Wealthy families or their advisors rarely appreciate hearing the term “generation-skipping transfer tax” (GSTT) The nuances of this specific tax law can be quite complicated, but there’s a reason for it: families and individuals often enjoy giving from one generation to the next, and the GSTT offers a fixed rate that ensures such gifts are taxed appropriately.
There is a recent study from Boston College’s Center on Wealth and Philanthropy, an estimated $59 trillion will be transferred from 2007 to 2061. While not all of that is subject to the GSTT, it does illustrate how important such a tax is today – and will become for the future (simplistically thinking about our federal deficit and the upward trending expectations for servicing our debt through higher taxes—the government will get their cut!).
This report also found that heirs via estates stand to inherit somewhere in the neighborhood of $36 trillion over that time frame, with federal estate taxes estimated around $5.6 trillion.
The problem with the GSTT?
The GSTT is one of the least-liked taxes in the U.S. tax code for a reason. It is incredibly confusing not just for families, but for many financial professionals as well. The importance for having the right team of professionals in place is critical, since it can directly affect estate planning for the wealthy.
The bottom line for GSTT is that all gifts, regardless of which generation is giving to which generation, are taxed equally or fairly. For example, a spouse gifting to another spouse has an unlimited exemption. That spouse then gives to his or her child, which is taxed. Then that child passes the gift on to their child, and tax is collected again, and so on. GSTT comes into play when wealthy families (with estates worth well over the gift tax exemption) skip generations to pass wealth.
So what are a few of the different options that wealthy families might want to consider to minimize or avoid GSTT in a creative, yet tax-compliant way?
- Gift under the lifetime exemption
This option may not be ideal for certain clients, but it does work to avoid the GSTT. Every person has a lifetime exemption, currently at $5.45 million in 2016 ($10.9 million combined for married couples). Only those families with estates valued over $10.9 million (assuming a married couple) will encounter the GSTT.
- Gift on an annual basis up to the exemption limit
Everyone can gift up to $14,000 per year ($28,000 combined for a married couple) without paying the GSTT. For wealthy families, it is possible to slowly dole out gifts on an annual basis over time, instead of waiting until death many years later (when such generosity might be less critical to the heirs).
- Irrevocable trust
Consider establishing an irrevocable trust, with the recipient being someone in a succeeding generation who would typically be subject to the GSTT. If a grandparent established such a trust for the grandchild, it can ensure the inheritance isn’t taxed multiple times by the U.S. government.
While there are other options, these are just a few ways that the GSTT can be avoided. Of course, depending on the next Presidential election, the future might very well include potential legislative changes that could end up evolving GSTT and estate taxes in general. Having the right team of experts in place with the knowledge base and acumen to address such topics as GSTT strategies can be the difference in meeting a wealthy family’s goals and objectives.