What Is the Generation-Skipping Transfer Tax (GSTT) and Who Pays?

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What Is the Generation-Skipping Transfer Tax (GSTT) and Who Pays?

What Is the Generation-Skipping Transfer Tax (GSTT)?

The generation-skipping transfer tax is a federal levy on a gift or bequest that prohibits the giver from avoiding estate taxes by deferring to grandchildren rather than children. The generation-skipping transfer tax ensures that grandchildren get the same amount as if the legacy came from their parents.

Prior to the implementation of the generation-skipping transfer tax in 1976, affluent persons could lawfully give money and property to their grandchildren without paying federal estate taxes. The Act essentially eliminated the loophole through which inheritances may be passed down through generations to avoid double estate taxes.

Key Takeaways

  • The generation-skipping transfer tax (GSTT) is a federal tax imposed when property is given or inherited to a recipient (other than a spouse) who is at least 3712 years younger than the donor.
  • The GSTT essentially eliminated the loophole through which affluent persons may lawfully give money and property to their grandkids while avoiding federal estate taxes.
  • The GSTT is a flat 40% tax.
  • Because of the large barrier, most persons will never be subject to the GSTT: the tax only applies when the transferred sum reaches $12.06 million per individual (for 2022).

Understanding the Generation-Skipping Transfer Tax

The generation-skipping transfer tax (GSTT) is an extra tax levied on a property transfer that skips a generation, also known as a generation-skipping transfer (GST). The GSTT was enacted to discourage families from evading inheritance taxes for one or more generations by making direct gifts or bequests to grandchildren or great-grandchildren. To avoid having to pay estate taxes twice, the parent’s generation is skipped. The GSTT assures that grandchildren get the equivalent worth of assets as if the bequest had been passed straight from their parents rather than their grandparents.

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The individual making the gift is known as the transferor, and the one receiving it is known as the skip person. A grandchild is often used as a skip person, although a skip person does not have to be a family member. A generation-skipping transfer is available to anybody who is at least 3712 years younger than the transferor.

The generation-skipping transfer tax is levied only if the transfer avoids the imposition of gift or estate taxes at each generation level. The Internal Revenue Service (IRS) levies a second layer of tax on gifts and bequests beyond the estate and lifetime gift exclusions to compensate for the taxes that may be avoided by skipping one generation. It implies that the GSTT is only payable when a beneficiary gets more than the GST estate tax credit.

Direct vs. Indirect Skips With the GSTT

The taxation of a GST is determined by whether the transfer is direct or indirect. A straight skip is an estate or gift tax-exempt property transfer. A grandmother handing property to a grandson is one example of a straight skip. For direct skips, the transferor or their estate is liable for paying the GST tax.

An indirect skip is a transfer that includes intermediary stages before arriving to the skip person. Indirect skips are classified into two types: taxable terminations and taxable distributions.

A skip person and a non-skip person are involved in a taxable termination. The main beneficiary is a non-skip person who receives property before it is transferred to the skip person. The transfer to the skip person happens when a non-skip person dies, usually the transferor’s kid. Consider a transferor who creates an income-producing trust for his son as an example of a taxable termination. Following the death of the son, the remaining property would be handed on to the transferor’s grandchild, who would then be liable to the GST tax.

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A taxable distribution is any income or property distribution from a trust to a particular person that is not otherwise subject to estate or gift tax. If a grandmother set up a trust to provide payments to her grandson, the payments would be subject to GST taxes, which the receiver would be responsible for paying.

How Much Is the Generation-Skipping Transfer Tax?

Historically, the GSTT was high, ranging from 35% to 77%. The current rate is 40%, and it has been in place since 2014. However, the Tax Cuts and Jobs Act significantly reduced the number of estates that would be impacted. The federal estate, gift, and GSTT exemption was increased to $12.06 million for individuals and $24.12 million for married couples on January 1, 2022, more than doubling the previous year’s maximum of $5.49 million (for individuals).

Some states, usually those that have their own estate taxes, also collect generation-skipping transfer taxes.

Only the value of a person’s estate in excess of the statutory exemption is liable to an estate tax or the GSTT at the flat rate of 40% upon death. As a result, only gifts and bequests to a skip person in excess of $12.06 million are liable to the 40% flat generation-skipping transfer tax.

The GSTT is levied at the time of the gift or property transfer; GSTs might occur before or after the transferor’s death. The transferor may offer the gift to the skip person while still living. However, at death, the transferor’s will may either direct that property be left to a specified person or direct the establishment of a trust from which payments would be paid. Form 709 is used to record GST taxes as well as transactions involving federal gift taxes.

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GSTT Strategies

Most recipients would escape the GST tax since the estates they inherit are worth less than the estate tax credit offered by the government. The GSTT exemption is quite generous (as noted above).

Although the GSTT is often associated with a transfer to grandkids, most individuals will not be subject to it since the GSTT exemption is so high. In circumstances where the tax may be applicable, transferors may set up dynasty trusts, which are intended to prevent or reduce estate taxes with each generational transfer. The corpus of the trust is not liable to estate taxes with the transfer since assets are parked in the trust and predetermined payments are made to each generation.

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