When implemented correctly, a generation-skipping trust (GST) can help grantors avoid costly estate taxes for their heirs that could range between 18 to 40 percent. Beginning January 1, 2018, the generation-skipping lifetime tax exemption was doubled to $11.2 million per individual and $22.4 million per couple with the Tax Cuts and Jobs Act. These amounts will increase annually to allow for inflation. The Act is in effect through January 1, 2026.
What is a Generation-Skipping Trust?
It is common for individuals to leave their assets to their surviving spouse and then their children. But for high-wealth individuals, this could trigger costly estate taxes. With a GST, a common strategy is to transfer assets directly to young descendants like grandchildren or great-grandchildren. The grantor’s children never receive title to the assets. However, they can still realize some financial benefits because the grantor could give his or her children access to income that may be generated from the trust’s assets.
Also referred to as “skip persons,” generation-skip beneficiaries can be anyone who is at least 37.5 years younger than the grantor. The beneficiary does not have to be related to the grantor, but he or she cannot be a spouse or ex-spouse.
Avoiding Tax with a Generation-Skipping Trust
Theoretically, the beneficiary of a GST will be subject to a second level of tax liability with a 40 percent tax rate in addition to any regular estate tax liability. This reflects the tax treatment if the assets were first transferred to the grantor’s child and then passed to the grandchildren upon the child’s death.
Implementing a GST strategy can be complicated because of the taxes that are associated with them. Help from a trust attorney may be needed to receive the maximum advantage of this trust’s transfer tax lifetime exemption to save heirs a massive tax bill in the future.
Properly structuring the lifetime exemption to the trust makes it possible to avoid a future GST tax liability. With this exemption in place and by making the trust irrevocable, any future appreciation of the trust is then allocated directly to the beneficiaries and will not be subject to the GST tax.
- Additional GST savings can be realized by making annual exclusion gifts to skip persons. The 2018 gift tax limit is $15,000 and can be gifted to as many grandchildren or great-grandchildren as desired.
- Using the deceased parent rule lessens tax liability for grandchildren if their parents have passed away.