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The Generation Skipping Transfer Tax
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"In the Old Days" |
Gift Tax Returns
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Basics of the GSTT
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"In the Old Days"
Under the traditional version of the Rule against Perpetuities, which some states have extended, it was possible for a trust to last for "a life in being plus 21 years". Thus a man in his 80's could have great grandchildren. He could set up a trust to pay income to his children for their lives, to his grandchildren for their lives, to his great grandchildren for their lives, and then to his great great grandchildren, but terminating 21 years after the death of his last great grandchild [and then distributed outright]. Along the way, it would have benefited several generations without being taxed at their deaths. This would be even more pronounced today when many states allow perpetual trusts.
For some reason, Congress (or the Treasury) didn't like that.
After an abortive attempt, they created the Generation Skipping
Transfer Tax ("GSTT").
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Basics of the GSTT
Very simplified:
At a time when there cease to be beneficiaries of a trust who are members of a
"higher" generation (e.g. children) so it now passes to the next generation,
[and it's not subject to estate tax] there occurs a "taxable termination"
subject to GSTT.
Furthermore, if there is a distribution from a trust to members of a younger
generation than those who continue to be beneficiaries, there is a "taxable
distribution". (If you think about it, you realize this is a special case of the
taxable termination).
Finally, if someone is wealthy enough to literally skip their children and leave
money to a younger generation initially -- there's a "direct skip".
In each of these cases, a tax is imposed. Again simplifying, the tax is imposed
at the highest estate tax rate. Therefore, if it is necessary to be subject to
some tax, it may be better to be subject to estate tax (and use lower brackets)
than GSTT.
Why do I say if it is necessary? Because each person has a $1,120,000 (how come such an odd figure? It started as $1,000,000 but is inflation pegged -- in $10,000 increments) exemption which they can apply to trusts they create. Prior to the repeal of the GST tax in 2010, the GST tax exemption is scheduled to increase as follows: $1.5 million in 2004 and 2005; $2 million in 2006, 2007, and 2008; and $3.5 million in 2009. TAX ACT OF 2001 This exemption is measured at the time of the transfer creating the trust. Thus, if you give $1,000,000 to such a trust, it will be exempt even if the value grows to $10,000,000.
Suppose you place $5,000,000 in such a trust? It would be 20% exempt. Even as the trust accumulates, it is 20% exempt -- and 80% taxable. It would be more desirable to have two trusts -- one with $1,000,000 which is 100% exempt (referred to as an inclusion ratio of zero) and one with $4,000,000 with an inclusion ratio of 1. The exempt trust would be the last one actually used for expenditures, and could continue to grow.
Trying to maximize use of the exemption leads to development of special techniques.
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Gift Tax Returns
Although gifts in trust can be sheltered from the gift tax by use of "Crummey" powers, they are still potentially generation-skipping transfers. You may file a non-taxable gift tax return, to elect to apply some of your exemption to gifts.
Why would you do so? Because if you don't, then the GSTT exemption will be applied at your death, based on the value at that time, which would hopefully have greatly increased (soaking up more exemption). In the case of insurance trusts particularly, it is therefore more efficient to file the return annually, using a little of your exemption, than applying it to the proceeds at death.
Under new rules of 2001, you could still get the allocation based on the value at time of gift even if you didn't file a return. Because some of the conditions are uncertain, it is often safest to file a return.
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