The Generation-Skipping Transfer Tax: A Quick Guide
Boil down the complexities to avoid costly errors in your clients' estate plans.
Sooner or later, every estate planner comes face to face with the generation-skipping transfer tax (GSTT). Many practitioners do not feel up to the challenge because this particular tax has a reputation for being as treacherous as the sea. But after you boil down all the complications, you're left with a fairly direct set of circumstances to watch for. This article is meant to help you identify situations that subject clients to the generation-skipping transfer tax and advise them appropriately.
The GSTT is the government's defense against an end run around estate and gift taxes. It imposes a flat tax on gifts and bequests above the estate/lifetime gift exclusion that avoid gift or estate tax by skipping one or more generations, such as to grandchildren. It is relatively straightforward in its provisions, but financial advisers need to be aware of recent and ongoing changes in exemption amounts, allocations and tax rate and the corresponding implications for estate plans. One important planning element is the optimal use of the lifetime exclusion in tandem with the annual gift exclusion, along with other common estate planning mechanisms.
Reining in Life Estates
The GSTT is a simplified version of a tax originally instituted in 1976. Back then, Congress explained that the tax was designed "to remedy the perceived abuse of using a trust to benefit several generations while avoiding Federal Estate Tax during the term of the trust."
Here's the abuse they saw: Wealthy families were going to estate planners who created a life estate in their assets for their kids, followed by a life estate in the assets for their grandkids, followed by a life estate in the assets for their great-grandkids and so on. Since life estates are not subject to the federal estate tax, these plans effectively moved incredible amounts of wealth from generation to generation without any risk of the estate tax. Less wealthy families were paying more in estate tax than more wealthy families, who could afford to engage in sophisticated estate planning. The initial GSTT that Congress created, however, was so widely criticized that the Tax Reform Act of 1986 retroactively repealed the 1976 version and implemented the current version.
This article has been excerpted from the Journal of Accountancy. View the full article here.