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08 Apr

Leveraging the GST Tax Exemption

In GSTT by admin / April 8, 2013 / 0 Comments

Estate Planner Sept-Oct 1998

The type of assets you transfer to your grandchildren and other heirs –and the means you use to transfer them — can make a difference in the amount of generation skipping transfer (GST) tax that will have to be paid. A 55% GST tax is imposed — in addition to the applicable estate tax — on transfers of property to people who are two or more generations below that of the property owner. Fortunately, an exemption from the GST tax exists. For 1998, this exemption is $1 million, but it will be indexed for inflation beginning in 1999.

Each individual’s exemption is allocated, either automatically or by specific allocation, to a particular transfer or transfers. How this allocation is made can greatly leverage the value of assets exempted from the tax. By allocating the GST exemption to a trust, you can ensure that the entire trust will never be subject to GST tax, even when assets pass out of the trust to multiple generations.

Leveraging With Discounts

Leveraging assets that would be exempt from the GST tax enables you to increase the value of these assets to your heirs. One form of leveraging is the transfer of discounted assets, such as stock in a closely held corporation where minority interest and lack of marketability discounts are available. Let’s look at an example. Sam gifts his 20% interest in ABC Corporation to his granddaughter. ABC is valued at $1 million, but the gift might be valued at $140,000 ($200,000 less 30% minority and lack of marketability discounts). Thus only $140,000 of GST exemption needs to be allocated. If the business is sold for $1 million, Sam’s granddaughter will receive $200,000. If the business appreciates to $2 million and is then sold, she will receive $400,000. Although, for GST purposes, Sam has only given her $140,000. The increased value in her hands occurs with no additional gift or GST tax, even though she now has an asset of much greater value.

Leveraging With Life Insurance

Another type of asset that allows for some of the greatest leverage is life insurance. You can create an irrevocable trust to hold an insurance policy on your life and make gifts to the trust to pay the premiums. The GST exemption can be allocated to the premiums and not to the death benefit. This offers great leverage. A late allocation of GST exemption based on the values of trust assets as of the date of allocation can result in less exemption being used. You must, though, adhere to complex rules ensuring proper allocation of the exemption.

Grandfathered Trusts

Trusts that were irrevocable on Sept. 25, 1985, are grandfathered from the GST tax unless additions were made to the trust after that date. With these trusts, you can obtain even more leverage by using trust assets to purchase a life insurance policy. For example, assume a grandfathered trust has $2 million in assets. The trustee, exercising the trustee’s power to invest in a variety of assets, purchases a policy on the life of the grantor, or perhaps even better, on the life of the spouse, child or grandchild of the grantor. When the insured dies, the insurance trust will collect proceeds which will remain exempt from GST tax. However, if additional contributions have been made to the grandfathered trust, it would lose its grandfathered status in whole or in part. The result is that a portion of the trust would be subject to GST tax upon distribution out of the trust to a skip-person. Again, be careful when purchasing life insurance to avoid adverse or undesirable estate or income tax consequences.

How Should You Leverage Your GST Tax Exemption?

Determining how to best leverage the GST exemption is complex. It requires the careful analysis of options. Please let us know if you have any questions about this or any other estate planning topics. We would be glad to help you maximize the value of your estate for your heirs.

The Return of Dynasty Trusts

Many states have repealed the rule against perpetuities, making it possible to extend the life of a trust indefinitely. Through the creation of such a trust that is exempt from GST tax, huge amounts of wealth can pass down through the generations free from transfer tax. Even if the rule against perpetuities has not been repealed in your state of residence or that of the trust beneficiaries, you may be able to establish nexus with another state and take advantage of the repeal. Nexus is the term used for the right that states have historically had to impose taxes on any company that’s had adequate contact with the state. You have to look into the tax codes of each state you deal with to stay on top of nexus.

08 Apr

A Simpler, More Flexible Approach to GST Planning

In GSTT by admin / April 8, 2013 / 0 Comments

Estate Planner Jan-Feb 1998

Many people understand the tax advantages of creating generation-skipping trusts that benefit grandchildren and make use of the $1 million exemption from generation-skipping transfer (GST) tax. Yet not everyone who would benefit from this type of planning is willing to undertake it. Why? Perhaps they:

  • Don’t have any grandchildren yet.
  • Have some children who have a more immediate need for the funds who would not benefit from having their inheritances tied up in generation-skipping trusts.
  • Think revising an existing estate plan would be too complex or expensive.

In planning to take advantage of the $1 million GST tax exemption, the goal is to have assets pass from grandparent to grandchild without being taxed in the child’s estate.

Generation-skipping trusts limit the children’s access to the funds to avoid taxation in the children’s estates. A simpler approach to GST planning, however, also allows more flexibility.

Back to Basics: A Case Study

Tom has an estate of $2 million that he plans to leave to his children, Susan and Sarah. Susan owns a successful business and has a large estate of her own. Sarah is a struggling actress and has few assets.

In his estate plan, Tom provides that his estate be divided equally between Susan and Sarah with their shares held in separate trusts for their benefit. Each child will have the right to receive all the income from her trust and as much trust principal as is necessary for her support. Knowing that Susan is financially secure and Sarah needs funds, Tom gives them each a general power of appointment: the right either to withdraw all funds from her trust or to direct the trustee to distribute the principal of the trust to any person, including herself. The general power of appointment, however, will cause the trust to be subject to tax in the child’s estate.

