however, you have to plan ahead to avoid wasting one of these GST tax exemptions.
One way to do this is with an A-B-C living trust. When one spouse dies, the estate can be divided in half. The deceased spouse's GST tax exemption can be applied to that spouse’s half (Trust B + Trust C). When the surviving spouse dies, his or her GST tax exemption can be applied to Trust A. This arrangement makes full use of both exemptions. Of course, this same planning can also be done in a will, but you would not enjoy the many benefits of a revocable living trust.