Beneficial rules for the generation-skipping transfer (GST) tax are currently in force, which may allow you to pass on assets to future generations without a federal tax bill.
GST Tax Basics
When it comes to arranging for gifts and bequests to loved ones, most planning strategies focus on avoiding or minimizing the federal gift and estate taxes. Rightly so. But there's one more piece to the puzzle. It's called the generation skipping transfer tax. The GST tax is intended to snare those who would try to foil the federal gift and estate tax system by transferring wealth to persons more than one generation younger than themselves (typically grandchildren).
If you have no intention of ever leaving any money or assets to your grandchildren, great grandchildren, or anyone else in those generations or below, you don't have to worry about reading this article. The GST tax only hits wealth transfers to individuals more than one generation below you. For example, say all your money and assets will go straight to your children and/or spouse via gifts and bequests. In this scenario, the GST tax is inapplicable. All you have to worry about is avoiding the gift and estate taxes. But if you set up a trust with primary or contingent beneficiaries more than one generation below you, it could trigger unexpected GST tax problems — as we'll explain a bit later. Here's the really bad part: When the GST tax applies, the rate is 40%. That 40% rate is on top of any gift or estate tax on the same transaction.
Bottom Line: Whenever you arrange for big gifts or bequests, make sure you take the GST tax rules into account. They can come into play in unexpected ways.
GST Tax on Direct Gifts
You can run afoul of the GST tax if you make direct gifts to grandchildren (or great grandchildren, or great-great grandchildren, you get the idea). By direct gifts, we mean transfers that go straight into the hands of your grandchild or into a trust with a single grandchild named as the sole trust beneficiary. Such direct gifts can be made while you're still alive or by bequest upon death. However you have to be a really generous person before direct gifts will cause GST tax problems. That's because you have a generous $11.40 million GST tax exemption for 2019 (up from $11.18 million in 2018). Your spouse has a separate $11.40 million exemption.
So you and your spouse can together make up to $22.80 million in direct gifts to grandchildren and lower generations without any GST tax worries. Your GST tax exemption will automatically be portioned out ("allocated" in tax language) to shelter all your direct gifts until the exemption has been used up.
Key Point: Anytime you use up all or part of your $11.40 million GST tax exemption, you use up an equal amount of your $11.40 million federal gift tax exemption and your $11.40 million federal estate tax exemption.
GST Tax on Indirect Gifts
By indirect gifts, we mean when you give or leave money to a trust with your grandchildren named as contingent beneficiaries, or when your grandchildren are primary beneficiaries of a trust, along with one or more other persons from an older generation. Such indirect gifts can be made while you're still alive or by bequest upon death. When money or assets come out of one of these multiple-beneficiary trusts to a grandchild, watch out! The GST tax will generally be due, unless you (or your estate's executor) chose to allocate (use up) some or all of your GST tax exemption to provide shelter. For gifts, you make an exemption allocation on Form 709 (the federal gift tax return) filed for the year you make the gift. For bequests, your executor can make the allocation as part of handling the estate tax return (Form 706). Here's a very simple example of how indirect gifts can cause big-time GST tax problems down the road.
Key Point: If you use up all or part of your $11.40 million GST tax exemption, you use up an equal amount of your $11.40 million federal gift tax exemption, as well as your $11.40 million federal estate tax exemption.
The GST Tax Rules in a Nutshell
For 2019, the lifetime GST tax exemption is set at $11.40 million (same as the estate and gift tax exemptions). Generation-skipping gifts in excess of the $11.40 million exemption are hit with the GST tax at a flat 40% rate. Remember: the GST tax is on top of the 40% gift tax rate. So you really do not want to make transfers that get hit with the GST tax.
Consult with your estate planning attorney for information about how to proceed in your situation.