Financially savvy high net worth individuals are becoming increasingly interested in intergenerational planning to protect and sustain family legacies. This frequently involves making monetary gifts, either directly or via trust, to the individual’s grandchildren or great-grandchildren. While it’s common practice to make inter vivos gifts to reduce a taxable estate, one must be aware of the implications of the Generation-Skipping Transfer (GST) Tax.
Implemented in 1976 to prevent individuals from avoiding estate tax through strategic gifting, the GST Tax levies a 40% tax rate on any generation-skipping transfers above the lifetime GST exemption. The most common types of generation-skipping transfers are gifts from grandparent to grandchild, great-grandchild, or more remote descendants, and gifts from a transferor who is more than 37.5 years older than the recipient. Such recipients of generation-skipping transfers are referred to as “skip persons.” It is worth noting, however, that gifts from grandparent to grandchild are not considered generation-skipping transfers if the grandchild’s parent is deceased.
Determining whether a generation-skipping transfer is subject to the GST Tax depends on an individual’s utilization of his/her gift tax exemptions and exclusions. As of 2023, every person has a lifetime estate/gift tax exemption of $12,920,000, a lifetime GST exemption of $12,920,000, and an annual gift tax exclusion of $17,000. (To note, the exemption and exclusion amounts typically change year-to-year to account for inflation. Additionally, the lifetime exemptions are set to revert to $5 million each in 2025, indexed for inflation.) The annual gift tax exclusion allows a transferor to gift an unlimited number of recipients $17,000 each per year without having to pay gift tax. This is true for both generation-skipping transfers and non-generation-skipping transfers.
However, if a transferor makes a generation-skipping transfer to a recipient that exceeds $17,000, the amount over the annual gift tax exclusion is charged against the transferor’s lifetime estate/gift tax exemption and lifetime GST exemption. By way of illustration, a $100,000 generation-skipping transfer reduces the transferor’s lifetime exemptions by $83,000 each. Once an individual has used his/her entire lifetime GST exemption, any taxable gift from a generation-skipping transfer is subject to the GST Tax at a rate of 40%.
Individuals interested in preserving generational wealth often make generation-skipping transfers by trust, such as a grandparent creating a trust for the benefit of a grandchild. For the grantor to utilize his/her 2023 $17,000 annual gift tax exclusion, the beneficiaries must have a present interest in the gift. Typically, this is accomplished by including Crummey provisions in the trust that allow the beneficiaries to withdrawal up to the annual gift tax exclusion amount. As with outright transfers, the taxable gift into a generation-skipping transfer trust is charged against the grantor’s lifetime estate/gift tax exemption and lifetime GST exemption.
To maximize the benefits of the lifetime GST exemption, the grantor of a generation-skipping trust should elect the GST allocation on a timely-filed annual gift tax return (Form 709). While Internal Revenue Code Section 2632 provides several categories of generation-skipping transfers that receive automatic allocation, grantors who want to delineate which transfers are allocated to the GST exemption should file the Form 709. Generally speaking in 2023, a grantor could make up to a $12,920,000 gift into a generation-skipping trust, file the Form 709 to allocate the taxable gift to his/her lifetime GST exemption, and the assets will grow GST Tax free. In contrast, distributions to skip persons from trusts that have not been allocated to the lifetime GST exemption are typically subject to the GST Tax.
For more information on the GST tax and the implications it may have for your estate plan or trusts, please contact the knowledgeable team of trust and estate administrators at Pendleton Square Trust Company, LLC. Additionally, click here to listen to Frazer Rice, Thought Leader with Pendleton Square, and Michael Grossman, Fiduciary Specialist at Adelman Katz & Mond LLP, discuss the GST Tax on Rice’s podcast, Wealth, Actually.
Pendleton Square Trust Company, LLC, does not provide legal or tax advice. Nothing in this article should be construed as providing legal or tax advice regarding your specific situation.
Pendleton Square guides generations forward and provides an unsurpassed client experience. We welcome the opportunity to help you meet your estate planning goals.