Before the introduction of the generational leap transfer tax in 1976, wealthy individuals could legally donate money and bequeath property to their grandchildren without paying federal inheritance tax. But the new legislation effectively closed the loophole where inheritances could skip a generation to avoid estate double taxation.
Key points to remember
- Prior to 1976, when the GST was enacted, wealthy individuals could legally give money and bequeath property to their heirs without paying federal estate tax.
- The new legislation closed the loophole through which inheritances could skip a generation.
- A generation leap transfer (TPS) is the transfer of assets to a person who is two or more generations younger than the settlor.
- The captain can be any member of the family other than the spouse, at least 37.5 years younger than the transferor.
- The GST tax was put in place to ensure that taxes are paid on donations in excess of the GST estate tax credit.
What is the GST?
A generation leap transfer (TPS) refers to the transfer of money or property, as a gift or inheritance, to someone who is two or more generations younger than the grantor. The party that gives is called the “assignor” and the recipient is called the “skip person”. While the person who jumps is often a grandchild, it can be any family member other than the spouse who is at least 37.5 years younger than the transferor.
What is the GST tax?
The GST tax is a federal tax imposed on gifts given to unauthorized persons to ensure that taxes are paid at every generational level and that they are not avoided through a trust. Tax is only due when an unauthorized person receives amounts greater than the GST estate tax credit. Fortunately, most people will never face the GST because of the high threshold.
Once a transferor exceeds the exemption, the GST tax is assessed at a flat rate.
GST can arise before or after the death of the transferor, and GST tax is imposed when the gift or transfer of ownership is made. During his lifetime, the transferor can deliver the gift directly to the captain. But on death, the will of the transferor can either stipulate that the property is bequeathed to a captain, or provide for the constitution of a trust from which the distributions will be made. Form 709 is used to report both GST taxes and transfers for which federal gift taxes are due.
Direct or indirect jumps
The imposition of a GST varies depending on whether it is a direct or indirect transfer. A direct jump is a transfer of property subject to inheritance or gift tax. An example of a direct jump would be a grandmother who donates property to a grandchild. The transferor or his estate is responsible for paying GST for direct jumps. An indirect jump involves a transfer that involves intermediate steps before reaching a person who is jumping. There are two types of indirect leaps: taxable termination and taxable distribution.
Once a transferor exceeds the exemption amount, tax is assessed at a flat rate rather than a percentage.
A taxable termination involves one person jumping and one person not jumping. A non-jumping person is a primary beneficiary who will receive ownership before it passes to the jumping person. The transfer to the non-skipping person occurs with the death of a non-skipping person, usually the child of the transferor.
As an example of a taxable cessation, consider a transferor who establishes an income-generating trust for his son. On the death of the son, the remaining property would pass to the transferor’s grandchild, at which time such property would be subject to GST.
A taxable distribution refers to any distribution of income or property, from a trust to a person who not otherwise subject to inheritance or gift tax. If a grandmother established a trust that made payments to her grandson, those payments would be subject to GST, which the beneficiary is responsible for paying.
The graph below shows the GST exemptions since 2010:
Reduce the tax burden of an heir
Most beneficiaries will avoid the GST because their estates will be worth less than the government’s estate tax credit. From 2006 to 2008, each taxpayer was entitled to an exemption of $ 2 million. However, the exemption has gradually increased each year.
In 2021, the individual exemption is $ 11,700,000 and in 2022, the amount increases to $ 12,060,000. Married couples can double these amounts to determine the exempt portion of their GST.
Create a Generation Break Transfer Trust
To reduce the effects of the tax on the GST, transferors can create a dynasty trust, designed to avoid or minimize inheritance taxes with each generational transfer. By placing assets in the trust and making specified distributions to each generation, the trust’s wealth is not subject to inheritance taxes as each generation passes.
The bottom line
Generation hopping transfer taxes can be complex and difficult to navigate, with strict rules and deadlines regarding lineage, skipped eligibility, declaration of gifts, and payment of taxes. An accountant or lawyer can help ensure the efficient and economical transfer from one generation to the next.