Can generation skipping help in saving taxes on your estate?
saving taxes on your estate

Can generation skipping help in saving taxes on your estate?

What is generation-skipping Transfer?

There is generation skipping when an individual transfers assets by gift or inheritance to a beneficiary who is at least 37.5 years younger than the benefactor. With the age gap, we can clearly see that a generation has been skipped. It could be from a man to his grandchild.

The benefactor in this kind of transfer is known as the transferor, and the beneficiary is called the skip person. The skip person can be anyone, whether family or stranger, of at least 37 years and 6 months.

Generation skipping transfer (GST) was used long before by very wealthy individuals who looked to avoid federal estate tax. This was because such skipped transfers were legally free from federal estate taxes. Generation skipping was a way to minimize estate taxes because an estate does not have to be taxed twice (during the children’s generation and then the grandchildren’s generation). Parents could transfer assets to their grandchildren without incurring any federal estate taxes until the Generation Skipping Transfer Tax (GSTT) was introduced in 1976.

Generation skipping transfer tax (GSTT)

The generation skipping transfer tax is a federal tax imposed on generation skipping transfers. GSTT served the purpose of ensuring that wealthy individuals still pay up taxes and that they do not withhold assets from their own immediate family and then give to the next generation with the aim of avoiding taxes.

The Generation skipping transfer tax ensures that the skip person (be it a grandchild) receives the same value of assets as would have been if a parent makes a bequeathal to their own child without skipping. It was a way to curb unfairness — children getting skipped out of inheritance, for their own children to receive them.

However, the skip person may not be a grandchild or great-grandchild. So long the age gap between the transferor and skip person is not less than 371⁄2 years, it is still a generation skipping transfer. A man who fathered at 40 can gift assets to the child by generation skipping.

Exemption amount for generation-skipping transfer tax

The generation-skipping transfer tax is only charged when the transfer is intended to avoid incurring a gift tax or estate tax. For example, there is an annual gift tax exemption amount of $15,000. Below that threshold, you can gift without incurring taxes. But when you exceed that amount, gift tax will be imposed. The same thing applies to generation-skipping transfers. If you gift property in a year by generation-skipping such that avoids gift taxes, the generation-skipping transfer tax will be imposed to make up for the avoidance. It is like a counter-attack by the Internal Revenue Service.

The exemption amount for GSTT is the same as federal estate tax, placed at $11.7 million for deaths in 2021. This amount is adjusted yearly due to inflation. The amount is doubled for couples just as with federal estate tax.

For couples, the annual exemption amount is also doubled, i.e. 2x$30,000.

On the other hand, the generation-skipping transfer tax rate is fixed at 40% since 2014.

Skip persons are not only real persons

The IRS also imposes the GSTT on transfers made to a skip person via a trust. Here, the trust is being regarded as a skip person.

Furthermore, all the beneficiaries in the trust are skip persons to the transferor. Anyone who is not a skip person will not receive a part of the trust assets.

Exceptions to generation-skipping

There is generation skipping only when a live generation is skipped. If Joe’s daughter is dead, Joe can pass assets to the daughter’s child (i.e Joe’s grandchild). Then there is no skipping since the parent is not alive to receive inheritance. In this case, the grandchildren move up to take their parents’ place and so the inheritance will not be charged generation-skipping transfer tax.

Generation-skipping no longer offers tax savings

Since 1976 when generation-skipping transfer tax was introduced, generation-skipping no longer offers tax savings. If you look forward to minimizing estate tax, there are other easier ways to do so, including annual giftings below the exemption amount, funding valuable unused assets into irrevocable trusts, holding property by joint tenancy, amongst others.

An experienced estate planning attorney near you can hep you utilize any or all of these strategies.

Ensure your loved ones get the most out of your estate by consulting an estate planning attorney near you.