The Generation Skipping Transfer Tax

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	Understanding the GST Personal Finance Advisor by Deloitte & Touche OnLine December 28, 1998

Congress set its sights on generation skipping in estate planning.

Transfers that skip a generation could be subject to a generation-skipping transfer (GST) tax of 55 percent. The GST tax is in addition to estate or gift taxes due on the transfer. Congress enacted the GST tax as a means of limiting gifts or transfers that bypass the next generation.

Skip Person: A generation-skipping transfer is generally defined as a transfer to a donee who is two or more generations younger than the donor. The transfer can be along family lines -- transfer to a lineal descendent by blood, adoption, or marriage. Examples of such transfers include those from (1) a grandparent to a grandchild, and (2) an aunt or uncle to a great-niece or great-nephew.

The GST tax also applies to transfers to nonfamily members. In this case, the donee’s birth date is the determining factor. Individuals born less than 12½ years after the donor are considered to be of the same generation as the donor, and individuals born more than 12½ years but less than 37½ years after the donor are considered to be in the next generation. Therefore, a transfer to a donee who is more than 37½ years younger than the donor is a generation-skipping transfer.

Exclusions and Exemptions: The $10,000 annual gift tax exclusion applies to generation-skipping transfers. In the case of a transfer to a trust, this $10,000 annual exclusion is available only if (1) the trust’s corpus or income is for the sole benefit of the skip-person beneficiary, and (2) the trust’s assets are included in the skip-person’s estate (that is, situations where the trust does not terminate before the skip-person’s death). Therefore, the $10,000 annual exclusion generally is not available for a transfer to a trust where there are multiple beneficiaries.

Each U.S. citizen or resident is entitled to a $1 million exemption for taxable generation-skipping transfers. The exemption is for GST purposes only -- it does not apply to estate or gift taxes on generation-skipping transfers. The donor can allocate the $1 million exemption to any transfer that is subject to the GST tax; however, once selected, the allocation is irrevocable. The executor of the donor’s estate can allocate the exemption at the date of the donor’s death. If the executor does not allocate the exemption, any unused portion of the $1 million exemption will be allocated on a pro-rata basis first to direct transfers (for example, outright bequest to grandchildren), and then to indirect transfers (for example, transfer in trust that will eventually go to grandchildren). Significant tax savings can be achieved through effective allocation of this $1 million exemption.

Amounts paid for qualified medical expenses or qualified educational expenses are not subject to the GST tax (or other federal transfer taxes). Additionally, the GST tax does not apply to certain trusts established before October 22, 1986.

Transactions: As a general rule, there are three types of transactions that trigger the GST tax -- direct skips, taxable terminations, and taxable distributions.

Direct Skips: These transfers are made during the donor’s lifetime (or upon his/her death), and are directly to a skip person (or to a trust for the benefit of a skip person). In most cases, a transfer of assets by a grandparent to a grandchild is a direct-skip transfer that will be subject to the GST tax (assuming the exemptions/exclusions discussed above are not available). If the donor’s child (that is, parent of the grandchild) is deceased at the time of the grandparent’s transfer to the grandchild, then the grandchild "steps into the shoes of" the deceased child. Therefore, the transfer would not be subject to the GST tax.

Taxable Termination: The GST tax may be triggered by an event that results in the termination of a trust and the transfer of the trust’s assets to a skip person. For example, a taxable termination will occur when (1) a parent created a trust to provide income to a child for life, (2) the child beneficiary dies, and (3) the assets remaining in the trust are transferred to a grandchild.

Taxable Distribution: The transfer of trust income or principal to a skip person other than by the termination of the trust is a taxable distribution that may be subject to GST tax. For example, in situations where a grandparent establishes a trust to provide income for a grandchild, the GST tax could apply to income distributions from the trust to the grandchild.

Transfer Tax Computation: The type of transfer will determine how federal transfer taxes are computed. The computation for a direct-skip transfer is on a "tax exclusive" basis -- GST tax is not included in the taxable transfer. However, the computation for a taxable termination or distribution is on a "tax inclusive" basis -- GST tax is included in the taxable transfer. Under the tax inclusive computation, the GST tax paid would be considered part of the total transfer and subject to transfer taxes. A $1 million direct transfer from a grandparent to a grandchild (assuming the grandparent is in the top gift-tax bracket) would result in $550,000 GST tax liability ($1 million times 55 percent) and $550,000 federal gift tax liability ($1 million times 55 percent). If the transfer to the grandchild was the result of a taxable or distribution in the amount of $1 million, the GST tax would total $550,000 and the grandchild would receive $450,000 (the gift tax would have been previously paid upon funding the trust).

These are some thoughts to consider about the generation-skipping transfer tax. Your financial and tax advisors also can provide information and should be consulted before any action is taken.