Beware of transfer rights that skip generations


Due to recent tax law changes, your family may be able to avoid adverse federal estate tax consequences when you bequeath assets to your adult children. For example, the Unified Estate and Gift Tax Exemption has been increased from $5 million to $10 million indexed to inflation ($12.06 million in 2022). Therefore, a married couple can shelter up to $20 million ($24.12 million in 2022) in taxes.

But what about the assets you give or bequeath to your grandchildren? It’s a whole other ball of wax. In the normal course of events, the Generation Skip Mutation Tax (GSTT) can be imposed on unsuspecting families. However, you have some ability to circumvent this possibility.

Background: The GSTT is designed to prevent wealthy individuals from circumventing inheritance and gift rules through generation-skipping transfers. In short, the tax applies to transfers to people related to more than one generation, such as grandchildren or great-grandchildren, and to unrelated people more than 37½ years younger. These designated beneficiaries are called “skip persons”.

Notably, you cannot circumvent this potential tax trap simply by transferring assets to a trust and naming heirs like your grandchildren as ultimate beneficiaries. For these purposes, all beneficiaries of the trust are treated as skippers – even the trust itself can be a skip person in certain circumstances.

Generally, the rules for GSTT mirror those that apply to federal estate tax. For example, the top tax rate for GSST is 40%, the same as for estates.

Similarly, the GSTT shares the same exemption amount, indexed to inflation, as the regular federal estate tax. Thus, the estate can benefit from an exemption of $10 million ($12.06 million in 2026).

However, this exemption is currently expected to revert to $5 million in 2026, plus indexation for inflation. And, of course, Congress can enact other laws affecting this limit before then.

Note: Be aware that there is another GSTT exemption for lifetime transfers that aligns with the annual gift tax exclusion. Similar to the annual gift tax exclusion, in 2022 you can give up to $16,000 per beneficiary (compared to $15,000 in 2021), including a grandchild or other descendant, each year without triggering GSTT liability.

With all of this in mind, consider the following three strategies to avoid or reduce GSST.

  1. Maximize the use of the GSTT exemption. Even though lifetime transfers reduce the tax shelter available, the current exemption of $12.06 million ($24.12 million for a married couple) should give you plenty of flexibility.
  2. Remember that you can use the annual gift tax exemption to protect yourself from tax gifts of up to $16,000 beyond the lifetime exemption. Use this option before taking advantage of the lifetime exemption.
  3. Take advantage of the possibility of using trusts within the usual limits of tax law.

Coordinate these strategies as part of your overall estate plan. Fortunately, you don’t have to go it alone. Seek advice from an experienced and reputable estate planning professional.


Comments are closed.