Most people know that the federal government imposes an estate tax, but few are aware that a generation-skipping transfer (GST) tax can also be imposed on the same assets subject to the estate tax. Failure to plan for the GST could lead to devastating tax consequences and additional filing requirements for the beneficiaries of those assets.
What is the GST Tax?
The GST tax is a tax on transfers to a “skip” person, whether the transfer occurs during a person’s life, at death, or upon the occurrence of another event that triggers the tax. Similar to the federal estate tax, the GST tax applies only to the value of the transfer that exceeds the current exemption amount. For 2023, the exemption amount is $12.92 million, the same exemption amount as the federal unified estate and gift tax exemption. The exemption increases to $13.61 million for 2024. If a GST transfer occurs during a person’s life, an annual exclusion amount may also apply depending on the type of transfer. The GST annual exclusion is also the same as the federal gift tax annual exclusion, $17,000 per transferee for 2023, and $18,000 per transferee for 2024. If a transfer exceeds the exemption, the excess value is taxed at a rate of 40 percent.
Who Is a “Skip” Person?
A “skip” person is defined as an individual at least two generations younger the transferor, i.e., a grandchild, great-grandchild, etc. If the individual is not related to the transferor, the transferee is considered a skip person if they are at least 37.5 years younger.
When Does the GST Tax Apply?
In general, the GST tax is applied to direct transfers to a skip person, either during life or at death. It may also be applied to a transfer to a trust where only skip persons are beneficiaries, or when a distribution is made from a trust to a skip person. It may also be applied when a trust terminates, or when all non-skip beneficiaries of a trust are deceased.
Transfers to Trusts
If a transfer is made to a trust, the GST exemption can be allocated to the transfer, either automatically or by affirmatively making an allocation, thus making the trust fully or partially exempt from GST tax. This is generally beneficial where a trust will eventually pass to skip persons, because a trust that is fully exempt will avoid having GST tax applied to any future distributions to skip beneficiaries.
If a trust is only partially GST exempt, meaning the exemption was not allocated to all transfers made to the trust, then the calculation of future GST tax becomes complicated. To avoid this complication, most trust documents will allow a trustee to divide a trust that is not fully exempt from GST tax so that there are “exempt” and “non-exempt” shares. The trustee is then able to make distributions to non-skip beneficiaries from the non-exempt share, while preserving the exempt share for current or future skip beneficiaries.
Reporting GST Transfers and GST Tax
If a transfer is made to a skip person, how it is reported depends on whether the transfer was made as a gift or at death. If the transfer was a gift to a skip person, or a trust for the benefit of a skip person, the transfer will be reported on the transferor’s gift tax return for the year of the gift. The gift tax return helps track the amount of GST exemption that has been used against transfers, which is helpful when implementing estate planning involving the skip beneficiaries. To the extent that there is insufficient GST exemption available to cover a GST transfer, tax will be calculated on the gift tax return. If a GST transfer is made at death, the transfer is reported on the decedent’s estate tax return, to the extent that the decedent’s estate is required to file one.
If a distribution is made from a non-exempt trust to a skip person, the trustee is required to report the distribution on Form 706-GS(D-1) and provide the skip beneficiary with sufficient information to calculate the GST tax owed on the distribution. In general, the skip beneficiary will be responsible for the payment of any GST tax owed on the distribution, and will report the distribution on Form 706-GS(D).
If a non-exempt trust terminates and skip beneficiaries receive the assets, or if all non-skip interests in the trust terminate, the trustee must file Form 706-GS(T) to report the taxable portion of the termination and pay the GST tax owed.
Conclusion
The federal transfer tax system can be complicated, especially when it involves transfers to skip persons. The application of the GST tax adds another level of complexity to an individual’s estate plan, and a lack of planning could result in substantial taxes owed. If you are considering gifting to your grandchildren, or are interested in understanding how the GST tax could impact your estate planning, we encourage you to contact your HBK tax advisor. They can put you in touch with one of our experienced estate planning professionals.
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