Avoid Generation-Skipping Trust (GSTT) Tax Pitfalls

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Due to recent tax law changes, your family may be able to avoid adverse federal estate tax consequences when you leave assets to your adult children.

The unified estate and gift tax exemption now stands at $12.92 million in 2023. This means that a married couple can shield up to $25.84 million from the federal estate tax. However, assets gifted or bequeathed to grandchildren in a generation-skipping trust require careful consideration to avoid unexpected tax liabilities.

First, beware the Generation-Skipping Transfer Tax (GSTT), a tax imposed on transfers to beneficiaries more than one generation away. To safeguard your wealth and ensure the financial well-being of future generations, it is essential to explore strategies that work around the GSTT. Keep in mind that you must implement these strategies before making any gifts or passing away.

The GSTT was created to prevent the wealthy from circumventing estate and gift rules through generation-skipping transfers. The tax applies to transfers made to related individuals more than one generation away, such as grandchildren or great-grandchildren, and any unrelated individuals more than 37 ½ years younger, known as “skip persons.”

Simply transferring assets to a trust and designating grandchildren or a significantly younger person as the ultimate beneficiary is not enough to avoid the GSTT. In this scenario, all trust beneficiaries, including adult children, would be treated as “skip persons.” The trust itself may even be considered a skip person under certain circumstances.

GSTT rules are the same as those applied to federal estate taxes. The top tax rate for the GSTT is 40%, which is identical to the rate for federal estate taxes. Additionally, the GSTT shares the same exemption rate, indexed for inflation, as the federal estate tax.

It is crucial to remember that the exemption is set to revert to $5 million, plus inflation indexing, in 2026. If Congress enacts new legislation before then, the change may happen sooner.

On a positive note, there is a GSTT exemption for lifetime transfers aligned with the annual gift tax exclusion. You can gift up to $16,000 per recipient, including a grandchild or other descendant, annually without incurring a GSTT liability.

Consult with your estate planning attorney to determine if these three strategies are suitable for you to avoid or minimize the GSTT:

  1. Maximize the GSTT exemption: Although lifetime transfers reduce the available estate tax shelter, the current $12.06 million exemption offers significant flexibility and an opportunity for wealthy individuals to benefit from generation-skipping trusts.
  2. Utilize the annual gift tax exemption: Shelter tax gifts up to $16,000 per recipient above and beyond the lifetime exemption by taking advantage of the annual gift tax exclusion before the lifetime exemption expires.
  3. Explore trust options: Investigate how trusts within the standard tax law boundaries can be used to protect assets from taxes and preserve wealth for future generations.

In summary, generation-skipping trusts are an important tool for wealthy individuals who want to preserve their wealth for future generations, but there are potential pitfalls. Careful planning and consultation with an estate planning attorney can help ensure that your assets are protected and your legacy endures.

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