The Generation Skipping Transfer Tax (GST), along with its more notorious and politically embattled counterpart, the Estate Tax, is skipping 2010. And much like the Estate Tax, the GST is set to return with a vengeance next year, barring congressional action. But, unlike in the case of the Estate Tax, taking advantage of the GST's 2010 absence doesn't require dropping dead before the ball drops again. Indeed, while uncertainty about the Estate Tax's future has planners frenzied, the GST's interruption should have planners, well, planning.
To make sense of this year's GST planning opportunities, a little background is in order for the uninitiated. The historical assumption underlying the transfer tax system was that, in order to prevent or reduce dynastic pooling of wealth, wealth should be taxed at each generation.[1] But under the pre-GST tax regime, testators/grantors were able to avoid a "generation" of tax by granting, say, a life estate to Child with remainder to Grandchild. That way, while there would be transfer tax at the creation of the life estate to Child, the remainder interest would pass to Grandchild tax-free upon Child's death, since it would not be includible in Child's estate. And of course, this three-generational model could be extended to include multiple successive life estates.
In response, Congress created the GST in 1976 and then refurbished it in the 1986 tax act. And while everything about the GST (who owes it, how much is owed, and when it is payable) is notoriously complicated, a few notes about it will suffice here. The GST is a tax (a significant tax that some call confiscatory) on top of any estate or gift tax that would be applied to a generation skipping transfer. A "generation skipping transfer" is any transfer, direct or indirect to a "skip person." And a "skip person" is either a person who is more than one generation removed from the transferor or a trust, all of whose beneficiaries are skip people. Finally, there are three types of generation skipping transfers - the direct skip (a transfer directly to a skip person), taxable distribution (a distribution from a trust to a skip person) or a taxable termination (when a skip person's interest in property vests because of the termination of someone else's interest).
While planning opportunities do abound for this year, multi-generational nested life estates that characterized the pre-GST era are not among them. For instance if, in 2010, Grandparent transfers property in trust with life estate to Child and remainder to Grandchild, the GST event (taxable termination) does not occur until Child dies, presumably not in 2010. However, depending on operation of local law, if Child is already a beneficiary of a similar arrangement, she may be able to disclaim it this year, terminating her interest and thereby vesting the remainder with Child. This action would force the otherwise "taxable termination" into this non-taxable year. Even though this disclaimer would likely be treated as a gift from Child to Grandchild in the current year, it would still result in substantial tax savings versus the GST.
Just as with taxable terminations, planning with otherwise taxable distributions this year is stifled by the GST's impending 2011 return. Only distributions from a trust to a skip person that occur this year will be tax free. And so, depending on a trust's instrument, the trustee's discretion, and the grantor's influence over the trustee, a trust may be able to accelerate distributions to a grantee in the current year so as to avoid future GST liability.
As opposed to the light treading required with taxable distributions and terminations this year, gifting outright to skip-persons requires no rigmarole or good luck or cooperation with local law. Indeed, these direct-skips afford amazing opportunities to planners and their clients this year. By directly giving to grandchildren (or great grandchildren)[2], taxpayers literally skip an entire generation (or two) of taxation, completely frustrating the congressional purpose of the GST. And once those assets have descended the family tree, they can't really climb back up. And thus, from a revenue/fisc point of view, the costs of 2009 inaction on the GST won't be measurable until well after the dust has settled on 2010, which may prove to be a landmark year for the grandchildren of the wealthy across the U.S.
It's important to keep in mind that there is still a gift tax this year, so gifts to grandchildren won't be tax free. But, if a taxpayer's got to pay a gift tax, 2010 is the year to do it. This year's gift tax rate (capped at 35%) is lower than it has been for many years and is due to increase again in 2011 (to a max rate of 55% for gifts over $3M).[3]
On a final note, I need to emphasize a few very important caveats. First of all, there is still the possibility of a retroactive fix on the Estate and GST taxes. However, as the year charges on, supporting retroactivity will become a tough sell for lawmakers looking to be reelected.[4] Additionally, any retroactive legislation will likely be met with widespread constitutional challenges.[5] Secondly, the GST is very complicated and gifting with generation skipping transfers this year could backfire if retroactive legislation is enacted and upheld. Interested parties should have frank discussions with their practitioners about the risks and intricacies of planning in this realm.
Posted by Jamie Delman , Associate Editor, Wealth Strategies Journal
[1] See BNA 800-2nd T.M. IV-A
[2] There is also the possibility that transferring to a trust, all of whose beneficiaries are skip people, will provide the same result. Under the statute, such a trust would be considered a skip person so transfer to that trust would ordinarily be considered a direct skip. However, if that trust pays out in subsequent years, those payments may be considered taxable distributions. Ordinarily, distributions from skip-person trusts do not implicate the GST because, under section 2611(b)(2), transfers of property that have already been subject to the GST are excluded from the definition of Generation Skipping Transfer. But, if a transfer is made into a skip person trust this year, it won't be subject to GST and therefore, future distributions made from it won't be protected under 2611(b)(2). Such rules notwithstanding, state laws always allow for transfers to minors to be managed by custodians until the minor reaches majority. See the Uniform Transfers to Minors Act, for instance.
[4] See, e.g., Melinda Merk & Andrew Prior, in Forbes
[6] Id.
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