S—Generation-Skipping Transfers

The basic intent of the federal estate tax system is to tax property as it is passed from one generation to the next. The generation-skipping transfer (GST) tax is intended to prevent wealthy families from reducing estate taxes by skipping one or more generations (e.g., grandparents pass their estate to grandchildren in order to reduce or avoid estate taxes at their children’s estates).

The GST tax is inadditionto the normal estate or gift tax and is applied to the transfer of property to a person two or more generations younger than the transferor (e.g., from grandparent to grandchild). Themaximumestate tax rate, 40 percent in 2022, is used in calculating the GST tax. However, there is an exemption that allows aggregate transfers of $12,060,000, during lifetime or at death, to be exempt from the GST tax ($24,120,000 total for both husband and wife).

To illustrate, assume that Grandparents have an estate totaling $32,000,000. Assume also that their Children have substantial estates in their own right and the Grandparents desire to fully use their GST tax exemptions.

UPON THE FIRST GRANDPARENT’S DEATH. To take maximum advantage of the GST tax exemption in 2022, $12,060,000 could be passed to a GST tax-exempt irrevocable trust (the “B” trust). Discretionary distributions can be made to all family members from this trust.

UPON THE SECOND GRANDPARENT’S DEATH. Again, in order to take maximum advantage of the GST tax exemption, an additional $12,060,000 could be passed to a GST tax-exempt irrevocable trust. After payment of $3,152,000 in federal estate taxes on a taxable estate of $7,880,000, $4,728,000 is passed to the GST tax-exempt irrevocable trust. In order to avoid any GST taxes, the remaining $4,728,000 is passed to the Children. Of the original $32,000,000 estate, estate taxes totaling $3,152,000 have been paid at the second death.

Application of the GST tax can be quite complicated and its impact is substantial in larger estates. For taxpayers with estates that exceed the temporary $12,060,000 exemption created by the 2017 Tax Act, consideration should be given to utilizing the expanded gift and GST exemption while it is available. However, careful analysis by qualified counsel is essential if unexpected tax consequences are to be avoided. By making life gifts to grandchildren using the GST exemption – taxpayers can avoid estate taxes at their deaths and at the death of their children. But, by making gifts while living – the recipient takes the current income tax basis (basis is not “stepped up” at death). For most taxpayers, holding assets until death may create a better tax result than making lifetime gifts. State laws differ on the length of time that property can remain in trust.