What is it?
The generation-skipping transfer tax is a federal tax on a gift or inheritance that prevents avoiding estate taxes by skipping a generation. Before this tax was introduced in 1976, wealthy individuals could legally make gifts or bequeath property to their grandchildren without paying any federal estate taxes. The 1976 law closed this loophole for the wealthy by introducing the GSTT. Most people will not currently be subject to this tax since it only applies when the transferred amount exceeds the lifetime exemption of $12.06 million. However, this exemption amount is set to sunset in 2026 to a projected amount of $6.4 million which will impact more individuals.
What kind of transactions does GSTT apply to?
The GSTT applies to direct skip transactions, taxable distributions from a trust, and taxable terminations of a trust. Direct skips are when the transfer skips a generation (goes directly to a grandchild) or is the transfer to a trust where all interests in the trust are held by a skip person. This tax also applies to unrelated individuals who are at least 37 1/2 years younger than the transferor. Taxable distributions are when a certain trust distributes income or principal to a skip person. Taxable terminations are when generation-skipping trusts terminate, and the assets of the trust are distributed to other skip persons (i.e., the children of the original beneficiaries of the trust). There are exceptions to these rules.
How much is the tax?
The applicable tax rate is 40% of the taxable transfer. Transfers under the annual exemption (in 2022 $16,000 per person or $32,000 for a married couple electing gift splitting) or do not exceed the $12.06 million lifetime exclusion are not subject to this tax.
How do you avoid the GSTT?
Taking advantage of the higher lifetime exemption of $12.06 million (adjusted annually for inflation) before the end of 2025 is one way to avoid this tax. Also, establishing a dynasty trust is a widely used tool. This type of trust is an irrevocable trust that extends as long as possible to preserve wealth for future generations.
If you have any questions you would like to have answered about this topic, please reach out to Elaine Dougherty, CPA in our Morgantown office at 304-554-3371. You may also email Elaine at edougherty@suttlecpas.com.
Please note that information and guidance on Estate Planning are situational. The information provided in this article is current as of the article’s date. It is intended for general informational purposes only. Consult with your financial or tax advisor about your specific situation.