Printer-friendly PDF: Negotiating the Generation-Skipping Tax.wpd
The Generation-Skipping Transfer (GST) tax thwarts multigenerational transfers of wealth by imposing a transfer tax “toll” at each generational level. Prior to its enactment, beneficiaries of multigenerational trusts were granted lifetime interests of income or principal, or use of trust assets, but those lifetime interests never rose to the level of ownership. Thus, it was possible for the trust to avoid imposition of gift or estate tax indefinitely.
The GST tax, imposed at rates comparable to the estate tax, operates for the most part independently of the gift and estate tax. Therefore, a bequest (i.e., transfer) subject to both estate and GST tax could conceivably require nearly three dollars for each dollar of bequest. The importance of GST planning becomes evident.
The GST tax operates by imposing tax on (i) outright transfers to “skip persons” (“direct skips”); (ii) transfers which terminate a beneficiary’s interest in a trust (“taxable terminations”), unless (a) estate or gift tax is imposed or unless (b) immediately after the termination, a “non-skip” person has a present interest in the property; and (iii) transfers consisting of a distribution to a “skip person,” unless the distribution is either a taxable termination or a direct skip (“taxable distributions”). A “skip person” is a person two or more generations below the transferor.
Of this troika of GST taxable events, lifetime “direct skips” result in the fewest GST taxes, since the tax is calculated on the value of the property that the skip person receives. Still, transfer taxes (GST and gift or estate) will consist of 122% of the amount transferred. In contrast, taxable terminations and taxable distributions of trusts which occur at death result in much higher GST tax liability, since an estate tax, which could nearly halve the estate, is imposed first, followed by the GST tax, which exacts another like amount. Taxable terminations and taxable distributions from trusts at death should be avoided wherever possible.
The potency of the GST tax is tempered somewhat by the GST exemption (GSTE). The GSTE, now $1.1 million, beginning in 2004, will be linked to the estate tax exemption, which is scheduled to increase to $1.5 million in 2004.
Once the GST exemption has been claimed with respect to trust property, that property will continue to grow without the imposition of GST tax; to that extent, multigenerational transfers of wealth may still be effectuated. (See Delaware Dynasty Trusts). To avoid “wasting” the GST exemption, trust distributions to “nonskip” persons should first be made from trust assets to which the GST exemption has not been allocated. In GST parlance, these distributions should be made from “non-exempt” trusts. Assets to which the GST exemption has been allocated are termed “exempt” trusts.
Marital deduction trusts require careful GST planning. The GSTE may be allocated at death only to property of which the decedent is deemed to be the transferor. If the decedent’s executor makes a QTIP election, the decedent’s estate may deduct the value of the property, but the surviving spouse, in whose estate the property will eventually be included (not the decedent), will be the “transferor” for GST tax purposes. If the first spouse’s unused GSTE exceeds his credit shelter equivalent (to which an allocation of GSTE is permitted), a portion of the first spouse’s GSTE will be wasted.
To permit the estate of a spouse electing QTIP treatment to also allocate GSTE to the QTIP, thereby making full use of the GSTE, Congress provided that the first estate may make a “reverse QTIP” election. Note that no analogous “QTIP” election exists with respect to a general power of appointment marital deduction trust. Therefore, if allocation of GSTE to a marital deduction trust is desired, a QTIP trust must be used.
No allocation of the GSTE may be made before the close of the “estate tax inclusion period” (ETIP). When comparing GRATs with sales to defective grantor trusts, in this regard at least, GRATs fare poorly: Since the entire term of the GRAT is an ETIP, the property will be included in the grantor’s gross estate if the grantor dies prior to the expiration of the GRAT term. In contrast, no ETIP period occurs when a sale of assets is made to a defective grantor trust (if the sale is respected). Thus a GSTE allocation may be made at the time of the initial sale to the trust, rather than at the end of the GRAT term.