For those who are extremely wealthy and looking for ways to best protect the wealth for generations to come, a generation skipping trust (GST) may accomplish those goals. Passing assets to grandchildren by skipping over your children has two large benefits: (1) it ensures that your children do not squander it, give it to charity or dispose of the wealth in a manner not in accordance with your wishes; and (2) it prevents the estate from being taxed twice – once when you children inherit and again when your grandchildren inherit.
The estate tax issue currently only applies to very high net worth families since the current federal estate tax exemption is $11.7 million per individual. Maryland has a state estate tax exemption in the amount of $5 million per individual. Portability allows spouses to transfer any unused exemption amount from the other spouse.
Your children are not left impoverished by this strategy. While they cannot spend or access the assets funding the generation skipping trust, the trust can be structured to allow the income produced by those assets to be distributed to your children. This preserves the assets for your grandchildren which they will inherit once your children pass away. The income distributions to your children can be in any timing or manner you choose. You can provide additional terms and provisions that create restrictions of use just like any other type of trust document.
Due to this tax loophole, a federal tax law was passed in 1986 that remains in effect today imposing a generation skipping transfer tax. This tax applies to any transfers from grandparents to grandchildren even if the transfer occurs via a trust. The GST tax rates typically coincide with the federal estate tax rates and exemption amounts. If a grandparent transfers more than $11.7 million to his or her grandchildren, then the amount above that will be taxed at a rate of 40%. The GST tax rates have fluctuated over the years. In 2001, the rate soared to 55%. In 2010 a Tax Relief Act temporarily decreased it to 0%.
The generation skipping trust can be structured by only transferring assets under the $11.7 million exemption amount (or $22.4 million for married couples) and then allow those assets to increase in value. No GST tax will be assessed on the increased value since it is an irrevocable trust. After 2025, this exemption amount is set to decrease back to $5 million established under the American Taxpayer Relief Act of 2012 which secured a permanent $5 million tax exemption on generation skipping transfers (although any law is subject to change). This act does not have a specific sunset clause like the current federal estate tax exemption. The reason for that is lawmakers wanted to ensure that people who transfer modest wealth (i.e. less than $5 million) do not bear the brunt of this tax burden.
Though grandchildren are the most common beneficiaries, the recipient of a generation skipping trust can be anyone who is at least 37 ½ years younger than the grantor as long as it is not the grantor’s spouse or ex-spouse. Contact the estate planning attorneys at Stouffer Legal in the Greater Baltimore area to learn more about gifting to grandchildren through a generation skipping trust. These are complex documents and need to be drafted by experienced attorneys.
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