Generation Skipping Transfer Tax (GSTT) is the tax imposed on transfers made to grandchildren, or individuals (other than a spouse) who are at least 37 ½ years younger than the donor of the gift. GSTT sounds complicated, and can be complicated, but the concept is simple. The tax was instated in 1976 to prevent wealthy individuals from leaving assets to their grandchildren as a way to avoid estate taxation twice – once when they leave assets to their children and then again when their children leaves assets to their children.
The IRS will not allow “skipping” to deny it the opportunity to tax a generation. Under current law, if transfers are made to a skipped generation in excess of the permitted exemption, currently $11.7 million, the IRS imposes a 40% tax on the transfer. The transfer could be made at death through a Will or Trust, or during a person’s lifetime as a gift outright or to a trust.
For those making transfers to grandchildren with a net worth less than $11.7 million, no need to fear any tax consequences – yet. With a new administration comes the possibility of changes to the tax law. Some recent proposals include reducing the estate tax, and likely the GSTT, exemption to $3.5 million per person. If your estate exceeds that threshold, there is additional planning you should take advantage of now before 2022.
Beware the Accidental Skip
If your estate is subject to GSTT, there are opportunities to explore with your estate planning attorney to ensure that you do not inadvertently trigger the GSTT. Certain transfers, such as direct bequests to grandchildren will surely trigger the tax, but there may be indirect skips that “accidentally” trigger the tax for the unwary.
To illustrate, if you leave assets to your son in trust with income for life, with the remainder to your grandchildren at his death, since those assets are not taxed in your son’s estate, they are subject to the GSTT because they will “skip” a generation. However, you can accomplish the same objective and avoid the tax by drafting the trust so the assets do pass through your son’s estate. Alternatively, by allocating a portion of your exemption to such a trust during your lifetime, the appreciation escapes estate tax and the GSTT. Accordingly, it is important to create your estate plan with a knowledgeable advisor, and not a do-it-yourself or online program.
Gifting to Minor Grandchildren
Even if you do not foresee estate taxes being an issue, if your grandchildren are under the age of 18, you should not make gifts directly to them because minors are not permitted to own assets directly. Rather, consider gifting to a trust for their benefit, a 529 plan or Universal Transfer to Minors Account. For college age beneficiaries, you will also want to be sure that your grandchild is not applying for any grants that may be adversely affected by the influx of a large gift from their grandparent. Lastly, if gifting to a disabled grandchild who is the recipient of any means-based government benefit programs such as Medicaid, you will want to gift to a Supplemental Needs Trust rather than outright to the grandchild. This will ensure that they maintain eligibility for their government benefits, while still enjoying the gift you give them.