Did you know that if you leave money directly to your grandchildren, the funds may be taxed twice? The Generation Skipping Transfer Tax (GSTT) is responsible. Understanding the GSTT requires a discussion of both of life’s two certainties – death and taxes.
Typically, when individuals pass away, their estate is left to the next generation. In turn, when those in the next generation pass away, they leave the estate to their own children – the grandchildren of the first individuals. In terms of taxation, here’s how the above scenario works. Currently, the government allows an individual to gift 5.43 million dollars during life, at death, or in a combination of the two, before funds are subject to tax. However, if an individual exceeds this amount, the amount over 5.43 million dollars can be heavily taxed. Under the above scenario, the amount over 5.43 million would be taxed when the first generation gives to the second, and would be taxed again when the second generation gives to the third. But, what about when the first generation skips over the second and gives directly to the third? The GSTT was developed to ensure that the government does not miss out on a generational level of transfer taxes when a generation is skipped over, and so the transfer on such skips is taxed twice.
So how do you know if a particular transfer will be subject to the GSTT? As always, if you are contemplating such a transfer, you should speak with your attorney, but the following types of transfers are those to which the GSTT generally applies:
A transfer to someone two or more generations below the transferor is called a direct skip, and the person to whom the money is transferred is called a “skip person.” Note, the skip person does not need to be related to the transferor for the GSTT to be applicable, but the most common relationship here is grandparent and grandchild. In a direct skip, the amount subject to GSTT is the value received by the skip person, and the transferor is liable for paying any GSTT – an additional gift which could cause more tax yet. An important exception is given under this provision for transfers to a grandchild whose parent is deceased, because if the grandparent could not have given to his or her child, the child’s share received by the grandchild will not be taxed twice.
A taxable termination occurs if a trust beneficiary’s interest terminates, leaving only “skip persons” with interests in the trust. For example, an individual creates a trust to benefit his or her only child, and in the event of that child’s death, the child’s share goes to his or her own children, the initial individual’s grandchildren. If the child passes away, the remaining trust beneficiaries are all skip persons. Consequently, the GSTT applies at the time of the child’s death, to the extent of the value of the trust property at that time. The liability for payment of the GSTT in this instance inures to the trustee, not the grandparent.
A taxable distribution is any other trust distribution to a skip person not otherwise discussed above. Most commonly, such a taxable event occurs when a trust is created whereby the trustee may distribute to a variety of family members which may include the children and/or grandchildren of the grantor of the trust. At the time of any distribution to a grandchild, the distribution is taxable at the value of the amount actually distributed to the grandchild, and the grandchild is responsible for the payment of any tax. As mentioned above, if the grandparent or trustee pays the skip person’s tax liability, that payment is considered to be an additional taxable distribution or gift, likely causing additional tax.
The Generation Skipping Transfer Tax is one of the most complicated provisions in the U.S. Tax Code. If you are considering making a gift to a grandchild, or anyone else two generations or more below you in age, be sure to consult an estate planning attorney. For more information, contact Mammel Law at 248-644-6326.