MoneyTips

The tax reform framework recently released by the Trump Administration repeals both the generation-skipping transfer tax and the estate tax. While most of us are familiar with the latter, we want to introduce you to the convoluted and highly technical rule known by its initials GST.

The idea behind it is simple: It used to be that if someone left money to heirs who weren't direct descendants – skipping over your kids and giving the cash to grandchildren or members of a later generation – that transfer skipped one cut of the estate tax. Instead of your money being taxed when it passed to your children, then getting taxed again when it passed to their children, the IRS got just one swipe at those assets.

The taxman figured that out several years ago, and now we have a whopping 40 percent tax applied on top of any significant gifts or inheritances that go to anyone more than one generation removed from you, which is called the generation-skipping transfer tax. Considering that the gift and estate tax is also 40 percent, it means that if you're not careful with your tax and estate planning, more than half of the assets you want to pass on will instead pass to Uncle Sam.

Frequently called "the grandparent tax," the generation-skipping transfer tax doesn't apply just to the kids your kids have. In addition to hitting any relative more than one generation away from you, the tax also applies to any unrelated person receiving direct or indirect gifts who is at least 37.5 years younger than the gift-giver.

Most taxpayers don't have to worry about triggering the tax, since it comes with a lifetime exemption of $5.49 million this year, meaning you can leave that much to grandchildren or other future generations without worrying about GST. Add in a spouse, and the two of you together can exempt $10.98 million before losing a single dollar to the taxman.

In addition, generous grandparents or great grandparents can make strategic use of the annual gift tax exemption, as well. This means you can leave up to $14,000 to each child annually, or $28,000 if you have a spouse. The best part about annual gifting of the money is that none of those dollars counts against your lifetime GST exemption.

However, even people who think they've done everything needed to sidestep the GST can get tripped up. For example, someone who sets up a trust fund to benefit their own child wouldn't have to worry about GSTs, but if that child dies and the assets are passed on to the children of the dead beneficiary, then the tax can kick in.

But again, that only applies if you're leaving more than the gift and estate tax limits. Keep it all under $5.49 million, which is easy for most of us, and you're cool. Also, remember that the estate and gift taxes are applied as a "unified tax." So, if you're feeling particularly generous in some years and give gifts of more than the current $14,000 annual gift tax limit to any one person, that amount gets applied to your estate tax exemption, lowering the total you can leave behind tax-free.

But go above the estate and gift exemptions (which are indexed for inflation), and the GST can become a factor in any trust where grandchildren are either contingent beneficiaries or are primary beneficiaries along with any relative from an earlier generation. Trustees can get around that by covering the initial gift of money to the trust with the GST exemptions.

Another tactic is to create a generation-skipping transfer trust using what are called "dynasty trusts." These arrangements are set up to convey money or other assets to multiple generations by giving each beneficiary of the trust a $1 million exemption from the gift tax. That exemption is then applied to the assets used initially to create the dynasty trust fund. The drawback is that creating a dynasty trust doesn't create tax savings for the person making the gifts.

If the GST applies to you, talk to a professional. And congratulations on being a multi-millionaire! Even better news: if President Trump has his way, then you won't have to worry about either the GST or the estate tax.

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Photo ©iStockphoto.com/designer491

Originally Posted at: https://www.moneytips.com/generation-skipping-transfer-tax-101

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