Why Choose a Generation-Skipping Trust?
A generation-skipping trust (GST) is a specialized trust that allows your assets to bypass your children and be directly passed to your grandchildren. This strategy avoids the hefty estate taxes that would apply if these assets directly inherited by your children.
Key Takeaways
- Effective Wealth Transfer: A GST is used to transfer assets to individuals who are at least 37½ years younger than the grantor, often these are the grandchildren.
- Estate Tax Benefits: By skirting direct inheritance by your children, you can significantly save on estate taxes.
- Tax Thresholds: Generation-skipping trusts are subject to taxation if transferred assets exceed the annually adjusted limit, which was $11.7 million as of 2021.
What Makes a Generation-Skipping Trust (GST) Valuable?
By moving assets from your estate directly to your grandchildren, the intermediate generation never takes title, thus avoiding additional estate taxes. While the most common beneficiaries are grandchildren, anyone at least 37½ years younger than the grantor can be a beneficiary.
Generation-skipping trusts offer disposable income to intermediate generations, without distributing the principal assets meant for the next generation.
Understanding the Generation-Skipping Transfer Tax (GSTT)
Initially, GSTs were created as an efficient way to bypass federal estate taxes. However, to close this loophole, the U.S. Tax Code was amended in 1986 to introduce the generation-skipping transfer tax (GSTT).
The exemptions were made secure by the American Taxpayer Relief Act of 2012, establishing a $5 million tax exemption. In real-life scenarios, GSTT primarily affects exceptionally wealthy individuals, with 2021 thresholds for the exemption being $11.7 million per person.
Recent Developments: Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act (TCJA) of December 22, 2017, played an impactful role by doubling the estate tax exemption, making GSTs even more beneficial. Starting Jan. 1, 2018, this act raised the estate tax exemption to $11.2 million for individuals and $22.4 million for couples, set to revert in 2026.
In summary, while the higher exemption thresholds exist, rich families can rely on generation-skipping trusts to transfer substantial assets at minimal tax repercussions.
Related Terms: Trust, Estate Tax, Grantor, High-net-worth Individual, Tax Exemption.
References
- Internal Revenue Service. “What’s New-Estate and Gift Tax”.
- Internal Revenue Service. “Rev. Proc. 2020-45”.
Get ready to put your knowledge to the test with this intriguing quiz!
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## What is the primary purpose of a Generation-Skipping Trust (GST)?
- [ ] To avoid all types of taxes indefinitely
- [ ] To provide a retirement plan for the grantor
- [x] To skip a generation for the purpose of reducing or eliminating estate taxes
- [ ] To fund the grantor's business ventures
## Who typically establishes a Generation-Skipping Trust?
- [ ] A bank
- [ ] An unrelated third party
- [x] A grantor or trustor
- [ ] The government
## In a Generation-Skipping Trust, who usually benefits from the assets directly after the grantor?
- [ ] The grantor's immediate children
- [x] The grantor's grandchildren or future generations
- [ ] The grantor's business partners
- [ ] The grantor himself/herself
## What type of tax is a Generation-Skipping Trust specifically designed to minimize?
- [ ] Income taxes
- [ ] Property taxes
- [x] Estate and gift taxes
- [ ] Sales taxes
## Which of the following statements is true about Generation-Skipping Trusts?
- [x] They can reduce the tax burden on the grandchildren when the assets are transferred.
- [ ] They immediately eliminate all forms of taxation on transferred assets.
- [ ] They can only be set up by high-net-worth individuals.
- [ ] They have no limitations imposed by IRS rules.
## What happens to the trust assets if all beneficiaries are deceased?
- [x] The assets may revert back to the grantor’s estate or a designated contingent beneficiary.
- [ ] They become the property of the state.
- [ ] They can be claimed by any remaining family members
- [ ] The assets dissolve
## A significant advantage of a Generation-Skipping Trust involves which of the following?
- [ ] Higher immediate liquidity
- [x] The potential to avoid double taxation on estate transfers
- [ ] Guarantees higher investment returns
- [ ] Complete avoidance of probate
## What is a 'skip person' in the context of a Generation-Skipping Trust?
- [ ] An appointed administrator of the trust
- [ ] The grantor’s spouse
- [x] A beneficiary who is at least two generations below the grantor
- [ ] A non-related individual named in the trust
## When establishing a Generation-Skipping Trust, what is a critical legal consideration?
- [ ] The grantor's business interests
- [x] Compliance with GST tax provisions and related IRS regulations
- [ ] Social security benefits
- [ ] The grantor’s place of employment
## What must occur for assets in a Generation-Skipping Trust to pass to the next generation tax-efficiently?
- [x] The trust must comply with specific legal requirements, including those relating to the generation-skipping transfer tax.
- [ ] The IRS must issue a statement of exclusion.
- [ ] State courts must grant approval every time assets are transferred.
- [ ] The beneficiaries must renounce their inheritance first.
