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The generation-skipping transfer tax (GSTT) targets property transfers to younger generations, adding a layer of complexity beyond standard gift or estate taxes. For high-net-worth individuals, understanding GSTT is crucial for effective estate planning.

Key aspects of the generation-skipping tax include who it affects, what triggers it, and strategies for minimizing its impact. By familiarizing yourself with these details, you can ensure more efficient and compliant wealth transfer to your descendants.

1. What Is the Generation-Skipping Transfer Tax and Why Was It Introduced?

The generation-skipping transfer tax (GSTT) is a federal tax on transfers of property to individuals who are at least 37.5 years younger than the donor. It’s an additional tax on top of federal estate taxes and gift taxes.

GSTT was introduced to close a loophole in estate planning where wealthy individuals could transfer assets directly to their grandchildren, bypassing their children, and thus avoiding a layer of estate tax. The GST tax ensures that estate taxes are collected at each generational level.

2. Non-Skip vs Skip Person

It’s important to understand the difference between a non-skip and a skip person.

• Non-Skip Person: An individual one generation below the donor (e.g., the donor’s child)
• Skip Person: A person who is two or more generations younger than the donor (e.g., grandchildren, great-grandchildren, great-nieces/nephews, or unrelated beneficiaries more than 37.5 years younger than the donor)

3. Deceased Parent Rule

If the parent of the skip person (e.g., the grandchild) is deceased at the time of the transfer, the grandchild may be treated as a non-skip person, thus avoiding GSTT. This rule helps preserve wealth within the family when an intervening generation has passed away.

4. Lifetime GST Tax Exemption and Current Tax Rate

In 2024, the lifetime federal estate, gift, and GST tax exemption amount is $13.61 million per individual and $27.22 million for couples. Transfers above these levels are taxed at 40%.

5. What Triggers the Generation-Skipping Transfer Tax

Three primary events trigger the GST tax.

Direct Skip

This occurs when assets are directly transferred to a skip person—either outright or through a trust.

• Example: Grandpa Stan gifts assets directly to his grandson, bypassing his daughter.
• Tax Responsibility: The transferor or their estate is responsible for paying the GSTT at the time of transfer unless the exemption is applied.

Taxable Termination

This is classed as an indirect skip and happens when an interest in the property held in a trust terminates (e.g., due to the death of a non-skip beneficiary or the expiration of the trust term) and the remaining trust assets are transferred to skip persons.

• Example: An income-producing trust was established by Fred for his daughter Samantha, a non-skip person and the primary beneficiary. When she died, the trust assets were passed to her children (i.e., skip persons). A taxable termination occurred because there were no other non-skip beneficiaries and the trust’s assets were not included in Samantha’s estate.
• Tax Responsibility: The trustee pays the GSTT upon termination.

Taxable Distribution

This is another type of indirect skip that occurs when a trust makes a distribution of income or principal to a skip person.

• Example: A trust established by Beth for her son Joe and his children makes a distribution to Joe’s children while he is still alive. If Beth did not allocate her GSTT exemption, the distribution to Joe’s children is taxable.
• Tax Responsibility: The skip person (recipient of the distribution) is responsible for paying the GSTT when the distribution is received.

6. Strategies to Minimize GSTT Liability

These are a few of the strategies that we recommend to our high-net-worth accounting clients at Alpine Mar to assist them in mitigating GSTT.

Trusts as a Strategic Tool

Generation-skipping trusts (GSTs), sometimes called dynasty trusts, allow assets to pass to subsequent generations with minimized tax impact.

Annual Gift Tax Exclusion

The annual gift tax exclusion allows you to give up to $18,000 per recipient (as of 2024) without incurring gift or estate tax. Note that these gifts are not subject to the GSTT, but any amount exceeding the annual exclusion may count against your lifetime GSTT exemption. Using this exclusion yearly can reduce the value of your estate gradually, potentially avoiding GSTT.

Leveraging Lifetime Exemptions

Using the GSTT lifetime exemption strategically reduces overall tax liability. It allows high-net-worth individuals to transfer substantial assets to skip persons within the exemption limits.

Contributions to 529 Plans

Contributing to 529 plans is a way to avoid GSTT. These contributions are considered completed gifts even if you change the beneficiary in the future. Furthermore, you can accelerate up to five years of annual gift exclusions in one year, allowing for contributions of up to $90,000 for individuals or $180,000 for married couples in 2024.

Charitable Contributions

Donations to qualified charities reduce your taxable estate and can align with your philanthropic goals while mitigating your GSTT liability.

7. Federal Estate Tax and Gift Tax Considerations

GSTT often overlaps with federal estate and gift taxes. Transfers above the $13.61 million estate tax exemption (2024) can incur both estate and GST taxes, necessitating careful estate and tax planning.

8. Allocation of Your GST Exemption

To avoid GSTT on the initial transfer (either outright transfers or transfers to a trust), you must allocate some or all of your GSTT exemption to the transfer. This allocation is typically reported on a gift or federal estate tax return using IRS Form 709 or IRS Form 706.

9. Benefits of Allocating Your Exemption to Trusts

When the exemption is allocated to a trust, any growth in the assets within the trust is sheltered from future GSTT. For example, say you established an irrevocable trust for your grandchildren with $8 million and allocated part of your GSTT exemption to exempt the full amount. Even if the trust grows, distributions to the beneficiaries do not incur additional GSTT, effectively sheltering any growth from future GSTT. This is one of the many reasons that trusts are a popular option among those looking to optimize their family office tax structure.

10. Potential Penalties for Non-Compliance

Non-compliance with GSTT regulations can result in significant penalties, including interest on unpaid taxes and fines. Accurate and timely reporting of all applicable transfers is crucial to avoid these penalties.

11. The Current GSTT Exemption Is Temporary

The provisions of the current federal estate, gift, and GSTT exemption are set to expire at the end of 2025. On January 1, 2026, the exemption will revert to the inflation-adjusted $5 million allowed under the 2017 law—unless Congress enacts new legislation to extend or modify the current law. This potential change emphasizes the need to use the higher exemption this year before it disappears.

Seek Professional Guidance for Effective Estate Planning

Understanding and navigating the complexities of the generation-skipping transfer tax (GSTT) is vital for high-net-worth individuals committed to effective estate planning. Familiarizing yourself with the tax’s implications, exemptions, and strategic planning opportunities ensures a smoother transfer of wealth to your future generations.

Given the complexity of GSTT regulations, seeking professional guidance is essential. Look for experts like Alpine Mar who offer specialized services for high-net-worth individuals to ensure strategic, comprehensive, and compliant estate planning.