Ensuring Your Estate Plan Covers the GST Tax
Posted by Cheryl A. Jankowski on March 21, 2024
If your estate plan involves gifting assets to grandchildren or individuals multiple generations below you, or even to non-relatives substantially younger than you, it's crucial to address not only gift and estate taxes but also the generation-skipping transfer (GST) tax.
Understanding the GST Tax
Among the provisions of the Internal Revenue Code, the GST tax stands out as one of the most formidable. It imposes a flat 40% tax on asset transfers to "skip persons," which include your grandchildren, other family members more than one generation below you, or nonfamily members over 37½ years younger than you. Calculated independently from gift and estate taxes, the GST tax can significantly impact your accumulated wealth.
Thankfully, there's a sizable GST tax exemption provided by law. As per the Tax Cuts and Jobs Act, for estates of individuals passing away after December 31, 2017, and before January 1, 2026, the GST tax exemption amount is a figure adjusted for inflation, reaching $10 million ($13.61 million for 2024). However, without congressional intervention, the exemption will revert to an inflation-adjusted $5 million starting January 1, 2026.
Optimizing the exemption requires careful planning. In certain scenarios, to apply the exemption, you must allocate it to specific assets through a timely filed gift tax return. In other instances, the exemption is automatically allocated (unless opted out), potentially resulting in undesired outcomes if you prefer to allocate your exemption differently.
To prevent costly errors, it's advisable to assess each transfer for potential GST tax liability and ensure optimal allocation of your exemption.
Taxable Transfers
The GST tax encompasses direct gifts to skip persons as well as two types of trust transfers:
1. Taxable Terminations: Trust assets transfer to your grandchildren upon the termination of the trust following your child's death.
2. Taxable Distributions: Trust income or principal is distributed to a skip person.
Direct gifts covered by the annual gift tax exclusion ($18,000 per recipient or $36,000 for married couples making "split" gifts per recipient) are exempt from the GST tax.
Automatic Allocation Rules
Automatic allocation rules aim to safeguard against inadvertent loss of GST tax exemptions. For instance, if you make a direct gift exceeding the annual gift tax exclusion to a skip person, your unused GST tax exemption is automatically applied without the need for a separate allocation on a gift tax return. Similarly, the exemption is automatically allocated to "GST trusts," which are trusts with potential future benefits for your grandchildren or other skip persons.
While these rules generally work efficiently, they may lead to unintended consequences in some cases.
Understanding the Changing Exemption
Although the current high GST tax exemption reduces its impact on many families, it's still prudent to plan for this tax. Post-2025, without congressional action, the exemption will decrease significantly.
Reach out to us if you have questions regarding the GST tax and how it pertains to your estate planning.
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Cheryl has extensive experience working with business owners and individuals on minimizing taxes, with a focus on succession planning. With a thoughtful approach, Cheryl helps clients explore their long-term goals and plan accordingly. Leveraging Cheryl’s expertise in this area, the goal is to implement plans that achieve the wishes of the client and provide for tax-efficient transitions. Cheryl’s passion for working with corporations and individuals has allowed her to become a trusted business advisor. She has worked with clients not only in the Western New York region but also throughout the country. The breadth of this experience has allowed her to collaborate with other professional advisors to ensure that plans are flexible and innovative in the ever-changing world in which we live. Cheryl started her career with the Firm in 1991 and rejoined in 2019 adding additional strength to the tremendous talent of the Lumsden McCormick tax team.