Because Susan has a substantial estate that will be subject to estate tax on her death, she wants to ensure that as much as possible passes to her children tax-free. To do this, on her father’s death she disclaims the general power of appointment while retaining the right to receive income and principal from her trust. By so doing,she converts her trust into a generation-skipping trust for the benefit of her children. At Susan’s death, her children will receive the proceeds of the trust tax-free.

Sarah is not concerned about GST tax because she has no children and her estate likely won’t be subject to estate tax. On her father’s death she exercises her general power of appointment to take the principal of her trust outright. At Sarah’s death, any portion of the trust estate that she did not use during her lifetime will be included in her estate and, if her estate is large enough, will be subject to estate tax.

Make GST Planning Easy

Generation-skipping trusts can offer additional advantages, but the disclaimer method allows you to provide for your children equally, leaving the decision to implement GST planning up to each child. This method also gives your children the option to disclaim their general powers of appointment over a portion of trust assets rather than over all trust assets. This provides your children with the flexibility to use part of their inheritances for GST planning and retain part for their own use. Consequently, your children may be more inclined to take advantage of GST planning.

We would be pleased to tell you more about these trusts and to help you make GST planning work for you and your heirs.

4 Disclaimer Method Pitfalls

Although the disclaimer approach simplifies GST planning, you need to consider additional issues, including the following four potential pitfalls:

1. Your child may not be able to deal emotionally with these complex decisions within nine months after your death, as is required for the disclaimer to be valid.

2. Your child may be incapacitated and unable to make a valid disclaimer.

3. Your child may have creditor problems and the state where the child resides may not allow him or her to disclaim assets that would otherwise be available for creditors.

4. Your executor or administrator may not be capable of handling the complexity the children’s disclaimers and GST allocations would add to administration of the estate.

08 Apr

5 Ways To Avoid the GST Tax

In GSTT by admin / April 8, 2013 / 0 Comments

Estate Planner Sept-Oct 1997

Did you know that as much as 79.7% of a transfer you make to your grandchild can end up going to the government? Transfers that skip a generation are subject not only to a gift or estate tax, but also to a generation-skipping transfer (GST) tax. While gift and estate taxes are based on a sliding scale at rates currently ranging from 37% to 55%, the GST tax is assessed at the highest currently applicable estate and gift tax rate — 55%. As a result, planning to reduce or minimize the GST tax is critical. Here are five ways you can avoid the GST tax.

1. Use Your GST Tax Exemption

The simplest way to reduce your GST tax burden is to use your GST tax exemption. Each person is allowed to make a total of $1 million of transfers to “skip persons” — persons who are more than one generation below you, such as grandchildren, great-grandchildren, grandnieces, grandnephews and unrelated people more than 37 years younger than you — without incurring the GST tax. Through smart allocation of your GST tax exemption, such as applying it to leveraged gifts like property that you expect to appreciate greatly or life insurance premiums, you can significantly increase its effectiveness. The GST tax exemption can be allocated either to outright gifts or to gifts made in trust.

2. Make Annual Exclusion Gifts

If you wish to give your grandchildren more than $1 million, you can make outright annual exclusion gifts of $10,000 ($20,000 if you and your spouse split gifts) to each of them. The gifts will not only qualify for the annual exclusion from gift tax, but also for annual exclusion from GST tax. This can be beneficial if you want to save your GST exemption or have already used it.

3. Make Gifts To Crummey Trusts

If your grandchildren are young or not financially responsible, you may prefer to make gifts to a trust, such as a Crummey trust. For gifts to the trust to qualify for the annual gift tax exclusion, the trust agreement must give the beneficiaries the right to withdraw all or a proportionate share of any gifts you make to the trust each year, and the trustee must notify all beneficiaries of the amount of these gifts and the amount that the beneficiaries may withdraw. For the gifts to also qualify for the annual GST tax exclusion, the trust must have only one beneficiary and must be taxed in his or her estate upon the beneficiary’s death.

4. Make Gifts To 2503(c) Minor’s Trusts

If your grandchildren are minors and you don’t mind if they have complete access to trust assets when they reach age 21, you can avoid the administrative burdens of a Crummey trust by making gifts to a 2503(c) minor’s trust. These gifts will qualify for the annual exclusion for gift tax and GST tax purposes if the trust agreement:

  • Allows trust income and principal to be distributed for the child’s benefit before he or she reaches age 21,
  • Allows the child to withdraw the entire trust corpus when he or she reaches age 21, and
  • Requires that, if the child dies before age 21, the trust corpus pass to the child’s estate or to the person the child has appointed.

5. Make Gifts From A Grandfathered Trust

Irrevocable trusts created before Sept. 25, 1985, are grandfathered from GST tax. Thus, if you created such a trust and have kept it grandfathered (by not adding new assets to the trust), distributions made from the trust to your grandchildren will not incur the GST tax. Distributions also can be made through the exercise of granted powers of appointment in favor of beneficiaries who otherwise would be considered skip persons.

Stretch Your GST Tax Exemption

Gifts made directly to grandchildren or other skip persons not only benefit them today, but avoid double exposure to transfer tax — once when you pass the property to your child and again when your child passes the property to your grandchild. The methods described above allow you to stretch your GST tax exemption for additional tax savings.

Predeceased Ancestor Rule Offers More GST Tax Protection

Gifts made to a grandchild will not trigger GST tax when the grandchild’s parent has died prior to the transfer to the grandchild. This special exception is referred to as the “predeceased ancestor rule.” Legislation has been introduced to extend the predeceased ancestor rule to include grandnieces and grandnephews, but Congress has not yet passed this legislation.